FINALEXAMINATION – FALL2015
1. Identify and discuss the five basic types of economic integration. For each give two
- Free Trade Area — all barriers to the trade of goods and services among member countries are
removed. No discriminatory tariffs, quotas, subsidies, or administrative impediments are
allowed to distort trade between members.
• European Free Trade Association (EFTA) — 1960 includes Norway, Iceland, Liechtenstein
and Switzerland — free trade in industrial goods.
• North American Free Trade Agreement (NAFTA) — 1991, includes Canada, USA and
- Customs Union — eliminates trade barriers between member countries and adopts a common
external trade policy. Necessities significant administrative machinery to oversee trade
relations with non-members.
• The Andean Pact — Includes Bolivia, Colombia, Ecuador and Peru — they established free
trade between them and imposes a common tariff of 5-20% on products imported from
Common Market — has no barriers to trade among member countries, includes a common
external trade policy, and allows factors of production to move freely among members. Labor
and capital are free to move because there is no restrictions on immigration, emigration, or
cross-border flows of capital among member countries.
• Mercosur — South American grouping of Argentina, Brazil, Paraguay, Uruguay and
Venezuela — it hopes to eventually establish itself as a common market.
• European Union functioned as a common market for years before moving beyond this stage.
- Economic Union — involves the free flow of products and factors of production among
member countries and the adoption of a common external trade policy, but it also requires a
common currency, harmonization of members tax rate and a common monetary and fiscal
• The European Union — it is an imperfect one but still is one.
1 - Political Union — a central political apparatus coordinates the economic, social, and foreign
policy of the member state.
• The European Union — might be moving toward a partial political union.
2. Assume that you are the CFO for a Canadian producer of aircraft engines and that your
company has received an order for 150 engines from an aircraft manufacturer in Australia.
It is valued at $20 million Canadian dollars and payment will be due upon delivery of the
engines which will occur nine months from now. The customer insists on paying you in
Australian dollars. Should you accept these terms? What are opportunities and the risks in
doing so? What options are available to offset any risk? What option would you
- Accept/Reject the terms — there is an automatic risk when dealing with different currency
no matter where your transaction occurs around the world. Deciding to accept or reject an
offer is a really difficult decision because it can either be in the producer’s advantage as it can
be profitable for the buyer. Markets are not predictable and you cannot totally know if your
transaction will be profitable 9 months from now. In fact, currency vary among different
factors that occur inside and outside the country. Therefor, we cannot predict weather the
foreign currency will depreciate or appreciate, or if any other risks may occur and make the
- Risks & opportunities in accepting the terms
• Foreign Exchange Risk
Transaction Exposure — loss of money if the local currency depreciates over the
• If the terms are accepted :
• Canada sells 150 engines to Australia @ a $20M value (e.g. 1$ AUD = 1.03$CAN;
thenAustralia will owe about $19.4MAUD for the 150 engines)
• BUT payments are due in 9 months :
• If depreciation of the CAN $ occurs (e.g. 1$ AUD = 0.95$CAN; then the $19.4M AUD
owed byAustralia will actually be worth about $18.4M CAN) — RISK
• If appreciation of the CAN $ occurs (e.g. 1$ AUD = 1.10$CAN; then the $19.4M AUD
owed byAustralia will actually be worth about $21.3M CAN) — OPPORTUNITY
Option available to offset risks
• Forward Exchange Rates
- Quoted most of the time for 30 days, 90 days and 180 days in the future but can be
extended to many months or years. They guarantee that they will not pay more (buyer’s
perspective) or receive less (seller’s perspective) than what the actual deal offered based
on the Forward Exchange Rate. Therefor, by using this strategy, the aircraft producer
2 won’t risk receiving less than $20M CAN and the Australian buyer won’t risk paying
more than $19.4MAUD.
• Currency Swap
- When two countries decide to make transactions (selling & buying) they can use currency
swap to get more favourable loan rates in foreign currency than they can actually get by
borrowing money from banks in the target currency. The two countries agree an interest
rate at which they will swap in order to save on cost (interest cost) and still receive the
loan they needed to do their transactions
• Leading & Lagging Strategies
- Process by which we accelerate payments from weak-currency to strong-currency (lead)
countries and delay inflows from strong-currency to weak currency countries (lag).
• In this particular case, I would recommend to use a Forward Exchange Rate since there is
no way of predicting future rates and fluctuation in the economies of the two countries.
Thus, by using this strategy both side will be profitable at the end of the transaction.
3. What is meant by the word ‘strategy’? Using Procter & Gamble as an example, describe
how the company could pursue each of the following strategies: international, localization,
and global standardization.
- Strategies are actions that managers take to attain the goals of the firm. For most firms, the
most important goal is to maximize the firm’s value for its shareholders by pursuing strategies
that increase its profitability of the enterprise and its rate of profit growth over time. We mean
by profitability the rate of return that the firm males on its own invested capital and by profit
growth the percentage increase in net profits over time.
- International Strategy
• Mostly used by small and medium businesses that find themselves with low pressure to
reduce costs and local responsiveness. It arises when firm produces a product locally and
has the chance to sell its product internationally with a very minimal or non-existent need to
customize it to fit its international market demands. The element that distinguished this
strategy from the others is that the companies are selling a product or service that has a
universal need while having virtually no competition, which is why they do not face any
pressure to reduce costs.
- P&G : By using this strategy, they can sell a unique product manufactured in Cincinnati
around the globe and then setting up marketing functions in the foreign country in order
to market their product in the appropriate way depending on the area it sales. The product
remains the same on a global scale but has a tailored marketing strategy depending on the
country in which it sales.
3 - Localization Strategy
• The focus of this strategy is customizing the firm’s goods or services to match the needs of
that specific international market. Customizing the product or service offered to local
demands increases its value in that local market. Localization has high cost due to the lack
of cost reductions associated with mass production. It is most appropriate when cost
pressures are not too intense and a strong difference in taste amongst consumers in different
- P&G : In this case, P&G would have to customize its products in order to match tastes
and preferences in different national market. Thus, by producing one product having
different features responding to different global needs, they create greater consumer value
which will differentiate them from competitors. For example, this strategy would be
efficient if P&G were to use their brand Olay to create a specific type of make-up that
would enhance specific skin tones found in China, Inda, Africa or North America. The
difference in skin tones in these areas are quite significant and by developing its product
in function of those differences would differentiate themselves from competition since
they create greater value for consumers. If the products succeed, then they would be able
to mass-produce standardized products for many huge markets and capture some
economies of scale.
- Global Standardization
• The goal of this strategy is to pursue a low cost strategy on a global scale. The focus is on
increasing profitability and profit growth by reaping the cost reductions that come from
economics of scale. Firms pursing global standardization prefer to market a standard
product worldwide to gain the maximum benefit from economies of scale and learning
effects. This strategy makes most sense when there are strong pressures for cost reductions
and demands for local responsiveness are minimal.
- P&G : By using this strategy P&G would have to concentrate its production, marketing
and R&D activities in few favourable locations in order to market a standardized product
world-wide. Therefor, by installing specific locations they can all work together to find a
way to offer a product that fits on a global scale. This will lead them to benefit from
economies of scale and learning effect while maintaining a cost advantage against
competitors who may not have expanded in those targeted areas.
4 4. When conducting business internationally, companies often face make-or-buy decisions
about whether they should perform a value creation activity themselves or outsource it to
another entity. Identify and briefly discuss the advantages of each of these alternatives.
- Advantages of Make
• Lowering costs :
- If the firm is more efficient at that production activity than any other firms
• Facilitating Specialized Investments :
- By investing in a specialized asset to supply another, mutual dependancy is created so the
firm will prefer to make the component internally rather than contract it to a supplier.
Substantial empirical evidence supports this prediction.
• Protecting Proprietary Product Technology :
- If it enables the firm to produce a product containing superior features, proprietary
technology can give the firm a competitive advantage.
Firms don’t want to outsource the production of products and components having
proprietary technology so that those suppliers don’t sell the idea to competitors
- To maintain control over its technology, the firm will prefer to make such product or
• Accumulating Dynamic Capabilities :
Firms can learn through their experience how to lower cost, design better products,
increase product reliability,…
- Skills become more valuable over time through learning
- Experience acquire by producing one kind of product might create a capability that is
then useful for producing another kind of product
• Improving Scheduling :
- Production cost savings result because it makes planning, coordination, and scheduling of
adjacent processes easier.
- Advantages of Buy
• Strategic Flexibility :
- Firm can maintain its flexibility, switching orders between suppliers as circumstances
- Firm can avoid political risks by buying from an independent supplier in a country,
thereby maintaining the flexibility to switch sourcing to another country if war,
revolution or other political change alters the country’s attractiveness as a supply source.
5 • Lower costs :
- Firms that buy its components from independent suppliers can avoid many problems and
cost associated with them if those products were produced in-house.
- Bureaucratic inefficiencies and resulting costs that can arise when firms vertically
integrate backward and produce their own components are avoided by buying component
parts from independent suppliers.
• Offsets :
- May help the firm to capture more orders from that country.
5. “The choice of strategy for a multinational firm must depend on a comparison of the
benefits of the strategy (in terms of value creation) with the costs of implementing it (as
defined by organizational architecture necessary for implementation). On this basis, it may
be logical for some firms to pursue a localization strategy and still others a transnational
strategy.” Is this statement correct? If so, why? If not, why not?
- Each firm must decide upon a strategy to develop globally and increase their firms reach. They
choose among four main strategies when they wish to start their global expansion. The
appropriateness and allure of each of these strategies vary depending on the extent of pressure
for cost reductions and local responsiveness. When looking at pressure for cost reductions, the
firm is requires to try to minimize its unit costs. On the other hand, pressures for local
responsiveness requires that the firm differentiate its product offering and marketing strategies
from country to country in oder to accommodate the diverse demands raising from national
differences in consumer tastes and preferences.
• Transnational Strategy
- In its essence, it is trying to capture all the major benefits of both localization and
standardization strategies. The benefits are the high market share that comes with
customized products and services and the low cost of production that accompanies mass
production. This may seem like the best strategy to implement for every company in
theory, but it is much harder to actually implement. The main downfall of this strategy is
the conflict it places on the firm itself since it wants to differentiate products depending
on markets, but at the same time, this raises costs which is the opposite of the firm’s goal
of reducing costs. How to implement such a strategy is one of the most complex
questions that large multinationals are facing today.
• Localization Strategy
- The focus of this strategy is customizing the firm’s goods or services to match the needs
of that specific international market. Customizing the product or service offered to local
demands increases its value in that local market. The downside of localization is its high
cost due to the lack of cost reductions associated with mass production. This forces firms
to make sure they are efficient in every way possible as to not have any unnecessary
6 expenses. Localization is most appropriate when cost pressures are not too intense and a
strong difference in taste amongst consumers in different nations exists.
- Both strategies are interesting and multinationals might benefit from them if they are properly
developed. However, I wouldn’t totally agree with this statement because implementing a
Localized Stratvegydoes give a firm a competitive edge, but if it is simultaneously facing
aggressive competitors, the company will also have to reduce its cost structure, and the only
way to do that may be to shift towards a Transnational Strategy. Although this might be the
best solution, such as Procter & Gamble accomplished, it is a really risky and demanding
strategy. Therefor, firms are better off using a Transnational Strategy but implementing such a
strategy may not be easy.
6. Define the terms ‘law of one price’ and ‘purchasing power parity’. Describe how they
and the money supply and price inflation influence exchange rates.
- Law of one price — In competitive markets free of transportation costs and barriers to trade,
identical products sold in different countries must sell for the same price when their price is
expressed in the same currency.
• Influence on exchange rates :
Law of one price is actually existing when the exchange rate is taken into account. If a
jacket sell at $80 CAN and that the exchange rate is ($1 EURO = $2.00 CAN) than the
jacket must sell at $40 EURO in London. However, if London sells its jackets at $60
EURO, then Montreal will buy from London and make a $20 CAN profit on its sell. At
some point, London will raise their prices due to an increase in demand and Montreal will
lower their prices due to an increase in supply, which will continue until the prices
equalize. Thus, prices will always equalize when exchange rates are taken into account
since demand and supply will move opposite ways in the two countries.
- Purchasing Power Parity — An adjustment in gross domestic product per capita to reflect
differences in the cost of living.
• Influence on exchange rates :
- PPP theory predicts that exchange rates are determined by relative prices and that
changes in relative prices will result in a change in exchange rates. According to the
economist, comparing a country’s actual exchange rate with the one predicted by the PPP
theorem based on relative prices, tests whether a currency is undervalued or overvalued.
- Money Supply & Price Inflation
• Influence on exchange rates :
- The growth rate of a country’s money supply determines its likely future inflation rate.
We can then use this information about the growth in money supply to forecast exchange
rate movements. (In theory at least)
An increase in a country’s money supply at a faster speed than the growth in it’s output
leads to an increase in inflation rates/price inflation. This phenomenon will then lead to a
depreciation of the currency itself, resulting in an increase in exchange rates.
7. Debate the relative merits of fixed and floating exchange rate regimes. From the
perspective of an international business, what are the most important criteria in a choice
between the systems? Which system is more desirable for an international business? Why?
- Fixed exchange rate — system under which the exchange rate for converting one currency into
another is fixed.
• Monetary Discipline
- Ensures that governments do not expand their money supplies at inflationary rates.
- Believes that government should not give in too much political pressure and expand
money supply too rapidly since this causes unacceptably high price inflation.
- With speculation and panic, investors scrambled to get their money out and convert it into
foreign currency before the local currency was devalued