IB: Exam 4 Review

Favorable markets

Favorable markets

Politically stable with free market system, low inflation, and low private sector debt

Unfavorable markets

Politically unstable, developing, mixed or command economies, and excess borrowing

Cost/benefit analysis

A systematic way to compare the costs and benefits of a decision or action to determine if it’s worth pursuing

Psychological distance

Distance due to cultural variables, legal issues, and other societal norms (e.g. U.S. companies see UK as closer than Mexico)

First-mover advantages

• Associated with entering a market early

• Create switching costs for customers that make it hard for later entrants to win business

• Preempt rivals and capture demand with a strong brand name

• Build sales volume and ride down the experience curve for cost advantage

First-mover disadvantages

• Associated with entering a foreign market early

• It can take time and investment to learn new business rules

• Regulations can change in a way that diminishes the value of an early’s entrant’s investments

Pioneering costs

Costs that an early entrant has to bear that a larger entrant can avoid; determined by costs, political/economic risks, and firm’s strategy

Four main entry modes

Exporting, licensing or franchising, joint ventures, and wholly owned subsidiaries (greenfield vs. acquisition) + turnkey projects

Exporting advantages

• Avoids substantial costs

• Experience curve and location economies

• Increased speed and flexibility

Exporting disadvantages

• Lower-cost locations might exist for manufacturing

• High supply chain costs can make exporting uneconomical

• Trade barriers (tariffs)

• Having to delegate powers to other companies (can be fought with wholly owned subsidiaries in foreign nations to avoid this problem)

Letter of Credit (L/C)

States that the bank will pay a specified sum of money to a beneficiary, normally the exporter, on presentation of particular, specific documents; issued by a bank at the request of an importer

Bill of Lading

A document issued by a carrier to acknowledge receipt of cargo for shipment; although the term is historically related only to carriage by sea, this may be used for any type of carriage of goods (it is the receipt, contract, and document of title)

Draft

An international business draft, also known as a foreign draft or bill of exchange, is a written order that allows the transfer of funds from one country to another; written by the exporter or an importer’s agent to pay a specified amount of money at a specified future time

Sight Draft

Payable on presentation to the drawee

Time Draft

Allows for delay in payment - normally 30, 60, 90, or 120 days (banker’s acceptance and trade acceptance)

Turnkey projects

Contractor agrees to handle every detail of the project for a foreign client, including the training of operation personnel; a key is handed over to the foreign client and often includes technology and advanced industries

Turnkey project advantages

• Helps combat limited foreign direct investment and is less risky than it is when there are risky political or economic factors

• Usage of the know-how for complex technological processes

Turnkey projects disadvantages

• No long-term interest

• Creating a competitor

• Selling competitive advantage

Licensing agreement

A licensor grants the rights to intangible property to another entity (the licensee) for a specified period, and in return, the licensor requires a royalty fee from the licensee; e.g. patents, inventions, formulas, processes, designs, copyrights, and trademarks

Advantages of licensing agreements

• Less development costs and risks

• Useful for intangible property that has business applications

• Avoids barriers to investment

Disadvantages of licensing agreements

• Lack of tight control for experience curve and location economics

• Not being able to coordinate strategic moves with profits

• Risk of giving technological know-how to foreign companies (RCA)

  • Cross-licensing agreement can combat

  • License combined with the joint venture entry mode

Franchising

Specialized form of licensing in which the franchiser not only sells intangible property to the franchisee, but also insists that the franchisee agree to abide by strict rules as to how it does business

Advantages of franchising

• Firm relieved of many costs and risks of opening foreign market

• Possible cicumvention of import barriers

• Strong sales potential

Disadvantages of franchising

• May limit the ability to take out profits of one country to support competitive attacks in another

• Quality control differs; subsidiary can help combat this

Joint venture

Entails establishing a firm that is jointly owned by two or more independent firms; most typically is 50-50

Advantages of joint ventures

• Local partner knowledge of host country

• Gains from sharing costs and risks

• Political considerations often only allow this mode of entry

• No ownership restrictions

Disadvantages of joint ventures

• Risk of giving technology control to partner

• Lack of direct control over subsidiaries for the experience curve or location economies

• Conflicts and battles for control if goals or objectives change

Wholly owned subsidiary

The firm owns 100 percent of the subsidiary and can either by greenfield ventures or acquisitions

Advantages of wholly owned subsidiaries

• Reduces risk of lost control

• Tight control (global strategic coordination)

• Location and experience curves

• 100 percent share in the profit generated

Disadvantages of wholly owned subsidiaries

• Very costly and different culture integration

• Need for more human and nonhuman interactions

• Interaction and integration with local employees

Pros and cons of acquisitions

• Pros: quick to execute, enable firms to preempt their competitors, can be less risky than greenfield ventures

• Cons: have a low success rate

Pros and cons of greenfield ventures

• Pros: allow the firm to build the kind of subsidiary company that it wants

• Cons: slower to establish, risky because they have no proven track record, can be problematic if a competitor enters via acquisition and quickly builds market share

Countertrade

Denotes a range of barter-like agreements, its principle is to trade good and services when they cannot be traded for money

Barter

Direct exchange of goods and services between two parties without a cash transaction (usually used for trading partners that are not creditworthy or trustworthy)

Counterpurchase

A reciprocal buying agreement that occurs when a firm agrees to purchase a certain amount of materials back from a country to which a sale is made

Offset

Involves one party agreeing to purchase goods and services with a specified percentage of proceeds from the original sale

Switch trading

Refers to the use of a specialized third-party trading house in a countertrade arrangement (it buys a firm’s Counterpurchase credits and sells them to another firm)

Buybacks

Occurs when a firm builds a plant in one country, or supplies technology, equipment, training, or other services to the country – and agrees to take a certain percentage of the plan’s output as partial payment for the contract (also called compensation)

Pros of countertrade

Can give a firm a way to finance an export deal/may be required by a government

Cons of countertrade

• Hard currency is better, and countertrade can be costly

• Network of operations is required which hurts small- and medium-sized exporters

Latin America (extra credit)

Central America and South America

Increases in investment (extra credit)

• Sixfold increase in FDI

• Fourfould increase in world trade

Brazil (extra credit)

Historically has attracted the most FDI

Balance of payments account

Track both payments to and receipts from other countries

Current account

Tracks the export and import of goods and services

Capital account

Includes capital transfer receipts and capital transfer debits

Financial account

Includes acquisitions, liabilities, and financial derivatives

Debits and credits

Must equal in the balance of payments, but statistical disrepancies may occur

FDI

10% or more ownership in a foreign business entity

Portfolio investment

Less than 10% ownership in a foreign business entity in terms of recording it on the Balance of Payments

Flow of FDI

The amount of FDI undertaken over a given time period

Outflows of FDI

The flows of FDI out of a country

Inflows of FDI

The flows of FDI into a country

Stock of FDI

The total accumulated value of foreign-owned assets at a given time

Trend in FDI

• Flow and stock of FDI has increased greatly over the last 35 years

• Has grown more rapidly than world trade and world output

Direction of FDI

• Historically, developed nations (U.S. is the favorite target of the EU)

• More recent, developing nations

  • South, East, and South East Asia

  • China and Latin America as well

• UK and France largest recipients of inward FDI

Source of FDI

• U.S. has been largest source since World War II

• UK, the Netherlands, France, Germany, and Japan

• Chinese firms also are major foreign investors

Internationalization theory

Seeks to explain why firms often prefer foreign direct investment over licensing as a strategy for entering foreign markets (also know as the market imperfections)

Internalization’s drawbacks of licensing

• Giving away valuable technological know-how to a foreign competitor (RCA)

• Lack of tight control over production, marketing, and strategy in foreign country

• Problem when competitive advantage is based on management, marketing, etc.

Kickerbocker’s strategic behavior theory

Based on the idea that FDI flows are a reflection of strategic rivalry between firms in the global marketplace (in oligopolistic industries)

Oligopoly

An industry composed of a limited number of large firms; rivals often quickly imitate their opponent’s actions

Multipoint competition

When two or more enterprises encounter each other in different regional markets, national markets or industries; theory suggests that firms will try to match each other’s moves in different markets to keep each other in check

Electric paradigm

Attempts to combine the two other perspectives into a single holistic explanation of foreign direct investment

Location-speific advantages

Arise from using resource endowments or assets that are tied to a particular location and that a firm finds valuable to combine with its own unique assets (as stated by John Dunning)

Externalities

Knowledge spillovers that occur when companies in the same industry locate in the same area

Benefit of FDI - Host Country

• Resource transfer effects

• Employment effects

• Increase in competition

Costs of FDI - Host Country

• Adverse effects on competition

• Adverse effects on the Balance of Payments

  • Capital outflows from foreign subsidiaries repatriating earnings to the parent country

  • There is a debit on the current account of the host country’s balance of payments associated with imports of input products by the foreign subsidiary

• Possible effects on national sovereignty and autonomy

Benefits of FDI - Home Country

• The effect on the capital account of the home country’s balance of payments from the inward flow of foreign earnings

• The employment effects that arise from outward FDI

• The gains from learning valuable skills from foreign markets that can subsequently be transferred back to the home country

Costs of FDI - Home Country

• Balance of Payments

  • Initial capital outflow to finance the FDI

  • Current account suffers if FDI is done to have a low-cost production location

  • Current account suffers if FDI is a substitute for direct exports

• Employment effects

  • If home country has unemployment, there may be concern about export of jobs

Production (operations management)

Activities involved in creating a product (goods and services or tangibles and intangibles)

Supply chain management

The procurement and physical transmission of material through the supply chain, from suppliers to customers

Purchasing

Worldwide buying of raw material, component parts, and products used in manufacturing the product or service

Logistics

Plans, implements, and controls the effective flows and inventory of raw material, component parts, and products used in manufacturing

Total Quality Management (TQM)

A system of management based on the principle that every staff member must be committed to maintaining high standards of work in every aspect of a company’s operations

Six Sigma

Quality improvement program that aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company (99.999666 accuracy or 3.4 million defects)

ISO 9000

EU focuses management attention on quality and blocks entry to the EU marketplace if it is not met

Upstream

Supply chain includes all of the organizations (suppliers) and resources that are involved in the portion of the supply chain from raw materials to the production facility (sometimes called the inbound supply chain)

Downstream

Supply chain includes all the organizations (wholesaler, retailer) that are involved in the portion of the supply chain from the production facility to the end-customer

Location economies

Firms should locate manufacturing activities where economic, political, and cultural conditions, including relative factor costs, are most conducive to the performance of that activity

Location externalities

Presence of global concentrations of activities

Country factors

• Formal and informal trade barriers

• Transportation costs

• Regulations affecting FDI

• Expected future movements in exchange rates

Fixed Costs

If they are very high, it could make sense for the firm to serve the world market from a single location or from a very few locations (e.g. $25 billion for semiconductor chips)

Minimum efficient scale

The level of output at which most plant-level scale economies are exhausted

Flexible manufacturing (lean production)

Enable firms to produce a wide variety of end products at a unit cost that traditionally would require mass production of a standardized output (Toyota via the ideals of Taiichi Ohno); reduce setup times, increase the utilization of individual machines through better scheduling’s, and improve the quality control

Mass customization

Describes the ability of companies to use flexible manufacturing technology to reconcile two goals that were thought to be incompatible: low cost and product customizations

Flexible machine cells

Groups of various types of machinery, a common materials handler, and a centralized cell controller

Value-to-weight ratio

• Electronic components/pharmaceuticals have high value-to-weight ratios (single location due to low transportation cost)

• Refined sugar, certain bulk chemicals, paint, petroleum products have low value-to-weight ratios (multiple locations due to high transportation cost)

Universal needs

Needs that are the same all over the world (one location becomes optimal)

Production facilities since the early 1990s

Multinationals have opted to set up production facilities outside their home country 10 times for every 1 they have opted to create such facilities at home

Concentrated v. decentralized

• Country Factors

  • Differences in political economy - substantial = concentrated, few = decentralized

  • Differences in culture - substantial = concentrated, few = decentralized

  • Differences in factor costs - substantial = concentrated, few = decentralized

  • Trade barriers - few = concentrated, substantial = decentralized

  • Location externalities - important = concentrated, unimportant = decentralized

  • Exchange rates - stable = concentrated, volatile = decentralized

• Technological Factors

  • Fixed costs - high = concentrated, low = decentralized

  • Minimum efficient scale - high = concentrated, low = decentralized

  • Flexible manufacturing technology - available = concentrated, not available = decentralized

• Product Factors

  • Value-weight ratio - high = concentrated, low = decentralized

  • Services universal needs - yes = concentrated, no = decentralized

Global learning

The idea that valuable knowledge does not reside just in a firm’s domestic operations it may also be found in its foreign subsidiaries

Make-or-buy decisions

Decisions about whether to perform a certain value creation activity in-house or outsource it to another firm (purchase from an outside supplier)

Factors in make-or-buy decisions

• Product success and specialized knowledge

• Strategic fit

• Cost and production capacity and supplier competencies

• Inventory planning

Specialized asset

An asset designed to perform a specific task, whose value is significantly reduced in its next-best use

Proprietary technology

A tool, system, or application that is owned and protected by company

Transportation

The movement of raw material, component parts, and finished goods throughout the global supply chain; largest percentage of any logistics budget with ocean being the least expensive and air being the most expensive

Reverse logistics

The process of moving inventory from the point of consumption to the point or origin for the purpose of recapturing value or proper disposal; the ultimate goal is to optimize the after-market activity or make it more efficient

Upstream allocation

A global company should allocate 20 percent of its efforts to the vendor category, 30 percent to the supplier category, and 50 percent to the partner category

Downstream allocation

A global company should allocate 20 percent of its efforts to the buyer category, 30 percent to the customer category, and 50 percent to the client category in the downstream/outbound portion of the chain

Just-in-time (JIT)

Goal is to economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to ender the production process and not before (speeding up the inventory turnover reduces amount of working capital and inventory holding costs); also can help improve product quality by spotting defective products immediately, but leaves a firm without a buffer stock of inventory (issues of supply disruption/increased demand)