Globalization and International Business
After reading this chapter, you should be able to:
- Understand the fundamental concepts and features of globalization
- Comprehend the evolution and growth of international business
- Distinguish between domestic and international business
- Analyse the different modes of entry into international business
JOURNEY OF THE WIMBLEDON TENNIS BALL
Wimbledon is the oldest tennis tournament in the world. It is one of the four Grand Slam tournaments and the only one still played on a grass court. The tournament is synonymous with all things British—the royalty, strawberries and cream and the legendary summer.
At the heart of the tournament is the little green ball manufactured by British MNE Slazenger, which travels more than 50,000 miles before it lands at centre court. The ball has to conform to certain specifications to find a place at Wimbledon. It has to be two-and-a-half inches (6.35cm) in diametre, have a weight of two ounces (56.7g), needs a water repellant barrier for protection against the rain, should be able to bounce between 53–58 inches after being dropped onto concrete from a height of 100 inches, is packed in a pressurized tin and stored at a temperature of 68 degree Fahrenheit.
The Slazenger balls travel over 50,000 miles between 11 countries and across four continents in their quest for perfection. Their complex supply chain has materials shipped from all over the world for manufacturing to Bataan in Philippines. Clay is shipped from South Carolina in the US, silica from Greece, magnesium carbonate from Japan, zinc oxide from Thailand, sulphur from South Korea and rubber from Malaysia. Wool is then shipped from New Zealand all the way to Stroud in Gloucestershire (UK), where it is woven into felt and then flown back to Bataan. The final production needs petroleum naphthalene from Zibo in China and glue from Basilan in the Philippines. The balls are then packed in tins which are shipped in from Indonesia and sent to Wimbledon.
The Slazenger supply chain is a typical example of locating production close to the source of materials in order to minimize cost. The manufacturing journey of the tennis ball is typical of the global nature of modern production aimed at searching for the most cost effective destinations across the world.
In doing so however, Slazenger has a huge carbon footprint and incurs a huge environmental cost!
References: The Unbelievable Journey of a Wimbledon Tennis Ball, https://www.forbes.com; Wimbledon tennis balls travel over 50,000 miles to arrive at centre court, https://www.theguardian.com; The 50,000 mile journey of Wimbledon’s tennis balls, https://www.wbs.ac.uk; last accessed on 2 October 2018.
Globalization is a popular term of usage these days. It is a common expression for a number of changes that can be observed in the global economy over the last couple of decades. It includes various processes which range from changes in economic systems, cultural homogeneity or sameness and worldwide changes in the political system.
Globalization is the process of increasing interconnectedness in the global economy, such that events in one part of the world have an effect on people and societies in various other corners of the globe. Globalization is the result of the phenomenon of convergence, which is the tendency for the tastes and preferences of people in different countries to become similar, leading to a sameness or homogeneity.
Globalization is the process of increasing interconnectedness in the global economy, such that events in one part of the world have an effect on people and societies in various other corners of the globe. However, globalization is not a single, all-encompassing process sweeping the globe. It may be described as a series of processes which results in products, people, companies, money and information being able to move freely to different parts of the world regardless of national geographical boundaries.
Globalization is the result of the phenomenon of convergence, which is the tendency for the tastes and preferences of people in different countries to become similar, leading to a sameness or homogeneity. Convergence is encouraged by increasing global linkages, that is, networks of individuals, institutions and countries which are tied together in terms of trade, financial markets, technology and living standards.
Globalization is therefore a shorthand expression for a variety of processes encompassing worldwide integration of financial systems, trade liberalization, deregulation and market opening, and increasing cultural, economic and social homogeneity or sameness.
There are two viewpoints which explain the current phenomenon of globalization:
- The Hyperglobalists consider globalization to be characterized by the declining powers of the nation state and increasing power of the TNC. They emphasize the decline of national cultures and hail the emergence of a global cosmopolitan corporate culture as the basic defining feature of globalization.
- The Transformationalists consider globalization to be characterized by a set of uneven processes and shifting patterns of change in the functions and powers of companies and governments. It considers globalization to be a changing global order which is characterized by deepening integration and fragmentation through the emergence of other important forces, such as regionalism. This view of globalization accepts the accelerated impact of economic globalization, at the same time recognizing local differences, with deep social and cultural roots, leading to underlying tensions in the global business environment. As the transformational view takes note of the underlying complexity of the globalization processes, it is widely recognized as a more valid approach than the hyperglobalization school of thought.
The process of globalization is not a new phenomenon, but the current phase of globalization is different from earlier episodes in terms of its scope and the degree of interdependence between different participants—individuals, organizations and countries. The increased intensity of the globalization process is the result of advances in international trade and investment as well as developments in technology, transport and electronic commerce.
Developments in communication and transportation technologies have moved the world towards becoming a ‘global village’ of interdependent people. Goods and services, as well as people, travel between continents, and this has led to an economic system that moves across national boundaries and markets. National markets and their associated economic systems are no longer isolated from one another by distance, time or culture: they have merged into one huge global market. Global linkages result in people in many countries wearing jeans, drinking cola and eating pizza and hamburgers.
In a nutshell, globalization refers to the emergence of a single, global business civilization: a remarkable event, which has both positive and negative aspects. For instance, changes in FDI rules in India are opening the doors for the global retail industry. This will give the Indian consumer the choice of a number of global products, but there is a growing fear that this will lead to unemployment of a large number of small indigenous retailers.
ELEMENTS OF GLOBALIZATION
Globalization, as discussed earlier, does not have a single unified form. It comprises interconnected, interdisciplinary and diverse elements (refer to Figure 1.1), which we shall discuss in this section.
Economic globalization is characterized by the emergence of increased global flows of international trade and investment. Its main agents are companies, investors, banks, financial institutions, private-sector industries, nation states and international institutions.
There are three elements of globalization—economic, political and cultural.
Economic globalization has led to the growth and development of international business through the creation of globalized business corporations. These global business corporations are known by various names, such as a multinational enterprise (MNE), or multinational corporation (MNC) and the transnational corporation (TNC) and are the face of international business. The simplest description of the TNC is that it is a business enterprise which has business activities beyond its national boundaries through the ownership or control of production or service facilities.
Figure 1.1 Elements of Globalization
Cultural globalization is a process of cultural homogeneity or having similar tastes, all over the global economy. The globalization of culture, visible in the form of a common preference for things such as McDonald’s burgers, Nike shoes, iPods and BlackBerrys, is a symbol of global similarity of taste.
This may be seen in the form of a common global preference for products such as McDonald’s burgers, Nike shoes and iPods. The phenomenon of cultural globalization consists of issues of cultural homogenization versus cultural hybridization. Cultural homogenization is the outcome of the impact of ideas and images that are able to travel globally due to the developments in telecommunication and the Internet. Cultural hybridization is the adaptation of global products and ideas according to local tastes and preferences. Cultural globalization therefore, is actually a process of glocalization, or the amalgamation of the global with the local. It assigns a local flavour to global products such as the vegetarian McDonald’s burger, cell phones with vernacular keys, and cartoon characters Tom and Jerry speaking Hindi so that they can fit better in the receiving culture.
Political globalization refers to processes of changes in the rules and structures of global governance. The global economy has seen several changes in political structure and ideology after the end of the two world wars.
Globalization is the process of increasing interconnectedness of the global economy as a result of convergence of tastes and preferences. Globalization consists of diverse, interconnected and interdisciplinary elements which may be economic, political and cultural in nature.
These include the rise and fall of socialism, the emergence of global and regional institutions of governance such as the International Monetary Fund (IMF), World Bank and the World Trade Organization (WTO). There has also been a move towards both trade and investment liberalization and the emergence of regional trading blocs such as the European Union and NAFTA, all of which you will read about in greater detail in later chapters.
International business refers to any business activity which involves the transfer of resources, goods, services, knowledge, skills or information across national boundaries. These activities may pertain to the production of physical goods or to the provision of services such as banking, finance, insurance, education, construction, etc. The activities that comprise international business are referred to as international transactions and take the form of international trade, international investment, and joint ventures and strategic alliances. International trade is the process of buying and selling of goods and services between nations also known as export and import. International investment is the process of investing resources in business activities outside the home country. Joint ventures and strategic alliances are contractual business arrangements between firms in different countries.
International business refers to any business activity which involves the transfer of resources, goods, services, knowledge, skills or information across national boundaries. These activities may pertain to the production of physical goods or to the provision of services such as banking, finance, insurance, education, construction, etc.
The main players in international business are individuals (through tourism or investment in shares and debentures), global business corporations—TNCs, as well as global financial institutions (IMF, World Bank and central banks of different countries) and governments. TNCs, however, are the most significant players in international business. The earliest TNCs originated in the developed regions of the world and were characterized by multiple operations at multiple sites in the global economy. These business organizations were gigantic corporations employing thousands of people and earning billions of dollars in revenue across the world. The TNCs of the present day, however, are found all over the globe and belong to both developed and developing nations. They have used various modes of entry into global markets and span the spectrum across industries as well.
The term TNC refers to a business enterprise with trade or investment operations in multiple global locations.
The world’s largest non-financial TNCs in 2017 ranked according to assets are Royal Dutch Shell (UK), Toyota Motor Corporation (Japan), Total SA (France), BP Plc (UK) and the Volkswagen Group (Germany).
The world’s largest non-financial TNCs ranked according to assets from the developing and transition economies in 2016 are CK Hutchison Holdings Limited (Hong Kong China), China COSCO Shipping Corp Ltd (China), Hon Hai Precision Industries (Taiwan), China National Offshore Oil Corporation (China), Samsung Electronics (Korea).1
The term TNC can be defined in several different ways—an easy workable definition is that it is a business enterprise with trade or investment operations in multiple global locations.
A typical TNC has the following characteristics:
- It has the ability to coordinate and control various stages of individual production chains within and between different countries.
- It has the ability to take advantage of geographical differences in the distribution of factors of production (natural resources, capital, and labour) and state policies (taxes, trade barriers, and subsidies).
- It also has the geographical flexibility to be able to switch and re-switch resources and operations between locations at an international level.
The transnationality index (TNI) is a measure of the degree of internationalization of a business enterprise. The Index has been compiled by the UNCTAD since 1990 and is composed of the average of three ratios—foreign assets/ total assets, foreign sales/total sales, and foreign employment/total employment. The TNI is a measure of globalization is driven by the growing foreign operations of MNEs. As expressed by the Transnationality Index (TNI), the internationalization of the top 100 companies (which are ranked by their foreign assets) has paralleled world FDI flows. The growth of MNEs began in the 1990s and has seen two main phases of expansion: between 1993 and 1997, and between 2003 and 2010. Since then, the internationalization index has been relatively stable – pushed up by waves of consolidation in some sectors, on the one hand, and dampened by slowing economic growth and international trade on the other. The overall transnationality of the world’s top 100 TNCs grew from 51 per cent in 1990 to 55 per cent in 1997, but fell to 52.6 per cent in 2001. The degree of internationalization of the world’s largest TNCs remained unchanged in 2012–13 as domestic production was in excess of foreign production, and is estimated to be 66 per cent in 2015.2
The transnationality index (TNI) is a measure of the degree of internationalization of a business enterprise.
TNCs – A CLASSIFICATION
Traditional TNCs: The typical traditional TNCs originated in the developed world. They were huge organizations with vast resources, operations in more than 100 countries, and multiple sites covering R&D, production, logistics, marketing and customer support. Examples from this category include General Electric, Ford, General Motors and AT&T, all from the US. Among the first TNCs to own foreign production facilities, have worldwide distribution networks and market their products as a global brand, was Singer Sewing Machine (presently known as Singer Sewing Company). In 1868, it built a factory in Scotland, the first successful American venture into foreign production. By 1880, the company was a global organization with an outstanding sales organization and several overseas manufacturing plants.
Dragon TNCs or latecomer TNCs refer to a cluster of firms, many of which originated from the peripheral regions of the global economy in a phase of catch-up industrialization and emerged as challengers to the existing large TNCs, and successfully established themselves in the global marketplace. Examples include Cemex from Mexico, Petronas from Malaysia, Samsung Electronics and LG from Korea and Lenovo from China.
Born global firms bypass internationalization as a process as they start and operate from day one in global markets as global players, servicing their customers wherever they are to be found. Examples include Logitech and Skype.
Micro TNCs are a separate body of internationalized SMEs that control and manage value-adding activities in more than one country, using advanced market servicing modes. This category includes Dutch animal nutrition and fish feed firm Nutreco, or the German renal dialysis machines firm turned global health services provider Fresenius.
State-owned TNCs are enterprises comprising parent enterprises and their foreign affiliates in which the government has a controlling interest. Examples include ONGC from India.
GROWTH OF INTERNATIONAL BUSINESS
The following factors have acted as drivers of globalization and international business.
The world economy has seen a massive economic change since the end of World War II. The most significant development has been the rise and fall of socialism. Post World War II saw the emergence of USSR and its allies as supporters of socialism as opposed to the capitalist strength of the US and other European countries. The 1980s saw the followers of socialism move towards free market principles, and led to the creation of 15 independent countries out of the Soviet Union, Czechoslovakia got divided into two nation states and Yugoslavia was divided into five successor states after a fierce civil war.
Economic Liberalization in Developing Nations
Large parts of the developing world also made a move to a market-based system. This includes countries such as Brazil, China and India. China has a hybrid system since it follows socialist principles, combined with a market orientation since 1978, creating huge opportunities for trade and investment flows. India followed a similar path towards market oriented reform and had since opened up its economy to global flows of capital.
The Latin American nations, many of which were under totalitarian rule since the end of World War II, have taken to both democracy and market-oriented reforms since the 1980s. Characterized by cycles of low growth, high debt and high inflation, all of which discouraged investment, these economies have now shown a fairly remarkable turnaround as a result of market-oriented reform packages. Today the BRICS countries (Brazil, Russia, India, China and South Africa) are among the largest markets in the world.
Globalization of Supply Chains
It refers to the sourcing of goods and services from different parts of the world as a result of increased mobility of factors of production in order to take advantage of differences in cost and quality. Traditionally, firms in the manufacturing sector have outsourced business operations to reap the benefits of better quality and lower costs. Improvements in modern communication technology, especially the internet, have now enabled the outsourcing of non-core business functions to low-cost destinations of the world. These outsourced functions range from simple back-office functions such as payroll accounting and customer call centres to specialized functions such as legal document processing and medical and hospital functions.
Globalization of Demand
It is the result of increasing interconnectedness among distinct national markets to form an integrated global structure. Facilitated by trade and invest ment liberalization, the growing demand for global brands such as McDonald’s, Nike, Coca-Cola, and Apple is a sign of growing global markets and has acted as a driver of international business. International business has grown due to increasing demand for global brands.
Emergence of Regional Trading Blocs
Trade volumes have increased as a result of a progressive reduction of tariff and on tariff barriers to trade and an increasing trend towards regional unification. The rise of preferential trading arrangements such as the European Union (EU) and the North American Free Trade Arrangement (NAFTA) have helped to create huge markets with increased opportunities for trade and investment.
The global political system has also seen major changes since World War II. This includes the rise and fall of socialism in Eastern Europe and parts of Africa beginning in the 1980s. The global financial crisis of 2008 however, has reinforced the role of the state even in purely capitalist economies. There are several hybrid models as well such as China which has a unique model of market socialism, since it opened up its economy to free market forces in 1978, but is guided by the state in its trade and investment decisions.
The growth of international business has been significantly driven by advances in communication, information technology and transportation technology through an increased flow of ideas and information across borders. Thus, we find that telecommunications has created a global audience and transport has created a global village. The technological revolution is driven by the following factors.
Discovery of the Microchip
The microchip is the most important innovation of the twentieth century, enabling an information revolution in the global economy. It has been the basis of the development of satellites, optical fibre and wireless technologies helping to create a global marketplace with the help of the Internet and the World Wide Web.
The Internet, cable and satellite TV connects a plethora of small business firms across the globe by giving them access to information on all aspects of business. For instance, global communication networks help manufacturing processes to be coordinated at different physical locations worldwide and also for the same advertising message to reach consumers in different countries.
There have been several major innovations in transportation technology since World War II. The most important of these are the development of commercial jets and super-freighters and the introduction of containerization. The advent of commercial jet travel has effectively shrunk the globe by cutting down considerably on travel time. There has also been an increase in the share of cargo travelling by air as a result of improvements in air travel.
Widespread containerization in the 1970s and 1980s has resulted in a four-fold growth of the world’s container fleet, reflecting growth in international trade as a result of the use of improvement in the modes of transporting goods across the world. The use of containerized transport has helped to reduce time, labour and cost in moving goods from one part of the world to another. The modern container industry was born as a result of a war surplus oil tanker moving from New Jersey to Houston with aluminium containers welded to its steel frame and has been a major driver of international business.
Emergence of Global Governance
The growth of international business activities led to the need for global institutions to manage and regulate the global marketplace and led to various multinational treaties in trade and investment. These organizations include the WTO (and GATT, its predecessor) in the area of international trade and the World Bank and the IMF in the area of international finance and the global monetary system. The UN, along with its associated institutions, is committed to preserving world peace through inter national cooperation and collective security.
IMPACT OF GLOBALIZATION
The process of globalization has had both positive and negative impact on the world economy. It therefore finds arguments in favour and against the phenomenon.
The global value chain and dispersal of production: Globalization has made the production process globally dispersed and created the global value chain. Global value chains aim at using the most economical location for the production of goods and services. TNCs are able to manage globalized production systems due to declining transportation costs and technological innovations to access low wage locations. Dell, for instance, manufactures laptops and computers holding only three days’ worth of inventory at its assembly locations. This is possible since Dell uses an internet based system for receiving orders and transmitting them to suppliers across the world.
Creation of a global marketplace: Globalization has created a customer base with homogeneous needs. Blue jeans, the I-Phone and I-Pad, McDonald’s burgers, Starbucks coffee and Netflix are all examples of products which are demanded across the world. This has been made possible as a result of declining trade and investment controls leading to growth and expansion of international business, translating into better living standards in almost all countries which have opened up. Thus, we find that Bollywood is a global industry and Indian classical and contemporary music finds an audience across the globe as a result of technological advances and platforms such as YouTube.
Globalization and national culture: We have seen that globalization has made the world into a ‘global village’ but homogeneous demand created by TNCs often has to be adapted to differences in national culture and business practices. The iconic Big Mac burger from McDonalds which is made with beef in the US, had to be modified in India according to religious beliefs and the beef patty was replaced with a chicken filling. Sandwich giant Subway, had to similarly modify its menu according to local taste and add items such as ‘chicken tikka’ as sandwich fillings. Pizza giant Dominos goes a step further and serves pizza made with water chestnut flour during the auspicious period of ‘Navratri’, to cater to India’s fasting population. The impact of culture is a two-way process and the influence of a foreign culture is often visible in the host country as well. Thus, we find that ‘Chicken Tikka Masala’ overtook fried fish and chips to become Britain’s national dish for the last couple of decades. More recently the British population has taken to drinking the healthy ‘Turmeric Latte’ as a popular drink – which is nothing but ‘haldi doodh’ from its former Indian colony.
Adverse impact on jobs and income in developed countries: It is often argued that shifting production to low cost destinations such as India for the IT industry or Bangladesh for apparel manufacturing, has an adverse impact on employment and income for workers in developed countries. To count the argument, it is seen that in the long run the reduced costs of production leads to increased demand and more consumers worldwide, which has on overall beneficial effect on production and thereby on jobs and income levels.
Loss of national sovereignty: A nation’s sovereignty depends on its freedom to govern and manage its own affairs. Increasing globalization often creates gigantic and powerful TNCs which interfere in a country’s political, social and economic system. They can put governments under pressure through lobbying and campaign contributions, thus influencing the legislative process. TNCs such as Walmart have revenues in excess of the GDPs of small countries like Greece and Poland. It is important for governments across the world to have a strong regulatory structure which ensures that business is run on market principles and not political processes.
Exploitative work practices: It is seen that in shifting production to low cost production sites in the developing countries, TNCs across the world use exploitative techniques which are forbidden in their own countries. This includes the use of child labour, paying low wages, having long working hours and not following traditional safety rules. The aftermath of the Bhopal Gas Tragedy in India at the hands of US TNC Union Carbide haunts the city more than three decades after the event. TNCs take advantage of weak legal systems and weaker enforcement to get away with creating a working environment in developing countries which they would not dare to do in their countries of origin.
Environmental degradation: Large scale global production has taken a heavy toll on the global environment. This is visible in the form of climate change all over the world, as nature’s resources are put to unsustainable use. As you saw in the opening case of this chapter the Wimbledon tennis ball is manufactured using products from eleven countries across four continents. However, the effort to create a perfect, low cost product has a huge environmental footprint and a cost for the planet. Depleting water levels in Kerala, led to a ban on the production activities of Coke in the Indian state. Many TNCs however, have taken stringent environmental measures at the cost of profit to protect the environment. These include Ford and General Motors in Mexico, Benetton in Italy and Kirin in Japan.
INTERNATIONAL VERSUS DOMESTIC BUSINESS
International business usually follows domestic business—traditionally a business firm establishes itself in the domestic market before exploring foreign markets. Large international TNCs such as Toyota, Honda and Mitsubishi began their operations in the domestic market and subsequently expanded their footprints into the international market. The Indian pharmaceutical firm Ranbaxy also started operations domestically before making its first foray in the international market as an exporter. Although international business is often an extension of domestic business, there are significant differences between the two.
The major differences between domestic and international business arise on account of business environments, increased risk and uncertainty and operational complexities.
Diverse business environments: International business operates in a diverse business environment as it is located in different countries. The business environment of an international business firm has different economic, cultural and politico-legal facets. Countries differ with regard to their currency, inflation and interest rates, economic regulations, political systems, social customs, laws, and government rules and regulations. This gives rise to complexities for business firms, which have to learn to operate in varying situations and adapt to them. The fast-food major McDonald’s, which has a presence in almost all countries of the world, adapts its menu to local taste and religious leanings. In India, it has replaced beef products with chicken, and in the Middle East, it does not serve any products containing pork.
Enhanced risk and uncertainty: Business firms face risks on account of the unpredictability of operational and financial outcomes. Uncertainty refers to the unpredictability of environmental or organizational conditions that affect firm performance. International business firms operate in situations of increased risk since they operate in multiple work environments. International corporations work in multiple financial environments, receive payments in different currencies and have to deal with the harmonization of firm accounts from subsidiaries in different countries. Market supply and demand conditions in the domestic market differ significantly from the international market.
Operational complexities: Operationally, international business is often more difficult and costly to manage than activities in the domestic market alone. These difficulties manifest themselves in all functional areas of the business. For example, local employees and expatriates (employees from a foreign country) may have trouble getting along with each other because of cultural and language differences. The cultural diversity encountered when operating in several countries may create problems of communication, coordination and motivation in the employees of the organization. Organizational principles and managerial philosophies differ widely across nations, increasing the complexity of operation and management of international business. The extent of differences varies between firms and is determined by factors such as geographical proximity, cultural heterogeneity and political compatibility.
There are several reasons which motivate a firm to move on the internationalization path. These may be broadly classified as pull and push factors. Pull factors are offensive motives which pull a domestic business firm into foreign markets. Push factors, on the other hand, are defensive motives which force the domestic firm to react and move into the international arena. Firms are motivated to enter inter national markets as a result of push and pull factors.
International business is the process of conducting business across national boundaries through international trade, international investment and international contracts and strategic alliances. International business has grown as a result of economic, political and technological factors. It differs from domestic business in scale, scope, complexity and enhanced risk and uncertainty.
Some of the reasons of firm internationalization are as follows:
The main motives of firm internationalization are increased profits, growth, competitive factors and strategic factors.
Increased profits: The basic objective of a business enterprise is to maximize profits through increased revenues and/or reduced costs. International trade and investment are the means through which a business firm is able to benefit from differences in labour costs, availability of resources and capital, and differences in regulatory frameworks, such as taxation differences. The rapid growth of the outsourcing industry is an example of the ability of firms in developed parts of the world to take advantage of the low-cost skilled labour force in countries such as India, Ireland and the Philippines.
Growth: A business firm is able to grow and maximize its profits through the benefits of large scale production. If the domestic market is saturated or overcrowded, an increase in the scale of operations is possible only by tapping into the demand in foreign markets. This gives the firm the benefits of new markets, reduced costs and consequently leads to profits and growth.
Competition: Domestic competition also forces a firm to move to foreign markets. The need to protect its existing market position in the face of a change in the domestic environment is a challenge that forces a firm to look at an overseas market. On the other hand, changes in an international market provide a firm with an opportunity to tap a new market. For instance, the liberalization of the Indian economy since 1991 has provided an opportunity to foreign firms to explore Indian markets, and increased domestic competition has also forced domestic Indian firms to look overseas.
Strategic motives: A firm’s decision to internationalize is based on its own capabilities which give it an edge over its rivals and help it to secure a ‘first mover advantage’ in a foreign market. As a result, a firm is able to enjoy the advantages of technological leadership, brand image and competitive positioning.
Transnational corporations vary widely in the degree and nature of their international orientations.
International orientations reflect the attitude or strategic predisposition of a TNC towards doing things in a certain way. The analysis provided by Wind, Douglas and Perlmutter (1973)3 within the EPRG frame work is helpful in understanding the international orientation of firms in international business.
The EPRG framework identifies four types of attitudes or orientations towards internationalization that are associated with successive stages in the evolution of international operations. These are: (1) ethnocentrism, or home-country orientation, (2) polycentrism, or host-country orientation, (3) regiocentrism, or regional orientation, and (4) geocentrism, or world orientation. These stages reflect the philosophy of the company in planning its international operations and the strategies based on it.
Ethnocentrism is the belief that the domestic or home-country culture is superior to any other. A TNC with an ethnocentric orientation relies on the values and interests of the parent company in formulating and implementing its internationalization plans. In the ethnocentric company, overseas operations are viewed as secondary to domestic operations, and primarily as a means of disposing ‘surplus’ domestic production. The firm’s international operations, therefore, take the form of an export department or international division and are manned by domestic personnel or export agents. As international marketing is normally characterized by the extension strategy, the domestic product mix is used in the foreign market too.
Domestic strategies are assumed to be superior and used in the international markets also. Managers are brought from the domestic country to subsidiaries. The hierarchy of the organization is usually highly centralized and directly subordinated to the headquarters located in the home country.
As it entails minimal risk and commitment to overseas markets (no international investment is required, and no additional selling costs incurred, with the possible exception of higher distribution costs), the ethnocentric position is appropriate for a small company just entering international operations or for companies with minimal international commitments.
The ethnocentric strategy may be unsuccessful if the home and host country markets are very different. This may need the TNC to either change its orientation or exit the country. An example of this is Japanese TNC Nissan’s experience in the US. When Nissan began exporting cars to the US, it did not factor in the difference in the weather conditions. While Japanese winters are quite mild, the weather conditions in some states in the US can be very harsh, resulting in very low temperatures and heavy snow. In Japan, the popular practice was to cover the car against snow falls and other calamities. Nissan executives assumed that their US customers would do the same. However, the American customers wanted their products customized for weather conditions – and Nissan finally had to switch from its ethnocentric strategy towards being more polycentric.
As a company spends a significant amount of time in international markets, it begins to recognize the importance of inherent differences in various markets, giving rise to a polycentric attitude. It recognizes the fact that local personnel and techniques are best suited to deal with local market conditions, so it emphasizes decentralizing of control and granting of autonomy to its overseas units. Foreign market operations are carried out through independent subsidiaries which have independent control over its marketing objectives and plans. This leads to a strategy of market segmentation in formulating the marketing strategy. Local laws, customs and cultures are noticed, and great care is taken to understand the local way of doing business.
This usually results in the maximum degree of geographic decentralization as local managers are recognized as being psychologically close to markets, environments and customers. Under polycentrism, marketing is normally characterized by adaptation strategy. Polycentrism, thus, is the opposite of ethnocentrism. ‘When in Rome, do as the Romans do’ is the essence of polycentric orientation.
A regiocentric company views different regions as different markets. Regions with important common marketing characteristics are regarded as a single market, ignoring national boundaries. Strategy integration, organizational approach and product policy tend to be implemented at a regional level. Objectives are set by negotiation between headquarters and regional headquarters on the one hand, and between regional headquarters and individual subsidiaries on the other. Market segmentation is based on finding regions (groups of countries) similar to each other. These similarities may be based on economic, cultural or political backgrounds. General Motors is a TNC with a regiocentric orientation as it has significantly different strategies in Europe, Americas and Asia. Top managers in different regions have considerable freedom in decision making. McDonald’s, the fast food giant, also recently adopted a regiocentric approach as it clubbed its global markets based on broad regional features.
A geocentric company views the entire world as a single market and develops a standardized marketing mix, projecting a uniform image of the company and its products for the global market. The business of the geocentric multinational is usually characterized by sufficiently distinctive national markets in which the ethnocentric approach is unworkable, and in which the importance of learning-curve effects in marketing, production technology and management makes the polycentric philosophy substantially sub-optimal. Developments in technology and increase in the rate of exchange of information has led to the formation of transnational enterprises called ‘Born Global’ who have a geocentric orientation from the very beginning of their existence.
There is improved coordination and control under the regiocentric and geocentric orientations as well as a set of standard policies for the organization. However, the costs of collecting information and administering policies on a worldwide scale makes the geocentric approach more expensive compared to the regiocentric attitude. Further, national differences may constrain and restrict multinational operations and make the global market approach unpractical.
As the process of globalization intensifies TNCs often evolve and move from ethnocentricism towards a more polycentric, regiocentric or geocentric strategy. For instance, General Motors offered more than 200 types of radios as vehicle equipment on the Australian market as a consequence of its regiocentric orientation. In the aftermath of the recent financial crisis, it moved to a more geocentric orientation by reducing the number of radios to fifty, leading to a cost reduction of almost 40 per cent.
MODES OF ENTRY
A business firm has to make several important decisions when entering a foreign market. International entry strategies concern where (location selection), when (timing of entry), and how (entry mode selection) international companies should enter and invest in a foreign territory during international expansion. These entry strategies are important because they determine an MNE’s investment environment, operation treatment, resource commitment, and evolutionary path.
Entry mode refers to the nature of international transaction chosen by a business firm to enter a foreign market. The choice of entry mode for a business depends on the degree of foreign market involvement that it wants to have.
Entry mode choices fall into three categories—trade-related, transfer-related, and investment-related. There is an increasing level of resource commitment, organizational control, involved risks, and expected returns in this sequence.
Trade-related Entry Modes
Trade-related entry modes include exports and imports and countertrade.
Exports and Imports
Export is the most basic level of entry in international business in which the firm has domestic production facilities and sells its products abroad. Firms may export or import either goods or services. Goods are tangible products which can be seen, hence goods coming into the country are termed visible imports and goods leaving the country are termed visible exports. The difference between the exports and imports is termed trade balance or balance of visible items.
Export is the most basic level of entry in international business in which the firm has domestic production facilities and sells its products abroad.
Service exports and imports include banking, insurance, travel and tourism related services, which are intangible and personalized. Countries such as Greece and Norway earn a significant amount of foreign exchange from foreign cargo carried on ships owned by citizens of these countries. Similarly tourism is a major foreign exchange earner for countries like the Bahamas and Mauritius.
Figure 1.2 Modes of Entry
A firm can either export goods directly or through export intermediaries. Export intermediaries are third parties that specialize in facilitating imports and exports. These intermediaries may offer limited services such as handling only transportation, documentation, and customs claims, or they may perform more extensive services, including taking ownership of foreign-bound goods and/or assuming total responsibility for marketing and financing exports. This helps small firms which may not be very knowledgeable about the legal, financial, and logistical details of exporting and importing.
Exports as a mode of entry have the following advantages:
- Exporting helps the firm to gain first-hand knowledge and expertise about the foreign market.
- It requires less financial and managerial resources than other advanced modes of entry.
- Generally, exporting is a type of international entry open to virtually any size or kind of firm, since it requires fewer resources.
Countertrade is a form of trade in which a seller and a buyer from different countries exchange goods with little or no cash or cash equivalents, changing hands. Because of this nature, it is also viewed as a form of flexible financing or payment in international trade. Countertrade includes four distinct types of trading arrangements.
Countertrade is a form of trade in which a seller and a buyer from different countries exchange goods with little or no cash or cash equivalents, changing hands. The different forms of countertrade include barter, offset, buyback and counterpurchase.
- Barter is the direct and simultaneous exchange of goods between two parties without a cash transaction. Barter trade occurs between individuals, between governments, between firms, or between a government and a firm, all from two different countries. For example, France shipped 138,067 tons of soft wheat to Cuba during the first quarter of 2001, half of which was through the wheat-for-sugar barter arrangement under which French trading companies purchased sugar and agricultural commodities from Cuba’s government-run food trading company. Barter is risky because firms have to be sure that they are exchanging products which have a domestic market to enable them earn a profit.
- A counter purchase is a reciprocal buying agreement in which a firm sells its products to another at one point in time and is compensated in the form of the other’s products at some future time (e.g., Russia purchased construction machinery from Japan’s Komatsu in return for Komatsu’s agreement to buy Siberian timber). Counter purchase is more flexible than barter because the volume of trade does not have to be equal.
- An offset is an agreement whereby one party agrees to purchase goods and services with a specified percentage of its proceeds from an original sale. For example, the Shanghai Aircraft Manufacturing Corp., China, may buy jets from Boeing using its proceeds from manufacturing the tail sections of the jets for Boeing. Offset is particularly popular in sales of expensive military equipment or high cost civilian infrastructure hardware. Switzerland’s Pilatus Aircraft Ltd. has an offset agreement with the Indian Air Force resulting from the sale of the PC-7 MkII Training Aircraft System. As part of India’s defence procurement policy (DPP) 2005, counter-trade obligations were imposed on foreign firms that were awarded defence contracts worth more than INR 300 crore for the transfer of critical technologies and production of components. At the end of March 2013, India had 23 offset contracts worth USD 4.6 billion which were at various stages of execution. The first of these contracts was signed in 2007.
- Buyback (or compensation arrangement) occurs when a firm provides a local company with inputs for manufacturing products (mostly capital equipment) to be sold in international markets, and agrees to take a certain percentage of the output produced by the local firm as partial payment. For example, a steel producer might send its goods to a foreign company, which would use the steel to manufacture a product such as shelving. The steel producer would then buy back the shelves at a reduced price, in effect partially paying the manufacturer with the raw steel. Buybacks helps developing country producers to upgrade technologies and machinery, and ensure after-sale service. Chinatex, a Shanghai-based clothing manufacturer, and Japan’s Fukusuke Corporation, arranged a buyback, whereby the latter sold 10 knitting machines and raw materials to the former in exchange for 1 million pairs of underwear to be produced on the knitting machines.
Contractual Entry Modes
Contractual or transfer-related entry modes are those associated with transfer of ownership or utilization of specified property (technology or assets) from one party to the other in exchange for royalty fees. They differ from trade-related entry modes in that the user in a transfer-related mode ‘buys’ certain rights of transacted property (e.g., use of technology) from the other party (owner). These modes are extensively employed in technology-related or intellectual/industrial property rights related transactions. This category includes the following entry modes:
International leasing is an entry mode in which a foreign firm (lessor) leases out its new or used machines or equipment to the local company (often in a developing country). International lease arises largely because developing country manufacturers (lessee) do not have financial capability to buy the equipment. In this mode, the foreign lessor retains ownership of the property throughout the lease period during which the local user pays a leasing fee. The major advantages of this mode for TNCs include quick access to the target market, efficient use of superfluous or outmoded, machinery and equipment, and accumulating experience in a foreign country. From the local firm’s perspective, this mode helps reduce the cost of using foreign machinery and equipment, reduces operational and investment risks, and increases its knowledge and experience with foreign technologies and facilities. For example, in the late 1970s, Japan’s Mitsubishi leased 100 new and used heavy trucks to Chinese companies in such industries as conduction, mining, and transportation.
International leasing is an entry mode in which a foreign firm (lessor) leases out its new or used machines or equipment to the local company (often in a developing country) in return for a fee.
International licensing is an entry mode in which a firm transfers its intangible property such as expertise, know-how, blueprints, technology and manufacturing design to its own unit or to another firm for a specified period of time in exchange for a royalty fee. The firm transferring the technology is known as the licensor and the firm to whom transfer is being made is known as the licensee. Licensing allows the licensee to produce and market a product similar to the one the licensor has already been producing in its home country without requiring the licensor to actually create a new operation abroad.
International licensing is an entry mode in which a firm transfers its intangible property such as expertize, know-how, blueprints, technology and manufacturing design to its own unit or to another firm for a specified period of time in exchange for a royalty fee.
- A licensor can reap the benefits of exploiting innovative technology by expansion abroad without any additional investment.
- It involves less risk than entry through the investment mode. Even if market conditions become very adverse, the maximum that the licensor stands to lose is his technical fee.
- The licensee also benefits through the technical collaboration as he is able to upgrade his technical capability and improve his competitiveness in the global market.
- Loss of quality control is a major disadvantage of this entry mode. It is often difficult for the licensor to maintain satisfactory control over the licensee’s manufacturing and marketing operations. This can result in damage to a licensor’s trademark and reputation.
- A licensee overseas can also become a competitor to the licensor. If the original licensing agreement does not specify the region within which the licensee may market the licensed product, the licensee may insist on marketing the product in third-country markets in competition with, the licensor. For example, in the 1960s, RCA licensed its leading edge colour television technology to a number of Japanese companies including Matsushita and Sony. Matsushita and Sony quickly assimilated RCA’s technology and used it to enter the US market and to compete directly against it. As a result RCA is now a minor player in its home market, while Matsushita and Sony have a much bigger market share.
- Further, a local licensee may benefit from improvements in its technology, which it then uses to enter the MNE’s home market.
International franchising is an entry mode in which the foreign franchisor grants specified intangible property rights (e.g., trademark or brand name) to the local franchisee, who must follow strict and detailed rules as to how it does business. In exchange for the franchise, the franchisor receives a royalty payment that amounts to a percentage of the franchisee’s revenues. Compared to licensing, franchising involves longer commitments, offers greater control over overseas operations, and includes a broader package of rights and resources, which is why service TNCs such as KFC often elect franchising (whereas manufacturing firms often use licensing). Production equipment, managerial systems, operating procedures, access to advertising and promotional materials, loans, and financing may all be part of a franchise. The franchisee operates the business under the franchisor’s proprietary rights and is contractually obligated to follow the procedures and methods of operation prescribed in the business system. The franchisor generally maintains the right to control the quality of products and services so that the franchisee cannot damage the company’s image. Sometimes the franchisor insists that the franchisee must buy equipment or key ingredients used in the product from the franchisor only. For example, Burger King and McDonald’s require the franchisee to buy the company’s cooking equipment, burger patties, and other products that bear the company name.
International franchising is an entry mode in which the foreign franchisor grants specified intangible property rights (e.g., trademark or brand name) to the local franchisee, in return for a royalty fee.
- Franchising allows the franchiser to maintain consistency of its products in different markets.
- It is a low risk and low cost mode of entry which ensures a quick global presence for the fi rm.
- It provides a fast and easy avenue for leveraging assets such as a trademark or brand names for a global presence. For example, McDonald’s has been able to build a global presence quickly and at relatively low cost and risk by using franchises.
- The franchisee may harm the franchiser’s image by not upholding its standards.
- Even if the franchiser is able to terminate the agreement, some franchisees still stay in business by slightly altering the franchiser’s brand name or trademark.
Differences Between Licensing and Franchising:
- Franchising refers to a transfer of the total business function whereas licensing is a transfer of just a part of the business, including transfer of right to manufacture or distribute a single product or process.
- Franchising gives the company greater control over the sale of the product in the target market, since the franchiser has the right to revoke the franchise if the franchisee fails to abide with the stipulated rules and procedures.
- Licensing is common in manufacturing industries, whereas franchising is more common in service industries where the brand name is more important.
Turnkey projects also called build-operate-transfer (BOT) is an investment in which a foreign investor assumes responsibility for the design and construction of an entire operation, and, upon completion of the project, turns the project over to the purchaser and hands over management to local personnel whom it has trained. In return for completing the project, the investor receives periodic payments that are normally guaranteed. BOT is especially useful for very large-scale, long-term infrastructure projects such as power-generation, airports, dams, expressways, chemical plants, and steel mills. Managing such complex projects requires special expertize. Turnkey projects are mostly administered by large construction firms such as Bechtel (the US), Hyundai (Korea), or Friedrich Krupp (Germany). Large companies sometimes form a consortium and bid jointly for a large BOT project.
Turnkey projects also called build-operate-transfer (BOT) is an investment in which a foreign investor assumes responsibility for the design and construction of an entire operation, and, upon completion of the project, turns the project over to the purchaser.
Investment-related Entry Modes
In contrast to the preceding trade-related and transfer-related entry modes, investment-related entry modes involve ownership of property, assets, projects, and businesses invested in a host country. Foreign investment takes two forms—foreign direct investment (FDI) and foreign portfolio investment (FPI).
Foreign Direct Investment (FDI)
It refers to investment in the assets of a company for the purpose of control of overseas operations and economic activities. FDI-related entry modes involve higher risk and greater financial commitment than both trade and transfer-related choices. The country making the FDI investment is called the home country and the country receiving FDI is called the host country.
Foreign Portfolio Investment
It is investment in financial instruments such as stocks and bonds through the stock exchange and other financial markets only to earn a return on the investment. FPI is based on basic portfolio theory according to which individuals or firms invest in large amounts of financial assets in search of the highest possible risk-adjusted net return. The key task of portfolio management is to reduce the variability (or risk) of a group of stocks so that the variability of the whole is less than that of its parts. If it is possible to identify some stocks whose yields will increase when the yields of others decrease, then, by including both types of securities in the portfolio, the portfolio’s overall variability will be reduced. This is why some people interpret this theory as ‘putting eggs in different baskets rather than one basket’. This logic also applies to the establishment of a conglomerate corporation that diversifies into many product lines rather than specializing in a single one.
- FDI investment is done to gain controlling interest or ownership in a foreign company, whereas FPI as a mode of investment is only targeted at earning returns from the investment.
- FDI is considered a more stable form of investment as it involves a long term commitment in terms of funds. FPI is more volatile and can exit easily since it is done through investment in the financial markets.
- FDI brings with it the spillover effects of technology and managerial expertize. FPI on the other hand helps to increase both the width and depth of host country financial markets.
- FDI leads to a more competitive environment and increased consumer welfare. FPI contributes to financial development in an economy.
- FDI is done through the routes of Greenfield investment, mergers and acquizitions and brownfield investment. FPI takes the route of investment in the international capital market in shares and debentures of different firms.
Investment-related entry modes involve ownership of property, assets, projects, and businesses invested in a host country. Foreign investment takes two forms—foreign direct investment (FDI) and foreign portfolio investment (FPI).
There are various modes of entry into international business involving varying degrees of foreign market involvement and associated risk. Traditionally firms have followed a step-by-step approach to enter foreign markets, beginning with exports and gradually moving into contractual forms of entry followed by investment. In recent years, many emerging market firms have skipped some stages of entry and used a higher entry mode to access foreign markets.
- Globalization is the process of increasing interconnectedness in the global economy, such that, events in one part of the world have an effect on people and societies in various other corners of the globe.
- Globalization is the result of the phenomenon of convergence, which is the tendency for the tastes and preferences of people in different countries to become similar, leading to a sameness or homogeneity.
- There are three elements of globalization—economic, political and cultural.
- Economic globalization is characterized by the emergence of increased global flows of international trade and investment.
- Cultural globalization is a process of cultural homogeneity or having similar tastes, all over the global economy.
- Political globalization refers to processes of changes in the rules and structures of global governance.
- International business refers to any business activity which involves the transfer of resources, goods, services, knowledge, skills or information across national boundaries. These activities may pertain to the production of physical goods or to the provision of services such as banking, finance, insurance, education, construction, etc.
- The term TNC refers to a business enterprise with trade or investment operations in multiple global locations.
- The transnationality index (TNI) is a measure of the degree of interationalization of a business enterprise.
- The growth of international business in the last few decades has been driven by economic, political and technological factors.
- The major differences between domestic and international business are related to diverse business environments, enhanced risk and uncertainty and operational complexities.
- The main motives of firm internationalization are increased profits, growth, competitive factors and strategic factors.
- Entry mode refers to the nature of international transaction chosen by a business firm to enter a foreign market. The choice of entry mode for a business depends on the degree of foreign market involvement that it wants to have.
- Entry mode choices fall into three categories—trade-related, transfer-related, and investment-related. There is an increasing level of resource commitment, organizational control, involved risks, and expected returns in this sequence.
- Trade-related entry modes include export and imports and countertrade.
- Contractual or transfer-related entry modes are those associated with transfer of ownership or utilization of specified property (technology or assets) from one party to the other in exchange for royalty fees.
- Investment-related entry modes involve ownership of property, assets, projects, and businesses invested in a host country. Foreign investment takes two forms—foreign direct investment (FDI) and foreign portfolio investment (FPI).
- International business
- Transnational corporation
- Modes of entry
- Foreign direct investment
- Foreign portfolio investment
- What is globalization?
- What are the main elements of globalization?
- What is international business?
- What is a transnational corporation (TNC). Explain its main characteristic features.
- Distinguish between
- Trade and investment-related modes of entry
- FDI and FPI
- International leasing and international licensing
- International leasing and international franchising
- Write short notes on:
- International licensing
- International leasing
- International franchising
- Turnkey projects
- Plan a class visit to the nearest shopping mall and divide students into groups to make a list of foreign brands and foreign products available. Students may then be asked to map the brand/product with the company it belongs to, the country of origin and the mode of entry it has used to enter the Indian market. (e.g., McDonalds has used the franchisee mode of entry)
- Explain clearly the main motive of a business firm for entering the international market.
- Enumerate the factors that have contributed to the growth of international business in the last few decades. (15)
[B.Com (Hons.), 2010, 2017]
- What is international business? List and explain the major differences between domestic and international business. (3, 4.5)
[B.Com (Hons.), 2011]
- What do you understand by International Business? Briefly explain the factors that have led to the growth of international business in recent years. (3, 4.5)
[B.Com (Hons.), 2007]
- List and explain the different modes of entry for an international business firm. (7)
[B.Com (Hons.), 2008]
- What are the complexities involved in international business? Compare and contrast it with domestic business. (7.5)
[B.Com (Hons.), 2014]
- What is globalization? What are the driving forces of globalization? (4, 4)
[B.Com (Hons.), 2015]
- What do you understand by the term ‘Globalization’? What are the different facets of globalization? Briefly discuss the drivers of Globalization. (5, 5, 5)
[B.Com (Hons.), 2018, 2017]
- What are the complexities involved in international business? Compare and contrast it with domestic business. Explain how the location of a country and its topography affect the operations of a global business firm. (15)
- What do you understand by International Business? Critically examine the factors that have contributed to the growth of international business in the last few decades. (5, 10)
- What is Globalization? What are the elements and drivers of globalization? What are the factors influencing the growth of globalization? (5, 5, 5)
[B.Com (Hons.), 2018]
- Explain the concept of Globalization. What are the benefits and ill effects of Globalization? (7)
- Describe the contractual entry modes in international business. (7)
[B.Com (Hons.), 2017]
- Explain the special problems encountered in international business as compared to domestic business.
[B.Com (Hons.), 2017]
- Define International Business and describe its features. (7)
- Why do companies globalize? Explain with suitable examples. (8)
[B.Com (Hons.), 2016]