Chapter 11

Chapter 11

International business-1
Business transaction taking place within the geographical boundaries of a nation is called domestic or
national business. International business comprises all commercial transactions that take place between two or
more countries. It refers to all those business activities which involve cross-border transaction of goods and
services between two or more countries. It involves not only international movements of goods, services and
resources but also of capital, tourism, technology, personnel and intellectual property such as patents,
copyrights, trademarks etc. International trade and international business are often used interchangeably, but it
is not true. International trade, comprising export and import, is only a part of international business.

Difference between international business and domestic business

Domestic business International business
Exchange of goods and services between the Exchange of goods and services between
individuals of the same nation individuals of different nations
Subject to the regulations and laws of only one Subject to regulations and laws of different
country countries
The cost of transportation is much less The cost of transportation is higher
Insurance is not compulsory Insurance is compulsory
Accounts are settled in national currency Accounts are settled in foreign currency
There are only limited formalities There are many formalities
Goods are subject to less risk Goods are subject to high risk
Goods are generally transported by rail or road Goods are generally transported by ship
No foreign exchange is required Foreign exchange is required
Domestic business is subject to political system Domestic business is subject to political system
and risk of one single country and risk of different countries
Currency of domestic country is used International business use currencies of more
than one country

Scope of international business

International business is much wider than international trade. It includes not only international trade
(i.e export and import of goods and services) but also wide variety of other ways in which the firms operates
internationally. Major areas of operations of international business are briefly discussed below:

1. Import and export of merchandise

Merchandise means goods which are tangible, i.e those that can be seen and touched. It does not
include services.

2. Import and export of services (Invisible Trade)

Services like travel and tourism, lodging, transportation, communication, entertainment, construction
and engineering, advertising, educational services, financial services etc can be imported and exported. Trade
in services is known as Invisible trade.

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3. Licensing and franchising

Permitting a person or a firm in a foreign country to produce and sell goods under a company’s trade
mark, patents, or copyrights for fees is another way of operating international business. It is under licensing
that Pepsi and Coca-Cola produced and sold all over the world.

Franchising is somewhat similar to licensing with the difference that is concerned

with provision of [Link]. KFC.

4. Foreign Investments
Foreign investments mean investment abroad in exchange for financial return. Foreign investment can
be of two types viz, Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI).

FDI takes place when a company invests directly in properties such as land, plant, machinery, etc. in
foreign countries. This is done with a view to undertaking production and marketing of goods and services in
those countries.

FPI takes place when a company makes investment in a foreign company by way of acquiring shares
or granting loans. The company which makes FPI earns income in the form of dividends, capital appreciation
and interest.
Commodity composition of India’s Exports (2011-12) Commodity Composition India’s Import

Product % of share Commodity Group % of share

Agriculture 12.4 pulses 0.40
Ores and Mine 2.8 Edible oils 2.10
Textile 8.7 Petroleum 31.7
Gems&Jewellery 14.7 Machinery(Except Electrical) 7.20
Engineering goods 19.2 Electrical Machinery 1.00
Chemicals 12.2 Transport Equipment 3.00
Leather 1.6 Chemicals 5.10
Handicrafts 0.4 Pearls & Precious stones 6.10
Petroleum 18.7 Gold & Silver 12.6
Others 9.3 Electronic Goods 7.10
Total 100

India’s Export of Services

Category Share
(%)
Transportation 12.1
Insurance 1.60
Software Services 45.6
Non-Software Services 29.6
Others 11.1

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India’s Major Trading Partners

Country Share in total trade
(%)
China 8.95
UAE 9.74
USA 8.23
Saudi Arabia 5.43
Switzerland 3.50
Singapore 2.53
Germany 2.75
Hong Kong 2.53
Indonesia 2.50
Iraq 2.73
Japan 2.29
Belgium 1.91
Kuwait 2.38
South Korea 2.30
Nigeria 2.14
Total of 15 countries 59.91

Nature of external trade

1. Distance
Due to long distance between various countries, it is difficult to establish personal contact between traders
from different countries. It takes more time for delivery of goods after placing the order. It involves high
transportation cost and greater risk.

2. Currency
Different countries have their own currencies. This creates problems in payments. Normally payments are
made in foreign currency.

3. High risk
Risk of loss due to massive perils is higher and so insurance is compulsory in foreign trade.

4. Formalities
Foreign trade is controlled and regulated by the government. It involves a long procedure and large numbers
of documents have to be filed.

5. Inadequate information
It is difficult to obtain accurate and up to date information about foreign markets.

6. Transportation and communication

Shipping and air ways are the two modes of transportation in foreign trade. Shipping is very slow and hence it
involves considerable delay. Air transport is faster but it is costly and not suitable for bulky goods.

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Importance of International Business

No nation is economically self sufficient. Every nation, for one reason or another, depends on other
nations for its requirements. Diversity and unequal distribution of natural resources warrant such
requirements. The benefits of international business to the nations and the business firms are:

Benefits to Nations
1. Price Stabilization
External trade can be used as an instrument for stabilizing price. If the prices of any commodity tend to
increase due to short supply, the country can import such goods to control price. Similarly excess output
can be exported to avoid sharp fall in prices.
2. Improves quality of products
In order to compete with foreign goods, domestic firms try to improve the quality of their products. They
introduce new technology, better management tools etc.
3. Promotes Co-operation among nations
External trade helps a country to establish trade relation with other countries. The establishment of trade
relations among nations reduces conflict and promote co-operation among them.
4. Optimum utilization of resources

External trade facilitates international division of labour and specialization. Different countries are gifted
by nature with different resources. Through external trade every country can specialize in the production
of those products which it can manufacture most economically. It need not spend huge money for
producing goods which can be easily imported at a lower cost.

Eg: India can produce agriculture products more efficiently than Gulf countries. On the other hand, Gulf
countries can produce petroleum products more efficiently than India. Such specialization results in
optimum utilization of the country's resources.

5. Earning of foreign exchange

External trade has a significant influence on country's economic growth. The international business helps
in earning foreign exchange by exporting goods and services. This foreign exchange can be utilized for
the import of essential commodities. Also a country can export its surplus output.

6. Generate Employment opportunities

External trade helps to increase production. It accelerates the economic growth and employment
opportunities of a country.

7. Increased Standard of living

Foreign trade helps in raising the standard of living of a country by providing better quality products.

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Benefits to Firms

1. Increased Capacity Utilization

It helps the firm in using their surplus production capacities and improving the profitability of their
operations. Large scale production helps to reduce the cost of production.

2. Prospects for growth

It helps firms in improving their growth prospects by creating demands for their products in foreign
countries.

3. Enhances competition
External trade enhances competition, which compels the domestic firms to improve technology of
production, production process and quality of products.

4. Improved business vision

It improves business vision as it makes firms to grow, more competitive and diversified.

Modes or ways of entry into international business

There are various ways through which a company can enter into international business. They are:

1. Exporting and importing

2. Contract manufacturing
3. Licensing and Franchising
4. Joint ventures
5. Wholly owned Subsidiaries

1. Exporting and Importing

When goods are sold to a foreign country, it is called export trade. When goods are purchasing from a
foreign country, it is called import trade. It is a convenient method to increase the sales. The exporting/
importing may direct or indirect. In direct exporting/importing, a firm itself approaches the overseas
buyers/suppliers and looks after all the formalities relating to exporting/importing activities.

Advantages
1) As compared to other modes of entry, exporting and importing is the easiest way of gaining entry into
international market. All other modes involve huge investments and complex procedures.
2) In this mode the exporting firm is not required to invest that much money and time as is needed when
they desire to enter into joint ventures or set up manufacturing plants and facilities in host countries.
3) Since exporting/importing does not require investment in foreign countries, it is less risky as
compared to other modes of entry into international business.

Disadvantages
1. Since goods are physically moving from one country to another exporting/importing involves
additional packaging, transportation and insurance cost.
2. Exporting is not possible in case the foreign country restricts imports.
3. Since export firms basically operate from home country, they do not have many contacts with the
foreign markets. This puts the export firms in a disadvantageous position.

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2. Contract Manufacturing
Contract manufacturing refers to a type of international business where the firm enters into a contract
with one or a few local manufacturers in foreign countries to get certain components or goods produced as per
its specifications. Contract manufacturing, also known as outsourcing, can take three major forms:

 Production of certain components.

 Assembly of components into final products.
 Complete manufacture of the products.
Goods are produced or assembled by the local manufacturers as per the technology and management guidance
provided to them by the foreign company. The goods manufactured by the local producers are delivered to the
international firms for use its final products or for outrights sales under its brand name in various countries
including the home and host [Link] major international companies such as Nike,Reebok,Casio,Sony
etc today get their products or components produced in developing countries under contract manufacturing.

Advantages
1) It permits the international firms to get the goods produced on a large scale without requiring
investment in setting up production facilities.
2) In contract manufacturing, there is no investment risk involved in the foreign countries.
3) It helps to get the products at lower cost because in most cases local producers situated in countries
which have lower material and labour costs.
4) In contract manufacturing cost of sale also less as compared to exporting because of the absence of
transportation cost, packaging insurance etc.
5) It is a grace to the foreign manufacturers as it ensures the greater utilization of their idle production
capacities.
6) The local manufacturers also get the opportunity to get involved with international business and avail
incentives, if any.

Disadvantages
The major disadvantages of contract manufacturing are as follows:

1. It may affect the quality of the products because local manufacturers might not follow the production
design and quality standards prescribed by the international firms.
2. Local manufacturer in the foreign country loses his control over the manufacturing process because
goods are produced strictly as per the terms and specifications of the contract.
3. The local producer is not free to sell the contracted out put as per its will. It has to sell the goods to the
international company at predetermined prices.

3. Licensing and Franchising

Licensing is a contractual arrangement in which the one firm grants access to its patents, trade secrets
or technology to another firm in a foreign country for a fee called royalty. The firm that grants such
permission to other firm is known as licensor and the other firm in the foreign country that acquires
such rights to use patents is called licensee.

Franchising is a term very similar to licensing. One major distinction between the two is that the
licensing is used in connection with production and marketing of goods, the term franchising applies
to service business

Examples of franchises include McDonalds, Subway, 7-11etc.

Examples of licenses include a company using the design of a popular character, e.g. Mickey Mouse, on
their products. Another example would be a clothing manufacturer like Life is Good licensing its designs

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and brand in a certain country to a local company. It can also apply to the use of software, e.g. a company
using Microsoft Office on its computers

Advantages
1) It is less expensive mode of entering into international business.
2) There is no investment risk.
3) Licensee gets the benefits with less investment on research and development
4) Since the business in the foreign country is managed by the licensee/franchisee who is local person,
there as he has greater market knowledge and customer contacts, lower risks of business takeovers or
government interventions.
5) Since the licensee/franchisee is a local person, he has greater market knowledge and customer
contacts. It helps the licensor/franchisor in successfully conducting its marketing operations.

Disadvantages
1) There is a danger that the licensee can start marketing an identical product under a slightly different
brand name.
2) If not maintained properly, trade secrets may lose in foreign markets. It can cause severe loss to the
licensor/franchiser.
3) Conflict often develops between the licensor/franchisor and licensee/franchisee over issue such as
maintenance of accounts, payment of royalty etc.

4. Joint Ventures

Joint venture is a very common strategy for entering into foreign markets. Joint venture means establishing a
firm that is jointly owned by two or more independent firms. JV is a business arrangement in which two or
more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a
new project or any other business activity. In a joint venture (JV), each of the participants is responsible for
profits, losses and costs associated with it. However, the venture is its own entity, separate and apart from the
participants' other business interests. It can be brought into existence in three major ways.

a) Foreign investor buying an interest in a local firm

b) Local firm acquiring an interest in an existing foreign firm.

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c) Both the foreign and local entrepreneurs jointly forming a new enterprise.

Advantages
1) Since the local partner also contributes to the capital, the international firm has less financial burden
to expand the business globally.
2) It helps to execute large projects requiring huge capital outlays and manpower.
3) Benefits of the local partners’ knowledge and experience are available to foreign company.
4) Joint ventures make entry in the international business.
5) In JV capital and risk are shared between two parties.
6) Establishing a presence in new, untapped markets, including international opportunities.

Disadvantages
1) Foreign firms entering into JV share the technology and trade secrets with local firms. It leads to the
risk of leakage of technology and secrets to others.
2) The dual ownership arrangements may lead to conflicts.
3) Different cultures and management styles result in poor integration and co-operation.

[Link]-Ericsson

Sony-Ericsson is a joint venture between Sony and the Swedish company Ericsson.
Ericsson is the Swedish manufacturing company of the telecommunications equipment while Sony is a mobile phone
manufacturing company. Ericsson used to get chips from Philips, but in March, 2000, a fire destroyed the production
facility of Philips. Facing an acute shortage of chips, Ericsson was prompted to form a joint venture with Sony. On
February 16, 2012, Sony acquired Ericsson’s share in the venture and renamed the company as Sony Mobile
Communications. Sony Mobile shifted its headquarters from Lund, Sweden to Tokyo, Japan on January 7, 2013.

5. Wholly Owned Subsidiaries

This entry mode of international business is preferred by companies which want to exercise full control over
their overseas operations. The parent company acquires the full control over the foreign company by making
100% investment in its equity capital. It is called wholly owned subsidiary. It can be established in either of
the two ways:

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1) Setting up new firm altogether to start operations in a foreign country.

2) Acquiring an existing firm in the foreign country to manufacture and/or promote its products in the
host nation.

Advantages
1) The parent firm is able to exercise full control over its operations in foreign countries.
2) It is not required to disclose its technology or trade secrets others.

Disadvantages
1) It is not suitable for small and medium size firms which do not have enough funds to invest abroad.
2) Some countries are averse to setting up of wholly owned subsidiaries by foreigners in their
countries. So it is subject to higher political risk.
3) The parent company alone has to bear the entire losses.