International Business Review
What is international Business?
The trade and investment activities by companies across national borders exceeding some
10 trillion dollars
When did globalization start?
1st phase: 1830 – 1880: during the growth of efficient transportation, such as railroads,
ocean transportation, invention of the telephone, and the rise of large manufacturing and
trading companies
2nd Phase: 1900 – 1930: rise of electricity and steel production until the worldwide
economic downturn starting 1929; western Europe was the most industrialized region,
establishing some of the first international firms such as Nestle, BP, Shell and Siemens
with foreign manufacturing
3rd Phase:1948 – 1970s: following WWII, Marshall Plan to rebuild Europe, US became
world’s dominant economy (least harm during WWII), an era of high tariffs and trade
barriers – General Agreement on Tariffs and Trade (GATT), later WTO [now 149
Nations], was formed to reduce international trade barriers; other important organizations
fostering global cooperation are Int. Monetary Fund, World Bank, and United Nations.
Forming MNE where companies like IBM, Boeing, Texas Instrument, Xerox,
McDonalds seeking cost advantages by locating factories in countries with low cost
labor/resources. Currency and capital started to flow freely across national borders. 1973
global oil crisis when OPEC proclaimed an oil embargo, followed by a stock market
crash worldwide [Jan 73 – Dec 74], 70s recession, devaluation of the almighty USD [US
(Nixon administration) stopped backing the USD with Gold reserves, also high inflation]
– USD rose above and beyond the true value since most commodities around the world
were traded in US currency - including the precious oil commodity, a corrective measure
requested by Europeans [meaning: dollars would buy fewer yens and marks], 1975 the
US began to float the dollar – fiat money: unbacked by any physical asset
4th Phase:1980 – Present: commercialization of the PC, Internet, low cost
communication, modernization of manufacturing, liberalization in central and Eastern
Europe, industrialization of East Asia (4 Asian Tigers [1960s – 90s]: HK, Singapore,
South Korea and Taiwan), growing integration of mergers and acquisitions, “death of
distance” – shrinking the world into a manageable marketplace. USA FDI inflows
interrupted by the 9/11/2001 event
Why go international?
Living standards of billions of people are improved due to international trade and
investment – wider selection of products and services at lower prices; accelerates
development of latest technology
Business:
 Earn higher margins and profits,
 Global procurement: raw material (closer to supply sources)
 Low cost & skilled labor,
 Acquire knowledge, opportunities (proactive or reactive motives)
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Market diversification, gain new ideas, less intense competition, stronger market
demands
Better serve key customers that relocated overseas
Economies of scale, production and marketing
Confront international competitors
Nations:
 Facilitates industries and workers to be more productive
 Allows countries to achieve higher living standards
 Without international trade, most nations would be unable to feed, clothe, and
house their citizens at current standards
 Not only do nations, companies, and stakeholders benefit from international trade,
modern life would be virtually impossible without it
Steps of Internationalization: (Market-seeking, asset-seeking, recourse-seeking or efficiencyseeking motives)
Domestic focus
Experimental export – asked to send product/services overseas
Export/Import: increased commitment
tangible merchandise (clothing, computers, cars) as well services (intangible)
such as banking, consulting, etc.
Licensing – owner of intellectual property (trademark or patent), or know-how
agreement, grants rights to another firm to use that property or knowledge for a specific
time period in exchange for royalties or other compensation. An entry strategy that does
not require substantial capital investment, nor involvement in a foreign market. Poor
partners may be unable to generate substantial sales.
Franchising – firm allows another the right to use an entire business system in exchange
for fees, royalties, or other forms of compensation. Usually an ongoing, stable entry
strategy compared to licensing (Subway, McDonalds, KFC). Process requires training
and monitoring; franchisees may acquire knowledge and become competitors.
Leasing – contractual strategy, in which focal firms rents out machinery or equipment to
corporate clients abroad, often for several years at a time (Fisher Industry).
Joint Venture – form of collaboration between two or more firms to create a jointly
owned enterprise as a minority, equal or majority partner.
FDI – Foreign direct investment, most committed involvement, long term, direct
influence on production, distribution and service of one’s product, partial or complete
ownership of acquired assets
Four risks in Internationalization:
Cross-cultural risk: difference in language, lifestyle, mindset, customs, religion, etc.
Country risk: political instability – government intervention in companies operation and
performance caused by political, legal and economic environment in a foreign country,
Venezuela – Exxon Mobil example
Currency risk: adverse fluctuation in exchange rates causing the foreign denomination
to rise sharply, or inflation, etc.
Commercial risk: potential loss or failure from poorly developed or executed business
strategies or procedures
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Advantage of Internationalization:
Developing new business opportunities
Access to foreign knowledge base – Germany: technology, India: software development
Reduction of poverty – China, Brazil
Disadvantage of Internationalization:
Loss of sovereignty – ability to govern own affairs: Wal-Mart, Coca Cola, Sony;
Complex business structures, either centralized or decentralized
Commitment of substantial funds
Sharing of technical know-how
Currency Exchange Rate – In cases of extreme appreciation or depreciation, a central
bank will normally intervene to stabilize the currency known as a managed float (many
Asian countries have an unofficial peg against the dollar)
Offshoring or outsourcing – results in job losses
Effect on the poor – child labor: 250 million around the world (Nike, sweat shops)
Effect on natural environment
Effect on national culture – McDonaldization, Coca-Colonization – erosion of local
traditions, appetite for “Western” products – across the world the same habits:
influenced by Hollywood
Participants of international business:
Focal firms – initialize international business transaction
Born Global firms – initiates international business very early, more adaptable to
internationalization, despite limited funding – producing true international products
International company - a company which exists in one country but sells products in
more than one country
Multi National Enterprise (MNE) – large companies with substantial resources,
performing various international businesses through a network of subsidiaries located
in multiple countries, including offices and production facilities; (170 MNE located in
the US, 70 in Japan, 35 in Germany)
Small Medium Enterprise (SME) – 500 or fewer employees – responsible of 25% of
export from Europe and N. America
Freight forwarder: specialized logistics services – arrange international shipping
Logistics Service Provider: DHL, FedEx, UPS, etc.
Foreign distributor: foreign market-based intermediary that works under contract for an
exporter – clearing products through customs, local advertising and distribution of
products
Trading Companies: intermediary that engages in import and export of commodities
(Cargill, Minneapolis, MN – 50 billion USD annually in sales, privately owned)
Theories of International Trade:
Absolute Advantage Principle: Adam Smith: 1776 - A country or companies benefits
by producing only those products in which it has absolute advantage, or can produce
using fewer resources than another, or at a lower absolute cost than another. The
country gains by specializing in producing those products, exporting them, and then
importing the products it does not have an absolute advantage in producing.
Comparative advantage: David Ricardo: 1817 - It can be beneficial for two countries to
trade without barriers as long as one is more efficient at producing goods or services
needed by the other. What matters is not the absolute cost of production, but rather the
relative efficiency with which a country can produce the product.
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Competitive Advantage of Nations: Michael Porter: 1980 - the competitive advantage
of a nation is dependent upon the collective competitive advantages of its firms. Over
time, this relationship is reciprocal: the competitive advantages held by the nation tend
to drive the development of new firms and industries with these same competitive
advantages.
Porter’s Diamond Model: explains competitive advantage at the firm and nation levels
as stemming from the presence and quality in the country of the following four major
elements – Firm Strategy, Structure, and Rivalry / Factor Conditions / Demand
Conditions / Related and supporting Industries
Industrial Cluster: A concentration of businesses, suppliers, and supporting firms in the
same industry at a particular location, characterized by a critical mass of human talent,
capital, or other factor endowments (Silicon Valley, Fashion Industry - Northern Italy)
International Value chain: A value chain is a chain of activities. Products pass through
all activities of the chain in order and at each activity the product gains some value. The
chain of activities gives the products more added value than the sum of added values of
all activities! (Dell corporation)
Cultural Environment of International Business:
The challenge of crossing cultural boundaries- different cultural environments
characterized by foreign languages and different values.
Culture refers to the learned, shared, and enduring orientation patterns in a society.
People demonstrate their culture through values, ideas, attitudes, behaviors, and
symbols.
Ethnocentric orientation: refers to a home-country mind-set
Polycentric orientation refers to a host-country mindset
Geocentric orientation refers to a global mindset where the manager is able to
understand a business without regard to country boundaries
Regiocentric orientation - policy to suit particular geographic areas
Low-context cultures rely on elaborated verbal explanations, putting much emphasis on
spoken words (Europe, N. America)
High-context cultures emphasize nonverbal communications and a more holistic
approach to communication that promotes harmonious relationships (Japan, China)
Monochronic cultures tend to exhibit a rigid orientation to time in which the individual
is focused on schedules, punctuality, and time as a resource (US, Canada, Germany)
Polychronic cultures refer to a flexible, non-linear orientation to time in which the
individual takes a long-term perspective and is capable of multi-tasking (Asia. Latin
America, Middle East)
Stereotypes: are generalizations about a group of people that may or may not be factual,
often overlooking real, deeper differences. (Latin Americans tend to procrastinate)
Government Interventions:
Protectionism refers to national economic policies designed to restrict free trade and
protect domestic industries from foreign competition
Government intervention arises typically in the form of tariffs (duty), nontariff trade
barriers (e.g. quota), and investment barriers (target FDI).
Governments impose trade and investment barriers to achieve political, social, or
economic objectives.
Tariff (duty) - tax imposed by a government on imported products, thus increasing the
cost to the customer
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Quota - a quantitative restriction placed on imports of a specific product over a specified
period of time
Investment barriers target FDI thus restricting foreign firm operations
National security - Countries impose trade restrictions on products viewed as critical to
national defense and security, such as military technology and computers
National culture and identity - Governments seek to protect certain occupations,
industries, and public assets that are considered central to national culture and identityprohibit certain imports (Swiss – watch making)
International Monetary Environment:
Foreign exchange refers to all forms of money that are traded internationally
Foreign exchange market is the global marketplace for buying and selling currencies (~
175 currencies) — mainly by banks and governments
Trade deficit refers to the amount by which a nation's imports exceed its exports for a
specific period of time
Trade surplus is the amount by which a nation's exports exceed its imports for a specific
period of time
Devaluation- government action to reduce the official value of its currency relative to
other currencies (encourage foreign investors among other reasons, etc.), it specifically
implies an official lowering of the value of a country's currency within a fixed
exchange rate system. The opposite of devaluation is called revaluation.
Depreciation is used for the unofficial decrease in the exchange rate in a floating
exchange rate system. The opposite of devaluation is called appreciation.
Exchange rate- the price of one currency expressed in terms of another- is constantly
changing
Eurodollars: deposits denominated in US dollars at banks outside the United States, and
thus are not under the jurisdiction of the Federal Reserve.
Fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange
rate system wherein a currency's value is matched to the value of another single
currency or to a basket of other currencies, or to another measure of value, such as gold.
A fixed exchange rate is usually used to stabilize the value of a currency, against the
currency it is pegged to. This makes trade and investments between the two countries
easier and more predictable, and is especially useful for small economies where
external trade forms a large part of their GDP. It can also be used as a means to control
inflation. However, as the reference value rises and falls, so does the currency pegged
to it. Fixed exchange rates may be preferable for their greater stability and certainty.
(China)
Floating exchange rate or fluctuating exchange rate is a type of exchange rate system
wherein a currency's value is allowed to fluctuate according to the foreign exchange
market. The exchange rate system of floating currencies may more technically be
known as a managed float - allowing a currency price to float freely between an upper
and lower bound, a price "ceiling" and "floor. (USA)
Bonds are debt instruments that allow the borrower to raise capital by promising to repay
the principal with interests on a specified date
Hedging is the use of financial instruments to manage exposure to currency risk
World's currency: only 8 percent of the world's currency exists as physical cash.
Direct quote: number of units of the domestic currency needed to acquire one unit of
foreign currency, known as the normal or American quote. The teller might say, “It
will cost you $1.30 to buy €1."
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Indirect quote: the number of units of the foreign currency obtained for one unit of the
domestic currency, known as the reciprocal or European term. The teller might say,
“For $1.00, you can buy €0.74.”
Currency Traders:
Hedgers, who seek to minimize the risk of exchange-rate fluctuations by buying
forward contracts or similar financial instruments.
Speculators, who seek profits by investing in currencies, and expect them to rise in
value in the future.
Arbitragers, who buy and sell the same currency in two or more foreign exchange
markets to take advantage of differences in the currencies exchange rate.
Regulating Exchange Rates:
Since dollar exchange rates are set on the open market, the Government can only indirectly
impact exchange rates. (In countries, like China, where the rate is fixed, the government can
directly change the rate.) The most direct way is by raising the Fed Funds Rate, which
increases interest rates throughout the banking system, reduces the supply of money, and
makes the dollar stronger relative to other currencies. If the Fed lowers the Funds rate, then of
course the opposite occurs, and the dollar becomes weaker.
The Treasury Department can also print more money, which increases the supply, weakening
the dollar. It can also borrow more money from other countries, known as selling Treasury
notes. This not only increases the supply of money, but it also increases the debt, both of which
weaken the dollar.
Euro appreciation: If the euro/dollar exchange rate goes from one euro equals $1.25 to a new
rate of one euro equals $1.50 → due to increased demand for Euros or decreased supply of
Euros, the euro becomes expensive to U.S. customers, and fewer BMWs will be sold.
Euro depreciation: If the euro/dollar exchange rate goes from one euro equals $1.25 to a new
rate of one euro equals $1.00 → the euro then becomes cheap to the U.S. consumer, and more
BMWs will be sold.
Factors that influence the supply and demand for a currency: (1) economic growth, (2) interest
rates and inflation, (3) market psychology, and (4) government action.
How exchange rates are determined:
In a free market, the “price” of any currency (rate of exchange) is determined by supply and
demand.
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The greater the supply of a currency, the lower its price
The lower the supply of a currency, the higher its price
The greater the demand for a currency, the higher its price
The lower the demand for a currency, the lower its price
Currency Wars: http://www.bbc.co.uk/news/business-11608719
To artificially keep ones currency weaker against key foreign currencies – in order make ones
products more attractive in foreign markets (Example: USA – China)
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Perception of Value
Understanding that the value of money is based on our perception of its worth is easier if we look
at how that perception can alter the specific amount of that value. Let's say that one American
dollar is worth 5 French francs. One day, the U.S. government announces that part of its
economic policy will be to allow the value of the U.S dollar to decrease slowly to about 3 francs
(the U.S. government might do this to encourage foreign investors, among other reasons). The
next day, the value of the dollar would likely drop sharply, which it has in similar situations.
Why? The government announcement led people to believe that their dollars would be worth less
-- therefore, they were worth less. The same effect can be seen in today's stock market, which is
another currency system. When a company declares that its profits are down, the value of the
company's shares can drop within minutes.
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Eurocurrency is any currency deposited in a bank outside its country of origin.
Firms may borrow from the Eurocurrency market. Eurodollars are US dollars held in
banks outside the US, including foreign branches of US banks. Thus, a US dollar
bank deposit to Barclays Bank in London is a Eurodollar deposit.
Bonds are debt instruments that allow the borrower to raise capital by promising to
repay the principal with interests on a specified date. Investors purchase bonds and
redeem them in the future at face value. A firm can purchase or sell bonds through
banks and stockbrokers on the global bond market.
changing currency value, or currency exposure, is one of the greatest challenges
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There are three types of currency exposure:
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Transaction exposure is currency risk by firms when accounts receivable or payable are
denominated in foreign currencies.
 Translation exposure is currency risk when a firm translates financial statements from
foreign currency into the functional currency of the parent firm. Exchange rate
fluctuations cause the values of exposed assets, liabilities, expenses, and revenues to
fluctuate as well, and may negatively affect the financial results of a firm.
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Economic exposure, also known as operating exposure, is currency risk from
exchange-rate fluctuations that affect the pricing of products, the cost of inputs, and
the value of foreign investments.
 When a firm prices its products, exchange-rate fluctuations either help or hurt
sales because products are either more or less expensive to foreign buyers.
 For example, the British pound has appreciated against the US dollar. US
firms should expect to sell more goods in the UK, because British customers
have stronger buying power when purchasing dollars.
 By the same token, a British firm's sales may fall in the US unless
management lowers its US prices by an amount equivalent to the fall of the
dollar.
Foreign exchange trading. A rather small number of currencies still dominate cross-border
trade and investment. Two thirds of foreign reserves are in US dollars, 25% in euros, 7% in
the yen and British pound, and 2% in the world's remaining 150 national currencies. Yet,
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about $3 trillion worth of currency is traded every day. Currency trade occurs within large
banks and through brokers that specialize in matching buyers and sellers.
 Currency dealers use the spot rate to trade foreign currencies at the current rate of
exchange when delivery is considered immediate (i.e., over the counter), or within
two business days between banks.
 Currency dealers use the forward rate, or the exchange-rate quota for future delivery
of currency. The forward rate is a contractual rate between the dealer and client.
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Dealers quote currency exchange rates in two ways. For example, if you were traveling to
Europe tomorrow and needed to buy Euros today, your local bank might give you:
 A direct quote: number of units of the domestic currency needed to acquire one unit
of foreign currency, known as the normal or American quote. The teller might say,
“It will cost you $1.30 to buy €1."
 An indirect quote: the number of units of the foreign currency obtained for one unit of
the domestic currency, known as the reciprocal or European term. The teller might
say, “For $1.00, you can buy €0.74.”
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There are three types of currency traders:
Hedgers, who seek to minimize the risk of exchange-rate fluctuations by buying forward
contracts or similar financial instruments.
Speculators, who seek profits by investing in currencies, and expect them to rise in value
in the future.
Arbitragers, who buy and sell the same currency in two or more foreign exchange
markets to take advantage of differences in the currencies exchange rate.
Financial managers must be aware of the trends that influence currency fluctuations, and
monitor currency trading daily.
Hedging is the use of financial instruments to manage exposure to currency risk.
There are four common hedging instruments:
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Forward contracts are financial instruments to buy or sell a currency at an agreed
upon the exchange-rate at the initiation of the contract for future delivery and
settlement. Refer to the example of Dow Chemical in the book, or Merkel at the
beginning of the chapter, to illustrate.
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Futures contracts are similar to forward contracts, except that maturity periods and
contract sizes are standardized to facilitate trading in organized exchanges such as the
Chicago Mercantile Exchange.
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Currency options give the purchaser the right to buy foreign currency assets exchange
rate within a specified amount of time. Currency options are traded on organized
exchanges such as the Philadelphia Stock exchange and are available only for major
currencies.
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Currency swaps are the exchange of two different currencies that are repaid in the
original swapped amounts, plus interest, after a specified period of time. The parties
swap principal at the current spot rate, and they repay the loan at the forward rate.
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Question: How Does the Government Regulate Exchange Rates?
Answer: Since dollar exchange rates are set on the open market, the Government can only
indirectly impact exchange rates. (In countries, like China, where the rate is fixed, the
government can directly change the rate.) The most direct way is by raising the Fed Funds
Rate, which increases interest rates throughout the banking system, reduces the supply of
money, and makes the dollar stronger relative to other currencies. If the Fed lowers the Funds
rate, then of course the opposite occurs, and the dollar becomes weaker.
The Treasury Department can also print more money, which increases the supply, weakening
the dollar. It can also borrow more money from other countries, known as selling Treasury
notes. This not only increases the supply of money, but it also increases the debt...both of
which weaken the dollar.
Question: How Do Exchange Rates Work?
Answer: Exchange rates change every day. This is because currencies are traded on an open
market, and the demand for them varies based on what is happening in that country. The
interest rate paid by a country’s central bank is a big factor, since a higher interest rate makes
that currency more valuable. Inflation is also taken into account, since high inflation in a
country makes that currency worth less the longer it is held. Finally, a country’s financial
stability will also impact a currency over time, since investors want to be sure they will get
paid back.
Question: What Are Exchange Rates?
Answer: The dollar's exchange rate tells you how much a dollar is worth in a foreign
currency, and vice versa. For example, on March 3, 2008, a dollar was worth $.98 Canadian
dollars, 7.01 Chinese yuan, and 103.57 Japanese yen. The Euro is normally quoted in terms
of its dollar value, for some reason, so one Euro was worth $1.52.
Fixed exchange rate: http://en.wikipedia.org/wiki/Pegged_exchange_rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange
rate regime wherein a currency's value is matched to the value of another single currency
or to a basket of other currencies, or to another measure of value, such as gold.
A fixed exchange rate is usually used to stabilize the value of a currency, against the
currency it is pegged to. This makes trade and investments between the two countries
easier and more predictable, and is especially useful for small economies where external
trade forms a large part of their GDP.
It can also be used as a means to control inflation. However, as the reference value rises
and falls, so does the currency pegged to it. In addition, according to the MundellFleming model, with perfect capital mobility, a fixed exchange rate prevents a
government from using domestic monetary policy in order to achieve macroeconomic
stability.
Maintaining a fixed exchange rate (Wikipedia.org) Typically, a government wanting to maintain a fixed exchange rate does so by either buying or
selling its own currency on the open market. This is one reason governments maintain reserves
of foreign currencies. If the exchange rate drifts too far below the desired rate, the government
buys its own currency off the market using its reserves. This places greater demand on the
market and pushes up the price of the currency. If the exchange rate drifts too far above the
desired rate, the opposite measures are taken.
Another, less used means of maintaining a fixed exchange rate is by simply making it illegal to
trade currency at any other rate. This is difficult to enforce and often leads to a black market in
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foreign currency. Nonetheless, some countries are highly successful at using this method due to
government monopolies over all money conversion. This is the method employed by the Chinese
government to maintain a currency peg or tightly banded float against the US dollar. Throughout
the 1990s, China was highly successful at maintaining a currency peg using a government
monopoly over all currency conversion between the Yuan and other currencies.
In cases of extreme appreciation or depreciation, a central bank will normally intervene to
stabilize the currency. Thus, the exchange rate regimes of floating currencies may more
technically be known as a managed float. A central bank might, for instance, allow a currency
price to float freely between an upper and lower bound, a price "ceiling" and "floor".
Management by the central bank may take the form of buying or selling large lots in order to
provide price support or resistance, or, in the case of some national currencies, there may be
legal penalties for trading outside these bounds.
The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and
other institutions easily buy and sell currencies.
The purpose of the foreign exchange market is to help international trade and investment. A
foreign exchange market helps businesses convert one currency to another. For example, it
permits a U.S. business to import European goods and pay Euros, even though the business's
income is in U.S. dollars.
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying
a quantity of another currency. The modern foreign exchange market started forming during the
1970s when countries gradually switched to floating exchange rates from the previous exchange
rate regime, which remained fixed as per the Bretton Woods system.
Extra Currency related Info:
http://money.howstuffworks.com/currency9.htm
Currency, or money (we'll use the terms interchangeably for the purposes of this discussion),
can be defined as a unit of purchasing power. Money allows people to accumulate wealth.
1. Diners Club issued the first credit card in 1950.
2. The Social Security Administration first offered automatic electronic deposit of money
into bank accounts in 1975.
3. The growing worldwide acceptance of the Internet has made electronic currency more
important than ever before. Purchases can be made through a Web site, with the funds
drawn out of an Internet bank account, where the money was originally deposited
electronically. People are earning and spending money without ever touching it. In fact,
economists estimate that only 8 percent of the world's currency exists as physical
cash. The rest exists only on a computer hard drive, in electronic bank accounts around
the world.
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