Managing In A Global Economy Coursebook

MANAGING IN A GLOBAL ECONOMY DLMBGE01 MANAGING IN A GLOBAL ECONOMY MASTHEAD Publisher: IU Internationale Hochschule GmbH IU International University of Applied Sciences Juri-Gagarin-Ring 152 D-99084 Erfurt Mailing address: Albert-Proeller-Straße 15-19 D-86675 Buchdorf [email protected] www.iu.de DLMBGE01 Version No.: 001-2023-1013 N. N. © 2023 IU Internationale Hochschule GmbH This course book is protected by copyright. All rights reserved. This course book may not be reproduced and/or electronically edited, duplicated, or dis- tributed in any kind of form without written permission by the IU Internationale Hoch- schule GmbH (hereinafter referred to as IU). The authors/publishers have identified the authors and sources of all graphics to the best of their abilities. However, if any erroneous information has been provided, please notify us accordingly. 2 TABLE OF CONTENTS MANAGING IN A GLOBAL ECONOMY Introduction Signposts Throughout the Course Book............................................. 6 Basic Reading.................................................................... 7 Required Reading................................................................. 8 Further Reading................................................................. 10 Learning Objectives.............................................................. 12 Unit 1 Introduction to Managing in a Global Economy 13 1.1 What is Globalization?........................................................ 15 1.2 Facts about Globalization and the Global Economy.............................. 17 1.3 Theoretical Explanations for Globalization..................................... 21 Unit 2 The International Company and its Environment 27 2.1 International Companies and their Operations.................................. 30 2.2 Operational Patterns in International Markets.................................. 33 2.3 Assessment of the Environment for Internationalization......................... 37 Unit 3 Culture and International Business 45 3.1 A Generic Perspective on Culture.............................................. 47 3.2 Organizational Culture....................................................... 51 3.3 Cultural Diversity and the Contemporary Manager.............................. 54 Unit 4 Strategy Development in International Business 59 4.1 Strategy in Globalized Business Operations..................................... 64 4.2 Strategy Concepts and Strategic Options....................................... 68 4.3 Managing Strategy........................................................... 75 Unit 5 International Human Resource Management 81 5.1 Characteristics of International Human Resource Management................... 83 5.2 The Global Manager.......................................................... 85 5.3 Instruments in International Human Resource Management..................... 89 3 Unit 6 Organization in International Business 95 6.1 Traditional Perspectives on Business Organization.............................. 97 6.2 Modern Views on Business Organization...................................... 100 6.3 Coordination and Control of Intra-Organizational Collaboration................. 103 Unit 7 International Marketing 111 7.1 Marketing in International Business.......................................... 113 7.2 Strategic Choices in International Marketing................................... 115 7.3 Marketing Mix Choices in International Marketing.............................. 118 Unit 8 Supply Chain Management and Accountancy in International Business 127 8.1 Supply Chain Management and International Business......................... 130 8.2 Quality, Supplier Networks, and Inventory in Supply Chain Management......... 133 8.3 Accounting in International Business......................................... 136 Appendix List of References............................................................... 144 List of Tables and Figures........................................................ 146 4 INTRODUCTION WELCOME SIGNPOSTS THROUGHOUT THE COURSE BOOK This course book contains the core content for this course. Additional learning materials can be found on the learning platform, but this course book should form the basis for your learning. The content of this course book is divided into units, which are divided further into sec- tions. Each section contains only one new key concept to allow you to quickly and effi- ciently add new learning material to your existing knowledge. At the end of each section of the digital course book, you will find self-check questions. These questions are designed to help you check whether you have understood the con- cepts in each section. For all modules with a final exam, you must complete the knowledge tests on the learning platform. You will pass the knowledge test for each unit when you answer at least 80% of the questions correctly. When you have passed the knowledge tests for all the units, the course is considered fin- ished and you will be able to register for the final assessment. Please ensure that you com- plete the evaluation prior to registering for the assessment. Good luck! 6 BASIC READING Lane, H. W. & Maznevski, M. L. (2014). International Management Behavior: Global and Sus- tainable Leadership (7th ed.). Hoboken, NJ: Wiley. McFarlin, D. & Sweeney, P. (2017). International Organizational Behavior: Transcending Bor- ders and Cultures (2nd ed.). New York, London: Routledge. Martin, L. (2014). International Business Development: A Concise Textbook Focusing on Inter- national B-to-B Contexts. Wiesbadeb: Springer Gabler. Trompenaars, F. & Woolliams, F. (2003). Business Across Cultures. Chichester: Capstone. 7 REQUIRED READING UNIT 1 Abeles, T. P. (2001). The impact of globalization. On the Horizon, 9(2), 2–4. Ndhlovu, T. P. (2012). Globalization: A theoretical reflection. World Journal of Entrepreneur- ship, Management and Sustainable Development, 8(2/3), 95–112. UNIT 2 Elango, B. (2011). Does market context impact payoffs to internationalization? European Business Review, 23(5), 434–453. Harris, P. R. (2002). European challenge: Developing global organizations. European Busi- ness Review, 14(6), 416–425. UNIT 3 Chitakornkijsil, P. (2009). Communication in global cultural teams and international com- munication challenge. International Journal of Organizational Innovation, 1(4), 102– 112. Sağ, S., Kaynak, R., & Sezen, B. (2016). Factors affecting multinational team performance. Procedia – Social and Behavioral Sciences, 235, 60–69. Wilkinson, M., Fogarty, M., & Melville, D. (1996). Organizational culture change through training and cultural immersion. Journal of Organizational Change Management, 9(4), 69–81. UNIT 4 Makino, S. (2014). Three important perspectives for understanding national context. In J. J. Boddewyn (Ed.), Multidisciplinary insights from new AIB fellows (pp. 79–114). Bing- ley: Emerald Group Publishing. Osland, G. E., Taylor, C. R., & Zou, S. (2001). Selecting international modes of entry and expansion. Marketing Intelligence & Planning, 19(3), 153–161. 8 UNIT 5 Acar, P., Gürbüz, F. G., & Yener, M. İ. (2015). The discovery of HR from strategy-as-practice perspective: A case study in durable consumer goods industry. Procedia - Social and Behavioral Sciences, 207, 325–334. Gholba, A., & Dyaram, L. (2016). Unlocking the value of developing leaders: Towards global leadership. Proceedings Of The European Conference On Management, Leadership & Governance, 129–137. Mathews, J. (2016). Toward a conceptual model of global leadership. IUP Journal Of Organ- izational Behavior, 15(2), 38–55. UNIT 6 Black, J. A., & Edwards, S. (2000). Emergence of virtual or network organizations: Fad or feature. Journal of Organizational Change Management, 13(6), 567–576. Roberts, J., & Armitage, J. (2006). From organization to hypermodern organization: On the accelerated appearance and disappearance of Enron. Journal of Organizational Change Management, 19(5), 558–577. UNIT 7 Gnizy, I., & Shoham, A. (2014). Uncovering the influence of the international marketing function in international firms. International Marketing Review, 31(1), 51–78. Vrontis, D., Thrassou, A., & Lamprianou, I. (2009). International marketing adaptation ver- sus standardisation of multinational companies. International Marketing Review, 26(4/5), 477–500. UNIT 8 Hentschel, B., Domański, R., Adamczak, M., Cyplik, P., Hadaś, L., Kupczyk, M., & Pruska, Z. (2015). Ranking of integration factors within supply chains of forward and backward types—Recommendations from researches. LogForum, 11(2), 161–169. Steven, C. (2016). Consequences of IFRS for capital markets, managers, auditors and standard-setters: An introduction. Accounting and Finance, 56(1), 5–8. 9 FURTHER READING UNIT 1 Abbas, J. A. (2014). Globalization and inequalities. International Journal of Commerce and Management, 24(2), 114–118. Das, K. D. (2010). Financial globalization: A macroeconomic angle. Journal of Financial Eco- nomic Policy, 2(4), 307–325. UNIT 2 Globerman, S. (2014). Regulation and the international competitiveness of US-based com- panies. Competitiveness Review, 24(5), 378–392. UNIT 3 Groeschl, S., & Doherty, L. (2000). Conceptualising culture. Cross Cultural Management: An International Journal, 7(4), 12–17. Mathebula, T. (2017). The relationship between the practice of transformational leadership and a high-performance culture. Proceedings Of The European Conference On Manage- ment, Leadership & Governance, 562–571. UNIT 4 Lojacono, G., & Venzin, M. (2014). Organizing export strategies. In L. Tihany, T. Pedersen, & T. Devinney (Eds.), Orchestration of the global network organization (pp. 283–298). Bingley: Emerald Group Publishing. Rundh, B. (2001). International market development: New patterns in SMEs international market behaviour? Marketing Intelligence & Planning, 19(5), 319–329. UNIT 5 Arthur, J. B., Herdman, A. O., & Jaewan, Y. (2016). How top management HR beliefs and values affect high-performance work system adoption and implementation effective- ness. Human Resource Management, 55(3), 413–435. Rattrie, L. T. B., & Kittler, M. G. (2014). The job demands-resources model and the interna- tional work context—A systematic review. Journal of Global Mobility, 2(3), 260–279. 10 UNIT 6 Morley, M. J. (2007). Person‐organization fit. Journal of Managerial Psychology, 22(2), 109– 117. Weymes, E. (2005). Organizations which make a difference: A philosophical argument for the “people focused organization”. Corporate Governance: The International Journal of Business in Society, 5(2), 142–158. UNIT 7 Douglas, S. P., & Craig, C. S. (2011). The role of context in assessing international marketing opportunities. International Marketing Review, 28(2), 150–162. Gherasim, A., & Gherasim, D. (2017). From general marketing to the international one. Economy Transdisciplinarity Cognition, 20(1), 60–64. UNIT 8 Corominas, A. (2013). Supply chains: What they are and the new problems they raise. Inter- national Journal of Production Research, 51(23/24), 6828–6835. Popatia, K. (2017). IFRS & GAAP: Reconciling differences between accounting systems and assessing the proposed changes to the IFRS constitution. Northwestern Journal of International Law & Business, 38(1), 137–159. 11 LEARNING OBJECTIVES Globalization can be seen as the trend towards furthering interconnectedness between countries, societies, cultures, and economies. Managing in a Global Economy explores various management issues that are affected by increased international business activi- ties. It discusses the context of global operations and describes the cultural diversity that managers face in international business. It also addresses strategizing processes and explores strategies for choosing individuals with the ability to work successfully in foreign surroundings. Furthermore, the most important operational issues such as marketing and organization are discussed in order to illustrate the challenges and risks of global busi- ness. The course aims to enable students to assume leadership positions in corporate internationalization processes. 12 UNIT 1 INTRODUCTION TO MANAGING IN A GLOBAL ECONOMY STUDY GOALS On completion of this unit, you will have learned … – the meaning of key expressions in the field of global business management. – the recent trends in international business. – why there is a trend towards international business models. – the basics of important theoretical explanations for globalization processes. 1. INTRODUCTION TO MANAGING IN A GLOBAL ECONOMY Introduction GLOBALIZATION: A REALITY BEYOND IDEOLOGY In today’s interdependent global economy, an American can drive to work in a car designed in Germany that was assembled in Mexico by Ford from compo- nents made in the United States and Japan that were fabricated from Korean steel and Malaysian rubber. She may fill the car with gasoline at a BP service sta- tion owned by a British multinational company. The gasoline could have been made from oil pumped out of a well off the coast of Africa by a French oil com- pany that transported it to the United States in a ship owned by a Greek ship- ping line. While driving to work, the American might talk to her stockbroker on a Nokia cell phone that was designed in Finland and assembled in Texas using chip sets produced in Taiwan that were designed by Indian engineers working for Texas Instruments. She could tell the stockbroker to purchase shares in Deut- sche Telekom, a German telecommunications firm that was transformed from a former state-owned monopoly into a global company by an energetic Israeli CEO. She may turn on the car radio, which was made in Malaysia by a Japanese firm, to hear a popular hip-hop song composed by a Swede and sung by a group of Danes in English, who signed a record contract with a French music company to promote their record in America. The driver might pull into a drive-through coffee shop run by a Korean immigrant and order a “single, tall, nonfat latte” and chocolate-covered biscotti. The coffee beans came from Brazil and the chocolate from Peru, while the biscotti were made locally using an old Italian recipe. After the song ends, a news announcer might inform the American lis- tener that anti-globalization protests at a meeting of the World Economic Forum in Davos, Switzerland, have turned violent; one protester being killed. The announcer then turns to the next item, a story about how the financial crisis, which started in the United States banking sector, might trigger a global reces- sion sending stock markets down all over the world. Source: Hill 2011, p. 4. Globalization has undeniably become a matter of fact in our lives today. Despite under- standable criticism of ethical misconduct occurring in international business, it is neces- sary to realize that globalization is a reality for all of us. Therefore, the question is not whether globalization is desirable but rather how to manage successfully in a business environment that is increasingly marked by international cooperation. This course will focus on the challenges facing managers in these processes. 14 1.1 What is Globalization? Globalization has become a widely discussed topic today. Since globalization is a matter of controversy, it will come as no surprise that, so far, not one single definition has been commonly accepted among scholars and the public. At the very least, it can be stated that globalization describes the increasing interconnections of economies and societies world- wide. Nevertheless, beyond this very broad description, viewpoints vary considerably, depending on the underlying perspective of the academic discipline defining this term. Business people may focus on the increasing cross-border trade of goods and capital, while political scientists would prefer to look into the impact of globalization on national governments. Social scientists are interested in the cultural and societal influences emerg- ing from globalization trends, while scholars from the field of international relations would most likely want to discuss the development of global institutions (Wall/Minocha/ Rees 2010). In order to approach a common understanding of globalization, we will gather the impor- Globalization tant aspects that are contained in this term. In the process, we will summarize a range of Globalization is the increasing interconnect- definitions provided by scholars. With respect to the key elements of various definitions, edness of societies and our summarized version is intended to capture a broad range of insights into globalization economies worldwide. (Wall/Minocha/Rees 2010) including: cultural and political forces increasing interconnection between societies and economies integration of economic processes and information transfer on a global level and beyond national boundaries shrinking political influence of national governments a shift from national and regional to fully integrated global markets increasing homogeneity of societies and markets worldwide with considerable impact on local cultures Without doubt, the business sector is affected by globalization. Let us investigate what kind of companies are actually contributing to the development of globalization. These companies can be broadly defined as ‘international companies’ and include all businesses operating across national borders. This can vary from simply buying or selling abroad to becoming a truly multinational company (Hill 2011). Various strategies of engaging in international business will be discussed later in this course. Globalization in Practice Global markets have developed in different ways. It is generally anticipated that over a certain period of time standardized goods and services naturally gain importance in an increasingly interconnected market. However, improved marketing research has led to a greater differentiation and segmentation of local markets than was previously the case. At the same time, technological progress has provided the opportunity to adapt products to the different markets. Consequently, many industries are now in a position to tailor their goods to the needs of consumers. 15 Similarly, globalized production has become reality in almost every industry. The reasons for internationalizing production vary considerably. Often, low relative unit labor costs play a key factor, however other circumstances are equally important. Operating inde- pendently from only one location, embedded in its political and economic environment, plays a role as well as desiring to move production closer to the sales markets or the source of raw material. In general, it can be stated that globalized production assists busi- nesses in the early stages of internationalization prior to becoming fully integrated multi- national companies. The latter require what is known as global thinking beyond national borders. Relationship Between Globalization and Government Finally, we will look at the relationship between globalization, and the autonomy and sov- ereignty of national governments. The increasing interconnectedness of economies, indi- viduals, and societies worldwide has changed the role of a nation state significantly. Nowadays, national boundaries have, to some extent, lost their importance as a result of technological progress allowing a cross-border flow of information and capital. It seems that nation states have lost competence and influence while to steer these pro- cesses. This can often be seen in legislation when national laws fail to sufficiently cover international business matters in areas such as legitimate taxation of multinational com- panies or liability issues in the case of international retailers distributing to almost any country worldwide or even relieving the tension in financial markets, which at times may harm an entire national economy. In many cases, the capacity of nation states to inter- vene and regulate is often restricted. The trend towards a loss of competence is accompanied by a decline in the autonomy of nation states. The increase in global economic exchange has significantly changed the way formerly strong states treat internal and external issues. This can be seen, for exam- ple, in many developing countries where relatively weak nation states have identified the need to engage with foreign states and the huge sector of non-governmental organiza- tions. The latter in particular have gained influence in recent years, steering a significant amount of political initiatives which had previously been a matter for the nation states only. Given the trends thus described, the legitimacy of states is increasingly at risk—even in Germany. One strategy to undermine nation state autonomy has been to establish supra- national organizations and multinational alliances, e.g. the European Community, the European Central Bank, the World Bank, and others. However, in the wake of the heated debate in Germany and other European countries, those developments have been ques- tioned by many people who have become particularly sensitive concerning national issues, which, in many cases, are ruled on Europe-wide instead of on a domestic level. In order to understand globalization, it is necessary to consider the main points of criti- cism raised by many activist groups. One complaint concerns the shift of jobs from devel- oped countries to those that are economically underdeveloped. It seems that many com- panies have transferred production sites and jobs to low-cost locations in foreign countries. These companies are accused of making use of cheap labor abroad while firing 16 employees in their own country. It has also been suggested that, very often, working con- ditions abroad are miserable and payments are simply not sufficient to eke out a living. On the whole, there is a general belief that increasing poverty in developing countries is a result of powerful enterprises striving to maximise corporate profit. Moreover, low ecologi- cal standards and the absence of environment protection law enforcement has allowed companies to transfer the production of hazardous goods to countries in which they are able to operate without interference. Incidents such as the pollution of the Niger Delta in Nigeria by multinational oil companies are an example of this unethical behavior. In order to generate even the smallest amount of revenue, poor countries often have no other option but to let these companies operate. At the same time, many of these compa- nies put pressure on the governments to allow certain production processes, despite their harmful effects on the environment. These procedures correspond with an aspect dis- cussed earlier in this unit: the potential decline in national sovereignty and autonomy. It can therefore be understood that labor and ecological standards need to be ratified on a global level in order to ensure that governments worldwide can keep up with global eco- nomic trends. 1.2 Facts about Globalization and the Global Economy We will now look at developments and trends in global business (Wall/Minocha/Rees 2010). This should provide you with an understanding of the extent of international busi- ness transactions and the importance of globalization for national economies. Economic Changes On the whole, the past decades were marked by an increase in growth in international trade and investment. From 1980 to 2007, worldwide exports grew at an average annual rate of 5 %. In 2007, exports worldwide accounted for 31 % of the gross world domestic product (GDP). Moreover, developing countries have been able to increase their share in global exports, an encouraging sign showing that globalization offers the possibility of increasing economic integration and consequently reducing poverty. It is also evident that foreign direct investment has increased remarkably; between 1980 and 2007, it went up by a factor of five. Not surprisingly, cross-border mergers and acquisitions also rose by 700 % between 1990 and 2007. Specific markets which were subject to liberalization during this time have contributed to this effect, e.g. financial services, telecommunications, and many more. The hundred larg- est multinational companies have experienced above-average growth of their foreign assets and their sales and workforces. Overall, value chains have been subject to globali- zation; today, multinational corporations source materials and produce and market prod- ucts on a global level. Modern technology and telecommunications in particular have hel- ped large companies manage their business across national borders and time zones. 17 All these developments are accompanied by a rapid growth in international currency transactions. Within three decades—from 1975 to 2005—daily turnover in currencies has increased by a factor of 150. This development can be seen in everyday life where cur- rency trading as well as trading in stocks and commodities has become possible instantly using private computers and online bank accounts. Political Changes The globalization trend has required political and regulatory changes on both national and international levels. The trend towards increasingly international business activities is definitely not a new one. However, the collapse of the former communist regime and the end of the Cold War around 1990 opened up unprecedented opportunities for global growth. These economic trends have been accompanied (if not facilitated) by a liberaliza- tion of markets. The vast majority of regulatory changes carried out by national govern- ments have been in favor of foreign direct investment. In addition, the world’s economic landscape has changed. Previously dominated by North America and Europe, the world economy today relies heavily on the Southeast Asian region, with China being a driving force. The latter is likely to become the largest economy in the world. Other countries such as India, Indonesia, and Thailand are also expected to become economic world powers, while previously leading nations such as the US and Europe will fall behind. Therefore, it is no surprise that multinational companies are shifting their focus onto the regions with future potential. Regional trading agreements have also increased in recent decades, allowing preferential treatment in terms of taxation and duties paid on trading activities within these regions. The European Community is a convincing example as it permits the free exchange of goods and services within the region. In addition, the common currency—the euro—has helped to save money previously spent on foreign exchange and exchange rate insurance. Other successful examples of regional trade agreements are the North American Free Trade Arrangement (NAFTA) and the Southern Africa Development Community (SADC). Bilateral trading agreements serve the same purpose but exist only between two coun- tries. These arrangements often facilitate foreign direct investments and help avoid dou- ble taxation. As important as these agreements are, they also discriminate against coun- tries not included in the treaties. Furthermore, it is worth mentioning that, with the increasing number of bilateral agreements and membership in regional trading agree- ments, the complex regulations have become difficult to manage. This definitely applies to companies engaged in international activities as well as governments needing to ensure alignment between national laws, bilateral treaties, and regional arrangements. Technological Changes Major developments in technology in the last two decades can be considered another facilitator of globalization trends. Nowadays, information is readily available on the inter- net in literally every corner of the world. In addition, mobile phone services enable people to communicate on the go and are provided at comparatively low costs. These technolo- gies have helped increase international business activities. Information concerning mar- ket trading, financial data, and currencies is instantly available, along with the opportu- 18 nity to immediately carry out transactions. All this is possible within seconds, as compared to days and even weeks in the past. It is no surprise that today multinational firms operate across continents, time zones, and cultural borders. When it comes to international business, managers are often under great pressure. For example, a manager located in Berlin might receive phone calls from a Chinese branch at 3 a.m., then have to start his normal office day at 8 a.m. At 9 p.m. he may have to take phone calls from his American head office. Another example would be Chinese colleagues urgently requiring information on Christmas Eve, unaware that it is a religious holiday in Germany (as it is not celebrated in China). In February, conversely, when the New Year is celebrated in China and office work normally stops for about a week, a manager in Berlin might not be able to contact any of his Chinese colleagues. This example demonstrates the impact of technological changes on a 24/7 work schedule in global business. Societal and Behavioral Changes The trends described above have also influenced the way people travel. After World War II, the average German felt lucky being able to travel to Italy or Austria occasionally. Today, people travel around the world and can be seen in every corner of the globe. From 1980 to 2008, the number of international travelers rose annually from 260 million to 800 million. One aspect contributing to this development is an increased amount of leisure time. In post-war Germany, working 48 hours over six days a week was not unusual for the working population. Nowadays, in many industries the weekly workload ranges between 35 and 40 hours. Moreover, paid leave has increased, with many sectors granting a minimum of 30 days per year. With regard to the changing patterns in cross-border communication owing to technologi- cal changes, information is now exchanged in all parts of the world, leading to the dissem- ination and increase of English as a global language. Fifteen years ago, travelers to China had problems communicating in English and the road signs were only in Chinese charac- ters, even in the major cities. Today, in cities such as Beijing and Shanghai, increasing numbers of people communicate in English and many road signs are now written in the Latin alphabet. Another significant demographic trend presently occurring worldwide is the increase in life expectancy and the shrinking of populations owing to improved medi- cal treatment and disproportionate birth rates. Women in Europe and Japan are having fewer babies and the majority of the population in these areas is 60 and older, while many developing countries are confronted with a younger population owing to high birth rates and many people dying as a result of diseases such as HIV/AIDS. These developments and the fact that market demands vary considerably between young and aging societies mean that the focus on production and market activities is shifting. The following diagram summarizes some of the factors contributing to globalization and global economic trends. 19 Figure 1: Facts about Globalization and Global Economic Trends Source: Created on behalf of IU (2015). 20 1.3 Theoretical Explanations for Globalization A number of theoretical concepts explain why international business and trade is benefi- cial for all countries involved. Without going into too much detail at this point, we will just briefly mention three theories: gains by absolute advantage gains by comparative advantage characteristics of competitive advantages Interestingly, all these theories date back to the 18th and 19th centuries, when industriali- zation was in its early stages, especially in Europe. The development of large industrial corporations led to intense theoretical reflection on the potential harm and benefit of cross-border business activities. Gains by Absolute Advantage When Adam Smith published his book “Wealth of Nations” (Smith 1776), he noted that trade between countries would lead to overall benefits if countries specialized in the pro- duction of those goods they had an absolute advantage in. By absolute advantage he meant that the goods could be produced at lower unit costs. Smith’s view is a simplifica- tion of reality, assuming that two countries could produce two identical products. How- ever, the principle of specialization and the positive outcome of focusing on those activi- ties remain convincing. The chain of argument can be described as follows. Two countries, A and B, produce two products, textiles and steel. With one unit of resource for each product, country A would be able to produce 20 units of textiles or 40 units of steel while country B could produce 80 units of textiles or 20 units of steel. It is obvious that country A is more efficient in produc- ing steel, while country B has an absolute advantage in producing textiles. If each country spends one unit of resource input on each product (2 units in total), the overall output would be 100 units of textiles and 60 units of steel. However, if country A spent 2 units of resource input on the product it has an absolute advantage in, in this case steel, it would produce 80 units of steel. If country B focuses on the product it does best, namely textiles, it would generate 160 units of textiles. By means of specialization, the overall output would be 80 units of steel and 160 units of textiles compared to 60 units of steel and 100 units of textiles in the case of country A and B not specializing. This example is summar- ized in the following table. Table 1: Absolute Advantage From Specialization and Trade Country A Country B Explanation Textiles 20 80 1 unit resource input for each product 21 Country A Country B Explanation Steel 40 20 1 unit resource input for each product Overall output 60 100 Specialization: Each country focuses on the product it has an absolute advantage in. Textiles 0 160 2 units resource input only in textiles Steel 80 0 2 units resource input only in steel Overall output 80 160 Source: Created on behalf of IU (2015) using Wall/Minocha/Rees 2010, p. 80. The theory of Adam Smith presupposes a scenario, in which each country has an absolute advantage in the production of at least one item. However it can be expected that in prac- tice some countries do not have an absolute superior production. Gains by Comparative Advantage More realistically, David Ricardo stated that even if two countries have no superior produc- tion of any kind, both countries would still benefit from specialization and cross-border trade (Ricardo 1817). To achieve this, the country with advantageous products must focus on the one product in which it has a comparative advantage. In other words, it needs to specialize in the product in which it has the greatest absolute advantage. For the disad- vantaged country, it is then important to focus on the product in which it is least disadvan- taged. This example is summarized in the following table: Table 2: Comparative Advantage From Specialization and Trade Country A Country B Explanation Textiles 320 80 1 unit resource input for each product Steel 40 20 1 unit resource input for each product Specialization: Each country focuses on the product it has a comparative advantage in. Comparison of the cost ratios of producing textiles and steel. Textiles 320 : 80 = 4 80 : 320 = 0.25 Steel 40 : 20 = 2 20 : 40 = 0.5 22 Country A Country B Explanation Overall output Comparative advant- Country A’s comparative advantage is greater in age in textiles: production of textiles than in steel Both countries 4 – 0.25 = 3.75 benefit from specialization (A in textiles, B in steel) Comparative advant- and trade. age in steel: 2 – 0.5 = 1.5 Source: Created on behalf of IU (2015) using Wall/Minocha/Rees 2010, p. 8. The table shows that when the cost ratios for production of textiles and steel are consid- ered it is apparent that country A’s greater advantage lies in the production of textiles, while country B, though disadvantaged in both productions, is less disadvantaged in the production of steel. Therefore, it is to the benefit of both countries, if country A concen- trates its input on textiles, while country B specializes in steel, and both countries then engage in mutual trade of both products. The theories of Adam Smith and David Ricardo are doubtlessly convincing. Yet, it is worth mentioning that they are based on assumptions that do not have much in common with real life scenarios. For example, both approaches presuppose it would be possible to sim- ply transfer resources and employees from one industry to the other. Furthermore, free trade without barriers such as tariffs and protectionist measures is assumed. Additionally, the underlying idea that there is mutual demand in the goods described. Finally, both the- ories provide a simplified scenario with two countries and two products. It can be assumed, that all these assumptions do not reflect the complexity and diversity in which international business is carried out. Characteristics of Competitive Advantages To conclude this chapter, we would like to consider the comparative and/or competitive advantages of a country. There are numerous theories to explain this concept, however we will focus on Michael Porter’s (2011) explanation of competitive advantages both on cor- porate and on national level. The question posed is why certain companies are successful in creating a superior market position whereas others are simply incapable of surviving. Studies suggest the existence of three key characteristics that lead to a company having greater success in a competitive market: Architecture: Successful companies manage to agree on preferential contractual obliga- tions with suppliers and customers. Innovation: Top companies are evidently more innovative than competitors. Incumbency advantages: These relate to a company’s ability to be an earlier player in its particular market (or markets). This provides the chance to establish a good reputation and to control access to resources. This advantage is also closely related to a firm’s innovation capacity. It can be stated that these advantages are not necessarily ever-lasting. In fact, there are quite a number of major companies that over time have lost one or more of their competi- tive advantages, often resulting in a complete breakdown of the corporation. Take as an example, the computer company ‘Commodore’, a major hardware provider in the early 23 days of computerization. During the 1980s, this company was a key international player in the production of computer hardware, however it failed to follow and adopt key develop- ments in the supporting software programs. Consequently, it disappeared from the mar- ket—a development that was hardly expected in 1985. If one transfers the concept of competitive advantage from a corporate to a national per- spective then, according to Porter, there are two key capacities that must be realized for a nation to be successful in international competition: product innovation process innovation It appears that these characteristics will determine the success of a nation more than any other factors. They relate to six variables, which need to be looked at in order to under- stand why certain countries have gained competitive advantages over others. 1. Demand conditions: Is there sufficient domestic demand? 2. Factor conditions: Does a country have natural resources, advantageous infrastruc- ture, and qualified labour forces? 3. Firm strategies: Is the private sector marked by internationally-successful, well-man- aged organizations? 4. Related and support industries: Does a country have business support services and a well-established sector of supply companies? 5. Government policies: What is the nature of the legal and regulatory framework in a country and what is the likelihood and extent of governmental interventions in the business sector? 6. Chance: Can a country, not unlike a company, recognize and seize opportunities or maximize the benefit of favourable circumstances, e. g. business opportunities in the former communistic European countries after the fall of the Berlin Wall. The first four variables in this list are most important and interconnected. They are influ- enced by one another, as seen in the following figure illustrating Porter’s view of competi- tive advantages. 24 Figure 2: Competitive Advantages on Corporate and National Level Source: Porter 1990 and Porter 1998, cited in: Wall/Minocha/Rees 2010, p. 89. In summary, it is important to recognize that all theories oversimplify economic reality. However, they help explain why international trade is beneficial for all parties. History clearly indicates the importance of international cooperation and exchange for national economic development. Numerous examples show that those countries that do not par- ticipate—or only to a minor degree—in cross-border trade are often less developed. SUMMARY This unit aims to lay the foundation for a shared understanding of global trends in the business management arena. Starting with a very broad definition of globalization as an increasing interconnectedness among societies and economies worldwide, we explained global markets and international business. We then considered a range of factors that influ- ence global trends, such as cultural and political forces, the integration of economic processes, the shrinking influences of national govern- ments, and the increasing connections between societies and markets worldwide. 25 With this deeper understanding of globalization, we eventually explored the current trends and facts of globalization. Here, we specifically dis- cussed economic changes, political changes, technological develop- ments, and changes in societal and behavioral patterns. It became obvi- ous that these aspects are interrelated. Finally, we briefly explored theories that explain the economic benefits of globalization. In particular, the treatises of Adam Smith and David Ricardo were outlined. Smith’s theory revealed why there are absolute advantages resulting from specialization and trade, while Ricardo’s theory showed that comparative advantages from specialization and trade benefit even those countries that face disadvantages in production of certain goods. Porter’s ideas elucidate the sources of competitive advantages on a corporate level and among nations. His studies have proven that a set of key characteristics help to achieve national gains from international business activities. 26 UNIT 2 THE INTERNATIONAL COMPANY AND ITS ENVIRONMENT STUDY GOALS On completion of this unit, you will have learned … – the key characteristics of international companies. – how companies enter international markets. – the special features of international business activities. – how to systematically analyze the environment in which international companies oper- ate or intend to operate. 2. THE INTERNATIONAL COMPANY AND ITS ENVIRONMENT Introduction COMPETING IN A GLOBALIZED ECONOMY Emblazoned across the huge blue barns of the Daewoo shipyards on Koje Island off the southern coast of South Korea are signs declaring ‘No change, no future’. Certainly it is a frequent mantra in Korea, as Hyundai Heavy Industries, Samsung Heavy Industries, Daewoo Shipbuilding, and Marine Engineering strive to main- tain their positions at the top of the global industry. Presently, the top three are in a sweet spot; orders are rolling in fast, deep hedging means they are insulated against the strong Korean Won and their share prices have been skyrocketing. All are frantically extending their docks and building new quays to enable an increase in capacity. “Korean shipbuilders are enjoying this very bullish market”, says Koh Youngyoul, chief strategy officer at Daewoo, which has a three-year backlog of orders worth $29 billion. But how long will it last? Korean shipbuilders are being threatened by China, which is set to have 23 docks for construction of large ships by 2015, many more than Korea’s 15. Meanwhile, Chinese manufacturers, already churn- ing out standard container ships, are trying to make high-tech liquefied natural gas carriers and large containers, Korean industry’s bread and butter. Korean estimations of the time China will need to close the technological gap range from four to ten years. Industrial operators know they must not be com- placent. “At the moment, China is simply building low-value added ships, while Korea is making many more highly technologically-oriented ships”, says Mr Koh of Daewoo, who expected to win orders worth $11 billion this year but had to correct this upwards to $17 billion after achieving their target in the first half. “There is no serious competition from China right now but it is only a matter of time until China catches up with Korea the way Korea caught up with Japan ten years ago”, says Mr Koh. Korea came from nowhere to become the world’s biggest shipbuilding country and, thanks to Hyundai, Samsung, and Daewoo, has a global market share of around 40 %. The rise of the Chinese industry has led to Korean manufacturers looking at Japan’s mistakes and ensuring they do not fall into the same trap. “Japan failed to accept diversity”, says Park Chung-Heum, executive vice-presi- dent of project planning at Samsung Heavy, which likewise received $10 billion in orders in the first half and raised its projected orders to $15 billion. 28 About 90 % of all Korean orders are for run-of-the-mill container carriers and tankers but the other 10 % are orders for vessels such as floating production storage and offloading oil facilities that Korean shipbuilders hope will be their future. Already Daewoo has built the Agbami FPSO vessel for Chevron, the U.S. oil giant, for a record $1.6 billion offshore oil production facility for Abu Dhabi Marine. Samsung is increasingly concentrating on offshore vessels such as barge-moun- ted power plants and drilling rigs. They have also built an Arctic tanker for Lukoil and ConocoPhillips that can break ice up to 1.5 m thick. “Six years ago, the aver- age price of a Samsung ship was $50 million or $80 million at today’s prices but now it is $170 million”, Mr. Park says from his office overlooking the Koje ship- yards, illustrating both the sophistication of the ships being built and the recent escalation of prices shipyards can demand. But all this newly added value carries a risk, namely technology leakage. Korea’s National Intelligence Service has been investigating leaks from Korean compa- nies to Chinese competitors and a former Daewoo employee has been arrested for selling drawings to a Chinese company. “We are very concerned about this sort of leakage”, says Mr Park of Samsung. “Now we are putting watermarks on our drawings and printing them on paper, not on CDs. This is a very critical time as China would like to be able to catch up with Korea”. Nevertheless, Sanjeev Rana, a shipbuilding analyst at Merrill Lynch in Seoul, says Korean shipbuilders will be able to remain market leaders in high value ships at least until 2010, although he adds that this is not necessarily a recipe for success. “Korea will maintain their lead in the value added segment but they need to maintain conventional shipbuilding in their portfolio; you can’t have everything value-added”, S. Rana says. “So even if they increase the high-tech component of their portfolio to 65 %, they still will be exposed to China by 35 to 40 %.” Strategy to cheap labor China might present a threat to Korean shipbuilders but it also offers significant opportunities. Samsung Heavy Industries, and Daewoo Shipbuilding and Marine Engineering, Korea’s second and third largest shipbuilders, respectively, have both opened yards across the Yellow Sea. There, Chinese workers construct the blocks that form the basis for Korean ships, which are then transported back to Korea for value-added production. This enables Korean producers to utilize Chi- na’s cheap labor without, in theory, giving away core technology. 29 “China is supplying one-third of the blocks used in the ships that are put together in the Koje yards”, says Park Chung-Heum, executive vice-president of project planning at Samsung Heavy. “The price of block fabrication in Korea has become very expensive so we are very happy to do this in China.” Samsung’s factory in Ningbo, Zhejiang province now produces 200,000 tonnes of ship blocks a year, while Daewoo’s subsidiary in the north-eastern port city of Yantai, Shandong province will churn out 220,000 tonnes of ship blocks when it reaches full capacity in 2011. However, Hyundai Heavy, Korea’s largest ship- builder, does not have a joint venture in China and has no plans to open one, Kefin Chang, a company spokesman stated. “Shipbuilding is a very labor-inten- sive industry and Hyundai Heavy wants to supply jobs for Koreans”, he said. Source: Wall/Minocha/Rees 2010, pp. 25–27. This introductory text describes the challenges that Korean shipbuilders face nowadays owing to the improved competitiveness of Chinese companies in this sector. What can be learned from this case study is that competing in a global economy is a process that needs ongoing attention and the capacity to adapt to the ever-changing characteristics of the environment in which international companies operate. Many people are unaware of the fact that, in the 1970s and 1980s, German shipbuilders found themselves in a situation similar to the Koreans today. At that time, Korean compa- nies were challenging the comfortable position of German shipbuilders. The latter had a technological advantage over Korean firms, which had been developing lower quality ves- sels. However, over a period of time, Korean shipbuilders were able to meet the technical standards of German competitors and even market ships at lower prices. As a result, the German shipbuilding sector, formerly a significant job provider in Schleswig-Holstein, Hamburg, Bremen, and the state of Lower Saxony, almost collapsed with only a few highly specialized producers remaining. The economic and political impact on these regions can still be experienced today, as the structural change proved to be a long-lasting process. 2.1 International Companies and their Operations In unit one, international companies were broadly defined as businesses operating across national borders. It was also stated that these operations vary considerably (Hill 2011). Let us now have a look at multinational enterprises (MNE) and elaborate on their specific characteristics. 30 Multinational Enterprises A multinational enterprise can be simply defined as a company that takes a global per- Multinational enterprise spective on markets and production. It searches for market opportunities beyond the A multinational enter- prise (MNE) is a company domestic arena and is ready to locate operations abroad (Daniels/Radebaugh/Sullivan searching for market and 2009). Some of these enterprises engage in foreign direct investments, while others focus production opportunities on a minimum number of countries in which to operate their business. In addition, the worldwide. size of the company is frequently mentioned as a key determinant of multinational enter- prises. However, in addition to all the big firms engaging in global activities, there are also a considerable number of small businesses taking a global view on markets and produc- tion. As a baseline, many authors regard a company operating in more than one country as a multinational enterprise. Dunning (1993), for example, defines a multinational enterprise according to two key characteristics: engagement in foreign direct investment and owner- ship and/or control of value-adding activities in more than one country. Usually, the organizational set-up is marked by a central headquarters where key strategic decisions are made. Furthermore, the multinational enterprise typically has several subsidiaries in a number of countries. These are allowed to operate with different degrees of entrepreneu- rial freedom and are thus able to adapt to the specific characteristics of their local envi- ronments. However, there are different organizational arrangements: these will be dis- cussed in more depth at a later stage of this course. Multinational enterprises can be further categorized on the basis of their different views on global markets (Wall/Minocha/Rees 2010): Global companies: These organizations produce standardized goods and provide stan- dardized services globally. Goods and services are not or only minimally customized to local needs. Multidomestic companies: These organizations have established subsidiaries abroad that mainly operate independently. They produce goods and offer services customized to local demand. Transnational companies: These companies integrate location-specific activities into a single production process. A brief note on terminology—the term ‘corporate’ is frequently used instead of company, firm, or enterprise. In common terms, it is used interchangeably. However, we will avoid using ‘corporate’ as it contains an element of ‘incorporation’. This could be potentially misleading, as in many countries the vast majority of businesses are not incorporated. One example is Germany, a world leader in international business activities. In this export nation, not even 0.5 % of the companies are large corporations; 99.5 % are small and medium-sized businesses (Institut für Mittelstandsstatistik 2003). While many of these business are internationally active, not many are in fact incorporated. Using the term ‘cor- poration’ has the potential to exclude these companies from consideration, thereby falsely disregarding their importance. 31 Expanding Internationally What is the driving force behind an internationally operating company? Typically, there are three major reasons for deciding to enter global markets (Daniels/Radebaugh/Sullivan 2009): increase sales access resources balance risks With many markets almost saturated nowadays, it has become increasingly important for companies to expand their sales operations to other countries. If costs of increasing pro- duction do not rise disproportionately, expansion of sales will result in higher profits for the company. For many international companies, the turnover from global markets is more important than the turnover generated domestically. To take the automotive indus- try as an example, for a company like Porsche, the US market is of key importance, as opposed to Volkswagen who depend heavily on sales in China, and Toyota who sell an important share of its vehicles in Africa. Interestingly, similar situations can be found in small firms. The large number of highly specialized small machine manufacturers in Ger- many are highly dependent on international markets. Gaining access to resources is a further motive for engaging in international business activities. There are many opportunities for generating competitive advantages by sourc- ing from abroad. In many cases, it is simply the non-availability of necessary goods or services in the company’s home country that drives the decision to enter global markets. Costs are frequently a key factor in companies expanding their operations internationally. Many companies have started producing abroad to reduce the costs of workforces at home. In China and many other countries in South-East Asia, there are numerous Euro- pean and American multinational enterprise production plants. India has become a major player in the service industry. With a cheap, yet well-educated workforce, it has attracted subsidiaries of international software companies and call center operators. Natural resources in the vicinity may also be a reason for operating internationally. Some compa- nies group their production around natural resources; oil companies, for example, have started to refine oil in countries such as Nigeria, where resources are extracted. Finally, the desire to balance and minimize a company’s risks has led to more interna- tional operations in the private sector. One of the main explanations is that it helps equal- ize the volatility of particular markets. In recent years, for example, car sales in Europe have been relatively low, yet on the rise elsewhere, in countries such as China. In other words, international operations help minimize the risk of recessive trends in one region by increasing sales in another. Similarly, production plants are often set up to reduce risks from inconsistent foreign currencies. Many European producers manufacture in the US in order to ward off the harmful effects of a potential downturn of the dollar. Manufacturing in the US means that production costs and sales prices are charged in the same currency. This also applies when firms decide to procure their supplies from different countries. Again, this procedure helps to soften the effects of a single currency experiencing an increase in value compared to the currency at home. Finally, it is worth noting that some 32 companies simply start international operations in order to compete with their competi- tors. For example, all major consultancy firms can be found in several African countries. In these countries, the formal private sector is small with only a few companies; however, they are seen as potential clients. Here, it seems internationalization means being present in markets in order to prevent competitors from growing. The following table summarizes key aspects of this section: Table 3: Characteristics of Multinational Enterprises Multinational Enterprises Definition: A company that takes a global perspective on markets and production. It searches for market opportunities beyond the domestic arena and is ready to locate operations abroad. Types of multinational Global companies are those that offer standardized goods and services enterprises: globally. Multidomestic companies have subsidiaries abroad that operate rela- tively independently. Products and services are customized to local demands. Transnational companies integrate location-specific activities into a single production process. Reasons for operating inter- increase sales nationally: access resources balance risks Source: Created on behalf of IU (2015). 2.2 Operational Patterns in International Markets The last section dealt with the reasons for doing business internationally. Now we will dis- cuss the various ways that companies enter international markets (Daniels/Radebaugh/ Sullivan 2009). It is necessary for a company to consider the most suitable approach. Determining factors for this decision mainly result from consideration of a company’s internal context and the environment abroad. Perhaps the most important issue is the financial capacity of a company: many companies start their international operations using inexpensive methods. If they prove successful, then other perhaps more expensive measures of operating abroad can be taken. The concepts underlying the internationaliza- tion of business are (Wall/Minocha/Rees 2010): export-based approaches non-equity-based approaches equity-based approaches 33 Export-Based Approaches This is usually the first approach adopted when a company decides to go international. At this point, we will be focusing on export, although it should be understood that import follows similar patterns. In practice, export means that a firm produces domestically and then applies various logistical means to export its goods to markets abroad. A simple device such as a mobile phone can easily explain the significance of import and export in our daily lives: the mobile phone producer might be located in Central Europe, the model designed in the UK, the software developed in the US, the materials sourced from the Democratic Republic of Congo and Taiwan, and production carried out in China. Export is broadly categorized by Wall/Minocha/Rees (2010) as: indirect export direct export Indirect export means that international operations, as a whole, are carried out by third party businesses. Acting as intermediaries, they are responsible for the shipment of goods abroad and their distribution via various channels in foreign markets. The responsibilities of these intermediaries vary, depending on the extent of their activities. Export houses, confirming houses, and buying houses constitute these intermediaries. Export houses buy the products from a domestic manufacturer and then ship them abroad to be sold. They take the full financial risk of the internationalization process. In contrast, confirming houses assume the role of agents working on commission, bringing buyer and seller together. The financial risks are taken by the producing company. Buying houses are simi- lar to confirming houses, however their business is dependent on the demand. They look for sellers to match the needs of the buyers identified abroad. Indirect export means that there are fewer risks for the producing company and costs are only incurred when goods are sold. This may be why many firms choose this business option. On the other hand, indirect export means having almost no control over the mar- ket activities abroad and little information on consumer reactions. There are also reputa- tional risks to consider. The company remains disconnected from its foreign customers. In comparison to indirect export, direct export means the production company carries out their own export activities. Physical distribution needs to be arranged and appropriate distribution channels chosen for abroad. Obviously, this method is more expensive com- pared to indirect export as it requires more resources and also entails higher risks. How- ever, the direct interaction with foreign markets and customers provides valuable market information and additional service provision opportunities. Non-Equity-Based Approaches This internationalization approach has gained tremendous importance in recent decades. It is the sale of know-how, either a sort of technology, patents, usage of brands, copyrights or others. It is outlined in a contract that grants the use of intellectual property. Today’s technology has become user-friendly, taking only seconds to transfer technology and/or intellectual property rights via the internet. This means physical distribution is no longer 34 required to enable international business activities. Industries heavily engaged in this internationalization process are tourism and transportation, technical management per- formance providers, and the hospitality industry. We will briefly discuss the following non- equity-based approaches to business internationalization (Wall/Minocha/Rees 2010): licensing franchising management contracting Licensing This basically means that the owner of any kind of intellectual property grants permission to the licensee to use the intellectual property, usually for payment of a license fee. Intel- lectual property is normally protected by a trademark, patent, or copyright against unau- thorized usage. In other words, licensing is the transfer of knowledge. It is a relatively cost- effective method of internationalization, frequently used when it is crucial to gain a considerable market share in a short period of time. One key challenge of this method is the protection of intellectual property. Imagine devel- oping a brand new technology and being offered a financially beneficial license contract from a Chinese company. In the past years, after entering into such agreements in China, a number of Western companies discovered slightly varied imitations of their products appearing in the market. Law enforcement regarding intellectual property rights protec- tion in China is still in its infancy, though improving. Were this to occur to a small or medium-sized company with limited financial resources, such an incident could seriously jeopardize its existence. Franchising This is similar to licensing. It transfers the right to third parties to undertake certain busi- ness activities using the franchise provider’s name, trademark, specific business proce- dures and much more. A well-known franchise concept is McDonald’s restaurants. Gener- ally, we can distinguish between (Wall/Minocha/Rees 2010): first-generation franchising second-generation franchising These two concepts differ in the way business activities are controlled by the franchise- provider. While the first concept allows the franchisee to use the concept without any major limitations, the second is marked by strict controls. Franchising is mainly used in the service industry. It requires relatively little investment in the internationalization process and allows a fast market penetration, however conflicts with franchisees have proven to be difficult to resolve. One example is the legal struggle between fast food franchiser X and a number of disgruntled franchisees in Germany over unrealistic forecasts and questionable operational requirements. The reputational dam- age resulting from such cases should not be underestimated. Often, this control has fran- chisees doubting their function as owner-managers. Little entrepreneurial freedom 35 remains when marketing methods, interior design, location, suppliers, pricing, and busi- ness strategies are closely regulated. This limited freedom is a disadvantage for the fran- chisee—the price paid for deciding to use a well-known brand. Management contracting Management contracting can take various forms of contractual agreements. Basically, it means that a service provider in one country carries out certain management tasks for a foreign company, which has decided not to establish a subsidiary in the country of service. The advantage of such an arrangement is that the service provider is located in the area and is knowledgeable about the specific characteristics of the market. In general, this cooperation is more cost effective than establishing an internal subsidiary. However, the disadvantage is that the foreign company has no way of receiving any direct feedback from customers and is therefore disconnected from the market. Furthermore, it proves difficult to supervise the service provider in the same manner as an internal subsidiary. Equity-Based Approaches An equity-based approach to international business is the method that requires the high- est level of commitment from the company in terms of personnel and finances. More feed- back from the foreign market is provided, and controlling the operations abroad and pro- tecting property rights is made easier. On the other hand, the investment bears a considerable loss should the internationalization fail. Three kinds of equity-based interna- tionalization approaches are (Wall/Minocha/Rees 2010): joint ventures alliances acquisitions Joint ventures A joint venture means that partner companies collaborate in a formal, often contractual, manner in order to create an entity with a new identity. The companies involved in the joint venture share strategic and operational duties. Joint ventures provide an opportu- nity to gain a better market position by combining competencies from two or more play- ers, thus creating a sustainable added value. Moreover, a joint venture helps reduce R&D expenditure as this no longer has to be carried out by each company individually. The joint approach also helps to gain benefits from insights into the expertise of the partner com- pany. However, in some cases, joint ventures have failed as a result of cultural differences and different legal systems. Alliances These are similar to joint ventures. However, they are not as structured and often involve a mismatch of capabilities and resources between partners. Alliances are the intermediary between joint ventures and acquisitions. Often, legislation prohibits formal agreements 36 negotiated in joint ventures or complete takeovers in the case of acquisitions. Companies will tend towards an alliance should the risks resulting from an acquisition or a joint ven- ture appear too high. Acquisitions Acquisitions are the method of internationalization that requires the highest commitment. Taking over or merging with an existing company is one way of organizing an acquisition; however it is also possible to create an entirely new entity. In any case, the acquiring firm holds full ownership of the newly established company. The initial stage is expensive; however, it helps to avoid some of the risks of other equity-based approaches, including a lack of control and problems owing to different organizational cultures. The following table provides an overview of the internalization patterns of companies: Table 4: Operational Patterns in International Markets Export-based approaches Non-equity-based approaches Equity-based approaches indirect export licensing joint ventures direct export franchising alliances management contracting acquisitions Source: Created on behalf of IU (2015). 2.3 Assessment of the Environment for Internationalization We have seen the different approaches to the internationalization of business operations. It is important to understand that moving operations beyond national borders normally requires extensive effort, time, and resources. In order to ensure that this money is well invested, a company aiming to gain access to international markets should thoroughly investigate the environment of the country or countries in which it intends to start opera- tions. Even though internationalization often happens by chance, it should be based on a thorough assessment of the environment in which the company intends to operate. This section will focus on three important contextual issues that require research when moving operations abroad (Daniels/Radebaugh/Sullivan 2009): political context legal context economic context 37 A further contextual aspect that must be considered in the internationalization process is the cultural context. Culture is a crosscutting issue that determines to a certain extent all other context factors. It is also closely related to ethics, a topic that is also of key impor- tance. However, cultural issues are so crucial to success that they are discussed in a sepa- rate unit. Political Context A political system consists of the governmental institutions of a country, its political organ- izations, various stakeholder groups, formal and informal relations between these groups, and the regulatory norms established to administer the political process. It is important for a political system to be supported by a majority of the country’s population. Therefore, its ability to govern the multitude of societal perspectives is of crucial importance. A com- pany needs to understand that it cannot just transfer the way it conducts business at home to foreign countries as it must take into consideration the various political systems in the countries into which it desires to move its operations. So what are the key elements of a political system analysis? They include the following: general emphasis placed on either individualism or collectivism, political structure ranging from democracy to totalitarianism, and assessment of various political risks. Individualism versus collectivism Let us examine the following example. You may have followed the political discussion in the United States on health reform strongly promoted by President Obama and his Demo- cratic Party. From an external perspective, it may seem that the country is deeply divided over this issue with only a slight majority now being in favor of a state-governed health system. However, a considerable number of Americans still believe that taking out health insurance should not be made mandatory by the government. Now imagine the same dis- cussion in Germany where most of the population is obliged to make financial contribu- tions to the health care system. It can be assumed that hardly anyone would want to end the state-governed health system with all the social welfare benefits it entails. Children, for example, are included in their parents’ health insurance at no additional cost. This example shows the standing of individualism in American society in contrast to the strong collectivistic tendency in Germany. Individualism is based on individual freedom, while collectivism often restricts individual freedom for the sake of collective societal gains. This is an important aspect in terms of internationalization. Political structure The political structure also needs to be assessed. In Central Europe, operating businesses in democratic systems is taken for granted but once operations are shifted abroad, totali- tarian systems may be encountered. Democracy is based on two important principles: the rule of law is universally applied and citizens are granted the right to participate in the decision-making process of a country by means of regular elections. Democratic systems 38 normally promote distribution of power. Contrary to this, totalitarian systems tend to place political power in the hands of one person, a few individuals, or a party. In other words, power is monopolized and opposition is often suppressed. When business activities are moved to two democratic countries, it should be understood that both countries do not necessarily offer the same political environment. Decision- making in politics varies considerably between parliamentary democracies with a multi- party parliament, as seen in Germany, and representative democracies with only two par- ties and a relatively strong president, as in the US. In the case of China and North Korea, both may have totalitarian systems but the degree of pressure on their people and the freedom granted to citizens varies considerably. China’s communist party leadership is certainly far from being deemed democratic while North Korea, which is led by a family and a supporting party, can be seen as a dictatorship, as it refuses to grant individuals any personal freedom. Assessment of political risk This assessment is important when a company intends to do business internationally. A company in the technology sector that is considering a move to Switzerland and Austria, for example, has no need to fear product or software piracy as they would be able to rely on a legal system that protects intellectual property. Now imagine the same scenario in China and Indonesia. It is critical for companies to take measures to protect individual rights as well as obtain information on how to deal with legal systems that have differing views on intellectual property. Consider the example of an African country in which judges went on strike for about one year and where political interference occurs frequently throughout court cases. A business manager would need to take a risk premium into account in order to operate in highly dangerous environments. The following political risks must be considered (Daniels/Radebaugh/Sullivan 2009): Systemic political risks are risks caused by a change in political leadership and a sub- sequent shift in political orientation. Often opportunities rather than risks are the result, but in terms of corporate risk management, it is valid to call them risks. Procedural political risks relate to changes in governmental behavior that might affect companies. Corruption and generally low procedural reliability are examples of this type of risk. Distributive political risks mean that governments feel they should receive more finan- cial benefits from certain industries or companies. When Germany introduced the road tax for trucks, this was a clear risk for the transport businesses affected. Catastrophic political risks are the impact of events such as war and civil unrest on pri- vate businesses. They can lead to a decrease in turnover or even to a complete opera- tional breakdown. Legal Context Legal systems are mechanisms that enforce laws by interpretation of the content of laws and regulations (Daniels/Radebaugh/Sullivan 2009). Usually, legal systems comprise the elements of constitutional law, criminal law, and civil/commercial laws. A distinction may 39 be drawn between common law, civil law, theocratic law, customary law, and systems that mix elements of the above systems. Common law is based on traditions, certain judicial codes, and previous court decisions. Civil law applies comprehensive legal codes that are designed to cover as many legal cases as possible. Theocratic law bases legal decisions on religious codes and employs religious leaders as judges. Customary law is based on certain traditions or experiences. Mixed law systems employ more than one of the abovementioned legal systems. It is interesting to note that, in many African countries, traditional laws and regulations can still be found alongside relatively modern common or civil law systems. Often the rules are contradictory, e.g. concerning the issue of land rights. In rural areas, land is still governed by local chiefs and customs passed down over centuries. Thus, a company could buy a piece of land in good faith, not knowing that the local chief has already assigned the plot to someone from the village. This relates directly to a key question that managers should ask when considering going abroad: what is the base rule in a legal system? What is the difference between the rule of man principle and the rule of law principle? The latter is widely applied in democratic political systems and is based on democratically legitimized law enforcement applying to every member of society. The idea of fairness underlies the rule of law. In opposition to this, the rule of man is an attribute of totalitarian systems. It grants a ruling person, group or party the ultimate power to determine the rules, how the rules are to be applied, and to whom they apply. The rule of man is often perceived as unjust. What are the most important legal issues that a manager considering the internationaliza- tion of his/her business would need to take into account? Firstly, what is required to estab- lish a business in a foreign country? Secondly, how difficult would it be to obtain business permission and what restrictions could possibly hinder the process? Thirdly, how are con- tracts concluded and are there sufficient legal means in place to enforce them? A further consideration would be labor and workplace regulations and to what extent unions and other groups are allowed to intervene in company policy. In terms of production, an inves- tigation into product standards in the respective countries is a prerequisite, as well as exploring how product liability is regulated. Marketing regulations also need to be observed. Think of the warnings carried on every pack of cigarettes in Germany. Equally important is the question of how long court cases normally last and to what degree extrajudicial arbitration is allowed. As a result of the increase in service industries, intellectual property rights have gained significant impor- tance, thus it is worth investigating whether the foreign legal system protects these rights and to what degree. Another major issue is a country’s environmental regulations. It might be tempting for a company to establish a potentially harmful operation in countries with weak law enforce- ment in environmental issues. However these countries tend to be unpredictable in their attitudes once a company has committed to building production plants. 40 Economic Context Economic context is closely related to the political and legal circumstances in a country (Daniels/Radebaugh/Sullivan 2009). In fact, these aspects are inseparable as economic activities are affected by political decisions and regulated by legal systems. Many types of economic systems are found throughout the world and can be based on theoretical frame- works ranging from true capitalism to a strictly command environment. However, these are extreme concepts, which are seldom found anywhere, perhaps with the exception of the strictly controlled command economy in North Korea. Western countries generally support market economies to a greater or lesser degree, with varying amounts of govern- mental interventions. Free market systems are known for their capacity in terms of wealth creation. However, they fail as far as wealth distribution, social security, and ecological issues are concerned. Germany has established a social market economy. It grants property rights but these are accompanied by an obligation to contribute to society. Furthermore, both the economic and the political system are designed to spread power, demonstrating the willingness to seek compromises and support broad participation in decision-making processes. Overall, this system has proven to be extraordinarily successful over a period of almost 70 years; it comes as no surprise, therefore, that Germany is considered the powerhouse of the Euro- pean Community in times of financial turmoil. Should you, as a manager, be interested in starting business operations abroad, then you will need to know to what degree governments intervene in business activities in the country/countries selected and also to what degree private ownership is granted. In a free economic system, such as the US, legislation protects private ownership. However, in many countries in Africa, foreigners will encounter a number of obstacles when trying to buy land. In countries such as North Korea and Cuba, private property is not allowed and government officials, rather than entrepreneurs, determine issues of business. Another area for investigation to obtain information on a potential market is the key fig- ures that represent a country’s economy. The primary figure for examination is the Gross Domestic Product (GDP). It represents the total goods and services produced in a country during a period of one year. The Gross National Income (GNI) is calculated by adding the revenues from import, export, and international activities carried out by domestic compa- nies to the GDP. Both indicators provide information on the overall market power of a country. The GNI is then divided by the population of a country to calculate the GNI per capita. This indicator describes the wealth created annually per person. It is useful to observe the growth rate of the GNI and also to compare the GNI with regard to its buying power. A manager might want to know whether the Gross National Income is rising stead- ily. She might also be interested in whether an increase in GNI is accompanied by rising prices, which could overcompensate for the positive effects of an increasing GNI. In this case, a market would be less attractive for international businesses as consumer spending is limited or even shrinking. The GNI is an average figure but for a business planning to go abroad with its operations more attention needs to be paid to income and wealth distribution. In many developing countries, the majority of the population has little income and lives mainly on subsistence 41 farming. In contrast, a small percentage of this same society may enjoy a high income and a considerable amount of personal wealth. It is not necessary to discuss poverty and dis- tribution aspects here but for a company moving into international markets, market potentials and risks simply must be considered. A further useful indicator for checking a potential market abroad is the trajectory of the cost of living; rising prices indicate inflation and decreasing prices indicate deflation. High inflation is normally accompanied by little confidence in future markets. Those holding large amounts of cash see their money losing value. In such an environment, consumers and companies struggle to plan for the future. The unemployment rate is another factor to consider. Some Southern European countries are suffering from youth unemployment levels of around 50 %. Moving operations into a country marked by high unemployment can have both positive and negative effects. Pro- viding a production plant with thousands of jobs attracts advantages such as tax holidays, easy access to commercial land, relatively low wages, and many others, however targeting consumers in this environment is difficult as only minimal buying power is available for newly launched products. Closely related to unemployment is the labor market—to what extent is it regulated? In the US, for example, making employees redundant in times of corporate crisis is relatively straightforward, while in Germany, laying off staff is complicated and expensive. Germany provides a high rate of social stability and is very committed to its working population. It is difficult to state whether regulated or free labor markets are better for firms wanting to go abroad. However, it is essential that a manager in charge of the internationalization proc- ess considers these issues, taking the effects on her company into account. Workforce skills, the cost of labor, and employee productivity are further matters of con- cern, which are in many cases interconnected. In many African countries, there is a strong belief that labor is cheap. This is true in terms of costs per working hour. Nevertheless, considering productivity and costs per unit output, many of these countries become extremely expensive owing to inefficiency, corruption, and theft. Let us take one example. In one of the poorest countries of the world, Malawi in Central Africa, a university graduate in engineering can be hired for as little as €200 per month. However, the skills acquired at the local university do not meet the standards required to work in contemporary architec- ture, structural engineering, or other technical sciences. The result is extremely low pro- ductivity, eventually leading to relatively high costs per output unit. Finally, the general business climate should be considered. One aspect is of particular importance—the prevalence of fraud, corruption, and political interference. These issues are linked to political and legal contexts. An excellent indicator for these is the Transpar- ency International Corruption Perception Index. Despite discussions on the methods applied to obtain this data, this indicator provides information on a country’s governance and transparency. For a company about to start its activities in that country, fraud, corrup- tion, and political interference can be major obstacles to business success. The following table summarizes the most important aspects to analyze regarding the envi- ronment of a new country in which a firm intends to start its operations: 42 Table 5: Aspects of the Environment to be Assessed When Preparing for Internationalization Political Context Legal Context Economic Context Individualism vs. collectivism Legal systems: Economic system: Democracy vs. totalitarianism mixture of constitutional, crimi- capitalism vs. command Political risk analysis: nal, civil, and commercial law economy systemic political risks Law systems: level of governmental inter- procedural political risks common law ference distributive political risks civil law Indicators: catastrophic political risks theocratic law Gross Domestic Product customary law (GDP) mixed systems Gross National Income (GNI) Base of rule: GNI per capita rule of man growth rate of GNI rule of law GNI compared to inflation income distribution wealth distribution inflation/deflation unemployment rate regulation of labor market available workforce skills cost of labor workforce productivity business climate (e. g. Cor- ruption Perception Index by Transparency International Source: Created on behalf of IU (2015). SUMMARY This lecture has provided an insight into international companies and the environment in which they operate. Following a general definition of the international company and a global perspective on markets and pro- duction, international companies were subsequently categorized into global, multidomestic, and transnational ones. The reasons for interna- tionalization are to increase sales, access resources, and limit risks. We then explored the different patterns of international business opera- tions and distinguished between export-based approaches, non-equity- based approaches, and equity-based approaches. We viewed the vari- ous sub-categories of these methods and also discussed the advantages and disadvantages of the different approaches. Which contextual aspects need to be considered when moving business operations abroad? We discussed an assessment framework for an envi- ronmental analysis comprising of political, legal, and economic con- texts. It became clear that these aspects are interrelated and thus all

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