Pdm 130 International Business

7/28/2019 Pdm 130 International Business

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INTERNATIONAL BUSINESS

CONTENT

CHAPTER 1


Chapter 2

INTERNATIONAL BUSINESS MANAGEMENT

CHAPTER 3

WHY GO INTERNATIONAL?

CHAPTER 4

INTERNATIONAL BUSINESS APPROACHES



CHAPTER 1


The beverages you drink might be produced in India, but with the collaboration of a USAcompany. The tea you drink is prepared from the tea powder produced in Sri Lanka. The spares and

hard disk of the computer you operate might have been produced in the United States of America.The perfume you apply might have been produced in France.

The television you watch might have been produced with the Japanese technology. The shoeyou wear might have been produced in Taiwan, but remarketed by an Italian company. Air Franceand so on so forth might have provided your air travel services to you. Most of you have theexperience of browsing Internet and visiting different web sites, knowing the products and servicesoffered by various companies across the globe. Some of you might have the experience of ‘evenordering and buying the products through Internet. This process gives you the opportunity oftransacting in the international business arena without visiting or knowing the various countries andcompanies across the globe.

You get all these even without visiting or knowing the country of the company where they areproduced. All these activities have become a reality due to the operations and activities ofinternational business.

Thus, international business is the process of focusing on the resources of the globe andobjectives of the organizations on global business opportunities and threats.

Evolution of International Business

The business across the borders of the countries had been carried on since times immemorial.

But, the business had been limited to the international trade until the recent past. The post World War If period witnessed an unexpected expansion of national companies into international or multinationalcompanies. The post 1990s period has given greater fillip to international business.

In fact, the term international business was not in existence before two decades. The terminternational business has emerged from the term international marketing, which in turn, emergedfrom the term ‘export marketing’.

International Trade to International Marketing: Originally, the producers used to export theirproducts to the nearby countries and gradually extended the exports to far-off countries. Gradually,the companies extended the operations beyond trade. For example, India used to export raw cotton,

raw jute and iron ore during the early 1900s. The massive industrialization in the country enabled usto export jute products, cotton garments and steel during 1960s.

India, during 1980s could create markets for its products, in addition to mere exporting. Theexport marketing efforts include creation of demand for Indian products like textiles, electronics,leather products, tea, coffee etc., arranging for appropriate distribution channels, attractive package,product development, pricing etc. This process is true not only with India, but also with almost alldeveloped and developing economies.

International Marketing to International Business: The multinational companies which wereproducing the products in their home countries and marketing them in various foreign countries



before 1980’s started locating their plants and other manufacturing facilities in foreign/host countries.Later, they started producing in one foreign country and marketing in other foreign countries. Forexample, Uni- Lever established its subsidiary company in India, i.e., Hindustan Lever Limited (HLL)HLL produces its products in India and markets them in Bangladesh, Sri Lanka, and Nepal etc. Thus,the scope of the international trade is expanded into international marketing and internationamarketing is expanded into international business.

NATURE OF INTERNATIONAL BUSINESS

The 1990s and the new millennium clearly indicate rapid internationalization and globalization.The entire globe is passing at a dramatic pace through the transition period. Today, the internationaltrader is in a position to analyze and interpret the global social, technical, economic, political andnatural Environmental factors more clearly. Conducting and managing international businessoperations is a crucial venture due to variations in political, social, cultural and economic factors, fromone country to another country. For example, most of the African consumers prefer less costlyproducts due to their poor economic conditions.

Whereas the German consumers prefer high quality and high priced products due to their

higher ability to buy. Therefore, the international businessman should produce and export less costlyproducts to most of the African countries and vice versa to most of the European and North Americancountries. High priced and high quality Palmolive soaps are marketed in European countries and theeconomy priced Palmolive soaps are exported and marketed in developing Countries like Ethiopia,Pakistan, Kenya, India, Cambodia etc. International business houses need accurate information tomake an appropriate decision. Europe was the most opportunistic market for leather goods andparticularly for shoes. Bata based on the accurate data could make appropriate decision to entervarious European countries. International business houses need not only accurate but timelyinformation. Coca Cola could enter the European market based on the timely information, whereasPepsi entered later. Another example is the timely entrance of Indian software companies into the USmarket compared to those of other countries. Indian software companies also made timely decision in

the caseof’ Europe.

INTERNATIONAL MARKETING

ResearchResearch is very important when marketing in your own country, but it is even more important

in foreign markets. This is because in your own country you can rely on some combination ofresearch results and your own intuition (i.e. your sense of how people think, how they use yourproducts, and how they will respond to certain messages). In foreign markets, you do not have the

same kind of personal familiarity with the markets, and therefore need to make up for it with moreextensive research.

The results of this research should then be considered in light of what the firm candeliver. - Doing detailed research is costly; a firm would typically only do detailed research onthe countries believed to be the most promising.

A. Demand Analysis

The firm needs to analyze and segment its customers. It should clearly identify who are theaccessible, target customers. It should understand how the country's culture might affect demand for



its product. Consider income levels, demographics, education levels, distribution of incomesurbanization, consumption patterns. Moreover, consider trends in each of these issues. (e.g. How fastare income levels rising? Is the population aging? etc.)

- Essentially, you want to spot an emerging demand for your product. It is often easier to break intoemerging markets than into saturated markets.- Determine existing demand (based on the data and on expert opinion).- Determine future demand (based on trends).

- Determine latent demand (demand for products not currently available in thecountry).- Determine responsiveness to marketing.- Determine spillover effects to neighboring countries.- Determine what adaptations to the product customers may prefer.- Determine customer bargaining power. (The fewer or larger the customers, themore they will be able to bargain down the selling price)

B. Competitor Analysis

- Identify existing competitors.

- Identify potential competitors.- Identify close substitutes to your own product.- Anticipate competitors' responses. Price war? Calls for government intervention

C. How to Collect Data

- Ideally, data should be collected by people who know the firm and industry, and who have a strong

familiarity with the country of study.

- Often such people are not available, so there is a risk that the data is misinterpreted or misdirected.

- There are many external sources of data: home government, other governments, international

organizations, service organizations, trade associations, databases, other firms.

D. Issues Internal to the Firm

- The firm should consider its own competencies. How will the firm's competencies fare in the foreign

market?

- How transferable are the firm's competencies? If a key function must be done overseas, can the

firm's advantages be transferred to that location?

- What risk is there of giving away competencies if marketing can only be done through a joint venture

or licensing?

- COSTS.

- Can you think of any examples of poor research in foreign markets? Can you think of

any foreign products that failed in our markets (or in your country’s markets if you are an internationa

student)? Do you think the foreign company could have avoided its mistakes through better research?



Product Design

- “Product design” refers to the characteristics of the product. We think of a product in broad terms toinclude the service and warranty elements.

- One of the issues often considered is whether to use a standard product or to adapt the product tothe local market. This perhaps unduly simplifies the question of what product the firm should sell in

the foreign market, but for the purposes of a general discussion we’ll focus on this issue.

- There are some important reasons why a company might want to sell a standardized product. Oneis that standardized products typically cost less, because this strategy exploits economies of scalemore. A second reason is that the firm's competency may be in that product as is and not in adifferent product.

- Many companies, however, do in fact adapt their products to local markets for a variety of reasons.Often the adaptations are small, are relatively inexpensive and do not cause the firm to deviate fromits competencies. There are many reasons why products might need to be modified for the foreignmarket. Differences in products result from differences across countries.

Environmental Differences

- Geography

- Geography, for example, affects people's mode of transportation. For example, trucks in

mountainous countries need stronger axles.

- Climate

- e.g. does the product need to withstand cold winters?

- Population density- In densely populated areas products typically need to be more compact.

For example, refrigerators need to be smaller because people’s kitchens are smaller.

- Population density can affect products indirectly as well. For example, smaller refrigerators make

their owners less likely to buy groceries in bulk.

Thus population density indirectly affects how food product companies package their products.

Individual Composition

- Income- Sellers of luxury goods need to consider how many high income people there are. (Notethat GDP per capita is not necessarily a good measure of this. In one country everyone might haveabout the same income, while another country with the same average income could have a widerange of income levels.)

- Age- Age affects demand for products associated with certain stages of the human life cycle. Forexample, populations with many children may have different needs in automobiles versus elderlypopulations. Of course, tastes also tend to differ across age groups.



- Education- Illiterate people may require product designs that allow use without reading. Educatedpeople tend to be better informed on certain issues.

- Religion- Some religions place restrictions on people’s consumption patterns or may influence them.Examples include restrictions on alcohol, beef, pork or certain types of attire. Religions may alsodiscourage materialism.

Group Interaction

1. Formal standards (codified by law or regulations). Examples include what side of the road youdrive on, safety standards and pollution Standards.

2. Informal standards- The classic example is the QWERTY keyboard, which is slightly differentin some European countries.

3. Symbols- Symbols in one country may be meaningless in another, or may mean somethingquite different. For example, yellow apparently symbolizes cowardice in Anglo-Saxon culturesbut symbolizes royalty in China.

4. Manners- Behavior that is acceptable in one country might be unacceptable in another countryFor example, in some cultures it might be rude for a pizza-delivery person to knock on thedoor.

Tastes- Other differences across countries are hard to classify, and could just be attributed to taste

differences.

Examples include:- North American preferences for sweeter foods.- Different countries’ preferences for different beverages.

Cost of Adaptation

There usually are plenty of reasons to adapt a product for a local market, but a firm alsoneeds to consider the costs of doing so. Some types of costs of adaptation are listed below:

1. Research and development costs- In some cases the costs of a new design may be small (suchas Cadbury’s cost of changing its proportions of ingredients), or may be substantial.

2. Market cultivation costs- Some product variations may necessitate a substantially differentapproach to promotion.

3. Line costs- A new product line may require additional machinery or workers to produce the newproduct.

4. Switching costs- In some cases, firms use the same production line to produce different types ofproducts. Nevertheless, there are costs associated with frequent retooling within a plant. This processis costly both in terms of money and time. On the other hand, some firms have cut such costssubstantially through flexible manufacturing processes.



5. Input costs- If the modified product requires a new input, costs could go up simply because the firmis buying more expensive inputs. (Of course, in some cases, product modifications could reduce theproduction cost, if the modified product uses cheaper inputs.)

Other Considerations

1. Trends- Some of the differences (such as education and tastes) can change over time.Others (such as geography and climate) do not.

1. Niche markets- Even though a majority of people may be of one type, a company may be ableto sell an unaltered product to a niche minority. For example, a European chocolate producermay choose to sell an unaltered product in the U.S. (i.e. they don’t add more sugar) to targetthe segment of U.S. consumers who prefer less sweet chocolates.

Pricing

- For homogenous products, the market sets the price.- For differentiated products, firms choose price to maximize their earnings. When different marketshave different elasticities of demand, a firm maximizes profit by practicing price discrimination. Price

is determined where MR=MC1 in each market.

What is the difference between elastic demand and inelastic demand? What are some reasons thatdemand might be more elastic in one country than in another?

- For example, suppose a firm sells in two markets (1) & (2). The marginal cost of the product is 1 for either market. The demand function in market 1 is Q1=5-P1 (where Q1 is the quantity sold in market1 and P1 is the price in market 1). So revenue from market 1 would be P1 (5-P1). The marginalrevenue is the derivative of this expression, so it is -2P1+5. If we set this expression equal to themarginal cost of 1,we get a price of P1=3. Now suppose in market 2 the demand function is Q2=6-2P2.This demand function would yield an optimum price of p2=2.

However, a MNE entering a new market must also consider long-run effects of its pricingdecisions today. Pricing can affect future demand (e.g. effect on potential competitorsconsumer/distributor awareness, network externalities, habits and addictions, signal of quality). It ispossible that a firm might employ predatory pricing to drive out competitors so that afterward the firmcan enjoy high profits. In most developed countries, this is illegal. Firms also need to be wary ofantidumping rules. Sometimes markets can’t be segmented so easily. For example, many WestEuropean manufacturing companies sell their goods at a lower price in Eastern Europe than inWestern Europe. So some Western retail chains are able to buy the goods from wholesalers inEastern Europe at a lower cost than if they bought the goods directly from the manufacturingcompany. This is often called the grey market. It is called the grey market because the legality of this

is not always clear. Ordinarily, when a manufacturer sells its goods, it gives up its right to have a sayon who may or may not buy the product. However, it may have the right to limit warranties andservicing. The legality of this practice will therefore normally depend on what agreements are inplace, and on whether the retailer is making true or false representations as to what warranties andservicing the manufacturer will provide.

- Do you think price discrimination between countries is ethical?

Place (Distribution)- Like a purely domestic firm, a MNE may sell its products directly to consumers or else to awholesaler or retailer. When goods across international borders additional issues arise, such as



exchange rate risk, overseas shipping and customs clearance, and navigating the foreignenvironment. The firm has to decide whether to handle its own distribution or contract part of thedistribution function to other firms.

Marginal revenue = marginal cost

A. Import Agents- Some agents, such as trading houses, will purchase for their own account. They usually require

exclusivity if they must invest resources into market development.

- Other agents simply handle exports for a fee and do not actually buy the product.

B. Advantages of Contracting1. They have expertise about distribution in the particular market.2. They can realize economies of scale.3. Export agents can match currencies and realize lower foreign exchange costsas well as risks.

C. Disadvantages of Contracting1. You have to pay them (or sell your product to them at a discounted price).2. The manufacturer might lose control over market development and customer service.3. The manufacturer might disclose some proprietary information.4. Incentive problem - the foreign distributor might have other agendas than just pushing yourproduct.

Factors Influencing Choice

1. Characteristics of distribution

(a) Retail concentration: whether retailing is dominated by a few large retailers or is spread outamong many small retailers. How does retail concentration affect an exporter’s choice of howto distribute its product?

(b) Channel length: number of intermediaries between producer and consumer (usually thechannel length is smaller if there is high retail concentration). How does channel length affectan exporter’s choice of how to distribute its product?

(c) Channel exclusivity: where it is difficult for new firms to secure shelf space in retail stores. Howdoes channel exclusivity affect an exporter’s choice of how to distribute its product?

2. Economies of scale and volume - more sales make an investment more feasible3. Product characteristics - more technical products might best be distributed by the manufacturer,

to ensure adequate service and promotion.4. Characteristics of the other party - Other party may have a conflict of interests.

Promotion (Advertising)

- The advertising task is the same in most markets - to communicate information andpersuade.7

- There are many reasons why advertising might need to be modified for the foreign market.- Consumer Tastes and Preferences - Usually culture related.- Source Effects



- Consumers’ opinion of a producer can matter. e.g. Japanese and German-made goods are oftenperceived as of high quality.- Consumers in some countries either like or dislike certain countries. Or they simply prefer domesticmanufacturers. How can a company get around this problem?- Regulation- Another decision to make is whether to use a global brand name, or to develop a new local brandname.- Advantages to a global brand name include:

- promotes global recognition- Economies of scale in brand development- Media coverage may cross borders (e.g. in PEI we see Boston ads)- enables standardized advertising- Disadvantages of using a global brand name include:- need to ensure quality remains high in foreign location- Grey market- Local prejudice against foreign brands- Names may not work well in some languages



Chapter 2

INTERNATIONAL BUSINESS MANAGEMENT

The size of the international business should be large in order to have impact on the foreign

Economies. Most of the multinational companies are significantly large in size. In fact, the Capital ofsome of the MNCs is more than our annual budget and GDPs of the some of the African Countries.Most of the international business houses segment their markets based on the geographic marketsegmentation. Daewoo segmented its market as North America, Europe, Africa, Indian subcontinentand Pacific markets.

International Business Opportunities Y2k & Euro India appears to be well positioned to takeadvantage of the opportunities by capitalizing on its reputation of being a global centre fordevelopment of commercial applications and outsourced software services. But despite theseadvantages, companies have not been able to cash in on the opportunities even though softwarefirms collectively have the potential, In the Y2K opportunities, a substantial part of the cost involved in

initial analysis, finalizing the strategy, testing and implementation. While most of the resourcesservices by companies to address the Y2K business are like “fast chicken,” capable of addressingonly the code-correction phase, the real testing requires not pseudo programmers who have enteredthe field, but genuine software professionals who have considerable experience. The European Unionhas decided to go for a single currency named Euro. And for this, currency and conversion relatedchanges are to be incorporated within the software. This opportunity is much bigger than the Y2Kone, but software developers are not geared well enough to tap the sizeable potential that it holds forthem. It is much more a difficult opportunity. The impact of Euro on the application system requiresmore knowledge. Some software companies are addressing this, particularly by extending their Y2Kservices to take part in euro projects also.

International markets present more potentials than the domestic markets. This is due to thefact that international markets wide in scope, varied in consumer tastes, preferences and Purchasingabilities, size of the population etc. For example, the IBM’s sales are more in foreign countries than inUSA. Similarly, Coca-Cola’s sales, Procter and Gamble’s sales and Satyam Computer’s sales aremore in foreign countries than in their respective home countries. The population for the year 2000indicates that: USA’s population would be 300 million, Mexico’s 126 million, Brazil’s 205 million,Indonesia’s 223 million, Pakistan’s 138 million, Nigeria’s 154 million and Bangladesh’s 146 million.The size of the population, sometimes, may not determine the size of the market. This is due to thebackwardness of the economy and low purchasing power of the people, In fact, the size of Eritrea an

African country is roughly equal to that of the United Kingdom in terms of land area and size of thepopulation. But, in terms of per capita income it is one of the poorest countries in the world withestimated per capita income of US $ 150 per annum.

Therefore, the international business houses should consider the consumers’ willingness tobuy and also ability to buy the products In fact, most of the multinational companies, which enteredIndian market after 1991, failed in this respect. They viewed that almost the entire Indian populationwould be the customers. Therefore, they estimated that the demand for consumer durable goodswould be increasing in India after globalization. And they entered the Indian market. The heavy inflowof these goods and decline in the size of Indian middle class resulted in a slump in the demand forconsumer durable goods.



Wider Scope:

Foreign trade refers to the flow of goods across national political borders. Therefore, it refersto exporting and importing by international marketing companies plus creation of demand, promotion,pricing etc. As stated earlier, international business is much broader in scope. It involves internationalmarketing, international investments, management of foreign exchange, procuring internationafinance from IMF, IBRD, IFC, IDA etc., management of international human resources, managementof cultural diversity, international marketing, management of international production and logistics,

international strategic management and the like. Thus, international business is broader in scope andcovers all aspects of the system.

Inter-country Comparative Study:

International business studies the business opportunities, threats, consumers’ preferences,behavior, cultures of the societies, employees, business environmental factors, manufacturinglocations, management styles, inputs and human resource management practices in variouscountries. International business seeks to identify, classify and interpret the similarities anddissimilarities among the systems used to anticipate demand and market products’. The systempresents inter-country comparison and intercontinental comparison/comparative analysis helps the

management to evaluate the markets, finances, human resources, consumers etc. of variouscountries. The comparative study also helps the management to evaluate the market potentials ofvarious countries. The study also indicates the degree of consumer acceptance of the product,product changes and developments in different countries. Managements of international businesshouses can group the countries with similar features and design the same products, fix similar priceand formulate the same marketing strategies. For example, Prentice Hall grouped India, Nepal,Pakistan Bangladesh; Sri Lanka etc. into one category based on the customers’ ability to pay anddesigned the same quality product and sell them at the same price in all these countries. Similarly,Dr. Reddy’s Lab does the same for its products to sell in the African countries. Differences inGovernment Policies, Regulatory Framework Sovereign governments enact and implement the laws,and formulate and implement policies and regulations. The international business houses should

follow these laws, policies and regulations. MNCs operating in India follow our labor laws, businesslaws and policies and regulations formulated by the Indian Government. For example, internationabusiness should enter into joint venture with the domestic company to enter Malaysia. Importantamong them include: Host Country’s Monetary System:

Countries regulate the price level, flow of money, production levels etc. through their monetarysystems. In addition, they regulate foreign exchange rates also through the monetary system. Thetools of monetary system include bank rate, cash reserve ratio, statutory liquidity ratio etcGovernments also regulate remittance of the profit of international business houses to othercountries. International companies should obey these regulations. The Indian Government introducedfull convertibility on current account; in fact, many Governments introduced full convertibility on

current account as a part of economic liberalization. National Security Policies of the Host Countries:Every country formulates the policies for its national security. Multinational companies should abideby these national security policies. For example, USA is a free economy as far as carrying out thebusiness compared to manyImpact of Culture of Switzerland Housewives

On Marketing of Dishwashers

In Switzerland, foreign dishwasher manufacturers expected the same rapid sales as they hadfirst obtained in other West European markets; but sales in Switzerland were so slow that researchhad to be done to find out why (this research should, of course, have been done before not after



market entry). The research showed that the Swiss housewife had a different set of values to, forexample, her French and English counterparts; she was very conscious of her role as strict andhardworking and her responsibility for the health of her family. To the Swiss housewife dishwasherssimply made life easy, and this conflicted with her Calvinistic work ethic. As a result of the research,dishwasher manufacturers had to change their advertising promoting, instead of ease andconvenience, hygiene and health. They did this by emphasizing that because dishwashers usedtemperature higher than hand hot, the process was more hygienic than washing up by hand.Thereafter, they had no automatic dishwashers in Swit7erland.

Language:

Language is an important factor in international business. Even though ‘English language’ is amajor language in business operations in the world, there are still a large number of ‘non-English’speaking countries. Therefore, international business houses should train their employees inthe local language of the host country. Added to this, there would be many languages in use in many,countries like ours. Therefore, the business houses should train their employees inthe local languages also.

Nationalism and Business Policy:

Nationalism is a dominating factor of the social life of the people of the host countries. In fact,nationalism also affects the business operations of the multinational corporations dramatically anddrastically. The US people used the slogan ‘Be American and Buy American Made’, when the USautomobile industry failed to meet the competition similar incidents are also observed in developingcountries. Therefore, international business houses should be cautious of Nationalism and its after effects



CHAPTER 3

WHY GO INTERNATIONAL?

We have discussed the nature of international business and the precautions that themultinational companies should take while operating in foreign countries. The basic question of “whydo the Business firms of a country go to other countywide?” might have been in your mindsTherefore, we answer this question, before proceeding further.

To achieve Higher Rate of Profits: As we have discussed in various courses/subjects likePrinciples and Practice of Management, Managerial Economics and Financial Management that thebasic objective of the business firms is to earn profits. When the domestic markets do not promise ahigher rate of profits, business firms search for foreign markets, which promise for higher rate ofprofits. For example, Hewlett Packard earned 85.4% of its profits from the foreign markets comparedto that of domestic markets in 1994. Apple earned US $ 390 million as net profit from the foreign

markets and only US $ 310 millions as net profit from its domestic market in 1994. Expanding theProduction Capacities beyond the Demand of the Domestic Country: Some of the domesticcompanies expanded their production capacities more than the demand for the product in thedomestic countries. These companies, in such cases, are forced to sell their excess production inforeign developed countries. Toyota of Japan is an example.

The Economies of Developed Countries

United States

In the US, the rate of growth of Gross Domestic Product (GDP) rose by 2.6 per cent in the

second quarter of 1996 over the corresponding period of 1995 much higher than the first quartergrowth rate of 1.7 per cent. The rate of growth of personal consumption rose strongly throughout thefirst half of 1996 overshadowing the economy’s performance on the business investment front, whichslowed between April and June 1996. Buoyant consumer demand has prompted further speculationabout the future course of the inflation curve and short-term interest rates. Recent data present acontradictory picture. While some surveys point to a stronger rate of growth of industrial production inthe third quarter of 1996, the growth rate of durable goods orders fell by 0.8 per cent between Mayand June 1996. Besides, statements by Alan Greenspan, the Chairman of the Federal Reserve,confirm a weaker growth prognosis. With growth showing signs of easing, there is a likelihood thatinterest rates will be on hold. But Consensus Inc. predicts that 10-year treasury bond rates willincrease from the 1995 level of 5.6 per cent to 6.7 per cent by November 1996, Canada the Canadian

economy’s growth rate is likely to pick up in 1996. An index of business confidence shows higher realspending on machinery and equipment in the first half of 1996, reflecting a high level of producerconfidence. On the consumption side, however, the picture is less promising. Low consumer demandhas been strengthened by a high unemployment rate of 9.8 per cent, high household debt levels, andconsumer worries over job security. Even so, retail sales are expected to pick up soon. So, theforecast for personal expenditure growth, rather than being downgraded, remains unchanged, but thelow spending level has helped in restraining inflation.

Consumer prices rose by only 13 per cent in the first half of’1996 well within the central bank’starget range of between 1and 3 per cent allowing the fifth round of interest rate cuts in 1996independent of US economic conditions. As the data available so far suggest that an upturn on the



industrial front is Linder way. Also, the trade surplus is favorable as strong net external demandenhanced by the low Canadian dollar, low domestic demand, and a stronger US growth rate led to aCanadian $4.10 billion trade surplus in May 1996.

Japan In recent months, the prospects of a sustained recovery in Japan have improvedalthough the Economic Planning Agency has warned that the recovery ‘is still fragile, and thatexpansionary trends have yet to be confirmed. Recently, there have been increasing signs of anupturn in private consumption, led by improving job opportunities and rising wages. Retail sales

rebounded in June 1996, rising by 2 per cent over June 1995, after posting declines in two previousmonths. Consensus Inc.’s forecasts for private consumption growth in both 1996 and 1997 have beenupgraded to 3.5 and 2.6 per cent respectively. On the supply side, however, the picture is lessoptimistic, with another fall industrial output growth indicating that inventories are still being workedoff. Meanwhile, utility costs rose by 1.3 per cent while food prices jumped by 6.8 per cent in July1996.

However, Consensus Inc. forecasts negligible inflation pressure in 1996 although moresignificant price rises are expected in 1997, Although the trade surplus narrowed to Y3 trillion in thefirst, half of 1996, the pace of contraction is slowing due to Japan’s higher competitiveness followingthe depreciation of the yen last year Australia Despite stronger than expected economic growth in the

first quarter of 1996, the “Reserve Bank of Australia (RBOA) lowered the cash rate by 0.5 per cent to7 per cent in end July 1996. The governor of the RBOA said that the lower, and declining, rate ofgrowth of wages suggested that economic growth had fallen below its potential levels. Moreoverrecent indicators of consumer spending point to a softer private.

Consumption growth rate in the second quarter of 1996 while excess capacity and highinventories suggest that industrial Production growth is likely to remain depressed over the next fewmonths. After a peak of 5.1 per cent in the last quarter of 1995, inflation declined to 3.4 per cent in thefirst half of 1996. This trend has also been reinforced by the weakening growth of weekly earnings,which averaged 3.7 per cent in the first six months of 1996. However, an upward pressure on wages

is building, which will determine the course of both inflation and monetary policy in the short run. Infact, Consensus Inc, expects that the 90day ‘bank bill rate will fall to 6.8 per cent over the next threemonths.

Severe Competition in the Home Country:

The countries oriented towards market economies since 1960s had severe competition fromother business firms in the home countries. The weak companies, which could not meet thecompetition of the strong companies in the domestic country, started entering the markets of thedeveloping countries. Limited Home Market: When the size of the home market is limited either dueto the smaller size of the population or due to lower purchasing power of the people or both, the

companies internationalize their operations. For example, most of the Japanese automobile andelectronic firms entered US, Europe and even African markets due to the smaller size of the homemarket. ITC entered the European market due to the lower purchasing power of the Indians withregard to high quality cigarettes. Similarly, the mere six million population of Switzerland is the reasonfor Ciba Geigy to internationalize its operations. In fact, this company was forced to concentrate onglobal market and establish manufacturing facilities in foreign countries.

Political Stability vs. Political Instability: Political stability does not simply mean thatcontinuation of the same party in power, but it does mean the continuation of the same policies of theGovernment for a quite longer period. It is viewed that USA is a politically stable country. Similarly,UK, France, Germany, Italy and Japan are also politically stable countries. Most of the African



countries and some of the Asian countries like Malaysia, Indonesia, Pakistan and India are politicallyinstable countries. Business firms prefer to enter the politically stable countries and are restrainedfrom locating their business operations in politically instable countries. In fact, business firms shifttheir operations from politically instable countries into politically stable countries.

Availability of Technology and Managerial Competence:

Availability of advanced technology and managerial competence in some countries act as

pulling factors for business firms from the home country. The developed countries due to thesereasons attract companies from the developing world. In fact, American companies, in recent years,depend on Japanese companies for technology and management expertise.’ IBM Gives FastestComputer to the World International Business Machines Corporation unveiled the fastest computer inthe world, which the US government will use to simulate nuclear weapons tests. The supercomputer,able to process more in a second than one person with a calculator could do in 10 million years, wasmade for the US department of energy’s Accelerated Strategic Computing Initiative (ASCI.). Thesystem could ease congressional opposition to the United States signing the Comprehensive TestBan Treaty, banning all actual nuclear weapons testing worldwide. “Without underground testing, weneed simulations to make sure the stockpile is safe, reliable and operational,” said David Cooper, amember of the President’s Council on Computing and chief information officer of Lawrence Livermore

Lab in California, where the system will be run. Called ASCI, White super computer will churn thefactors involved in a nuclear detonation, including the weapon’s age and design. This couldeventually allow the government to manage its entire stockpile of nuclear weapons without any realnuclear tests, Cooper said. The US Senate last year filed to ratify the test ban treaty, insisting on thenation’s right to continue testing nuclear weapons underground.

“If you polled the weapons designers right now, they would say that testing is still moreeffective,” Cooper said. The new supercomputer is a major step toward full simulation but is not yetcapable of testing the nuclear weapons stockpile to standards set by experts. A system that couldreplace actual nuclear tests must have a computing capability of 100 teraflops, or trillions ofoperations per second, versus the ASCI White computing capacity as tested by IMB of 12.3 teraflops,

Cooper said “We’re still on timescale to do by 2004,” he added. The system contains 8,192 coppermicroprocessors and is 1,000 times more powerful than its chess playing predecessor ‘Deep Blue,’which defeated World Champion Gary Kasparov in 1997. IBM Is selling the system, which will take upthe floor space equivalent to two basketball courts and weighs as much as 17 full-sized elephants tothe DOE for $110 million.

But designing the most powerful computer in the world has other pay-offs of IBM, includingbragging rights that could allow it to take a greater share in the supercomputer market, as well as theuse of the advanced technology in its lower-level computer products. “We’re seeing more and morethat deep computing will become a critical element. In how real business is run every day, and thatIt’s not just in the territory of the propeller heads,” said Nicholas Donofrio, IBM senior vice-president

technology and manufacturing.

High Cost of Transportation:

Initially companies enter foreign countries through their marketing operations. At this stage, thecompanies realize the challenge from the domestic companies. Added to this, the home companiesenjoy higher profit margins whereas the foreign firms suffer from lower profit margins. The majorfactor for this situation is the cost of transportation of the products. Under such conditions, the foreigncompanies are inclined to increase their profit margin by locating -their manufacturing facilities inforeign countries where there is enough demand either in one country or in a group of neighboringcountries. For example, Mobil, which was supplying the petroleum products to Ethiopia, Kenya



Eritrea, Sudan etc. from its refineries in Saudi Arabia, established its refinery facilities in Eritrea inorder to reduce the cost of transportation. Similarly, Caterpillar located its manufacturing facilities atdifferent centers in order to reduce the cost of transportation. This company produces high valueadded parts in limited locations and less valued and non critical components and assembles the finalproducts in a number of foreign countries.

Nearness to Raw Materials

The source of highly qualitative raw materials and bulk raw materials is a major factor forattracting the companies from various foreign countries. Most of the US based and European basedcompanies located their manufacturing facilities in Saudi Arabia, Bahrain, Qatar, Oman, Iran andother Middle East countries due to the availability of petroleum. Theses companies, thus, reduced thecost of transportation.

Availability of Quality Human Resources at Less Cost

This is a major factor, in recent times, for software, high technology and telecommunicationcompanies to locate their operations in India. India is a major source for high quality and low cost

human resources unlike USA, developed European countries and Japan. Importing human resourcesfrom India by these firms is costly rather than locating their operations in India. Hence thesecompanies started their operations in India and other similar countries.

To Avoid Tariffs and Import Quotas

It was quite common before globalization that governments imposed tariffs or duty on importsto protect the domestic company. Sometimes Government also fixes import quotas in order to reducethe competition to the domestic companies from the competent foreign companies. These practicesare prevalent not only in developing countries but also in advanced countries. For example, Japanesecompanies are competent competitors to the US companies. USA imposed tariffs and quotas

regarding import of automobiles and electronics from Japan. Harley Davidson of USA sought and gotfive years of tariffs protection from Japanese imports. Similarly, Japan places high tariffs on imports ofrice and other agricultural goods from USA to avoid high tariffs and quotas, companies prefer directinvestment to go globally. For example, companies like Sony, Honda and Toyota preferred directinvestment if] various countries by establishing subsidiaries or through joint ventures in variousforeign countries including USA and India, Similarly, General Electrical, and Whirlpool also haveforeign subsidiaries. Xerox, Canon, Phillips, Unilever, Lucky Gold Star, South

Korean Electronics Company, Pepsi, Coca Cola. Shell, Mobil etc. established manufacturingfacilities in various foreign countries in order to avoid tariffs, import duties and quotas. Havingdiscussed the need for international business, we shall discus the basis for international business.

Stages of Internationalization The internationalization process generally includes fives stages. Vizdomestic company, international company, multinational company, global company and transnationacompany. Now, we will study stage of internationalization in detail.

Stage 1: Domestic Company

Domestic company limits its operations, mission and vision to the national political boundaries.These companies focus its view on the domestic market opportunities, domestic suppliers, domesticfinancial companies, domestic customers etc. These companies analyze the national environment ofthe country, formulate the strategies to exploit the opportunities offered by the environment. The



domestic companies’ unconscious motto is that, “if its not happening in the home country, it is nothappening”

The domestic company never thinks of growing globally. If it grows, beyond its presentcapacity, the company selects the diversification strategy of entering into new domestic markets, newproducts, technology etc. The domestic company does not select the strategy ofexpansion/penetrating into the international markets.

Stage 2: International Company

Some of the domestic companies, which grow beyond their production and/or domesticmarketing capacities, think of internationalizing their operations. Those companies who decide toexploit the opportunities outside the domestic country are the stage two companies. Thesecompanies remain ethnocentric or domestic country oriented. These companies believe that thepractices adopted in domestic business, the people and products of domestic business are superiorto those of other countries. The focus of these companies is domestic but extends the wings to theforeign countries.

Markets and extend the same domestic operations into foreign markets. In other words, these

companies extend the domestic product, domestic price, promotion and other business practices tothe foreign markets. Normally internationalization process of most of the global companies starts withthis stage two process. Most of the companies following this strategy due to limited resources andalso to learn from the foreign markets gradually before becoming a global company without muchrisk. The international company holds the marketing mix constant and extends the operations to newcountries. Thus the international company extends the domestic country marketing mix and businessmodel and practices to foreign countries.

Stage: 3 Multinational Companies

Sooner or later, the international companies learn that the extension strategy (i.e., extending

the domestic product, price and promotion to foreign markets) will not work. The best example is thatToyota exported Toyopet cars produced for Japan in Japan to USA in 1957. Toyopet was notsuccessful in USA. Toyota could not sell these cars in USA as they were overpriced, underpoweredand built like tanks. Thus these cars were not suitable for the US markets. The unsold cars wereshipped back to Japan.

Toyota took this failure as a rich learning experience and as a source of invaluable intelligencebut not as failure. Toyota, based on this experience designed new models of cars suitable for the USmarket. The international companies turn into multinational companies when they start responding tothe specific needs of the different country markets regarding product, price and promotion. Thisstatue of multinational company is also referred to as multidomestic. Multidomestic company

formulates different strategies for different markets; thus, the orientation shifts from ethnocentric topolycentric. Under polycentric orientation the offices /branches/subsidiaries of a multinationacompany work like domestic company in each country where they operate with distinct policies andstrategies suitable to that country concerned. Thus they operate like a domestic company of thecountry concerned in each of their markets.

Philips of Netherlands was a multidomestic company of this stage during 1960s. It used tohave autonomous national organizations and formulate the strategies separately for each country. Itsstrategy did work effectively until the Japanese companies and Matsushita started competing with thiscompany based oil global strategy. Global strategy was based on focusing the company resources toserve tile world market. Philips strategy was to work like a domestic company, and produce a number



of models of the product consequently it increased the cost of production and price of the product. Butthe Matsushita’s strategy was to give the value, quality, design and low price to the customer. Philipslost its market share as Matsushita offered more value to the customer Consequently Philips changedits strategy and created “industry main groups” in Netherlands which are responsible for formulating aglobal strategy for producing, marketing and R &D.

Stage 4: Global Company

A global company is the one, which has either global marketing strategy or a global strategyGlobal company either produces in home country or in a single country and focuses on marketingthese products globally, or produces the products globally and focuses on marketing these productsdomestically. Harley designs and produces super heavy weight motorcycles in USA and markets inthe global market. Similarly, Dr. Reddy’s Lab designs and produces drugs in India and marketsglobally. Thus Harley and Dr. Reddy’s Lab are examples of global marketing focus. Gap procuresproducts in the global countries and markets the products in its retail organization in USA. Thus gapis an example for global sourcing company. Harley Davidson designs and produces in USA and gainscompetitive advantage as Mercedes in Germany. The Gap understands the US consumer and gotcompetitive advantage.

Stage 5:’Fransnational Company

Transnational company produces, markets, invests and operates across the world. It is anintegrated global enterprise which links global resources with global markets at profit. There is nopure transnational corporation. However, most of the transnational companies satisfy many of thecharacteristics of a global corporation.

Characteristics of a Transnational Company

The characteristics of a transnational company include: geocentric orientation, scanning orinformation acquisition, long run visions etc. We discuss these characteristics in detail.

(i) Geocentric Orientation:

A transnational company is geocentric in its orientation. This company thinks globally and actslocally. This company adopts global strategy but allows value addition to the customer of a domesticcountry. This company allows adaptation to add value to its global offer. Table 1.1 presents stages ofinternationalization. The assets of a transnational company are distributed throughout the world,independent and specialized. The R & D facilities of a transnational company are spread in manycountries, but specialized in each Country based on the local needs and integrated in world R & Dproject. Similarly, the production facilities are spread but specialized and integrated.In case of Caterpillar, manufacturing and assembly facilities are located in many countries

Components are shipped for assembly and the assembled product is shipped to the place of thecustomer. Units of the transnational corporation in different countries create and develop theknowledge in all functions and share among them. Thus knowledge and experience is shared jointly.Transnational gains power and competitive advantage by developing and sharing knowledge andexperience. of the knowledge among all, Colgate operating companies across globe is an examplehere.

(ii) Scanning or information Acquisition:

Transnational companies collect the data and information worldwide. These companies scanthe environmental information regarding economic environment, political environment, social and



cultural environment and technological environment. These companies collect and scan theinformation regardless geographical and national boundaries.

(iii) Vision and Aspirations:

The vision and aspiration of transnational companies are global, global markets, globacustomers and grow ahead of other global/transnational companies

(iv)Geographic Scope:

The transnational companies scan the global data and information. by doing so, they analyzethe global opportunities regarding the availability of resources, customers, markets, technologyresearch and development etc. Similarly, they also analyze the global challenge and threats likecompetition from the other global companies, local companies of host countries, political uncertaintiesand the like. They formulate global strategy. Thus the geographic scope of a transnational companyis not limited to certain countries in analyzing opportunities, threats and formulating strategies. (v)Operating Style: Key operations of a transnational are globalize. The transnational companiesglobalize the functions like R & D, product development, placing key human resources, Procurementof high valued material etc. For example, the R&D activity of Proctor & Gamble, and key human

resource.

vi) Adaptation:

Global and transnational companies adapt their products, marketing strategic and otherfunctional strategies to the environmental factors of the market concerned, For example, MercedesBenz is a super luxury car in North America, luxury automobile in Germany, standard taxi in Europe.(vii) Extensions: Some products do not require any change when they are marketed in othercountries. Their market is just extension. For example, Casio calculators of Japan, Hero pens ofChina, and BIC’s line of pens, butane lighters and razors.

(viii) Creation through Extension:

Transnational companies create the global brand through extending the product to the newmarket. Rothmans Cigarette extended its product to many European countries and African countriesand created it as global and national basis

(ix) Human Resource Management Policy:

The transnational company’s human resource policy is not restricted by national political orlegal constraints. It selects the best human resources and develops them regardless of nationality,ethnic group etc. But the international company reserves the top and key positions for nationals.

(x) Purchasing:

Transnational Company procures world-class material from the best source across the globe.



Which Company is truly multinational?

Four senior executives of the world’s largest firms with extensive holdings outside the hostcountry speak.

Company A:

“We are a multinational firm. We distribute our products in about 100 countries we manufacture

in over 17 countries and do research and development in three countries. We look at all newinvestment projects both domestic and overseas using exactly the same criteria”. The execution fromcompany A continues, “of course most of the key posts in our subsidiaries are held by home countrynationals. Whenever replacements for these men are sought, it is practice, if not the policy, to looknext to you at the head office and pick someone (usually country national) you know and trust”.

Company B.

“We are a multinational firm. Only 1 percent of the personnel in our affiliate companies arenon-national. Most of these are US executives in temporary assignments. In major markets, theaffiliates managing director is of the local nationality”. He continues, “Of course there are very few

non-Americans in the key posts at headquarter. The few we have are so Americanized that weusually do not notice their nationality. Unfortunate you cannot find good foreigners who are willing tolive in the United States, were out headquarters is located. American executives are more mobile. Inaddition, American has the drive and initiates we like. In fact, the European nationals would prefer toreport to an American rather than to so other European”.

Company C:

“We are a multinational firm. Our product division executives have world w profit responsibility. As our organizational chart shows, the United States is just one region par with Europe, Latin America, Africa, etc. in each division”. The executives from company C go on to explain, “The

Worldwide product division cone is rather difficult to implement. The senior executives in charge ofthese divisions have overseas experience. They have been promoted from domestic posts and tendto view fore consumer needs as really basicallythe same as ours. Also, product division executives tend focus on the domestic market because thedomestic market is larger and generates more revenue than the fragmented foreign markets. Therewards are for global performance, but strategy is focus on domestic. Most of our senior executivessimply do not understand what happens overseas and really do not trust foreign executives, eventhose in key positions”.

Company D (non-American):

‘We are a multinational firm. We have at least 18 nationalities represented at ourheadquarters. Most senor executives speak at least two languages. About 30 percent of our staff atheadquarters is foreigners. He continues by explaining “since the voting shareholders must by lawcome from the home country, the home country’s interest must be given careful consideration. But weare proud of our nationality; we should not be ashamed of it. In fact, many times we have beenreluctant to use home country ideas overseas, to our detriment, especially in our U.S. Subsidiary. Ourcountry produces good executives’ who tend to stay with us a long time. It is harder to keepexecutives from the United States.



CHAPTER 4

INTERNATIONAL BUSINESS APPROACHES

International business approaches are similar to the stages of internationalization orglobalization. Douglas Wind and Pelmutter advocated four approaches of international business.They are:

1. Echnocentric Approach

The domestic companies normally formulate their strategies. Their product design and theiroperations towards the national markets, customers and competitors. But, the excessive productionmore than the demand for the product, either due to competition or due to changes in customerpreferences push the company to export the excessive production to foreign countries. The domesticcompany continues the exports to the foreign countries and views the foreign markets as an

extension to the domestic markets just like a new region. The executives at the head office of thecompany make the decisions relating to exports and, the marketing personnel of the domesticcompany monitor the export operations with the help of an export department. The company exportsthe same product designed for domestic markets to foreign countries under this approach. Thus,maintenance of domestic approach towards international business is called ethnocentric approach.Organization structure of Ethnocentric Company, this approach is suitable to the companies duringthe early days of internationalization and also to the smaller companies.

Managing Director • Manager

• R & D manager

• Finance Manager

• Production

• Manager

• Human

• Resources

• Manager

• Marketing

• Assistant Manger

•

North India• Assistant Manager

• South India

• Assistant Manager

• Exports

2. Polycentric Approach



The domestic companies, which are exporting to foreign countries using the ethnocentricapproach, find at the latter stage that the foreign markets need an altogether different approachThen, the company establishes a foreign subsidiary company and decentralists all the operations anddelegate’s decision-making and policy-making authority to its executives. In fact, the companyappoints executives and personnel including a chief executive who reports directly to the Managing

Director of the company. Company appoints the key personnel from the home country and thepeople of the host country fill all other vacancies. Organization Structure Of Polycentric Company.

3. Regiocentric Approach

The company after operating successfully in a foreign country thinks of exporting to theneighboring countries of the host country. At this stage, the foreign subsidiary considers the regionsenvironment (for example, Asian environment like laws, culture, policies etc.) for formulating policiesand strategies.

However, it markets more or less the same product designed under polycentric approach inother countries of the region, but with different market strategies.

4. Geocentric approach

Under this approach, the entire world is just like a single country for the company. They select theemployees from the entire globe and operate with a number of subsidiaries. The headquartercoordinates the activities of the subsidiaries. Each subsidiary functions like an independent andautonomous company in formulating policies, strategies, product design, human resource policies,operations etc.

• Managing Director

• CEO

• Foreign Subsidiary(Uganda)Manager

• R&D Manager

• Finance Manager

• Production Manager

• Human Resource Manager

• Marketing Managing

• Director

• CEO

• Foreign Subsidiary Manager

• R&D Manager

• Finance Manager



• Marketing

Organization Structure of Geocentric Company

Theories of International Business The fundamental question that arises for most of us at this juncture, is why should the business firms of one country should go to the another country, when the



industries of that country also produce goods and market them. What is the basis for internationalbusiness? A number of theories have been developed to explain the basis for international businessComparative Cost Theory It is quite common that some countries have the advantage of producingsome goods at a lower cost compared to other countries. This is due to the availability of cheaplabour, skilled labour, cheap and qualitative raw materials, advanced technology, competentmanagement practices etc. Availability of these factors enhances productivity and thereby reducesthe cost of production per unit. Similarly, other countries have this advantage in producing othergoods. For example, Japan has the advantage in producing electronics at low cost whereas India has

similar advantage in producing textiles. According to comparative cost theory the countries in the longrun will tend to specialize in the business (production and marketing) of those goods in whosebusiness they enjoy comparative low cost advantage and import other goods in which the countrieshave comparative cost disadvantage, if free trade is allowed. This specialization helps for the mutualadvantage of the countries participating, in the international business.

David Ricardo illustrated the Comparative Cost Theory in 1817. He used a two country, twocommodity model. The conclusions of his model are: Business between two countries is profitablewhen a country produces one good at a lower cost than other country and that other producesanother good at a lower cost than the former country. Business between two countries is alsoprofitable when one country produces more than one product efficiently, but, when it produces one of

these products comparatively at greater efficiency than the other product. Both the nations canengage in international business when one country specializes in the production in which it hasgreater efficiency in production.

Assumptions of the Theory:

The assumptions of the comparative cost theory include:•The only element of cost of production is, labour.•Production is subject to the law of constant returns.•There are no trade barriers.•Trade is free from cost of transportation.

Derivates of the Theory:

The advantages desired from this theory are:

•Efficient allocation of global resources•Maximization of global production at the least possible cost•Product price, become more or less equal among world markets•Demand for resources and products among world nations will be optimized

Thus, we learn from this theory that, the basis for international business is the comparative

advantage of the nations to produce certain products at lower cost than other countries. TheOpportunity Cost Theory Another example is that, India produces textile garments by utilizing itshuman resources worth of Rs I billion and exports to the US in 1999. The opportunity cost of thisproject is, had

• Managing Director

• CEO

• Foreign Subsidiary(Uganda)Manager

• R&D Manager

• Finance Manager





• Marketing Managing

• Director

• CEO

• Foreign Subsidiary Manager

• R&D Manager

• Finance Manager

• Production Manager • Human Resource Manager

• Marketing

India developed software packages by utilizing the same human resources and exported thesame to USA in 1999; the worth of the exports would have been Rs 10 billion. Opportunity costapproach specifies the cost in terms of the value of the alternatives, which have to be foregone inorder to fulfill a specific act. Thus, this theory provides the basis for international business in terms ofexporting a particular product rather than other products. The previous example suggests that itwould be I India to develop and export software packages rather than textile garments to USA. Weslightly modify the previous example. For example, assume that India earned Rs 15 billion byexporting the same software packages to UK in 1999 rather than to USA. This theory suggests thatthe opportunity cost of India’s software exports to USA in 1999 is Rs 15 billion. Thus, this theory alsoprovides the basis for international business of exporting a product to a particular country rather toanother country.

The Modern Theory of Factor Endowments (Heckscher Ohlin Thesis) Bertil Ohlin and ElHeckscher explained the basis of international business in terms of factor endowment. This theoryexplains the reasons for comparative cost differences. They are: Different prevailing endowments ofthe factors of production and Different factors of production are to be used in different degrees ofintensity for producing different goods. According to this theory a country will specialize in theproduction and export of those goods whose ratio between capital and other factors of production is

higher than those in other countries.

Assumptions:

Heckscher Ohlin theory is built on the following assumptions:

Perfect competition is in existence for both product and factors in both the countries. Factors ofproduction are fixed in each country. Factors of production are of equal quality in both the countries.Factors of production have full employment in both the countries Factors endowments vary from onecountry to another country. Business between two countries is free from all barriers. There is no costof transportation; Production in both the countries is subject to law of returns Factor intensity varies

between goods.

Merits: Despite the assumptions, this theory enjoys the following merits: This theory provides morevalid basis for the existence of international business compared to the other theories.

•This theory is superior to the comparative cost theory as it provides the reasons for thedifference in cost of production in two countries in terms of differences in factor endowments.•The theory specifies that international business is an extension to domestic or interregiona

trade.



Hence, this theory is viewed as the modern theory of international business. This theoryis also called General Equilibrium Theory of international business as it deals with theequilibrium between demand for and supply of the products.

•This theory indicates the impact of international business on product and factor prices.

Derivatives:

The ultimate conclusions we draw from this theory are:

•Price of the internationally traded products tend to be equalized in all the countries of theglobe and in all the regions of each country. However, existence of the cost of transportation andnonexistence of perfect competition are the limitations to this conclusion.

•Prices of factors of production also tend to equalize across the globe. However, existence ofthe cost of transportation and the nonexistence of the perfect competition are the limitations to this

conclusion also. Ultimately we can learn from this theory that the tendency of equilibrium ofproduct/service prices and the prices of factors of production is the basis for international business.

Adam Smith’s Theory of Absolute Differences in Cost According to Adam Smith, every country shouldspecialize in Producing those products, which it can produce at less, cost than that of other countriesand exchange these products with other products.

These other products are produced absolutely at less cost by other countries. According toSmith, “whether the advantage which one country has over another be natural or acquired is in thisrespect of no consequence.” Criticism: According to this theory every country should be able toproduce certain products at low cost compared to other countries and should produce certain otherproducts at comparatively high price than other countries. International trade takes place only under

such condition. But, in reality most of the developing countries do not have absolute advantage ofproducing at lowest cost any commodity, yet they participate in international business.

The Productivity Theory

It is criticized that the comparative cost theories are not applicable to developing countries.Hence, H.Myint proposed productivity theory and the vent for surplus theory. The productivity theorypoints toward indirect and direct benefits. This theory emphasizes that the process of specializationinvolves adapting and reshaping the production structure of a trading country to meet the exportdemands. Countries increase productivity in order to utilize the gains of exports. This theory

encourages the developing countries to go for cash crops, increase productivity by enhancing theefficiency of human resources, adapting latest technology etc.

Limitations: However, this theory has also certain limitations.

•Labour productivity did not increase after certain level•Increase in working hours•Increase in proportion of gainfully employed labour in proportion to disguised unemployedLabour

The Vent for Surplus Theory



International trade absorbs the output of unemployed factors. If the countries produce morethan the domestic requirements, they have to export the surplus to other countries. Otherwise, a partof the productive labour of the country must cease and the value of its annual Produce diminishes.Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. Thissurplus productive capacity is taken by another country and in turn gives the benefit underinternational trade.

Appropriateness of this Theory for Developing Countries:

According to this theory, the factors of production of developing countries are fully utilized. Theunemployed labour of the developing countries is profitably employed when the vent for surplus isexported. International trade permits for more efficient use of capital and labour. Hence I.S. Mildescribed this theory as, “serving relic of the Mercantile Theory.”

Mill’s Theory of Reciprocal Demand

Comparative cost advantage theories. Do not explain the ratios at which commodities areexchanged for one another. J.S. Mill introduced the concept of ‘reciprocal demand’ to explain the

determinations of the equilibrium terms of trade. Reciprocal demand indicates a country’s demand forone commodity in terms of the other commodity; it is prepared to give up in exchange. Reciprocaldemand determines the terms of trade and relative share of each country.

Equilibrium = Quality of a product exported by country A

Quality of another product exported by country B

Assumptions:

Assumptions of this theory are: Existence of two countries, trade in only two goods, both the

goods are produced under the law of constant returns, absence of transportation Costs. Existence ofperfect competition and existence of full employment.

Pdm 130 International Business

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