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Chapter 4

Chapter 4 Competing in world market.docx

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University of Toronto St. George
Rotman Commerce
Michael Khan

Chapter 4 Competing in World Markets Why nations trade When their home markets mature and sales slow, companies in every industry know the importance of expanding business to other countries. International trade is vital to a nation and its businesses. Trading with other countries increases economic growth in two ways: by providing a new market for products and by providing access to needed resources. Companies can expand their markets, seek growth opportunities in other nations, and make their production and distribution systems more efficient. They can also reduce their dependence on the economies of their home nations. International Sources of Factors of Production Business decisions to operate abroad depend on the basic factors of production in the other country: the availability, price, and quality of labour, natural resources, capital and entrepreneurship. [India highly qualified computer scientists- many global computer software and hardware firms have set up operations in India.] Trading with other countries also allows a company to spread risk because different nations may be at different stages of the business cycle or in different phases of development. If demand falls in one country, the company may find strong demand in other nations. [General Motors, IKEA] Size of the International Marketplace Companies are also attracted to international business because of the size of the global marketplace. The world’s population is approximately 7 billion now. Only one in six people live in a well- developed country. The portion of the world’s population living in less developed countries will increase in the coming years because more developed nations have lower birthrate. When firms in developing nations increase their global business, they also increase their ability to reach new groups of customers. Firms that are looking for new revenue are usually attracted to giant markets, such as China and India. Consumer demand also needs purchasing power. Population size does not guarantee economic prosperity. With 10 countries with the highest population, only one country also has a GDP on the top 10 list- the US. With a population of 34 million people, Canada places 36 from the top of the population rankings but 11 with $45,888 per capita GDP. Many developing countries have typically posted high growth rates in their annual GDP. China and India, these countries represent opportunities for global businesses, even though their per-capita incomes are lower than in more developed countries. Many North American firms are setting up operations in these and other developing countries. They want to benefit from local sales as a result of expanding economies and rising standards of living. [Wal-Mart in China/Brazil] Canada’s trade is overwhelmingly tied to the United States, and U.S trade is tied to Canada. Both countries are similar in their social and cultural values. That means that when a business finds a market in one country, it will most likely find the buyers in the other country, too. Much of Canada’s trade with US is resource-based. Canada’s energy supply of oil, natural gas, and hydro-electricity will continue to grow as the US continues to need safe, secure, and reliable supplies and energy. Absolute and Comparative Advantage Trading has helped countries to meet the demand for goods and services. A country can focus on producing what it does best. It can then export the extra output and buy foreign products that it doesn’t have or cannot produce efficiently. The foreign sales of a product depend on whether the country has an absolute advantage or a comparative advantage. A country has absolute advantage in making a product when it has a monopoly on making that product or when it can produce the product at a lower cost than any other country. China has had an absolute advantage in silk production for centuries. Today, absolute advantages are rare. Some countries almost have absolute advantages in some products. For example, climate differences can give some nations or regions an advantage in growing certain plants. Saffron may be the world’s most expensive spice. It costs around $4650 per kilo. It’s native to the Mediteraranean, Asia Minor, and India. Today, Saffron is grown mainly in Spain, where the plant thrives in the Spanish soil and climate. A nation can develop a comparative advantage when it can supply its products more efficiently and at a lower price than it can supply other goods, compared with the outputs of other countries. China profits from its comparative advantage in producing textiles. A nation can also develop a comparative advantage in skilled human resources by ensuring that its people are well educated. [India-software development-highly educated workforce and low wage scale] Measuring Trade between Nations International trade provides competitive advantages to both the countries and the individual companies involved. To measure global business activity, we need to look at two ideas- the balance of trade and the balance of payments. Another important factor is the currency exchange rates for the trading countries. A nation’s balance of trade is the different between its exports and imports. When a country try exports more than it imports, it has a positive balance of trade, called a trade surplus. When a country imports more than it exports, it produces a negative balance of trade, called a trade deficit. Canada tends to maintain a balance between exports and imports by running a trade surplus with the US and a trade deficit with other trading partners, particularly China. The US is one of the world’s top exporters, but is has an even greater demand for foreign-made goods, which creates a trade deficit. A nation’s balance of trade plays a central role in shaping its balance of payments- the overall flow of money into or out of a country. The balance of payments is also affected by overseas loans and borrowing, international investments, profits from international investments, and foreign aid payments. To calculate a nation’s balance of payments, subtract the monetary outflows form the monetary inflows. A positive balance of payments, or a balance of payments surplus, means more money has moved into a country than out of it. A negative balance of payments, or balance of payments deficit, means more money has gone out of the country than entered it. Major Canadian Exports and Imports The global economy has grown to more than $74 trillion of total GDP. Canada’s economy represents about $1.3 trillion, and the US economy represents about $14.7 trillion. Trade is an important reason why global GDP has grown and keeps growing. Canada’s top exports in 2010 were industrial goods and materials, energy products, and machinery and equipment. On the import side, Canada’s top imports were machinery and equipment, industrial goods, and materials, and automotive products. U.S annual imports are nearing $2 trillion, making the United States the world’s leading importer. Exchange Rates An exchange rate is the value of one country’s currency in terms of the currencies of other countries. The value of currency is an important economic measure for every country. Each currency’s exchange rate is usually stated in terms of another currency. Many factors can affect foreign exchange rates: economic and political conditions, actions by the central bank, balance-of-payments position, and speculation over future currency values. Currency values fluctuate, or “float”, depending on the supply and demand for each currency in the world market. In this system of floating exchange rates, currency traders create a market for the world’s currencies based on each country’s trade and the likelihood of investments. Nations can affect exchange rates in other ways. They may form currency blocs by linking their exchange rates to each other. Many governments practise protectionist policies that try to protect their economies against trade imbalances. For example, nations sometimes take actions to devalue their currencies. It is a way to increase exports and encourage foreign investment. Devaluation is a reduction in a currency’s value in terms of other currencies or in terms of a fixed standard. Brazil devalued its currency. Investing in Brazil became less costly than investing in others. For an individual business, the impact of currency devaluation depends on where the business buys its material and where it sells its product. Usually, business transactions use the currency of the country where the transactions take place. Exchange rate changes can quickly create or destroy a competitive advantage. They are important factors when investors decide whether to invest in other countries. Currencies that easily convert into other currencies are called hard currencies. Examples of hard currencies are the euro, the U.S dollar, and the Japanese yen. The Russian Ruble and many central European currencies are soft currencies because they cannot be converted as easily. {Barter} The foreign currency market is the largest financial market in the world. Its daily volume is more than US $3 trillion. This amount is about 10 times the size of all the world’s stock markets combined. {Most liquid and most efficient financial market in the world} Barriers to international trade International companies must follow a variety of laws and exchange currencies. They may also need to change their products to suit different tastes in other countries. Companies that do international business face social and cultural differences, economic barriers, and legal and political barriers. Some of these barriers are easy to deal with, but other barriers require a company to make major changes in its business strategy. Social and Cultural Differences The social and cultural differences among nations range from language and customs to educational background and religious holidays. Understanding and respecting these differences are important for international business success. Language English is the second most widely spoken language in the world, followed by Hindustani, Spanish, Russian, and Arabic. Understanding a business colleague’s primary language can make the difference between closing an international business transaction and losing the sale. Some firms rename their products or rewrite slogans for foreign markets. Some communication barriers involve more than bad translations. Companies may make mistakes by presenting messages using unsuitable media, overlooking local customs and regulations, or ignoring differences in taste. Yellow flowers are used in their Day of Dead activities for Mexicans. Values and Religious Attitude North American society places a higher value on business efficiency and lower unemployment than European society. But in Europe, employee benefits are more valued. In Canada, vacation time is decided on by each provincial government. North American culture values national unity and accepts regional differences. Canada and the US are seen as separate national markets that have independent economies. European countries that are part of the 27 member EU are trying to create a similar marketplace. British consumers differ from Italian consumers in important ways. Religion plays an important role in every society. Businesspeople must also learn to be sensitive to the major religions in countries where they operate. People who do business in Saudi Arabia need to remember Islam’s month-long observance of Ramadan, when work ends at noon. Economic Differences North American business opportunities usually do well in densely populated countries such as China and India. Although selling products there is tempting for Canadian firms, managers must think about the economic factors of doing business in China and India: the country’s size, its per-capital income, and its stage of economic development. These economic factors are important to think about when deciding whether a country is right for an international business venture. Infrastructure Businesses that compete in world markets need to think about the host country’s economic measures, including its infrastructure. Infrastructure refers to the basic system of communication (telecommunication, television, radio, and print media), transportation (roads and highways, railroads and airports,) and energy facilities (power plants and gas and electric utilities). The internet and technology use can also be considered part of infrastructure. Federal systems provide a type of infrastructure for businesses. In Canada, buyers have widespread access to cheques, credit cards, and debit cards, and to the electronic systems needed to process these payments. In many African countries, such as Ethiopia, local businesses do not accept credit cards. Currency Conversion and Shifts Countries share many similarities in their infrastructure. But businesses that cross national borders face basic economic differences: national currencies. Foreign currency fluctuations, or ups and downs, may mean more problems for global businesses. Political and Legal Differences In China, the government is very strict about Internet use. Many Chinese websites are now registering overseas to try to avoid government censorship. The government’s use of censorship can be a threat to companies thinking about doing business there. To compete in today’s world marketplace, managers in international business need to be familiar with the legislation that affects their industries. Political Climate The political structures of many nations promote stability similar to the political stability in Canada. Other nations have very different political structures that change frequently. This is the situation in Indonesia, Congo, and Bosnia. Host nations often pass laws to protect their own interests, sometimes at the expense of foreign businesses. The political structures have had huge changes in Russia, Turkey, the former Yugoslavia, Hong Kong, and in several central European countries, including the Czech Republic and Poland. Since the collapse of the Soviet Union, Russia has struggled to develop a new market structure and political processes. Legal Environment When doing business internationally, managers must be familiar with three dimensions of the legal environment: Canada law, international regulations, and the laws of the countries in which they plan to trade. Some laws protect the rights of foreign companies to compete in Canada. Others spell out the actions allowed for Canadian companies doing business in foreign countries. Canada’s Corruption of Foreign Public Officials Act (CFPOA) and the American Foreign Corrupt Practices Act (FCPA) make it illegal for companies to bribe foreign officials, political candidates, and government representatives. These acts set out the fines and jail time for managers who are aware of illegal payoffs. Corruption continues to be an international problem. The commonness of bribing and the international rules against bribery create difficulties for Canadian businesspeople who want to do business in foreign countries. The growth of online business has introduced new elements to the legal situation of international businesses. Patents, brand names, trademarks, copyrights, and other intellectual property are difficult to keep watch over, given the availability of information on the internet. International Regulations To make international commerce more standard, Canada and many other countries have treaties some and signed agreements that describe the expected conduct of international business and protect some of its activities. Canada has entered into many friendship, commerce, and navigation treaties with other nations. These treaties describe many aspects of international business relations, including the right to conduct business in the treaty partner’s home market. Other international business agreements involve product standards, patents, trademarks, tax policies, export controls, international air travel, and international communications. One area has no international regulations- the use of protection of water supplies. Types of Trade Restrictions Trade restrictions include taxes on imports and complicated administrative procedures. These trade restrictions create additional barriers to international business. They may limit the products and services available to consumers and can increase the costs of foreign-made products. Trade restrictions are also used to protect citizen’s security, health and jobs. A government may limit exports of strategic and defence-related goods to unfriendly countries to protect its country’s own security. Trade restrictions may be used for different political reasons, but most are in form of tariffs. Government also impose some nontariff barriers, also called administrative barriers. These barriers include quotas, embargoes, and exchange controls. Tariffs Taxes, surcharges, and duties on foreign products are referred to as tariffs. Government access two types of tariffs- revenue tariffs and protective tariffs. Both tariffs make imports more expensive for domestic buyers. Revenue tariffs generate income for the government. A protective tariff has one purpose: to raise the retail price of imported products to match or top the prices of similar products made in the home country. In other words, protective tariffs try to limit imports and give local competitors an equal chance to succeed. Tariffs are a disadvantage to companies that want to export to the countries that have the tariffs. Nontariff Barriers Nontariff trade barriers are also called administrative trade barriers. These barriers restrict imports without using the strict rules that tariffs use. Nontariff trade barriers may be in the form of quotas on imports, restrictive standards for imports, and export subsidies. Quotas limit the amounts of particular products that countries can import during specified time periods. Limits may be set as qualities, such as the number of cars or bushels of wheat. Limits can also be set as values, such as dollars’ worth of cigarettes. Quotas help prevent dumping. In one form of dumping, a company sells products in other countries at prices below the cost of production. In another form of dumping, a company exports a large quantity of a product at a lower price than the same product in the home market. This action drives down the price of the domestic product. Dumping benefits domestic consumers in the importing market, but it hurts domestic producers. An embargo is more severe than a quota. An embargo is a total ban on importing a specified product. It can also be a total stop to trading with a particular country. Many countries, including Canada, have long-standing trade embargoes with North Korea and Iran. Embargo durations can vary depending on changes in foreign policy. Another form of administrative trade restriction is exchange control. A central
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