Chandran

International Business- Dr. R. Chandran

1. International Business: Meaning And
Scope

Interdependency is a natural phenomenon; nations, living beings and
companies cannot totally depend on themselves. It is the major driving
force for international business.

Learning value:
This chapter covers the essential aspects,

1. Definition of international business
2. Emergence of developing nations in international business
3. Motives of international business from companies and nations
4. Fundamental differences between Domestic and International business
5. Few successful organizations in Domestic & International business

International business: Meaning and Scope
In the post independence era, more than half-century Indian entrepreneurs
concentrated on domestic operations and a surplus production was exported.
The physical movement of goods, called EXPORT cannot represent
International business. International business is defined as “any commercial
transaction-taking place across the boundary lines of a sovereign entity”. It
may take place either between countries or companies or both. Private
companies involve themselves in such transactions for revenue, profit and
prosperity. If governments are involved, they need to maintain their image,
dependency and economic growth. Sometimes economic ties are
strengthened through such transactions. These transactions include
investments, physical movements of goods and services, transfer of
technology and manufacturing. Today every company, whether small or
large, single entity or partnership, joint stock or government owned, is
determined to expand internationally. Earlier the slogan “export or perish”
has now become “internationalize or perish”.
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Only for Private Circulation


International business has a wide spectrum of activities beyond mere
exports. Currently Indian corporate acquire and takeover companies
elsewhere. They invest a huge sum to find a right location for cost-effective
production base. They are on the lookout for right joint-venture partners.
Hence International business operations extend their dimensions.

The future success of company will depend upon its operations in many
other countries through investment, manufacturing and marketing and not
only on the revenue generated indigenously. In the same way nations
success will depend on the businessman operating successfully in other
countries and establishing their credentials there. In the 1950’s and 60’s,
companies form United States built business operations throughout the
world and brought image to the nation. In 1970’s and 80’s, Japanese
electronics and automobile companies made great revolution everywhere in
the world.

Why should we study International business?
Three decades ago very few companies ventured in to international arena,
and most of them restricted themselves to physical movement of goods and
services i.e. exports and imports. Restrictions, regulations and other barriers
prevented them to take risks. Today, the whole world is open. Duties, license
quotas and other investment limitations have gradually been eliminated.
Anyone can do business in any part of the world. Risk factors are properly
analyzed and evaluated and information about them is abundant. The
aspiring international businessman can go to anywhere and explore
opportunities.

In such a situation few key factors like finance flow or investment is a great
force. To manage business internationally the right human resource is
necessary and to manufacture goods, right technology is a pre-requisite.
There should also be sizeable market to generate revenue. To manufacture
goods in any country, raw material, components, consumables and capital
items are required. Easy access to all the above is as easy as domestic
procurement today. Hence scope of international business is widened.

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COMPANY OVERSEAS
COUNTRY OF OPERATION
ORIGIN KEY FACTORS

FINANCE

HUMAN
RESOURCE

TECHNOLOGY

MATERIAL

REFORM PROCESS
Almost all countries are reforming their economy by LPG i.e. Liberalization,
Privatization and Globalization. Many South East Asian nations, China,
South Korea and a few Latin American countries were quick to introduce the
reform process. India too, injected new vigour in to its economy and
industry by introducing an open door policy, eliminating licenses, replacing
foreign restrictions by other models and in general liberalizing procedures. It
is clear that through reforming process, manufacturers in India are required
to increase the production capacity and divert products to various
destinations. Companies with surplus money should invest in different
countries with motive of getting higher returns on their investment. Every
business house such as Tatas, Birlas, Mittals, Mallayas have begin their
aggressive operations abroad.

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STRENGTH OF HUMAN RESOURCES
Countries like India have been endowed with efficient technical and non-
technical human resources. Companies with their origin in India have proved
themselves all over the world specially information technology, steel,
healthcare, garments and jewellery.

Today international business is growing at a fast pace. Countries, which until
now did not ventured in to the international arena and untapped markets
have emerged as potential ground for business. Latin America, sub-Saharan
Africa and the Commonwealth of Independent States (CIS) are favourite
destinations of future prosperity. Trade policies announced by various
governments in the world are positive, proactive and pragmatic. Autocracy,
authoritarianism and despotism are disappearing in all parts of the world.
International bodies, such as World Trade Organisation strongly advocate
elimination of barriers.

It is mandatory for professionals to understand the whole network of
political, legal, competitive and socio-cultural aspects wherever the business
is setup. When E-Merck set up a business unit in India, there was a need for
five hundred professionals who understood drug price control order, in-
process control system, food and drug administration and legal procedures,
not only in India but in all countries in South Asia, Middle East and Africa.

Hence, there will be an unprecedented demand for trained professional in the
field of international business to handle business, investment, manpower,
technology, services and marketing. To operate effectively, managers must
understand modes, functions, means, environments, growth opportunities
and risk factors. To this end they need to have access to a strong information
base. To integrate all resources and produce a cost-effective product it in to
revenue a strong professional force is directly involved at all stages. Thus a
large force of trained manpower is required to handle future international
business in all countries. Proper understanding of culture, economic
indications, infrastructure, cost of operation, political scenario and working
condition will make effective manager in international business in any
country.

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REASONS TO ENTER INTERNATIONAL
BUSINESS
All organizations, irrespective of their size, are keen to enter in to
international business. Established companies are expanding their business.
Many countries encourage trade, and removal of strangulating trade barriers.
It motivates companies to aggressively multiply their targets. The
governments of various countries are also determined to make their
economy grow through international business that has therefore become a
inevitable part of their economic policy. The objective behind international
business can be looked at:

1. From an individual company’s angle.
2. From the government angle.

From an individual company’s angle

1. Managing the product life cycle:

All companies have products, which pass through different stages of
their life cycles. After the product reaches the last stage of the life
cycle called the declining stage in one country, it is important for the
company to identify other countries where the whole cycle process
could be encashed. For example, Enfield India reached maturity and
declining stage in India for the 350 cc motorcycle. The company
entered Kenya, West Indies, Mauritius and other destinations where
the heavy engine two-wheeler became popular. The Suzuki 800 cc
vehicle reached the last stage of its life cycle in Japan and entered
India in the early 1980’s, where it is still doing good business today.
HP laptops are moving all the developing countries the moment they
reached maturity in the U.S. market.

2. Geographic expansion as a growth strategy:

Even if companies expand their business at home, they may still look
overseas for new markets and better prospects. For example, Arvind
mills expanded their business by either setting up units or opening

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warehouses abroad. Ranbaxy’s growth is mainly attributed to
geographic expansion every year to new territories. Arabindo Pharma,
Cipla and Dr. Reddys follow the same.

3. The adventurous spirit of the younger generation

The younger generation of business families has considerable
International exposure. They are willing to take risks and challenges
And also create opportunities for their business. Laxmi Mittal has
Emerged as the steel king of the world and Vijay Mallya of the UB
Group took a major risk in setting up operations in South Africa.
Kumar Birla expands to Australia and Europe through acquisitions.

4. Corporate ambition:

Every corporate in the country has strategic plans to multiply its sales
turnover. In case some of the ventures fail, others will offset the losses
because of multi-location operations. For example, Coco Cola is still
to day not earning any profit in a number of countries. But this will
not affect the company because more than a hundred countries are
contributing to offset losses. Kellogge cannot think of profits in India
for further five years. They are ambitious to be visible and then
revenue.

5. Technology advantage:

Some companies have outstanding technology through which they
enjoy core competency. There is a need for such technology in all
countries. Biocon, Infosys, Gharda chemicals are known for their core
competency in biotechnology, IT and pesticides respectively and a
huge demand exists throughout the world for their technology.
Thermax, Ion Exchange, Bharat Heavy Electricals and Larsen &
Toubro have marched ahead in International business.

6. Building a corporate image

Prior to profits and revenue generation, many companies first build
their corporate image abroad. Once the image is built, generating
revenues is a comparatively easy task. Samsung and LG built their

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image in India for the first three years and generation of revenue and
profits has been considerable, as they have expanded to semi-urban
and rural India as well. Today their market share and penetration
levels have gone far ahead of other players in India.

7. Incentives and business impact

Companies, which are involved in international business, enjoy fiscal,
physical and infrastructural incentives while they setup business in the
host country. The Aditya Birla Group enjoyed such incentives in
Thailand and Indonesia. All such incentives contribute to the company
to enjoy multiple advantages like economies of scale, access to import
inputs, competitive pricing and aggressive promotion.

8. Lobour advantage

Many companies have a highly productive lobour force. Their unique
skills may not be available throughout the world. Manufacturing units
in India have consistently performed well, whether in a diamond
industry, handicraft, woodwork or leather. Companies nurture the
skills of the artisans and win world markets. Knitwear, handlooms,
embroidery, metal ware, carpet weaving, cashew processing and
seafood call for cost-effective lobour force. India is endowed with
such skills.

9. New business opportunities

Many companies have entered in to business abroad, seeing unlimited
opportunities. National foreign trade policy emphasizes focus
markets. Enormous amount of growth potential is untapped in Latin
America, Sub-Saharan Africa, CIS countries and China.

10. Emergence of SEZ’S, EOU’S, AEZ

Current approvals of Special economic zones, Agrizones and
Technology parks by Ministry of Commerce & Industry give new
dimensions to international business. The companies setting up units
in SEZ’s enjoy innumerable benefits and competitiveness.

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From a Government Angle

1. Earning valuable foreign exchange

Foreign exchange earning is necessary to balance the payments for
imports. India imports crude oil, defense equipments, essential raw
materials and medical equipments for which the payments have to be
made in foreign exchange. If the exports are high and imports are low
it indicates a surplus balance of payment. On the other hand if imports
are high and exports are low it indicates an adverse balance of
payment, which all economies would want to avoid. A vast majority
of the nations in the world are facing adverse balance of payment.

2. Interdependency of nations

From time immemorial, nations have depended on each other. Even
during the era of Indus valley civilization, Egypt and the Indus Valley
depended on each other for various items. Today, India depends on
the Gulf regions for crude oil and in turn the Gulf region depends on
India for tea, rice etc. Developed countries depend on developing
countries for primary goods, whereas developing countries depend on
developed countries for value added finished products. No single
country is endowed with all the resources to survive on her own.

3. Trade theories and their impact

The theories of absolute advantage, comparative advantage and
competitive advantage, which have been propounded by classical
economists, indicate that a few nations have certain advantages of
resources. The resources may be in the form of labour or
infrastructure or technology or even a proactive policy of the
government. Such theories are remaining foundations till today, for
international business practices with few changes and trends.

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4. Diplomatic relations

Diplomacy and trade always go hand in hand. Many sovereign nations
send their diplomatic representatives to other countries with a motive
of promoting trade besides maintaining cordial relations. Indian
diplomats in Latin America have done a remarkable job of promoting
India’s business in the 1990’s. Indian embassies and high
commissions in all the countries around the world play a catalytic role
of promoting trade and investment.

5. Core competency of nations

Many countries are endowed with resources, which are produced at an
optimum level. Such countries can compete well anywhere in the
world. Rubber products from Malaysia, knitwear from India, rice from
Thailand and wool from Australia are a few illustrations. Competing
with a focused competency in any major resource or technology gives
core competency status. India’s core competency in IT is known
throughout the world.

6. Investment for infrastructure

Over the years all countries have invested huge amounts of money on
infrastructure by building airports, seaports, economic zones and
inland container terminals. If the trade activities do not increase, the
country cannot recover the amounts invested. Hence, the government
fixes targets for every infrastructure unit and time frame to achieve it.
Economies like Mauritius, Hong Kong, Singapore, Malta and Cyprus
invest in trade related infrastructure in order to elevate themselves to
be foreign trade oriented economies. Infrastructure and international
business are the two eyes of a growing economy.

7. National image

A new era has emerged from conquering countries by sword to
winning it by trade. A businessman gives priority to the image of the
country he belongs to. We come across products with labels such as

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“made in China” and “Japan” & “made in India”. Businessmen from
India, China and Japan bring credentials to their country. When
L.N.Mittal operaters in Indonesia or Kazakhstan or Trinidad he is
perceived by the people as Indian. The stigma cannot be detached.

8. Foreign trade policy and targets

All developing countries announce their trade policies. A clear road
map is drafted and given to promotional bodies so that timely
implementation is possible. Every trade policy in India, in the past had
its agenda and action plans right from import control order in 1947.
All the trade policies had three fold objectives in their agenda-
production promotion and competitiveness.

9. National targets

By the year 2010, India aims to have a 2% share of the global market
from the current level of 1%. By the year 2009-10, our trade status
should cross $ 500 billion.

10. WTO and international agencies

The apex body of world trade, the WTO, a free, transparent and regulatory
body upholds provisions related to the elimination of tariffs and non-tariff
barriers. The International Bank for Reconstruction and Development
(IBRD), popularly called the World Bank extends financial assistance on a
soft loan basis in order to assist developing countries in their infrastructure
and industrial development. The International Monetary Fund (IMF)
maintains currency stability in various countries through regulatory
mechanisms. Many more organizations like International Maritime
Organization, International Standard Organization, International
Telecommunication Union, International Civil Aviation Organization are
major catalysts to promote trade between nations. Over the past few years
their role in promotion of trade, especially amongst developing economies is
unprecedented.

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Fundamental differences between DOMESTIC BUSINESS
OPERATIONS AND INTERNATIONAL BUSINESS
OPERATIONS

Many well-known business units are highly successful in their home
countries. However, they are not able to face the challenges abroad. On
the other hand there are organizations that do very well in international
business but they lose out in local arena. There are a number of
organizations that do business, both domestic and international,
successfully, by properly allocating right resources in right countries.
These organizations are quick to see the advantages and disadvantages
involved in both operations. If business is slow in the home country, they
concentrate more on international business, and if risk is high in
international business they focus their attention on the domestic front.
Understanding differences and deciding policies and strategies enable
organizations to succeed or fail.

There are certain similarities between domestic and international business
in terms of broad objectives and goals of the company, namely:

1. Generating revenue- either by creating opportunities or by
optimizing strengths
2. Corporate image building
3. Customer satisfaction and building loyalty as patronage buyers
4. Carrying out their operations respecting and adhering to local
regulations
5. Generation of employment opportunities
6. Both are subject to a set code of conduct and ethics that includes
corporate governance.
7. Mass production through cost reduction and achieving economies of
scale
8. Building a strong network in order to make product and services
available in any part of the nation or world
9. Adapting new standards and change in style and function.

At the same time, there are major macro level differences. These are
analyzed below, under various parameters.

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DOMESTIC BUSINESS VERSUS INTERNATIONAL BUSINESS

Domestic Business International Business
Dimension
Operations Operations
The environment is not fully known.
The economic, political, legal,
Innumerable hidden factors which may
1.Environment socio-cultural, competitive and
emerge any time to pose as problems.
technology environments are known
They will lead to pitfalls.
Only long term planning and strategy
Can be worked out for short terms
2. Plan and strategy will work. Strategic inputs are required
and carried forward to long term
in multiples.
The maximum domestic competitive
3. Competitive International competitive forces play a
forces operate and one can
forces and their vital role and its difficult to understand
understand their movements as they
intensity their motive and movement
are visible
Local currency is used for
Transactions are carried out in various
transactions. Costing, pricing,
currencies. Fluctuations in cross
revenue and margins are computed
4. Currencies and currency movement and associated risks
in a single currency. Volatility may
their movements are common. Currency fluctuation
have a minimum impact in business
influences pricing and costing and
in short term. One can overcome
investment decisions.
easily.
Comparatively one can predict Very difficult to predict and risks may
future risks and shocks and they will crop up at any time, due to the political
5. Business risks
not have a major impact on the situation, the society itself and several
businesses with strong background. unknown factors.
It is reasonable and easy to conduct Very expensive and difficult to conduct.
business research, demand analysis Reliability criteria depends on
6. Research
and customer surveys. It is also individual countries and there is no
reliable. uniformity in the output and findings.
Due to past laurels and established
Multilingual, multi-strategic and multi-
systems, corporates can succeed
cultural human resources and they
even if the human resources have
7. Human resources should be able to withstand large risks.
minimum skills and knowledge.
Every individual is profit center, hence,
Team commitments is evaluated and
accountable.
appraised
Narrowed down to work in a single
Broadened to cover many countries and
8. Organizational country with a steady growth
geographic and cultural diversity may
vision and objective objective. Each one will understand
influence the vision and objective.
the vision and objective easily.
Adapted to the local environment, as Varies from country to country subject
9. Product and per the requirements of the domestic to regulations. This is especially true for
usage customers affordability, beliefs, consumer & medicinal items.
values, cultural elements and buying Standardization, adaptability, usage

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behavior. pattern & warranties are parts of product
International regulations and host
Only local regulations are fully
country regulations are applicable.
applicable to conduct business.
Advanced countries impose strict
10. Legal aspects There is minimum adherence to
regulations compared to LDCs. Strict
international regulations related to
adherence to contractual obligations is
IPR.
common.
Depending on the size of the All overseas operations except exports,
business one can start with a call for huge investments to set up and
11. Investment and minimum investment. Involvement expand the business in many countries.
Sourcing of regulatory bodies is minimal. Special regulatory bodies are involved
Individual ability and repayment in the process since foreign currency is
terms determine the funds. transacted.
A majority of companies use cost Companies use marginal cost pricing or
12. Pricing strategy plus margin pricing or competitive transfer pricing or competitive pricing to
pricing. succeed.
Government or market practice governs
The business house can use its
the distribution channel. Cash and carry,
13. Distribution discretion to select any channel to
shopping malls and mail order services
channels reach the customer. No restriction
are becoming popular in international
exists here.
business.
Different countries have different
Advertising, personal selling and
restrictions. For example,
other promotional methods are not
advertisements for liquor and cigarettes
14. Promotion restricted through strict legal
are not permitted in some countries and
framework if they are not socially
campaigns using female models are
objectionable.
banned in others.
International players with advanced
Domestic players are involved in all
technology and systems are involved.
15. Logistics the activities. The cost of logistics is
Proportionately, the cost is low for
very high locally.
physical movements.

Some business groups like Adanis started only overseas operations
without any linkage with domestic operation right from the beginning.
Tata group established a good name at home country and gradually
moved to other countries. For companies in IT, such as Wipro or
Infosys, the major focus is on overseas operations. All the companies
cited as examples above are successful in their own right, but the
strategies and operation systems differ from country to country.

Organizations like RELIANCE INDUSTRIES have inherent strength in
indigenous business such as completing the project prior to stipulated
time. This experience enables the company to grab any business

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opportunity in petrochemicals around the world and build reputation.
Gammon India, IRCON (Indian Railway Construction), Larsen &
Toubro (L&T) and Sapoorji Pallonji are successful due to their
meticulous way of understanding both operations.

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2.Methods of Entry in International Business

For every human being or business unit, the origin is one,
but, the laurels are built in multiples and that too, in
various destinations. The vision, business models, right
decisions and proper implementations have created
business enterprises in the and in the contemporary world.

Learning value

International business provides a wide range of advantages and
opportunities. Companies in developing and less developed countries
operate through physical exports, whereas those in advance countries
operate through joint ventures, collaborations, franchises and other
methods. Firms would prefer to go international only if the benefits
surpass anticipated risks, and they carry out an in-depth analysis before
entering international business. Generally, they give serious
consideration on the following aspects:

a. Current and potential size of the market.
b. Level of completion for a specific product or service
c. Economic growth of the country and reform process
d. Purchasing power of the people
e. Political and legal environments and their impact in business
f. Infrastructures like banking, insurance, port facilities etc
g. Socio-cultural background of the country
h. Availability of technical and non-technical work force
i. Foreign exchange reserve and repatriation facilities

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DIFFERENT MODES OF ENTRY IN INTERNATIONAL
BUSINESS

1. EXPORTS

Export deals with physical movement of goods and services from one
place to another through a customs port followings the rules of both
the country of origin and country of destination. Depending upon the
involvement of the exporter, exports can be classified as direct or
indirect. Direct exporters export their goods and services in their own
name and the buyer directly remits proceeds, in a proper manner and
through a proper channel. The proper channel means that the
remittance is made through the banking channel in the currency,
which is quoted in the invoice, and the proper channel means that the
goods are legally exported through a customs port.

Indirect exporters supply goods to direct exporters. Lack of expertise,
international contacts and manpower cause them to depend upon
direct exporters. Farmers rarely export grains on their own. Artisans
cannot develop international contacts to clinch business deals.
Therefore, they become indirect exporters. Their products are to other
countries but not in their names.
Exporters can be classified in several ways:

1. Depending upon the size of business, they are classified as small
and large exporters. Current national trade policy provides
incentives and facilities to promote both small & large exporters in
different ways that are status holders due to their performance in
earning foreign exchange.
2. Depending upon the product lines exported, they are classified as
single product and multiple product line
3. Depending upon their legal status, they are classified as
proprietary, partnership, private limited and public limited
companies
4. Depending upon the destination of their exports, they are classified
as single destinations or multi destination exporters. Nowadays, the
majority of the companies adopt the philosophy of multi product,
multi location, multi strategic, and multi dimensional operations.

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5. Depending upon the frequency of their exports, they are classified
as occasional exporters and dynamic exporters.

EXPORT
INVOLVEMENT

DIRECT INDIRECT
EXPORTERS EXPORTERS

Own name and beneficiary Not on there own name but
supply to direct exporters

CLASSIFICATIONS

SIZE PRODUCT LEGAL DESTINATION FREQUENCY
LINE STATUS

PARTNER PUBLIC
SHIP PVT LTD LTD
SMALL LARGE PROPRIETARY OCASSIONAL BRISK

SINGLE MULTI
PRODUCT PRODUCT SINGLE MULTIPLE

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2. INTERNATIONAL LICENSING

International licensing is an agreement between the licensor and the
licensee over a period of time for the use of brand name, marketing,
know-how, copyright, work method and trade mark by paying a
license fee. For example, British American Tobacco Company
(BATS) has given licenses in many countries for the manufacture of
their brand of cigarettes “555”. In India, ITC is the licensed producer
of “555”.
Pepsi cola licensed to Heineken of the Netherlands giving them the
exclusive right to produce and sell Pepsi cola in Netherlands. The
licensor has minimum involvement in day-to-day functions. Therefore
the returns are also comparatively low. Licensing specifies the
territory as well as period. The licensor gives such permission after
establishing such a command-able position globally. It has a brand
command.

Licensing Concept and Practice

Licensor Country A

License Fee

Country B
Licensee
Manufacture and Market

One or more countries as per agreement

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Licensing Process
PROVIDE THE RIGHT TO
USE INTELLECTUAL RECEIVES ROYALTY
LICENSOR PROPERTY AND BRAND MONEY
NAME

USE THE INTELLECTUAL PAYS ROYALTY TO THE
LICENSEE PROPERTY TO PRODUCE LICENSOR FOR USING
PRODUCTS FOR SALE IN HIS INTELLECTUAL PROPERTY
COUNTRY AND BRAND AND BRAND NAME

3. FRANCHISING

Franchising is a form of licensing wherein the franchiser exercises more
control over franchisee. The franchiser supplies the main part of the
product, and provides the following services to the franchisee:

1. TRADEMARKS
2. OPERATING SYSTEMS
3. PRODUCT, &
4. BRAND NAME
Company support systems like advertising,
training of employees, quality assurance are also involved in franchising.
McDonald, Dairy Queen, Domino’s Pizza and KFC are the known
franchise brands. NIIT & Aptech have appointed franchisees in Africa,
south East Asia, Gulf countries and China. Hotels like The Hilton and
Marriott are well known operators in hotel sector. Jatia’s in India are the
national franchisees of McDonalds. All the investments on premises, HR,
operations and promotions are totally borne by the franchisees.

In practice the franchiser is determined to maintain a standard throughout
the world in terms of quality brand logo and symbol. But the product is
adaptable depending on the socio-cultural background of the country.
McDonalds sells BEEF BURGERS in Russia & VEG BURGERS in
India.

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International Business- Dr. R.creator with
Well-known Chandran
brand command can
become strong franchiser
FRANCHISE
R En cashes on the past &
present efforts

FRANCHISEE
FEE SELECT

FRNCHISEE Invests on all the
resources

Sometimes the franchisers initiate the process where the economy is on
boom. In many developing nations, franchisees initiate the process and
they are forced to bear all the expenses.

4. CONTRACT MANUFACTURING

Many companies outsource their products and concentrate mainly on
marketing operations. Contract manufacturing is the strategy of
identifying a manufacturing unit to produce items at a competitive price
in any part of the world. Nike is procuring its athletic footwear in a
number of factories in South East Asia. Mega Toys is sourcing from
China. Hundreds of international companies with their origin in European
countries have selected manufacturing centers in India, China and South
East Asia. Mark and Spencer, J.C. penny, Target and H & M have
contract manufacturing arrangements in many parts of the world.
Contract manufacturing with a dimension in the service sector offer
ample opportunities for Indian companies in the form of BUSINESS
PROCESS OUTSOURCING (BPO) and KNOWLEDGE PROCESS
OUTSOURCING (KPO).

All the developed nations are becoming end user of outsourced products
and services of developing nations.

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A well-known marketing company

Supply Selects

Manufacturers- China/India/SEA

5. CONTRACT MARKETING

All the companies, which are strong in production, may not have equal
marketing strengths. However, they may be comfortable dealing with
marketing outlets around the world such as TESCO, Maeys, ‘K’ Mart,
Wal-Mart and Spinneys. Such manufacturing units enter in to a
marketing agreement and concentrate more on production at lower costs.
Thermax, Ion Exchange and Supreme industries have selected marketing
firms in other countries, which have a good background with technology
support. Majority of technology-based companies essentially have to
identify competent organizations with marketing infrastructure to
aggressively promote their products or projects. Many Indian companies
are contract marketers for Germany based medical equipments, dental
care items and hearing aids. Their contractual obligations include
TARGETS & TERRITORIES.

A well-known manufacturer in India

Selects

Marketer in GCC with technical
support

Territorial rights with commitment

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6. MANAGEMENT CONTRACTS

Companies with a low level of technology and managerial expertise may
seek the assistance of foreign countries. A management contract is an
agreement between two companies whereby one company provides
managerial and technical assistance for which proper monetary
compensation is given, either as a flat lump sum fee or a percentage on the
sales or a share in the profits.
Delta airlines, Air France and KLM offer such
services in developing countries. Exxon is a major operator in Gulf region in
the field of oil exploration.

7. JOINT VENTURE

VENTURE ORIGINATES FROM ADVENTURE, which means NEW,
either market or technology or environment.
A joint venture is a binding contract between two venture partners to set up a
project either in home country or host country or a third country. In this case
both parties are committed to joint risk taking and joint profit sharing. For
example, The Taj group of hotels has a joint venture in Russia for setting up
Five Star Hotels. Mahindra & Mahindra has recently entered in to a joint
venture with Renault to manufacture cars.

Partner one from Partner two from
Country A Country B

New
Venture

Joint commitment

A large number of joint ventures have been miserable failures in the past. In
the initial stage every venture promises excellent opportunities to both the
venture partners. However, when the operation actually starts, certain
functional level grievances and issues become inevitable. Therefore, it is

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absolutely necessary for both the venture partners to understand all the
aspects of management, investment and regulations of the countries where
they operate. The business units should have clear guidelines and operation
manuals wherein the role of every one should be clearly defined.
Hence, a joint venture is nothing but a “marriage binding” between two
partners from different backgrounds with an understanding, commitment and
mutually rewarding experience to work together.

8. COLLABORATION

While a joint venture deals with the project in totality, in financial terms and
the proportionate partnership commitments, Collaboration deals with only a
part of the functions. For example Bajaj Auto has technological
collaboration with Kawasaki of Japan, who offers the technology for two
wheelers. Others well known technological collaborations are Ind-Suzuki,
Kinetic-Honda and Hero-Honda. All the developing countries encourage
technology collaborations. The investors in the US, Japan, Germany and UK
enjoyed the fruits by offering technical expertise to the developing nations.
The world famous Kellogg Business School has collaborated with the Indian
school of business (ISB) in Hyderabad, by offering teaching methodology.
Likewise, there may be financial collaborations, HR collaborations, systems
collaborations and strategic collaborations. The common term used for
collaboration is TIE-UP.

9. FOREIGN DIRECT INVESTMENT

The flow of funds from one destination to another is called investment.
Companies, which are constantly involved in international business, invest
their money in manufacturing and marketing bases through ownership and
control. Kellogg, Pepsi, Coca Cola and the Hyatt group of hotels are willing
to invest even if the profits are expected after a long gestation period.
Currently every developing country is formulating strategies by offering
ample amount of incentives to attract investments.

23

Any Country

Investor Money Projects/Technology/
Trade

Short term/Long
term
ROI

Foreign firms adopt certain methods as mentioned below:

a. They control the operations through subsidiaries to achieve strategic
synergies.
b. They have control through technology, manufacturing expertise,
intellectual property rights and brand name.
c. One permanent person or a team in the country of operation is
appointed to monitor day to day operations.

The most attractive part of the operation is the direct investment, which
contributes to optimization of resources in the host country, generating
employment opportunities and enhancing the standard of living in the host
country. The other major developments, which have taken place during the
past two decades, are exposure of the host countries to advance technology
and quality products. It is boon to the host country since capital is great
resource it is coming through investment.
The main disadvantages are lack of clarity of repatriation of profits,
imposition of restrictions by host countries and elimination of small and
medium industries due to the financial power of the investor. A number of
South American countries like Argentina and few South East Asian nations
like Indonesia fell pray to the dominant forces of overseas investors. They
feel that the old colonialism may re-emerge through investments.
Generally, a foreign investment takes place on full swing in developing
countries only in the past two decades. China, Taiwan, India, Brazil,
Argentina and other developing countries have started attracting huge
foreign investments. If it takes place in specific sectors like infrastructure,
mining, marine technology and agro processing, it is highly beneficial to
both the host country and investor.

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10. MERGERS AND ACQISITIONS

In this case the company in the host country selects a foreign company
merges itself with it. The foreign company acquires the control of
ownership. This mode of entry gives an outstanding competitive edge over
others. Such companies strengthen their international manufacturing
facilities and marketing network. Proctor & Gamble entered Mexico and
became leaders in five years by acquiring Loreto. Tata bearing acquired
Metal Box in India. It is an easy and fast method since the cost of acquisition
is comparatively low. At the same time the disadvantages are:
a. It is a complex task involving banks, lawyers, bureaucrats and
obviously politicians.
b. The host countries may impose restrictions on acquisitions.
c. The labour problem is a big challenge to acquisitions specially
in developing countries where unemployment is a critical issue.

The global STEEL-KING L.N.Mittal was successful right from the first
acquisition of steel mill in Indonesia. Many other acquisitions followed in
Trinidad, Kazakhstan, Hungary and others. The recent Aditya Birla Group
Company Hindalco acquisition of Novelis has strengthened its production
synergy and market access for non-ferrous category in the international
market.

11. TAKE-OVERS

This is a strategy whereby a company identifies a healthy unit with strong
brand name and network and brings it under the management of another unit
in order to become a leader in the field and guarantee success. Since there
may be many parties wanting to takeover a well-known company,
competition becomes inevitable. It is obvious that only one entity will win
and the winner has to withstand hostilities. Therefore, the process is called a
“hostile take over” and the winner is called the “take over tycoon”. Well-
known examples are the Hindujas who took over Ashok Leyland and
Uniliver who took over Brook Bond and Lipton. Take-over is also on
different levels, such as company takeover, business takeover, product
takeover and brand takeover. Some takeovers in the past have made many
corporate success stories. For example, Uniliver’s take over of Brook Bond
and Lipton enhanced its position as a leader in the tea industry in India.
Always takeovers cost more as compared to acquisition but probability of
success is high.
25


FOREIGN ENTRY DECISION FOR MNCs

Exploit competitive advantage
through entry abroad

Produce at Home and Produce Abroad
Export

Licensing or Management Maintain Control over
Contracts assets abroad

Majority or Wholly owned Joint Venture
affiliate

Build from scratch Acquire or
Merge or Takeover

For all the decisions the company has to analyse the opportunities and risk
factors, future potential and long term prospects available in the destination.
Once the entry is wrong, a major pitfall occurs in one country of the entry
level, it may cause a major damage to the company. Entry of ENRON in
INDIA was one such incident one cannot forget.

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12. TURNKEY PROJECTS

A turnkey project is a contract under which a company is fully involved
from concept to completion. It covers right from supply of manpower,
capital, and erection of plant, installation and commissioning up to the trial
operation of a project. The turnkey project contractors either get a fixed fee
or the cost plus profits are collected over a period of time. Today,
infrastructure projects like power plants, airports, refineries, railway lines,
highways and dams are undertaken on a turnkey basis. Bechtel, Brown
Bovery, Hyundai, Mitsubishi, L&T and Daewoo are turnkey contractors for
international projects. They use terms like BOT (Build, Operate and
Transfer) and BOOT (Build, Own, Operate and Transfer) depending upon
the level of involvement and obligations. Whenever turnkey project
contractor is capable of cutting costs on material and manpower or finances
or speed of completion: every component increases profitability.

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Mode of Operation and Benefits to International Companies

EXPORTS

EXPORT PROCEEDS

JOINT VENTURE

PROFIT SHARE/DIVIDEND

ACQUISITION/TAKE OVER

PROFIT REPATRIATION
HOME HOST
COUNTRY COUNTRY
(SENDER) LICENSING/FRANCHISING (RECEIVER)

LICENSE FEE/FRANCHISE FEE

TURNKEY PROJECT

PACKAGE DEAL

FDI

RETURN ON INVESTMENT

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13. COUNTER TRADE

In all the above operations, foreign exchange is necessary for transactions.
For exports, the supplier gets the proceeds in foreign exchange. For joint
ventures, profits are shared in foreign exchange. For international licensing,
the license fee is paid in foreign exchange. The current challenge to many
international business organizations is to get payments in foreign currency.
A vast majority of the countries in the world do not have the necessary
reserves of foreign exchange to remit. However they can still be actively
involved in international business, by using COUNTER TRADE
mechanism. Counter trade came in to existence in the absence of foreign
exchange reserves in a country. Sometimes the country is not willing to pay,
though foreign exchange reserves are with it. Such unwillingness will lead to
non-repatriation of payment. Ultimate solution is to enter in to counter trade
practices.
Counter trade can be classified in to three categories:
1. Pure Barter
2. Buy Back
3. Counter Purchase

Counter Trade

Pure Barter Buy Back Counter
Purchase

Product to Buy from the Change of
product host partner in destinations
exchange setting up unit till finding
FOREX

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Pure Barter

In this system goods and services are mutually exchanged between two
countries depending upon their bargaining strength. A country with surplus
products can finalize deals with another country that has a shortage of the
same range of products. At the same time, the second country may have a
surplus of a different range of products, which are in short supply in the first
country. Hence, both countries can exchange their products by fixing a price
in advance for a given period of time. This age old system that was prevalent
during the era of ancient civilizations is being practiced currently. The Indus
Valley supplied timber for maritime activities to Mohenjadaro and Harappa.
The same practice has re-emerged with sophisticated pre fixation of value.
Pure barter is defined as “the mutual exchange of goods and services
between two countries depending upon their bargaining strength, in order
that both the countries enjoy the benefits”.
For example Russia supplied newsprint and crude oil
to India for decades, and in turn India supplied tea, garments, medicines and
tobacco products to Russia at a comparatively low price, thus enabling both
countries to enjoy the advantages.

Buy Back

A buy back is an arrangement by which the home country representative sets
up a project in the host country, which does have sufficient foreign exchange
reserves to fully pay for the project to the supplier. The project amount is
partially paid in foreign exchange and the remaining amount is paid in kind.
Usually, the home country representative comparatively at low price
purchases the end product of the same project. This can be marketed in the
home country or it could even be diverted to a third country in order to
maximize the profit margin. Buy back arrangements have become popular
since many turnkey project contractors get greater benefits by marketing the
end product in any part of the world at a higher margin. Bharat Heavy
Electricals (BHEL) sets up projects in other countries. Partially it gets the
payment in foreign exchange. For the balance amount it takes back tankers
from the host country and markets them in any other country and also brings
them back to India to sell at a higher price. Such deals enable the home
country businesses to get international exposure very fast. The host country
is an ultimate beneficiary since the project is locate in and owned by it. At

30


the same time, it need not have to pay the full sum of money necessary to
invest in the project.

COUNTER PURCHASE

This is a method, wherein company A from country A supplies product X to
country B. Country B, which has a surplus of product Y, compensates by
supplying it to company A, which finds a market for e product Y, say
country C. Country C sells a product Z to a country D, which has sufficient
foreign exchange to pay for it. Country D can then pay country C, and
finally country A collects payment routed through company B and C. Thus
purchasing takes place against supply until a country, which has sufficient
foreign exchange reserves is found. He transaction.
Many multinationals use this system to make large amounts of
money at every stage of For example, Pepsi International supplies rice to
South Africa from India. From South Africa it procures steel equivalent to
the amount of rice collects and supplies it to Ghana. From Ghana, it procures
coffee and cocoa equivalent to the steel imports and sells them to Canada,
which has sufficient foreign exchange reserves to pay for them. By
appointing one representative or employee the company can carry out
routine functions deals in the Far East are Marubeni Corporation, Mitsubishi
and Majuko.
The age-old economic theory of inter-dependency of nations has
been redefined with the counter purchase mechanism. Today, to trade with
other countries, it is not necessary that the country in question has to have
sufficient foreign exchange reserves. Without foreign exchange reserve one
can continue trade.
The model on the next page shows the benefits that both the
home country and the host country enjoy on successful completion of the
transactions undertaken. Today, anyone can do business with any country.
Foreign exchange as a medium of transaction had a dominant role in all the
countries in the past. Due to counter purchase mechanism very few countries
with foreign exchange reserve can comfortably contribute to international
business.

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3.Key Factors Influencing International Business
Analyzing similarities and dissimilarities prevalent in countries
gives wisdom; selecting a country for business enkindles spirit
and minimizing risks knocks the door of success.

Learning value:

This chapter highlights the major factors influencing the direction of
international business;

1. Importance of environmental factors
2. Economic environment
3. Social environment
4. Political environment
5. Cultural environment
6. Technological environment
7. Legal environment
8. Competitive environment

A pilot has to check the atmosphere prior to take-off and landing his aircraft.
A sailor has to understand waters & before sailing peacefully.
A farmer has to plant seeds depending on the nature of the soil and
monsoon.

On the same line, an international business entry or operation depends upon
multiple environmental factors. They may change the direction, strategy and
every moment of international business operations.

Prior to going deep in to the topic, we can ask ourselves few questions and
seek answers.

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a. Why ENRON could not succeed in India?
b. What is the major hindrance for success of Kellogg in
India?
c. Why KFC has not made any break through in India as it
did in other countries?
d. What made Whirlpool & Caterpillar stop business in India?

An international marketer is required to understand, evaluate and work out
various parameters before venturing into any country. These Parameters are
called environmental factors and they determine the direction and purpose of
the international business operation. Many decisions depend upon
environmental factors right from selection of the country, location of the
plant, liaison with the government, and entry of investment from local
bodies, product launch, channel management, promotion and opening of
outlets. The first challenge for an organization is to navigate from its home
country to the host country. Thereafter it has to develop a proper system so
that the venture is successful in the host country; learn all about the
regulatory bodies both in the host country and home country; understand the
customer’s changing tastes and attitude towards foreign goods and finally
obtain revenue and make the business effective with right people.

A majority of the multinational corporations and large business houses
appoint a team of experts who are specialists in economies, political science,
sociology, industrial psychology and policy matters, to advice the
management on its strategic decisions. These experts are called risk analysts.
Prior to entry or investing millions of dollars, the experts gather all the
relevant information about the country and interpret those facts to facilitate
the company. By such risk analysis, companies can safeguard themselves
from future dangers. The major risks are:
1. Political
2. Economic
3. Exchange
4. Socio culture
5. Financial
6. Legal
7. Technological
8. Competitive

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9. Infrastructural and
10. Labour.

An organization can overcome the effects of all the risks by taking into
account the different environmental factors.
Since the home environment is known, one can understand and overcome
the pitfalls in the event that any action goes wrong. The international
business related environments vary from continent, country to country and
even from region to region. A detailed and comprehensive analysis of such
fast changing environment is essential for formulating business strategies.
Even well known companies with financial power, advance technology and
an efficient management team have failed in other countries. Examples are
the Enron project which did not take off in India; American style of
managing a sales force which never worked for Procter and Gamble in
Japan; the multilayer marketing technique of Amway, which did not work in
South Korea and Kentucky Fried chicken and McDonald’s hamburgers,
which failed in Brazil and Tashkent respectively. Thus, it is important for a
company to have an international team to design strategies to suit varying
environments of different countries.
In this chapter we discuss the environmental factors relevant to international
business. The economic environment, political environment, cultural
environment, technological environment, legal environment and competitive
environment play a vital role in determining an international business
operation. Certain environments are quite conducive to a company at the
time of entry and later on they may pose major challenges. Argentina
attracted huge investments before 2000. After 2002, they became
detrimental to innumerable organizations. Hence environmental factors
could be stimulant or detrimental. If it is stimulant, the business will
flourish. But if it is detrimental, then the company has to be cautious.

ECONOMIC ENVIRONMENT:

The economic environment can be classified into three categories:

a) Economy in the home country
b) Economy in the host country
c) Economy at a global level.

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a) Home country Economy

Since 1940, hundreds of MNCs from the USA have ventured abroad, with
the support of their home country. After 1990, many Indian companies
started venturing into sub-Saharan Africa, South East Asia and Latin
America due to the liberal policies adopted in India.

In order to encourage the business community to venture overseas, it is
necessary for a country to have liberal economic and trade policies.

1. Economic policies

The country’s economic policies are formulated and the targets are fixed
looking at business opportunities in other countries. It is made simpler for
businessmen to invest or set up units abroad.

2. Trade and commercial policies:

The trade policy is announced by the ministry of
commerce and industry and the target for
nSational foreign trade is fixed. All the
promotional bodies are geared to achieve the
target. Many incentives are held out to overseas
companies, so that they set up operations in the
home country through local partners, Indonesia,
Thailand and Brazil extend all facilities in their
home country to promote their nationals.
3. Promotion and regulatory measures:

The home country should take the opportunity to do business abroad. It can
do this by being proactive, encouraging persons to take risks and extending
fiscal and promotional support. If restrictions are imposed and bureaucratic
hurdles are encountered at all stages the business community will not think
35


of taking any risks. By removing exchange control restrictions and draconian
codes of business and providing an environment conductive to foreign trade,
small countries like Malta, Cyprus and Mauritius have today transformed
themselves into foreign trade economies.

b) Host Country Economy.

When a firm from one country enters any other country, the following major
criteria are taken into account:
1. Size of the market
Many multinational firms are thinking of entering India, China, Brazil
and Indonesia, because of their large potential markets. Coca cola,
Pepsi, Hewlett Packard and Samsung are looking to India as a future
destination keeping in mind the size of population which represents
the size of the market.
2. Gross Domestic Product (GDP)
GDP is an indicator o the health of the economy; it also determines pr
capita income. A country with a high GDP is an attractive destination
for any international businessman. If a constant growth rate is
maintained, such a country would always be a magnet for investors.
Thailand, Malaysia and Indonesia were attractive during the 1990’s
due to a very high growth rate in GDP, until the currency crisis
affected their economies.

3. Industrialization
Many firms in the developing world were interested in entering into
Europe or the USA. The recent trend amongst companies in India is
towards Latin America specially, Brazil, Argentina, Chile. This is due
to the industrialization program, which is taking place in these
countries. It is obvious that industrialization brings about prosperity
and affluence.

4. Banking
Banking is the only channel through which remittances take place,
and hence is a major infrastructure for international business.
European, American and far East economies have highly effective
banking systems. Sub –Saharan Africa and commonwealth
Independent states (CIS) are not able to provide good banking
36


services to the international business community. Thus, a firm which
enters Africa or the CIS countries has to necessarily depend on other
countries for banking services.

5. Purchasing Power
Another major determining factor for any international business unit
is whether the people can afford to buy for a product is low. In other
countries like Saudi Arabia, both the income and willingness to pay
for the product are high. In the Scandinavian countries the per capita
income is very high and they are ready to pay a premium price for
highly sophisticated items. However, the low population is a limiting
factor.

6. Foreign Exchange
Another determining factor in international business is whether
tforeign exchange facilities are available transactions. Although more
than 70% of the countries in the world do not have foreign exchange
reserves, the majority of them are becoming liberal in transacting
foreign exchange as a long term strategy for their future economic
development. Against this, some countries with surplus foreign
exchange reserves do not permit free movement of the currencies.
Such countries that have restrictions in repatriation of foreign
exchange will not be attractive to international business firms.
Therefore, countries with sufficient foreign exchange reserves, a
liberal policy on repatriation and which have a demand for the
products and services are an ideal destination for any company to do
international business.

7. Income Levels
Economies are classified into low income and high income
economies. Industrialized nations are high income economies and
enjoy a high per capita income. Companies manufacturing or
marketing premium quality or high technology products have an easy
entry into such advanced countries with the proper strategies.
Developing countries, which are the low income economies, are price
sensitive. Many of them are under pressure from high population,
unemployment and lack the vision to industrialize fast. Still they need
only primary goods and rated one amongst less developed countries.
Differences in the income levels may limit the involvement and
investments. Sometimes, in a densely populated country, a small
37


percentage of the population can afford to buy premium products.
Since this does not represent the purchasing power of the whole
country, the revenue is minimum.

8. Economic diversity
In the same country, a few urban centers may offer outstanding
business opportunities, while in remaining areas there is no demand at
all. Nairobi I Kenya, Lusaka in Zambia, Johannesburg in South
Africa, Sao Paulo in Brazil and Casablanca in Morocco are cities with
the highest purchasing power and demand for refrigerators, air
conditioners, TV sets etc. However in other parts of the country, there
is hardly any opportunity to do business. In Madagascar, despite the
fact that it is a highly resourceful country, one can not get even the
basic item for survival, exept in two cities, Tamatave and Antamarino.

c) ECONOMY AT A GOBAL LEVEL

Besides the home country and the Host country, there are certain other factors, which

can influence the pattern of international business. Organizations such as the World

Trade Organization, World Bank, International Monetary Fund, Asian development

bank and the organization of petroleum Exporting countries (OPEC) can affect

international business. The preferential treatment given to the members of NAFTA,

ASEAN, the European Union and COMESA can have a negative impact on the trade

between outside cartels and non-members. When shipments move from one

destination to another, there are transit ports which charge huge sums as surcharge or

transit charges.

38


SOCIAL ENVIRONMENT

The social environment encompassing religious aspects, language,
customs, traditions and beliefs, influences buying consumption habits.
Many companies face failure in foreign countries, due to their inability to
understand the socio cultural environment. For example whenever any
company establishes business in some African countries, the local
population expects that many jobs will open up for them. Very few
countries perceive tat they may be exploited.
Due to the entry of foreign firms the economic and hence the
social environment of an area can completely change. An example is
southern China, which has completely changed to an affluent society due
to the fact that almost 2000 companies get their products manufactured in
coastal south China.

1. National Taste
In Thailand, People prefer black shampoo; Nestle brews
different varieties of instant coffee because people in those
countries have different tastes, uncommon in other countries.
Green is the favorite color of all the Arab countries; Red is still
widely used in Russia, in banners, posters, and hoardings
although communism is in no way relevant to modern Russia.

2. Language
Cross culture and cross border operations call for necessary
language skills, e.g. South Koreans have learnt Indian
languages to operate in India. One can see this in Hyundai or
LG factories in India.

Companies also have to change their brand names and
slogans in different countries. In Japan, General Motor’s slogan
“body by fisher” means “corpse by fisher”, and Pepsi Cola
slogan “come alive” means come out of the grave. Prior to
promoting the brand, one has to take into account the socio-
cultural background of a specific nation and different
interpretations of a name in the local language.

3. Values and beliefs

39


It is also important for companies to understand the significance
of different designs and colors in different countries. For
example, blue is perceived as feminine in Holland and
masculine in widen. Green is favorite color in the Muslim
world, but is associated with illness in Malaysia although it is a
Muslim country. White indicated death in china and Korea but
it is the color of bridal dresses in Europe. Red is associated with
danger in many countries but it is a favorite in Russia.
Another example is ‘swastika’, which is considered
sacred in India, but has completely different connotations in the
west.

4. Demography
A number of demographic factors such as age, sex ratio, family
size and occupation influence the business of many companies.
Different companies concentrate on different segments. For
example, Barbie generates huge revenues through the children’s
segment of affluent countries.

5. Literacy rate
Countries with a high literacy rate experience a better standard
of living. Here the need is for standardizes goods, supported by
technical services. For a country with an educated population,
the amount of training required for the staff will be far less than
in the case of the country which has a low literacy rate. This is
an important factor, as it influences the cost incurred. The ame
argument holds in the case of educating the consumer about the
products manufactured.
6. Female Workforce
The most spectacular change that has taken place in the current
era is the empowerment of women throughout the world. In
China, Indonesia, Russia and Thailand, women are major
contributors to the GDP. With economic independency, women
no longer have to depend on men to make decisions about what
to buy; they can make their own decisions about whether to
purchase any consumer product or durable. Delux, a well
known brand of paint in Europe was promoted through
campaigns directed at women, because it was felt that women
have an aesthetic taste for colors in the household paint
segment. The performance of the i-pod of Apple hit the roof in
40


terms of revenue generation due to female customers. The
female work force is very strong in various sectors in many
countries. Examples are: Indian women in IT enabled services
and handicrafts, Chinese women in the soft toys and ceramics
and Indonesian women in garments and paper work, who have
brought great success to their countries.

7. Double Income Families
As the household income increases, the demand for the number
of products increases proportionately. This is specially true for
packaged food items, electronic gadgets, household appliances,
health equipment, Japanese entertainment electronics and
French perfumes dominate in the whole of Europe and North
America. Pizza Express, McDonald and Kentucky Fried
Chicken invariably rule the households of double income
families throughout the world.

8. Impulse buying
Benefit oriented buying is taking place everywhere. Pre-
planned shopping and scheduled purchases are gradually going
away. Throughout the world, people need instant items. They
see, ask and buy. It is a major challenge to international
businessmen to provide benefits to lure impulse buying.

POLITICAL ENVIRONMENT.

The political environment in international business operates in
different dimensions:

1. The home country political environment;
2. The host country political environment, and
3. The global political environment.

1. Home Country Political Environment
In an ideal world, one would not normally expect domestic policies to
affect the firm’s international activities. Some countries like the USA
encourage their organization to establish activities abroad, especially
in their core competency fields. Japan encouraged their electronics
and auto companies to spread their activities outside Japan. Domestic
41


firms that continue to invest and manufacture abroad while ignoring
their home country are often accused of creating domestic
unemployment problems and may be subject to political pressure,
from the government. Indian government encourages business houses
to go and perform outside in steel, healthcare, mining, textile and
automobile.

2. Host Country Political Environment
If the actual benefits of foreign firms are shared in terms of
employment, taxes and social security with the locals, political
atmosphere tends to be hospitable. If it is felt that the foreign firms
contribute nothing to the well being of the nation, it may produce a
hostile reaction from the business community and labor organization,
which in turn puts pressure on the government. In extreme cases, this
may lead to either political turmoil or the appropriation of the assets
of the foreign firm.
Mc Donald had to face a change in the ruling party, in Israel.
When the National Religious Party (NRP) came into the power it
demanded that McDonald should change its practices or be shut
down.

3. Global Political Environment
This may be describes as the combined politics of the home country,
the host country and the other countries in the world.
Multilateral agreements between international organizations,
such as GAAT, the UNO and the Commonwealth, may constitute an
impediment to free trade as well as to the nature and scope of the
operation of international firms. Embargos, Cartels, free trade pacts
and customs’ unions allow a few nations to enjoy competitive
advantages, whilst others lose their business prospects. However,
there may also be advantages, e.g., the commonwealth generalizes
Systems of Preferences (CWGSP) offers good opportunities to all
commonwealth countries to supply and receive goods and services at
concessional rates, which ultimately give them a competitive edge
over non-commonwealth nations.
Global politics can influence business in vastly varying ways.
For example the economic embargo on Iraq by the Security Council
of the United Nations in 1991 meant that conducting trade with that
country was illegal for all international firma. Another example is
China Ordering Microsoft to stop selling. “Windows 95” as it
42


contained politically offensive material including phrases like
“communist bandits”. Microsoft agreed to change the material for re-
entry.

CULTURAL ENVIRONMENT

The cultural environment for international business refers to the
set of factors which shape the material and psychological
development of a nation and represents the primary influence
on individual lifestyle, attitude, pre-deposition and behavior as
consumers in the market. The most important task of
international business is to identify relevant similarities and
differences among countries, and means and methods to match
the organization’s culture with that of the country of its
operation. For example, when Toshiba gained 100 percent
ownership of Rank-Toshiba in the Plymouth all the managers in
charge learnt the British Style of working.
Working it is the operation of a business or dealing with
customers one cannot overlook cultural elements. The
performance of a company in the international arena partly
depends on how well the strategic elements fit into the culture
of the host country. Culture may be described as the totality of
the complex and learned behavior of members of a given
society. Elements of culture include beliefs, art, morale, code of
conduct and customs. Culture has the following three
characteristics:
- It is learned: acquired by people over time through
their membership in a group that transmits culture from
generation to generation.
- It is interrelated: i.e. one aspect of the culture is
connected with another part, e.g. religion and marriage,
or business and social status.
- It is shared: i.e. tenets of a culture extend to other
members of the group.

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Culture is perhaps one of the most important determinants of
human behavior. Food habits, social class, the family system,
community units and other cultural and sub-cultural elements
influence the process of decision making in day to day dealings
and the buying habits of customers.
Thus, there is a need for cross-cultural understanding
because of the significant differences in attitude, belief,
motivation, perception and life styles between nations. For
example, branded products will move fast in Europe and
America, but Africans perceive branded products as being very
expensive.

The Influence Of Culture On International Business

1. The Utility value of a product may differ considerably from
country to country because of differences in beliefs, values and
lifestyles. Fast foods, such as Kentucky Fried Chicken,
McDonalds, hamburgers and pizzas are more popular in
modern societies than in traditional societies. Similarly,
branding and packaging are very susceptible to cultural bias.
2. Products are launched in markets on the basis of either
perceived or real utility value. Products from certain parts of the
world such as Western Europe, Japan and United states
command premium prices in developing countries because it is
felt that they are of better quality than locally manufactures
products. They have a higher value.
3. Culture is perhaps the most powerful influence in determining
the acceptability of advertising copy, design and other elements
in various countries. Advertisements released in France may not
be acceptable in the United Kingdom. Many advertisements
acceptable to the other pats of the world will not be accepted in
the Saudi Arabia. Liquor advertisements are prohibited in many
countries.
4. Holidays in different countries vary on religious grounds.
Friday is a holiday in the whole of gulf region. In China, the
offices and factories are closed for a week for the New Year
celebrations. For companies having firms in different countries,
it is therefore impossible to impose the rule of common
business practices everywhere, as productivity would be very
low during festive days. Any strict implementation of company
44


policy will have direct repercussions, which may even lead to
closure of the business in different countries.
5. Local norms and practices may affect certain distribution
strategies. Eating in public places during Ramadan days is
prohibited in Muslim countries. Therefore, eateries are not
opened during the day at this time. In Spain, mail order
shopping is very popular, whereas in the US and Europe chain
stores are preferred, and door-to-door delivery is common in
many Scandinavian countries. Shopping malls are coming up in
urban India faster than in any other country in the world. Still
small traditional shops near hometown are perceived as
trustworthy suppliers when the customers need groceries.

TECHNOLOGY ENVIRONMENT

Technology and its applications are key factors in determining the
international competitiveness of a firm in conducting international business.
Multimedia using Pentium 4 is common in advanced countries whereas it
will take at least another five years to introduce such products in Africa.
Leadership in technology is achieved and maintained through a consistent
program of intensive research and development, which can be very
expensive. Only those companies that are able to maintain their
technological activities will remain competitive.
A Company may invest millions of dollars in R&D, despite the fact that
the projected revenue in the home country would be very low. However
other countries will generate huge revenues over a period of time. The
Hoffkins, Bio Rad, Genen technology and Pfizer are examples of institutions
and firms, who are investing huge sums of money in R&D, because they are
sure of their returns on their investments over a period of time. In the late
20th century, Asian tigers, Japan, South Korea, Hong Kong, Singapore and
Taiwan achieved a miraculous success due to their investment and
implementation of the technology policies in specific sectors.
Few countries, such as Japan for electronic equipment, Germany for
medical equipment, and the USA for pharmaceuticals have remained leaders
in their fields for decades. Other countries have remained behind them. The
time between the innovation and its adoption and its adoption may vary from
country to country. Innovating countries are few. Following countries are
many. Technology leaders encash on skimming pricing strategies, wherein
the margins are huge. Eriksson, Nokia, Motorola and LG have been
45


successful since they manufactured cell phones. Currently, the business
opportunities exist in every country in the world. The people around the
world are adaptable to the technology too. While technology innovation is
adaptable to the masses, the companies involved in such business prosper.
Today Hewlett Packard, Fujitsn, Apple, Samsung and Lenova compete
against each other by educating the workers on using their laptops and
launch their new versions everywhere.

LEGAL ENVIRONMENT :

This relates to the laws and regulations governing the conduct of business
activities in the country. Before entering any country, firms avail of the
services of local legal firms to understand business interpretations pertaining
to labor legislations, taxes, environment, pollution, investment, distribution,
contracts, logistics etc. The international legal environment has three
aspects:

a) Home country laws
b) Host country laws
c) International laws.

a) Home Country Laws
These deal with two important issues:
i) Conduct of the firm in the domestic territory.
ii) Trade with the other countries

For international operators, the home country laws are not stringent. They
are more of facilitating or regulating in nature, but not controlling in normal
practice.

b) Host country laws
These include investment regulations, tariffs and duties, anti-dumping
regulations and protection of local industries from unfair competition
from industrialized countries. Tariffs and duties are used to discourage
imports of non-essential products in order to conserve foreign exchange
and maintain a favorable balance of trade and to generate revenue.
Seven advanced countries impose laws against developing countries.
Super 301 against Indian nylon skirts imposed by USA as inflammable
fabric and ban on Indian sea food by Europe are the examples.
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c) International Laws
These comprise treaties, conventions and agreement between nations,
and have basically the same standing as laws. They are particularly in
areas relating to patents and trademark protection and privacy laws.
One has to understand the broad provisions of UN resolutions, and
multilateral trade agreements such as the WTO. Disputes are solved by
different means. Food and drug administration, health regulation,
registration formalities are judiciously implemented in international
business operations. Investment restrictions in some sector, promotion
in others and the role of regulatory authorities are part of legal
environment. For example, Nigerian government nationalized the assets
of British petroleum, when it was revealed that the company as selling
Nigerian crude oil to South Africa, despite an embargo.

COMPETITIVE ENVIRONMENT:

Competition is a threat imposed by an environment, which may effect
or hamper or challenge the operation of an international business firm.
Competition either could be from the firm’s home country or host
country or third country. Some times product related competition may
crop up through substitutes or low cost production process or
technology or cost reduction through economies of scale. The current
international business operation has to encounter competition as various
levels such as entry, operation, production, administration, human
resource, technical resource, and financial resource. Distribution and
logistics.
Motorola had to face the face the competition from Nokia, soon
Nokia concentrated in fast growing markets of India and China
resulting the follower became leader in the world. Cuba based White
Spirit Company; Havana club entered very late in the field and
surpassed the erstwhile leader like Smirnoff.
Tusker and Phoenix – the major beer brands in COMESA
countries (Common Market for East and South Africa) have been
overtaken by King Fisher after UB group took over National Breweries
of South Africa.
For international companies, facing competition is a way of life. According to
them, competition keeps their mind alert, quality war is inevitable. Beyond theoretical
models, they believe in learning competitiveness in streets, countries and production
centers. They consolidate competitive advantages and succeed. Hyundai motors in

47


India, Honda motors in Europe and Tata Motors in Africa withstood all the
competitive forces and succeeded.

FACTORS INFLUENCING INTERNATIONAL BUSINESS

ENTITY ENVIRONMENT ACTIVITIES END
RESULT

Economic
Manufacturing
Political

INTERNATIONAL
FIRM Social
Investment

Cultural International
Destinations

Legal Trading

Technology

Competitive Marketing

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4.FOREIGN DIRECT INVESTMENT

Financial resource is crucial, time bound and critical. If it is not
available in right time from anywhere, the probable results are
bankruptcy, decline and loss of status whether it is a nation or
company or individual.

Learning value:
1. Meaning and correct trends of FDI
2. Benefits to host countries through FDI

3. Destinations of FDI flow

4. Criteria of attracting FDI

5. Major challenges for FDI in various countries

Definition and Importance
Investment is “the flow of funds one destination to another”, for any activity,
including industrial development, infrastructure and manufacturing. When
the investment goes from the home country to another country it is defined
as ‘investment outflow’ and when the foreign investment comes from other
countries to home country it is termed as ‘investment inflow’. Both inward
and outward movements are encouraged in majority of the countries.

All developing countries produce primary goods, and to exploit them
financial resources are necessary. Developed countries are also in need of
FDI for further development of technology and modernization.

The current Foreign Direct Investment (FDI) is related to investment
in developing countries and Less Developed Countries (LDCs) require huge
investments in other activities, such as infrastructure, healthcare, housing,
power generation etc.

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With the liberalization of the Indian economy, a large Indian market is
being opened up to foreign investors. Practically, FDI represents foreign
assets in domestic structures, equipment and organizations. It does not
include foreign investment in the stock markets. Foreign direct investment in
useful to a country if the focus is more on projects rather than investments in
the equity of companies because equity investments are potentially “hot
money” which can leave at the first sign of trouble. South Korean, South
African and Argentinean crisis were partially due to such problems.

When a firm invests directly in facilities in a foreign country it is said
to be FDI. It involves the active control of the investment not really
determined by level of stock ownership. Many multinational enterprises
become involve in FDI with the ultimate objective of reaping short term as
well as long term benefits. Ownership may become transnational, i.e.,
ownership in more than one country. Factors influencing FDI are related to
increasing business opportunities across national borders and their
involvement could be in the following functional areas.

• Production

• Marketing / services

• Research & development

• Raw materials or other resources

The parent company has direct managerial control, but the degree of
control may depend on the type of country and company policy. Prior to
their investment decisions it is necessary to carry out risk analysis and
interpretations of the same. MNCs do not develop blind faith in any
country. A team of experts analyse risks carefully and invest gradually.

CHARACTERISTICS OF FDI
FDI is an activity by which an investor, who is resident in one country,
obtains a lasting interest in, and is a significant influence on the management
of an entity in another country. This may involve either creating an entirely
new enterprise, so-called “Greenfield” investment or, more typically,
changing the ownership of existing enterprises via mergers and acquisitions.
Other types of financial transactions between related enterprises, like
reinvesting the earnings of the FDI enterprises or other capital transfers, are
also defined as foreign direct investment.
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1. POLITICAL RISKS
2. ECONOMIC RISKS

INVESTMENT PATTERNS
• Follow Competitors – Oligopolistic industries and interdependence of a
few major competitors force a strategic approach of following
competitors:

American Motor Company (AMC) invested in Shanghai Motor Company
in China. All others were on bee line including Japanese and South
Korean companies besides other American companies.

• International Product Life Cycle – Reduces cost by shifting production to
developing countries. Essel Propack moved to China for instance.

• Location – Specific advantages make FDI easier than exporting or
licensing. Mahindra tractors are manufactured in North America.
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• Contract manufactures – brings down the cost of manufacturing and also
contributes to consolidate competitive sourcing and competing in world
market. Honda motors manufactures its vehicles in Europe.

• Assured return on investment – R & D centres and futuristic projects
enable the investor to achieve great success through high revenue. Roseh
products invest huge money in Genentech in California to get innovative
products to their outlets around the world.

More than two thousand multinational from the USA and Europe have
invested in Chinese Special Economies Zones and Export Processing Zones.
Indonesia, Thailand, Philippines and Malaysia have also now become
attractive destinations. In Latin America, Brazil, Argentina and Columbia
are also attracting huge investments. Malta, Cyprus, Panama, Mans Island
and Mauritius are growing only through Foreign Direct Investment, either in
manufacturing, trading, or any other form. The reputation of such
destinations depends on their ability to attract investments through their
policies and hassle-free industrial climate.

BENEFITS AND COSTS OF FDI

Benefits for Host Countries
• Capital: Multinational enterprises invest in long-term projects, taking
risks and repatriating profits only when the projects yield returns.

• Technology: Technology effects emerge especially when the
liberalization of investment flows drives a more rapid rate of technology
development, diffusion and transfer. Such processes may involve the
transfer of physical goods and/or the transfer of knowledge. A vast
majority of economic studies dealing with the relationship between FDI
on the one hand and productivity and economic growth on the other
hand, have found that technology transfer through FDI has contributed
positively to productivity and economic growth in host countries.

• Market access: Investors can provide access to export markets. The
growth of exports itself offers benefits in terms of technological learning,
competitive stimulus, etc. They can transform normal customers to
intellectual customers.

• Increase in domestic investment: The increase in FDI inflow is associated
with a manifold increase in the investment by national investors.
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• Export promotion: It seems that FDI could be related with export trade in
goods, and the hosting country can benefit from an FDI-led export
growth.

• Generating employment: It leads to generation of both direct and indirect
employment opportunities in the host country.

• Infrastructure: In order to facilitate and enable the investors perform well,
the host country studies other competitive destinations and enhance the
level of infrastructure to match the requirements of the investors. India’s
silver valley in Bangalore, Hitch city in Hyderabad and Tidel Park in
Chennai have revolutionized the areas through connectivity.

• Social effects: Closed economies have started to liberalize their economy
through market reforms that are favourable to foreign investors through
privatization, property rights and liberal labour policies. Society at large
gets the benefit while employment, infrastructure, literacy and health care
are bound to improve as an impact of FDI inflow.

• Formation of Clusters: Group of similar projects and manufacturing
centres are formed in a specific location by way of providing common
production , R&D, training and pollution control system to group
competing companies. In Italy, Brazil and India, such clusters have made
wonders.

• Spillover: Statistical evidences exist across the world to show that FDIs
have a number of spillovers. Business history is replete with examples
where persons trained in companies started their own ventures and
became successful leaders in their respective fields. Silicon Valley in the
U.S. provides many examples of such spin-offs. Intel is a spin-off of
Fairchild. The main competitor to Intel today is its spin-off. Even in
India, the machine tool industries of Ludhiana and Bangalore are spin-
offs of yesteryears’ popular companies like SKF, Bosch or MICO.

Cost for the Host Country

• The investing companies may not serve the host country’s interests.

• There is an outflow of earnings as they are repatriated to their home
country.

• Import of substantial inputs from the country of the investor.

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• Hiring expatriate managers for management positions

• The investing country has controlling technology, for which it charges a
huge technology fee.

• FDI can even wipe out the local firms. Infant industries and other home
industries may suffer if they cannot compete. Home country producers do
not have money power or technology to withstand the onslaught of the
investors.

Benefits for Home Country
• Inwards flow of earnings on a long term basis.

• High salaries for employees.

• Exposure to foreign market.

Costs for the Home Country
• Initial capital outflow is extremely large.

• Exports may decrease.

• Imports may increase if FDI is intended to serve the home country.

• Employment loss to the home country population.

• Profits are repatriated abroad. They may not stay in the country for
reinvestment.

• Major tax heavens will enjoy the money at the cost of home country.

MOTIVATIONS FOR FDI
• Exporting may not be feasible with high transportation costs and trade
barriers.

• Companies, with operations only in the home country, have limited scope
for prosperity and in order to grow fast investing in fertile grounds
outside is a strategic move.

• Ownership advantages are used to benefit from global expansion.

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• Location specific advantages are important at the time of selecting right
destination:
1. Availability of low cost labour force.

2. Natural resources available in abundance and do not deplete.

3. The cost incurred in research and development can be recovered at the
earliest by identifying a suitable location.

4. The cost of transportation and logistics is low in the specific as well as
neighboring countries.

STRATEGIES FOR FOREIGN INVESTORS TO INVEST IN INDIA
There are several strategies by which foreign enterprises could be
lured to set up Indian operations. Broadly, entry strategies for such
organistions may be classified into two major types:-

1. A foreign investor may directly set up its operations in India through a
branch office, a representative office, a liaison office or a project
office to carry out business.

2. It may do so through and Indian arm i.e. through a subsidiary
company set up in India under Indian laws.

3. It may invest in business units in SEZs and EOUs.

Generally, the second option of setting up operations through an
Indian arm is advisable, especially if the investment is large. A foreign
company is one which has been incorporated outside India and conducts
business in India. These companies are required to comply with the
provisions foreign companies can set up their operations in Indian by
opening liaison offices, project offices and branch offices. Such companies
have to register themselves with the Registrar of Companies in New Delhi,
within 30 days of setting up business in India.

Liaison Office/Representative Office
A foreign company can set up a liaison or representative office in India to
test the Indian market. Once it is convinced about the potential of the Indian
market, it can then bring in greater investment. There are, however, certain
limitations regarding the type of work which can be done through a liaison
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or representative office. A liaison office is not allowed to undertake any
business activity in India and therefore cannot earn any income in India. The
role of such office is thus limited to collecting information about possible
market opportunities and providing information about the company and its
products to prospective Indian customers.

The Foreign Investment Promotion Board of the Reserve Bank of
India is a regulatory body governing such operations. Foreign investors are
required to follow the basic procedures prior to opening such offices.
Permission is initially granted for a period of three years, and may be
extended from time to time.

Project Office
Foreign companies planning to execute specific projects in Indian can set up
temporary project/site offices for the purpose. Specific approval from the
RBI is required for setting up a project office, which is generally given for
Government approved projects, but the RBI can give approval for setting up
project offices even for executing private sector projects. Approval for
setting up project offices is specific to a particular project that is to be
executed and lasts only till the completion of the project.

Branch Office
The Government has allowed foreign companies engaged in manufacturing
and trading activities abroad to set up branch offices in India for the
following purposes:-

1. To represent the parent company/other foreign companies in various
matters in India e.g. acting as buying/selling agents in India.

2. To conduct research work in the area in which the parent company is
engaged, provided the results to the research work are made available to
the Indian companies.
3. To undertake export and import trading activities.

4. To promote possible technical and financial collaborations between the
Indian companies and the overseas companies. A branch office is not
allowed to carry out manufacturing activities on its own but is permitted
to subcontract them to an Indian manufacturer.

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Permission for setting up branch offices is granted by the Reserve Bank
of India on a case-to-case basis. The RBI normally considers the
operating history of the applicant worldwide and its proposed activities in
India for granting the approval.

Through an Indian Arm
The entry strategies through an Indian entity are given below. The Indian
entity may be a subsidiary of the foreign company in India or it may be
joint venture.

As an Indian company
A foreign company can commence operations in India through
incorporation of a company under the provisions of the Indian
Companies Act, 1956. Foreign equity in such Indian companies can be
up to 100% depending on the business plan of the foreign investor
subject to the prevailing investment policies of the Government and
receipt of requisite approvals. For registration as an Indian company and
its incorporation, an application has to be filed with the Registrar of
Companies. Once a company has been duly registered and incorporated
as an Indian company, it will be subject to the same Indian laws and
regulations that are applicable to other domestic Indian companies.

Joint venture with an Indian partner
Foreign companies can set up their operations in India by forging
strategic alliances with Indian partners. Setting up operations through a
joint venture may entail the following advantages for a foreign investor:-

1. Established distribution/marketing set up of the Indian partners.

2. Available financial resources of the Indian partner.

3. Established contacts of an Indian partner, which help the process of
setting up operations.

Wholly owned subsidiary company
The other investment option open to foreign investors is the setting up of
a wholly owned subsidiary. This implies that the foreign company can
own 100% shares of the Indian company. All such cases are subject to
prior approval from the Foreign Investment Promotion Board (FIPB).
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The FIPB considers cases on a flexible basis and grants permission for
100 percent ownership based on the following criteria:-
1. Where only a “holding” operation is involved and all
subsequent/downstream investments to be carried out would require
prior approval of the Government;

2. Where proprietary technology is sought to be protected or
sophisticated technology is proposed to be brought in.

3. Where at least 50% of the production is to be exported.

4. Proposals for consultancy.

5. Proposals for power, roads, ports and industrial model
towns/industrial parks or estates.

6. Business units in SEZs, AEZs, Techno-Parks and EOUs:

The investor who invests to setup units in the above categories does
not need mandatory permission from Foreign Investment Promotion
Board of Reserve Bank of India. It is called automatic route. Such
units can enjoy 100% profit repatriation to their home countries.

STRATEGIES FOR INDIAN INVESTORS TO INVEST IN FOREIGN
COUNTRIES
Foreign Investment through GDRs (Global Depository Receipts),
ADRs (American Depository Receipts) and FCCBs (Foreign Currency
Convertible Bonds).
Foreign Investment through ADRs and GDRs and FCCB’s is treated
as Foreign Direct Investment. Indian Companies are allowed to raise equity
capital in the international market through the issue of GDRs/ADRs/FCCBs.
These are not subject to any ceilings on investment. An applicant company
seeking the Government’s approval in this regard should have a consistent
track record of good financial performance for a minimum period of 3 years.
This condition can be relaxed for infrastructure projects such as power
generation, telecommunication, petroleum exploration and refining, ports,
airports and roads.

There is no restriction on the number of GDRs/ADRs/FCCBs to be
floated be a company or a group of companies in a financial year. The
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reason for this is that a company engaged in the manufacture of items
covered under automatic route is likely to exceed the percentage limits under
automatic route, whose direct foreign investment after the proposed
GDRs/ADRs/FCCs is likely to exceed 50 percent / 51 percent / 74 percent as
the case may be. There are no end-use restrictions on GDRs/ADRs/ issue
proceeds, except ban on investment in real estate and stock markets. The
FCCB issue proceeds need to conform to external commercial borrowing
end use requirements. In addition, 25 percent of the FCCB proceeds can be
used for general corporate restructuring.

Use or GDRs
The proceeds of the GDRs can be used for financing capital goods imports,
capital expenditure including domestic purchase/installation of a plant,
equipment and building and investment in software development,
prepayment or scheduled repayment of earlier external borrowings, and
equity investment in joint ventures and wholly owned subsidiaries, in India.

Restrictions
However, investment in stock markets and real estate will not be permitted.
Companies may retain the proceeds abroad or may remit funds into India in
anticipation of the use of funds for approved end uses. Any investment from
a foreign firm into India requires prior approval of the Government of India.

FDI POLICY
The Government has put in place a liberal, transparent and investor-friendly
FDI policy, wherein FDI up to 100% is allowed on the automatic route in
most of the sectors except in:

• Activities that attract industrial licensing.

• Proposals where the foreign collaborator has previous/existing ventures
in India.

• Proposals for acquisition of shares in an existing Indian company in
favour of non-residents.

• Activities where the automatic route is not available under the notified
sectoral policy.

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Salient Features of FDI Policy
In view of sectoral policies, security concerns and other strategic
considerations, restrictions, such as equity cap, divestment condition,
minimum capitalization and lock-in period have been imposed of FDI in a
few sectors, which are given below.

1. Agriculture and plantations excluding tea plantations.

2. Real estate business excluding integrated township development.
However, NRI/OCB investment is allowed for real estate business.

3. Retail trade in any form.

4. Lottery, betting and gambling activities.

5. Security services.

6. Atomic energy.

Non-resident Indians’ Scheme
The general policy and facilities for Foreign Direct Investment as available
to foreign investors/companies are fully applicable to NRIs as well. In
addition, the Government has extended some concessions for NRIs and
Overseas Corporate Bodies in which NRIs have invested more than 60%.
These include:

• NRI/OCB investment in the real estate and housing sectors up to 100%:

• NRI/OCB investment in the domestic airline sectors up to 100%;

• NRI/OBC investment up to 74% in the banking sector.
Since 2001, the investments of NRIs in India have grown 20% every year
till 2007 due to liberal policies. Few NRIs from the Middle East and
Europe invest in huge amounts in real estate and SEZs. The confidence
level has increased on India amongst NRIs resulting huge investments in
India.

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FDI Policy Initiatives
The FDI policy is reviewed on an ongoing basis and suitable
liberalization measures are taken. Some of the main initiatives
undertaken are mentioned below:

• Issue of equity shares has been allowed against a one-time fee or
royalty and External Commercial Borrowings received in convertible
foreign currency, subject to meeting all tax liabilities and procedures.

• The policy governing the payment of royalties under foreign
technology collaboration has been further liberalized by allowing all
companies, who have entered into foreign technology agreements, to
pay royalties on the automatic route to the extent of 8% on exports
and 5% on domestic sales without any restriction on the duration of
the royalty payments. This is irrespective of the extent of foreign
equity in the shareholding.

• The foreign investment in the banking sector has been further
liberalized by allowing a FDI limit in private sector banks up to 74
percent under the automatic route including investment by FIIs.

• The foreign banks regulated by a banking supervisory authority in the
home country and meeting the Reserve Bank’s licensing criteria have
been allowed to hold 100 percent paid up capital to enable them to set
up a wholly-owned subsidiary in India.

• FDI up to 100% has been permitted in printing scientific and technical
magazines, periodicals and journals subject to compliance with all
legalities and with the prior approval of the Government.

• FDI up to 100% has been permitted on automatic route on marketing
of petroleum products, subject to the existing sectoral policy and
regulatory framework in the oil marketing sector.

• FDI up to 100% has been permitted on automatic route in oil
exploration in both small and medium sized fields subjects to, and
under the policy of the Government on private participation in:

1. Exploration of oil.

2. The discovered fields of national companies.

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• FDI up to 100% has been permitted on automatic route for petroleum
product pipelines subject to, and been permitted for Natural Gas/LNG
pipelines with prior Government approval.

• 100% FDI is permitted in any venture related to Special Economic
Zones and 100% export oriented units either as a developer or as a
unit holder or service provider. The same scheme is applicable to
agricultural zones and technology parks.

Country-wise distribution of approvals
In terms of the quantum of investment, Mauritius with 22.61% of the
total approvals is the highest, followed by the U.S.A. (12.62%), the
Netherlands (9.78%), the U.K.(8.28%), Japan (5.68%), Singapore
(3.59%), Germany (3.53%), Hong Kong (1.64%), Switzerland (1.39%)
and Belgium (1.27%). Other countries constitute the remaining 29.61%
of approvals.

Sectoral distribution of approvals
Drug & pharmaceuticals sector has a major share of the approvals
followed by the services sector, both financial & non-financial, electrical
equipment including computer software & electronics, the food
processing industry, telecommunications and automobiles. All put
together account for 60%. Other sectors account for 40% of the
approvals.

Country-wise distribution of approvals
In terms of quantum of investment, Mauritius with 24.10% of the total
approvals is the highest, followed by the U.S.A. (12.53%), Singapore
(11.955%), U.K. (7.93%) and U.A.E. (3.52%). Other countries constitute
the remaining 39.97% of approvals.

State-wise distribution of approvals
The choice of location of projects depends on the commercial judgment
of investors and is based on factors such as market size and growth
potential, availability of skilled man-power; availability and reliability of
infrastructure facilities; fiscal and other incentives provided by State
Governments. The Central Government supplements the efforts of the
State Government by providing fiscal incentives for investments in the

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infrastructure sector as also high priority industries such as information
technology, through specific schemes such as the Growth Center
Schemes. Transport Subsidy Schemes, New Industrial Policy for the
North-East and other hill States, Electronics Hardware Technology Park
(EHTP), Software Technology Park (STP), Export Promotion Zones
(EPZs), Special Economic Zones (SEZs). Maharashtra, Delhi, Tamil
Nadu, Karnataka, Gujarat, Andhra Pradesh, Madhya Pradesh, West
Bengal, Orissa and Uttar Pradesh accounted for a major portion of FDI
investment approvals during the cumulative period i.e. from August 1991
to March 2004.

FDI Promotion Initiatives
Several steps have been initiated during the year to facilitate increased FDI
inflows, which include, inter alia, the following:

• On the policy front: While our FDI policy is already very liberal, it is
being further progressively liberalized. Equity caps in the banking
sector, the petroleum sector and printing of scientific/technical
magazines/periodicals & journals have recently been raised as a
measure of further liberalisation of policy.

• On the investment promotion front: The Government organized
“Destination Authority has been actively involved to ensure speedy
resolution of investment related problems, which has been widely
acknowledged as an effective problem-solving platform.

• On the competitiveness issue: The Government has received reports
on various studies on current potential and risks involved in various
business activities in India. Different sectors with competitive
advantages have been enlisted to attract foreign investment.

• An exclusive website is hosted by the promotion authorities is
comprehensive and informative with online chat facilities. About
2000 investment related queries were replied to during the year.

• The Committee on Reforming Investment Approval and
Implementation Procedures submitted its reports on simplification of
investment procedures. Steps have already been initiated to implement
these recommendations. The Department is coordinating with other
ministries to implement the same at all levels in the Central
Government.
63


• Every state government takes a major initiative like Vibrant Gujarat to
bring all the investors around the world and show cause their
advantages and encourage them to invest.

The advantages of India as an investment destination rest on a number of
factors, which include a large and growing market; world-class scientific,
technical and managerial manpower; cheap labour; an abundance of
natural resources; a large English speaking population; independent
judiciary, etc. This has now been recognized by a number of global
investors who have either already established a base in India or are in the
process of doing so. Ongoing initiatives such as further simplification of
legislation, de-licensing, setting up of regulatory authorities such as
Central/State Electricity Regulatory Commissions, etc. is expected to
provide the necessary impetus to increase FDI inflows in the future.
Inflows of FDI would depend on domestic economic conditions and
the FDI policy, world economic trends, and strategies of global investors.
The Government, on its part is fully committed to creating strong
economic fundamentals and an increasingly proactive FDI policy regime.

The positive efforts of the Government to improve the investment
climate, including sustained improvement of infrastructure, have led to
renewed optimism about India as an emerging investment destination.

Criteria considered by investors prior to selecting a destination.

1. Political stability and a strong policy to protect investors.

2. Safety and security for life, money and output.

3. Investment protection through legal provisions.

4. Good governance as compared to other countries.

5. Proactive government policies and implementing authorities,
bureaucrats.

6. Continuous infrastructural development..

7. Banking system with updated technology.

8. High productivity of the labour force and unhindered working
conditions.
64


9. Clear and simple tax procedures without any ambiguity.

10. Availability of raw material, components and consumables.

11. Hospitable society, especially secular approach towards investors.

12. Demand for the products the investor manufacturers.

13. Ample potential opportunities for products in the neighboring
countries.
Even though the developed and developing countries are extending
schemes of tax holidays and many other incentives, very few countries
are capable of attracting FDIs. Still, China is an attractive destination
because it ranks on a higher scale as compared to others on all the
parameters mentioned above. India, could not attract an expected
investment in the last and early part of current decade though the scenario
is changing gradually now.

The reasons are:
1. Poor infrastructure, which does not match international standards.

2. Political instability, but now it is not a major constraint.

3. High levels of corruption, which are deep-rooted at all levels.

4. Bureaucratic red tape, which the investor does not have to face in
other destinations in the world.

5. Interpretation of policies and their implementation are quite complex.

6. Heterogeneous society with different states, cultures and languages.
7. Inordinate delay in projects.

8. Draconian labour legislation.

9. Lack of transparency in regulatory bodies.

10. High cost of production due to expensive power and other inputs and
transportation.

65


5.OFFSHORE BANKING

No other resources will be effective in the absence of financial
resources and that too, at the right time. Non-availability can
cause major damage to international operations. The purpose
of offshore banking is to provide international business firms
funds at cheaper cost, at a high place and at right time.

Learning value:

After completion of the chapter the reader will learn:

1. Concept and practice of offshore banking
2. Operation mechanism of offshore banks
3. Attractive centres for offshore banks
4. South East Asian offshore banks
5. Initiatives in India for offshore banking

Any international business unit, whether manufacturing or trading is always
looking for funds for their operations. Every company cannot take funds
from its home country due to strict regulations or interest cost or taxes.

All over the world the business community is in search of locations where
their investments are safe and the funds can be taken out without any
barriers and invested comfortably for any ventures in any part of the wo9rld.
Currently, Mauritius, Malta, Panama, Man’s Island, Cyprus, Seychelles and
Hawaii are a few centres attracting offshore banks. Since 2003, the
Government of India has permitted banks to set up offshore banking
operations in Special Economic Zones. Hence, the system of offshore
banking has become part of international business.
Offshore banks are banking units set up by foreign banks in territories where
the restrictions and regulations are limited and the intervention of the
country of location is minimal. Offshore banking units bring foreign
66


currency funds from non-residents and the international money market, and
invest them in the host country or in projects set up by the host country in a
third country. In short, it is a hassle free and safer banking system for saving
and borrowing funds for business.

ESTABLISHMENT OF OFFSHORE BANKING UNITS

The origin of offshore banking units can be traced to the growth of financial
activity in tax havens. A “tax haven” is a place where non-residents can
receive income or own assets without paying high taxes. Some such places
are Bahamas, Bermuda, Hong Kong, the Netherlands, Panama and
Switzerland.
Some features of these tax havens are:
1. Low rate or complete absence of income tax on foreign investment
and income.
2. High degree of economical and political stability and a political
system, which directly or indirectly encourages and fosters business
activity at the center.
3. Strict and well enforced rules of banking secrecy.
4. Absence of exchange control
5. Availability of supporting infrastructure such as an efficient
communications and transportation network.
6. Presence of well developed legal system and professional accounting
expertise.
7. Investor’s confidence due to past credential.
8. No incidence of violence or criminal activities.

These features encourage various types of business operations some of
which are bona fide but most of them generate what has been termed as
‘dirty offshore funds’.

OPERATIONS OF OFFSHORE BANKS

Offshore banking centres are an integral part of the foreign currency
markets. Therefore, the operations of banking units set up at these centers
comprise foreign currency transactions, in the form of accepting and placing
of funds in foreign currency outside the country of issue. The functional
offshore centers engage in the issue and placement of foreign currency
certificates of deposits, loan/credits and bonds.

67


These centers contribute to the economic development of the host
country in the following ways.
1. The offshore banking units can raise foreign currency loans and bonds
for the host country at reasonable interest rates, due to their connections
with well known international banks These foreign currency funds can be
lent to the host countries or invested in onshore projects or even projects
in a third country. Indirectly, the host country gains better access to
international capital markets.
2. The functional offshore centers contributes to the foreign exchange
income of the host country through local operating expenditures, such as
rent paid on leased property, salary paid to local staff, and license
fees/taxes recovered from the offshore units.
3. The presence of functional units speeds up the communication and
transport network in the host country, which helps to upgrade local skills
and technology and constitutes productive assets to the host country.
4. The onshore banking industry in the host country is compelled to
improve its efficiency and skills in order to retain its competitive edge.
5. The local staff employed at the centre develops sophisticated
international banking skills and this pool of highly trained personnel can
be brought in to the host country to attain a faster growth level.

Once an offshore centre consistently offers an attractive package of
incentives, the above benefits will accrue to the host county, which will be
able to induce more and more reputed foreign banks to set up banking units
in its territory.

ROLE OF OFFSHORE BANKS AND INVESTMENTS

In today’s highly integrated global network international Offshore Financial
Centers (OFCs) have come to play a vital role in facilitating investment
worldwide. An offshore centre exists for comfort and convenience. OFCs
are jurisdictions where offshore banks are exempted from a wide range of
regulations, which are normally imposed on onshore institutions. Specially,
deposits are not subject to statutory reserve requirements. Bank transactions
are mostly exempted from tax or treated under a favourable fiscal regime
and they are free of interst and exchange control restrictions. In many cases,
offshore banks are exempted from regulatory scrutiny with effect to liquidity
or capital adequacy.
An important activity in OFCs is offshore banking, which is the cross border
intermediation of funds and provisions of services by banks residing in
68


OFCs to non-residents. Offshore banking is an increasingly attractive
alternative to heavily regulated financial markets of emerging economies.
They exploit the risk return trade off by being more profitable than onshore
banks and in many instances they have more leverage.

OFFSHORE BANKING – METHOD OF OPERATION

Offshore banks deal mostly with other financial institutions and transact
wholesale business in currencies other than that of the country hosting the
OFC. Offshore banking is carried out typically through offshore
establishments that are offshore branches. Offshore branches are legally
indistinguishable from parent banks onshore, which facilitate intra-branch
transfers. Offshore activities may also take place through what are called
parallel-owned banks. These are banks established in different jurisdictions
having the same owner(s), but at the same time they are not subsidiaries.

Offshore banks are mainly engaged in three types of transactions;
Foreign currency loans and deposits, the under writing of bonds, and Over
the Counter (OTC) trading in derivatives for risk management and
speculative purposes. Foreign currency transactions form the bulk of
offshore banking operations. They include transactions between banks and
original depositors, between banks and ultimate borrowers, and between
banks themselves on the inter bank market. Underwriting of bonds floated in
international capital markets is also a significant part of offshore banking
activities.

OFCs IN DEVELOPED COUNTRIES AND EMERGING
ECONOMIES

In the developed countries, OFCs appear to be losing their attractiveness and
appeal for financial institutions, which are operating in liquid, increasingly
competitive and well-regulated financial markets. With competition under
prudential supervision and capital account convertibility being increasingly
adopted, the distinction between onshore and offshore banking is
progressively disappearing in industrialized countries.

In Aisa, offshore interbank markets developed after 1968 when Singapore
lauched the Asian Dollar Market (ADM) and introduced the Asian Currency
Units (ACUs) and Japan established the Japanese Offshore Market (JOM).

69


The ADM was an alternative to London Eurodollar market for the
investment of oil surpluses from Indonesia and Malaysia and ACUs enabled
local banks to engage in international transactions under a favourable tax
and regulatory environment.

OFFSHORE FINANCIAL CENTRES IN SINGAPORE,
MALAYSIA AND MAURITIUS

Singapore

Singapore is an established financial centre. The financial service sector is
supported by sound economic and financial fundamentals and attractiveness
as a base for financial institutions. This has been aided by its geographical
location in a fast growing area that bridges the gap between the time zones
of the North American and European financial markets, political and
financial stability, a skilled labour force and significant government
incentives.

Singapore is the fourth largest foreign exchange trading centre in the world,
the fifth largest trader in derivatives and the ninth largest offshore lending
centre. The Asian Dollar market (ADM) in one of the premier offshore
banking centres in Asia. The STOCK Exchange of Singapore (SES) is a
leading stock market in Asia, and the Singapore International Monetary
Exchange (SIMEX) has grown into one of the world’s leading derivatives
exchanges.

There are three categories of commercial banks in Singapore:
I. Full banks II. Restricted banks III. Offshore banks

Full banks are allowed to carry out the full range of banking services
under the Banking Act. Restricted banks may engage in the same range of
domestic branch and cannot accept Singapore dollar savings accounts and
Singapore dollar fixed deposits of less than Singapore $ 250,000 from non-
bank customers.

In 1973, with a view to facilitate Singapore’s goal to become an
international financial centre through the entry of more foreign banks,
another category of same opportunities as the full and restricted banks in

70


business transacted, their scope of business in the Singapore dollar retail
market is slightly more limited. In the domestic market, offshore banks
cannot accept any interest-bearing deposits from persons other than
approved financial institutions, nor can they open more than one branch. By
the end of November 1998, there were 104 offshore banks in Singapore, all
of which were branches of foreign banks. By 2003 the number of banks
crossed 120.

In Singapore, offshore banking is carried out by separate book-
keeping entities known as Asian Currency Units. ACUs do not have the right
to incur assets and liabilities in Singapore dollars but can engage in all types
of banking transactions in other currencies. Various incentives have been
given to encourage the development of ACUs, the most important of which
is that ACUs face a tax on profits of only 10% compared with the standard
corporate rate of 27% and are not subject to reserve and liquidity
requirements. ACUs have functioned in the region primarily as a centre for
routing capital from markets in Europe, North America and the Middle East
to the fast growing regions of Asia.

Important measures to promote offshore banking in Singapore include:

• 1973 – Offshore banking licenses issued to seven foreign banks;
corporate tax of ACU on interest earnings from overseas loans reduced
from 40% to 0%; interest received by non-resident holders of approved
Asian dollar bonds exempted from tax.
• 1976 – Non resident deposits with ACUs and approved Asian dollar
bonds held by non-residents exempted from Singapore estate duty.
• 1979 – Income earned from offshore general reinsurance business
granted 10% concessionary tax rate.
• 1980 – Stamp duty on ACU offshore general reinsurance business
granted 10% concessionary tax rate.
• 1980 – Stamp duty on ACU offshore loan agreements and Asian dollar
bond certificates abolished.
• 1983 – ACUs granted 5 year tax holiday for all income derived from
syndicated offshore loans arranged in Singapore.
• 1989 – A concessionary 10% tax rate was granted on income from
international oil trading activities.
• 1990 – Monetary Authority of Singapore (MAS) raised the ceiling on
foreign ownership of shares in local banks to 40% from 20%.

71


• 1992 – Stock Exchange of Singapore (SES) granted membership to seven
foreign brokerage houses, allowing them to trade directly on the local
market.
• 2002 – Offshore transactions became equivalent to domestic transactions.
• 2006- offshore banks started investing huge money in other Asian
countries like India, Sri Lanka, Indonesia, Thailand and Vietnam.

With a view to creating a more level playing field for local and foreign
banks, the maximum limit for offshore banks for Singapore dollar credit
facilities at any one time to non-bank residents was raised from S$ 200
million to S$ 300 to S$ 1 billion, with a view to boosting Singapore as a
financial centre. In 2004, many of the investors and joint venture partners
avail of offshore facilities to invest in the mega projects of South Asia and
South East Asia.

Malaysia

Malaysia established an International Offshore Financial Centre (IOFC) in
Labuan in 01991. The Offshore Banking Act 1990 provides a regulatory
framework for offshore banking operations in Labuan. As confidentiality is
the hallmark of an offshore financial centre, an offshore bank has to
maintain strict secrecy in the affairs of its customers. Offshore banks are
expected to observe a strong self-regulatory code of conduct which places
emphasis on ‘knowing your customer.’
The Labuan Offshore Financial Services Authority (LOFSA)
established in 1996, is the single regulatory authority with the following
roles and functions:

• To be responsible for setting national objectives, policies and priorities
for the orderly development and administration of the Labuan IOFC.
• To be responsible for the promotion and development aspects and
recommend new measures to the government to speed up growth and
development of the Labauan IOFC.
• To supervise the activities and operations of the offshore financial service
industry in Labuan and to process applications to conduct business in the
Labuan IOFC, specially in offshore banking, offshore insurance and
insurance related business, offshore trust and fund management,
incorporating and registering of offshore companies as well as for setting
up of Labuan trust companies.

72


• To administer and enforce offshore financial services legislation and
work with the offshore players in Labuan to promote offshore financial
services.

The Labuan IOFC operates in a free exchange control environment.
Offshore companies are given a non-resident status for exchange control
status. Offshore companies can continue to transfer funds freely to and from
their accounts outside Malaysia without approval from the central bank of
Malaysia. The foreign currency accounts held with the offshore banks are
not considered as external accounts and are not subject to exchange control
measures. The offshore banks are also allowed to issue financial and non-
financial guarantees to residents in Ringgit. They can receive fees and
commissions related to guarantee in Ringgit. The holding requirement of one
year is not applicable to assets in Ringgit held in collateral by the offshore
banks for credit facilities granted to residents. The payments of existing
loans and guarantees in foreign currency by Malaysian residents to the
offshore banks do not require prior approval from the Central Bank.
In Labuan no tax is imposed on the income of offshore companies that
are non-trading companies, and offshore trading companies enjoy a low tax
regime with a rate of only 3% of their net income of RM 20,000 (USD
8000). Other benefits and incentives include:
• No tax on offshore companies carrying out offshore non-trading activities
such as holding of securities, shares, immovable properties and taking of
loans and placing of deposits.
• No withholding tax for dividends paid by an offshore company,
distribution from an offshore trust, royalties received from an offshore
company by a non-resident, interest earned on deposits with offshore
banks, and interest earned on loans to Malaysians.
• No inheritance, death, or estate duty.
• Exemption from paying stamp duty on all offshore business transactions.
• Double tax treaty agreements signed with over 40 other countries and
investment guarantee agreements with 50 countries.

Mauritius

Mauritius is fast becoming an international financial and business centre.
Offshore transactions are normally conducted with non-residents and in
currencies other than the Mauritius Rupee. Mauritius has focused its
offshore business on specific areas such as investment funds, investment
holdings and international trading. The island is becoming an attractive
73


destination for offshore fund structuring and investment vehicles. Mauritius
enjoys international exposure as a domicile for emerging market funds, and
is being considered as a gateway for investment into India, the Indian sub-
continent and the African region.

In 1989, offshore banks were allowed to be set up in Mauritius and
subsequently the incorporation of offshore companies was allowed. In 1992,
the offshore financial services sector was officially set up with the
proclamation of two acts of parliament, namely the Mauritius Offshore
Business Activities Act and the Offshore Trusts Act.
Offshore business can be conducted through the follo9wing entities:
an ordinary status company, an international company, a trust, or a
partnership. The Mauritius Offshore Business Activities Authority
(MOBAA), set up in 1992 under the Mauritius Offshore Business Activities
(MOBA) Act 1992, is entrusted with the task of licensing, supervising and
developing non-banking offshore business in Mauritius. The MOBA Act
1992 sets out the broad parameters for the conduct of offshore business.
An offshore business activity is defined as an activity carried on from
within Mauritius with non-residents and in foreign currencies. The MOBA
Act of 1992 provides fro a whole range of approved offshore activities
which include Offshore Funds Management; International Financial
Services; Operational Headquarters; International Consultancy Services,
Shipping and Ship Management; Aircraft Financing and Leasing:
International Licensing and Franchinsing; International Data Processing and
Information Technology Services; Offshore Pension Funds; International
Trading; International Employment Services; International Assets
Management; and Offshore Insurance.
Currently, eleven offshore banks of international standing operate in
Mauritius. Both the volume and range of business undertaken by offshore
banks have registered sustained progress. Various factors have registered
sustained progress. Various factors have contributed to the attractiveness of
Mauritius as an OFC which include:
• Exemption from compliance with the Exchange Control Act.
• Freedom to conduct all legitimate banking and other financial business
with non-residents.
• Exemption from credit, interest rates and other restrictions normally
applied to business of domestic banks.
• Low income tax rate of 5 percent on all offshore profits.
• Free repatriation of profits without further taxation.

74


• Exemption from stamp duty on documents relating to offshore business
transactions.
• Exemption from stamp duty on documents relating to offshore business
transactions.
• Exemption from customs duty on imported office equipment.
• No withholding tax on interest payable on deposits raised from non-
residents by offshore banks.
• Double taxation avoidance treaty with a number of countries.
• Expatriate staff is subject to a concessionary personal income tax rate.
• No estate duty or inheritance tax is payable on the inheritance of shares
in an offshore entity.
• No capital gains tax.

OFFSHORE FINANCIAL CENTERS AND IMPLICATIONS
FOR INDIA

A synthesis of the role and evolution of OFCs in select countries, their
operative mechanisms, regulatory framework and privileges delineated in
the preceding sections highlight various factors that contribute to the
attractiveness of OFCs, Certain common facilities/exemptions/concessions
have been worked out to form offshore banking in India.
With the Government having announced the policy of promoting
Special Econ9mic Zones (SEZs) which would, inter alia, serve to attract
world class investors, and at the same time contribute towards the country’s
export efforts, it is pertinent to take into account the factors highlighted
above that have contributed to successful OFCs around the world. This is
very important, as it is necessary to create a policy environment relating to
finance and banking which is conducive as also internationally competitive.
The main requirements of such a policy are given below.
• Conducive fiscal regime, such as minimal taxation or low tax jurisdiction
with an extensive web of bilateral tax treaties; no income tax, capital
gains or wealth taxes on individuals, stamp duty, customs duty, estate
tax, inheritance tax, etc.
• No withholding of income tax on non-resident depositors in OFCs.
• Stringent banking secrecy rules.
• Absence of exchange control or minimal control.
• Exemption from several prudential regulations including reserve
requirements limitations on investments, limitations on acquisitions of
immovable property, etc.

75


• Minimum formalities for incorporation.
• Adequate legal framework that safeguards the integrity of principal agent
relations.
• Conducive regulatory framework – a separate banking act to provide a
regulatory framework covering the operations of banks and financial
institutions in the SEZs. For instance, the Offshore banking licence for
the setting up of a branch or subsidiary.

Offshore Banks:
Regulatory Framework in Selected Offshore Financial Centres.

Offshore Activities
Prudential Tax Role of
Financial and
Regulations Privileges Regulators
Centre Restrictions
Offshore
banks are
under the
oversight of
the offshore
Both private
Finance
and public
Committee
companies
chaired by the
may operate
Governor with
onshore and
representatives
offshore. All No taxes are
Anguilla N/a of both the
four levied
Government
domestic
and private
banks offer
sector. The
offshore
Eastern
banking
Carribean
services.
Central Bank
does not
supervise the
offshore
sector.
Offshore Minimum Offshore Offshore
banks may be paid in banks have a banks are
Antigua &
legally capital is US 50 year regulated by
Barbados
established $ 1 milion. reprieve from the Supervisor
under the Licensing taxes on of Banking
76


international includes profits. There and Trust
Business information are no income Corporations
Centre (IBC) on capital gains, and the
Act (1982) shareholders, or other Ministry of
and are directors, and wealth tax on Finance.
defined as officers with individuals.
corporations satisfactory The Eastgern
licensed to evidence that Caribbean
carry out the latter Central Bank
banking have the does not
business in necessary supervise the
currencies education offshore
other than and sector.
those of experience,
Caricom and recent
financial
information
on the
applicant.

Offshore
banks must
submit
quarterly
returns and
an annual
audit must be
submitted to
the Inspector
of Banks in
the Ministry
of Finance,
which has the
ability to
carry out
onsite
inspection.
Deposits Locally Offshore
Taxation is
Bahrain from non incorporated banks must be
minimal
bank offshore and licensed by the
77


institutions onshore BMA, which
are allowed banks must also
only if they follow the supervises
are atleast same rules. them. A
equivalent to Offshore deposit
US$ 50,000. institutions insurance
Offshore are required scheme is in
banks cannot to disclose place for all
extend loans fully their commercial
to residents ownership banks. The
of Baharain; structure. BMA has the
cannot offer They are sub ability to
current subject to provide lender
accounts. regular of the last
reporting resort (LOLR)
requirements facilities to
to the onshore banks
Baharain are excluded
Monetary from LOLR
Authority support.
(BMA) on a
monthly,
quarterly,
semiannual
and annual
basis.
Prudential
requirements
are applied
on a
consolidated
basis.
Typically ACUs are ACU are ACUs must be
offshore exempt from taxed at a licensed by the
banking is several concessionary MAS, which
operated prudential rate of 10 also supervise
Singapore
through regulations, percent them.
Asian most natbly (normal Inspections on
Currency the reserve corporate tax the accounts
Units requirements rate is 26 of the ACUs
78


(ACUs). (normally 6 percent). are carried out
These are percent) the There is no on a regular
operational minimum withholding basis. There is
units whose liquid asset or income tax no formal
function is to ratio on non deposit
conduct (normally not resident insurance
business in less than 18 ACUs scheme. The
the Asia percent) depositors. MAS has
Dollar limitations on ability to act
market. ACU investments, as lender of
may also be limitation on lasat resort,
operated by acquisition of but not an
onshore immovable obligation to
commercial property and do so. In 1996,
banks and some of the the Banking
merchant limitations on Act was
banks. In credit amended to
these cases, facilities allow foreign
ACUs are (limits to a regulators to
distinct single inspect the
accounting borrower and Singaporean
entities related party branches of
separately or parties) banks under
licensed by Foreign their
the Monetary ACUs are oversight.
Authority of required to
Singapore provide a
(MAS) guarantee
ACUs accept from their
deposits and parent
make loans institutions
in foreign ensuring
currencies liquidity on
and are demand to
prohibited the ACU
from doing should it run
business into
denominated difficulties.
in Singapore ACUs are
dollars. They required to
79


cannot accept provide
time deposits detailed
of less than financial
SGD statements to
250000; the MAS on
operate a monthly
savings basis.
account;
have more
than one
location (no
branches)
Total credit
facilities to
Singapore
non-bank
customers
must be less
than SGD 50
million

India as offshore banking, an emerging sector

The concept and practices are not new to Indian banks. Indian public sector
banks such as Bank Of India, State Bank Of India, Punjab National Bank
and Bank Of Baroda already had operations in other countries. They have
developed systems and expertise to handle offshore operations. The
customers, both investing and borrowing segments are also aware of the
mechanism. But in real terms, the awareness has been created while news
items started appearing on overseas banking units (OBU) could be set up in
special economic zones (SEZ) without mandatory requirements of SLR
(Statuary Liquidity Ratio).

80


6. Essentials of Trade Finance

“Means and methods of transaction determine perfection.
No one can claim that his business is
successful until a complete receipt of money is ensured for his
business.
deal, through proper channel and right currency
Learning Value:

On going through this chapter the reader will learn certain essential
aspects of transaction either export or import or investment.

• Foreign exchange transaction.
• Exchange rate mechanism fro merchant trade.
• FEMA on international trades
• UCPDC and its essential provisions
• Safe and secured transaction through Letter of Credit.

Different countries have different currencies. All the
currencies are neither equivalent in value nor stable. Whether the
company is involved in trading or manufacturing or investing there is
a need for expertise in managing currencies at all the stages of
operation.

Exchange Rate is defined as the rate at which one currency is
exchanged for another currency.
Foreign Exchange trading is a sale or purchase of one currency and
traded with another.

In a foreign exchange transaction:

81


• The transaction is always talked of from the banks point of
view.
• The item referred to is the foreign currency.

When we say “Purchase” we mean (buying rate):

• The bank has purchased and
• It has purchased foreign currency.

Similarly, “Sale” means (selling rate):

• The bank has sold and
• It has sold foreign currency.

Direct Quotation: A given number of units of domestic currency
per unit of foreign currency, e.g., $1 = Rs.40.00. With effect from 2nd
August 1993 direct quotations are being used in India.

Indirect Quotation: A given number of foreign currency per unit
local (domestic) currency, e.g., Rs.100 = $2.5.

Two-Way Quotation

The foreign exchange quotation by the bank has two rates- one at
which quoting bank is willing to buy and the other at which it is
willing to sell. For example US $1 = Rs.45 – Rs.45.20.
Here, the bank will enter into purchase transaction at Rs.45.00
and sell transaction at Rs.45.20. Hence the principle in case of direct
quotation is BUY LOW & SELL HIGH. From the Ads point of view,
conversion of foreign currency on behalf of an exporter into Indian
Rupees would be a purchase transaction, and conversion of domestic
currency into foreign currency on behalf of an importer would be a
sale transaction. Likewise, outward remittance would involve sale of
foreign currency while inward remittance would involve purchase of
foreign currency. In case of Indirect Rate Quotation the principle is
BUY HIGH & SELL LOW.

Types of Exchange Rates

82


Ready of Cash: Refers to transaction to b settled on the same day
e.g., transaction done on 3rd June to be settled on 3rd June.
Tom: Refers to transaction where delivery of foreign currency to be
done on the next day tomorrow, e.g., transaction done on 3rd August to
b settled on 4th August.
Spot: Refers to transaction where delivery of foreign currency to be
done on the second working day (day after tomorrow) from the date of
contract e.g., transaction done on 3rd June to be settled on 5th June.
Forward: Refers to transaction where delivery of foreign currency to
take place on a date farther than the spot date e.g., transaction done on
3rd June to be settled on any date after 5th June, normally.
Cross Rates: If the quotation for a particular currency is not
available, we can obtain it through the rate of that currency, of which
the rate is available.
Value Date: The date on which payment, delivery of funds or an
entry to an account becomes effective.

Cover Rate and Base Rate

The rate at which the banks can cover the merchant transactions in the
inter-bank market without any profit or loss is called the Cover Rate.
That is, the rate at which the bank can buy the dollars to cover import
transactions in US$ and the rat at which it can sell the Dollars to cover
an export transaction in Dollars is called the Cover Rate.
The base rate is arrived from the cover rate after allowing for
some cushion for adverse movement of the rates. In practice there are
instances where the cover rate and the base rate are the same.

Fixed and Floating Exchange Rates
• In a fixed exchange rate regime, the rate of the domestic
currency vis-à-vis a foreign currency is fixed. In Hong Kong
the HK dollar rate is fixed i.e. $1 = HK$ 7.80. In case of higher
demand of the foreign currency viz. the dollar, the central bank
of the country sells dollar from its reserve to maintain the rate.
• In a floating exchange rate regime, the rate of the domestic
currency vis-à-vis foreign currency depends on supply and
demand and market forces. Most major currencies viz. US
Dollar, British Pound, Euro Japanese Yen etc. are floating ones.

Principle Types of Merchant Rates
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As mentioned above, in a purchase transaction the bank buys foreign
currency from the customer and pays him in rupees. Some
transactions result in the bank getting the foreign exchange
immediately, while some involve delay in getting the foreign
exchange.
Depending upon the time of realization of foreign exchange by
the bank, two types of buying/selling rates are quoted in India.

• TT buying rate is applied when the transaction does not
involve any delay in realization of foreign exchange by the
bank i.e. the nostro a/c of the bank has already been
credited. For example, purchase of drafts, MT’s, TT’s etc.
and/or cancellation of drafts sold earlier.
• Bills buying rate is applied when a bill is purchased. The
proceeds will be realized by the bank after the bill is
presented to the drawee and he makes payment. The rate is
loaded with transit/usance period interest.
• TT selling is applied when the correspondent bank’s account
is credited immediately. For example, issue of drafts, TT’s
drawn on a correspondent bank and/or cancellation of
foreign exchange purchased earlier.
• Bills selling rate is used for all other transactions involving
handling of documents by the bank e.g. payment against
import bills etc.

SELLING TRANSACTIONS

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RATES
A. Outward remittance in foreign currency
(TT,MT, PO,DD)
B. Cancellation of purchase, e.g.
TT Selling Rate
• Bill purchased returned unpaid.
Exchange
• Bill purchased transferred to
Margin:
collection amount.
0.125% to
0.150% • Earlier inward remittance
(converted into rupees) is refunded to
the remitting bank.
C. A forward purchase contract is cancelled.
Transaction involving transfer of proceeds of
Bill Selling Rate
import bills.
Exchange
{Even if proceeds of import bills are remitted
Margin:
in foreign currency by way of DD, MT, TT,
0.175% to
PO, the rate to be applied is the Bill Selling
0.200%
Rate(and not TT Selling Rate)}.
Foreign – TCs/
Currency Notes At the option of Ads.
Selling Rates
BUYING RATES TRANSACTIONS
A. Clean inward remittance (PO, MT, TT, DD)
TT Buying Rate for which cover has already been
Exchange credited to Ads account abroad.
Margin: B. Conversion of proceeds of instruments sent
0.125% to for collection.
0.180% C. Cancellation of outward TT, MT, PO etc.
D. Cancellation of a forward sale contract.
A. Purchase / Discounting of Bills and other
Bill Buying Rate
instruments.
Exchange
B. Where banks has to claim cover after
Margin:
payment.
0.125% to
C. Where drawing bank at one centre remits
0.150%
cover for credit to a different centre.
Foreign-TCs /
Currency Notes At the option of Ads.
Selling Rates

Persons residing in India:
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Section 2 of FEMA, 1999 defines the term resident in India as a
person residing in India for more than 182 days during the course of a
financial year.

Persons residing outside India:
Section 2 of FEMA, 1999 defines person residing outside India as a
person who is not resident in India (NRI).
Non-resident Indians generally fall under one of the following broad
categories:

• Non-Resident Indian (NRI)

• An NRI is a person holding an Indian passport:
o Who has gone abroad for a gainful employment or
business or vacation, or for any other purpose
indicating an indefinite period of stay outside India.
o Who are working abroad on foreign assignments-
persons employed by IMF/IBRD/UNO/UNESCO etc.
or who are employed in Central/State Government
and Public Sector Undertakings and deputed abroad
on temporary period.

• Persons of Indian Origin (PIO)

o For the purpose of being eligible for the facilities of
opening and maintenance of various types of bank
accounts and making investments in shares and
securities in India, a PIO means a citizen of any
country other than Bangladesh or Pakistan, if:
• He held an Indian passport at any point of time, or
• Whose parent/s or grand parent/s was citizen of India
(undivided India), or
• Spouse of a non-resident Indian.

Overseas Corporate Bodies (OCBs)

Overseas firms, trusts or companies, predominantly owned by non-
resident Indians are called Overseas Corporate Bodies. The level of
ownership of NRIs in such bodies should be minimum 60%, by one or

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more NRI owners. The facilities for investment into India, granted to
OCBs were almost similar to those granted to individual non-resident
Indians.
However, with effect from 16.08.2003, OCBs have been
completely derecognized as an investor class by the RBI. Now they
are not allowed to make fresh investments in India.

Correspondent Banking

Nostro Account: A foreign currency account maintained by a bank in
India with a bank abroad. “Our account with you”. E.g., State Bank of
India, Kolkata.
Vostro Account: A rupee account of a foreign bank with an Indian
bank. “Your account with us”. E.g., Citibank’s rupee account with
State Bank of India, Kolkata.
Loro Account: A bank’s account with another bank. “Their account
with you”. E.g., Citibank’s HK $ account with Hong Kong Bank,
Hong Kong.
Mirror Account: These are dummy accounts maintained by banks to
know the actual position of their accounts with the foreign
correspondent banks. We may call it a pass-book of our accounts
maintained with the correspondents.
Escrow Account: These accounts are maintained by citizens outside
the country or by the citizens residing outside the country, but
accounts maintained in the parent country. These accounts are being
maintained exclusively for business purposes and like current
accounts, do not carry any benefit of interest, overdrafts etc. Basically,
such accounts are opened to carry merchant trading activity with prior
approval from the RBI and general transactions are not permitted.

International Organizations as facilitators of International
Business:
International Organizations like the World Bank were set up to
maintain orderly international financial conditions and to provide
capital and advice for economic development, particularly of
developing countries. International Business Organizations are
required to understand the system and lending criteria of such
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institution, so that it would be easy to avail their funds to develop
business.

World Bank Group
• International Development Association
• International Finance Corporation
• Multilateral Investment Guarantee Agency

Other International Organizations
• International Monetary Fund
• Bank of International Settlements
• Asian Development Bank
• African Development Bank

Asian Clearing Union
• Established in 1974
• Members- Central Banks of India, Iran, Bangladesh, Nepal,
Pakistan, Sri Lanka and Myanmar (Burma).
• To provide facility to settle payments for current
international transactions.
• Promote use of participant’s currencies in current
transactions.
• Promote monetary cooperation.
• Exempted categories:
Travel between India and other countries.
Foreign trade financed by World Bank, ADB etc.
Payments between India and Nepal, Pakistan and Iran
individually.
• With effect from 1.1.1996, 1 A.C.U. $ = 1 U.S. $.
• ACU accounts are settled at the end of every two months.
• The balance outstanding in ACU Vostro account with the
Authorized Dealers is subject to CRR and SLR.

Offshore Banking Unit (OBU)
An Offshore Banking Unit (OBU) of a bank is a deemed foreign
branch of the parent bank situated within India, and shall undertake
international banking business involving foreign currency
denominated assets and liabilities. The Reserve Bank of India (RBI)
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has given permission to certain select banks in India, fulfilling certain
criteria, to set up OBUs in “Special Economic Zones” (SEZ), for
facilitating exports from India. Offshore Banking Units can accept
Multi Currency Deposits from NRIs and Eligible Resident Indians as
per FEMA. Companies/Units within the “SEZs” in India as well as
companies outside “SEZs” as per existing FEMA guidelines can go
for Multi Currency Borrowing from OBU.

E-Money India
This is a completely online mode of sending money from US to India.
Any person/organization who wishes to make a payment (in foreign
currency) to an individual/organization in India (in Indian rupees) can
use e-Money India. The customer needs to follow three simple steps
to send money to India:
• Register on the e-money India site by providing elementary
details.
• Provide his bank details.
• Provide the receiver’s details in India.
Presently, a customer can make an inward remittance in US Dollars
only for family maintenance, purchase of property, investments, or
transfers to NRE accounts.
Remittances from foreign tourists visiting India and trade-
related remittances can also be sent. The remittance will be delivered
to his/her beneficiary’s doorstep as a locally payable demand draft or
deposited directly into the receiver’s account in India in Indian
Rupees only.

LETTER OF CREDIT: Short term transactions for goods and
services.
The concept:
In simple terms, a letter of credit is an undertaking by a bank to
make a payment to a named beneficiary within a specified time,
against the presentation of documents which comply strictly with the
terms of the letter of credit.
A letter of credit is opened by an importer (applicant), to ensure
that the documentation requested reflects and proves that the seller has
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performed under the requirements of the underlying sales contract, by
the exporter by making them conditions of the letter of credit (N.B.
The sales contract is not an inherent part of the Letter of Credit,
although the Letter of Credit may contain a reference to such
contract). For the exporter, a letter of credit, apart from cash in
advance, is the most secure method of payment in international trade
as long as the terms of the credit are met. The following diagram
shows those involved in a Letter of Credit transaction:

Issuing Bank Advising/
Confirming
Bank

Importer Underlying Exporter
(Applicant) Contract (Beneficiary)

Its main advantage is providing security to both the exporter and
the importer. The security offered, however, comes at a price and
must be weighed against the additional costs resulting from bank
charges.
The exporter must understand the conditional nature of the letter of
credit and the fact that payment will not be made unless the terms of
the credit are met precisely.
When an exporter asks for payment by letter of credit, he is
transferring the risk of non-payment by the buyer to the issuing bank
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(and the confirming bank if the letter of credit is confirmed),
providing the exporter presents the required documents in strict
compliance with the credit.
An importer should only be thinking of opening a letter of credit of
his country’s exchange control regulations require it or if his supplier
insists upon it. It is worth noting that over 50% of letters of credit are
rejected on first presentations, which can cause expensive delays for
both the exporter and importer. Up to one half of these rejections
could have been avoided if more care was taken to ensure the credit
properly represented the sales contract.
Exporter will need to be certain that it is necessary to use a letter
of credit. Typical considerations include:
• Is it a legal requirement in the importing country?
• What is the value of the order will the bank charges be out
of proportion to the value?
• ‘Always Traded This Way’ always using letter of credit for
a particular customer or region without periodically re-
assessing the reasons for requesting this method of payment.
• What is the credit rating of the importer and are they a new
customer or has a trading relationship already been established?
• What is the country risk of the issuing bank? Would a
confirmed letter of credit be more suitable?
• What is the standing of the issuing bank? Would a
confirmed letter of credit be more suitable?
• What is the usual practice in trading with that country and in
that particular commodity?
• Are there any other measures that could be taken to protect
the exporter such as credit insurance?
• Insistence by a Credit Insurer to trade on letter of credit
terms with buyers in certain markets.
• Recommendation by banks who may advise that the best
method of payment is a ‘confirmed irrevocable letter of credit’
irrespective of the country, strength of issuing bank and without
much regard to the value of the consignment.
• Strategic decision made by the exporter however, this
strategy should be flexible to adapt to the changing risk profile
of both the country and the buyer.
It is important to remember that all parties in the letter of
credit transaction deal with documents, not goods.

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Types of Letter of Credit (L/C)

Revocable: A revocable letter of credit can be amended or cancelled
at any time by the importer without the exporter’s agreement unless
documents have been taken up by the nominated bank. Little
protection is offered to the exporter with a revocable credit and they
are rarely seen.
Irrevocable: An irrevocable letter of credit can neither be amended
nor cancelled without the agreement of all parties to the credit. Under
UCP 600, all letters of credit are deemed to be irrevocable unless
otherwise stated. Here, the importer’s bank gives a binding
undertaking to the supplier provided all the terms and conditions of
the credit are fulfilled.
Unconfirmed: An unconfirmed letter of credit is forwarded by the
advising bank directly to the exporter without adding its own
undertaking to make payment or accept responsibility for payment at a
future date, but confirming its authenticity.
Confirmed: A confirmed letter of credit is one in which the advising
bank, on the instructions of the issuing bank, has added a confirmation
that payment will be made as long as compliant documents are
presented. This commitment holds even if the issuing bank or the
buyer fails to make payment. The added security to the exporter of
confirmation needs to be considered in the context of the standing of
the issuing bank and the current political and economic state of the
importer’s country. A bank will make an additional charge for
confirming a letter of credit.
Confirmation costs will vary according to the country
involved, but for many countries considered a high risk will be
between 2%-8%. There also may be countries issuing letters of credit
which banks do not wish to confirm they may already have enough
exposure in that market or not wish to expose themselves to that
particular risk at all.
Standby Letter of Credit: A standby letter of credit is used as
support where an alternative, less secure, method of payment has been
agreed. They are also used in the United States of America in place of
bank guarantees. Should the exporter fail to receive payment from the
importer he may claim under the standby letter of credit? Certain
documents are likely to be required to obtain payment including: the
standby letter of credit itself; a sight draft for the amount due; a copy
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of the unpaid invoice; proof of dispatch and a signed declaration from
the beneficiary stating that payment has not been received by the due
date and therefore reimbursement is claimed by letter of credit. The
International Chamber of Commerce publishes rules for operating
standby letter of credit ISP98- International Standby Practices.
Revolving Letter of Credit: The revolving credit is used for regular
shipments of the same commodity to the same importer. It can revolve
in relation to time or value. If the credit is time revolving once utilized
it is reinstated for further regular shipments until the credit is fully
drawn. If the credit revolves in relation to value once utilized and paid
the value can be reinstated for further drawings. The credit must state
that it is a revolving letter of credit and it may revolve either
automatically or subject to certain provisions. Revolving letters of
credit are useful to avoid the need for repetitious arrangements for
opening or amending letters of credit.
Transferable Letter of Credit: A transferable letter of credit is one
in which the exporter has the right to request the paying, or
negotiating bank to make either part, or all, of the credit value
available to one or more third parties. This type of credit is useful for
those acting as middlemen especially where there is a need to finance
purchases from third party suppliers.
Back to Back Letter of Credit: A back to back letter of credit can be
used as an alternative to the transferable letter of credit. Rather than
transferring the original letter of credit to the supplier, once the letter
of credit is received by the exporter from the opening bank, that letter
of credit is used as security to establish a second letter of credit drawn
on the exporter in favour of his importer. Many banks are reluctant to
issue back-to-back letters of credit due to the level of risk to which
they are exposed, whereas a transferable credit will not expose them
to higher risk than under the original credit.
Uniform Customs and Practice for Documentary Credit
(UCPDC): Most letters of credit are subject to UCP 600 which are the
universally recognized set of rules governing the use of the
documentary credits in international trade. UCP were originally
formulated in 1993 by the International Chamber of Commerce (ICC)
and last updated in 2003 ICC publication. All definitions and general
documentary requirements referred to in this briefing are in
accordance with UCP 600 unless otherwise stated (it should be
remembered that in some instances this may differ from national law).

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SITPRO would only recommend using letters of credit which are
subject to UCP 600.
It is important to negotiate, at contractual stage if possible,
which party will bear bank charges. It is worth remembering that on a
small transaction these may be totally out of proportion and if these
costs are not included in the pricing any profit may be completely
eroded.

Essential checks when the Letter of Credit is received
Even when the above steps are followed, it is essential to check the
Letter of Credit as soon as it is received. The following is a checklist
to be reviewed immediately on receipt of a Letter of Credit.
• Is the credit subject to UCP 600?
• Are there any terms or conditions within the credit which
cannot be met? If so immediate arrangements must be made
with your importer for the credit to be amended.
• Can the goods be shipped within the period set by the Letter
of Credit?
• Do any documents need to be legalized?
• Can the mode of transport specified be used?
• Can shipment be made from the port/airport specified?
• Are the prices correct?
• Do the credit terms confirm with the underlying sales
contract?
• Are drawings under the credit negotiable or payable in the
exporter’s country rather than abroad?
• Are the description, price and quantity of the goods are in
accordance with the terms of the contract? (Remember that
under-drawing a credit may sometimes cause problems, e.g., if
trade discount has been forgotten when the opener instructed
his bank).
• Are the insurance requirements of the credit acceptable?
• Can the required documentation be obtained?
• If part shipments and trans-shipment of goods are
prohibited, can the full quantity of the goods be exported on a
vessel direct from the port of loading to the port of destination?
• Can the goods be shipped within the period specified and
documents presented to the bank within 21 days from the date

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of shipment (unless a shorter time is stipulated) but, I any case
before the credit expires?

Checklist for preparing documents
Amount Payable:
• Do not overstate of the amount to be drawn as this could
lead to the rejection of documents when presented.
• The words “circa” or “about” relating to the quantity or unit
price of the goods or to the amount of the credit allow a
tolerance of 10% either way.
• Unless a credit stipulates that the quantity of the goods
specified must be exceeded nor reduced, a tolerance of 5%
either way is permissible, always providing that the total
amount of the drawings dos not exceed the amount of the
credit. However, this tolerance does not apply when the credit
specifies quantities in number of packing units or individual
items.

Shipment:
• Can specified shipping documentation can be obtained?
• If the seller is chartering a vessel or shipping on deck, does
the credit specifically permit such methods?
• Do the ports of shipment and discharge, if specified, conflict
with the price quotations?
• If partial shipment or transshipments have to be made, does
the credit allow this? Any installments not shipped within a
stipulated period will effectively cancel the credit.
• Is the time available for shipment sufficient and the period
allowed for presentation of documents after shipment also
sufficient?
• If a credit on a day when banks are not open, the validity is
usually extended to the next working day. However, this does
not apply to the stipulated time after shipment allowed for the
presentation of documents, usually 21 days.

Individual Documents

Draft: The draft must be drawn by the beneficiary on the party
specified in the credit or as requested by the advising bank. It must be

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drawn in accordance with the terms of the credit. One should check
that it is:
• Correct in words and figures.
• Drawn payable at sight or sometimes at a given future time.
• Clause in accordance with the credit terms.
• Correctly dated.
Bill of Lading: It is a transport document issued by the shipping
company to prove that the consignment has left the port of despatch.
A traditional bill of lading has a threefold purpose:
• Formal receipt by the ship owner for goods.
• Evidence of the contract of carriage.
• Document of title to goods.
They should:
• Be issued by a shipping company or its accredited agent.
• Not be issued by a forwarding agent nor under a charter
unless specifically authorized by the Letter of Credit.
• Be shipped on board, unless the credit provides otherwise.
• Bear a proper amendment, duly dated and signed by the
shipping company, if a “received for shipment” item has
been converted into a “shipped” document. The same
applies to any other alteration.
• Be in a complete set (unless otherwise indicated in the Letter
of Credit) with any required number of non-negotiable
copies, each negotiable copy being signed by the shipping
company.
• Be free from any detrimental clauses added by the shipping
company indicating damage to goods or packing.
• Cover an ocean voyage. Bills of lading evidencing shipment
by a local vessel are not normally acceptable if
transshipment is not allowed.
• Bear a precise notation concerning payment of freight, i.e.
either “freight paid” or freight payable at a given
destination.
• Bear goods description either in general or particular terms:
however, the wording chosen must not conflict with the
credit or other documents.
• Bear shipping marks, number of packets and weights,
consistent with all other documents. In particular, car should
be taken that details on the bill of lading (often the last
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document to become available) do not contradict details
typed on earlier documents.
• Show ports of shipment and discharge in agreement with
credit terms.
• Be endorsed on the reverse if made out to the shopper’s
order.
• Be presented within the time limit specified in the credit for
presentation of documents. If no such period is stipulated,
banks will refuse documents presented later than 21 days
from the date of the bill of lading.
• Must bear a shipment date on or before the last stipulated
shipment date but, in any event, within the validity of the
credit.
• Unless otherwise stipulated in the credit, banks will accept
short form bills of lading issued by shipping companies or
their agents or combined transport bills of lading issued by
shipping companies or their agents.

Insurance Documents
Check that:
The extent of the cover agrees precisely with the credit terms, bearing
in mind that Institute Cargo Clauses (all risks) do not always cover
special risks.
The date of the insurance document is not later than the shipment date
or, if dated after shipment, it bears a clause to the effect that cover
commences not later than the date of shipment.
Claims are payable in the place specified in the credit.
The amount payable in the accordance with the credit terms plus any
specified percentage and is in the currency of the credit.
Marks, weights and description of the goods agree with the bill of
lading and all other documents.
The policy or certificate required by the terms is signed by the
insurance company, agents or underwriters and endorsed as necessary.
Cover is not by means of a broker’s cover note, unless this is specified
in the credit.
Any insurance policy or certificate made out to the order of the
shippers has been blank endorsed.

Invoice

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Check that:
• These have been completed by the exporter in the name of
the importer unless the credit specifies otherwise.
• Totals of all invoices agree with the amount of the drawing.
• Prices and shipment terms (FOB and CIF etc) agree with the
credit.
• If a combined invoice and certificate of origin is called for,
the certificate of origin is duly completed and signed.
• If invoices have to be visaed, this has been done by the
authority stipulated in the credit. Also remember the time
lag between forwarding documents to a consulate and their
return.
• The full and exact description of the goods as shown on the
credit appears on the invoice and that the quantity and
specifications are as called for. If goods are described as
being “……in accordance with Performa invoice
number……dated…..” this can reduce superfluous, error-
producing, detail.
• There are no additional goods, charges or deductions not
authorized in the credit. However, a deduction of normal
trade discount is allowed as long as the final amount is
correct-neither overdrawn nor under drawn.
• If both an invoice and a packing list are called for, no
“combined invoice and packing list” should be offered. An
appropriately detailed extra invoice may often satisfy the
packing list need, if suitably headed.
• Performa invoice numbers or references numbers are
required by the credit are shown.
• Marks and weights net unless the credit states otherwise,
number of cases and name of vessel agree with the bill of
lading and other documents.

Certificate of Origin

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An exporter’s own certificate on a separate sheet is acceptable unless
the credit states otherwise.
Check that:
All details quoted, shipping marks and description of goods, agree
with the Letter of Credit, bill of lading and other documents.
The certificate does not conflict with other documents with regard to
value and country of origin.

Weight Note/List
Check that:
• Certificates of weight must bear an authorized signature of
the person/firm/company issuing the certificate in the detail
required.
• If a weight lists is called for by the credit, this requires the
individual weight of each parcel or package together with the
total weight.
• If a weight note is called for by the credit it can merely state
the weights concerned in general terms, perhaps one total.

Other Documents which provide evidence of the movement of
goods
Airway Bill or Air Consignment Note:
• These should be issued and stamped by an airline on
standard forms and should appear to be the original for the
shipper, usually in 3 copies, this shows: name of consignee,
goods, which must agree with the credit and all other
documents, flight number and date, freight paid or to be paid at
destination again in accordance with the terms of the credit.
• Ensure that the correct copy is submitted, bearing a clear
reception stamp with signature of the carrier or his agent.
• Airway bills issued by freight forwarders and referred to
master Airway Bill are not acceptable unless a certificate is
presented stating that the forwarders are acting as agents for the
carriers.

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Parcel Post Receipt
Check that:
• The receipt shows evidence of dispatch to the party named
in the credit.
• The Post Office stamp shows a dispatch date on or before
the last stipulated date for shipment.
• The credit does not call for postal dispatch on a FOB basis;
these are not acceptable as postal charges to destinations have
to be prepaid.

Forwarding Agent’s Receipt
It is very important to establish at the outset whether there’s a
requirement for:
• A forwarding agent’s receipt showing goods received for
shipment or;
• A forwarding agent’s receipt showing goods received and
dispatched, as in the case of the CMR note. Normally, one set
of documents accompanies the goods on this type of journey.

INCOTERMS- A GENERAL GUIDE
A set of common and understandable terms with commitment
amongst the business community is to be implemented by every entity
in trading such as, shipper, receiver, shipping company, banker
clearing houses and insurance company.
Incoterms are a set of rules for the interpretation of the most
commonly used trade terms in international trade- International
Commercial Terms. They were first published by the International
Chamber of Commerce (ICC) in 1936 and since then have been
updated I 1953, 1967, 1976, 1980, 1990 and the current revision 2000.
Parties to a contract are often unaware that there are different
trading practices in their respective countries, for example, FOB for
an American company may have a different meaning than FOB for a
UK trader. This can lead to misunderstanding and, in the worst
scenario, costly litigation. Incoterms set out to avoid this problem by
giving a set of standard rules that are recognized throughout the
world.
The basic purpose of each Incoterm is to clarify how functions,
costs and risks are split between the buyer and seller in connection

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with the delivery of the goods as required by the sales contract.
Delivery, risks and costs are known as the critical points. Each term
clearly specifies the responsibility of the buyer to the other extreme
where everything is fundamentally the responsibility of the seller.

The Obligations of the Seller and Buyer
The main purpose of Incoterms is to clearly set out the obligations of
the seller and the buyer in relation to the delivery of the goods and the
division of functions, costs and risks related to the delivery. The way
this is presented in each Incoterms is under ten clauses each for the
seller and the buyer, where each clause on the seller’s side “mirrors”
the obligations to contract for carriage and insurance and clause B3
deals with buyer’s obligations to contract for carriage and insurance.

Incorporating Incoterms
It is important to ensure that where the protection of Incoterms is
intended to be incorporated into a contract of sale that an express
reference to the current edition of Incoterms is always made. For
example, it is not enough to quote just “FOB Southampton” but
instead “FOB Southampton Incoterms 2000” should be used.
Alternatively, suitable wording can be included in the contract
stating that the contract is subject to Incoterms 2000. However, if this
is the case, you should be careful to ensure that standard contracts,
and any other standard paperwork mentioning Incoterms, are updated
to quote “Incoterms 2000” rather than Incoterms 1990.
Failure to incorporate the correct version of Incoterms could
result in dispute as to which version is intended or indeed, if
Incoterms were intended to be incorporated at all.

The Incoterms
The thirteen Incoterms are split into four distinct groups:

Group E- where the goods are mad available to the buyer at the
seller’s premises;
Group F- where the seller must deliver the goods to a carrier
appointed by the buyer;
Group C- where the seller must contract for the carriage of the goods
without assuming risk of loss of, or damage to the goods or additional
costs due to events occurring after shipment;

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Group D- where the seller has to bear all costs and risks required to
bring the goods to the place of destination.
The following is a list of all of the Incoterms, the group to which they
belong and a brief outline of responsibilities under that Incoterm.
However, it should be remembered that this is just a brief outline and
is not a substitute for reading and understanding Incoterms 2000 itself.
Additionally it has been noted whether the term is suitable for any
mode of transport or just conventional maritime and inland waterway
transport.

Group E Departure
EXW- Ex Works (named place) (any mode of transport).
The seller must place the goods at the disposal of the buyer at the
seller’s premises or another named place not cleared for export and
not loaded on any collecting vehicle.

Group F Main Carriage Unpaid
FCA- Free Carrier (named place) (Any mode of transport).
The seller must deliver the goods, cleared for export, to the carrier
nominated by the buyer at the named place.
FAS- Free alongside Ship (named port of shipment) (Maritime and
inland waterway transport only).
The seller must place the goods, cleared for export, alongside the
vessel at the named port of shipment.
FOB- Free on Board (named port of shipment) (Maritime and inland
waterway transport only).
The seller delivers the goods, cleared for export, when they pass the
ship’s rail at the named port of shipment.

Group C Main Carriage Paid
CFR- Cost and Freight (named port of destination) (Maritime and
The seller delivers the goods when they pass the ship’s rail in the port
of shipment and must pay the costs and freight necessary to bring the
goods to the named port of destination. The buyer bears all additional
costs and risks after the goods have been delivered (over the ship’s
rail at the port of shipment).
CIF- Cost, Insurance and Freight (named port of destination)
(Maritime and inland waterway transport only). The only obligations
are the same as under CFR with the addition that the seller must
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procure insurance against the buyer’s risk of loss of, or damage to the
goods during carriage.
CPT- Carriage Paid to (named place of destination) (any mode of
transport).
The seller delivers the goods to the nominated carrier and must also
pay the cost of carriage necessary to bring the goods to the named
destination. The buyer bears additional costs and risks after the goods
have been delivered to the nominated carrier.
CIP- Carriage and Insurance Paid To (named place of destination)
(any mode of transport).
The obligations are the same as under CPT with the addition that the
seller must procure insurance against the buyer’s risk of loss of, or
damage to the goods during carriage.

Group D Arrival
DAF- Delivered at Frontier (named place) (Any mode of transport).
The seller must place the goods at the disposal of the buyer on the
arriving means of transport not unloaded, cleared for export but not
cleared for import, at the named point and place at the frontier.
DES- Delivered Ex Ship (named port of destination) (Maritime and
The seller delivers when the goods are placed at the disposal of the
buyer on board the ship, not cleared for import, at the named port of
destination.
DEQ- Delivered Ex Quay (named port of destination) (Maritime and
The seller delivers when the goods are placed at the disposal of the
buyer, not cleared for import, on the quay at the named port of
destination.
DDU- Delivered Duty Paid (named place of destination) (any mode of
transport).
The seller must deliver the goods to the buyer, not cleared for import,
and not unloaded at the named place of destination.
DDP- Delivered Duty Paid (named place of destination) (any mode of
transport).
The seller must deliver the goods to the buyer, cleared for import, and
not unloaded at the named place of destination.
As can be seen, this list runs from the term where the buyer has
most of the responsibility (EXW) through that where the seller has the
majority of the responsibility (DDP). It is worth noting that in
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Incoterms 2000 the only term that requires the buyer to clear the
goods for export (including obtaining any export license necessary) is
EXW and the only term that requires the seller to clear the goods for
import (including obtaining any import license necessary)is DDP.

UCPDC ICC (2007) – 600 – IMPORTANT PROVISION

Background
In May 2003, the International Chamber of Commerce (ICC)
authorized the ICC Commission on Banking Technique and Practice
to bring a revision of the Uniform Customs and Practice for
Documentary Credits. The commission has framed ICC-600 which
will be applicable from 1st July 2007.

Meaning
The Uniform Customs and Practice for Documentary Credit (UCPDC)
is a set of rules on the issuance and use of letters of credit. It is being
utilized by bankers and commercial parties for more than 175
countries.

Essential Articles for Trading Operations
Article 2: Definitions of advising bank, applicant, confirmation,
beneficiary etc. As per the definition of credit, credit is an
arrangement which is irrevocable and constitute a definite undertaking
of the issuing bank to honour a complying presentation. Means there
is no revocable credit.
Article 3: Interpretations of various commonly used words in credit
are given. Important of which is that if on or about or similar will be
interpreted as a stipulation that an event is to occur during a period of
5 calendar days after the specified date, both start and end dates
included.
Article 4: A credit by nature is a separate transaction from the sale or
other contracts on which it may be based. Banks are in no way
concerned or bound by such contracts even if any reference is given in
the credit.
Article 5: The bank deals in documents and not with goods, services
or performance to which the documents may relate.
Article 6: A credit must state availability of the bank, expiry date and
place of presentation.

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Article 7: Issuing Bank undertaking for making payment as per terms
of LC or reimbursing to nominated bank having made the payment by
way of negotiation as per the terms of LC.
Article 8: Confirming Bank undertakings for reimbursement to
another nominated bank that has honored or negotiated a complying
presentation.
Article 14: A presentation must be made by or on behalf of the
beneficiary not later than 21 calendar days after the date of shipment
but not later than the expiry date of the credit. Further, a nominated
bank acting on its nomination, a confirming bank, if any, and the
issuing bank shall each have a maximum of 5 banking days (7 in
earlier UCP - 500), following the day of presentation to determine if
presentation is complying. This period is not curtailed or otherwise
affected by the occurrence on or after the date of presentation of any
expiry date or last date for presentation.
Article 20: Clause in Bill of Lading stating that the carrier reserves
the right to transship will be disregarded.
Article 22: In case of Charter Party Bill of Lading, banks will not
examine the Charter Party contract, even if they are required to be
presented by the terms of credit.
Article 23: In case of air transport document indicating that
transshipment will or may take place is acceptable, even if credit
prohibits transshipment.
Article 28: If there is no indication in the credit of the insurance
coverage required, the amount of insurance coverage must be at least
110% of the CIF or CIP value goods.
Article 29: If the expiry date of a credit or the last day for
presentation falls on a day when bank is closed for reasons other than
Force Measures (Article 36), the expiry day / presentation day will b
extended to the first following banking day. But the latest date for
shipment will not be extended as a result of this.
Article 30: If the word ‘about’, ‘app’ etc is mentioned in the credit it
will be construed as + or – 10% for amount and + or – for quantity.
The tolerance of 5% in quantity is allowed even if partial shipment is
not allowed.
Article 31: Partial drawings or shipment are allowed.
Article 33: A bank has no obligation to accept a presentation outside
its banking hours.
Article 36: Force Majeure- A bank assumes no liability or
responsibility for the consequences arising out of the interruption of
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its business by acts of God, riots, civil commotions, insurrections,
wars acts or terrorism, or by any strikes or lockouts or any other
causes beyond its control. A bank will not upon resumption of its
business, honour, or negotiate under a credit that expired during such
interruption of its business.
Article 38: For the purpose of this article, transferable credit means a
credit that specifically states that it is transferable. A credit may be
transferred in part of more than one second beneficiary provided
partial drawings or shipments are allowed. But a transferred credit
cannot be transferred at the request of a second beneficiary to any
subsequent beneficiary i.e. it can be transferred only once.

International business organizations are relocating their
manufacturing units. Destinations are changing for their goods.
Companies like Mitsubishi and support their goods through ship
liners. Obviously, trade finance transactions are integral parts of
their business.

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7.MULTINATIONAL CORPORATIONS

The world is my playground; Playing is my duty. No barriers or
obstacle is known to me. Let me play everywhere and anywhere and
at any time.
Going and performing in any part of the world is fundamental
principle of an MNC.

Learning value:
On going through the chapter, reader will

1. Understand the concept of MNCs.

2. Role of Head-Quarters and subsidiaries in the current scenario.
3. Basic philosophy of MNCs.

4. Risk analysis of MNCs.

5. Criticism of MNCs and few illustrations.

THE CONCEPT
If we ask any employee of a multinational company in a developing country,
he is proud of his status, sense of achievement and affluence as compared to
his peers. The system, style, technology and working style elevate his
position little higher than others.

What is Multinational Corporation?
“The multinational is a business unit which operates simultaneously in
different parts of the world. In some cases the manufacturing unit may be in
one country, while the marketing and investment may be in other countries.
In other cases all the business operations are carried out in different
countries, with the strategic head quarters in any part of the world.” For
example, the Manhattan based company, Colgate Palmolive Inc., which
manufactures and markets dental care, health care, hair care and skin care

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products, in more than 120 countries. Procter and Gamble, based in
Cincinnati also has similar product lines and operates in more than 150
countries. Their logo, symbol, products and brands are easily identified in
the malls, outlets and media.

There are multinationals that have a total turnover exceeding the GDP
of many small or less developed nations. The Minnesota Mining and
Manufacturing Company, called for short, 3M, have more than a thousand
product lines. The top three multinationals in the world today could combine
to purchase a small nation. Few multinationals in the total employee force
that is larger than the population of a country and my even have the power to
bring down governments. Therefore, multinationals have money power,
muscle power, managerial power, technology power and political power
through which they influence many economies in the world.
At one time American based multinationals rules the world. Today,
many Japanese, Korean, European and Indian multinationals have spread
their wings in many parts of the world. Few nations have created specific
product based MNCs such as General Motors, Ford Motors and AMC in
case of U.S.A and Sony, Sharp, Hitachi and Casio incase of Japan.

Germany concentrated on technology based items like dental equipments
and telecommunications. From the centre they started moving to various
countries and established their empires.
The strategic nerve centre is the company’s headquarters, where major
decisions are taken and policies are formulated. The main roles of a typical
multinational at headquarters are:

1. Strategic role: It is a policy making entity for operations worldwide.

2. Execution: Decisions on implementation of policies, methods and means
of operations, in different countries.

3. Control: Since the operations are vast it is necessary to maintain control
over global strategic, costs, systems and operations.

All the three roles are played by the head quarters after completing major
five pre-requisites:
1. The business opportunity has been explored in a specific area.

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2. Sufficient investment has been made in tangible and intangible assets.

3. The production facility has been already developed.

4. The key persons are taking responsible positions.

5. The location is ideal and conducive for further expansion.

Every multinational has to operate through its satellite units in many
countries, called subsidiaries. Therefore, multinationals have headquarters
and a number of subsidiaries that are scattered throughout the world.
As an expansion process, few multinationals are fast expanding their
operations in developing countries. While doing so the headquarter is
involved in a serious risk analysis and finally select the country where they
are comfortable to do business. At the headquarters, the experts from
political science, economics, accountancy, sociology and diplomacy are
advising the top management on different issues prior to entry into any
country. The entry decision is crucial for any MNC and it is an outcome of
many brains and not a daring decision of a single mind.

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A typical multinational operates as per the following model:

HEADQUARTERS

S1 S2 S3 S4

In most cases the power rests with the main company at its head
quarters. However, a few multinationals do give considerable powers to their
subsidiaries. Currently, multinationals are motivated solely by revenue
wherein profits are the main criteria.

CLASSIFICATION OF MULTINATIONALS

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Depending upon the relationship between the headquarters and
subsidiaries, multinationals can be classified into three broad categories:

1. Pyramidal Model Multinationals

HQ
(STRONG)

S1 S2 S3 S4 S5

A pyramid indicates a broad bottom and narrow top. According to the
typical pyramid model, the multinational operates as follows:

a) It has strong headquarters and weak subsidiaries.

b) All decisions are made at the headquarters and imposed on the
subsidiaries,

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c) Major decisions related to new product development, plant location and
managerial decisions are taken only at the headquarters. At times, the
head-quarters may be quite autocratic towards its subsidiaries.

d) They may be quite old fashioned in their day-to-day functioning.

e) They do not bring sentiments and emotions for the local population into
their dealings.

f) They exercise complete control in their deals.

g) They run their business through power.
Sympathy, compassion and human approach are generally far off in their
approach. Lower is the prime motive in their style. Age old colonialism and
imperialism got percolated to follow such style.

Due to rigidity in their style of functioning, such organizations may invite
opposition from citizens in developing countries at any time. Fortunately,
such multinationals changed became adaptable to local environment.
2. Umbrella Model Multinationals

HQ

S1 S2 S3 S4

Here the headquarters acts as a facilitator. Such MNCs believe in

a) Mutual exchange of knowledge and technology.

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b) Constant motivation of subsidiaries.

c) Building an image for both headquarters and the subsidiary.

d) Harmony between employees at different levels, and between employees
and employers.

e) High respect for the sovereignty of the county where they operate.

Such organizations are concerned about their image, goodwill and
reputation. For them doing business is a way of life. They invite
representatives from the subsidiaries to the headquarters for strategic
decisions. They do not practice favoritism, nepotism, parochialism and racial
superiority. Merit is the only consideration for growth and career
enhancement. An Indian is the CEO of Mc.kinsey, Afghani is the head of
HR in Yahoo, Indonesian is the research head in Biorad and Indian woman
is heading Pepsi world-wide operations.

3. Inter-conglomerate Multinationals

Conglomerate indicates grouping of business activities aiming at high profits
and revenue generations, whether it is related to existing core business or
not. Inter –conglomerate multinationals are aggressive in expansion and
achieving a high turnover. Such multinationals enter into any business where
the profits are exponentially high. They generally do not consider any other
aspect, except high profits, as a performance indicator.

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INVESTMENT

PROFITS
HUGE
REVENUE

EXPANSION
HIGH RATE AND
OF RETURN
AGGRESSION

a) High profit motivation.

b) They do not restrict themselves to their core competency.

c) A ‘hire and fire’ policy is very common.
d) They set high targets for themselves.

e) No social consideration in the country of their operation.

f) Growth, expansion, takeovers and aggression are constant endeavours.

The investments are high and are made with expectations of high returns,
which will be used for aggressive expansion, diversification and takeovers?

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Although multinationals can be classified on the above basis, today the
classification is not rigid. Hence, multinationals have become flexible over
the past two decades. As the indigenous forces become strong in any
developing country, the pure pyramidal model will not work. Organizations,
which work under a pure umbrella model cannot generate sufficient revenue
to sustain itself and it is also difficult for such organizations to face stiff
competition. Organisation, which functions under the inter-conglomerate
model, cannot focus only on profit, considerations for social causes and
sensitivity towards the host country have to be maintained or else the
nationals in the host country pose major challenges and pull down the
operations.

Classification of Multinationals Depending upon their Origin

CLASSIFICATION BASED ON ORIGIN

ETHNOCENTRIC REGIO-CENTRIC CONTINENTAL POLYCENTRIC TRANSNATION AL GLOBAL

Succeed at Understand Focus on Group the Facilitate Cross the
home and complete one requirement accessibility borders and
spread with background continent of the whole to serve the
home and focus on and continent customers customers at
influence a specific strengthen and provide door steps
region product and
services

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1. Ethnocentric: Such multinationals concentrate more on their place
of origin. Since they understand their own socio-cultural background
it is easy for them to succeed in their home country. Instead of taking
high risks in other countries they first succeed in their home country
and then slowly more abroad with few changes in the product and
mode of functioning. Mitsukoshi Super Market practices ethnic touch
of Japan in its malls wherever it operates.

2. Regio-centric: Few multinationals focus their activities only in a
particular region like South East Asia or the Gulf region. There are
certain practices that are uniform in nature in a specific region, and
hence they succeed. A region covers many nations; hence the
organization operates in all parts of the region to get the title
‘multinational’. “Continent”, the French super market chain has an
influence in the whole of Indian ocean rim countries.

3. Continental: There are multinationals that are very successful in
particular continent for their specific product ranges. The cost of
storing and warehousing can be brought down if the product is
distributed in the whole continent. There are hundreds of
multinationals doing exceedingly well only in Europe, but are not able
to face cross-cultural challenges in other continents. Therefore, they
remain as continental multinationals. TESCO serves the whole
European continent by understanding the need of every European
community.

4. Polycentric: The majority of multinationals have to simultaneously
enter different countries. It is not possible to adopts a ‘wait and watch’
policy to enter different countries and commence operations. Once a
company invests in an innovation, it has to spread its activities
everywhere, otherwise it will lose the opportunity, and competitors
will step in to get the business. Therefore, companies like Proctor &
Gamble, Unilever, Sony, Electrolux, Henkel and Colgate-Palmolive
are present in almost every part of the world.

5. Trans-national: Multinational like Hewlett Packard has set up sub-
head quarters close to the subsidiaries for easy accessibility. The sub-
headquarters are located in Singapore or Hong Kong but the main
office remains in California. The trans-national multinationals sole

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problems arising from nearby countries through their sub-headquarter.
It is serving the purpose of administrative convenience.

6. Global organizations: These organizations have a physical
presence in other parts of the world and cater to customers in different
countries through standardized products by consolidating resources
from any part of the world. Today, every company dreams of
becoming a global company. Companies shift their manufacturing
bases to more profitable locations, open up warehouses in special
economic zones and train people to be multilingual, multi-strategic
and multi-functional in order to manage the business successfully.

The difference between polycentric and global multinationals is that
the latter is very closed to customer and does not give extra weight-
age to the headquarters. Global orgainsations take into account
customer tastes and preferences. They employ cost cutting techniques
and are able to provide customers with good quality, low-priced items.
They have enormous respect for the country in which they operate and
integrate themselves into the society.

BASIC PHIPLOSOPHIES OF MULTINATIONALS
MNCs will always look out for opportunities. They carry out risk
analysis, and send their personnel to learn and understand the business
climate. They develop expertise in understanding the culture, politics,
economy and legal aspects of the country that they are planning to enter.
They look at the global, rather than only local potential. The essential
element that distinguishes the true multinational is its commitment to
manufacturing, marketing, developing R&D, and financing opportunies
throughout the world, rather than just thinking of the domestic situation.

STRUCTURE OF MULTI-NATIONAL CORPORATIONS

MNCs can be categorized in 3 main structures:

1. Attachment of Subsidiaries with General (or Top) Management of
the Parent Company and with the CMD

2. Creation of an International Division

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3. Putting in place Group Structure

1. Attachment of Subsidiaries with Top Management of the
Group

Top
Management

Financial Asian American
Division/ Subsidiary Subsidiary
Planning Division Division
Division

No discrimination between various departments of the organization and
foreign subsidiaries.

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2. Organizations with an International Division

Parent
Company

International MARKETING
FINANCE Division HR

FINANCE MARKETING HR

3. Creation of a Group Structure

Organization according to functions
Organization according to products
Organization according to geographical zones
Mixed organization

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3.1 FUNCTIONAL ORGANISATION

Top
Management

Marketing Finance HR

COUNTRY A COUNTRY B COUNTRY C

3.2 PRODUCT ORGANISATION

CMD

PRODUCT A PRODUCT B PRODUCT C

PRODUCTION MARKETING FINANCE

ASIA EUROPE AMERICA

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3.3 Organization according to Geographical Zones

CMD

ASIAN AMERICAN AFRICAN EUROPEAN
DIVISION DIVISION DIVISION DIVISION

PRODUCT A PRODUCT B PRODUCT C

PRODUCTION MARKETING

3.4 MIXED ORGANISATION

CMD

PRODUCT A PRODUCT B INDIA

USA EUROPE AFRICA

PRODUCT PRODUCT PRODUCT
A B C

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Some of characteristics of MNCs are
Mode of Transfer ( as per convenience)
An MNC has considerable freedom in selecting the financial channel
through which funds or profits or both are moved. For example, patents and
trademarks can be sold outright or transferred in return through contractual
binding or royalty payments. Similarly, the MNC can move profits and cash
from one unit to another by adjusting transfer prices on inter company sales
and purchases of goods and services. MNCs can use these various channels,
singly or in combinations, to transfer funds internationally, depending on the
specific circumstances encountered.

Timing Flexibility
Some of the internationally operating companies have to comply with strict
payment schedule; others can be accelerated or delayed. MNCs can extend
trade credit to their other subsidiaries through open account terms, say from
90 to 180 days. This gives a major leverage to financial status. In addition,
the timing for payment of fees and royalties may be modified when all
parties to the agreement are related. In the same way while price of raw
material is low then they can procure a huge quantity and stock for usage.

Value addition through tax reduction
By shifting profits from high-tax to low-tax nations, MNCs can reduce their
global tax payments. In additions, they can transfer funds among their
various units, which allow them to circumvent currency control and other
regulations. Cyprus, Panama and Malta are safe destinations for such
operations.

STRATEGIC APPROACH TO MULTINATIONALS
In order to explain new and potentially profitable projects, a good
understanding of multinational strategies is necessary. The three broad
categories of multinationals and their associated strategies are examined
below.

A. Innovation Based Multinationals
Firms such as IBM, Philips and Apple create barriers to entry for others by
continually introducing new products and differentiating existing ones, both

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domestically and internationally. Firms in this category spend large amounts
of money on R&D and have a high ratio of technical to factory personnel.
Their products are typically designed to fill a need perceived locally that
often exists abroad as well. In the field of chemical and pharmaceuticals
Hopkins and E. Merck adopt the same strategy.

B. The Mature Multinationals
The principal approach in such firms is the presence of economies of scale.
It exists whenever there is an increase in the scale of production, marketing
and distribution costs could be increased in order to retain in existing
position or more aggressive. The existence of economies of scale means
there are inherent cost advantages of being large. The more significant these
economies of scale are, the greater will be the cost disadvantage faced by a
new entrant in the same field in a given market. Philip Morris, Toshiba and
Whirlpool are falling under this category.

Reduction in promotion costs
Some companies such as Coca Cola and Proctor & Gamble take
advantage of the fact that potential entrants are wary of the high costs
involved in advertising and marketing a new product. Such firms are able
to exploit the premium associated with their strong brand names. MNCs
can use single campaign and visual aspects in all the countries
simultaneously with different languages like Nestlé’s Nescafe.

Cost advantage through multiple activities
Other firms take advantage of economies of scope. Economies of scope
exist whenever the same investment can support multi-profitable
activities, which are less expensive. Examples abound of the cost
advantages of producing and selling multiple products related to common
technology, production facilities and distribution network. For example,
Honda has increased its investment in small engine technology in the
automobile, motorcycle, lawn mower, marine engine, chain saw and
generator business. Mitsubishi enjoys this advantage of steel trading, lifts
and escalators, vehicles and power generation.

C. The Senescent Multinationals

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There are some product lines where the competitive advantages erode
very fast. The strategic followed in such cases are given below.
1. One possibility is to enter new markets where little competition currently
exists. For example Crown Cork & Seal, the Philadelphia-based maker of
bottle tops and cans, reacted to the slowing of growth and heightened
competition in business in the United States by expanding overseas. It
sets up subsidiaries in such countries as Thailand, Malaysia, Zambia and
Peru, estimating correctly that in these developing and urbanizing
societies, people would eventually switch from home grown produce to
food in cans and drinks in bottles.

2. Another strategy often followed when senescence sets in is to use the
firm’s global scanning capability to seek out lower cost production sites.
Costs can then be minimized by integration of the firm’s manufacturing
facilities worldwide. Many electronics and textile firms in the US shifted
their production facilities to Asian locations such as Taiwan and Hong
Kong, to take advantage of the lower labour costs.

REASONS FOR THE GROWTH OF MNCs
1. Non-transferable knowledge

It is often possible for an MNC to sell its knowledge in the form of patent
rights and to license a foreign producer. This relieves the MNC the need to
make foreign direct investment. However, sometimes an MNC that has a
production process or product patent can make a larger profit by carrying out
the production in a foreign country itself. The reason for this is that some
kinds of knowledge cannot be sold and which are the result of years of
experience.
2. Protecting Reputations

Products develop a good or bad name, which transcends international
boundaries. It would be very difficult for an MNC to protect its reputation if
a foreign licensee does an inferior job. Therefore, MNCs prefer to invest in a
country rather than licensing and transfer expertise, to ensure the
maintenance of their good name.
3. Building Reputations

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Sometimes, MNCs invest to build their image and reputation rather than
protect their reputation. This motive is of particular importance in the case of
foreign direct investment by banks, because in the banking business an
international reputation can attract deposits. If the goodwill is established the
bank can expand and build a strong customer base. Quality service to a large
number of customers is bound to ensure success. This probably explains the
tremendous growth of foreign banks such as Citibank, Grind lays and
Standard Chartered in India and other developing countries.

4. Protecting Secrecy

MNCs prefer direct investment, rather than granting a license to a foreign
company if protecting the secrecy of the product is important. While it may
be true that a licensee will take precautions to protect patent rights, it is
equally true that it may be less conscientious than the original owner of the
patent.

5. Product Life Cycle theory and impact

It has been argued that opportunities for further gains at home eventually dry
up. To maintain the growth of profits, a corporation must venture abroad
where markets are not so well penetrated and where there is perhaps less
competition. This hypothesis perfectly explains the growth of American
MNCs in other countries where they can fully exploit all the stages of the
life cycle of a product. A prime example would be Gillette, which has
revolutionized the shaving systems industry. HP laptop, Sony Walkman and
Xerox face various stages of their life-cycle in their home country.

6. Availability of Capital
The fact that MNCs have access to capital markets has been advocated as
another reason why firms themselves move abroad. A firm operating in only
one country does not have the same access to cheaper funds as a larger firm.
However, this argument, which has been put forward for the growth of
MNCs, has been rejected by many critics.

7. Invest and prosper “out” and not “in”

The strategic motive for making investments has been advocated as another
reason for the growth of MNCs. MNCs enter foreign markets to protect their
market share when this is being threatened by the potential entry of
indigenous firms or multinationals from other countries. Fast growing
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countries like India and China give a great boost to MNCs originated in U.S,
Japan and Europe.
8. Avoiding Tariffs and Quotas

MNCs prefer to invest directly in a country in order to avoid import tariffs
and quotas that the firm may have to face if it produces the goods at home
and ship them. For example, a number of foreign automobile and truck
producers opened plants in the US to avoid restrictions on selling foreign
made cars. Automobile giants like Fiat, Volkswagen, Hyundai, Honda and
Mazda are entering different countries around the world not with the
products but with technology and money.

9. Symbiotic Relationships

Some firms have followed clients who have made foreign direct investment.
This is especially true in the case of accountancy and consulting firms. Large
US accounting firms, which know the parent companies’ special needs and
practices, have opened offices in countries where their clients have opened
subsidiaries. These US accounting firms have an advantage over local firms
because of their knowledge of the company and because the client may
prefer to engage only one firm in order to reduce the number of people with
access to sensitive information. Templeton, Goldman Sachs and Ernst and
Young are moving with their clients even to small countries like Panama,
Mauritius, Malta and Sri Lanka.

MULTINATIONALS: CREATURES OF MARKET
IMPERFECTIONS
Broadly, two kinds of imperfections are relevant.

1. Structural imperfections: These may be natural or manmade.
Government regulations on investment, taxes and subsidies, capital
markets and monopoly aspects create imperfections. This kind of
imperfection is now disappearing from industrial countries, but is still
appearing in developing countries.

2. Imperfections in transactions and markets: Uncertainty in delivery, the
volatility of exchange rates; the difficulty that customers face in
evaluating unfamiliar products; the costs of negotiating deals, economies
of scale in production, purchasing, research and developments and

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distribution give advantages to existing firms and impose barriers against
newcomers.
Due to these and other imperfections, firms locate their production and
other operations internally. As these market imperfections disappear, the
importance of MNCs may diminish. The days for this may not be far off due
to the international apex body, WTO and its regulatory norms are strictly
implemented in near future.

TRANSFER PRICING
Transfer prices are the charges made when a company supplies goods,
services or finance to another company to which it is related. It is an
internationally accepted principle that transactions between related parties
should be based upon the same terms as those between unrelated parties.
Thus both tax treaties entered into between countries and domestic tax
legislation of various countries have adopted the arm’s length principle.

Abuse of Transfer Pricing
In the era of global competition transfer pricing has became an unwanted
reality. The price charged by a company in Country A to another company
in Country B is reflected in the profit and loss account of both the
companies, either as income or expenditure, and impacts the tax paid by the
two related companies. By resorting to transfer pricing, related entities can
reduce their total taxation by transferring higher income to low-tax
jurisdictions and greater expenditure to those jurisdictions where the tax rate
is very high. For example, the current tax rate on domestic companies in
India is 33.3%. Take an example, the Company A is located in India and
Company B in Singapore, and that both belong to the same group. If the tax
rate in Singapore is 15% then Company B will transfer raw material to
Company A at slightly higher prices. This will enable Company A to show a
higher expenditure and reduce its taxable profits. On the other hand, a
slightly higher income will not harm Company B much as the tax rate in its
country is very low, thus the global group as a whole will benefit form tax
savings. In this game, the first country is the major loser and due to low
profits employees may struggle for their incentives.

Detection of Transfer Pricing

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Globally, there are several methods of detecting transfer pricing to check
whether transactions between related parties have been at an ‘arm’s length’.
The transaction method relies directly or indirectly on information about the
prices at which similar transactions have been entered into by unrelated
parties. This method is further divided into the Comparable Uncontrolled
Price (CUP) method and cost plus (C+) method.

Prices charged in similar business transactions between two
independent parties is the yardstick adopted under the CUP method.
Whereas under the C+ method, as arm’s length price is determined by
applying an appropriate mark-up on the costs incurred. The transactional
profit method, as the name indicates, is transaction-specific; it examines
whether or not profits from a particular deal are reasonable.

Importance of Transfer Pricing Regulations in Developing Countries
Import of raw material, semi-finished goods for assembling and most
important of all, intellectual property such as know-how and technology are
areas prone to transfer pricing. Such goods or services can be sent to
associate companies in India at a higher or lower rate than the prices charged
to unrelated parties, to secure a global tax advantage. In today’s high-tech
age, Indian companies often rely on technology and know-how from their
foreign joint venture partners; thus strict regulations are very important.

Regulations in Dealing with Transfer Pricing
The important sections relating to transfer pricing in the Income Tax Act
1961 are Section 40A (2), Section 80 1A (9) and Section 1A (10). The first
enables tax authorities to disallow any expenditure made to a related party,
which they feel is excessive. Certain tax benefits are available under Section
80 1A such as a tax holiday for a certain number of years. If transfer pricing
is suspected then the tax authorities can deny such tax holidays.

The most important provision in the tax laws is in Section 92. This
allows the Indian tax authorities to adjust the taxable income of the Indian
party, if they feel that the prices charged in a transaction are not at an arm’s
length due to close connection between the Indian entity and a foreign party.

COUNTRY RISK
When making overseas direct investments it is necessary to allow for risk
due to the investment being in a foreign country. Country risk is one of the
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special issues faced by MNCs when investing abroad. It involves the
possibility of losses due to country-specific economic, political and social
events.

Among the country risks that are faced by MNCs are those related to
the local economy, those due to the possibility of confiscation i.e.
government takeover without any compensation, and those due to
expropriation i.e. government takeover without any compensation, and those
due to expropriation i.e government takeover with compensation which at
times can be generous. In addition there are the political/social risks of wars,
revolutions and insurrections. Even though none of these latter events are
specifically directed towards an MNC by the foreign government, they can
damage or destroy an investment. There are also risks of currency non-
convertibility and restrictions on the repatriation of income. International
magazines like Euro Money and The Economist regularly conduct country
risk evaluations in order to facilitate MNCs.

Methods of Reducing Country Risk and Control
1. Controlling crucial elements of corporate operations
Many MNCs try to prevent operations in developing countries by other local
entities without their element of operations. For example, food and soft drink
manufacturers keep their special ingredients secret. Automobile companies
may produce vital parts such as engines in some other country and refuse to
supply these parts if their operations are seized.

2. Programmed stages of planned disinvestment
An alternative technique for reducing the probability of expropriation is for
the MNC to promise to hand over ownership and control to local people in
the future. This is sometimes a requirement of the host government. There is
a calculative move to involve themselves in stages.

3. Joint ventures
Instead of promising shared ownership in the future, an alternative technique
for reducing the risk of expropriation is to share ownership with private or
official partners in the host country from the very beginning. Such shared
ownerships, known as joint ventures rely on the reluctance of local partners,
if private, to accept the interference of their own government as a means of
reducing expropriation. When the partner is the government itself, the
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disincentive to expropriation is concerned over the loss of future
investments. Multiple joint ventures in different countries reduce the risk of
expropriation, even if there is no local participation. If the government of
one country does expropriate the business if faces the risk of being isolated
simultaneously by numerous foreign powers.

PROBLEMS FROM THE GORWTH OF MNCs
Much of the concern about MNCs stems from their size, which can be
formidable. MNCs may impose on their host governments to the advantage
of their own shareholders and the disadvantage of citizens and shareholders
in the country of operation. Even in India, MNCs have neglected the
interests of the minority shareholders in the past.

It can be difficult to manage economies in which MNCs have
extensive investments. Since MNCs often have ready access to external
sources of finances, they can blunt local monetary policy. When the host
government wishes to constrain any economic activity, MNCs may
nevertheless expand through foreign borrowing. Similarly, efforts at
economic expansion elsewhere. Although it is true that any firm can
frustrate plans for economic expansion due to integrated financial markets,
MNCs are likely to take advantage of any opportunity to gain profits. As we
have seen, MNCs can also shift profits to reduce their total tax burden by
showing larger profits in countries with lower tax rates.

Concern has been expressed, especially within the US, that their
MNCs can defy the foreign policy objectives of the government through
their foreign branches and subsidiaries. MNCs might break a blockade and
avoid sanctions by operating through overseas subsidiaries. This has led to
greater concern in some host countries, as they feel that companies operating
within their boundaries may follow orders of the US or any other foreign
government, and even within international trade unions. For example, in
1981 Chrysler Corporation was given loan guarantee to continue its
operation. The US government insisted on wage and salary roll backs as a

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condition. Chrysler workers in Canada did not appreciate the instructions
from the US Congress to accept a reduced wage.
The examples below illustrate some of the controversies faced by
MNCs.

Parke-Davis
Parke-Davis India is a 40% subsidiary of Parke-Davis Inc, USA which in
turn is a division of the US-based company, Warner-Lambert. In 1995 the
latter set up a 100% subsidiary. Among other products, it planned to
manufacture and market confectionary products, although Parke-Davis India
was already operating in this field. Later the parent company bought the
brands of ‘Halls’ and ‘Chiclets’ from Parke-Davis India for about Rs.10
crores, which according to analysts was low price in relation to growth
prospects and sales. Post-transfer, the sales of Parke-Davis grew just 3% in
1995-96 and then fell 1.5% the following year. And revealingly while the
Sensex dropped 39% in 17 months from September 1994, Parke-Davis
shares plunged almost 70% in the same period. Practically, a loss of about
Rs.285 crores in market capitalization was witnessed during the same
period.

Pfizer
There is undeniable attraction for an MNC to retain all the profits of a
venture, rather than sharing them with minority shareholders. Obviously
such a prospect is attractive to the MNC and alarming to the retail investor,
especially since the regulatory framework cannot control corporate action in
this matter. Although not having to share the profits may be the real reason.
MNCs cite other factors, including lack of stringent patent and copyright
laws in India for their actions. Often it is also the high cost of acquiring the
additional shares to take the parent company’s holding above 51%. For
example the additional 11% equity stake required for Pfizer would set the
parent company back some Rs. 290 crore at the current valuation, and to buy
out the remaining 60% from the other shareholders, would cost it Rs.775
crore. Setting up a 100% subsidiary is possible.

SmithKline Beecham
This case gives us an insight into the royalty issues. In 1997, SmithKline
Beecham India announced its plan to pay 5% of net revenues earned from
the sale of Horlicks to its parent company for using the brand name. At that
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point Horlicks accounted for 80% of the company’s Rs. 430 crore net sales.
Although it paid about Rs.5 crore in 1996, the estimated annual outgoings
worked out to about Rs.20 crore, against a net profit of Rs.45.6 crore in the
same year.

The immediate impact on the SmithKline Beecham Consumer
Healthcare stock was drastic, as the stock price fell by almost Rs.100 from
Rs.365 in Feb 1997 in just 10 days, reflecting a loss of about 27% or about
Rs.275 crore in terms of market capitalization.
Here, the main issue for investors was whether royalty payment
needed to be paid to the parent company at all. Although the Indian
company does not own the brand and is only its licensed user, it has
nevertheless spent a huge amount on brand promotion and advertisement
expenses for Horlicks, over the last four decades, and approximately Rs, 175
crores over the past 10 years. Critics feel that the company could have used
this money to promote a brand of its own, with considerable success.

Philips
On 1st December 2001, the parent company of Philips announced that it
wanted to buy out the other shareholders of its 51% subsidiary Philips India,
and delist it from the stock markets. It offered to pay Rs. 105 for each share.
The deadline for accepting the offer was 14th December. The beauty of the
strategy was that Philips did not need to persuade every individual
shareholder to sell to achieve its goal. According to the SEBI regulations,
Philips needed to increase its shareholding to 90% in Philips India to apply
for delisting the latter. Since Philips owned 51% shares, it needed to pick up
only 39% more.
When the offer opened, three financial institutional – GIC, LIC and
UTI – together held 22% of the shares, while another 27% were held by the
minority shareholders. Within days of the announcement, most minority
shareholders started worrying about what would happen to anyone who did
not sell their entire stake, Philips would need to pick up only another 17% of
the shares to reach a level of 90%. So, if Philips managed to pick up only
90% of the shares, all those who held out would be trapped. They would
agree to buy them after the deadline was over, provided it already had the
90% it needed.

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This fear reportedly led to many minority shareholders selling out,
even though the FIs had not announced their decision. Finally the FIs did
announce that they too were taking up the offer. A major factor influencing
their decision was that, if enough minority shareholders sold out, the
liquidity of the Philips India stock would be drastically reduced. In that case,
they would find it impossible to sell later because there would not be enough
buyers.

For a majority of the shareholders, the offer price was not the critical
factor in their decision to sell. In fact, many of them thought the price was
too low and that Philips had timed its offer cleverly. Royal Philips had
strictly followed SEBI guidelines which state that the offer price should not
be less than the average price of the past six months, Philips made sure that
most shareholders would sell out even if it was not the most attractive
option.

CRITICISM OF MULTINATIONALS IN DEVELOPING
COUNTRIES
1. They do not give enough importance to the society in which they operate.
An example in Union Carbide, which did not show concern for the
people of Bhopal. In South Africa, HIV medicines are sold at an
expensive price irrespective of the cost. When people die out with these
dreaded diseases in some region then MNCs consider that place as a huge
potential for business prosperity.

2. While many Indian companies, such as the Tatas and Birlas allocate
funds for charitable works like hospitals, temples and scholarships for
higher studies, not many MNCs do so, though they generate huge
revenue.

3. They generate profits when the situation is favourable, but will close their
business if any risk is anticipated. E.g., many multinationals pulled out of
South East Asia during the currency crisis, especially in Thailand and
Indonesia.

4. Active participation is needed in developing countries for infrastructure,
especially roads, ports, power plants etc. They enjoy but do not
contribute.
However, most multinationals in India deal in non-essential products
such as soaps, shampoos, lotions and other consumer products. Whether

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Uniliver, Johnson & Johnson, Colgate or Ricket & Coleman, their
contribution is not for the welfare except revenue generation. Hardly any
multinational is getting involved in developing activities such as
infrastructure.

5. There is a misconception that MNCs generate employment. However the
managerial cadre and the sales force personnel do not represent real
employment in developing countries.

6. Due to aggressive promotion and money power, MNCs can venture into
small towns in all parts of the country, leading to the decline of small
industries.

7. One Union Carbide could cost the life of thousand of living beings in
Bhopal due to sheer negligence and disrespect for the pollution control
norms. It shows that just for earning money such a multinational never
had a concern for valuable human lives.

FOREIGN COMPANIES
A foreign company is one that has been incorporated outside India
and conducts business in India. These companies are required to comply
with the provisions of the Indian Companies Act, 1956 as far as the Indian
operations are concerned. Foreign companies can set up their operations in
India by opening liaison offices, project offices and branch offices. Such
companies have to register themselves with the Registrar of Companies
(ROC), New Delhi within 30 days of setting up a place of business in India.

The Indian entity may be a subsidiary of the foreign company in India
or it may be a joint venture company with an Indian partner.

As an Indian Company
A foreign company can commence operations in India by incorporating a
company under the provisions of the Indian Companies Act, 1956. Foreign
equity in such Indian companies can be up to 100% depending on the
business plan of the foreign investor, the prevailing investment policies of
the Government and receipt of requisite approvals. For registration as an
Indian company and its incorporation, an application has to be filed with the
Registrar of Companies (ROC). Once a company has been duly registered
and incorporated as in Indian company, it will be subject to the same Indian
laws and regulations that are applicable to other domestic Indian companies.
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Joint Venture with an Indian Partner
Foreign companies can set up their operations in Indian by forgoing strategic
alliances with Indian partners. Setting up operations through a joint venture
entails the following advantages for a foreign investor:-

1. The Indian partners have an established distribution/marketing setup.
2. The Indian partner has available financial resources.

3. The established contacts of the Indian partner help to smoothen the
process of setting up of operations.
Even before independence, India had so many multinationals in the field of
engineering, chemicals, Pharma and consumer goods. Metal Box, Spencer,
Uniliver, Colgate Palmolive, Sandoz, Pfizer, Siemens and Bayer entered and
prospered due to their monopoly in their respective field. Currently
indigenous organizations have proved that they are nowhere inferior to them.
The current decade is the era of Indian MNCs to operate every part of the
world.

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8.GLOBALISATION- CONCEPT AND PRACTICE

Soon after the independence the slogan of the business community
was “export or perish”, after 50 years of independence, we have
modified it as “globalize or perish”. It is ringing on the ears of
every corporate board room right from the TATAS, BIRLAS,
MITTALS, MALLYAS and MAHINDRAS.

Learning value:
On completion of this chapter, reader will have a complete idea on:
1. Meaning of globalization

2. Driving forces of globalization

3. Competitiveness in globalization

4. India as global player
5. Role of global managers

6. Stages of building globalization

Globalization is a way of life. The countries are not far off, business partners
are not away, goods could be manufactured anywhere, and barriers are
broken. The whole world is on the table. What is required for global players
is a “global mindset”. The global village has now shrunk to global table.

WHAT IS MEANT BY GLOBALISATION?
Globalisation is the “strategy of optimizing” the resources available in
various countries and catering to customers throughout the world with
internationally standardised products, at competitive prices. It advocates that
the nation or a company or product involved should be global. A global man
is one who is born in India, studies in the UK, wears Reid & Taylor, shops
in Marks & Spencer, drives a Lexus, acquires a steel plant in Kazakhstan

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and ships his hot rolled coil to China. Thus, he becomes a part of
globalisation process.
Liberalisation, the rise of developing countries, new technology and
falling trade barriers are changing the economic landscape profoundly, and
contributing to fast track globalisation in many countries. Increasingly we
are living in a global world. In practical terms, this means that a steel
company in the United States will consider other countries as well as the US
when deciding where to locate a new $ 1 billion steel mill. Other examples
are automobile manufacturers such Fort Motors, who entered emerging
markets such as China or India with modified versions of existing cars,
rather than designing a new car from scratch and Mazda, which designs its
sports car in California, produces components in Tokyo, makes prototypes in
Worthington, and finally assembles the car in Mexico in order to market it in
North America at a very low price. China sources its fibre from South
Korea, uses funds from Macauk and a labour force in Beijing and finally
markets its soft toys all over the world.

The economic landscape is not the same as it was twenty years ago,
nor is the pace of global economic change expected to slacken in the next
twenty years. This will have an effect on everybody from the highest to the
lowest. India’s finance minister will have to view the integration of India’s
economy with the rest of the world as fundamental to the country’s
transformation into an economic superpower, and a junior manager in a firm
will have virtually no chance of making it into the top ranks of the company
unless he or she combines superb qualities and skills in job performance
with extensive international experience.

Financial MAZDA
Resources
TOKYO

Design
California North America
MIATA
MEXICO
(Assembly)
CAR South America
Prototype BRAND Europe
Worthington

Assembly Low Cost
Units
TOKYO 137


GLOBALISATION TRENDS
Globalisation can be defined in several different ways depending on
the level we choose to focus on. The philosophy is “the whole world is my
market; wherever the opportunity arises I will tap it irrespective of location,
standard of economy, ethnic relations and all other parameters.” “Cross
border customers are my neighbours; I will be close to them at any time” – a
slogan of a global manager. “Globalisation is a mindset rather than physical
pharmaceutical giant in India.

At a worldwide level globalisation refers to the growing economic
interdependence among countries, which is reflected in the increasing cross-
border flow of goods, services, capital and know-how. Clear evidence of this
is offered by the following trends:

Between 1989 and 200, cross-border trade in goods and services grew
at an average annual rate of 6.4 percent. This is almost twice as fast as the
average annual growth rate of 3.2 percent in the world’s GDP during the
same period.

From 1980 to 2000 foreign direct investment grew from 4.8 percent to
10 percent of the world’s GDP. Destinations for flow of funds have changed
drastically. It has increased to 18% till the first half of 2007.

In 1970 cross-border transactions in bonds and equities, as a ratio of
GDP, stood at under 5 percent in the US, Germany and Japan. By 2001, the
respective figures for these countries had soared to 152 percent, 197 percent
and 83 percent respectively. After 2001 every year it witnesses more than
15% in all those three countries.

At the level of a specific country, globalisation refers to the ability of
the country to expand its trade and aggressively dominate in other parts of
the world; by motivating its entrepreneurs by investing, manufacturing and
marketing.

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Despite the fact that globalisation is taking place very rapidly, all the
countries are not equally integrated into the global economy still. Some key
indicators to measure the global integrated into the global economy still.
Some key indicators to measure the global integration of any country’s
economy are exports and imports as a ratio of GDP, inward and outward
flow of foreign direct investment and portfolio investment, and flow of
royalty and know-how payments associated with technology transfer. The
growths of China and India with respect to some of these indicators during
the last two decades ensure that they will emerge as major global players.
At the level of a specific industry globalization refers to the strength
of a company in the face of international competition. The more global an
industry, the greater is the face of international competition. The more global
an industry, the greater is the advantage that a company can derive from
leveraging technology, manufacturing and brand names.

Specific industries which are on the verge of globalization co-ordinate
their strategic actions across countries. For example, the athletic footwear
industry is dominated by the firms of Nike, Reebok and Adidas. In the same
way Armani, Versace and Vanity Fair are looking at global markets and
strategizing their activities with new vigour. Currently Wal-Mart, Mark &
Spencer and TESCO chains are integrating by cost effective sourcing. The
current aggressiveness of Vodafone to dominate in the communication area
especially in Asia is daring and expensive globalization in non conventional
sector.

SOME LESSONS FROM GLOBAL COMPANIES
Toyota is a good example of a highly globalised company. At the end
of 1995 one-third of Toyota’s global output came from wholly or partially
owned affiliates located in twenty-five foreign countries spread over North
and South America, Europe and Asia.

Furthermore, Toyota exported 38 percent of its domestic production
from Japan to foreign markets and engaged in significant intro-firm flows
among its affiliates. Within its South East Asian regional network Toyota
exported diesel engines from Thailand, transmissions from the Philippines,
steering gears from Malaysia and engines from Indonesia. In effect units
were set up by Toyota in the whole of South East Asia, to assemble different
automobile parts, depending on the competency and resources of the
country.

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Key indicators of the globalisation of a company are international
dispersion of its sales revenue and asset base, intra-firm trade in intermediate
and finished goods, and intra-firm flows of technology. These all lead to its
physical presence, scattered investments, global image, brand promotion and
building borderless customer patronage.

FREE MARKET
IDEOLOGY

RISE OF
DEVELOPING
ECONOMIES
CROSS BORDER FLOW
OF:
TECHNOLOGY GOODS
ADVANCES GLOBALISATION
SERVICES
INVESTMENTS
TECHNOLOGY
HUMAN RESOURCES

NEW BUSINESS
OPPORTUNITY
DUE TO WTO

CHEAP
LABOUR
FORCE

HUGE
INVESTMEN
TS IN INFRA 140
STRUCTURE


DRIVING FORCES OF GLOBALISATION

DRIVING FORCES FOR GLOBALISATION
Globalisation occurs because specific managers in specific companies make
decisions that result in increased cross-border flow of capital, goods and
known-how. Managers are increasingly making such decisions because
globalization is becoming more feasible and desirable. The following trends
lie at the core of these developments.

1. An ever-increasing number of countries are embracing the free-market
ideology, Economic policy makers in industrialized and industrializing
nations have shifted from a ‘planning’ mentality to a ‘market’ mentality,
which has been well documented. Since the end of the second world war,
the rising tide of free-market ideology that started with developed
economies has swept up South Korea, Taiwan, Hong Kong, Singapore
and other South East Asian economies, and is now moving into China,
India, Brazil, parts of Africa and central and eastern including Russia. As
per BRIC report, four countries will surpass the developed nations in
terms of growth and prosperity.

2. The economic centre of gravity is shifting from the developed to
developing countries. Economic liberalization promotes competition,
efficiency, innovation, new capital investment and faster economic
growth. Today’s market mechanisms have allowed the developing
economies to start catching up with the advanced economies, so that
China, India, South Korea, Taiwan, Indonesia and Thailand are emerging
as major players in the global market. In fact Taiwan, Hong Kong and
Singapore, which were amongst the world’s poorest countries in the

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1950s are already listed as advanced economies. Despite short-term
growth for the region are still valid. Their shares in global markets are
eating slowly the shares of developed countries especially in plastic,
rubber, medical and electronic components.
Larger economies, notably China are advancing rapidly. Having
sustained an annual GDP growth rate above 10 percent since 1980, China
has already transformed itself into the third largest economy in the world
at least on a purchasing power parity basis and seems poised to overtake
Japan in the near future.
These numbers indicate that the world’s economic centre of gravity is
shifting. Today, any company that seeks to grow has little choice but to
go where the growth is. For the vast majority of the world’s top 500
industrial corporations, such growth can only take place globally as the
home markets are saturated.
3. Technological advances are constantly improving. The cost of air
transportation, telecommunications and computers has declined sharply
over the past two decades. The decline in transportation costs, especially,
has motivated companies to explore new avenues and new countries. In
the case of computers and telecommunications, the consistent decline in
costs, and the recent widespread adoption of technologies such as video
conferencing and electronic mail have made operations simple, effective
and fast. By combining these trends with mobile telephones, video
telephones, the Internet and increasingly powerful computers, one can
optimize a real-time coordination of globally dispersed activities. This
will lead to a further increase in the intensity of global competition and
an even greater search for the best locations for the discrete activities in
company’s value chain.
4. The main hidden principle of WTO is to generate new business
opportunities throughout the world. The opening of borders to trade,
investment and technology transfers not only creates new market
opportunities for companies but also enables competitors from abroad to
enter the home markets.

5. The availability of cheap labour has caused many companies to shift their
manufacturing units to locations where a competent work force is
available at much lower rates. Increasing competition forces competitors
to offer better global services, to capture economies of scale, to exploit
the cost reducing or quality-enhancing potential of optimal locations and

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to tap technological advancements wherever they may occur. This has
resulted in an accelerated growth of globalization.
6. All the countries are vigorously developing their airports, seaports,
energy sources and social amenities. Singapore, Malaysia, South Korea
and India facilitate companies by assuring.

ORGANISATION AND GLOBALISATION
Due to the increased rate of globalization, the global economic landscape
will undoubtedly look very different 20 years from now. Companies will
need to adapt to this changing landscape and those that choose to move first
will have a better chance of turning these changes into competitive
advantage.

The author regards three fundamental changes in the global economic
landscape as inevitable. These are described below.

Developing countries will essentially dominate the world economy in the
future
Given the commitment of the post-Deng Chinese leadership to economic
reform, China is likely to remain in the most successful economic story. Its
status as a super power is visible in innumerable fields like textiles,
garments, chemicals, silk, soft toys and ceramics. Despite its rapid growth
since 1979, China’s economy has attracted attention, only during the last few
years.

China is not alone. As the economies of other countries such as India,
Brazil, Mexico and Russia continue to gather momentum, they will
increasingly become major contributors to the creation of new wealth. It is
expected that in 20 years, China’s economy will be larger than that of the
U.S. and India’s will be as big as that of Japan. The regional composition of
the world’s largest corporations will change radically, spreading, over the
developing countries, rather than just being limited to the U.S. and Europe,
where the majority of them are situated today. As a consequence intra-
industry competition will intensify.
As an example from India, consider the case of the loosely held Tata
Group, a group of companies involved in a number of businesses, such as
steel, cement, engineering, chemicals, tea, construction, IT, hotels and
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trucks. The group’s intention is to triple its sales by 2010 and to achieve this
target it has narrowed down the group’s portfolio and increased control over
the individual companies. It is inevitable that the Tata Group will emerge as
a global power through cross border alliances and strategic moves. In the
field of steel it acquired larger unit, Corus as compared to its own Tata steel.

Similar strategic moves are taking place in many business houses in
India, like Reliance, the Aditya Birla group and Murugappa. The same trend
is visible in the economies of Indonesia, Brazil, Mexico and Malaysia.
Ranbaxy, a pharmaceutical major has multiplied its operations in all the
continents in the world and aiming at achieving Rs.20, 000 crores by 2008.
LN Mittal group has emerged as a global steel giant, probably one amongst
the top richest three in the world in near future.

CRITERIA FOR GLOBAL ORGANISATIONS
Assuming that the trends described here are inevitable the following issues
need serious consideration by any medium-sized or large company that is
inclined to go global.

1. Size of the market:

How extensive do you want your markets to be, particularly the major
emerging markets for your products and services? How should you build a
necessary global presence?

2. Location advantage:

To what extent do you want to capture the cost reducing and quality
enhancing potential of locations around the world for the execution of
various activities in your company’s value chain? How should you deal with
the problem of suboptimal locations currently in use?

3. Global competitiveness:

How effective do you want to be in exploiting global presence and turning it
into a true global competitive company as opposed to global mediocrity?
How should you eliminate the existing shortcomings and impediments?
4. Management efficiency and mindset:

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Is the mindset of your company’s top management sufficiently global? As
the world around you changes and new opportunities open up in various
parts of the world, is your company generally a leader or a laggard in
identifying and exploiting these opportunities? How should you create the
needed global mindset?

5. Vision and long term objective:
Does your company have vision? Is it there with everyone? Whether proper
road-map is in place. Is it only for generation of money or for leadership?

6. Right human resource to handle:
Do you have sufficient HR, especially technical? Or yet to be appointed in
the location of operation?

Once a company has selected the country or countries that will serve as a
launch vehicle for its products, it must determine the appropriate mode of
entry. This issue rests on two fundamental questions:
• To what extent will the company rely on exports versus local production
in the target market? Here the firm has a range of choices as follows. (i)
100 percent export of finished goods, (ii) export of components but
localized assembly, (iii)100 percent local production.
• To what extent will the company exercise ownership and control over the
activities carried out locally in the target market? Again, it faces a range
of choices as follows: (i) 0 percent ownership by licensing or franchising,
(ii0 partial ownership such as joint ventures or collaboration, (iii) 100
percent ownership as a wholly owned subsidiary.

Local production would be appropriate under the following conditions:

1. Longer local production: The local market is larger than the minimum
efficient scale of production. The larger the local market, the more local
production will translate into scale economies while holding down tariff
and transportation costs. An example is the entry of the Japanese tyre
group Bridgestone into the US market by acquiring the local production
base of Firestone instead of exporting tyres from Japan.
2. Cost of logistics and tariffs: Shipping and tariff costs of exporting to the
target market are so high that they neutralize any cost advantages of
manufacturing the product at any place other than the target market. This

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is the main reason why cement companies such as Cemex and Lafarge
Coppe engage heavily in local production in all the countries they enter.
3. Localization and customization of products: The need to customize the
product to suit local requirements is high. Customization of a product
requires a deep understanding of local market needs and the ability to
incorporate this understanding into which products to market and their
design. Localising production in the target market area significantly
enhances a firm’s ability to respond to local market needs.
4. Requirement for local production: There is a strong requirement for
local production by the host country. This is one of the major reasons
why foreign automobile companies rely heavily on local production in
markets such as the European Union, China and India. The Hyundai
Corporation has strengthened its production base in India and
components are procured in India. Besides the above criteria, the
strategic approach for successful companies could be on the following
lines:
a. Product focus, i.e. Bic pens and Ray ban.
b. Human Resource focus, i.e. Infosys and Wipro.
c. Technology focus, i.e. Microsoft and Singapore airlines.
d. Service focus, i.e. FEDEX and Singapore airlines. They are going in
their respective business with complete focus.

The Extent of Ownership Control over Locally Performed Activities
Entering the market via an alliance permits a company to share the costs and
risks associated with market entry and allow rapid access to local know-
how. However it also has the potential for various types of conflict. Alliance
based entries are often more appropriate under the following conditions:

1. The company is short of capital. In the 1950s, Xerox Corporation decided
to enter the European market through an alliance with the United
Kingdom’s Rank Organisation. Rank’s goodwill and presence in the UK
benefited the Xerox Corporation immensely.
2. There are large physical, linguistic and cultural differences between the
host and the home country. The more dissimilar and unfamiliar the target
market, the greater is the need for a firm to rely on a local partner to
network and provide local know how. Given a choice the company would
prefer to obtain these assets through an acquisition. However, in
unfamiliar markets, a firm’s ability to manage an acquired subsidiary is
often very limited, and hence the involvement of a local partner becomes
inevitable.
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3. A subsidiary would not be able to integrate its operations easily with the
other multinational operations and hence puts major constraints on a
firm’s ability in the initial stages of operations.
4. In a typical joint venture, the two partners pool different but
complementary know-how. They interact regularly through their core
operations and understand each other’s working. Both partners learn the
other’s know-how and often if one firm learns faster than the other it may
sooner or later seek to dissolve the alliance.
5. Government regulations stress upon local equity participation.
Historically, several countries with a very large market potential such as
China and Brazil have been successful in imposing joint ventures.

STAGES OF GLOBAL ORGANISATIONS

Globalization process does not take place instantly. It is a deliberate and
cautious move for several companies. Nike and Addidas took more than a
decade to move to other countries from their origin. Apple, HP and Dell are
fast globalizing their operations due to technology advantages. if they are
not quick then technology obsolescence will crop up and finally they have to
lose their current status to their competitors. However, in the normal
process, a complete globalization has to pass through several stages as
described in the following table:

Stages Purpose Action End Result
Make the presence One market established.
Physically export and
feel – the move Trial and errors are
Stage # 1 establish one strong
for product or overcome, confidence is
contact overseas
service built
Study the whole Find out a right partner. Awareness is created in
nation and explore Jointly promote the one territory. The demand
Stage # 2
the avenues for product/s. establish brand level is known for the
production in one market. production.
Identify location or
Set up production Becoming close to the
develop a complete
Stage # 3 facility with a customer at a reduced cost
network. Reduce the cost
local or alone and part of the local
and service the market.
Expanding to Take the products from The whole region is
Stage # 4
neighboring areas the unit and spread in aware. Loyalty is built.

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through nearby countries and build The network members
production brand name become patrons.
Analyse the potential in
Review all the various regions. Evaluate Comparing and selection
Stage # 5 pitfalls and gear the partners, investment of right locations, right
up to other regions climate and Socio- partners and right markets
Cultural background
Global production
Produce, distribute, invest
Emerging as Global investments
Stage # 6 and build corporate image
global enterprise Global brand name
and face competition
Status of global company

SPEED OF GLOBAL EXPANSION
Having begun the journey towards globalization, a company must still
address the question as to how fast it should expand globally.

Rapid globalization enables a firm to grow aggressively but it can also
spread managerial, organizational and financial resources quickly. The
absence of one of these resources can jeopardize a company’s ability to
perform.

Faster global expansion is more appropriate under the following
condition:

A. It is easy for competitors to replicate a firm’s recipe for success. This
possibility is obvious for fast food and retailing companies such as
Kentucky Fried Chicken and Starbucks. Once the concept has been
created in a market, competitors can come in and easily replicate it with
relatively low investment.

B. The scale of economies is extremely important. Mass production through
cost reduction leads to rapid success. Firms which come in later may lose
out in a specific sector. This is the reason why tyre manufacturers such as
Goodyear, Michelin and Bridgestone, which went global at rapid rate
now have considerable advantage over other firms such as Pirelli and
Continental, which were slower in entering the global market.

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C. The management is highly capable of managing global operations. For
example, consider the case of global companies such as Anglo Dutch
conglomerate Unilever or the Swedish-Swiss company ABB. If these
companies successfully introduce a new product line in one country, it is
relatively easy, and also logical, for them to globalize this line rapidly.

THE ROLE OF GLOBAL MANAGERS – CRITERIA FOR
SUCCESS
The management, which may be very successful domestically may not be
able to maintain the same level of performance level in its global operations.
Global operations require the investment of extremely large sums of money
and the managers have to live up to high expectations. To handle business in
a global context and make an organization successful, the managerial team
requires certain unique qualities.

1. They should have a strong information base.

2. They should possess multi-lingual skills.

3. The managerial cadre should be adaptable in its approach.

4. They should understand the strategies of their competitors.

5. Cost management should be meticulous.
6. The persons should be highly innovative and be able to identify new
avenues.

7. They must be able to understand and implement all the organizational
policies.

8. The leader must be acceptable, not only to his team, but also to
institutions like banks, which support the company.

In short, the managerial team should consist of personnel who are multi-
lingual, multi-cultural, adaptable, informative, multi-functional, efficient
and enthusiastic. Only then will a company be able to succeed in its
global operations.

149

STAGES FOR GLOBALIZATIONBusiness- AN Chandran
International FOR Dr. R.
ENTERPRISE

Stages Objective Action Plan Anticipated risks and End Result
hurdle
“Physical (i) Identify one (i) Local resistance for (i) Entry into one
movement of country. bringing. country- successful.
goods and (ii) Focus on one (ii) Technical and (ii) Learning
Stage:1 services from product or services. commercial barriers. experience in a
the country of (iii) Explore (iii) Competitive forces country outside.
its origin”. opportunity for from local and
exports. imported goods.
“Strengthen (i) Build a strong (i) Local competitors (i) Strengthen one
and stabilize relation in one pose threats. country by
one overseas market. (ii) Price war is overcoming all the
market.” (ii) Promote brand inevitable. hurdles.
Stage:2 name with (ii) One or few
customers and importers extend
channels. cooperation and
support for constant
flow of goods.
“Establish (i) Narrow down to (i) Competitors (i) Local production
manufacturing one local partner. increase their brings down the cost.
base in the (ii) Locate an ideal production capacity. (ii) The enterprise
Stage:3 importing place for (ii) Local regulations becomes close to the
country”. production. on labour, transaction customers.
(iii) Workout for and infrastructure may (iii) Brand loyalty is
financially together. trouble the operation. built.
“Spread the (i) Develop fast (i) Every part of the (i) Access in the
distribution and network in the region works whole region.
increase neighbouring differently. (ii) Easy to
production in countries. (ii) Rules are not experiment in other
Stage:4 the region”. (ii) Setup uniform. regions.
warehouses / sub- (iii) Demand level is (iii) Revenue is
dealer network in not similar in every increased.
the region. country.
“Move to other (i) Set up (i) Cross cultural (i) Global take off
regions by subsidiaries. complexities. assured.
investing and (ii) Develop strong (ii) Local adaptability. (ii) The enterprise has
producing”. systems. (iii) Promotional a competency in skill
(iii) Induct right barriers. and knowledge to go
Stage:5 people with global.
performance.
(iv)Flexible to local
environment.

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“Global (i) Organization to (i) Challenge on (i) Global investment.
mindset, be global. governance. (ii) Global
customer (ii) Investment to be (ii) Ethical standards. competency.
orientation and global. (iii) Concern for the (iii) Global branding.
constant (iii) Technology to locals. (iv)Global
Stage:6 innovation”. be global. (iv) Human Resources. Organization.
(iv) Real
optimization of
resources takes
place.

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9.WORLD TRADE ORGANISATION (WTO)

Transparent, free and rule-based trading system
Provide common institutional framework for conduct of trade relations
among members
Facilitate the implementation, administration and operation of
Multilateral Trade Agreements
Rules and Procedures Governing Dispute Settlement
Trade Policy Review Mechanism
Concern for LDCs and NFIDCs
Concern on Non-trade issues such as Food Security, environment,
health, etc.

Learning value:

Chapter deals with:

1. GATT & WTO
2. WTO overview
3. Developments in WTO
4. Environmental issues
5. Dilemma of developing countries
6. Impact of WTO on Indian Businesses

The roots of the World Trade Organisation (WTO) lie in the General
Agreement on Tariffs and Trade (GATT) which was established in 1948 by
23 original founders, India being one of them. The 8th round of talks under
GATT (1986-1994), KNOWN AS THE Uruguay Round, led to the birth of
the WTO on 1st January 1995. In the Uruguay Round, new agreements such
as the General Agreement on Trade in Services (GATS) and the Agreement
on Trade Related Aspects of Intellectual Property Rights (TRIPS) and Trade
Related Investment Management System (TRIMS) were negotiated. All the
three major agreements along with their associate agreements now rest under
the umbrella organization, namely the WTO.

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The WTO, which has its headquarters in Geneva, Switzerland, has a
membership of 150 countries. More than 98% of the global trade is
transacted among the members.

As the only regulatory body of world trade, the WTO’s objective is to ensure
a freer, more transparent and more predictable trading regime in the world.
The WTO is based on a sound legal system and its agreements are ratified
by the parliaments of member countries. No one country controls the WTO;
wherein the top decision makers are the designated ministers of member
countries.

The WTO agreements cover:
• Goods, e.g., all industrial products, FMCGs etc.
• Services, e.g., banking, insurance, consultancy etc.
• Intellectual property, e.g., patents, copyrights, designs and trademarks
etc.

Two important principles that underline most agreements are:
a) Most Favoured Nation Clause: No discrimination among member
countries.
b) National Treatment Clause: Equal treatment to imported and domestic
products.

These agreements broadly address three concerns:

Same rule for all: It restricts governments or organisations from ‘distorting’
normal trade by way of subsidising, dumping or discriminatory licensing
policies. Government policies are framed to eliminate distorting effects. The
WTO allows exports to be relieved of all indirect taxes such as excise, sales
tax etc. since they have a cascading effect on the cost of the product.

Administration of agreements: It has detailed guidelines as to how the
agreements should be administered at a national level. These apply to anti-
dumping proceedings, standardization, sanitary and phytosanitary measures,
or settlement of disputes.

Fair deal to businesses: It ensures rights for the business community e.g.,
the right to information, the right to present evidence etc. For example, the
Agreement on Customs Valuation allows the importer to justify the value of

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imported goods or requires the customs to give written reasons for rejecting
the value disclosed.

DIFFERENCE BETWEEN GATT AND THE WTO

• GATT signifies two aspects – GATT as a body and GATT as a
formulator of agreements.
• GATT – the body no longer exists; it was merged with the WTO on
1st Jan, 1995.
• GATT – the agreement rests in the WTO along with other
agreements.
• The WTO now includes GATT, GATS, TRIPS and the Dispute
Settlement body. GATT covered trade in goods only, whereas the
WTO covers trade in goods, services, and intellectual property rights
as well.
• Throughout its duration, from 1948 to 1994, GATT was ad hoc and
provisional; WTO and its agreements are permanent.
• GATT has contracting parties, whereas the WTO has member nations.
• The WTO is an inherently superior system as compared to GATT, as
it has a sound legal basis; even its agreements are ratified in the
members parliament.
• WTO has two significant functions, which GATT did not have. These
are:
(i) Trade Policy Review Mechanism – a periodic process to examine
a country’s trade policies and to note changes and (ii) an in-built
mechanism to settle disputes, which cannot be overlooked by anyone.
• The WTO is more democratic in character. If decisions cannot be
reached by consensus, the matter is decided by putting it to vote; each
WTO member having one vote. In the case of GATT, it was
controlled by a power lobby.

WTO: THE ORGANISATION

The World Trade Organisation (WTO) monitors global trade. Its decisions
are absolute and every member must abide by its rulings. Extra powers given
to the WTO are supposed to ensure that disputes are settled in harmony with
international trade principles. It is located in Geneva, Switzerland. At its
head is the Director General, who serves a term of four years. Its staff is
made up of 500 persons of varying nationalities.

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The Decision Making Process

The Ministerial Conference, comprising designated ministers of the member
nations is the supreme decision making forum. The ministers meet at least
once in two years. The Ministerial Conference can take decisions on ‘all
matters’ under any of the multilateral agreements.

Second level

The day-to-day work is handled by the General Council, which also acts as
The Dispute Settlement Body and The Trade Policy Review Body. The
General Council acts on behalf of the Ministerial Conference and meets
under these three different terms of reference.

Third level

Three more councils, each handling a different broad area of trade, report to
the General Council: the Council for Trade in Goods, the Council of
Services and the Council for TRIPS.

Fourth level

Each of the higher-level councils has subsidiary bodies. The Council for
Trade in Goods, for example, has 11 committees dealing with specific
subjects such as agriculture, subsidies etc.

Four Principles

The WTO has 145 members and makes decisions on a basis of unanimity.
No country has a power of veto.

The four principles which members abide by are:
1. Extending trade concessions equally to all WTO members.
2. Aiming for a freer global trade with lower tariffs everywhere.
3. Making trade more predictable through the use of rules.
4. Bringing about more competition by cutting subsidies.

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The definition of ‘trade’ has steadily expanded and now includes intellectual
protection, investment, trade in services and agriculture as well as trade in
manufactured goods.
In its short life the WTO has already become the focus of intense
controversy. Heralded by the richer nations as the ticket to world prosperity,
to many others it’s looking more and more like another Trojan horse in the
citadel of international development.
‘Freeing up’ trade- GATT’s Uruguay Round concluded at the end of 1993,
basically ‘freed up’ world trade. This meant doing away with barriers which
had prevented developing countries from exporting their goods to the richer
countries of the North. It also opened up all countries to foreign penetration
in completely new areas, such as service industries and intellectual property
rights. This offered richer nations and multinational corporations a golden
opportunity to take over new sectors in countries that were previously able
to protect their own smaller industries.

The WTO has the task of policing this new world order, and is beginning to
make its presence felt. Fairer trading provisions, which guarantee protection
to producers in the developing world, have already come under fire. The
USA, on behalf of the American MNC Chiquita, has challenged
arrangements whereby bananas from the Windward Islands are marketed in
Europe under the protection of the European Union’s Lome Treaty.
Dismantling such arrangements would bring Chiquita greater profits, but
would prove disastrous to the farmers and the economies of the Eastern
Caribbean. The WTO has upheld the US complaint.

It was perceived that the WTO is controlled by the industrialized nations,
just as they control the World Bank and the IMF. At the conference held in
Singapore in December 1996, delegates from developing countries
complained at being excluded from ‘behind the scenes’ discussions. The
charge was accepted by Renato Ruggier, who was the WTO’s Director
General at that time. While the WTO claims that its rules-based system is a
means of protecting smaller nations from the larger trading powers, many of
those smaller nations have complained of being bullied by the very
countries, which set the rules in the first place.
International resistance - While some developing countries, particularly
Latin America and East Asia, may be able to compete in the world trade, the
world’s least developed countries are predicted to lose out. Even in richer
countries, the expansion of MNCs has a negative impact on smaller

156


businesses, labour standards and basic freedom. A growing international
movement is forming in protest against the WTO and its expanding ‘free
trade’ agenda. Multilateral negotiations, known as ‘rounds’, held in Seattle
and Doha. Qatar made the representation of developing countries stronger
than before especially regarding issues related to agricultural subsidies and
labour legislation. In many ways the advanced countries appear to have
double standards. This approach has been challenged and the influence of
the advanced countries in the WTO is gradually diminishing.

Developments
• The agenda of the WTO, the implementation of its agreements, and the
much-praised dispute settlement system all serve to advance interests of
developed countries, sidelining those of the developing countries.

• The Least Developed Countries (LCDs) are marginalized in the world
trade system, and their products continue to face tariff escalations.

• Rules uniformly applied to WTO members have brought about
inequalities because each member has different economic circumstances.

Compared to GATT, the WTO is much more powerful because of its
institutional foundation and its dispute settlement system. Countries that do
not abide by its trade rules are taken to court.

Historically, GATT enforced phased-in tariff reductions worldwide. Until
the Uruguay Round, which ended in 1994, the trade negotiations focused on
nonagricultural goods, mainly because the U.S. wanted to protect its farm
sector. Over the years, as the corporate interests of the developed countries
expanded, they also lobbied for more issues to be incorporated into the
WTO.

Changes in rules come about mainly through multilateral negotiations or
“rounds”. Each round offers a package approach to trade negotiations, in
which many issues are negotiated together and trade-offs between different
issues are made. Between the rounds, negotiations on single issues take
place.

One of the commonly used yardsticks to measure the success of the WTO
is the volume of world trade. The results seem excellent in this respect, with
world trade up by 25% in the last four years. But the benefits of increased
trade are not widely shared. For example, the LDCs represent 20% of the
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world’s population, but they generate a mere 0.03% of the trade flows.
Developing countries have little power within the WTO framework for the
following reasons:

1. Although developing countries make up three-fourths of the WTO
membership and can in theory influence the agenda and outcome of trade
negotiations, they have never used this to their advantage. Most
developing country economies are in one way or another dependent on
the U.S., the EU, or Japan in terms of imports, exports, aid, security, etc.
Any obstruction of a consensus at the WTO might threaten the overall
well-being and security of dissenting developing nations.

2. Mutual give and take policies with tariff reduction exist between
countries. This type of bartering benefits the large and diversified
economies, because they can get more by giving more. For the most part,
negotiations and trade-offs take place among the developed countries and
some of the richer or larger developing countries.

3. Developing countries have discovered that seeking recourse in the
dispute settlement system is costly and requires a level of legal expertise
that they may not have.

Nelson Mandela, commenting on the negotiations said: “The developing
countries were not able to ensure that the rules accommodated their realities.
It was mainly the preoccupations and problems of the advance industrial
economies that shaped the agreement.” He added that rules applied
uniformly are not necessarily fair because of the different circumstances of
members.

“Trade and labour standards” is a highly sensitive issue. To date, a clause
of labour standards has not been included in the policies framed by the
WTO. The issue has been raised by some industrial nations, who feel that
the subject should be studied by the WTO as a first step towards bringing the
matter of “core labour standards” into the organizations. There is a great
divide between most of the industrialized nations and the developing
countries on the subject. Developing countries like India are most very vocal
on labour issues. They feel that developed nations try to annihilate the
comparative advantage they have of cheaper labour, and argue that the
International Labour Organisation (ILO) is the right platform to discuss the
issue and not the WTO.

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Environmental Issues
The WTO has no specific agreement on environment; it has a “Trade &
Environment Committee’, which plays a limited role. There is increasing
pressure by environmentalists on the WTO to take proactive measures to
protect the environment. The US banned import of tuna fish from Mexico in
accordance with its Marine Mammals Law, which has the mandate like
dolphins. At that time Mexico appealed to GATT whose verdict went
against the USA.
Trade experts fear that free trade will be undermined in the guise of
protecting the environment, if such issues find a place and are emphasized in
the WTO. There are more than 200 Multilateral Environmental Agreements
(MEAs) on various aspects of the environment. Twenty of these include
provisions that can affect trade e.g., the Montreal Protocol for Protection of
the Ozone Layer, the Basel Convention on Trade or Transportation of
Hazardous Goods. The WTO is off the view that the most effective way of
dealing with environmental issues is through international agreements.

Dilemma of Developing Countries-
Exports from developing countries continue to face significant market access
impediments. Recent UN studies confirm that tariff peaks and tariff
escalation still hamper developing country exports and their attempts to
export new products such as beef, cigarettes, clothing, footwear and wooden
articles.

To gain access to new markets in developing countries, the developed
counties are acting in the interests of transnational corporations. They have
rapidly imposed new agreements in telecommunications, information
technology, and financial services. The Millennium Round talks paved the
way for further economic liberalization in both the traditional and new
sectors, which is contrary to the interests of developing countries.

For example, Washington has interpreted WTO agreements to protect key
industries. For example the U.S. has selectively opened its markets in the
field of textiles and clothing, but this liberalisation has proved of little
benefit to the developing nations. Similarly, the U.S. has misused the
measures designed to safeguard domestic industries from a sudden increase
in imports. It has also introduced its own Rules of Origins, rules used to
identify where textiles or clothing products come from, changing the

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conditions of competition and adding to the restrictions against the low-cost
textile exports from other countries.
New rules regarding information on plants will have both agricultural and
medical implications. The Trade Related Intellectual Property Rights
Agreement (TRIPS) fiercely protects the rights of corporations but easily
allows the shared knowledge of indigenous communities to be patented by
others. When fully implemented, developing countries will lose billions of
dollars to the richer countries, as MNCs will continue to control virtually all
the patents of developing countries.

The agreement between the U.S. and China, stipulated the terms on which
China would join the WTO. This is the most significant deal between the
two countries since diplomatic relations were established more than two
decades ago. The Clinton administration hoped that this would pave the way
for Congress to now vote permanent Normal Trade Relations (NTR) (also
known as Most Favored nation), thereby giving China the same trading
privileges now enjoyed without an annual review, by almost every other
U.S. trading partner. The only other nations denied NTR status by the U.S.
are: Afghanistan, Cambodia, Cuba, Laos, North Korea, an Yugoslavia,
China has enjoyed NTR since 1980, but only by an annual vote of Congress.
Only if the U.S. Congress approves permanent NTR for China can the
November agreement be implement. WTO membership for China and
permanent NTR status will clear the way for Taiwan to join the WTO.

IMPACT OF WTO AGREEMENTS ON INDIAN BUSINESSES: AT A
GLANCE

AGREEMENTS OBJECTIVE OF IMPACT ON BUSINESS
AGREEMENT INDIAN IMPLICATIONS
POLICY/ LAWS
General Prohibits: actions India started Import on all
Agreement on of Govt/ reforms during manufacturers,
Tariffs & Trade organizations that GATT negotiation traders and service
(GATT) distort normal period (86-94) providers
trade; • Import duties • Competition to
discrimination down form intensify as more
between member peak 300% to imported
nations and 15%. Already products finds
discrimination complies WTO easy access.
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POLICY/ LAWS
between domestic binding on Around half of
and lawfully most tariff the products
imported foreign lines. reserved for
goods. Set • Committed to Small Industries
guidelines for remove all already in OGL.
implementation of QRs Removal of QRs
agreements and (Quantitative set to further
settlement of Restrictions) accelerate import
disputes. by 2003* i.e. of all products.
import • WTO led
restrictions/ external
licenses to go. liberalisation
• Committed to speedily done;
create freer Half baked
trade regime as internal
per GATT liberalization to
agreement; hurt domestic
already industries’
amended host competitiveness
of legislation, severely;
more to follow industry suffers
from poor
*India’s plan of infrastructure,
phasing our QRs absence of VAT,
(chiefly obsolete labour
restrictions in laws, lack of
import through coordination
negative lists) is among ministries
contested by US. and non-
Recently WTO availability of
panel economical,
recommendations quality services-
have gone against Banking,
India, i.e. it could Insurance, inland
mean early phase transport etc.
out, even before
2003. It will affect
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POLICY/ LAWS
consumer goods,
agricultural,
textiles and
petroleum
products etc.
- Availability of
economical, quality
services-Banking,
insurances, in land
transport etc.
• Ignorance among
SMEs on WTO
shockingly high;
set to attract
injuries from
sudden spurt in
unfair imports.
• Reassessment of
comparative
advantage
required. Many
will have to
change
businesses; rigid
legislation and
rules would be a
big stumbling
block in the way.
• Only those
businesses,
whether
producing for
domestic market
or for foreign
markets, who
have

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POLICY/ LAWS
international
vision will
survive and grow
(in most of the
product
categories)
1.a.
Agreement on Requires countries India has amended
• India has
Implementation to follow the its law in amended its law
of Article VII of agreement for conformity with in conformity
GATT (94) valuation of agreement by with agreement
(valuation of imports to check notification 26 by notification 26
Goods) arbitrary decisions (NT) 24.04.95; (NT) 24.05.95;
Customs Customs Act. Customs Act.
• Importers and
exporters to
benefit from
more transparent
regime. While
rejecting the
value given by
importer,
Customs will
have to give
reasons in
writing. Clear
guidelines
provided for
computing value.
1.b. To check arbitrary (India does not use • Indian companies
Agreement on ways of PSI service of PSI exporting to the
Preshipment companies in companies) countries using
Inspection valuation of goods PSI companies
(PSI) (Around 30 (such as SGS,
countries use them) Bureau Veritas
etc) to benefit

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POLICY/ LAWS
form improved
systems.
Arbitrary actions
of PSI companies
in computing
Export value to
be checked.
1.c. Agreement To check misuse of Bureau of Indian • Indian exporters
on Technical mandatory product Standards (BIS) is of electrical
Barriers to Trade standards by following the machinery,
(TBT) countries. agreement (most consumer
Recommends Indian Standards articles,
countries to base are base on Intl. pharmaceuticals,
their standards Standards) detergents,
around Intl. BIS is also to serve automobiles,
Standards. as an enquiry point household
Requires countries electric/
to establish electronic
‘enquiry points gargets,
insecticides,
hazardous
chemicals,
fertilizers, toys
etc to benefit
from the
agreement as
import of these
products are
subject to
Mandatory
product
Standards.
• Enquiry points to
help in accessing
the information
• Threat: The

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POLICY/ LAWS
agreement also
covers PPM
(Process and
Production
Methods). That
could be used for
discrimination
against Indian
exports for
agri/food/pharma
products.
1.d. Agreement • Same as above • Most of India’s • Companies
on Sanitary and except that standards are at exporting
Phytosanitary MFN rule- par with the fresh/processed
Measures (SPM) countries can Intl. standards fruit/ vegetables/
deny import (Implementatio juices, meant
from certain n to improve) dairy products
region/ country etc should
due to fear of understand the
spread of Mandatory
pests/disease Standards. They
should follow the
developments
taking place at
various Intl.
Organisations as
FAO, Codex
Alimanatrius etc.
which have
serious
implications for
their businesses
in agri, process
food, and dairy
products.
1.e. Agreement • To ensure • System • Improved system
on Import
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POLICY/ LAWS
Licensing transparency in progressively within India and
Procedures issuance of improved, in other countries
import licenses though still far will have a
and also from being positive tall out
prescribes time perfect. Delays for small
limits for & misuse of businesses that
licenses to be discretionary are usually at the
issued powers receiving end of
frequent. EDI restrictive policy
being put in environment.
place.
1.f. Rules • Allows export • Foreign Trade • Exporting
applicable on product to be Policy provides companies have
Exports. relieved to schemes to right to demand
indirect taxes neutralize the from Govt. such
(e.g. Excise) incidence of schemes that
prohibits direct indirect taxes* neutralize the
tax benefits e.g. DEPB*, incidence of
(e.g. Income Adv. License, indirect taxes on
Tax waivers on Spl. Imp. the export
export earnings License etc & product. In
• Also allows Draw Back. absence of such
countries to • Govt provides schemes Indian
levy duties on IT waver# on products will be
exports for export earnings at serious
controlling it, if (80HHC of IT disadvantage
situation so Act) internationally as
demands, but • e.g. Customs all countries have
prohibits other duty on import such schemes in
restrictions contents used place.
(except in few in export • The IT waiver on
cases) product, excise, export earnings is
sales tax/VAT temporary
etc. Few measure;
countries have • According to an
launched EXIM Bank

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POLICY/ LAWS
complaint study, Indian
terming it as exports suffer
‘subsidy’ from cost
#prohibited as disability of
per GATT 16.3% over their
overseas
counterparts due
to absence of
VAT, inadequate
financing and
infrastructure
bottlenecks.
1.g. Agreement • Prohibits export • India may have • Business will
on Subsidies and subsidies; scrap IT waiver have to
Countervailing allows on export understand what
Measures (SCM) permissible earnings by is permissible
subsidies 2003. Foreign and what is not.
• Requires Trade Policy is E.g. subsidies
developing following the given by Govts.
countries to GATT to small
phase them out directives businesses are
by 2003 (with cautiously in usually
some introducing the permissible (non-
exceptions) and Duty actionable) or
to freeze their Exemptions given for R&D or
level and schemes and is for adaptation to
coverage during suitably new environment
transitional modifying requirements.
period. them to make • Even during
them WTO transition period
compatible (upto 2003).
Importing
Also see : Indian countervail
Imports Regime to ‘subsidies’ by
be further increasing duties.
liberalized • Export subsidies

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POLICY/ LAWS
on import
sensitive
products
(textiles, leather
products etc.) can
be maintained by
importing
countries.
1.h. Agreement • Allows • The required • If undue spurt in
on Safeguard countries to take system is put in imports causing
Measures action against place in ‘injury’ to
undue import Commerce domestic
surge injurious Ministry manufacturers,
to domestic measures can be
manufacturers taken during the
during the transition period
transition period (initially for 4
years extendable
upto 10 years.
From Jan’95)
through raising
duties (beyond
bound rates) or
by imposing
QRs; for new as
well as for
development of
existing
industries.
1.i. Agreement • Allow countries • Directorate of • Most important
on Antidumping to take Anti-Dumping for domestic
Measures (ADP) measures established in manufactures. A
against Commerce number of
imported goods Ministry sectors have been
benefiting from • Anti-dumping hurt by ‘unfair
‘unfair trade duties already import’

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POLICY/ LAWS
practices’. been imposed • Actions have
in more than 30 been taken
cases, against such
provisional import in many
duties on few cases. Mostly
• Also see : Is large units have
you industry been operating in
hurt by excess these sectors. No
import action so far for
those sectors
hurt, in which
small businesses
are predominant
because of their
ignorance
1.j Trade Related • Currently • Direct impact • Currently 5 types
Investment prohibits on Govt’s of TRIMS
Measures countries form FOREX & (investment
(TRIMS) imposing 5 Industrial conditions) are
types of policies. prohibited out of
investment Foreign 24 already
conditions on investment identified. Issue
investors permissions. comes up again
in year 2000
• Allows export
performance
requirement,
majority stakes
for locals etc.
1.k. Market • Different • Reduced duties • Massive increase
Access negotiations are on most tariff in competition
Negotiations taking place lines for domestic
with developed successively to manufacturers
countries and comply with • The reduction in
developing the agreement duties in
countries by • Peak rate of developed

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POLICY/ LAWS
keeping low duty is down countries not to
tariff rate in from 300% to have much
mind. 15% for goods impact, these
and services have already
except luxury been very low.
items. The actual
benefit for India
will come from
removal of QRs
in these countries
(a) Agreement on • Multi Fibre • (Impact on • Opportunity:
Textiles & Agreements and Textiles/ Important
Clothing other QRs Garments development for
usually imposed Export) textiles/
by developed Also see : Impact Garments
countries to be of act on Indian Exports from
phased out by textile India. Quotas
year 2005 (in 4 will be phased
phases) out in 2005.
• Threat: the level
of competition
will be manifold.
• Countries
imposing quotas
authorized to
take safeguard
measures.
Punitive actions
already taken
against India in
few cases
(b) Agreement on • The subsidies • No obligation • Removal of
Agriculture on agriculture to of India to distortions like
be removed and reduce subsidy high subsidies
converted in given to and QRs will
‘tariffs’; 36% farmers (AMS expand market

170


POLICY/ LAWS
reduction of calculations for Indian
tariffs by reveal it is Agriculture
developed, 24% taxed than products. E.g.
by developing. subsidized). closed markets as
Min. market Sets high tariffs Japan will have
access in closed 100% on to procure rice
markets primary min 3% of home
products, 150% consumption
on processed • QRs imposed by
food. 300% on India on variety
edible oils. of agri products
• No could be phased
commitment out by 2003 or
regarding before (through
market access some bilateral
9being under agreements with
balance of Austr4alia. NZ,
payment EU etc. It has
Cover, though already been
disputed) started
competition to
hot up.
1.1 Agreement • MFN & • (India is not a • Govts. are large
on Govt. National party to the buyers (often
Procurement Treatment on agreement) purchasing 10-
the purchase of 15% of their
goods as per GNP) India is not
their a party to the
commitments agreement, hence
GOI could
exercise its right
to purchase from
domestic
manufacturers
even at higher
cost. This right is
to come under
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POLICY/ LAWS
severe pressure
in coming
negotiations. If
gone against, it
will have
ser8ious fall out
on almost all
domestic
manufacturers
supplying to
Govt./PSUS.
• Indian exporters
of goods and
services can
export to the
countries that
signed this
agreement. Only
the US disallows.
*Chiefly of Textiles,
footwear, computer
hardware &
Software, telecom
equipment, electrical
machinery, Pharma
products, agri-food
products,
vehicles/spares,
paper/stationery etc.
1. Agreement on • Recommends • Restructuring • Currently the
State Trading that STEs of STEs like agreement has
Enterprises conduct their MMTC, STC limited scope. In
activities etc. the coming
commercially Commercializa negotiations it is
• WTO to be tion on of their likely that
informed of activities monopoly/canali
zing agency
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POLICY/ LAWS
their activities status like that of
Public
P0etroleum
companies will
be broken.
2. General • All services • Foreign Trade • Services
Agreement on come under Policy constitute 45% of
Trade in Services GATS (12 incorporates GDP, State
(GATT) sectors). services monopolies in all
Require chapter for the the major sectors
countries to first time; same (banking,
ensure MFN status as to insurance,
principle, merchandise transport-rail
transparency, • Committed to etc).
mutual open 10 sectors Liberalization in
recognition of • Partial the sectors will
qualifications liberalization in be extremely
etc. Banking sector, beneficial to
• Lists Telecom sector Indian companies
liberalization (TRAI in competing
commitments of established in domestically as
countries line of SEBI), well as
• Further insurance (IRA internationally.
negotiation by established) etc • Huge potential
2005 Also see : what is for export of
service, India the services as
world service accountancy,
provider date processing
& software
mgmt,
consultancy,
legal services,
feasibility
studies.
See also ; what is
service, India the
world service
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POLICY/ LAWS
provider
• E-commerce and
internet will fuel
export of services
further
3. Trade Related • Provide • Immediate • Impact will be on
Intellectual protection to change all businesses
Property Rights IPRS as Patents, required in • Main source of
(TRIPS) copyrights, Patents Act technology for
Trade marks, (1970), Trade SMEs reverse
Ind..Designs, and engineering will
Layout designs Merchandise be difficult, with
for ICs, Marks Act the stricter IPR
Geographical (1958), Regime and in
indications and Designs Act new regime
Undisclosed (1957) etc. ‘ignorance of law
information • TRIPS will be no
• National and agreement will excuse’ (the
MFN Treatment also trigger burden of proof
• Developing changes in is on infringe.)
countries to certain • The Transfer of
implement provisions of Technology cases
within 5 years. Contract Act may increase
(1872), Law of however on
Torts, commercial
Companies terms as
Act(1961), IT counterfeit trade
Act (1961), will have
MRTP Act effective
(1969) etc. deterrent
• New Acts to be (amended laws)
enacted. • India’s own
R&D institutions
could reap
benefits within
India as well as

174


POLICY/ LAWS
abroad.
• Also see : New
Patent Laws. The
IPR Regime.
8. Patents • Patents to be • Patents Act • Immediate
given for amended impact on
process as well (1999). Now Pharma, Agri-
as products allows product chemicals and
• Life 20 years patents in food; patented
• Compulsory pharmaceutical products cannot
licensing on s, agri- be manufactured
case to case chemicals and without license
basis food. Patent • India has
• Microorganisms life increased transition period
to be patented to years 20, granted till 1st Jan
and protection micro- 2005. (with the
of plant organisms condition that
varieties by made applicant would
patents or sui patentable. be given
generic system • New law for Exclusive
or both plant varieties Marketing Rights
being drafted (EMR) for 5
years form 1st Jan
1995 till
grant/rejection of
patent, whichever
ends earlier)
b. Copyrights • Definition 7 • The new • Would benefit
scope amendment bill Indian Software,
broadened. Now contains Music and Film
includes changes as per Industry besides
Software, TRIPS authors and
Sound agreement publishing
recordings, companies
films etc.
• Min. protection

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POLICY/ LAWS
50 years (25
years for
photographic
works)
c. Trademarks • Covers Trade as • New • Impact on
well as Service amendment bill counterfeit
Marks- to cover TRIPS Trade-Care
Protection for 7 promulgation should be
years (renewals exercised in
indefinitely) choosing names
of the companies
of products e.g.
other “Brand
names cannot be
sued as
Company’s name
(name as Maruti,
Reliance, Usha
etc used by other
businesses will
be contested )
d. Industrial • Covers new and • New • Implications for
Design & Layout original amendment bill Indian Designers
Industrial contains as well as
designs & changes as per Garment/
Layout agreement; Textiles Industry
includes using protected
service marks designs and
manufactures of
Ics.
e. Undisclosed • Does not • Impact on • Employees,
information & demand it to be know-how consultants,
Trade Secrets intellectual agreements, licensees, sub-
property but Contract Act contractors, etc.
stipulates their etc. restrained form
protection divulging

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POLICY/ LAWS
through confidential
contractual information
obligations • Provisions on
Undisclosed Test
Data, submission
of which is
required by
Govts before
grant of
permission (e.g.
in pharma
products)
stipulates
adequate
protection.
f. Geographical • Prohibits • No specific law • Major impact on
indications countries to on Agri-food
permit Geographical products.
trademarks indication yet; Benefits from
containing Being drafted improved system
misleading • Taking up • Our not having
information on membership of law on GIs has
geographical Paris led to
origin of goods Convention and controversies on
other important Basmati,
Treaties as Darjeeling Tea,
Lisbon Treaty Alphanso
for GIs. Mangoes etc.

CONTRIBUTIONS OF THE WTO
It is a tribute to human civilization that sovereign nations have agreed to
subordinate their freedom (to act) and have agreed to work within the
framework of rules to promote global trade. The Uruguay Round of
negotiations resulted in formation of a rule based system, which is expected
to lead to smooth and orderly international trade.

177


• The WTO and its agreements have an impact on every economic activity,
be it agriculture, trading, service or manufacturing.

• World markets are opening up due to lowering of tariffs and dismantling
of other restrictions in developed and developing countries to benefit
from their comparative advantages.

• Domestic markets will be increasingly threatened because of lowering of
tariffs leading to freer entry of foreign goods and because of foreign
companies’ establishing local manufacturing bases.

• Whereas the developing countries will have greater opportunities in
sectors in which they have cost bases comparative advantages e.g.,
textiles, agriculture etc., the developed countries benefit due to the
opening of the service sector and tightening of Intellectual Property
Regime.

• Export markets will become more difficult because of competition
among developing countries with similar comparative advantages.

• Products from developing countries will face higher quality standards in
developed markets particularly in the areas where they have comparative
cost advantage.

• Every company, whether serving the domestic or international market,
will have to undertake an internal exercise to identify factors affecting its
international competitiveness in terms of cost as well as quality. It will
need to study whether it can remain competitive once the product can be
imported freely or tariffs are further lowered or both.

• The WTO regime will be of greater benefit to those countries that show
ability and skill in the ongoing dialogue. The governments that are in
constant touch with their industries and affected groups will be able to
clearly determine how and what should be negotiated at multilateral
negotiations to the best of their advantage.

• International trade is becoming increasingly trade, deregulation and
privatization of internal economy have now been strengthened and
legalized under the WTO. Countries have no option but to follow this
direction. Countries that have understood this have moved swiftly in fine-
tuning their domestic and international trade policies, to create a winning

178


environment for industry and business. Those who are still debating the
issue or do not understand it clearly will be left behind.

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10. INTELLECTUAL PROPERTY RIGHTS

Human brain is a powerful creator, executor and controller
of every function in the world, if optimum utilized. By
converting its efforts one becomes world renowned, others
remain common. Invent, Create and beyond,
Commercialise.

Learning value:

On going through this chapter reader will understand:

1. The concept and importance of IPR
2. Classification of IPR
3. Methods of protecting IPR
4. Procedure to file IPR

What would have happened if Stevenson had not invented steam engine,
Edison had not invented gramophone, Graham Bell had not invented
telephone, Albert & Wilbert had not invented airplane and finally Einstein
had not propounded three laws of gravitational force?
Every product/s we use or enjoy is an outcome of known and unknown
intellectuals. They continue to invent for the society and future.
“It is intangible, sometimes perishable, infringeable and intrudable property
of mind could be encashed by anyone if it is not legally protected”.

Intellectual property refers to ideas, discoveries and inventions that can be
commercially exploited. At one time, intellectual property was manipulated
by smart business. They could take ideas from innovations and inventors and
make fortune. Currently, such inventions can be owned, protected and
marketed by the inventor himself. Such legal protection is scheduled as a
part of the WTO agreement. In some sectors like the pharmaceutical,
chemical, engineering and manufacturing sectors ‘Intellectual Property
Rights’ has become common parlance.

180


The term Intellectual Property Rights (IPR) is often shortened further to
Intellectual Property (IP). Intellectual property is a series of legal rights that
afford, in most cases temporary protection for different types of inventions,
designs, brand names or original creations. The legal rights given are the
rights to prevent unauthorized use of the invention, design, brand name or
creation for the period of protection. The right given can be an absolute
monopoly right or simply a right to prevent reproduction.
The legal rights in intellectual property can be transferred between
parties, licensed to other parties and can even mortgage or used as security.
IP only comes into existence after an application has been made and/or
registration has been obtained. Alternatively, it may come into existence
automatically upon creation of an original design or other work or upon the
creation of a reputed brand name, with most forms of intellectual property,
the temporary protection afford expires after a finite term. However, this is
not true for all forms protection, some of which can last forever. The various
forms of intellectual property are given briefly below.

Components of IPR in current context

Patents: New and inventive technical innovations can enjoy an absolute
monopoly for twenty years.

Supplementary Protection Certificate: This is an extension of up to five
years on the absolute monopoly given by a patent, where the invention
consists of a medicinal product for which approval by the relevant authority
has yet to be given.

Trademarks: The owner of a trademark has an absolute monopoly for ten
years. The legal protection of any brand name has the title of trademark and
it is shown on any product as TM.

Designs: This is an absolute monopoly for twenty-five years, given for a
new design of a manufactured article.

Unregistered Design Right: This prevents reproduction of an original
design, which lasts for a maximum of fifteen years.

Copyright: Copyright prevents reproduction of an original literary, artistic,
musical or dramatic work. It is valid for a period of seventy years after the
death of the author.
181


Confidentiality and Trade Secrets: This prevents misuse of confidential or
secret information.

Plant Variety Right: This relates to a new horticultural genus or species. It
gives the monopoly rights of the new variety of plant to the scientist.

Trade
Marks
Patents Designs

Intellectual
Property

Copy Plant Variety
Rights
Rights
Trade
Secrets

Intellectual property rights legally prevent unauthorized use of ideas and
designs. Thus if a patent exists for a product, other persons are prevented
from making or selling that product. If a brand name is registered as a
trademark then using the same or similar brand name amounts to
infringement of that registration and is illegal.
Thus intellectual property rights have obvious commercial benefits as
they enable a company to maintain a monopoly in a particular area of
business to the exclusion of competitors.

182


However, it may become necessary or advisable to join forces with other
parties to exploit the protected area of business. This is permitted under
intellectual property rights if the other parties, the licenses, pay a lump sum
or royalties to the primary party. Thus if there is a big market, which a
single party cannot, or does not wish to exploit alone, one or more licenses
can be appointed who can also take advantage of the market and the main
party will receive royalties on their income.
Alternatively, it may be desirable for the party to simply sell the
intellectual property rights at an appropriate price. This is possible since the
rights can be assigned (ownership transferred) to other parties. Suppose a
party develops a product in an area in which it has no commercial interest,
then the party may consider selling that invention to another party who
operates in that area, as an alternative to licensing the party to exploit the
invention.
Intellectual property rights can thus be used to avoid competition or to
derive an income through licensing of selling the rights.
The existence of intellectual property rights also provides a useful tool
for monitoring the activities of competitors. Published patent application,
registered designs and applications for registration of a trademark can
indicate the technical and commercial direction a competitor is taking, or
thinking of taking. For example, published patent applications contain
technical information relating to inventions and can indicate the area of
technology that is currently of interest to the applicant or proprietor. An
application for a new trademark may indicate a new line of business or
change of corporate identity for a company.
All this material is available for public inspection and can be a valuable
source of commercial information as it is unavailable elsewhere.

THE PROCEDURE TO OBTAIN IPR PROTECTION

Intellectual property rights can be obtained in one of two ways, by
application or by automatic derivation. Where an application procedure is
involved, it usually follows the steps set out in the following sequence:
1. File application
2. Search carried out to ascertain originality
3. Examination carried out

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4. Objections raised/No objections raised
5. Dealing with objections
6. Grant/Registration

It is a simple six step procedure that anyone can follow.

Where an application procedure is involved, the protection ultimately
obtained is usually an absolute monopoly, patents registered designs and
registered trademarks fall into this category.
Intellectual property rights arise automatically if an original work, such
as a drawing, design document, or prototype is created. These rights are
usually limited to preventing any form of reproduction of misinterpretation.
Copyrights, unregistered design rights (including semiconductor topography
rights) and unregistered trademarks fall into this category.

CONCEPT AND MEANING OF IPR

Patents

Patent protection can be obtained for many types of technical innovations.
For example, a new piece of apparatus or machinery to carry out a particular
operation, a method or process for performing an operation or making a
product or the use of a piece of equipment or product for a particular
purpose.
In order to determine if patent protection can be obtained, it is necessary
to consider whether the technical innovation is both novel and innovative.
Both these terms have a legal definition. It is usually relatively
straightforward to determine if a technical innovation is novel or not. The
determination is based upon whether the innovation is different from that
which existed previously. It is more difficult to assess if an innovation is
inventive. This determination is based upon whether it will be obvious,
given what existed previously, to arrive at the invention. Unfortunately this
is a legal definition, which cannot be applied without knowledge of the
concerned body of case law on the subject.
Patent protection is not available for every type of innovation. It is
excluded in the case of innovations that are artistic and not technical
innovations, and innovations that are not applicable in industry. Once again
these are strict legal definitions and a thorough knowledge of case law is
needed to accurately assess whether an invention is an excluded invention.
Patents are obtained via an application procedure that involves a search and
184


an examination. Once any objections raised are dealt with, the application
can proceed to grant the patent. Once the patent has been granted, it remains
in force for 20 years, subject to payment of annual renewal fees to keep the
patent in force, and a granted patent provides a patentee with an absolute
legal monopoly which can be used to prevent unauthorized use of the
patented invention.
Generally speaking, patents are territorial and it is necessary to obtain a
patent in each country in which protection is required. A patent in a
particular country does, however enable a patentee to prevent importation
into that country of an infringing product from wherever that importation
takes place. Therefore, it is common for patentees to protect their inventions
in the countries which constitute either their major markets, or which contain
their major competitors’ manufacturing sites. Whilst patents are essentially
territorial, there are a number of international conventions that make the
process of applying for international patent protection more simple and cost
effective than filing a national patent application in all the countries of
interest. The most important these international conventions are the
European patent Convention and the patent Cooperation Treaty.

Trademarks

Traditionally trademarks were any word or logo that serves to designate the
origin of goods or services. In recent years the law has come to recognize
that there are many other ways of designating the origin of goods or
services, e.g. advertising jingles, smells and the shape of goods or
packaging. Nowadays, therefore, these are also recognized as trademarks.
For registration, a trademark must be capable of distinguishing the
goods or services of one party from those of other parties. Furthermore,
trademarks that consist of anything other than words or logos must be
capable of being represented graphically. Any sign that does not satisfy
these requirements cannot be registered as a trademark. Signs which are
inherently non – distinctive or descriptive or which consist of words or
symbols, things that traders in the same area of business may wish
legitimately to use to identify the origin of their gods may be excluded from
registration. For example surnames and geographical locations would not be
allowed as trademarks.
In some countries, for example the United Kingdom, rights can be
obtained on a trademark simply by using a symbol or sign extensively
enough, so that it is identified with the product. In these circumstances, the
person or company using the trademark has legal resources through an
185


action for ‘Passing Off or Unfair Competition’, against other parties who are
attempting to misrepresent themselves by using a similar trademark.
Most countries however provide a statutory registration procedure for
registration of trademarks and it is always advisable to register a trademark,
where possible, since infringement of a registered trademark is a strict
liability offence and is not dependent upon proving a reputation or any
misrepresentation. Furthermore, in certain circumstances, infringement of a
registered trademark can be a criminal offence and is punished accordingly.
A registered trademark is obtained by filling an application with the
Trade Marks Registry, which is then searched and examined. Once any
objections raised are overcome, the mark is advertised in order to allow any
interested party to object to the registration should they have grounds to do
so. Subject to no objection being raised, the mark is then entered into the
Register of trademarks. Once registered, a trademark can usually be kept in
force for as long as is required. Subject only to the payment of renewal fees.

Copyright

Copyright, as its name suggests, is a right to prevent copying of an original
artistic, musical, literary or dramatic work. Because copyright is only a right
to prevent copying of the original work, there is no absolute legal monopoly
and copyright cannot therefore be used to prevent the independent
production of an identical or similar work without any reference to the
original work.
From 1st January 1997, the copyright lasts for a period of 70 Years
from the death of the original author of the work.
Copyright is given on a national basis in the country in which the
original work created but may be enforceable internationally by virtue of the
Berne Convention or universal copyright convention.
In some countries, copyright can be used to prevent unauthorized
application of the original work to a manufactured article and thus similar
protection to that given by Unregistered Design right in the United Kingdom
is afforded. However, a notable exception to this is the United States of
America.

Confidentiality and Trade Secrets

There are laws that protect confidentiality of information. Companies or
individuals may wish to keep commercial or technical information
confidential. If this information is made public in breach of that confidence
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then it is possible to bring an action or breach of confidence against the
offending party. For example, an employee has an obligation to keep all
information, which is given to him or her by the employer, confidential.
If confidential information is disclosed to a third party out of choice
then the obligation of confidentiality also passes to the third party. It should
be ensured that the third party is aware of the fact that they are expected to
treat the information as confidential and they agree to do so. In particle
terms this agreement should be given in writing in case there is ever any
dispute as to what was agreed.
There is an exception to the protection of confidential information in
circumstances where the dissemination of the information is deemed to be in
the public interest. This is allowed, notwithstanding any obligation of
confidence.
The current decade has witnessed innumerable inventions in
India in the field of biotechnology, agro chemicals, telecommunications,
pharmaceuticals, electronics, agriculture, food processing and natural herbal
medicines. Biocon, Bharat Serum, Ranbaxy, Gharda Chemicals, Cadila,
United Phosphorous and Glen Mark afford to employ separate invention
team and protect another team with legal expertise.

PATENT COOPERATION TREATY

The original Patent cooperation Treaty was signed in Washington in 1970
but it has been modified many times since. The convention only came into
force on 1st June 1978. This convention provides a mechanism whereby
protection can be ultimately obtained in all. Or selected countries that have
signed the treaty. This is carried out through a procedure which involves the
filling of a single application that is subjected to a single international search
and an international preliminary examination. At the end of the international
preliminary examination an examination report is produced which sets out
an opinion on the patentability of the invention described in the application.
After completion of the examination report, the applicant has the option of
proceeding with the application, or allowing the application to lapse, if the
examination report is dismissive of possibilities for protection. If the
applicant wishes to proceed further, the application is split into separate
national applications in the countries of interest and may be subjected to a
further national search and examination. The national offices function
independently and may place as much weight as they wish on the opinion of
the international authority, which was set out in the international preliminary
examination report. Attitudes vary widely from country to country as to the
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weight attached to the contents of the international preliminary examination
report. For Example, an applicant in the United Kingdom, Should know that
the Japanese and united States patent offices will often ignore the contents
on the report and will carry out a full search and examination, just as if the
application had not previously been searched or examined by the
international authorities.

ROLE OF PATENT AND TRADEMARK ATTORNEYS
Patent and trademark attorneys are generally speaking, professional advisors
who are qualified by an examination in the Law of Intellectual Property.
However, it is important to note that the term, ‘Patent and Trademark
Attorney’ may also be used by a solicitor, who may not have experience, or
relevant qualifications, in intellectual property rights.
Knowledgeable patent and trademark attorneys are qualified to give
advice on infringement or exploitation of intellectual property rights and can
also carry out searches to ascertain the patent, design and trade mark
activities of competitors or any other person or company.
They are fully experienced in the procedures for obtaining forms of
intellectual property rights and can offer advice on the forms available for
any particular innovation or idea, and the procedures necessary to obtain the
best protection.
Innovators and inventors in any field are required to consult a
knowledgeable attorney prior to filing their applications. Following strict
procedures and also keeping documentary evidence at all stages will enable
the applicant to protect his intellectual property.
Internationally renowned
research organizations like Genentech, BioRad, Hoffkins, E-Merck and
Pfizer are retaining attorneys permanently as a part of management team in
the organization for this purpose.

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11. TRADE BARRIERS

Diamond will not glitter without going through
tedious process;
Vessels cannot sail all the time without resistance;
And even on fertile soils the plant has to out grow the
harmful weeds to give yields.

Learning Value:

After completing the chapter one will understand:

1. The importance of barriers
2. Types of trade barriers
3. Impact of barriers in international business
4. Benefits to home and host countries
5. Relevance of trade barriers in the current decade

A trade barrier is defined as “any hurdle, impediment or road block that
hampers the smooth flow of goods, services and payments from one
destination to another”. They arise from the rules and regulations governing
trade either from home country or host country or intermediary. Trade
barriers are man-made obstacles to the free movement of goods between
different countries, and impose artificial restrictions on trading activities
between countries. Despite the fact that all international organisations such
as GATT, WTO and UNCTAD advocate reduction or elimination of
barriers, they still continue in different forms.
Free and fair international trade is an ideal situation as it is beneficial to all
countries. However, different countries impose various types of barriers. The
contribution of GATT in removing such trade barriers has not been
satisfactory as even now, both developed and developing countries, present
such trade barriers. Such barriers are usually imposed by the country that

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imports the goods, but they adversely affect the volumes of both imports and
exports. The volume of exports is reduced due to such trade restrictions and
the tariff results in an escalation in prices.

OBJECTIVES OF TRADE BARRIERS

1. To protect domestic industries from foreign goods.
2. To promote new industries and research and development activities by
providing a home market for domestic industries.
3. To maintain favourable balance of payment, by restricting imports
from foreign countries.
4. To conserve foreign exchange reserves of the country by restricting
imports from foreign countries.
5. To protect the national economy from dumping by other countries
with surplus production.
6. To mobilize additional revenue by imposing heavy duties on imports.
This also restricts conspicuous consumption within the country.
7. To counteract trade barriers imposed by other countries.
8. To encourage domestic production in the domestic market and thereby
make the country strong and self-sufficient.

Since trade barriers are harmful for the growth of free trade, efforts were
made to reduce such trade barriers, and international organisations initiated
collective efforts of all countries involved in trade. WTO ministerial
conferences held in concern or Doha Qatar or Hong Kong are focused on
breaking barriers of trading in different forms.

TYPES OF TRADE BARRIERS

Broadly, Trade barriers are classified as tariff barriers and non-tariff barriers.
They are now an inseparable part of global business and the location of a
business operation and pricing decisions are determined by tariffs. A country
may use both tariff and non-tariff barriers order to restrict the entry of
foreign goods.

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Tariff Barriers

A tariff barrier is a levy collected on goods when they enter a domestic tariff
area (DTA) through customs. Tariff refers to the duties imposed on
internationally traded commodities when they cross national boundaries and
may be in the form of heavy taxes or custom duties (operated through a price
mechanism) on imports, so as to discourage their entry into the home
country for marketing purposes.
Tariffs enhance the price of the imported goods, thereby restricting their
sales as well as their import. Governments impose tariffs only on imports
and not on exports as they are interested in export promotion. Only a few
exported items of any country are taxed.
The aim of a tariff is thus to raise the prices of imported goods in domestic
markets, reduce their demand and thereby discourage their imports.
Tariff barriers are major determinant factor to build or get away from the
business. In India, over the past ten years the prime import duty has been
reduced to 15% from 100% on many consumer durables and electrical items.

Classification of Tariffs

A) On the basis of origin and destination of the goods crossing national
boundaries

1. Export duty: An export duty is a tax levied by the country of origin, on a
commodity designated for use in other countries. The majority of
finished goods do not attract export duty. Such duties are normally
imposed on the primary products in order to conserve them for domestic
industries. In India, export duty is levied on oilseeds, coffee and onions.
2. Import duty: An import duty is a tax imposed on a commodity originating
in another country by the country for which the product is designated.
The purpose of heavy import duties is to earn revenue, to make imports
costly and to provide protection to domestic industries. Countries impose
heavy import duties to restrict imports and thereby remove the deficit in
the balance of trade and balance of payment.
3. Transit duty: A transit duty is a tax imposed on a commodity when it
crosses the national frontier between the originating country and the
country which it is cosigned to. African and Latin American nations
impose such transit duties at any point of time. Sri Lanka is another
country enjoying such benefits from Indian companies.

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B) On the basis of quantification of tariffs

1. Specific duty: A specific duty is a flat sum collected on physical unit of
the commodity imported. Here, the rate of the duty is fixed and is
collected on each unit imported. For example, Rs. 800 on each TV set or
washing machine or Rs. 3000 per metric ton on cold rolled steel coils.
2. Ad-valorem duty: This duty is imposed at a fixed percentage on the value
of a commodity imported. Here the value of the commodity on the
invoice is taken as the base for calculation of the duty, e.g., 3% ad-
valorem duty on the C&F value of the goods imported. In the ad-valorem
duty, the percentage of the duty is decided but the actual amount of the
duty changes as per the FOB value of a product.
3. Compound duty: A tariff is referred to as compound duty when the
commodity is subject to both specific and ad-valorem duty.

C) On the basis of the purpose they serve

1. Revenue tariff: It aims at collecting substantial revenue for the
government, but does not really obstruct the flow of imported goods.
Here, the duty is imposed on items of mass consumption, but the rate of
duty is low.
2. Protective tariff: Protective tariff aims at giving protection to home
industries by restricting or eliminating competition. Protective tariffs are
usually high so as to reduce imports. However, if the protective duties are
too high, it may hurt consumers, as imports will stop, leading to
shortages in the consumer market.
3. Anti-dumping duty: Dumping is the commercial practice of selling goods
in foreign markets at a price below their normal cost or even below their
marginal cost so as to capture foreign markets. Many countries follow
dumping practices. It is international practice which has a “do or die”
instinct associated with the company’s policy. It is harmful to less
developed countries where the cost of production is high.
4. Countervailing duty: Such duties are similar to anti-dumping duties but
are not so severe. Countervailing duties are imposed to nullify the
benefits offered, through cash assistance or subsidies, by the foreign
country to its manufacturers. The rate of such duty will be proportional to
the extent of cash assistance or subsidy granted.

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D) On the basis of trade relations

1. Single column tariff: Under this system tariff rates are fixed for various
commodities and the same rates are made applicable to imports from all
other countries.
2. Double column tariff: Under this system two rates of duty are fixed on all
or some commodities. The lower rate is made applicable to a friendly
country or to a country with which the importing country has a bilateral
trade agreement. The higher rate is applicable to all other countries.
3. Triple column tariff: Here, three different rates of duties are fixed. They
are general tariff, international tariff and preferential tariff. The first two
categories have minimum variance but the preferential tariff is
substantially lower than the general tariff and is applicable to friendly
countries where there is a bilateral relationship.

Mutual understanding of products and tariffs is concluded through a cartel. It
is also called preferential tariff.

Benefits of tariff to the home country

1. Imports from abroad are discourage or even eliminated to a considerable
extent.
2. Protection is given to the home industries and manufacturing sector. This
facilitates an increase in domestic production.
3. Consumption of foreign goods is reduced to a minimum and the
attraction for imported goods is brought down.
4. Tariff brings in substantial revenue to the government. In addition it also
creates employment opportunities within the country, by promoting
domestic industries.
5. Tariffs aim to reduce the deficit in the balance of trade and balance of
payment of a country.

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Trade Barriers

Tariff
Non-Tariff
Barriers
Barriers

On the basis On the basis On the basis On the basis 1. Quota
of origin of of purpose of relations 2. Licensing
1. Export Quantification 1. Revenue 1. Single 3. Consular
Duty 1. Specific tariff column formalities
Duty
2. Import 2. Ad-Valorem 2. Protective 2. Double 4. Trade blocs
Duty Duty tariff column 5. Customs
3. Transit 3. Compound 3. Anti 3. Triple Regulations
Duty Duty Dumping column 6. State Trading
4. Counter- 7. Forex
veiling Regulations
8. Health & Safety
9. Miscellaneous

Non -tariff Barriers

Along with tariff barriers, non-tariff barriers are imposed by countries in
order to restrict free trade at a global level. Non-tariff barriers are
quantitative restrictions as they directly restrict the entry of foreign goods
over and above a specific limit fixed by the government. Other forms of
non-tariff barriers are licenses, exchange control, complicated
documentations, technical certifications etc. Non-tariff barriers are useful for
reducing the total quantity of goods that are imported from abroad, but they
do not affect the price of imported goods. However, the net effects of tariffs
and non-tariff barriers are more or less the same. The impact of non-tariff
barriers is more direct and faster.

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Types of non-tariff barriers

1. Quota system: The quota system is an important non-tariff barrier. Under
this system, the quantity of a commodity permitted to be imported from
various countries during a given period is fixed in advance. Such quotas
are usually administered by requiring importers to have licenses to import
a particular commodity. Imports are not allowed over and above a
specific limit. This suggests that tariffs restrict imports indirectly while
quotas restrict imports directly. Developing countries may use quotas in
place of tariffs. The quota system acts as a barrier to international trade as
it restricts the flow of goods in an artificial manner. There are different
types of quota and a country can introduce any type of quota as per the
need of the situation.
The types of quotas are:
Tariff quota: A tariff quota combines the features of the tariff as well as
the quantity. Here, the imports of a commodity up to a specified volume
are allowed duty free or at a special low rate of duty. Imports in excess of
this limit are subject to a higher rate of duty.
Unilateral quota: In a unilateral quota system, a country fixes its own
ceiling on the import of a particular item.
Bilateral quota: In a bilateral quota, the quantity to be imported is
decided in advance, but it is the result of negotiations between the
country importing the goods and the country exporting them.
Mixing quota: Under a mixing quota, the producers are obliged to utilise
a certain percentage of domestic raw material in manufacturing the
finished products.
2. Import Licensing: Import licensing is an alternative to the quota system.
It is useful for restricting the total quantity to be imported. In this system,
imports are allowed under license. Importers have to approach the
licensing authorities for permission to import certain commodities.
Foreign exchange for imports is provided against the license. Such
import licenses are the practice in many countries. This method is used to
control the quantity of imports. Import licensing may be used separately
or along with the quota system.
3. Consular formalities: Some importing countries impose strict rules
regarding the consular documents necessary to import goods. Such
documents include import certificate, certificates of origin and certified
consular invoices. Penalties are imposed for non-compliance of such
documentation formalities. The purpose of consular formalities to restrict
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imports to some extent and prevent free imports of commodities that are
not necessary.
4. Preferential treatment through trading blocs: Some countries form
regional groups and offer special concessions and preference to member
countries. As a result trade is developed among the member countries and
allows advantages to all member countries. On the other hand, it can
cause a considerable loss to non member countries, as a trading bloc acts
as a trade barrier. Even trade agreements and joint commissions are used
as trade barriers as they restrict free movement of goods at the
international level.
5. Customs regulations: Customs regulations and administrative regulations
are very complicated in many countries. There are a number of
‘Commodities Act,’ pertaining to the movement of drugs, medicines,
minerals, bullion etc. Restrictions under such acts are useful to curtail
imports. Tax administration also acts as barrier to free marketing
amongst countries.
6. State trading: State trading refers to import-export activities conducted by
the government or a government agency. Stat trading is useful to restrict
imports, as the final decision is taken by the government. Such state
trading acts as a barrier, restricting the freedom of private parties.
7. Foreign exchange regulations: Countries impose various restrictions on
the use f the foreign exchange earned through exports. Such restrictions
have the following objectives.
a) To restrict the demand for foreign exchange and to use the foreign
exchange reserves in the best possible manner.
b) To check the flow of capital.
c) To maintain the value of exchange rates. Under such regulations the
foreign exchange earned should be surrendered to the government.
The government provides foreign exchange to the businessmen as per
priorities that are fixed periodically.
8. Health and safety measures: Many countries have specific rules regarding
health and safety regulations, which are mainly applicable to raw
materials and food items. Imports are not allowed if the regulations are
not followed properly.
9. Miscellaneous non-tariff barriers: Such barriers include prior import
duties such as deposits, embargoes and import restrictions due to
environmental regulations, provision of subsidies to domestic industry,
canalization of imports of some commodities and technical and
administrative regulations. All such measures act as non-tariff barriers as
they restrict the free flow of goods and services between countries.
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12. INTERNATIONAL INSTITUTIONS AND
ROLE IN INTERNATIONAL BUSINESS

Learning Value:

1. World bank
2. IDA & IFC
3. IMF
4. ADB
5. IMO
6. ILO
An international organisation must be established by a treaty (constituent
instrument) providing it with legal recognition. International organizations
so established are subjects of international law, capable of entering into
agreements among themselves or with states.
Purpose of International organizations

International Organizations exist to increase international relations, promote
education, health care, economic development, environmental protection,
human rights, and conflict resolution throughout a region.

GLOBAL REGIONAL
ORGANISATIONS ORGANISATIONS

1. United Nations 1. European Union
2. World Trade 2. Asia Co-operation
Organization Dialogue
3. International 3. Common wealth of
Hydrographic Organization Independent States
4. International Seabed 4. African Union
Authority 5. APEC
5. Organisation for the 6. Organization of American
Prohibition of Chemical States
Weapons
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198


World Bank
The World Bank (the Bank), a part of the World Bank Group (WBG), was
formally established on the 27 December 1945 following the ratification of
the Bretton Woods agreement. The concept was originally conceived in July
1944 at the United Nations Monetary and Financial Conference in July 1944.

The World Bank Group (WBG) is a family of five international
organizations responsible for providing finance and advice to countries for
the purposes of economic development and eliminating poverty. The Bank
came into formal existence on 27 December 1945 following international
ratification of the Bretton Woods agreements, which emerged from the
United Nations Monetary and Financial Conference (1 July – 22 July 1944).

The World Bank Group consists of

• the International Bank for Reconstruction and Development
(IBRD), established in 1945, which provides debt financing on the
basis of sovereign guarantees;
• the International Finance Corporation (IFC), established in 1956,
which provides various forms of financing without sovereign
guarantees, primarily to the private sector;
• the International Development Association (IDA), established in
1960, which provides concessional financing (interest-free loans or
grants), usually with sovereign guarantees;
• the Multilateral Investment Guarantee Agency (MIGA),
established in 1988, which provides insurance against certain
types of risk, including political risk, primarily to the private
sector; and,
• the International Centre for Settlement of Investment Disputes
(ICSID), established in 1966, which works with governments to
reduce investment risk.

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The Bank’s mission is to aid developing countries and their inhabitants
achieve the MDGs (Millennium Development Goals), through the
alleviation of poverty, by developing an environment for investment, jobs
and sustainable growth, thus promoting economical growth and through
investment in and empowerment of the poor to enable them to participate in
development. The World Bank sees the four key factors necessary for
economic growth and the creation of a business environment as:

1. Capacity Building – Strengthening governments and educating
government officials
2. Infrastructure creation – implementation of legal and judicial systems
for the encouragement of business, the protection of individual and
property rights and the honoring of contracts
3. Development of Financial Systems – the establishment of strong
systems capable of supporting endeavors from micro credit to the
financing of larger corporate ventures
4. Combating corruption – Eradicating corruption to ensure optimal
effect of actions

Areas of operation

• Agriculture & Rural Development
• Conflict & Development
• Development Operations & Activities
• Economic Policy
• Education
• Energy
• Environment
• Financial Sector
• Gender
• Governance
• Health, Nutrition & Population
• Industry
• Information & Communication Technologies
• Information, Computing & Telecommunications
• International Economics & Trade
• Labor & Social Protections
• Law & Justice

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• Macroeconomic & Economic Growth
• Mining
• Poverty Reduction
• Poverty
• Private Sector
• Public Sector Governance
• Rural Development
• Social Development
• Social Protection
• Trade
• Transport
• Urban Development
• Water Resources
• Water Supply & Sanitation

WORLD
BANK

IDA IFC

IFC
Purpose of IFC is to:

• Promote open and competitive markets in developing countries
• Support companies and other private sector partners
• Generate productive jobs and deliver basic services
• Create opportunity for people to escape poverty and improve their
lives

IFC promotes sustainable private sector development in developing
countries. Our particular focus is to promote economic development by
encouraging the growth of productive enterprise and efficient capital
markets in our member countries.

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IFC invests in enterprises majority-owned by the private sector throughout
most developing countries in the world. Developing regions include:

• Sub-Saharan Africa
• East Asia & the Pacific
• South Asia
• Europe & Central Asia
• Latin America & the Caribbean
• Middle East & North Africa

The International Finance Corporation has 179 member countries. To join
IFC, a country must:

• Be a member of the World Bank (IBRD);
• Have signed IFC's Articles of Agreement; and
• Have deposited with the World Bank Group's Corporate Secretariat an
Instrument of Acceptance of IFC's Articles of Agreement.

Products and Services of IFC

IFC is a dynamic organization, constantly adjusting to the evolving needs of
our clients in emerging markets. We are no longer defined predominantly by
our role in providing project finance to companies in developing countries.
We have also:

• Developed innovative financial products;
• Broadened our capacity to provide advisory services; and
• Deepened our corporate governance, environmental and social
expertise.

Financial Products
• Loans for IFC's Account
• Syndicated Loans
• Equity Finance
• Quasi-Equity Finance
• Equity & Debt Funds
• Structured Finance
• Intermediary Services
• Risk Management Products
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• Local Currency Financing
• Municipal Finance
• Trade Finance

IDA
The International Development Asso- ciation (IDA) is the part of the World
Bank that helps the world’s poorest countries. Established in 1960, IDA
aims to reduce poverty by providing interest-free loans and grants for
programs that boost economic growth, reduce inequalities and improve
people’s living conditions.

IDA complements the World Bank’s other lending arm—the International
Bank for Reconstruction and Development (IBRD)—which serves middle-
income countries with capital investment and advisory services. IBRD and
IDA share the same staff and headquarters and evaluate projects with the
same rigorous standards.

IDA is one of the largest sources of assistance for the world’s 80 poorest
countries, 39 of which are in Africa. It is the single largest source of donor
funds for basic social services in the poorest countries.

IDA lends money (known as credits) on concessional terms. This means that
IDA credits have no interest charge and repayments are stretched over 35 to
40 years, including a 10-year grace period.

Eligibility for IDA support depends first and foremost on a country’s relative
poverty, defined as GNI per capita below an established threshold and
updated annually (in fiscal year 2007: US$1,025).

Some countries, such as India, Indonesia and Pakistan, are IDA-eligible
based on per capita income levels, but are also creditworthy for some IBRD
borrowing. They are referred to as “blend” countries.

Eighty-two countries are currently eligible to borrow from IDA. Together,
these countries are home to 2.5 billion people, half of the total population of
the developing world. An estimated 1.5 billion people there survive on
incomes of US$2 or less a day.

203


FY06 Top Ten IDA Borrowers
($million)

Pakistan 1183
Vietnam 768
Tanzania 751
Ethiopia 505
India 500
Bangladesh 462
Nigeria 422
Congo (DRC) 365
Ghana 355
Afghanistan 240
New IDA Lending by Region:

Sub-Saharan Africa.............50%
South Asia............................27%
East Asia/Pacific..................11%
Europe/Central Asia...............5%
Middle East/North Africa.........4%
Latin America/Caribbean........3%

New IDA Lending by Sector:

Social sector........................28% Public admin and law...........24%
Industry...............................22% Infrastructure......................15%
Agriculture..........................11%

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INTERNATIONAL MONETARY FUND
The IMF is an international organization of 185 member countries. It was
established to promote international monetary cooperation, exchange
stability, and orderly exchange arrangements; to foster economic growth and
high levels of employment; and to provide temporary financial assistance to
countries to help ease balance of payments adjustment.

The purposes of the International Monetary Fund are:

• To promote international monetary cooperation through a permanent
institution which provides the machinery for consultation and
collaboration on international monetary problems?
• To facilitate the expansion and balanced growth of international
trade, and to contribute thereby to the promotion and maintenance of
high levels of employment and real income and to the development of
the productive resources of all members as primary objectives of
economic policy.
• To promote exchange stability, to maintain orderly exchange
arrangements among members, and to avoid competitive exchange
depreciation.
• To assist in the establishment of a multilateral system of payments in
respect of current transactions between members and in the
elimination of foreign exchange restrictions which hamper the growth
of world trade
• To give confidence to members by making the general resources of
the Fund temporarily available to them under adequate safeguards,
thus providing them with opportunity to correct maladjustments in
their balance of payments without resorting to measures destructive
of national or international prosperity.
• In accordance with the above, to shorten the duration and lessen the
degree of disequilibrium in the international balances of payments of
members

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IMF LENDING
A core responsibility of the IMF is to provide loans to countries
experiencing balance of payments problems. This financial assistance
enables countries to rebuild their international reserves; stabilize their
currencies; continue paying for imports; and restore conditions for strong
economic growth. Unlike development banks, the IMF does not lend for
specific projects.

A member country may request IMF financial assistance if it has a balance
of payments need—that is, if it cannot find sufficient financing on
affordable terms to meet its net international payments. An IMF loan eases
the adjustment policies and reforms that a country must make to correct its
balance of payments problem and restore conditions for strong economic
growth.

An IMF loan is usually provided under an "arrangement," which stipulates
the specific policies and measures a country has agreed to implement to
resolve its balance of payments problem. The economic program underlying
an arrangement is formulated by the country in consultation with the IMF,
and is presented to the Fund's Executive Board in a "Letter of Intent." Once
an arrangement is approved by the Board, the loan is released in phased
installments as the program is carried out.

TECHNICAL ASSISTANCE:

IMF technical assistance supports the development of the productive
resources of member countries by helping them to effectively manage
their economic policy and financial affairs. The IMF helps these
countries to strengthen their capacity in both human and institutional
resources, and to design appropriate macroeconomic, financial, and
structural policies.

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ASIAN DEVELOPMENT BANK

The work of the Asian Development Bank (ADB) is aimed at improving the
welfare of the people in Asia and the Pacific, particularly the 1.9 billion who
live on less than $2 a day. Despite many success stories, Asia and the Pacific
remains home to two thirds of the world's poor.

ADB is a multilateral development financial institution owned by 67
members, 48 from the region and 19 from other parts of the globe.

ADB's vision is a region free of poverty. Its mission is to help its developing
member countries reduce poverty and improve the quality of life of their
citizens.

ADB's main instruments for providing help to its developing member
countries are

• policy dialogue
• loans
• technical assistance
• grants
• guarantees
• Equity investments.

ADB's annual lending volume is typically about $6 billion, with technical
assistance usually totaling about $180 million a year.

INTERNATIONAL MARITIME ORGANISATION
The Convention establishing the International Maritime Organization (IMO)
was adopted in Geneva in 1948 and IMO first met in 1959. IMO's main task
has been to develop and maintain a comprehensive regulatory framework for
shipping and its remit today includes safety, environmental concerns, legal
matters, technical co-operation, maritime security and the efficiency of
shipping.

Specialized agency of the United Nations with 167 Member States and three
Associate Members, IMO is based in the United Kingdom with around 300
international staff.

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MEASURES OF IMO

IMO's specialized committees and sub-committees are the focus for the
technical work to update existing legislation or develop and adopt new
regulations, with meetings attended by maritime experts from Member
Governments, together with those from interested intergovernmental and
non-governmental organizations.

Firstly, measures aimed at the prevention of accidents, including standards
for ship design, construction, equipment, operation and manning - key
treaties include SOLAS, the MARPOL convention for the prevention of
pollution by ships and the STCW convention on standards of training for
seafarers.

Secondly measures which recognize that accidents do happen, including
rules concerning distress and safety communications, the International
Convention on Search and Rescue and the International Convention on Oil
Pollution Preparedness, Response and Co-operation.

Thirdly, there are conventions which establish compensation and liability
regimes - including the International Convention on Civil Liability for Oil
Pollution Damage, the convention establishing the International Fund for
Compensation for Oil Pollution Damage and the Athens Convention
covering liability and compensation for passengers at sea.

INTERNATIONAL LABOUR ORGANISATION
The International Labour Organization (ILO) is devoted to
advancing opportunities for women and men to obtain decent and
productive work in conditions of freedom, equity, security and
human dignity. Its main aims are to promote rights at work,
encourage decent employment opportunities, enhance social
protection and strengthen dialogue in handling work-related issues.

In promoting social justice and internationally recognized human
and labour rights, the organization continues to pursue its founding

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mission that labour peace is essential to prosperity. Today, the ILO
helps advance the creation of decent jobs and the kinds of
economic and working conditions that give working people and
business people a stake in lasting peace, prosperity and progress.

International Telecommunication Union
The ITU is a specialized agency of the United Nations and is the world's
oldest international organization.25 In general, the ITU seeks "to promote, at
the international level, the adoption of a broader approach to
telecommunications issues in the global information economy and
society."26 ITU decisions are made on a one nation, one vote basis;27
therefore, each member-nation has equal authority in the ITU decision-
making process. In part due to this voting policy, developing countries view
the ITU as an important organization to provide assistance and aid
infrastructure development in these nations

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13. INTERNATIONAL LOGISTICS
Logistics is defined as a “system of handling the physical movement of
goods and services from the place of origin to the destination as fast as
possible at a low cost and with safety and security.” Logistics provides the
means for the actual transfer of goods or services from the seller to the
buyer. Once a product or service has been marketed and ordered, it is
necessary to employ logistics to pack, deliver and manage the items for
delivery. In order to be effective, logistics must address the following issues.
Distribution has always been an important and inevitable function, but it is
only relatively recently that it has been recognized as a major function in its
own right. The main reason for this lapse was probably been the natur4e of
distribution itself. It is a function made up of many sub-function and sub-
systems, each of which has been, and may still be, treated as a distinct
management operation.
Both the academic and the business world now accept that there is a need to
understand all the operations in a global perspective in order to see how they
are interrelated.
Logistics primarily involves three broad areas of functions.
Logistics = Supply + Materials Management + Distribution
(L = S + M + D)
Logistics is an art and science of determining business success. Acquiring
goods, distributing and finally maintaining them to win the goodwill of the
customer is the major responsibility of logistic management.

Importance of Logistics Management

In advanced countries a large part of the final price of a product often goes
towards logistics. In the case of bulk cargoes like sulphur, Bitumen, grains,
iron ore and crude, the cost of logistics is the main factor in fixing the price.
Major turnkey projects, can be completed provide the right materials are
supplied in the right time. During an emergency, thousands of lives may be
lost if medicines do not reach in time. Therefore, logistics is the
management of cost and time. Hence, the UK Institute of Logistics and
Transport has defined logistics as “the positioning of resources at the right
time, in the right place, at the right cost and in the right quality”. Logistics is
an important activity making extensive use of human and material resources
that affect the national economy.

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A study indicated that about 30 % of the working population in the United
Kingdom is associated with work that is related to logistics. Another such
study undertaken by Michigan State University in the USA and reported in
the Financial Times indicated that logistics alone represented between 10 %
and 15 % of the gross domestic product of most important element at 46%,
followed by storage/warehousing at 22 %, inventory carrying at 20 %, and
administration at 12 %.

Cost of Logistics for key countries in comparison to GDP

LOGISTICS
COUNTRIES GDP GDP%
($M)
North America
Canada 585.105 70.191 12.00
Mexico 334.726 49.753 14.86
US 7576 795.265 10.50
Sub total 8495.931 915,209 10.77

Europe
Belgium/Luxemburg 286.383 32.573 11.37
Denmark 174.237 22.440 12.88
France 1537.582 171.230 11.14
Germany 2353.472 306.264 13.02
Greece 122.870 15.269 12.43
Ireland 67.392 9.611 14.26
Italy 1214.272 137.027 11.28
Netherlands 392.550 44.495 11.33
Portugal 101.182 12.871 12.72
Spain 581.565 67.022 11.52
UK 1151.348 122.344 10.63
Sub total 7981.853 941.146 11.79

Asia/Pacific
Hong Kong 153.068 20.992 13.71
Japan 4599.706 522.982 11.37
Korea 484.777 59.764 12.33
Singapore 94.063 13.074 13.90
Taiwan 273.440 35.686 13.05

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Sub total 5605.072 652.498 11.64

ELEMENTS OF LOGISTICS AND DISTIBUTION

1. Storage, Warehousing and Handling of Materials

Warehousing

Warehouses Depots Order
Processing

Location of warehouses
Number & Size of distribution depots
Type of operations
Order processing

2. Transport

Transport

Mode Delivery Loading Route Schedule

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Mode of transport
Type of delivery operation
Load planning
Route schedule

3. Inventory

Inventory

Product Location of Quantity of
Stock stock Stock

What to stock?
Where to stock?

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4. Inventory Channel

SUPPLIERS

BULK DELIVERY

RAW MATERIALS
INVENTORY
TRANSFER

PRODUCTION

TRANSFER

WORK IN PROGRESS
INVENTORY & ASSEMBLY

FINISHED GOODS
INVENTORY
TRANSFER
214
PRIMARY Only for Private Circulation
DISTRIBUTION


How many intermediaries are required?
How much will it cost?
How long will it take to reach various centres?
5. Information and Control

Information &
Control

Designing Procedure Forecasting
System

Design of systems
Control procedures
Forecasting

6. Packaging and Unitization

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Packaging

Unit Total Handling
Packing Packaging System

Unit load
Protective packaging
Handling systems

Logistics and Interrelationship with other functions

Value addition

Attitude towards distribution and logistics has changed over the past two
decades. For a long time the view prevailed that various elements within
logistics created additional cost for companies. Although there is a cost
associated with the movement and storage of goods, it is now recognised
that distribution and logistics contribute to the value of a product. This is due
to the fact that logistic operations provide the means by which the product
reaches the consumer or end user in an appropriate condition at the required
location.
Dell supplies a laptop within sixty minutes in the US, from the moment
order is placed. Honda Motors delivers car in Europe and North America i9n
ten hours. Many mail order companies use logistics as a major weapon to
win the market today.
It is therefore, possible for companies to compete on the basis of providing a
product either at the lowest possible cost so that the customer will by it,
because it is the least expensive or at the highest possible value to the
customer. Few companies may try to achieve both these objective such as
Hyundai Motors, LG in rural India and Electrolux in Europe. This is
particularly important today as there are many products that are not sold on
the basis of their brand name alone, but also on the basis of availability or

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price. This applies to many food products as well as technical products such
as mobile phones and personal computers. Sony, Hitachi and Samsung are
very strong in adding value through low cost of distribution.

The role of depots and warehouses

Companies like Sony, Johnson & Johnson, Asian Paints, HP and Sansui
have succeeded through establishing depots and warehouses wherever they
operate. There are many reasons why depots and warehouses are required;
the main reasons are given below:
• To keep down production costs by allowing long productions runs, thus
minimising the time spent on machine set-ups.
• To match demand and requirements with production capabilities, to
smoothen the flow and assist in operational efficiency.
• To enable large seasonal demands to be catered for more economically.
• To provide good customer service.
• To allow trade off with the transport systems
• To facilitate order assembly.

In addition, it should be noted that there are a number of different types of
depots each of which might be considered in the planning of the physical
distribution structure. These might include:
• Finished goods depots/ warehouses – these hold the stock from the
factories.
• Distribution centers which might be central, regional or national or local
depots – all of these will hold stock to a greater or lesser extent.
• Transshipment depots or stockless, transit or cross decking depots –by
and large, these do hold stock but act as intermediate points in the
distribution operations and selected orders to customers.
• Seasonal stock holding depots.
• Overflow depots.

Asian Paints emerged as a market leader in India by setting up warehouses
all over the country, which led to effective distribution. Other well-known
companies like ICI, Berger, Shalimar, Nerolac etc. compete with Asian
Paints.

Cost relationships

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The major cost relationships are discussed, starting with storage and
warehousing. The major cost breakdown is outlined below, with the
percentage values indicating the approximate relative importance of the
different factors based on conventional warehouses.
Percentage
I. Building costs including rent, furnishing and depreciation 24
II. Building services, such as heating and lighting 16
III. Equipment related 13
IV. Labour overheads 38
V. Management, supervision and security 9

Procurement

Procurement is one of the key links in the supply chain. It can have a
significant influence on the overall success of the organisation. Ensuring that
there is a sufficient supply of raw materials of the required quality, at the
right price, in the right place at a right time is obviously crucial to any
manufacturing plant. Over the years many organizations have developed
large departments to deal with the sheer weight of supplier transactions.
Recently, many companies have reduced the number of suppliers in order t
reduce the cost of transactions. Single entity takes the responsibility and
committed to supply many product lines required by customers.
In addition to supplier reduction programmes many companies have moved
away from the traditional adverse relationship with suppliers. Companies
practice cooperation and coexistence concept wherein the buyer is also part
of supplier. This style of relationship recognizes that both the parties need to
make a profit to survive.
Procurement is not just about raw materials. The following goods and
services also need to be acquired:

1. Utilities like gas, water, electricity and telephones
2. Fuel including diesel and petrol
3. Capital assets such as machinery, vehicles and buildings
4. Stationery
5. Consultancy services
6. Outsourced services such as distribution contracts, IT services etc.
7. IT equipment, e.g., hardware, software and support systems.

Very large sums of money are involved in the above areas. Depending on
the nature of business of the organization concerned, emphasis will be
218


placed on different elements. For a transport company, fuel may represent as
much as 35% of the total operating budget, but for a manufacturing plant the
major costs may be running costs of the plant. These costs need to be
carefully managed.

TRANSPORT MODE AND CHARACTERISTICS

Sea Freight

There are two main container loads in sea freight namely (i) the
conventional load (ii) unit load. Both are applicable in the present practice.
The main features in conventional sea freight are:

(i) Conventional Load

Cost

For some products, the most economic means of carriage remains that of
conventional sea freight. This particularly applies to bulk goods like rock
phosphates, boilers and transmission equipments that are being transported
to large distances. Where speed of service is unimportant, the lower cost of
sea-freight makes it very competitive.
Flexibility: There are many liners and tramp ships available in many ports in
the world. In addition to this, sailings are quite frequent making sea transport
quite flexible in terms of the alternatives that are quite open.
Availability: Liner services are widely advertised and extensively
categorised and most types of cargo are categorised.
Speed: Sea freight tends to be slow for several reasons, which include the
turnaround time in the port and inefficient handling methods. This is
especially true when compare to the more conventional “through transport”
systems with which sea freight must compete. The problem is particularly
apparent on some of the short sea routes.

(ii) Unit Load (Container System)

Container is a metal box having the unit 1 x 20 feet. These boxes ensure
safety, security, reliability and easy mobility during transit and at the time of
handling both at the port of discharge and destination.
Container systems can now be viewed as a specialised mode of freight
transport although the container is now a fundamental feature of all major
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national and international transport modes, whether rail, sea, road or air.
Containers facilitate what is known as the ‘intermodel’ system of freight
transport enabling the smooth movement of goods in bulk, from one
transport mode to another.
The main attributes of containers and containerization are as follows:
• They enable a number of small packages to be consolidated into large
single unit loads.
• There is a reduction in the handling of goods as they are distributed from
the point of origin to the point of destination.
• There is a reduction in individual packaging requirements, depending on
the load within the container.
• There is a reduction in damage to products caused by other cargo.
• Insurance charges are lower due to the damage potential is reduced.
• Handling costs at the docks and other modal interfaces are reduced.
• Turnaround time is faster for all types of transport used. Port utilization
also improves.
• The all round delivery time is faster and hence service levels are better.
• Documentation is much simpler – this applies to both company and
custom documentation.
• The concept of ‘through transit’ become feasible and allows a truly
integrated transport system to be developed.
• The systems that were developed in the early days of containerisation,
have been integrated across the different modes. This has considerably
improved transportation in recent years.
• There is a need for special facilities and handling equipment, which are
expensive. Thus, only a limited number of transfer points are feasible.
• The initial cost of the containers is quite high.
• Trade is seldom evenly balanced. Very often return loads may not be
available and so the cost increases.
• Containers may leak, thereby causing damage due to rain or sea water.
• Loads may be affected by the position in which they are stowed, e.g.,
above or below deck.

Sea freight container details
Container
Outside Dimensions
Type
6.045m
20’ day 2.438m
2.438m
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6.045m
20’ dry
2.438m
high cube
2.591m
6.045m
20’
2.438m
refrigerated
2.438m
6.045m
20’ open top 2.438m
2.438m
6.045m
20’ flat rack 2.438m
2.438m
6.045m
20’ open side/top 2.438m
2.438m
12.192m
40’ dry 2.438m
2.591m
12.192m
40’ dry high cue 2.438m
2.896m
12.192m
40’reefer 2.438m
2.743m
12.192m
40’ reefer high cube 2.438m
2.743m
12.192m
40’ open top 2.438m
2.438m
13.716m
45’ dry high cube 2.436m
2.896m

Storage System

Ways to classifying storage systems are given below:
• Bulk storage for solids such as silos, bunkers and stockpiles.
• Loose items storage, e.g. casting and fabrications held loose on the floor.

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• Pallet storage systems
• Small item storage for individual items or small unit loads.
• Non-standard unit loads such as loads.

Stock Location

The location of stock within a store is an important aspect of stock
management and can be considered at different levels. For example, the
placement of stock within a warehouse will affect the effort required to
move material in and out of the warehouse. I twill also affect the efficiency
of selecting orders, as this depends on the distance employees have to travel
to get the required stock.
At another level, it is important to locate certain stocks so that they can be
easily lifted and handled by the operator. For example, items that have to be
lifted mechanically should be stored at ground level for lifting and using
material handling equipments. Fast moving product lines that have to be
accessed frequently located at a level for optimum operator arm movement,
i.e. neither too high or too low.

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14. INTERNATIONAL TRADE THEORIES

To build a large mansion and an action plan, a strong
foundation is a prerequisite. To establish a large
international business, conceptual base is important. Trade
theories and their impact in every aspect of operation are
widely viewed as major inputs by organizations around the
world.

Learning Value:

On going through this chapter the reader will learn:

1. Importance of trade theories in the economy
2. Classical theories and their implications
3. Competitive advantages of nations
Their limitations in globalised era

International Trade Theories

Many renowned economists have carried out considerable research on scale
of economies, productivity of the work force and advantages of resources,
which certain countries are endowed with. The theories formulated by them
were accepted by the contemporary economies. European industrialization,
the emergence of the United State as a major power and rapid colonisation
were the three major international developments during the era of classical
economic theories. Today, these factors have lost their relevance. The
revolution taking place in communications, transportation and banking
makes every country resourceful if they formulate proactive policies. The
diminishing importance of borders between countries has enabled many
entrepreneurs to shift their manufacturing base anywhere in the world, invest
their money in safe destinations and explore the resources at any point of
time. Therefore, the theories of absolute advantage, comparative advantage
are not really applicable in current international business operations.
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However, it is important to understand, interpret and modify these concepts
and apply them to current practices in business, especially the functions of
labour productivity, resource exploration and demand forecasting.

THE THEORY OF ABSOLUTE ADVANTAGE

The classical theories of international trade that were propounded by Adam
Smith, David Ricardo, John Stuart Mill and others were based mainly on
differences in the cost of labour between different nations. Among the
classical theories, the most discussed theory was the theory of ‘Absolute
Advantages’ put forward by Adam Smith, which was widely accepted and
relevant during his contemporary era.
Adam Smith was a champion of free trade and he claimed that free trade
always leads to better division of labour and thereby encourages
specialization both in national and international markets. He advocated that
every country is specialized in certain production function and ultimately
will be able to enjoy the benefits. Countries can exchange the products they
produce at a lower cost with each other. He remarked that, “it is the wise
decision of every prudent master never to make goods at home, which will
cost him more, but to buy them, which is cheaper”. For example a cobbler
does not attempt to make his own shoe, but he buys them from the
shoemaker and vice versa. An individual select the occupation for which he
thinks himself best fitted. Similarly, every country tries to specialise in the
production of those commodities, in which it enjoys greater advantages e.g,
Malta produces glass. China produces soft toys, South Korea produces
synthetic fibres, and India produces metal ware and Myanmar produces good
quality timber,
The theory of absolute advantage can be explained with the help of an
example, consider two countries A and B, each in which produces two
different types of goods, namely X and Y. With one unit of labour, country
A can produce either 20 units of commodity X or 10 units of commodity Y.
On the other hand, with one unit of labour, country B can produce either 10
units of X or 20 units of Y. This clearly shows that country A has an
absolute advantage in the production of goods of the type X and country B
has an absolute advantage in the production of goods of the type Y. In this
case, trade between countries A and B will be mutually beneficial, as with
two units of labour, A can produce 40 units of X and B can produce 40 units
of Y, i.e 80 units of X and Y between them. On the other hand without
international trade, they can produce only 60 units of X and Y between them
with the same amount of labour. Thus country A should specialize in the
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production of X by using all the available labour, which country B should
devote its labour for the production of commodity Y.
In China one unit of labour produce three soft toys per day, whereas, in
India, one unit of labour can produce only 1.5 soft toys per day, At the same
time one unit of labour in India cuts and polishes 10 carats of diamond a day
whereas in China it is possible to achieve only 6 six carats a day with the
same amount of labour.
In the above example the main factor is labour, In today’s era of
inventions and innovations, automation, outsourcing and cost reduction, and
mass production, the theory of absolute advantages does not have much
relevance.
The major drawback of the theory of absolute advantage is that it fails to
explain the fact that even less developed countries, which have no real
absolute advantage in any commodity are engaged in the export of goods.
The limitations and shortcomings of this theory are given below:
1. It has not advocated quality, premium and brand aspects of a product.
2. It has restricted itself only to considering the maximum to labour force.
3. It has failed to take into account the fact that many cost reduction
techniques are adopted in mass production.
4. There are many duties applicable when goods enter into other countries,
which have not been accounted for.
5. The nature of the commodity may incur huge transportation costs, which
may be even greater than the cost of the labour.

The theory of international trade, based on absolute cost difference is not
fully applicable in the current century, although it was an acceptable concept
during the period when industrialization was catching up in Europe during
the time of Adam Smith. Another theory, the theory of comparative cost
advantage was therefore evolved as the basis for international trade.

THE THEORY OF COMPARATIVE COST ADVANTAGE

It was David Ricardo, one of the prominent classical economists, who
propounded the theory of comparative cost advantage or the theory of
comparative advantage. He argued that it was the comparative difference in
cost that led to trade between two nations. According to him, each country
would specialize in the production of a commodity in which it has a
comparative advantage in cost. The country should export these
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commodities and import those commodities that it produces at a higher
comparative cost. The theory of comparative advantage is based on certain
underlined assumptions given below:
a) There should be two countries that produce the same two
commodities.
b) Labour is the only factor applied in production. It is assumed that the
supply of labour is given and fixed. Also, the labour force is assumed
to be homogeneous.
c) Cost of labour, i.e, wages determine the price.
d) Production is subject to the law of constant returns.
e) There is no change in taste and preference of the people.
f) No change in technology in expected.
g) Factors of production are perfectly mobile within two countries but
are not freely mobile between the countries.
h) There is no transportation cost.
i) There is full employment of factors in both the countries.
j) There is homogeneity in consumption, buying behaviour and
affordability.

Based on the above assumption, Ricardo showed that two countries could
indulge in trade even when one of them has an absolute advantage in
production of one of the two commodities vis-à-vis the other country.
Ricardo explained the theory of comparative advantage with the help of the
example given below.
Suppose the two countries viz. England and Portugal produce two
different types of goods say wine and cloth, whose labour costs in terms of
man hours required for unit of production are as follows:

Country Wine Cloth
England 120 100
Portugal 80 90

It is very clear from the table that Portugal has to expand less labour as
compared to England in the production of both the commodities. Thus
Portugal has an absolute cost advantage in both the goods while England has
an absolute cost disadvantage in both of them. But Portugal would benefit by
producing wine and exporting it to England in return for cloth as it has a
comparative advantage in the production of wine. This is due to the fact that
the relative cost of producing a unit of wine (80/120), is less than the relative
cost of producing a unit of cloth (90/100). On the other hand, England has
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the least comparative disadvantage in the production of cloth, whose relative
cost (100/90) is less than relative cost of wine (120/80). Thus Portugal
should concentrate more on the production of wine whereas England should
concentrate on cloth, thus benefiting both countries.
Ricardo explained the principle of comparative cost in international trade,
but did not explain the determination of the terms of trade i.e. the rate at
which one commodity will be exchanged for the other. Since the ration of
exchange, say wine for cloth would be the same for both the countries after
they enter into trade, it must be somewhere between domestic exchange
ratios of the two goods within each country. Since wine is costlier in
England than cloth, as it takes more Labour to produce wine than cloth, the
exchange ratio in England would be 1 unit of wine = 120/100 = 1.2 units of
cloth. On the other hand, cloth is costlier in Portugal as it takes more labour
to produce cloth than wine. The exchange ratio would be 1 unit wine =
80/90 = 0.89 units of cloth. So the international rate of exchange of wine for
cloth would thus be settled somewhere between 1 unit of wine = 1.2 units
and 0.89 units of cloth. Assuming that the rate is established at 1 unit of
cloth = 1 unit of wine, England would gain because at home the ratio was
1.2 units of cloth for 1 unit of wine. Portugal would also gain because at
home it could produce only 0.89 units of cloth for 1 unit of wine. Thus, with
international trade both the countries will benefit.
On the same lines Spain produces chicken and Chile produces wine at
lower cost; Australia produces wool made ups and Singapore produces
edible oil at relatively low cost; Malaysia produces rubber products at a low
cost compared to knit wear, which Indonesia produces at a lower cost
compared to rubber. In the latter case both countries are situated close to
each other and hence it would be a distinct advantage for Malaysia to focus
on rubber and supply it to Indonesia and for Indonesia to focus on knit wear
and export it to Malaysia.
An important implication of theory of comparative cost is based on the
principle of complete specialization. According to above example, England
should specialize in the production of cloth and Portugal in the production of
wine. Each country would produce only goods in which it has a comparative
advantage and trade the surplus of production with other countries. The
underlying basis of complete specialization is that the comparative
advantage is permanent, irrespective of the scale of production in both
countries- Ricardo assumes the production is subject to the law of constant
returns i.e. the cost per unit of output would remain the same whatever be
the scale of production. He also assumes that a permanent supply of raw
material and other consumables associated with the product are available,
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e.g., if wine is to be produced, grapes should be available all the times with
no price fluctuations. Obviously, this cannot be the case and the availability
of raw material (in this case grape) would affect the cost of the end product.
This aspect of the theory has been criticised as the comparative advantage
may only exist for a given range of production, sooner or later the law of
increasing costs will come in to operation and the advantage may turn in to a
disadvantage. Hence, countries do not specialize completely and
specialization also changes in many countries due to multifarious reasons.

The major limitations of the theory are as follows:

1. Theory of comparative advantage is based on the value of the labour.
It considers labour as the only factor of production and assumes that
all labour is homogeneous. However, labour does not alone produce
goods; there are other factors, such as availability of raw materials
that have been ignored. Further, labour units are not homogeneous as
there are different grades such as skilled, unskilled, semi skilled,
efficient, less efficient etc. hence the whole theory is unrealistic.
2. The assumption that labour is used in same fixed proportions in
production of both the goods in both the countries is too simplistic. In
fact, labour is used in varying conditions in producing different goods,
as some goods are more labour intensive than others, e.g., cotton
becomes yarn, yarn becomes grey; grey becomes fabric and fabric is
turned in to garments. It is difficult to verify the cost of labour at each
stage.
3. The theory assumes constant labour costs even output of goods
increases due to specialization under international trade. But in reality
the cost may either increase or decrease as a greater quantity of goods
are produced in the wake of trade. If costs decline with increased
production, comparative advantage will be larger and vice versa. The
theory does not takes in to account these changes in costs.
4. Ricardian theory is based on the assumption that factors of production
are mobile within the country but are immobile internationally. The
theory advocates uniform wages in a particular country. Practically,
however wages differ between one region and another in the same
country and between one industry and another within the same
country. Within the country, wages are very high in urban areas and
lower in the interior areas. In USA, India and Australia, local
transportation costs are than freight rates to neighbouring countries.
These costs are not considered in the Ricardian theory.
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5. The theory is one sided as it considers only the production costs, i.e.,
only the supply side. The demand factors that affect the price of goods
and through them the prices of the factors of production are not taken
in to account. This negligence of demand factors renders the theory
incomplete and liable to providing wrong conclusions.

However, in spite of these weaknesses, Ricardo’s theory of comparative
advantage is accepted as the basis of international trade. This is due to the
fact that the theory provides a sound rationale for exchange of goods
between two trading nations. Improvements have no doubt been made in
the theory, but these mainly related to the factors that give rise to
comparative advantage. The basic principle of trade viz, that a country
should export goods in which it has comparative advantages and import
those goods where its comparative advantage is the least, still holds good.

MODERN THEORY OF INTERNATIONAL TRADE: THE
HECKSCHER-OHILIN THEORY

The classical theory of comparative advantage was based on a model where
labour was the only factor considered in production and differences in labour
productivity were regarded as the cause for differences in comparative cost
and international trade. In 1993, Heckscher and Ohilin took the Ricardian
model and conceptualized further by thinking the source of a country’s
comparative advantage through the endowment of its factors of production.
It was Eli-Heckscher who put forward the idea that international trade results
from the fact that different countries have different factor endowments i.e., a
few countries have more capital than labour while others have more labour
than capital. These differences in factor endowments are the cause of
comparative cost differences. Bertil Ohilin further refined this theory and
formulated what are known as the ‘general equilibrium theory’, ‘factor
proportion theory’, which is commonly known as the ‘modern theory of
international trade’.
The theory states that the production patterns and trade among
various countries are determined by the difference in factor endowments.
The country that has abundant capital will produce and export capital
intensive goods, and the countries with abundant supply of labour will
produce and export labour intensive commodities. The main cause of
differences in relative availability of factors of production or the difference
in factor endowments.
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Assumptions of Heckscher-Ohilin Theory

1. The theory is based on a 2 × 2 × 2 model. It takes in to consideration
that there are two countries, two commodities and two factors of
production.
2. Transport costs or other impediments to trade are not taken in to
account. This assumption applies that the prices of commodities under
trade will be the same in both the countries.
3. The Theory assumes the existence of perfect competition in both the
commodity and factor markets. This implies that both capital and
labour are perfectly mobile in respective country, and would move
from low paying industries in to high paying ones. Perfect
competition in the commodity market implies that neither a
monopolistic nor oligopolistic environment prevails.
4. All production factors are homogeneous in degree, specially it expects
returns to scale in production of each commodity in each country. For
example a 10 percent increase in factor inputs in each industry results
in exactly 10 percent output in that industry.
5. The production functions are such that the two commodities show
different factor intensities. This means that different combinations of
factors or production techniques are used in different industries. The
goods ‘Y’ may be capital intensive while the goods ‘X’ may be labour
intensive. Goods that are labour intensive will always remain labour
intensive irrespective of relative changes in the price of labour.
6. The production function differs between two commodities but
nevertheless remain same in both the countries. Thus the production
techniques and factors intensity used in producing goods ‘Y’ in
country A is the same as that is used in producing goods ‘X’ in
country B. the same is true about production function for goods ‘X’ in
country A and B. This implies that the best available techniques are
known to both the countries and are used in the price of labour.
7. The theory assumes that full employment resources exists in both the
countries so that production takes place on the same point on the
production possibility curve and not somewhere below it.
8. It also assumes that preferences and technology levels do not change.
Practically, technology has become accessible to anyone both
indigenous and internationally. Germany, Japan and USA have proved
their high levels of technology in medical equipments, entertainment
electronics and chemicals & drugs respectively. Today, productivity is
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directly proportionate to technology. Based upon these assumptions,
the Heckscher-Ohilin theory demonstrates the proposition that capital
rich countries export capital intensive goods and labour rich countries
export labour intensive goods.

There are two alternative ways of defining whether a country is capital or
labour intensive. The first way, known as capital abundance is based on
factor prices and states that a country A is capital rich as compared to
country B if capital is relatively cheaper in country A than in country B.
Thus the abundance or scarcity of a factor is identified on the basis of
factor price. The second way compares the overall physical amount of
labour and capital in two countries. For example, country A is said to be
capital rich if ratio of capital to labour is larger the ratio in country B.
Logically, country B will be labour rich if its ratio of labour to capital is
larger than in country A.

a. Capital abundance – based on factor price ratio orientation; According
to the criterion of factor price, country A is abundant in capital
compared to country B if,

PAK < PBK where;

PAL PBL

PAK – price of capital in country A
PAL – price of labour in country A
PBK – price of labour in country B
PBL – price of labour in country B

The above equation shows that capital is relatively cheap in country A and
labour is relatively cheap in country B. Hence we can say that country A is a
capital rich and country B is a labour rich one.
According to the Heckscher-Ohilin theory, the capital rich country A
would export capital intensive goods and labour rich country B would export
labour intensive goods. This proposition can be explained by following
diagram;

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Y Y

A
B
C
E
A R X1
P C
A Y
P F
C
I
T
Y G X
K
H
M

O
S Q L N A C B X
LABOUR

In the figure, we have two isoquants YY and XX showing the production of
one unit each of goods ‘Y’ and goods ‘X’ in each one of the two countries.
These isoquants are common to both countries showing that production
functions are same in both countries. According to these isoquants, goods
‘Y’ are capital intensive and goods ‘X’ are labour intensive. Country A is
rich in capital and hence capital here is cheaper relative to labour, which is
shown by the relative factor price line AA. On the other hand, country B is
labour rich and hence the relative price of labour is low, a fact shown by the
relatively flatter factor price line BB.

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Consider country A whose factor price line AA is tangential to the
isoquant YY at the point E. Since the isoquant YY represents one unit of
goods ‘Y’, we find that in country A, one unit of goods ‘Y’ can be produced
with OR of capital and OS of labour, the factor price ration line shows the
rate at which one factor can be exchanged for the other. Thus on the factor
price line AA, with points A and E being on the same line, OS of labour is
worth RA of capital and OR of capital is worth SA of labour. As we have
seen, the cost of producing one unit of goods ‘Y’ is equal to OR of capital
plus OS of labour. It is found that OS of labour, we find that the cost of
producing one unit of goods ‘Y’ is equal to OR of labour SA of labour
which has been substituted for OR of capital which is equal to OA of labour.
By the same reasoning, the cost of producing one unit of goods ‘X’ in
country A is OK of capital plus KA of capital (because OL of labour is
worth KA of capital) and hence equal to OA of capital. In terms of labour
alone, this cost is equal to OL of labour plus LA of labour (because OK of
capital is worth LA of labour) and hence equals OA of labour.
Now, let us examine the cost of producing one unit of both types of
goods in country B. Since country B is labour rich and therefore labour is
relatively cheaper here, the factor price ratio line BB is flatter than AA. This
price line BB is tangential to the isoquant YY at the point F. This shows that
the cost of producing one unit of ‘X’ in country B in terms of capital alone.
To find this we draw a price line CC parallel to and below the price line BB
in such a way that it is tangential to the isoquant XX at point the H. The
price line CC represents the same factor price ratio as the line BB as the two
are parallel. At point H the cost of producing one unit of ‘X’ in country B is
OM of capital plus ON of labour. Since on this price line CC, ON of labour
corresponds to MC of capital, the price of one unit of ‘X’ is equal to OC of
capital in country B. Thus, in country B the cost of producing one unit ‘Y’ is
OB in terms of capital while for ‘X’ it is OC in capital alone. Hence in
country B it is more expensive to produce ‘Y’ than to product ‘X’ in the
same quantities as OV>OC.
The above analysis shows that country B has a cost advantage in production
of ‘X’ and it is relatively cheaper to produce ‘Y’ in country A. This fact
establishes the Heckscher-Ohilin theory, that a country abundant in capita
will export capital intensive goods and a country abundant in labour will
export the labour intensive goods.
One of the major drawbacks of this analysis is that it defines factor
abundance in terms of factor prices. This is not free from flaws due to the
fact that factor prices do not depend on abundance or scarcity of factor
supplies alone, but they are also influenced by demand factors. It is
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therefore, not possible to say anything about factor prices on the basis of
factor endowments alone. It would thus be more fruitful to study factor
abundance in terms of physical amounts of the factors available in two
countries.

b) Suppose country A has more capital than labour, and country B has more
labour than capital. Taking into consideration the differences in factor
endowments, we can draw a production possibility curve of these two
countries (AA1 of country A and BB1 of country B) with respect to the
goods ‘X’ and ‘Y’ of which ‘X’ is labour intensive and ‘Y’ is capital
intensive. This is shown in the following diagram.
Y

R

P1

A
P1
YB S1

S

O X
A1 P1 P2 Y
The resources endowment in county A is such that with the given total
resources of labour and capital, it can produce more of capital intensive
goods of ‘Y’ over ‘X’. Similarly, country B can produce more of labour

234


intensive goods ‘X’ than capital intensive goods ‘Y’ and thus has an
advantage in the production of ‘X’. The production possibility curve AA1,
of country A shows relative abundance of capital while the production
possibility curve BB1 of country B shows relative abundance of labour.
Thus country A will have a bias towards the production of capital intensive
goods ‘Y’ while country B will be more inclined to produce labour intensive
goods ‘X’.
The nature of this bias is illustrated in the diagram. If both countries produce
both the goods in the same proportion, it will be represented by the ray OR.
The production of country A will be represented by the point S while that of
country B will be represented by point S’ on their respective production
possibility curves. The slope of country A’s production possibility curve at
S’ is steeper than the tangent P1P1 than the slope of the production
possibility curve of country B at point S shown by the tangent P2P2. This
implied that good Y is cheaper in country A than in country B and that good
X is cheaper in country B than in country A.
As it is clear from the respective price lines P1P1 and P2P2, the operating
cost of expanding production of goods Y is lower in country A than country
B and vice-versa for good X.
This shows that the capital rich country A has a bias in favour of capital
intensive goods Y and the labour abundant country B has a bias in favour of
prevailing Labour intensive goods X.

Comparison of Ricardian and Factor Endowment Trade Models

Ricardian Heckscher-Ohilin
Two factor model
One factor model (labour)
(labour and capital)
Comparative advantages on the basis
Comparative advantage is of production conditions along with
determined by the production the market demand pattern of goods,
condition alone and it leads to because the price determined the
export. demand for goods may not always
lead to export
Heckscher-Ohilin theory regards
Classical theory of international
international trade as arising from
trade is totally different from internal
differences in factor endowments and
trade and hence requires a separate
deals with it specific to international
theory to explain the causes the trade
trade
Ricardian theory does not take factor More realistic theory as it is based on
235


prices in to account. It takes the price relative factor prices, which
of goods as being determined by the influence the relative prices of goods.
production condition alone
It takes no note of production factor It assumes a linear homogeneous
in the two countries production function of one degree

PURCHASING POWE PARITY AND IPACT ON TRADE

The estimates of per capita income in various countries are not strictly
comparable because they are based on conversion of per capita income of a
country as measured in its local standard money unit (the rupee in India) to a
common currency denominator (US $ in this case), the conversion being
based on the official exchange rates. The official exchange rates do not
reflect the purchasing power of different countries in their respective
counties. Thus, India may have had a low per capita income e.g., US $ 420
in 2002 can buy in the USA due to relatively lower prices in India. Hence,
the comparison of national and per capita incomes do not reflect the true
value or purchasing power or command over goods and services in their
respective countries.
A change in exchange rate will also change the per capita income of a
country as expressed in foreign currency. For example, when India devalued
its currency against the US dollar, even when there was no change in the
economy. This is illustrated by the following example:

In India in 1990: INR 21 = US
$1
After devaluation in march-April 1992: INR 29 = US
$1
After 10 years, in 2002: INR 46 = US
$1
After 5 years in 2007: INR 40 = US $
1

The practice of devaluation and depreciation of local currency against the
US $ was very common in all developing countries and less developed
nations, over the past two decades. Surprisingly, for the first time, Indian
rupee is appreciating against dollar in 2007.

The competitive advantage of Nations

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Competition is a challenge posed by any goods or service with equal or extra
benefits, which cause the company or country to lose its share of business.
Competition may come from the home country, host country or a third
country. It may come from the same range of products or through
outstanding technology or cost effective substitutes. Many companies devote
considerable time and energy facing or managing competitors. As far as
nations are concerned, they consolidate their resources and move ahead,
withstanding competitors and prospering in international trade. To prove
such consolidating forces Michael Porter developed a model, which was
applicable during the second half of twentieth century.
He conducted a comprehensive study of ten nations to learn about the
factors that lead to success and the “five forces” influencing strategy. None
of the five forces were new and were in fact known to people around the
world. Porter advocated the conversion of these five forces in to a main
competitive force that would enable a country to succeed in world trade. By
‘success’ he means that a country should be the centre of production for a
particular item. This implies that for a given quality of goods, production
costs must be the lowest.
However, he does not believe low production costs are solely due to
comparative advantage. Sustaining comparative advantage depends on the
ability to produce more with a given level of inputs. This in turn is based on
innovation and upgrading of products, production processes and
management.

Forces influencing Competitiveness

This model determines the competitive environment as being determined by
the following forces:

1. The power of buyers, and how much leverage they have in
determining the price.
2. The power of suppliers, and the competition among suppliers which
determines the price of inputs to the firm.
3. The threat from potential new entrants in to the industry i.e. the degree
of market contestability.
4. The threat from substitute products.
5. The degree of competition (rivalry) in the industry.

Porter’s Diamond – Four Determinants of National Competitive
Advantage
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1. Factor conditions: The basic factors are labour, land, natural
resources, capital and infrastructure. Porter argues that advance
factors including communications, infrastructure, sophisticated and
skilled labour, research facilities and technological know how are
created and most important for competitive advantage.
2. Demand conditions: The character of the home market demand shapes
the way in which a company responds to the needs of the buyer.
Nations can gain competitive advantage if sophisticated and
demanding buyers provide a clear picture of buyer needs and demand
innovations and product improvement.
3. Related and supporting industries: The existence or absence of
internationally competitive suppliers. Their existence provides:
a. Lower transportation costs
b. Lower communication costs
c. Firm strategy, structure and rivalry
4. Inferences: No single management system is universally appropriate.
Domestic
Competition spurs innovation.

The diamond as a system: The points on the demand constitute a system
and are self re-in forcing.

1. Domestic rivalry stimulates the production of specialized intermediate
goods. Suppliers of these goods can grow and realize economies of
scale, and may become potential competitors of the firms they supply.
They will enhance inter-firm rivalry.
2. Domestic rivalry also leads to specialized pools of labour, e.g.,
computer scientists in Silicon Valley.
3. Keen domestic competition leads to more sophisticated consumers
who come to expect innovation and up gradation. It facilitates the
development of supplier industries. The diamond promotes
geographic clusters of competitive industries.
4. This leads to localized industries with numerous final goods
producers, supporting firms and specialized labour. Positive feedback
flows throughout.

How the Diamond Works: the Italian ceramic industry

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Italian producers located near the small town of Sassuolo accounted for 30%
of the total world production of ceramic tiles and 60% of their exports,
constituting an industry of US $ 10 billion.
Rebuilding and reconstruction activities after World War II led to a
strong demand for tiles, especially in Italy as they were well suited to the
climate and taste of the people. This led to the following steps:

1. A local pool of trained workers; engineers, designers, technician and
maintenance workers etc, was formed.
2. Companies producing kilns and presses were started to replace
imported items with local products. This was facilitated by the local
need to modify imported equipments.
3. Retail outlets and specialized showrooms were established throughout
Europe.
4. The Italian market was the most sophisticated due to familiarity with
the product. This led to demand for better products by the customers.
5. Intense rivalry was fueled by geographic proximity.
6. Disadvantages in labour costs led to continuous process, production
and automation.
7. Exports were facilitated by the existence of an industry association
that promoted the product abroad. Advertising by the individual
companies also promoted a positive image.

The same kind of competitiveness can be seen in the following countries
with respect to specific products:

1. Cut flowers – Netherlands
2. IT – India
3. Soft Toys and ceramics – China
4. Rubber products – Malaysia
5. Glasses – Malta

Implications for business

1. Locations Implications: One direct implication is that firms should
concentrate production in the country with the best diamond in the
industry. This seems to rule out geographic separation of assembly
and manufacture of parts, (the diamond works when these two
‘points’ are in same country). However, Porter acknowledges that a

239


firm may want to source some materials and some components
overseas.
2. First mover advantages: There are a number of advantages associated
with early entry in to an industry. The firm that enters first are likely
to gain customers loyalty and access to distribution channels.
Moreover, first mover may enjoy economies of scale. To the extent
that diamond is mutually reinforcing, early advantages might
snowball.

Implications for the government

1. An early lead in an industry is reinforced through the dynamics of the
diamond.
2. The government should also focus on creating specialized factors such
as education, apprenticeship, promotion, support for basic research,
high quality infrastructure etc.
3. The government should limit direct cooperation among industry
rivals. A recent trend is cooperative research ventures. While these
may provide benefits for developing broad-based technology on a
limited basis, they will blunt the motivational force of strong rivalry.
4. The government should enforce strong domestic snit-trust policies.
While strategic alliances and mergers have become popular, they
undermine vigorous competition.

If we supply this model to the Indian automobile industry, IT industry, gem
and jewellery industry, we will see the current advantages and the decisions
necessary to be taken, for them to have a competitive edge over their
competitors in the world.

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Firm Strategy,
Structure and
Rivalry

Factor Demand
Conditions Conditions

Related and
Supporting
Industries

PURCHASING POWER PARITY

The PPP was formulated by Gustan Cassel in the year 1920, when inflation
was high. It represents a synthesis of the work done by economists like
David Ricardo, Wheatley and Henry Thorton in the nineteenth century.
The theory puts forward the idea that when currencies are exchanged among
nations, their purchasing power is only transferred. This means that we
should be able to buy the same amount of goods in either country, when
expressed in either country’s currency because people value currencies for
what they pay.
The theory suggests that the principle determinant of exchange rate is the
difference in National Inflation Rates. This means, a country, where costs
and prices are relatively less than other country will find its currency
appreciating. The sole focus on inflation differentials among countries is the
dominant factor that explains the movements in the exchange rates and also
indicates why the spot rate is what it is at a given point of time.
The law of one price is usually the basis to interpret the theory. According to
this law, after making allowances for tariff and transport costs, the price of

241


the goods in one country should not significantly differ from that in another
country. Mathematically, this can be expressed as:

P = e.P* -------------- (1)

Where, P is the price of a product in the domestic country.
P* is the price of the same product in foreign country.
E is the domestic currency price of the foreign currency.

Thus if an item costs USD 1 in USA and its price in India is Rs. 45.50 then
thus the exchange rate is 45.50 to USD 1.
Equation (1) can be written as

e = P/P*

Further if P and P* can be interpreted as the domestic and foreign index,
representing the respective inflation figures; the exchange rate becomes a
ratio of the (relative) price level (or inflation rates) in the two countries.
An important application of the PPP theory is that the nominal exchange rate
must be adjusted significantly and sufficiently so as to reflect/compensate
the underlying inflation difference. Once this happens, the international
competitiveness of any country’s product in the world market shall be
maintained.
Thus the PPP theory tries to restore the real exchange rate, which is relevant
for international business.

Foreign Price Index
Real Exchange Rate (R) = Nominal Exchange Rate ×
Domectic Price Index

The above equation is explained with following numerical example:
Suppose the nominal exchange rate is Rs. 40= USD 1, the foreign price
index is 100 and the Indian domestic price index increase to 110 due to
inflation. If the Indian authorities fail to adjust the nominal exchange rate
what happens to the Real Exchange Rate (R)?

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R= 44 ×100 = Rs. 40
110

The real exchange rate thus appreciates to Rs. 40 although the nominal
exchange rate is Rs. 44/USD. This will adversely affect the exporter’s
ability to compete globally due to the fact that is a U.S. buyer pays US$ 1
for a product, the Indian exporter will get Rs.44 due to nominal exchange
rate, which is worth only Rs.40 in real terms because of the effect of
inflation in India. The supporters of PPP theory insist that the nominal
exchange rate should be depreciated by 10% [the difference between Rs.44
and Rs.40] and the nominal exchange rate should be depreciated by 10% to
Rs.48.40 per US$ so as to restore the old exchange rate; in which case R will
become:

R = 48.40 x 100 = Rs.44 which is the odd nominal exchange rate
110 prior to inflation

Thus if nominal exchange rate is adjusted to inflation differentials then the
exchange rate will be constant in terms of purchasing power.

The essence of theory is that one must export to a country whose inflation
rate is higher than the domestic rate. In the case of imports the strategy
should be reversed as nominal exchange rates are not adjusted on a real time
basis.

However the PPP theory does not take into account actual practice factors
such as current account performance, portfolio decisions, interest rates,
economic growth, and the central bank’s intervention, which have an effect
on the variations in exchange rates. Thus relative price level differences
alone cannot explain exchange rate movements exhaustively.

Further, the law of one price which is the basis of PPP theory has also
been empirically challenged by absolute advantage theory and Factor
Endowment theory. Studies have shown that there are significant and
persistent differences among the relative prices of narrowly defined
domestic and foreign manufactured products.

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The floating exchange rate regime of 1970s and 1980s clearly showed that
exchange rates over short periods depend significantly on asset market
considerations rather than price movements.

The other issues associated with PPP theory are those of index numbers,
inconsistency in the basket of products considered for inflation calculations
and the weight age procedures adopted. However the theory holds well in
long run. Empirically when prices gets affected by a large number of
variables the exchange rate may overshoot the value postulated by the PPP
theory.

Thus, there is more to exchange rates than what is stated in PPP theory.
The deviations of exchange rates from those postulated by the theory are
fairly persistent in countries with unstable monetary policies. The PPP
theory plays a significant role in describing exchange rates in the long run or
when inflationary forces are significant. Whether or not the PPP theory
provides a tool to determine real exchange rate or prices in international
markets is a moot point that continues to be debated. This is the reason why
the PPP theory failed to explain volatility of exchange rates, which was a
prominent feature of the floating rate experience during late 1990s.

Current account performance and the monetary aspect of exchange rates
are a simplified approach to study exchange rate variations. The view put
forward by Keynesian Balance of Payment (BOP); dominate analysis during
the 1950s because capital movements were minimal. The influence of asset
markets and portfolio preferences of investors plays an important role in the
present context of exchange rate determination and the PPP theory only
supports the exchange rate variations in long run.

THEORY OF PRODUCT LIFE CYCLE

Theory of international product life cycle propounded by Raymond Vernon
emphasizes that every product has to pass through different stages.
Conceptually, the life cycle consists of four stages- introduction, growth,
maturity and decline.

244


To understand the concept very clearly the international product life cycle
starts from the location where the products originates. The introduction stage
is marked by innovation. Innovation is an outcome of research and
development. According to product life cycle theory, the production location
for a specific product moves from one country to another at different stages.
Generally, the life cycle movement starts from advanced countries where
considerable amount is spent for research and development. Many occasions
failures may occur. Still they pursue innovation. Out of ten innovations, two
may be commercially viable for which they do not hesitate to spend money
other eight innovations.

1. Introductory Stage
New products are generally developed after observation of demand, utility
and benefits a group of a group of customers enjoy in a given market. It is a
normal practice that Japanese company develops a new product for Japanese
market first and US Company develops a product for US market first. The
Research and Development group creates a new product and predominantly
the company concentrates on the domestic market and gradually starts
export to other countries. By way of getting constant market feed back the
company modifies or alters or adds new features to match international
markets.
Importance of innovation and decision of locations
Over the past 50 years all the new products have been developed either in
US or in Europe or in Japan. The industrialized countries are having
advantage of research, technological infrastructure, and manpower.
Companies like Merck, Siemens, Sony, Honda motors, General motors,
Matsushita allotted huge funds for such development. Those companies are
capable of taking the risk on new product development in anticipation of
long term gainful results. Innovations are taking place in such companies on
continuous basis. Few companies concentrate more on technological
innovative products. Few companies are making improvements in the
existing products. Few companies modify methods of manufacturing and
process.
Even though the debate is going on that developing countries and less
developed countries have lacunae in research capabilities currently
innumerable innovations are taking place in developing and less developed
countries also. In future, the industrialized countries will locate innovation
centers or R&D intensive operations in developing countries.

Movement of labour and products
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In the first stage of the product life cycle a minimum percentage of the total
production may be exported. Labors intensive items are not standardized in
the initial stage. Rapid change in the production process may not take place.
Obviously, production with standardization will be a Herculean task. At the
same time, since cost of production is not known to the customer, there is a
possibility of adding comfortable margins. For example, entertainment
electronic items innovated by Sony made a windfall gain right from the
beginning. Dell is enjoying the same kind of benefits for its laptops. The
major challenge in this stage is to educate and enhance the skill levels of
labors force until the standardization is achieved. Once the labors force is
trained and competitive, the organization can perform well.

2. Growth stage
Growth stage has few salient features:
1. It increases in export to many countries by which the company generates
huge revenue.
2. More competitive forces crop up from a country by innovation, country of
entry and any other third country.
3. The organization becomes high capital intensive.
4. The innovator resorts to foreign production units in order to bring down
the cost and come closer to customer.
Since the customers are aware of the products and the demand is likely to
grow substantially, setting up manufacturing units become inevitable. While
Sony products have huge demand in South East Asia and Middle East, the
company started manufacturing products in Malaysia. Hewlett Packard
started setting up units in South East Asia due to rapid growth in sales in the
whole region. The innovating company will increase its quantum of exports
and is prepared to incur small loss in the export markets where the
manufacturing subsidiary unit will commence its operations.

3. Maturity stage
This stage has following features:
1. There is a gradual fall in quantum of exports from innovating country.
2. Standardization and quality aspects are pre-requisites.
3. Sophisticated machineries are used, hence is huge.
4. Price war is inevitable due to many players.
5. Production facilities are available in many developing countries at a
low labors cost.
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Though the demand is growing in few countries, especially in the less
developed ones it declines in all the developed and few developing
countries. Cost cutting is the only strategy available for the innovator to
sustain. Few of the companies shifted their focus to get products
manufactured wherever per unit cost is low. It is a general trend that
innovating countries no longer enjoy production advantage. Since many
physical, fiscal and infrastructural incentives are offered by the developing
countries, such innovators are lured and increase there production in
developing countries. Today, we see such manufacturing units in Indonesia,
Thailand, Malaysia and Brazil. India is also emerging as a strong production
centre for automobiles, health care and consumer products.

4. Declining stage
1. The main feature of the declining stage is that maximum production takes
place in less developed countries.
2. The innovating country starts importing from other countries.
3. The days of keeping high margins are over.
4. It is the stage of survival and no prosperity for the innovator.
5. The innovator may completely deviate from a specific product and go in
for a completely new product.

The industrial countries disappoint the innovator because the affluent
customer demands more and more. New products are flooded in the market
with so many features. Since cost factor is the only weapon, production from
less developed countries will win. The innovator of the product cannot
depend on the first production unit which gave the first product for
launching.

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Maturity
Production in
Developing
Countries:
Cost cutting

Growth Declining
Exports and Import from
Overseas LCDs;
Production For survival
Expansion

Introduction
Country of
origin:
Innovation.

Limitations of Product Life Cycle

The theory is having application in few specific sectors such as
entertainment, electronics and certain medicinal items. The movement of
production centres from different stages may not be applicable in the
following circumstances;

248


1. A vast majority of the products are having very short life cycle such
as computers, tape recorder, musical discs and fashion items. Shifting
production from one country to another country may not achieve cost
reduction. The very nature of product itself is subject to obsolescence.
2. Cost involved in perfumes, cosmetics and other essential oils which
fail under luxury category do not make any impact on the customer
because brand is important to them.
3. Wherever costs of logistics are high the export is minimal at any
stage. At the same time, few countries are producing certain essential
bulk cargo. Irrespective of life cycle stages, they export all the time.
Articles like bitumen from Iran, sulphur from Jordan and coal from
China. They cannot shift production facilities to other countries.
4. Many MNCs are using aggressive marketing promotion such as
advertising, personal selling and sales promotion. Any other
competition will not be a great concern for such products.
5. Few products are very much associated with outstanding services and
specialized knowledge. More than product life cycle stages, customers
need assured technical support. Lifts and escalators will be accepted
by customers provided service is given top priority. Same concept is
applicable to life saving medical equipments produced in Germany.

Irrespective of the types of products the companies are all the time
introducing new products simultaneously, both in the domestic and
international markets. It is obvious that in the globalization era, companies
develop different products to different segments and different prices. They
cannot wait for an opportunity to start in the domestic market first and going
to other markets later on. Multi domestic operations are very common
among MNCs. Innovations are carried out to launch products in many
countries at a time especially health care items and industrial consumables.
Hence, product life cycle theory has very limited applications in the current
globalised era.

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15. CROSS CULTURAL COMMUNICATION

The major challenges to do international business are not
only managing people, money and resources. To trigger all
those resources and succeed one has to understand two
areas:
1. CULTURE
2. COMMUNICATIONS

Learning Value:

On completion of this chapter the reader can:

1. Understand the complexities of culture
2. General characteristics of culture
3. Implications of culture in business operations
4. Different nations and different methods to deal
5. Challenging cultural elements in the current era

A unique set of traits, behaviours, values, habits, norms and ethics innovated
and practiced in the past and forwarded to the future generation for day to
day practice is culture.

Culture is the essence of life. For many nations it is the basis of their
identification and countries are often identified by their cultural inheritance.
The culture of the country affects the way people behave, and often explain
why they behave the way they do. In general, we often talk about oriental
culture, western culture and material culture, but these terms are not explicit
and can have a number of connotations. The pattern of behaviour in different
cultures will reflect in business deals, working conditions, productivity
levels and whether a company is accepted in different countries.

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When business firms operate in different nations, different cultures
come together to do business. More than anything else they have to respect
the cultural sentiments of each other. Often, businesses fail not because of
logistical shortcomings, but due to the erroneous evaluation or total lack of
understanding of the other party’s cultural values.

As stated above the culture determines an individual’s actions or
behaviour. The society that people grow up in shapes their basic beliefs,
values and norms. They absorb, almost unconsciously, a world view that
defines their relationship to themselves, to others, to nature and to the
universe. A society’s beliefs, values and norms are influenced by their
family and by the social, educational, and religious systems of a country.
What people buy, why they buy, when they buy and how much they buy, are
all primarily determined by the typical culture of each country. Cultural
attitudes vary considerably among countries, so it is difficult to find general
patterns amongst them. For examples, despite the fact that their economic
levels are similar, the French and Germans are culturally quite different. The
French are somewhat hostile to frozen food, but the Germans welcome it.
Thus, for a frozen food exporter, both these countries hold different
importance.

GENERAL CHARACTERISTICS OF CULTURE
Culture is a distinctly human capacity for adapting to circumstances and
transmitting these coping skills and knowledge to subsequent generations.
Culture gives people a sense of belonging and shapes their behavioural
pattern. Culture impacts behaviour morals and productivity at work and
includes values and patterns that influence company operations and actions.
Corporate culture affects the way in which an organization copes with
competition and change, whether in technology, economies or people.
The way people do business is different in different countries. In
Japan employees are extremely loyal to their employers and will not easily
leave their jobs. The Japanese have great respect for protocol and even the
way a person presents his visiting card may determines his compatibility to
initiate business discussions. The Indian business community strongly
believes in the concept of a family business, with the line passing from
father to son. In France it is usual to work five days week, starting early in
the morning. In Germany, serious business discussions do not call for
humour. Delaying, often for weeks, to get a better bargaining strength, is an

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integral part of Chinese business. In Brazil, no major business decisions will
be taken the carnival.

Characteristics
Self-identity and appreciation of others can manifest as a humble bearing in
one country and egoistic behaviour in another. Independence and creativity
are countered in other cultures by group cooperation and conformity.
Americans keep their distance in business negotiations, while this is not so
in Latin America and Vietnam.

Communication and Language
In addition to the multitude of different languages, some countries have
hundreds of dialects, spoken amongst their different communities and
geographic units. Furthermore, even though body language is universal, the
meanings given to gestures often differ in different cultures.

Dress and Appearance
This includes garments and adornments as well as body decorations that are
distinctive of different cultures. For example the Japenese Kimono, the
African head dress, the Englishman’s hat and the Indian saree.

Food and Eating Habits
The manner in which food is selected, prepared, presented and eaten often
differs in different cultures. Americans love beef, yet it is forbidden to
Hindus. Both, Moslem and Jewish cultures forbid pork, which is consumed
extensively by the Chinese. Many restaurants cater to diverse foods and
offer national dishes to meet varying cultural tastes. Eating habits also differ
from one country to another, from hands and chopsticks to a full set of
cutlery. Even when cultures use cutley such as a fork, one can distinguish a
European from an American by the hand in which he holds a fork or spoon.

Relationships
Cultures fix human and organizational relationships by age, gender, status
and degree of kindness, wealth, power and wisdom. The family unit is the
most common expression of these characteristics. In a Hindu household a
joint family lives under one roof. In some cultures, the authoritarian figure in

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the family is the head male and this fixed relationship is then extended from
home to community.

Values and Norms
Value systems vary in different cultures Persons who are barely surviving,
place importance on food and shelter. Richer persons need security while
that with high security needs, value material things, money and position as
well as law and order. The younger generation in many and position as well
as law and order. The younger generation in many countries concentrates on
quality of life, self-fulfillment and status. In some Pacific island cultures, the
more one gives away or shares, the more he or she is recognized.

Beliefs and Attitudes
One of the most difficult tasks in carrying out international business
understands the beliefs and attitudes of people in different countries and
cultures. People in all cultures seem to have a concern for the supernatural
that is evident in their religions and religious practices. Western culture is
largely influenced by judeo-Christian traditions, while East Asian cultures
are dominated by Buddhism. Confucianism, Taoism and Hinduism. The
Japanese also believe in Shintoism, which is an off-shoot of Buddhism,
which originated in India. Religious beliefs can play an important role in
political and legal aspects. This is especially true of Muslim countries like
Saudi Arabia, Kuwait and Qatar, where business operations are strongly
influenced by religious beliefs.

Mental Processes and Learning
The way people think and the process of learning vary from country to
country. The British will enter into any business only after doing their home
work thoroughly and follow strict documentation procedures; they also
expect their counterpart to do the same. The Germans have a preconceived
notion that they are technically superior and can produce perfect items, and
lay great stress on logic, while the Japanese reject the western idea of logic.
Learning is much respected in the whole of Europe. Europeans are never
adverse to learning new things and they generally will not enter into
discussions without a strong information base. The Americans spend a lot of
time on documentation. Some cultures favour abstract thinking and
conceptualization while others prefer strong base and continuous learning.

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Work Habits and Practices
Another dimension for examining a group’s culture is its attitude towards
work. In some countries, the culture is oriented towards work, and holidays
are minimum. An example is China, except for ten continuous days holiday
during the Chinese New Year. A work ethic in which all members are
excepted to engage in a desirable and worthwhile activity in the same
culture For some cultures, the worthiness of the activity is narrowly
measured in terms of income produce and the worth of he individual is
assessed in terms of job status. In Japan, the culture lies in family which is
transferred to the organization that employs the person and the quality of
ones performance is expressed in work group participation, communication
and consensus.

Global Culture – A Rationale
Today, there is an increasing need for an uniform culture across different
countries, however it is not entirely possible. The main reason for this is the
close bond with traditions and beliefs, which has been carried over
generations. Time and space have largely divided the world into diverse
forms and patterns, and cultural differences an evident even within a
country. India itself is a land of varied cultures and beliefs. So is Canada,
which is divided between English speaking and French speaking cultures.
Even though cultures vary, our need to interact remains and it is essential to
adapt to a new country and its culture. This is especially important in the
exchange of commerce and persons doing business across the world have
constantly felt a need for this. Many corporates fail because they did not take
cultural differences into account. An American cannot sell port to a Muslim.
This shows that there is a strong need to understand diverse cultures, for
business to succeed.

CULTURE AND BUSINES ACROSS THE GLOBE
United States of America
The fourth largest nation in the world, the USA has been considered a
melting pot of diverse cultures. An overview of the dominant culture of the
USA reveals the following traits:

1. Highly achievement-oriented.
2. Highly organized and institutionalized.
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3. Freedom loving and self-reliant.

4. Work-oriented and efficient

5. Friendly and informal

6. Competitive and aggressive

Doing business and negotiating with Americans
1. Basic concept of negotiation: Conflict and confrontation seen as an
opportunity to exchange views.

2. Selection of negotiators: American negotiators are usually chosen
based on their past record of success and their knowledge and
expertise.

3. The role of individual aims: Americans encourage individual aims and
achievements.

4. Complexity of language: Americans are low context communicators
Messages are not overridden by non-verbal communication.

5. Value of time: For most Americans time is money. They set schedules
are appointments and tend to priorities events.
6. Risk taking propensity: Americans are willing to take risks.

7. Form of satisfactory agreement: American culture is legalistic.
American prefers and expects detailed contractual agreements to
formalize negotiations.

Canada
Canada is a bilingual and multicultural country. Throughout Canada, the
family is the center of the society and homes are often passed from one
generation to another. Canada has one of the world’s highest standards of
living and the people are very industrious. Canadians are friendly but
conservative and tend to observe formalities and rules of etiquette. They are
patriotic and law abiding and confident of their future and welcome foreign
business.

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Doing business and negotiating with Canadians

1. Basic concept of negotiations: They focus on points of disagreement as
they work through a problem by a linear process. This process involves
identifying the problem/opportunities, the objectives, the alternatives, the
decision and finally the plan of action.
2. Selection of negotiators: Canadian negotiators are usually chosen based
on their past record of success and their knowledge and expertise.
3. Role of individual aims: Canadians are expected to put the objectives of
the firm/country ahead of their personal aims.
4. Complexity of language: English speaking Canadians are low context
communicators, whereas French speaking Canadians are high context
communicators.
5. Value of time: Promptness in both beginning and ending a meeting is
appreciated. They are rigidly bound by their schedules and deadlines.

People’s Republic of China

The Chinese have always held themselves in high esteem. They see
themselves and their country and culture as the center of civilisation.

Negotiating in China

China is a group-oriented society and any negotiations must cover the
interests of many different parties. The Chinese will examine their
counterpart’s attitude and speech and apply it to solving the problem. The
following points should be taken into account when doing business with
China:
1. The Chinese are interested in long range benefits.
2. They stand by their word, and emphasis is placed on trust and mutual
connection.
3. They prefer to negotiate through intermediates.
4. They will not compromise on their goals.

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Japan

Language and communication
The Japanese prefer ambiguous terminology to direct and specific
references. Sentences are frequently left incomplete. All business and
negotiations are extremely polite and formal, but informality is seen during
socialising. Often, negotiations are carried out during business
entertainment.

Dress and appearance
Neat, orderly and conservative dress is recommended for executive staff,
Blue collar workers and students generally wear a distinctive uniform and
even a company pin which executives may also wear. Colours have
considerable significance in the Japanese culture.

Food and eating habits
Eating is ritualistic, communal and time consuming, Businessmen avoid
taking their wives to a business dinner even if invited.

Time and age consciousness
The Japanese are punctual, but they expect the other party to wait for group
decisions that may take time. In negotiating a licensing agreement, the final
decision may take up to three years but once the decision is taken,
production may be started within a few weeks. Their planning is long term
and implemented quickly. They give respect to seniority and the elderly.

Reward and recognition
There is a tendency to accept only group appreciation and not individual
rewards,. Great emphasis is put on security as well as a social need for
belonging. Money if given to Japanese should be in an envelope or else it is
considered to be an insult.

Relationships
They are group oriented rather than individualistic. They are sensitive to
what others think or expect and have a sharp sense of right and wrong.

Attitudes and beliefs
They are extremely adaptable. They do not resist change and are open to
automation and new technology. The Japanese are hard working, both for
the family and business. They are cooperative with the management.
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Europe

The three large markets in the EU are Great Britain, Germany and France. In
doing business with the EU the following points are to be considered.
1. Customer service is the key to success.
2. Price lists should be published in the local currency and not in any
foreign denomination.
3. Sales personnel must know their products. Europeans are
sophisticated buyers of foreign products.
4. Europeans gauge the commitment of the company by the way they
treat their sales representatives.
5. Europeans value personal contact and mementos, so a token gift may
create a favourable impression.

Australia

Australians are generally easy going and friendly. Australians speak directly
and frankly; they dislike pretensions of any kid and will not shy away from
disagreement. It is necessary for men to shake hands before and after
meetings, but not necessary that women should do the same. The basic rules
of etiquette in Australia are that:
1. Men should never wink at women, even if they are friends.
2. Yawning in public is rude.
3. Eye contact is important, especially in business meetings.

CONCLUSION

The international business community is constantly expanding its activities
in different part of the world. The business executives and managers are
required to interact with society, customers, and bureaucrats. Handling the
work force is a major challenge even to multinationals. This has led to any
transnational companies taking the advice of experts in a chosen field prior
to entering a country.

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16 . GLOBAL HUMAN RESOURCE MANAGEMENT
Human being is the only intangible asset which will bring
an unimaginable quantum of tangible output provided the
asset is identified, nurtured and groomed to shoulder global
business responsibilities.

Learning Values:

1. Discuss the role culture that plays in determining the effective use of
human resource management.
2. Identify critical HRM issues faced by multinational and global
organizations.
3. Discuss human resources as core competent tools for Global
organizations
4. Define Global HR planning and process.
5. Specify four important HR benchmarking measures.
6. Evaluate human resource information system (HRIS).

Human Resources as a Prime Mover

Strategic Human Resources Management deals with Organizational use of
employees to gain or keep a competitive advantage against competitors.
Core Competency is a unique capability in the organization that creates high
value and that differentiates the organization from its competition.

259


Possible HR Areas for Core Competencies in Global Market

Outstanding
Service

Unusual
Innovation Quality
GLOBAL
HRM

Special
Productivity
Skills

HR-Based Competencies
260


1. Organizational Culture
a. The shared values and beliefs of the workforce
2. Productivity
a. A measure of the quantity and quality of work done,
considering the cost of the resources used.
b. A ratio of the inputs and outputs that indicates the value added
by an organization.
3. Quality Products and Services
a. High quality products and services are the results of HR-
enhancements to organizational performance.

Global Customer Service Dimensions

Service
Excellence

Physical Facilities and
Equipment

Care and Concern

Confidence in Employees
Knowledge

Dependable and Accurate
Performance

Timely Assistance

Key Terms in Global Human Resource Management

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Culture shock
The feelings of frustration and confusion that result from being constantly
subjected to strange and unfamiliar cues about what to do and how to get it
done when trying to live in a new culture. Many MNCs struggle hard at
operational level due to their inability to overcome cultural shocks,
especially in developing countries.

Ethnocentric HRM Perspective
A view of HRM whereby an organization thinks that the way of doing things
in the parent country is the best way, no matter where business is done.
Imposing ethnic or parent company’s norms and operation styles will lead to
detriments.

Expatriate manager
A manager who is on assignment in a country other than the parent country
of the organization. This person is also called a parent country national
(PCN). Such a manager has to be so quick in adopting the culture of his
working domain if he wants to be an effective manager.

Foreign Corrupt Practices Act of 1977 (FCPA)
A law that makes it illegal for an American organization to pay bribes to
foreign officials for the purpose of getting a competitive advantage in doing
business.

Geocentric HRM Perspective
A view of HRM whereby nationality is ignored and managers are hired on
the basis of qualifications. Merit and performance are the key criteria for
HRM. They are highly respectable and capable of handling any turbulent
situation.

Global Corporation (GC)
A corporation with a geocentric HRM perspective. National boundaries are
ignored and HRM is viewed as a way of integrating operations all over the
world.

Global Human Resource

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The policies and practices related to managing people in management an
internationally oriented business.

Host Country National (HCN)
An employee of an international organization who is from the local
workforce rather than being from the parent country of the organization.

Parent Country National (PCN)
An employee from the corporation’s home country is on assignment in
another country. Generally the investing companies are prone to such a
syndrome to bring key human resources from home country which may
enkindle hatred amongst the people in the country of operation.

Sullivan Principles
Reverend Sullivan was the first African-American to serve on the Board of
General Motors. The tenets of his principles were designed to eventually
eliminate oppressive racism in South African business.

Third Country National (TCN)
An employee working for an international organization who is from a
country other than the parent country of the organization or the host country
in which the assignment is located.

Global organizational move Challenges
1. Foreign direct investment (FDI) flows
Driving force for globalization 2. Cross-border inter-firm agreements

1. Satisfied employees
2. Competitive products and services
3. Searching for new or broader markets
Organizations expand beyond domestic
4. Acquiring new, more efficient
boundaries to achieve
manufacturing technology
5. Large, inexpensive labor forces

Global human resource management 1. “people challenge” the most difficult for
(GHRM) includes the same functions as firms becoming international
domestic HRM, plus several aspects 2. Most critical to success, acquiring a
unique to international management competent workforce (survey of top

263


execs.)

1. Finding suitable candidates
2. Intercultural understanding
3. Career management
4. Employee retention
The top HR challenges include
5. Adjusting to environment
6. Partner dissatisfaction
7. Relocation reluctance

1. Individualism versus collectivism
The cultural nature of global human 2. Power distance
resource management 3. Uncertainty avoidance
cultural differences 4. Masculinity versus femininity

1. Fit (congruence among HR policies,
firm’s plan & values of foreign culture)
2. Internal fit (HR policies that allow for
The concept of "fit" in global human
smooth work flow: HQ & local)
resource management
3. External fit (HR to consider the local
cultural/socioeconomic environment)

1. Early stages of internationalization
strategy
Multinational Corporation (MNC) - HRM 2. Ethnocentric orientation - PCN hires
Philosophy 3. Adapting products and services to local
markets

1. National boundaries disappear
2. Geocentric orientation – TCN hires
Global Corporation (GC) - HRM
3. The world is the market for its products &
Philosophy
services

1. Finding competent expatriate managers
2. To capitalize on the diversity of a global
workforce without suppressing each
The real challenge
nation’s desire to maintain its cultural
identity

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1. Host Country Nationals (HCNs)
Three sources of employees for 2. Parent Country Nationals (PCNs)
international assignments include 3. Third Country Nationals (TCNs)

1. Complex & sensitive task
2. Technical competence
3. Self image: self-confidence, self-esteem,
stress coping
Selecting the expatriate manager 4. Interaction skills: interpersonal style,
sensitivity to nonverbal communication
perceptual orientation: open-mindedness,
tolerate uncertainty accept cultural
differences
1. Fascination
2. Culture shock
Stages of reaction to foreign experience
3. Adaptation

1. Select managers who desire/want foreign
assignments (where possible)
Effective measures to deal with culture
2. Language fluency
shock
3. Preparation for cultural differences

1. Provide intercultural training – improves
chances for success
2. How much & type of training depends on
level of contact with host culture
3. Degree of dissimilarity between home &
Training the expatriate manager host cultures
4. Training to differ/vary at different phases
of expatriate’s assignment
(ex. pre-departure, overseas assignment,
repatriation)

1. Expensive proposition
2. Pay expatriate premium, COLAs,
allowances
Compensating the expatriate manager 3. Financial (education, home leave)
4. Social adjustment (language, cross
cultural training, locate home)
5. Family support (child care, trailing
265


spouse, schools)

1. Less expensive
2. Have distinct advantages in cultural
sensitivity, understanding local employee
needs/motivation strong reservations exist
in using HCNs:
3. Concern that locals will not adopt PC
culture & management system
4. Level of commitment to organization
Host Country Nationals and the Global
may not be high
Corporation
5. Don’t have the expertise or requisite
skills that PCNs/expatriates possess
6. Communication between HQ and host
offices will be less effective
7. Most problems can be eliminated by
careful recruitment, selection, and
training of HCNs

When recruiting try to use the same recruitment
methods as local businesses &
HCNs - Recruitment other successful GCs

1. Foreign Corrupt Practices Act – (1977)
forbids in conducting to give the firm an
unfair advantage
2. There exists varying degrees of
employment discrimination in other
The legal and ethical climate of global
countries which may cause
human resource management
problems/dilemmas for PCNs managers
3. Civil Rights Act of 1991 applies to US
firms’ operations overseas
4. Sullivan Principles

FACTORS AFFECTING GLOBAL HR PLANNING

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Strategy of Culture of Competitive / Current
the the Financial Organization
Environment
organization organization Situation

Need for Human Available
resources: Financial
Quantity and Resources
Skill Levels

HR policies and Plans for:
• Recruiting
• Selection
• HR development
• Compensation
• Performance
Management
• Staffing Adjustments

Linkage of Organizational and HR Strategies
267


Global HR Planning Process

Benefits of Global HR Planning
268


1. Better view of the HR dimensions of business decisions abroad
2. Lower HR costs through better HR management.
3. More timely recruitment for anticipate HR needs
4. More inclusion of protected groups through planned increases in
workforce diversity.
5. Better development of managerial talent

Scanning the External Environment

1. Environmental Scanning
a. The process of studying the environment of the organization to
pinpoint opportunities and threats.
2. Environment Changes Impacting HR
a. Governmental regulations
b. Economic conditions
c. Geographic and competitive concerns
d. Workforce composition

Internal Assessment of the Organizational Workforce

1. Auditing Jobs and Skills
a. What jobs exist now?
b. How many individuals are performing each job?
c. How essential is each job?
d. What jobs will be needed to implement future organizational
strategies?
e. What are the characteristics of anticipated jobs?
2. Organizational Capabilities Inventory
a. HRIS databases—sources of information about employees’
knowledge, skills, and abilities (KSAs)
b. Components of an organizational capabilities inventory
• Workforce and individual demographics
• Individual employee career progression
• Individual job performance data

Assessing HR Effectiveness
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1. Diagnostic Measures of HR Effectiveness
a. HR expense per employee
b. Compensation as a percent of expenses
c. HR department expense as a percent of total expenses
d. Cost of hires
e. Turnover rates
f. Absenteeism rates
g. Worker’s compensation per employee

1. HR Audit
a. A formal research effort that evaluates the current state of HR
management in an organization
b. Audit areas:
i. Legal compliance (e.g., EEO, OSHA, ERISA, and
FMLA)
ii. Current job specifications and descriptions
iii. Valid recruiting and selection process
iv. Formal wage and salary system • Benefits
v. Employee handbook
vi. Absenteeism and turnover control
vii. Grievance resolution process
viii. Orientation program
ix. Training and development
x. Performance management system

270

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