International Burch University Sarajevo

International Burch University Sarajevo 1 1 Faculty of Economics, Management Department Chapter Chapter International Business Management

INTRODUCTION: WHAT IS INTERNATIONAL BUSINESS?

International business refers to the trade and investment activities by companies across national borders.

Globalization of markets refers to ongoing economic integration and growing interdependency of countries worldwide. Stress the dramatic growth in world trade, which now exceeds some $10 trillion annually.

There are two ways to invest internationally: passively (portfolio investment -financial assets) or actively (foreign direct investment- capital, technology, labor, land, plant and equipment).

Also important are importing (global sourcing)-buying products/services from abroad and bringing them back to the home country. Exporting- manufacturing a product or service in one country and selling it to another.

Questions: Answer:

Why firms go international Primarily to increase sales and profits!

How international business is different from Complexity and Risks domestic business

Who participates in international business Multinational Enterprise (MNE) Small and Medium-sized Enterprise (SME) Born Global - entrepreneurial firm that is international from inception Why you should study international business Competitive advantage- for you and your firm!

WHAT IS INTERNATIONAL BUSINESS?

■ International business refers to firm cross-border trade and investment activities. ■Globalization of markets (or the globalization of economies) refers to ongoing economic integration and growing interdependency of countries worldwide. Integration is central to globalization, which has resulted in the widespread diffusion of products, technology, and knowledge worldwide, regardless of where they originate. ■ Macro perspective- globalization of markets means intense economic interconnectedness between/among countries. Market globalization is characterized by: ◘ Cross-border transactions- unprecedented rates of growth-from $100 billion per year (1960) to current numbers $10 trillion annually ◘ Substantial international flows of capital, technology, and knowledge. ◘ Development of sophisticated global financial systems and mechanisms. ◘ Greater collaboration among nations through multilateral regulatory agencies such as the World Trade Organization and the International Monetary Fund. ■ Micro perspective- firm level, activity Companies conduct value-adding activities on a global scale, i.e. organize, source, manufacture, market, etc. This text focuses primarily on the international business activities of the individual firm. ■ Firm international expansion is made more compelling and easier due to market and product globalization- for companies small and large. ■ A “level playing field” has made cross-border activities appealing to all types of firms- large and small; manufacturing and service sectors (e.g. banking, transportation, engineering and design, advertising, and retailing). WHAT ARE THE KEY CONCEPTS IN INTERNATIONAL TRADE AND INVESTMENT? ■ International trade and investment are the most conventional forms of international business transactions.

International Trade ■ Cross-border exchange of products (merchandise) and services (intangibles) typically through exporting and importing ■ Exporting is the sale of products/services to customers located abroad. ■ Importing (global sourcing) is the procurement of products/services from foreign suppliers for consumption at home. ■ Exporting and importing may include both intermediate (raw materials and components) and finished products.

International Investment ■ Cross-border investment is the transfer of assets to another country or the acquisition of assets in another country. ■ The factors of production (assets) include capital, technology, managerial talent, entrepreneurship, labor, and land. ■ Trade = goods and services cross national borders. Cross-border investment= the firm itself crosses borders.

Two Types of International Investment: ■ International portfolio investment (typically short-term) is the passive ownership of foreign securities such as stocks and bonds for the purpose of generating financial returns. ■ Foreign direct investment (FDI) (typically long-term) is an internationalization strategy in which the firm establishes a physical presence abroad through acquisition of productive assets such as capital, technology, labor, land, plant, and equipment.

The Nature of International Trade ■ Macro-International Trade: Aggregate export and import flows of products and services between nations. ■ Micro-International Business: Cross-border transactions of an individual business enterprise. ■ Gross domestic product (GDP) is the total value of products and services produced in a country during a year. ■ The exponential growth of cross-border trade relative to world GDP is due in part to advanced economies such as Canada and Japan sourcing to low-cost locations, e.g. China and Mexico. ■ The rapid integration of world economies is fueled by factors such as the decline of trade barriers, e.g. tariffs, liberalization of markets, privatization and the economic vitality of emerging markets.

The Nature of International Investment ■ Foreign Direct Investment (FDI) - (asset ownership and long time frame) is the ultimate commitment-level of internationalization, and thus this text focuses primarily on FDI as opposed to International Portfolio investment. ■ Motivations for firm FDI: (Notice how these fit into the value chain) (1) Primary Activity: Set up manufacturing or assembly facilities; (2) Primary Activity: Open a sales/ representative office, or other facility to conduct marketing or distribution activities; or (3) Support Activity: Establish a regional headquarters- a new legal business entity, recognized by the host country.

■ FDI and Competitive Advantage: Large, resourceful companies with substantial international operations are able to leverage FDI to: Manufacture/assemble products in low-cost labor countries, i.e. India, Russia, Brazil, China, and Mexico; Invest in western markets, even though they may originate from emerging economies themselves: ■ Examples- India's Mittal Steel Co. acquired the Belgium-based Arcelor SA in August 2006, creating a $38 billion conglomerate -- the world's largest steel company. Russian oil and gas firm Lukos established thousands of service stations in the U.S. and Europe. ■ September 11, 2001 interrupted FDI inflows with the worldwide panic that ensued following the terrorist attacks in the United States. ■ Developed economies = Australia, Canada, Japan, the United States, and most countries in Western Europe. ■ Developing economies = Parts of Africa, Asia, and Latin America. Of particular significance is the growth of FDI into developing economies despite widespread poverty and less investment capital than advanced economies. ■ The improved lives of billions are directly linked to world trade and investment. Services as well as Products ■ Key international players: Tangible merchandise (products) and intangibles (services- e.g. banks, consulting firms, hotels, airlines, construction companies, retailers, etc.). ■ International trade in services accounts for about one quarter of all global trade and is growing faster than products, however the absolute value of merchandise trade is still much greater than the value of services trade. ■ Challenges unique to services: ◘ Not all services can be exported. ◘ Physical presence in host country is a prerequisite for many services. ■ $2 trillion worth of services are sold abroad every year ■ Larger, developed economies account for the greatest proportion of services. ■ EBay- the largest auction-based retailer on the Internet, earned $6 billion in 2006, 40 percent of which came from international sales. ■ China has 1.3 billion people with an estimated 132 million Internet users. ■ India has 1 billion people with an estimated 40 million Internet users. ■ U.S. has an estimated 210 million Internet users. ■ EBay expanded to India, China, Korea, and Europe in anticipation of most of its future revenue growth coming from abroad.

International Financial Services Sector ■ Banking and financial services are the most active cross-border services. ■ Explosive growth of global capital markets is attributed to: (1) Money → internationally into portfolio investments and pension funds (2) Banks/financial institutions internationalization → increased amount of cheap, local investment capital, stimulating local financial markets and encouraging savings. ■ International banking is prospering- return on equity: ◘ Saudi Arabia exceeds 20 percent ◘ U.S. it is 15 percent ◘ France and Germany it is less ■ Citibank, Deutsche Bank, BNP Paribas, and other international banks are thriving because of high oil prices, booming consumer banking, and low taxes. ■ Banks bypass Islamic rules against paying interest by structuring loans as partnerships.

HOW DOES INTERNATIONAL BUSINESS DIFFER FROM DOMESTIC BUSINESS? ■ Complexity- Environmental forces differ from country to country- economic conditions, political systems, laws and regulations, and national culture- vary according to nation. ■ Risk- Uncontrollable variables- over which the firm has little or no control ■ Foreign environments involve new risks that firms must manage. The Four Risks in Internationalization

Cross-cultural risk ■ Differences in language, lifestyles, attitudes, customs, and religion, where a cultural miscommunication jeopardizes a culturally-valued mindset or behavior. ■ Cultural blunders- hinder the effectiveness of foreign managers. ■ Language- critical dimension of culture- a window to people’s values ■ Language differences impede effective communication. ■ Cultural differences may lead to suboptimal business strategies.

Country risk (also known as political risk)

■ Differences in host country political, legal and economic regimes may adversely impact firm profitability. ■ Also, laws, regulations and indigenous factors e.g. property rights, intellectual-property protection, product liability, taxation policies, inflation, national debt, and unbalanced international trade, may encumber firm operations and performance. ■ Government intervention: restricts market access; imposes bureaucratic procedures hindering business transactions; and limits the amount of earned income that firms may repatriate from foreign operations. ■ Economic freedom differs among nations- Hong Kong, Singapore and Ireland are known as having the highest levels of economic freedom, see:

Currency or financial risk ■ Risk of adverse exchange rate fluctuations, inflation and other harmful economic conditions create uncertainty of returns. ■ When currencies fluctuate significantly, the value of the firm’s assets, liabilities and/or operating income may be substantially reduced.

Commercial risk ■ Less than optimal formulation and/or implementation of strategies, tactics or procedures, e.g. partnering selections, market entry timing, pricing, product features, and promotional themes ■ Failures in international markets are far more costly than domestic business blunders.

Risks: Always Present but Manageable ■ These types of risks are omnipresent in international business. ■ Managers need to understand their implications, anticipate them, and take proactive action to reduce adverse effects. ■ Some risks are extremely challenging, e.g. the East Asian economic crisis of 1998 generated substantial commercial, currency, and country risks- several East Asian countries lost currency values of between 35 and 70 percent, leading to the collapse of national stock markets, deepening trade deficits, and suspension of normal business activity. ■ Political and social unrest surged to Indonesia, Malaysia, South Korea, Thailand, and the Philippines.

WHO PARTICIPATES IN INTERNATIONAL BUSINESS? ■ Focal firms are those companies that directly initiate and implement international business activity.

Multinational Enterprise (MNE) - Also known as Multinational Corporation (MNC). ■ Multinational enterprises are the most important type of focal firm; add value in multiple countries, through a network of subsidiaries, leveraging manufacturing, R&D, procurement, and marketing activities, to yield the most economic sense. ■ In addition to a home office, an MNE owns a worldwide network of subsidiaries. ■ Examples- Caterpillar, Kodak, Nokia, Samsung, Unilever, Citibank, Vodafone, Carrefour, Bechtel, Four Seasons Hotels, Disney, DHL, & Nippon Life Insurance. ■ Examples of Fortune’s Global 500- Exxon Mobil, Royal Dutch Shell, BP, General Motors, DaimlerChrysler, Toyota, Ford, and Wal-Mart.

Small and Medium-sized Enterprise (SME) ■ SME is a company with 500 or fewer employees. ■ Small firms comprise 90 - 95 percent of all firms in most economies. ■ More and more SMEs participate in exporting, licensing, and global sourcing. ■ Small firms: ◘ Are the drivers for innovation. ◘ Account for one-third of exports from Asia; a quarter of the exports from the affluent countries in Europe and North America ◘ Contribute more than 50 percent of total national exports in Italy, South Korea, and China. ■ Born-global firms- young, entrepreneurial SMEs that initiate international business from inception, and are found in both advanced economies as well as emerging markets such as China and India. ■ International business complexities are considerably more challenging for SMEs than MNEs. ■ SME Strategies for success: (1) SMEs are often more innovative, adaptable, and have quicker. (2) SMEs are better able to serve niche markets. (3) Smaller firms can better leverage the Internet. (4) Due to limited resources, SMEs tend to minimize fixed costs and outsource. (5) Smaller firms tend to flourish on private knowledge that they cultivate through their knowledge networks and international social capital.

Non-governmental Organizations (NGOs) ■ Non-profit international organizations include non-governmental organizations (NGOs) and charitable groups. ■ They serve special causes, the arts, education, politics, religion and research. ■ Examples: (Nonprofit Organizations) ◘ Bill and Melinda Gates Foundation ◘ CARE- dedicated to reducing poverty ◘ British Wellcome Trust- supports health and education ■ Examples: (MNE operating charitable foundations) ◘ GlaxoSmithKline (GSK)- ● Canada, Czech Republic, France, Italy, Romania, Spain & U.S ● Barretstown-Ireland and L’Envol (France) for seriously-ill children ● Slovakian children- promotes healthy eating/exercise ● Spain- healthcare for homeless children ● Russia- Children with disabilities ● Ethiopia- reduction of preventable children’s’ diseases ● Vietnam- birthing support

WHY DO FIRMS PURSUE INTERNATIONALIZATION STRATEGIES? Firms internationalize seeking growth and profit opportunities to enhance competitive advantage. Specifically: 1. Seek growth opportunities through market diversification. 2. Earn higher margins and profits. 3. Gain new ideas about products, services, and business methods. 4. Better serve key customers who have relocated abroad. 5. Locate closer to supply sources, benefit from global sourcing advantages, or gain flexibility in the sourcing of products. 6. Get access to lower-cost or better-value factors of production. 7. Develop economies of scale in production, marketing, and other activities. 8. Confront global competitors effectively or thwart the growth of competition in the home market. 9. Invest in a potentially rewarding relationship with a foreign partner

WHY SHOULD YOU STUDY INTERNATIONAL BUSINESS? This may be considered from the global economy, national economy, the firm, and managerial levels.

Facilitator of the Global Economy and Interconnectedness ■ Since is the General Agreement on Tariffs and Trade (GATT) (1947), following World War II, the world has transformed with unprecedented growth in IB. ■ Firms increasingly focus on mass production efficiencies. ■ 1980s: political/economic transformations of Emerging Markets (about 25 countries) have given new impetus to worldwide economic interconnectedness. ■ Fast-growth developing economies- Brazil, India, China, and Poland- have registered substantial market liberalization, privatization, and industrialization, fueling global economic transformation. ■ Two drivers of the changing business landscape- globalization and technology ■ The Internet and e-commerce make international business a viable and increasingly imperative option for firms of all sizes and resource levels. ■ Technological advances both facilitate, and are facilitated by, globalization.

Contributor to National Economic Well-Being ■International business promotes economic prosperity and living standards. ■Consequently countries around the world are opening their borders to foreign trade and investment as never before. ■International trade is a critical engine for job creation. ◘ It is estimated that every $1 billion increase in exports creates more than 20,000 new jobs. ◘ Cross-border trade directly supports at least 12 million U.S. jobs. ◘ One of every seven dollars of U.S. sales is made abroad. ◘ One of every three U.S. farm acres; and one of every six U.S. jobs is producing for export markets. ■ International business is both a cause and a result of increasing national prosperity. ■ International trade gains: ◘ Benefits of free exchange of products, services, capital, and technology. ◘ Reduces poverty in developing economies ◘ Prosperity is accompanied by literacy rate gains, nutrition and health care improvements, with some tendencies towards freedom and democracy. ■ 1994: Following the launch of North American Free Trade Agreement (NAFTA), the volume of trade among the three countries increased dramatically, improving living standards for millions- a market of 450 million consumers. ■ International business and international relations may even serve to mitigate the new era of global tensions.

A Competitive Advantage for the Firm ■ International Business = Superior Performance ■ Maximize returns- Foreign markets often generate returns far superior to those in domestic markets. ■ Global scale economies- International players can maximize their efficiencies by securing cost-effective factor inputs from around the world. Examples: Manufacturing facilities in emerging markets like Brazil, Mexico, and Poland; software development in India (Microsoft); auto assembly in Romania (Renault) ■ Resource acquisition: Access to otherwise unavailable critical resources ■ Enhanced competitiveness/knowledge transfer: Internationalization broadens competitive options.

An Activity with Societal Implications ■ As trade barriers decline and global power increases, so does responsibility to society to be a good corporate citizen and consider all stakeholders in decisions. ■ This means having both economic and social goals; transcending legal standards by proactively implementing ethical standards. ■ Large corporations like Wal-Mart, Unilever, and Sony have annual revenues larger than the GDPs of many of the nations in which they do business. ■ The internationalization of thousands of firms negatively impacts the natural environment, e.g. pollution (Royal Dutch Shell’s oil refining operations in Nigeria). ■ Large banks and international investment brokers have disrupted the economies of nations with aggressive currency trading or by manipulating stock markets, e.g. MNEs abruptly withdrawing invested capital. ■ Human Rights violations- Some MNEs ignore human rights and basic labor standards by establishing factories in countries that pay low wages with substandard working conditions, e.g. Nike in Asia. ■ Building factories abroad often leads to job losses in the home country. ■ National governments and international institutions such as the World Trade Organization are working to improve environmental, financial and labor standards around the world. ■ 2006: Example -- Power of society –the news of Dubai Ports World possibly operating some U.S. ports hit the media, societal disapproval forced Congress to swiftly squelch the deal. ■ Proactive development and implementation of Corporate Social Responsibility (CSR) - Examples: ◘ Starbucks will only sell coffee from Rain Forest Alliance certified growers. ◘ Philips, Unilever, and Wal-Mart have signed on for sustainable development practices. ◘ McDonald’s will sell organic milk and purchase beef from farmers certified for animal welfare and environmental standards. ■ CSR is global and strategic. It must be embedded into global firms at their strategic levels if international corporate citizenship is to be achieved and sustained. International Burch University Sarajevo 2 2 Faculty of Economics, Management Department Chapter Chapter International Business Management

GLOBALIZATION OF MARKETS AND INTERNATIONALIZATION OF THE FIRM

Globalization of Markets: A Macro Concept • Two mega trends have altered the international business landscape: globalization and technological advances. • Market globalization refers to the interconnectedness of national economies and growing interdependence of buyers, producers, suppliers, and governments in different countries. • Globalization allows firms to view the world as one large marketplace for goods, services, capital, labor, and knowledge.

Phases of Globalization 1st Phase: 1830, peaking around 1880 Aided by railroads, ocean transport; resulting in the rise of mass production and growing trade 2nd Phase: 1900, peaking late 1920s Fueled by electricity and emergent modern technologies; early MNEs 3rd Phase: 1948, peaking around 1970 End of WW II; Marshall Plan; Gradual reduction of trade barriers, especially under General Agreement on Tariffs and Trade (GATT) 4th Phase: 1980, peaking around 1997 Fueled by information and communications technologies. Rapid liberalization in Emerging Markets

The Death of Distance

The Drivers and Consequences of Market Globalization Firms are Compelled to Internationalize • Firms implement internationalization proactively are more successful than those reactively engaging. E.g., Vodafone has established production and marketing operations all around the world. Has some 200 million customers in 30 countries

Technological Advances as a Driver of Market Globalization • Advances in technology provide the means for internationalization of firms • Advances in technology: – Reduces cost of doing international business; – Enables even small firms to go international – Helps coordinate worldwide activities; – Mitigates geographic distance

Information Technology • Cost of computer processing fell by 30% per year since late 1980s, and continues to fall. • Increases productivity across the firm • Impact of IT on our daily lives has been profound – laptops, intelligent cell phones, Internet, Google, etc.

Declining Cost of Global Communication and Growing Number of Internet Users

Communications Technology • Especially important. Includes telecommunications, satellites, optical fiber, wireless technology, and the Internet. • The Internet, and Internet-dependent systems such as intranets, extranets, and e-mail, connect millions of people across the globe. • The Internet opens up the global marketplace to all firms, large and small

Manufacturing and Transportation Technologies • Revolutionary developments now permit manufacturing that is both low-scale and low cost, with the support of computer-aided-design of products (CAD), robotics, and production lines managed and monitored by microprocessor-based controls. • In the 1960s, technological advances have led to the development of fuel-efficient jumbo jets, giant ocean-going freighters, and containerized shipping. • Thus, the cost of transportation has declined substantially, spurring rapid growth in international trade. Societal Consequences of Market Globalization • Positive consequences – More jobs – Economic development and growing prosperity – Technology and knowledge transfer • Negative consequences – Natural environment – Disruptive effects in national economies – Human rights violations abroad (e.g., sweatshops) – Job losses at home

Economic Freedom Enhances Income Growth • In the long run, globalization generally leads to: – higher living standards – more efficient resource usage – greater access to technology, products, and services • In particular, liberalization of markets appears to enhance income levels

Unintended Consequences of Market Globalization • Loss of national sovereignty – Power shifts to MNEs and larger countries • Offshoring and the flight of jobs – Dislocation of jobs • Effect on the poor – Benefits of globalization are not evenly distributed • Effect on the natural environment – Effect on national culture – Loss of national cultural values and identity

Corporate Social Responsibility • Over time, governments pass legislation that promotes improved environmental conditions. • In addition, many firms now consider the societal consequences of their actions -- Corporate Social Responsibilty (CSR) • Examples: Benetton in Italy (clothing), Alcan in Canada (aluminum), and Starbucks have attempted to embrace practices that protect the environment, often at the expense of profits.

Firm Level Consequences of Market Globalization • Countless new business opportunities for internationalizing firms • New risks and intense rivalry from foreign competitors • More demanding buyers who source from suppliers worldwide • Greater emphasis on proactive internationalization • Internationalization of firm’s value chain

Examples of How Firms’ Value Chain Activities Can Be Internationalized Value Chain: Sequence of value adding activities performed in the course of developing, producing, marketing, and servicing a product. Implications for Management • Global orchestration’ of value-chain activities (e.g., in order to cut costs, access resources, target new markets) • Exploit knowledge acquired worldwide • Increase productivity • Collaborate with foreign partners

Implications for Managers: Acquiring Global Competence is a Requirement • Open-mindedness • Tolerance for ambiguity • Perceptiveness • Premium on personal relationships • Flexibility, adaptability, and self-reliance • Good sense of humor • Warmth in human relationships • A curious mind International Burch University Sarajevo 3 3 Faculty of Economics, Management Department Chapter Chapter International Business Management

Participants in International Business

Three Types of Participants in IB 1. The focal firm – initiator of IB transaction, including MNEs and SMEs 2. Distribution channel intermediary – specialist firm providing logistics and marketing services in the international supply chain 3. Facilitator – a firm providing special expertise in legal advice, banking, customs clearance, market research, and similar areas

The MNE as a Focal Firm • A Multinational Enterprise (MNE) is a large organization with a network of production plants, regional headquarters, and country subsidiaries in numerous countries. • Examples include: Nestlé, Sony, Unilever, Nokia, Ford, Citibank, ABB, and Shell Oil. • Some MNEs in countries like China and Russia may be state owned.

The SME as a Focal Firm • A Small and Medium-Sized Enterprise (SME) is a relatively small player in its respective industry (in the U.S., those with 500 employees or less). • SMEs can be more flexible and quicker to respond to international opportunities. • As limited resources often prevent them from engaging in FDI, SMEs internationalize via exporting, joint ventures, and contractual arrangements

Foreign Market Entry Strategies of Focal Firms Cross-border business transactions can be grouped into three categories: 1. Trade: buying and selling of products (mainly exporting and importing) 2. Contractual exchange of services or intangibles (mainly licensing and franchising) 3. Equity ownership in foreign operations: establishing foreign presence through direct investment (FDI)

Examples of Contractual Strategies Licensor: Focal firm grants the right to the foreign partner to use certain intellectual property in exchange for royalties. • Anheuser-Busch signed a licensing agreement with Japanese beer brewer Kirin in which Kirin produces and distributes Budweiser in Japan. Mega Bloks (Canadian toymaker) signed an agreement with Disney that gives the SME the right to manufacture toys that feature Disney characters like Winnie the Pooh, Power Rangers Franchisor: Focal firm grants the right to the foreign partner to use an entire business system in exchange for fees and royalties. • For firms like Subway or KFC, it’s an efficient way to internationalize, • In China, Subway is the third-largest U.S. fast-food chain.

Examples of Contractual Strategies Turnkey Contractor: Provide engineering, design, and architectural services in the construction of airports, hospitals, oil refineries, and other types of infrastructure. E.g., European Channel Tunnel, Three Gorges Dam in China, Delhi Metro Rail Ltd. Build-own-transfer venture- an increasingly popular type of turnkey contract in the developing economies where contractors acquire an ownership in the facility for a period of time until it is turned over to the client.

International Collaborative Venture (ICV) • Arrangement in which partners pool their resources and share the cost and risks of the new venture. • Through an ICV, a focal firm can exploit partner’s complementary technologies and expertise, avoid trade barriers, connect with customers abroad, and configure value chains more effectively. • A middle ground strategy between exporting and FDI

Two Types of International Collaborative Ventures • Joint Venture: One firm creates and jointly owns a new legal entity together with another firm. Advantages: share costs and risks; gain access to needed resources; gain economies of scale; pursue long-term strategic goals. • Project-Based Collaborative Venture: Firm collaborates with foreign partners on a project with a relatively narrow scope and a well-defined timetable, without creating a new legal entity. Often used to share the cost and risks of knowledge-intensive R&D projects. Distribution Channel Intermediary • Specialize in physical distribution and marketing service; connect the focal firm with the end user in the foreign market. • Assist the focal firm by providing logistics services such as warehousing and customer support. • Especially critical to exporters • Based either in the home country or the foreign market.

Intermediaries Based in the Foreign Market • Distributor: Takes title to the exporter’s goods and performs marketing functions such as sales, promotion, and after sales service. • Serves as an extension of the firm in the foreign market, performing many downstream marketing functions

Agent and Manufacturer’s Representative • Agent: (also known as a ‘broker’): Does not take title to the goods. Works on a commission basis. • Manufacturer’s Representative: Works under contract to the exporter to represent and sell its goods. Acts as a contracted salesperson in a designated territory. Retailer • Stores that mainly serve regular consumers. • Some, large firms sell directly to retailers, bypassing distributors (wholesalers) • Retailers provide direct access to retail customers Examples: Carrefour, IKEA, Royal Ahold, Seibu, Toys “R” Us, Wal-Mart, and Zara

Trading Company • Based in the home country, a trading company is an intermediary that engages in imports and exports of a variety of products. • Large trading companies such as Cargill are high-volume, low-margin resellers. • Many trading companies deal primarily in commodities such as grains, minerals, coal, and metals.

The Role of Trading Companies in IB • Trading companies work with remarkably low margins; they tend to be high-volume, low-margin resellers. • Five of the 10 largest trading companies are based in Japan. Trading companies have historically played a very important role in Japan’s external trade. • Being an island economy and lacking most raw materials needed for industrialization, Japan had to import them. • Trading companies are also more common in South Korea, India, and Europe.

Export Management Company (EMC) • Acts as an export agent on behalf of the focal firm. Based in home country. • An EMC finds export customers, negotiates terms of sale, and arranges for international shipping, typically for smaller exporters. • Most specialize in specific industries and geographic areas.

Online Intermediaries • Examples include Amazon, Dell, eBay, and Alibaba – English-language portal based in China that specializes in business-to-business exchanges. • Traditional retailers such as Wal-Mart and Tesco have also set up online presence. • One negative aspect is the ease with which unscrupulous marketers prey on unsuspecting customers with fake products (e.g., fake pharmaceuticals).

Facilitators in IB • Facilitators assist the focal firm with specialized services required in cross-border transactions. • Facilitators include: Banks, international trade lawyers, freight forwarders, customs brokers, consultants, ad agencies, and market researchers.

Examples of Other Facilitators • International trade lawyers • International business consultants • Tax accountants • Market research firms

International Burch University Sarajevo 4 4 Faculty of Economics, Management Department Chapter Chapter International Business Management

Theories of International Trade and Investment

Foundation Concepts Comparative advantage Superior features of a country that provide it with unique benefits in global competition – derived from either national endowments or deliberate national policies Competitive advantage Distinctive assets or competencies of a firm – derived from cost, size, or innovation strengths that are difficult for competitors to replicate or imitate

Examples of National Comparative Advantage • Abundant, low-cost labor in China • Mass of IT workers in India • Huge reserves of bauxite in Australia • Abundant agricultural land in the USA • Oil in Saudi Arabia

Examples of Firm Competitive Advantage • Dell’s prowess in global supply chain management • Procter & Gamble’s skill in marketing • Samsung’s leadership in flat-panel TV • Apple’s design leadership in cell phones and personal music players

Theories of International Trade and Investment

Why Nations Trade: Classical Theories • Mercantilism: the belief that national prosperity is the result of a positive balance of trade – maximize exports and minimize imports • Absolute advantage principle: a country should produce only those products in which it has absolute advantage or can produce using fewer resources than another country • Comparative advantage principle: it is beneficial for two countries to trade even if one has absolute advantage in the production of all products; what matters is not the absolute cost of production but the relative efficiency with which it can produce the product.

Limitations of Early Trade Theories • Do not take into account the cost of international transportation • Tariffs and import restrictions can distort trade flows • Scale economies can bring about additional efficiencies • When governments selectively target certain industries for strategic investment, this may cause trade patterns contrary to theoretical explanations • Today, countries can access needed low-cost capital in global markets • Some services cannot be traded internationally

Classical Theories: Factor Proportions Theory • Factor proportions (endowments) theory: each country should produce and export products that intensively use relatively abundant factors of production, and import goods that intensively use relatively scarce factors of production • Examples: . China and labor . USA and pharmaceuticals . Canada and electric power

Classical Theories: International Product Cycle Theory • International product cycle theory: each product and its associated manufacturing technologies go through three stages of evolution: introduction, growth, and maturity. Think of cars, TVs. • In the introduction stage, the inventor country enjoys a monopoly both in manufacturing and exports • As the product’s manufacturing becomes more standard, other countries will enter the global marketplace • When the product reaches maturity, the original innovator country will become a net importer of the product • Applicability to the contemporary global economy: Today, the cycle from innovation to maturity is much shorter making it harder for the innovator country to sustain its lead in a particular product

How Nations Enhance Competitive Advantage • The contemporary view suggests that governments can proactively implement policies to enhance a nation’s competitive advantage, beyond the natural endowments the country possesses • Governments can create national economic advantage by: stimulating innovation, targeting industries for development, providing low-cost capital, minimizing taxes, investing in IT, etc.

Michael Porter’s Diamond Model: Sources of National Competitive Advantage 1. Firm strategy, structure, and rivalry – the presence of strong competitors at home serves as a national competitive advantage 2. Factor conditions – labor, natural resources, capital, technology, entrepreneurship, and know how 3. Demand conditions at home – the strengths and sophistication of customer demand 4. Related and supporting industries – availability of clusters of suppliers and complementary firms with distinctive competences Industrial Clusters • A concentration of suppliers and supporting firms from the same industry located within the same geographic area • Examples include: the Silicon Valley, fashion cluster in northern Italy, pharma cluster in Switzerland, footwear industry in Pusan, South Korea, and the IT industry in Bangalore, India • Can serve as a nation’s export platform National Industrial Policy Proactive economic development plan enacted by the government to nurture or support promising industries sectors. Typical initiatives: . Tax incentives . Investment incentives . Monetary and fiscal policies . Rigorous educational systems . Investment in national infrastructure . Strong legal and regulatory systems (Examples: Japan, Dubai, and Ireland) New Trade Theory Economies of scale are an important factor in some industries for superior international performance – even when the nation has no clear comparative advantage. Some industries succeed best as their volume of production increases. Examples: commercial aircraft, automobiles, pharmaceuticals all have very high fixed costs that require high-volume sales to achieve profitability.

How Firms Internationalize • Internationalization is usually gradual and evolutionary (Internationalization Process Model) • Slow internationalization results from the uncertainty and uneasiness that managers have about doing international business • A predictable pattern of internationalization may include the following stages: 1. domestic focus 2. pre-export stage 3. experimental involvement 4. active involvement 5. committed involvement

Dominance of FDI-Based Explanations of the International Firm • Most IB theories about the firm emphasize the MNE, since it was long the major player in international business • Foreign direct investment (FDI) is the main strategy used by MNEs in international expansion; thus, earlier theories emphasized motives for, and patterns of, FDI FDI BASED EXPLANATIONS: Monopolistic Advantage Theory • Suggests that FDI is preferred by MNEs because it provides the firm with control over resources and capabilities in the foreign market, and a degree of monopoly power relative to foreign competitors • Key sources of monopolistic advantage include proprietary knowledge, patents, unique know-how, and sole ownership of other assets FDI BASED EXPLANATIONS: Internalization Theory • Explains the process by which firms acquire and retain one or more value-chain activities inside the firm – retaining control over foreign operations and avoiding the disadvantages of dealing with external partners • In contrast to arm’s-length entry strategies (such as exporting and licensing) which imply developing contractual relationships with external business partners, FDI provides the firm with control and ownership of resources FDI BASED EXPLANATIONS: Dunning’s Eclectic Paradigm Three conditions determine whether or not a company will internalize via FDI: 1. Ownership-specific advantages – knowledge, skills, capabilities, relationships, or physical assets that form the basis for the firm’s competitive advantage 2. Location-specific advantages – advantages associated with the country in which the MNE is invested, including natural resources, skilled or low cost labor, and inexpensive capital 3. Internalization advantages – control derived from internalizing foreign-based manufacturing, distribution, or other value chain activities NON-FDI BASED EXPLANATIONS: International Collaborative Ventures • While FDI-based internationalization is still common, beginning in the 1980s firms have emphasized non- equity, flexible collaborative ventures to internationalize. • Collaborative venture: a form of cooperation between two or more firms. Through collaboration, a firm can gain access to foreign partner’s know-how, capital, distribution channels, and marketing assets, and overcome government imposed obstacles. • Venture partners share the risk of their joint efforts, and pool resources and capabilities to create synergy.

Two Types of International Collaborative Ventures 1. Equity-based joint ventures result in the formation of a new legal entity. Here, the firm collaborates with local partner(s) to reduce risk and commitment of capital. 2. Project-based alliances involve cooperation in R&D, manufacturing, design, or any other value-adding activity, a partnership aimed at a narrowly defined scope of activities and timeline International Burch University Sarajevo 5 5 Faculty of Economics, Management Department Chapter Chapter The Cultural Environment of International Business

Cross-Cultural Risk • A situation or event where a cultural miscommunication puts some human value at stake • Arises when we enter environments characterized by unfamiliar languages and unique value systems, beliefs, attitudes, and behaviors • One of the four major risks in international business

Manifestations of Cross-Cultural Risk • Ethnocentric orientation: using our own culture as the standard for judging other cultures • Polycentric orientation: a mindset in which the manager develops a greater affinity with the country in which he/she does business than the home country. • Geocentric orientation: a global mindset in which the manager is able to understand a business or market without regard to national boundaries.

Managers should strive for a geocentric orientation

Definitions of Culture • Incorporates both objective and subjective elements. • Objective aspects of culture include tools, roads, television programming, architecture, and other physical artifacts. • Subjective aspects include norms, values, ideas, customs, and other meaningful symbols. • Hofstede, a well-known Dutch organizational anthropologist, views culture as ‘collective mental programming’ of people, and the ‘software of the mind,’; How we think and reason.

What Culture Is not Culture is: • Not right or wrong. Culture is relative. There is no cultural absolute. Different nationalities simply perceive the world differently. • Not about individual behavior. Culture is about groups. It refers to a collective phenomenon of shared values and meanings. • Not inherited. Culture is derived from the social environment. We are not born with a shared set of values and attitudes; we learn and acquire as they grow up.

Culture is Learned • Socialization: The process of learning the rules and behavioral patterns appropriate to one's given society, i.e. cultural learning. • Acculturation: The process of adjusting and adapting to a culture other than one's own, commonly experienced by expatriate workers. • Culture is like an iceberg – above the surface, certain characteristics are visible; below the surface is a massive base of assumptions, attitudes and values that strongly influence decision-making, relationships, conflict, and other dimensions of business. Cross-Cultural Proficiency is Paramount in Managerial Tasks Examples • Developing products and services • Communicating and interacting with foreign business partners • Negotiating and structuring international business ventures • Interacting with current and potential customers • Preparing advertising and promotional materials

Cross-Cultural Differences may Create Challenges • Teamwork. What should managers do if foreign and domestic nationals don’t get along? • Lifetime employment. Workers in Japan often expect to work for the same firm throughout their careers; How should a foreign firm handle this? • Pay for performance system. In China and Japan, a person’s age is important in promoting workers. Yet how do such workers perform when merit performance-based measures are used? • Organizational structure. Preferences for centralized, bureaucratic structures may deter information sharing. • Union-management relationships. Workers in European firms enjoy a more equal status with managers. • Attitudes toward ambiguity. If you’re uncomfortable working with minimum guidance or taking independent action, you may have difficulty fitting into some cultures.

Three Approaches to Interpreting Culture • Metaphors refer to a distinctive tradition or institution strongly associated with a society- a guide to deciphering attitudes, values, and behaviors. • Stereotypes are generalizations about a group of people that may or may not be factual, often overlooking real, deeper differences. • An idiom is an expression whose symbolic meaning is different from its literal meaning- a phrase that cannot be understood by simply knowing what the individual words mean.

Examples of Metaphors • American football is a metaphor for distinctive traditions in the U.S. • The Swedish stuga (a cottage or summer home) is a cultural metaphor for Swedes’ love of nature and a desire for individualism through self development. • The Japanese garden (tranquility and harmony) • The Turkish coffeehouse (social interaction) • The Israeli kibbutz (community) • The Spanish bullfight (ritual)

The Nature of Stereotypes • Stereotypes are often erroneous and lead to unjustified conclusions about others. • Still, most people employ stereotypes, either consciously or unconsciously, because they are an easy means to judge situations and people. • There are real differences among groups and societies- we should examine descriptive behaviors rather than evaluative stereotypes. • An example: Some Latin Americans procrastinate via the “mañana syndrome”. To some Latin Americans, mañana means an indefinite future with many uncontrollable events; thus, why fret over a promise? Examples of Stereotypes Some stereotypes about Americans: • Argumentative and aggressive, compared to Japanese who tend to be reserved and humble. • Individualistic lovers of personal freedom, compared to Chinese who tend to be group oriented. • Informal and nonhierarchical, compared to Indians who believe titles should be respected. • Entrepreneurial and risk-seeking, compared to Saudi Arabians who tend to be conservative, using time- honored methods to get things done. Direct and interested in immediate returns, compared to Latin Americans who usually take time to be social and get to know their business partners.

Idioms Idioms exist in virtually every culture and are used as a short way of saying something else. Examples: • "To roll out the red carpet" is to extravagantly welcome a guest; no red carpet is actually used. • In Spanish, the idiom "no está el horno para bolos” literally means "the oven isn't ready for bread rolls," yet really means "the time isn't right." • In Japanese, the phrase “uma ga au” literally means “our horses meet,” yet really means “we get along with each other.”

E. T. Hall’s High- and Low-Context Cultures • Low-context cultures rely on elaborate verbal explanations, putting much emphasis on spoken words. • Tend to be in northern Europe and North America, which place central importance on the efficient delivery of verbal messages; speech should express one’s ideas and thoughts as clearly, logically, and convincingly as possible. • Communication is direct and explicit, no “beating around the bush”. Agreements are concluded with specific, legal contracts.

High Context Cultures • A high-context culture emphasizes nonverbal messages and use communication as a means to promote smooth, harmonious relationships. • Prefer an indirect, polite, “face-saving” style that emphasizes a mutual sense of care and respect for others; careful not to embarrass or offend others. • It is difficult for Japanese people to say “no” when expressing disagreement. Much more likely to say “it is different” -- an ambiguous response. • In East Asian cultures, showing impatience, frustration, irritation, or anger disrupts harmony and is considered rude and offensive. • To succeed in Asian cultures, it is critical to notice nonverbal signs and body language. Hofstede’s Classifications of National Culture 1. Individualism versus collectivism refers to whether a person primarily functions as an individual or within a group. 2. Power distance describes how a society deals with inequalities in power that exist among people. 3. Uncertainty avoidance refers to the extent to which people can tolerate risk and uncertainty in their lives. 4. Masculinity versus femininity refers to a society’s orientation based on traditional male and female values.

Individualistic vs. Collective Societies • Individualistic societies: ties among people are relatively loose; each person tends to focus on his or her own self-interest; competition for resources is the norm; those who compete best are rewarded financially. . Examples- Australia, Canada, the UK, and the U.S. tend to be strongly individualistic societies. • Collectivist societies: ties among individuals are more important than individualism; business is conducted in the context of a group where everyone’s views are strongly considered; group is all-important, as life is fundamentally a cooperative experience; conformity and compromise help maintain group harmony. . Examples-China, Panama, and South Korea tend to be strongly collectivist societies.

High vs. Low Power Distance • High power distance societies have substantial gaps between the powerful and the weak; are relatively indifferent to inequalities and allow them to grow. . Examples- Guatemala, Malaysia, the Philippines and several Middle East countries • Low-power distance societies have minimal gaps between the powerful and weak. . Examples- Denmark and Sweden, governments instituted tax and social welfare systems that ensure their nationals are relatively equal in terms of income and power. • Social stratification affects power distance- in Japan almost everybody belongs to the middle class, while in India the upper stratum controls decision-making and buying power. • In high-distance firms, autocratic management styles focus power at the top and grant little autonomy to lower-level employees.

High vs. Low Uncertainty Avoidance Societies • High uncertainty avoidance societies create institutions that minimize risk and ensure financial security; companies emphasize stable careers and produce many rules to regulate worker actions and minimize ambiguity; decisions are made slowly. . Examples -- Belgium, France, and Japan • Low uncertainty avoidance societies socialize their members to accept and become accustomed to uncertainty; managers are entrepreneurial and comfortable with taking risks; decisions are made quickly; people accept each day as it comes and take their jobs in stride. . Examples -- India, Ireland, Jamaica, and the U.S.

Masculine vs. Feminine Cultures • Masculine cultures value competitiveness, assertiveness, ambition, and the accumulation of wealth; both men and women are assertive, focused on career and earning money, and may care little for others. • Examples- Australia, Japan. The U.S. is a moderately masculine society; as are Hispanic cultures that display a zest for action, daring, and competitiveness. • In business, the masculinity dimension manifests as self-confidence, proactiveness and leadership. • Feminine cultures emphasize nurturing roles, interdependence among people, and caring for less fortunate people- for both men and women. • Examples-Scandinavian countries- welfare systems are highly developed, and education is subsidized.

Subjective Dimensions of Culture Subjective dimensions- values and attitudes, manners and customs, deal versus relationship orientation, perceptions of time, perceptions of space, and religion. • Values represent a person’s judgments about what is good or bad, acceptable or unacceptable, important or unimportant, and normal or abnormal. • Attitudes and preferences are developed based on values, and are similar to opinions, except that attitudes are often unconsciously held and may not have a rational basis. • Prejudices are rigidly held attitudes, usually unfavorable and aimed at particular groups of people. • Examples- values in North America, Northern Europe, and Japan - hard work, punctuality, and the acquisition of wealth.

Deal vs. Relationship Orientation • Deal-oriented cultures- managers focus on the task at hand, are impersonal, typically use contracts, and want to just “get down to business.” . Examples- Australia, Northern Europe, and North America • Relationship-oriented cultures- managers value affiliations with people, rapport, and get to know the other party in business interactions; relationships are more important than the deal- trust is highly valued in business agreements. . Examples- China, Japan, Latin American countries- it took nine years for Volkswagen to negotiate an automobile factory in China.

Manners and Customs • Manners and customs are ways of behaving and conducting oneself in public and business situations. • Informal cultures -egalitarian, in which people are equal and work together cooperatively. • Formal cultures- status, hierarchy, power, and respect are very important. • Varying customs: eating habits, mealtimes, work hours and holidays, drinking, appropriate behavior at social gatherings (handshaking, bowing, kissing), gift-giving (complex), role of women Religion • A system of common beliefs or attitudes concerning a being or system of thought people consider to be sacred, divine, or highest truth, as well as the moral codes, values, traditions, and rituals associated with this system. • Influences culture, and therefore business and consumer behavior. • Example: The ‘protestant work ethic’ emphasizes hard work, individual achievement, and a sense that people can control their environment- the underpinnings for the development of capitalism.

Language as a Key Dimension of Culture • The “mirror” or expression of culture; essential for communications; provides insights into culture. • Linguistic proficiency is a great asset in international business • Language has both verbal and nonverbal (unspoken, facial expressions and gestures). • There are nearly 7,000 active languages, including over 2,000 in each of Africa and Asia

Technology, the Internet, and Culture • Technological advances are a key determinant of culture and cultural change- more leisure time, and computers, multimedia, and communications systems that encourage convergence in global culture. • The “death of distance” refers to the demise of the boundaries that once separated people, due to modern communications, information, and transportation technologies - more homogenized cultures are developing. • The Internet also promotes the diffusion of culture, with rapidly growing number of Internet users.

Are Cultures Converging? • Critics charge that globalization is harmful to local cultures, their artistic expressions and sensibilities, and their replacement by a homogeneous, often ‘Americanized’, culture. • Others argue that increased global communications is positive because it permits the flow of cultural ideas, beliefs, and values. • The homogenization (or the ‘banalization’) of culture is demonstrated by the growing tendency of people in much of the world to consume the same Big Macs and Coca-Colas, watch the same movies, listen to the same music, drive the same cars, and stay in the same hotels.

Managerial Guidelines for Cross-Cultural Success

Guideline 1: Acquire factual and interpretive knowledge about the other culture; and try to speak their language. Guideline 2: Avoid cultural bias. • Self-reference criterion: The tendency to view other cultures through the lens of one's own culture- understanding this is the first step. • Critical incident analysis -a method for analyzing awkward situations in cross cultural interactions by developing empathy for other points of view. Guideline 3: Develop cross-cultural skills, such as perceptiveness, interpersonal skills, adaptability

International Burch University Sarajevo 6 6 Faculty of Economics, Management Department Chapter Chapter Political and Legal Systems in National Environments

Country Risk Exposure to potential loss or adverse effects on company operations and profitability caused by developments in a country’s political and/or legal environments. Also referred to as ‘political risk’. Each country has a unique political and legal system that may pose challenges for company strategy and performance

What Gives Rise to Country Risk? • Immediate cause is a political or legal factor, but economic, social, or technological developments may be the root cause. • Laws may be unexpectedly strict, political/ legislative actions may harm business (even though not the intent). • Example - In China, the government censors material that criticizes the government. Yahoo must monitor the information that appears on its Web site to prevent the Chinese government from shutting down its China operations. • Weak law enforcement is also often a factor.

What are Political and Legal Systems? • Political system - a set of formal institutions that constitute a government and how these groups interact with each other. Includes legislative bodies, political parties, lobbying groups, and trade unions. • Legal system - a system for interpreting and enforcing laws and regulations. Includes institutions and procedures for ensuring order and resolving disputes.

Three Major Types of Political Systems • Totalitarianism • Socialism • Democracy

These categories are not mutually exclusive. E.g., most democracies include some elements of socialism.

Totalitarianism • Government controls all economic and political matters. • Either theocratic (religion-based) or secular • A state party is led by a dictator. Membership is mandatory for those wanting to advance. • Power sustained via secret police, propaganda, regulation of free discussion and criticism. • Examples: China (1949–1980s), Germany (1933–1945), Soviet Union (1918–1991), and Spain (1939–1975). • Today, some states in the Middle East and Africa employ totalitarianism. • Many ex-totalitarian states have much government intervention, red tape, and bureaucracy

Socialism • Capital and wealth vested in the state and used primarily as a means of production for use rather than for profit. • Group welfare outweighs individual welfare. • Government’s role is to control the basic means of production, distribution, and commercial activity. • Socialism occurs in much of the world as social democracy (e.g., Western Europe, Brazil, India). . Frequent government intervention in the private sector. . Corporate income tax rates are higher.

Two Key Features of Democracy • Private property rights: The ability to own property and assets and to increase one’s asset base by accumulating private wealth. Property includes land, buildings, stocks, contracts, patents. Encourages initiative, ambition, innovation. • Limited government: The government performs only essential functions that serve all citizens, such as national defense, maintaining law & order, foreign relations, and providing basic infrastructure

Democracy’s Link to Economic Freedom • Empirical evidence suggests that democracy -- greater economic freedom –leads to higher economic living standards. • Economic freedom flourishes in systems characterized by: . Free market economics . Strong ‘rule of law’ . Minimal government intervention in business Command (Centrally Planned) Economies The state is responsible for making all decisions: what goods and services the country produces; quantity of production; prices at which they are sold; and distribution. ● The state owns all wealth, land, and capital, and allocates resources based on which industries they want to develop. ● Common in the 20th century, command economies proved so inefficient that most have gradually died out. ● Central planning is less efficient than market forces in synchronizing supply and demand. ● Today many countries exhibit some characteristics of command economies; e.g., China, India, Russia, and certain countries in Central Asia, Eastern Europe, and Middle East.

Market Economies and Mixed Economies In market economies, • Decisions are largely left to market forces, the interaction of supply and demand. • Individuals and firms are main decision-makers. • Government intervention is limited. • Associated mainly with Capitalism Mixed economies have features of both market and command economies, combining state intervention and market mechanisms (e.g., Sweden, Singapore)

Five Types of Legal Systems The five legal systems are the foundation for laws and regulations: • Common law • Civil law • Religious law • Socialist law • Mixed systems

Common (Case) Law • A legal system that originated in England and spread to Australia, Canada, USA, and other former members of the British Commonwealth (also known as case law). • The basis of law is tradition, past practices, and legal precedents set by courts via interpretation of statutes, legislation, and past rulings. • Judges have much power to interpret laws based on the circumstances of individual cases. Thus, common law is relatively flexible.

Civil (Code) Law • Found in France, Germany, Italy, Japan, Turkey, and much of Latin America. • Based on an all-inclusive system of laws that have been “codified”, clearly written by legislative bodies • Laws are more ‘cast in stone’ and not strongly subject to interpretation by courts * * * * * * * * A key difference between civil law and common law is that common law is mainly judicial in origin and based on court decisions, whereas civil law is mainly legislative in origin and based on laws passed by legislatures.

Religious Law • Strongly influenced by religious beliefs, ethical codes, and moral values, viewed as mandated by a supreme being. • Most important religious legal systems are based on Hindu, Jewish, and Islamic law. • Islamic law spells out norms of behavior regarding politics, economics, banking, contracts, marriage, and many other social and business issues.

Socialist Law • Found mainly in China, former Soviet Union, and a few states in Africa • Based on Civil Law, with elements of socialist principles that emphasize state ownership of property -- state rights take precedence over individuals’ • Tends toward loose treatment of property and intellectual property rights

Actors in Political and Legal Systems • The government, or the ‘public sector’, is the most important actor, operating at federal and local levels. • Supranational agencies such as the World Trade Organization, United Nations, and the World Bank • Regional trade organizations, such as the European Union (EU), the North American Free Trade Agreement (NAFTA), etc. • Special interest groups such as labor unions and environmental groups • Local competing firms oppose foreign firms, and lobby their governments accordingly.

Country Risk Produced by the Political System: Government Takeover of Corporate Assets • Confiscation: seizure of foreign assets without compensation. E.g., Venezuelan President Hugo Chavez confiscated a major oil field owned by French firm Total. • Expropriation: seizure of corporate assets with compensation. • Nationalization: government takeover of an entire industry, with or without compensation. In 2006, the government of Bolivia nationalized much of the country’s oil and gas industry. • Privatization: selling state-owned enterprises to private interests.

Country Risk Produced by the Legal System • Foreign investment laws affect the type of entry strategy firms choose, as well as their operations and performance. Nations impose restrictions on inward FDI, such as Japan’s large retail store law or the U.S. and Dubai Ports World • Controls on operating forms and practices affect firms’ production, marketing, and distribution activities. E.g., China requires market entry via joint venture in its huge telecommunications sector. • Marketing and distribution laws determine which practices are allowed in advertising, promotion, and distribution. E.g., laws may restrict TV advertising aimed at children. • Laws regarding income repatriation limit the amount of net income or dividends that firms can bring back to the home country. Environmental laws are intended to preserve natural resources, combat pollution, and ensure health and safety. E.g., in Germany, firms must follow strict recycling regulations.

Country Risk Arising from the Home-Country Legal Environment • Extraterritoriality: application of home-country laws to other countries. E.g., the European Union has pursued Microsoft for perceived monopolistic practices. • Foreign Corrupt Practices Act (1977) made it illegal to offer bribes to foreign parties. But, definition of a “bribe” is unclear; Harms U.S. interests because foreign competitors are not so constrained.

Accounting and Reporting Laws Differ widely around the world. Examples: • Physical asset valuations: Canada and the U.S. use historical costs. Some Latin American countries use inflation-adjusted market value. • Uncollectible accounts allowance: in the U.S. – yes; France, Spain, and South Africa – no • Research and development costs are: expensed as incurred in most of the world; Capitalized in South Korea and Spain; Belgium, Malaysia, and Italy use both conventions.

Transparency in Financial Reporting Transparency -- degree to which firms regularly reveal substantial financial & accounting information • Timing and transparency of financial reporting vary widely around the world. • Sarbanes-Oxley Act (2002) promotes greater transparency in accounting practices. But, cost of compliance is high; Discourages foreign firms from listing or transacting extensively in the U.S.

Ethical Values and Practices Ethics refers to the moral behavior of people, firms, or governments- issues often arise, or may be exacerbated, by deficiencies in legal systems. Corruption typically involves the use of bribery and fraud to achieve business goals. Most common in developing economies.

Contract Law Local contract law is a factor in five types of contracts: 1. Sale of goods or services; 2. Distribution via foreign intermediaries; 3. Licensing and franchising; 4. Foreign direct investment; and 5. Joint ventures.

Protection through Legal Contracts • A legal contract spells out the rights and obligations of each party; especially important when relationships go awry. • Three approaches for resolving contractual disputes: 1. Conciliation is the least adversarial method; a formal process of negotiation that aims to resolve differences in a friendly manner. Common in China. 2. Arbitration is a process in which a neutral third party hears both sides of a case and decides in favor of one party or the other, based on an objective assessment of the facts. 3. Litigation is the most adversarial approach, and occurs when one party files a lawsuit against another; Most common in the United States.