Chp. 10 International Management

Chapter 10: Managing Political Risk, Government Relations, and Alliances

The Nature and Analysis of Political Risk

  • Definition: Political risk refers to the unanticipated likelihood that a multinational corporation's (MNC's) foreign investments will be adversely affected by a host government’s policies.

  • Key Characteristics:
      - Political risks are particularly prevalent in emerging economies around the world.
      - Case Study: After joining the World Trade Organization (WTO), China enacted policies that created new political risks for MNCs operating there includes:
        - Price controls
        - Currency restrictions
        - Sales limits on state-owned enterprises
        - Restriction on the flow of convertible currency out of China
        - Challenges like industrial piracy and ambiguous interpretations of regulations
      - Chinese MNCs also face political risks in the U.S.

Macro and Micro Analysis of Political Risk

  • Macro Political Risk Analysis:
      - Focuses on major political decisions that affect all businesses in a country.
        - Example: China’s restrictions on foreign exchange transactions impact all MNCs.

  • Micro Political Risk Analysis:
      - Targets government policies that affect specific sectors or businesses.
        - Example: U.S. tariffs on steel and aluminum are micro risks affecting particular industries.

Macro Risk Issues and Examples

  • There are numerous countries grappling with economic troubles.
      - Russia has increased controls over foreign currency.
      - India poses a challenge with its convoluted legal and bureaucratic processes, leading MNCs to accept counterfeiting risks.
      - India's slow judiciary promotes non-compliance.
      - Foreign investors in Vietnam are mandated to enter joint ventures (JVs) with local partners.
      - Central and Eastern Europe and Latin American countries (like Venezuela, Bolivia, and Ecuador) present macro political risks.
      - A significant macro political risk is government corruption, including bribery.

Micro Risk Issues and Examples

  • Core Essence: Micro risks often involve differential treatment of MNCs.
      - Historical Context: U.S. steel producers accused foreign steelmakers of dumping products at below-market prices.
      - Example: A 2018 steel tariff affected not only steel importers but also MNCs manufacturing products with steel, such as washing machines and vehicles.
      - WTO and EU regulations introduced new micro political risks:
        - The WTO deemed the U.S. 1916 Anti-Dumping Act as conflicting with global trade regulations, restricting American firms from leveraging it against imports.
        - The EU’s authority to scrutinize and block significant mergers and acquisitions introduces uncertainty regarding regulatory compliance.
        - Sometimes it can be ambiguous whether macro or micro risks are in effect.

Terrorism and Its Overseas Expansion

  • Definition: Terrorism is the application of force or violence against others intended to promote political or social ideologies.

  • Classification of Terrorism:
      - Classic terrorism: well-defined objectives pursued by trained individuals (e.g., organized groups).
      - Amateur terrorism: sporadic acts by individuals with unclear motives.
      - Religiously motivated terrorism: driven by strong convictions with less focus on defined goals.

  • MNCs must navigate potential hostile political climates in regions with a high likelihood of terrorism during overseas expansions.

Analyzing the Expropriation Risk

  • Definition: Expropriation refers to the seizure of businesses without adequate compensation to their owners.

  • Drivers of Expropriation:
      - Indigenization laws may necessitate that local nationals hold major stakes in operations.

  • Noteworthy Considerations:
      - Industries highly susceptible to expropriation include extractive, agricultural, and infrastructural fields.
      - Larger firms often present more substantial targets for expropriation compared to small firms.

  • Minimizing Expropriation Risk: MNCs may employ several strategies:
      - Form partnerships with local businesses.
      - Limit the application of advanced technology to prevent local reproduction if expropriated.
      - Develop affiliates reliant on the parent firm for critical operational aspects.

Managing Political Risk and Government Relations

  • Initial Steps: MNCs must conduct a detailed analysis of the political risks they will face.

  • Risk Management Framework:
      - Development of a comprehensive framework to categorize various political risks and assign quantitative ratings for each risk.
      - A three-dimensional framework should integrate:
        - Political risks
        - Types of general investments
        - Special investments

Political Risks

  • Types of Political Risks:
      - Transfer Risks: Result from government policies restricting the movement of capital, payments, production, personnel, and technology.
        - Examples include export/import tariffs and restrictions on capital repatriation.
      - Operational Risks: Arise from government regulations constraining local operations.
        - Examples include price controls, financing limits, export requirements, taxes, and local sourcing mandates.
      - Ownership-Control Risks: Involves governmental restrictions that affect ownership or control over local operational entities.
        - Examples include foreign ownership caps and confiscations.

General Nature of Investment

  • Conglomerate Investment: Involves production of dissimilar goods or services to those at home; typically considered high-risk investments due to perceived limited benefits to the host country versus MNCs.

  • Vertical Investments: Focuses on the production of raw materials or intermediary goods for further processing; subject to government takeover due to their export nature.

  • Horizontal Investments: Focuses on goods/services matching the home market; made to satisfy local demand, with lower risk of government takeover.

Special Nature of Investments

  • Foreign Direct Investment (FDI): Categorized by economic sector, technological sophistication, and ownership structure:
      - Primary Sector: Agriculture, forestry, mineral extraction; higher risk.
      - Industrial Sector: Manufacturing operations; medium risk.
      - Service Sector: Transport, finance, insurance; lowest risk.

  • Types of Special Investments:
      - From type one (highest risk) to type five (lowest risk) based on sector engagement and technological dependency.
      - Firms with unique technology face lower risk than those with readily available tech.
      - Wholly owned subsidiaries have greater risk than partially owned entities.

Quantifying the Variables in Managing Political Risk

  • MNCs evaluate political risk through a multi-variable analysis for an overall risk rating.

  • Comparison Capability:
      - MNCs can juxtapose political risk ratings across different locales.

  • Three Quantified Factors:
      - Political and Economic Environment
      - Domestic Economic Conditions
      - External Economic Conditions

Techniques for Responding to Political Risk

  • Analyzing political risk can be accomplished via frameworks or quantitative analyses. MNCs must respond effectively to these risks:
      - Careful development of response strategies is essential.
      - Establishing positive government relationships can lead to mitigating risks proactively:
        - Three related strategies include:
          - Relative bargaining power analysis
          - Integrative, protective, and defensive techniques
          - Proactive political strategies

Relative Bargaining Power Analysis

  • Definition: This principle maintains that the MNC seeks to maintain bargaining power superior to that of the host nation.

  • Key Example: An MNC possessing proprietary technology unavailable domestically can bolster its position should expropriation arise.

  • Factors Influencing Bargaining Power: Include host perceptions of MNC size, experience, and market legitimacy.

Integrative, Protective, and Defensive Techniques

  • Integrative Techniques: Embed operations within the host’s infrastructure:
      - Foster political relations with the host government.
      - Strive to produce products locally, leveraging regional suppliers.
      - Form JVs and hire local management.
      - Conduct local R&D and establish productive labor relations.

  • Protective/Defensive Techniques: Minimize host government interference:
      - Limit local manufacturing; handle R&D offshore.
      - Hire only essential local personnel; raise capital from diverse sources.
      - Diversify operations across multiple countries.

Proactive Political Strategies

  • Addressing unpredictable governmental changes requires a strategic approach:

  • Proactive political strategies aim to shape political environments prior to firm impacts.
      - These strategies become vital in politically unstable regions and may include:
        - Formal lobbying efforts
        - Campaign financing initiatives
        - Advocacy outreach through embassies/consulates
        - PR campaigns to manage public perception
        - Sustaining communication with political entities

  • While no singular strategy guarantees success, building relationships aids MNCs in executing their ventures.

Managing Alliances

  • Overview: MNC partners may include former state-owned companies, and relationships with government entities can be complex.

  • Joint Ventures: Many foreign investors, particularly in China, create alliances with state-owned firms to enhance market entry success in international markets.
      - Challenge: Managing alliances, particularly with government-linked partners, poses distinct difficulties.

The Alliance Challenge

  • Research Focus: Specifically, how alliances form through interfirm negotiation processes.

  • Cultural Management: Successful alliances require the navigation of operations across diverse national cultures.

  • Challenges:
      - Anticipating potential alliance termination complexities (both legal and business).
      - Recognizing life cycle stages of alliances similar to businesses.

The Role of Host Governments in Alliances

  • Ownership Sharing: Many host governments mandate joint ownership of subsidiaries with local entities; this can occur even if alliances/JVs aren’t compulsory.

  • Benefits: MNCs may find strategic advantages in forming alliances for market entry and expansion beyond mere compliance.

  • Roles Through Alliance Lifecycle: Host governments play significant roles throughout the creation, management, and dissolution of alliances.

Challenges and Opportunities in Alliance Management

  • Joint Ventures: Increasingly popular among multinational corporations (MNCs), with successful instances noted in various sectors (e.g., Honda and GM).

  • Decision-Making: MNCs need to navigate numerous decisions surrounding international joint ventures (IJVs) amidst bureaucratic environments.
      - Example: Vietnam has opened its market, yet foreign investors encounter mixed signals, seen in Ford's operational experiences.