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Chapter 4 Understanding the Global Context of Business Chapter Overview Through the process of globalization, the world market is rapidly evolving into a single interdependent economic system. The three major marketplaces within this system are North America, Europe, and Pacific Asia. Business success in the international arena is largely dependent on competitive advantage, which can take several different forms. With an absolute advantage, a country engages in international trade because it can produce a product more efficiently than any other nation. With a comparative advantage, a nation can produce some products more efficiently than others. With a national advantage, a country competes effectively in the global marketplace due to factor conditions, demand conditions, related and supporting industries, and organizational strategies, structures, and rivalries. Additional key factors that influence international business include import-export balances and currency exchange rate differences. In deciding to engage in international business, individual firms must first determine whether a market exists for their products abroad – either in their current form or with adaptations to suit foreign demands. If so, firms must also assess whether they have the expertise to manage international trade. Finally, firms must evaluate whether the conditions of each country they plan to enter are conducive to international trade. Once firms decide to enter the global market, they must decide how to effectively manage the business. Levels of involvement range from importing and exporting, to organizing as an international firm, to operating as a multinational firm. A company’s level of global involvement will directly affect its organizational strategy. Options include use of independent agents, licensing arrangements, branch offices, strategic alliances, and direct investment. Depending on local conditions, a company’s international organizational strategy may well vary for different foreign countries. Several barriers can inhibit global trade. Social and cultural differences include language, social values, and traditional buying patterns. Economic differences may compel companies to form close relationships with foreign governments in order to do business abroad. Political and legal differences can take a range of forms. Quotas, tariffs, subsidies, and local content laws are designed to protect domestic industries. Furthermore, local business practice laws can make practices that are standard in one country illegal in another. 38 Chapter Objectives 1. Discuss the rise of international business and describe the major world marketplaces. 2. Explain how different forms of competitive advantage, import-export balances, exchange rates, and foreign competition determine the ways in which countries and businesses respond to the international environment. 3. Discuss the factors involved in deciding to do business internationally and in selecting the appropriate levels of international involvement and international organizational structure. 4. Describe some of the ways in which social, cultural, economic, political, and legal differences among nations affect international business. REFERENCE OUTLINE Opening Case: Where Does Management Stand on Beer Breaks? I. The Rise of International Business A. The Contemporary Global Economy 1. Trade Agreements a. General Agreement on Tariffs and Trade (GATT) b. North American Free Trade Agreement (NAFTA) c. European Union (EU) d. World Trade Organization (WTO) B. The Major World Marketplaces 1. North America 2. Europe 3. Pacific Asia C. Forms of Competitive Advantage 1. Absolute Advantage 2. Comparative Advantage 3. National Competitive Advantage D. Import-Export Balances E. Exchange Rates 1. Exchange Rates and Competition 2. The U.S. Economy and Foreign Trade II. International Business Management A. Going International 1. Gauging International Demand 2. Adapting to Customer Needs B. Levels of Involvement 1. Exporters and Importers 2. International Firms 39 3. Multinational Firms C. International Organizational Structures 1. Independent Agents 2. Licensing Arrangements 3. Branch Offices 4. Strategic Alliances 5. Foreign Direct Investment III. Barriers to International Trade A. Social and Cultural Differences B. Economic Differences C. Legal and Political Differences 1. Quotas, Tariffs, and Subsidies 2. Local Content Laws 3. Business Practice Laws LECTURE OUTLINE I. The Rise of International Business (Use PowerPoint 4.4.) An increasingly large number of firms engage in international business. The world economy is becoming a single interdependent system through the process of globalization. Exports are products that are produced domestically and shipped for sale abroad; imports are products that are produced abroad but sold domestically. The total annual volume of world trade is estimated to be $8 trillion. A. The Contemporary Global Economy (Use PowerPoint 4.5, 4.6.) International trade is becoming increasingly important to most nations and their largest businesses. Governments and businesses are more aware of the benefits of globalization to businesses and shareholders. New technologies have made travel, communication, and commerce faster and cheaper. In addition, competitive pressures push firms into foreign markets to keep up with competitors. 1. Trade Agreements. Virtually every nation has formed trade treaties with other nations. a. General Agreement on Tariffs and Trade (GATT). This agreement reduces or eliminates trade barriers by encouraging nations to protect domestic industries. 40 b. North American Free Trade Agreement (NAFTA). This agreement removes tariffs and other trade barriers among the U.S., Canada, and Mexico. c. European Union (EU). This pact eliminates most quotas and sets uniform tariff levels on products imported and exported within the Western European member-nations. d. World Trade Organization (WTO). This organization encourages fair trade practices, promotes multilateral negotiations, and resolves disputes among members. B. Major World Marketplaces (Use PowerPoint 4.7, 4.8.) The contemporary world market revolves around three dominant marketplaces: North America, Europe, and Pacific Asia. 1. North America. Though the United States dominates the North American business region, Canada and Mexico are also major commerce centers. 2. Europe. Germany, the United Kingdom, France, and Italy dominate Western Europe; emerging from its communist foundations, Eastern Europe is now playing a larger role in the European business region. 3. Pacific Asia. Though Japan dominates this region, other important commerce centers include China, Thailand, Malaysia, Singapore, Indonesia, South Korea, Taiwan, Hong Kong, the Philippines, and Australia. C. Forms of Competitive Advantage (Use PowerPoint 4.9, 4.10.) No country is totally self-sufficient; every country relies on imports and exports. Countries tend to export those products that can be produced better or less expensively than in other countries. 1. Absolute Advantage. A country enjoys an absolute advantage when it can produce a product more cheaply than any other country. 41 2. Comparative Advantage. A country’s comparative advantage lay in its ability to produce certain products more cheaply or better than other products. 3. National Competitive Advantage. A country competes due to factor conditions, demand conditions, related and supporting industries, and organizational strategies, structures, and rivalries. D. Import-Export Balances (Use PowerPoint 4.11.) Critical in global business is a country’s acceptable balance between its imports and exports. An import-export relationship can be measured through a country’s balance of trade and balance of payments. 1. Balance of Trade. A nation’s balance of trade is the difference between the economic value of its imports and its exports. A trade deficit occurs when a country’s imports exceed its exports. A trade surplus occurs when a country’s exports exceed its imports. 2. Balance of Payments. Balance of payments refers to the flow of money into or out of a country. A country’s balance of payments results primarily from its balance of trade, though other contributing factors include money spent by tourists, foreign aid, and the buying and selling of currency. E. Exchange Rates (Use PowerPoint 4.12, 4.13, and 4.14.) An exchange rate is the rate at which a nation’s currency can be exchanged for the currency of another. Fluctuations in exchange rates can greatly impact a country’s balance of trade. With fixed exchange rates, the value of a country’s currency remains relatively constant to that of another country. With floating exchange rates, the value of a country’s currency relative to another currency varies with market conditions. 1. Exchange Rates and Competition. Exchange rate fluctuations affect overseas demand for their products and can be a major factor in competition. 2. The U.S. Economy and Foreign Trade. U.S. imports and exports have increased steadily in the past 10 years. 42 Notes: __________________________________________________________________ __________________________________________________________________ __________________________________________________________________ II. International Business Management The primary key to a firm’s success largely lay in how well the firm is managed. The basic management responsibilities in international business are extremely complex. A. Going International (Use PowerPoint 4.15.) Not every business is prepared to go international. A major decision factor is the business climate of other countries. Other factors include demand and product adaptations. 1. Gauging International Demand. Foreign demand for a company’s product may be greater than, the same as, or weaker than domestic demand. Determining international demand may require market research and/or prior market entry of competitors. 2. Adapting to Customer Needs. Product modifications may be required to meet the standards of various countries. B. Levels of Involvement (Use PowerPoint 4.16.) A firm may enter the global marketplace through different levels of involvement. 1. Exporters and Importers. Representing the lowest level of global involvement, exporters and importers conduct only a small part of their business globally. An exporter distributes and sells products in a small number of foreign countries. An importer buys products in foreign markets and then imports them for resale in its home country. 2. International Firms. More complex than exporters and importers, international firms conduct a significant portion of business in foreign countries. These firms basically remain domestic with global operations. 43 3. Multinational Firms. Multinational firms do not ordinarily think of themselves as having domestic and international divisions. Planning and decision-making are geared to international markets. Headquarters locations are almost irrelevant. C. International Organizational Structures (Use PowerPoint 4.17.) Whether an importer, exporter, international firm, or multinational firm, a firm’s level of global involvement will influence the firm’s choice of international organizational strategies. 1. Independent Agents. Independent agents are foreign individuals or organizations that agree to represent the exporter’s interests, including assisting in product sales, collection of payments, and in helping to ensure customer satisfaction. 2. Licensing Arrangements. In licensing arrangements, firms give individuals or companies in a foreign country the right to manufacture or market the firm’s products. In return, the licensor typically receives a fee and royalties, which are usually calculated as a percentage of the license holder’s sales. 3. Branch Offices. To gain more direct control and a more tangible presence in foreign countries, a firm sends some of its own managers to overseas branch offices with this arrangement. 4. Strategic Alliances. Strategic alliances include a company and a foreign partner that combine resources and capital to begin a new business. 5. Foreign Direct Investment. Foreign direct investment means buying or establishing tangible assets in a foreign country. Notes: __________________________________________________________________ __________________________________________________________________ __________________________________________________________________ 44 III. Barriers to International Trade (Use PowerPoint 4.18.) Success in foreign markets includes a firm’s ability to respond to social, cultural, economic, legal, and political differences. A. Social and Cultural Differences (Use PowerPoint 4.19, 4.20.) These barriers include a plethora of differences in language, religion, perceptions, shopping patterns, etc. between and among different populations. B. Economic Differences (Use PowerPoint 4.21.) When trading with different types of economic systems, firms must be aware of the level of government involvement in a given industry. C. Legal and Political Differences (Use PowerPoint 4.22.) Governments can present many trade barriers in international business, including the control of the flow of capital and the use of tax legislation to encourage or discourage global activity in given industries. 1. Quotas, Tariffs, and Subsidies. A quota restricts the number of products of a certain type that can be imported into a country; a quota raises the prices of those imports by reducing their supply. A tariff is a tax placed on imports; tariffs directly affect prices by raising the price of imports. A subsidy, a form of indirect tariffs, is a government payment to help a domestic firm compete with foreign firms. 2. Local-Content Laws. Many countries, including the United States, require that products sold in a particular country are partially made there. This guarantees that a percentage of the profits remain in that country. 3. Business-Practice Laws. Firms must learn the local laws in other countries before engaging in global business; what is legal in one country may be illegal in another. 45 1. Italy. 46