Business Essentials, 7th Edition Ebert/Griffin

BUSINESS MANAGEMENT 0611TOPIC 3: THE GLOBAL CONTEXT OF BUSINESSThe Business Environment

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L E A R N I N G O B J E C T I V E SAfter reading this chapter, you should be able to:Discuss the rise of international business and describe the major world marketplaces and trade agreements and alliances.Explain how differences in import-export balances, exchange rates, and foreign competition determine the ways in which countries and businesses respond to the international environment.Discuss the factors involved in deciding to do business internationally and in selecting the appropriate levels of international involvement and international organisational structure. Describe some of the ways in which social, cultural, economic, legal and political differences among nations affect international business.

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In this chapter we will examine the global context of business.We will discuss the rise of international business and describe the major world marketplaces, trade agreements and alliances.We will explain how differences in import-export balances, exchange rates, and foreign competition determine the ways in which countries and businesses respond to the international environment. We will discuss the factors involved in deciding to do business internationally and in selecting the appropriate levels of international involvement and international organizational structure.

Teaching Tips:Ask the class to engage in the following way with the each objective:

Objective 1: Discuss the rise of international business and describe the major world marketplaces, trade agreements and alliances.Please join with another student and list one key reason you both believe is responsible for the growth of international business. In addition, discuss one key international market that you think is important.Responses will vary. Of course the Internet will be a popular response. The fall of the Soviet Union could be another answer, as well as the opening of China to market development. Markets could be any such as China, Russia, India, Brazil or other countries or continents.

Objective 2: Explain how differences in import-export balances, exchange rates, and foreign competition determine the ways in which countries and businesses respond to the international environment.Please remain in your teams from Objective 1. I would like each team to discuss the impact you think foreign currency exchange rates have on international business transactions. Also please name at least two foreign currencies that are used around the world besides the U.S. dollar. Once you have completed your discussion, join with another team and share your answers with your combined team. Each team will then tell the class its best reasons for why and how exchange rates affect international business transactions and name the foreign currencies they have listed.Answers will vary. You can provide the answers that exchange rates affect the pricing of goods and services as well as payments received, or you can allow the students to just discuss the topic and wait until later in the chapter to discuss this topic.

Objective 3: Discuss the factors involved in deciding to do business internationally and in selecting the appropriate levels of international involvement and international organizational structure.Please form new pairs of two students. Each pair will list the factors you believe are important when deciding to do business internationally.Answers will vary. Again, allow the students to discuss this and return to the topic later in the chapter.2

Whats in It for Me?By understanding the material discussed in this chapter, youll be better prepared to:Understand how global forces affect you as a customerUnderstand how globalisation affects you as an employeeAssess how global opportunities and challenges can affect you as a business owner and as an investor3

Whats in this for you?By understanding the material discussed in this chapter youll be better prepared to:Understand how global forces affect you as a customer.Understand how globalization affects you as an employee.Assess how global opportunities and challenges can affect you as a business owner and as an investor.

Teaching Tips:Which of these three points will be most interesting to you and why? Also, as you discuss this in your teams, please think of two ways you will be affected. We will then share with the class.Answers will vary.

The Contemporary Global EconomyGlobalisationThe process by which the worlds various national economies and trading systems are fast becoming a single, highly interdependent systemExports: Domestically produced products sold in foreign marketsImports: Foreign products sold in domestic markets4

First, lets define globalization. It is the process by which the worlds various national economies and trading systems are fast becoming a single, highly interdependent system.

We will also examine exports and imports.Exports are domestically produced products sold in foreign markets.Imports are foreign products sold in domestic markets.Teaching Tips:Please return to your student team and prepare a list of three products that you personally use that are exported and three that are imported. We will share the answers with the class.Answers will vary.

The Major World MarketplacesDistinctions Based on WealthHigh-income countriesUpper middle-income countries Low middle-income countries Low-income countries (developing countries) Geographic ClustersNorth AmericaEuropePacific Asia

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Lets examine some of the major world marketplaces. First, we will examine distinctions based on wealth. These distinctions are set by the World Bank and are based on the per capita income, or average income per person, in each group of international consumers.High-income countries are those whose per capita income is greater than $11,115 dollars per year.Upper middle-income countries are those whose per capita income is between $3,595 and $11,115 per year.Low middle-income countries are those whose per capita income is between $905 and $3,595 per year.Low-income countries, also known as developing countries, are those whose per capita income is less than $905 per year.

Second, we need to examine the major geographic clusters where the high and upper middle-income countries are located and fewer of the low middle-income or low-income countries are located. These include:North AmericaEuropePacific Asia Teaching Tips:In your student teams, please give an example of each one of the four wealth distinctions weve just reviewed. Also please list a country example for each wealth distinction. We will share our examples with the class.Answers will vary.

Trade Agreements and AlliancesSignificant Agreements and TreatiesNorth American Free Trade Agreement (NAFTA)Canada, Mexico, and the United StatesEffects: increases direct foreign investment, increases exports and imports, creates jobsEuropean Union (EU)Most European nationsEffects: eliminates quotas, removes trade barriers, and sets uniform tariffs on internally traded EU imports and exportsAssociation of Southeast Asian Nations (ASEAN) Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Vietnam

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There are three significant trade agreements and treaties that we will discuss.The North American Free Trade Agreement (NAFTA)This trade agreement includes Canada, Mexico and the United States.The trade agreement increases direct foreign investment, increases exports and imports and creates jobs. It also eliminates most tariffs and duties on products shipped between the three countries.The European Union (EU)This union includes many or most European nations, but notably absent is Switzerland.The effects of this trade union is a common currency, elimination of quotas, removal of trade barriers, and sets uniform tariffs on internally traded EU imports and exports. It also allows its citizen members to travel between member nations without visas.The Association of Southeast Asian Nations (ASEAN)This association was formed in 1967 and its purpose is to allow economic, political, social and cultural cooperation among its partner countries.In 1995, Vietnam became the group's first Communist member.Because of its relative size, The ASEAN association does not have as large an impact on the world economy as NAFTA and EU countries.

Teaching Tips:Within our text Latin America is noticeably absent from the maps. In your student teams, please see if you know any trade associations or agreements in Latin America, or which countries might be potential upper- and middle-income countries. We will share our examples with the class.Answers could include the MERCOSUR, Mercado Comun del Sur or Common Market of the South, which includes Argentina, Brazil, Paraguay and Uruguay, with associate members Chile, Bolivia and Venezuela or the ANDEAN trade pact, which includes Bolivia, Ecuador and Peru. Students could also mention the Free Trade Area of the Americas, which would unite all of the Americas, north, central and south into one common market. In addition, students may mention CAFTA or the Central American Free Trade Area which includes central American countries.Key markets could include Argentina, Brazil and Chile. Argentinas Buenos Aires market is known as the Paris of South America and has a higher income level. Brazil is home to Sao Paulo, one of the three largest cities of the world, as well as Rio de Janeiro. The income in those two cities also offers a high- or middle-income market. Chile has Santiago, which is a very modern capital with a higher income.

FIGURE 4.1 The Nations of the European Union

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Lets take a look at the countries currently in the European Union.

Teaching Tips:Which countries do you think are in the high- or middle-income levels in the European Union?Answers may vary. Most likely answers would be Great Britain, Germany, France, etc.

FIGURE 4.2 The Nations of the Association of Southeast Asian Nations (ASEAN)

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Lets look at the countries within the Southeast Asian Nations.

Teaching Tips:Which was the first Communist country to be admitted to the ASEAN group?Vietnam became a member in 1995.

Trade Agreements and Alliances (contd)Significant Agreements and TreatiesGeneral Agreement on Tariffs and Trade (GATT):Signed after World War II. Its purpose was to reduce or eliminate trade barriers, such as tariffs and quotas. World Trade Organisation (WTO)Began on January 1, 1995Goals:Promote trade by encouraging members to adopt fair trade practices.Reduce trade barriers by promoting multilateral negotiations.Establish fair procedures for resolving disputes among members.9

There are two significant trade agreements that have impacted the world.General Agreement on Tariffs and Trade or GATT.This agreement was signed after World War II. Its purpose was to reduce or eliminate trade barriers, such as tariffs and quotas.The World Trade Organization or WTO.The WTO began on January 1, 1995.The WTO has three goals:Promote trade by encouraging members to adopt fair trade practices.Reduce trade barriers by promoting multilateral negotiations.Establish fair procedures for resolving disputes among members.

Teaching Tips:In your student teams, go back to the countries you selected in Latin America. Now please discuss how you think the three goals of the World Trade Organization could assist in increasing trade between the United States and a Latin American nation. What issues might a business face that relate to these goals? We will share our answers with the class.Answers will vary by country. Fair trade is an issue in many Latin American countries, as children are employed on the streets selling items or making handicrafts that are sold to larger retailers. Also there is the issue of fair traded coffee from Colombia or even Brazil. Students might mention the issues faced between the U.S. and Venezuela regarding oil production and sale and how the WTO might assist in resolving this issue.

Import-Export BalancesBalance of TradeThe total economic value of all the products that a country exports minus the economic value of all the products that it importsTrade SurplusA positive balance of trade that results when a country exports more than it importsTrade DeficitA negative balance of trade that results when a country imports more than it exports10

As we examine international trade, we return to import-export balances, which we discussed in earlier chapters. As you will remember, the balance of trade is the total economic value of all the products that a country exports minus the economic value of all the products it imports.

A trade surplus exists when there is a positive balance of trade that results when a country exports more than it imports.

A trade deficit exists when a negative balance of trade results from a country importing more than it exports.

Teaching Tips:Who remembers what the balance of trade is between the U.S. and China?The U.S. has a trade deficit with China and China has a trade surplus with the United States.

Import-Export Balances (contd)Balance of PaymentsThe flow of money into or out of a countryThe money that a country pays for imports and receives for exportsits balance of tradecomprises much of its balance of paymentsExchange RateThe rate at which the currency of one nation can be exchanged for that of anotherFixed exchange ratesFloating exchange rates11

As we discussed earlier, the balance of payments is the flow of money into or out of a country. The money that a country pays for imports and receives for exportsits balance of tradecomprises much of its balance of payments.

We are also going to discuss exchange rates. An exchange rate is the rate at which the currency of one nation can be exchanged for that of another nation. There are both fixed and floating exchange rates:Fixed exchange rates were set at the end of World War II to try to stabilize the worlds economy and make the value of one countrys currency remain constant against another countrys rate.Now we have floating exchange rates. This means that the value of any nations currency floats against its value in the marketplace.

Teaching Tips:In your student teams, discuss where you have traveled in the world and what happened when you tried to exchange U.S. dollars for the local currency. How did you figure out how much things would cost? If you havent traveled, imagine where you would go and how you would handle currency exchange upon your arrival. Lets share our experiences and imagined journeys with the class. Answers will vary.

Exchange Rates Impact Global TradeWhen an economys currency is strong:Domestic companies find it harder to export productsForeign companies find it easier to import productsDomestic companies may move production to cheaper production sites in foreign countriesImplications for the balance of trade?12

Exchange rate fluctuation can have an impact on the balance of trade. In the example from our text, we discuss the purchase of English tea at 10 British Pounds. If the exchange rate was about $2 to each Pound, the box of tea would cost $20. However, if the exchange rate between the two currencies varies, lets say to $1.25 to the Pound, meaning the dollar was stronger than the Pound, the box of tea would cost us only $12.50. If the dollar would remain strong against the pound as in this example, all the costs of English goods in the U.S. would decrease and the costs of U.S. goods sold in Britain would increase.

Teaching Tips:In this example what happens to the balance of trade?In this example, the British would spend less on U.S. goods, and the U.S. would tend to spend more on British goods, resulting in a trade deficit.

Exchange Rates Impact Global Trade (contd)When an economys currency is weak:Domestic companies find it easier to export productsForeign companies find it harder to import productsForeign companies may invest in domestic production facilitiesImplications for the balance of trade?

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When an economys currency is weak:Domestic companies find it easier to export products.Foreign companies find it harder to import products.Foreign companies may invest in domestic production facilities.Lets talk about the Euro, the currency of the European Union. Officially introduced in 2002, the Euro has replaced many currencies, including the German Deutsche mark and the French Franc. It is expanding further in use throughout the European Union. In 2002 its value was pegged to the dollar, meaning 1 EU = $1 USD. As of June 2008, the value of the dollar has weakened so that $1 USD = .65 EU.Teaching Tips:In your student teams, assume you have just arrived in the country of Paraguay. The currency of this Latin American landlocked country is called the Guarani. You walk up to an exchange window and you find that for $1 you can obtain 5,000 Gs. You decide you want to be a Guarani Millionaire. How many dollars do you need to exchange to get 1 million Guaranis?$200Now lets say you have spent your money and it has gone a long way. You fell in love with the country and decided to buy a home to vacation in or retire to. The house is $20,000, so you decide to buy it. Once youve bought the house, you decide to have the electrical wiring replaced. You are quoted a price of Gs. 4,000,000. You think, OK, thats not too bad. That is like $800. You leave, and return six months later to find that the exchange rate has fallen and now $1 USD = Gs. 3,500! What happened to the price of the electrical project?The quote remained the same so the price did not increase in Guaranis. But the price to you in dollars increased by $342.86!!

Forms of Competitive AdvantageAbsolute AdvantageWhen a country can produce something that is cheaper and/or of higher quality than any other countryAn advantage based on possessing a scarce resource (e.g., oil) or favorable physical locationComparative AdvantageWhen a country can produce goods more efficiently or better than other countries can produce the same goodsAn advantage based on superior productivity (e.g., technologically advanced manufacturing capability)14

Now lets look at the forms of competitive advantage. The exchange rates we have just been discussing play into this factor. When a country can produce something that is cheaper and/or of a higher quality than any other country, it has achieved what is called Absolute Advantage. This is an advantage based on possessing a scarce resource (like oil) or a favorable physical location. Coffee production in Brazil offers an example of absolute advantage.

When a country can produce goods more efficiently or better than other countries can produce the same goods, they have a Comparative Advantage. This is an advantage based on superior productivity (or for example, technologically advanced manufacturing capability). For example, it is more productive to produce an automobile in Japan than in the United States.

Teaching Tips:Join with another student. In your student team, please think of two examples of both Absolute Advantage and Comparative Advantage. We will share our examples with the class.U.S. firms can produce computers and grain cheaper than Korea can, so we export those items to Korea. However Korea can produce DVDs more cheaply than the U.S., so we import those from Korea. This is an example of comparative advantage.Brazil has almost ideal conditions for growing coffee beans, so they are an example of an absolute advantage.

Forms of Competitive Advantage (contd)National Competitive AdvantageConditions favoring heavy involvement in international business:Factor conditionslabor, capital, entrepreneurs, physical resources, and information resourcesDemand conditionsa large domestic consumer base that promotes strong demand for innovative productsRelated and supporting industriesstrong local or regional suppliers and/or industrial customersStrategies, structures, and rivalriesdomestic firms and industries that stress cost reduction, product quality, higher productivity, and innovative products15

National competitive advantage exists when an environment favors heavy involvement in international business. There are four factors to consider in national competitive advantage:Factor conditions. These include:LaborCapitalEntrepreneursPhysical resourcesInformation resourcesDemand conditions. These include:A large domestic consumer base that promotes strong demand for innovative productsRelated and supporting industries. These include: Strong local or regional suppliers Industrial customersStrategies, structures and rivalries. These include:Domestic firms and industries that stress cost reductionProduct qualityHigher productivityInnovative ProductsTeaching Tips:In your student teams, please think of a country or industry where these conditions exist. We will share our examples with the class.Japan and the auto industry is one example. They have a strong demand for cars and have lots of natural resources.

International Business ManagementGoing InternationalGauging International DemandForeign demand for a companys product may be greater than, the same as, or weaker than domestic demandAdapting to Customer NeedsA firm must decide whether and how to adapt its products to meet the special demands of foreign customersOutsourcingPaying suppliers and distributors to perform certain business processes or to provide needed materials or servicesOffshoringOutsourcing to foreign countries16

When a company considers going international it needs to examine certain factors which include:Gauging international demand: Foreign demand for a companys product may be greater than, the same as, or weaker than domestic demand. Adapting to customer needs: A firm must decide whether and how to adapt its products to meet the special demands of foreign customers. For example, when Wal-Mart first entered Brazil, it included a do-it-yourself lawn and garden section in its stores. They failed. Why? Brazilian consumers hire gardeners to take care of their lawns and hence would never think of cutting their lawn themselves.Outsourcing: Paying suppliers and distributors to perform certain business processes or to provide needed materials and services. If labor is cheaper at another firm, or they are specialists in a specific process, this might be used.Offshoring: This is more specifically the outsourcing of production processes to foreign countries.

Teaching Tips:Please join with another class member. In your team, please choose one of the four factors we have just discussed. Please prepare two examples of companies that might use the factor your team selected. Lets share our answers.Answers will vary.

Levels of International InvolvementExportersMake products in one country to distribute and sell in othersImportersBuy products in foreign markets and bring them home for resaleInternational firmsConduct much of their business abroad and may maintain overseas manufacturing facilitiesMultinational firmsDesign, produce, and market products in many nations

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There are also levels of international involvement for the company to consider. Lets look at four of these.Exporters: Exporters make products in one country to distribute and sell in other countries.Importers: Importers buy products in foreign markets and bring them home for resale.International firms: International firms conduct much of their business abroad and may maintain overseas manufacturing facilities.Multinational firms: Multinational firms design, produce and market products in many nations.

Teaching Tips:In our student teams, lets each choose one level of international involvement. Then each team should please list two examples of the kind of company that might operate at the level your team has chosen. Lets share our answers.Answers will vary, but examples could include:Exporters: Taiwanese computer motherboard manufacturers who manufacture in Taiwan and sell in the U.S.Importers: U.S. clothing companies that import clothes made in India for sale in the U.S.International firms: Hershey, which buys chocolate from different locations but manufactures all in the U.S.Multinational firms: Nestle, with headquarters in Switzerland, produces and sells in many nations, as does Coca-Cola.

International Organization StructuresIndependent AgentA foreign individual or organization that represents an exporter in foreign marketsLicensing Arrangements (or Agreements)Domestic firms give foreign individuals or companies exclusive rights to manufacture or market their products in that marketBranch OfficesA firm sends its own managers to overseas branch offices so that it will have more direct control than it does over agents or license holders18

There are a number of ways to organize a firms international operations.They can hire an independent agent, a foreign individual or organization that represents an exporter in a foreign market. These people have the advantage of knowing the local market, operating in the market, but also may represent other competitive brands.Domestic firms can give foreign individuals or companies exclusive rights to manufacture or market their products in that market through Licensing Arrangements or Agreements. Such agreements provide more security for the exporter.A firm may send its own managers to overseas branch offices so that it will have more direct control than it does over agents or license holders.

Teaching Tips:In your student teams, please choose one of the three types of international organization structures we have just reviewed. Then think of an example of a company or industry that might use your chosen form of international organization structure. Why would this be a good form for your example firm? We will share answers with the class.Answers vary but build off the information in this slide.

International Organization Structures (contd)Strategic Alliance (or Joint Venture)A company finds a partner firm in the country in which it wants to do businessEach party agrees to invest resources and capital into a new business or to cooperate in some mutually beneficial wayForeign Direct Investment (FDI)Involves buying or establishing tangible assets in another country

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There are two other international organization structures we will discuss. The first of these is the joint ventures and/or strategic alliance. A company finds a partner firm in the country in which it wants to do business and collaborates with them.Each party agrees to invest resources and capital into a new business or to cooperate in some mutually beneficial way.Foreign Direct Investment involves buying or establishing tangible assets in another country.

Teaching Tips:In your student teams, please provide an example of one of these two additional international organization structures. Why are they the correct fit for your chosen example firm?Answers will vary.

Barriers to International Trade

Social and Cultural Differences

Economic Differences

Legal and Political Differences

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There are of course barriers involved in international trade. These include some of the external business environmental factors that we discussed earlier in the semester:Social and cultural differences. Economic differences.Legal and political differences.

Teaching Tips:In your student teams, please choose one of the five external environmental difference factors and provide three examples of each. Please base your examples on our recent study of external business environments. We will share our examples with the class.Answers will vary. Refer back to the external environments.

Legal and Political DifferencesQuotas, Embargoes, Tariffs, and SubsidiesQuota: Restricts the number of products of a certain type that can be imported, raising the prices of those importsEmbargo: Government order forbidding exportation and/or importation of a product or all products from a specific countryTariffs: Taxes on imported productsSubsidy: Government payment to help a domestic business compete with foreign firmsProtectionismThe practice of protecting domestic business at the expense of free market competition21

Legal and political differences are huge when conducting international trade. These involve quotas, embargoes, tariffs and subsidies.A quota restricts the number of products of a certain type that can be imported, raising the prices of those imports. For example, in the 1980s, there was a quota put on Japanese motorcycles so that Harley Davidson could rebuild its company and regain U.S. market share.An embargo is a government order forbidding exportation and/or importation of a product or all products from a specific country. For example, there is an embargo on the import of Cuban cigars.A tariff is a tax on imported products. These serve to bring the price of the good imported into a similar price range with other similar products produced within that country.A subsidy is a government payment to help a domestic business compete with foreign firms. Many European countries pay farmers to grow crops to keep from importing U.S. grains.

Protectionism is the practice of protecting domestic business at the expense of free market competition.Teaching Tips:In your student teams, please prepare two examples of either quotas, embargoes, tariffs and subsidies. We will share our answers with the class. Answers will vary.

Legal and Political Differences (contd)Local Content LawsRequirements that products sold in a country be at least partly made thereBusiness Practice LawsHost countries govern business practices within their jurisdictionsCartelsAssociations of producers that control supply and pricesDumpingSelling a product abroad for less than the cost of production at home

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Additional legal and political differences include the following:Local content laws: These are requirements that products sold in a country be at least partially made there. This applies if a company wants to put a tag on a product saying Made in the U.S.A., for example.Business Practice Laws: These laws allow host countries to govern business practices within their jurisdictions.Cartels: Associations of producers that control supply and prices, such as the oil cartel.Dumping: The selling of a product abroad for less than the cost of production at home.

Teaching Tips:In your teams come up with an example of dumping. Lets share our examples.Answers will vary.