Subject- IB

Unit 1

By- K.R. Ansari

Overview of International Business

International Business is all commercial transactionsprivate and governmental between two or
more countries. Private companies undertake such transactions for profit; governments may or
may not do the same in their transactions. These transactions include sales, investments and
transportation.
International business grew over the last half of the twentieth century partly because of
liberalization of both trade and investment, and partly because doing business internationally had
become easier. In terms of liberalization, the General Agreement on Tariffs and Trade (GATT)
negotiation rounds resulted in trade liberalization, and this was continued with the formation of
the World Trade Organization (WTO) in 1995.
Definitions
John D Daniels and Lee H Radebaugh in their book, International Business, define
international business as, all commercial transactions- private and governmentalbetween two or
more countries. Private companies undertake such transactions for profit; governments may or
may not do the same in their transactions. These transactions include sales, investments and
transportation.
The Internet Public Library (IPL) defines International Business as, doing business in
international markets, and business information specific to various countries or geographic
regions of the world. A great part of international business is international trade which is
defined as, The business of buying and selling commodities / services / investments beyond
national borders.
According to Harcourt Brace & Company, Orlando, Florida, International business consists
of transactions that are devised and carried out across national borders to satisfy the objectives of
individuals and organizations.
These definitions see the term international business as an action. The next one looks at the
term as referring to the actor.
According to International Business Journal, International business is a commercial
enterprise that performs economical activity beyond the bounds of its location, has branches in
two or more foreign countries and makes use of economic, cultural, political, legal and other
differences between countries.
Types of IB
The four types of international businesses one can start are as follows: 1. Exporting 2. Licensing
3. Franchising 4. Foreign Direct Investment (FDI).
1. Exporting:
Exporting is often the first choice when manufacturers decide to expand abroad. Simply stating,
exporting means selling abroad, either directly to target customers or indirectly by retaining
foreign sales agents or/and distributors. Either case, going abroad through exporting has minimal
impact on the firms human resource management because only a few, if at all, of its employees
are expected to be posted abroad.
2. Licensing:
Licensing is another way to expand ones operations internationally. In case of international
licensing, there is an agreement whereby a firm, called licensor, grants a foreign firm the right to
use intangible (intellectual) property for a specific period of time, usually in return for a royalty.

Subject- IB

Unit 1

By- K.R. Ansari

Licensing of intellectual property such as patents, copyrights, manufacturing processes, or trade

names abound across the nations. The Indian basmati (rice) is one such example.
3. Franchising:
Closely related to licensing is franchising. Franchising is an option in which a parent company
grants another company/firm the right to do business in a prescribed manner. Franchising differs
from licensing in the sense that it usually requires the franchisee to follow much stricter
guidelines in running the business than does licensing. Further, licensing tends to be confined to
manufacturers, whereas franchising is more popular with service firms such as restaurants,
hotels, and rental services.
One does not have to look very far to see how important franchising business is to companies
here and abroad. At present, the prominent examples of the franchise agreements in India are
Pepsi Food Ltd., Coca-Cola, Wimpys Damino, McDonald, and Nirula. In USA, one in 12
business establishments is a franchise.
However, exporting, licensing and franchising make companies get them only so far in
international business. Companies aspiring to take full advantage of opportunities offered by
foreign markets decide to make a substantial direct investment of their own funds in another
country. This is popularly known as Foreign Direct Investment (FDI). Here, by international
business means foreign direct investment mainly. Let us discuss some more about foreign direct
investment.
4. Foreign Direct Investment (FDI):
Foreign direct investment refers to operations in one country that ire controlled by entities in a
foreign country. In a sense, this FDI means building new facilities in other country. In India, a
foreign direct investment means acquiring control by more than 74% of the operation. This limit
was 50% till the financial year 2001-2002.
There are two forms of direct foreign investment: joint ventures and wholly-owned subsidiaries.
A joint venture is defined as the participation of two or more companies jointly in an enterprise
in which each party contributes assets, owns the entity to some degree, and shares risk. In
contrast, a wholly-owned subsidiary is owned 100% by the foreign firm.
An international business is any firm that engages in international trade or investment.
International trade refers to export or import of goods or services to customers/consumers in
another country. On the other hand, international investment refers to the investment of resources
in business activities outside a firms home country
Approaches to IB
1. Ethnocentrism:
In ethnocentric orientation, home country is considered to be superior. Further, the manager
looks for similarly in the foreign market. He supposes that products and processes that have
succeeded in the home country would also succeed abroad and should therefore be used.
In the ethnocentric orientation foreign operations are viewed as secondary to domestic operations
and primarily as a means of disposing off surplus domestic production. Plans for overseas
markets are developed in the home office, utilizing policies and procedures identical to those
employed in the domestic market. An export department or international division, and the
marketing personnel most commonly administer overseas marketing by an export department or
international division. The ethnocentric position appears to be appropriate for a small company
just entering international operations, or for companies with minimal international commitments
because this approach entails a minimal risk and commitment to overseas markets - no

Subject- IB

Unit 1

By- K.R. Ansari

international investment is required and no additional selling cost incurred, with the possible
exception of higher distribution costs.
2. Polycentrism:
As the company begins to recognize the importance of inherent differences in overseas markets,
a polycentric attitude emerges. The prevalent philosophy at this stage is that local personnel and
techniques are best suited to deal with local market conditions. Subsidiaries are established in
overseas markets and each subsidiary operates independently of the others and establishes its
own marketing objectives and plans. In polycentric orientations the manager recognizes that each
country is unique. To succeed abroad, such uniqueness has to be respected and addressed in the
company offerings. The centralized structured as favored in the ethnocentric culture is found to
be not appropriate structure. In this orientation local operations
are given more autonomy. Subsidiaries are setup with operational independence.
3. Regiocentrism:
A regiocentric company views different regions as different markets. A particular region with
certain important common marketing characteristics is regarded as a single market, ignoring
national boundaries. Objectives are set by negotiation between headquarters and regional HQ on
the one hand and between regional HQ and individual subsidiaries on the other.
4. Geocentrism:
A geocentric company views the entire world as a single market and develops standardized
marketing mix, projecting a uniform image of the company and its products, for the global
market. Geocentric business practices are neither home operations nor the host country
companys but a hybrid of the two. A company follows a geocentrism approach when it bases its
operations.
Porters Theory of Competitive Advantage
Michael Porters theory of the competitive advantage of nations provides a sophisticated
tool for analyzing competitiveness with all its implications. Porters theory contributes to
understanding the competitive advantage of nations in international trade and production. Its
core, however, focuses upon individual industries, or clusters of industries, in which the
principles of competitive advantage are applied. His theory begins from individual industries and
builds up to the economy as a whole. Since firms, not nations, compete in international markets,
understanding the way firms create and sustain competitive advantage is the key to explaining
what role the nation plays in the process. Therefore, the essence of his argument is that the
home nation influences the ability of its firms to succeed in particular industries1. Given this
interdependence, it appears that in order to draw conclusions on the competitiveness of the
particular industry, consideration of the different facets of the competitive diamond of the whole
nation is needed..
Porter's model includes 4 determinants of national advantage, which are shortly described
below:
Factor Conditions
Factor conditions include those factors that can be exploited by companies in a given nation.
Factor conditions can be seen as advantageous factors found within a country that are
subsequently build upon by companies to more advanced factors of competition. Factors not
normally seen as advantageous, such as workforce shortage, can also be seen as a factor

Subject- IB

Unit 1

By- K.R. Ansari

potentially strengthening competitiveness, because this factor may heighten companies' focus on
automation and zero defects.
Some examples of factor conditions:

Highly skilled workforce

Linguistic abilities of workforce
Rich amount of raw materials
Workforce shortage

Demand
conditions
If the local market for a product is larger and more demanding at home than in foreign markets,
local firms potentially put more emphasis on improvements than foreign companies. This will
potentially increase the global competitiveness of local exporting companies. A more demanding
home market can thus be seen as a driver of growth, innovation and quality improvements. For
instance, Japanese consumers have historically been more demanding of electrical and electronic
equipment than western consumers. This has partly founded the success of Japanese
manufacturers within this sector.
Related
and Supporting Industries
When local supporting industries and suppliers are competitive, home country companies will
potentially get more cost efficient and receive more innovative parts and products. This will
potentially lead to greater competitiveness for national firms. For instance, the Italian shoe
industry benefits from a highly competent pool of related businesses and industries, which has
strengthened the competitiveness of the Italian shoe industry world-wide.
Firm Strategy,
Structure,
and Rivalry
The structure and management systems of firms in different countries can potentially affect
competitiveness. German firms are oftentimes very hierarchical, which has resulted in
advantages within industries such as engineering. In comparison, Danish firms are oftentimes
more flat and organic, which leads to advantages within industries such as biochemistry and
design.
Likewise, if rivalry in the domestic market is very fierce, companies may build up capabilities
that can act as competitive advantages on a global scale. Home markets with less rivalry may
therefore be counterproductive, and act as a barrier in the generating of global competitive
advantages such as innovation and development.
By using Porter's diamond, business leaders may analyze which competitive factors may reside
in their company's home country, and which of these factors may be exploited to gain global
competitive advantages. Business leaders can also use the Porter's diamond model during a phase
of internationalization, in which leaders may use the model to analyze whether or not the home
market factors support the process of internationalization, and whether or not the conditions
found in the home country are able to create competitive advantages on a global scale.
Finally, business leaders may use this model to asses in which counties to invest, and to assess
which countries are most likely to be able to sustain growth and development.

Subject- IB

Unit 1

By- K.R. Ansari

International trade Theories

International trade and international investment patterns and trends are sought to be explained in
terms of theories. The causes, effect and courses of international trade and investment are
visualized in the theories. There many theories, because the intricacies and dynamics of trade and
investment cannot be captured by any one theory.
Theory of Mercantilism
The mercantilists proposed theory of mercantilism. They were a group of economists who
preceded Adam Smith. The foundations of economic thought between 1500 and 1800 were based
on mercantilism. Mercantilists believed that the world had a finite store of wealth; therefore,
when one country got more, other countries had less. Mercantilists restricted imports and
encouraged or subsidized exports as a conscious policy to make their citizens better off.
Mercantilists judged the success of trade by the size of the trade balance. Mercantilism was a
sixteenth-century economic philosophy that maintained that a countrys wealth was measured by
its holdings of gold and silver. This required that the countries to maximize exports and
minimize imports.
Theory of Neo-Mercantilism
Mercantilism is still in vogue. Mercantilist policies are politically attractive to some firms and
their workers, as mercantilism benefits certain members of society. Modern supporters of these
policies are known as neo-mercantilists, or protectionists. The neo-mercantilists want higher
production through full employment and that every industry produces an exportable surplus
leading to favourable BOT.
Theory of Absolute Cost Advantage
Adam Smith was the first to come up with the theory of absolute advantage. Theory of Absolute
Cost Advantage suggests that a country should produce and export those goods and services for
which it is more efficient than other countries and hence has absolute cost advantage, and import
those goods and services for which other countries are more efficient than it and hence enjoy
absolute cost advantage over it.
Mechanism of the theory: A country is said to be more efficient than another country, if it can
produce more output (goods) for a given quantity of inputs, such as labour or capital inputs. An
example is that there are only two countries, India and USA. They both produce Buses and Cars.
With 1 unit of labour & capital mix, India can produce 6 Buses or 2 Cars, where as USA with the
same 1 input-mix can produce 2 Buses or 5 Cars.
Merits of the Theory: There emerges specialization in lines of production across the countries.
Specialization has its advantages of quality enhancements, innovation, cost minimization and so
on. With the well earned export revenue, imports can be funded.
There is societal advantage.
Limitations of the theory: The main plank of the theory, that is, specialization comes under the
lens of scrutiny. Specialization has its doses of demerits. For strategic reasons countries dont
want specialization. The absolute advantage theory requires that to effect trade between
countries, one country is to be superior in one product and the other in a different product. What
about a situation, mostly this is the reality, when one country is superior to other in production of
both the products? Will there be no trade between countries?

Subject- IB

Unit 1

By- K.R. Ansari

Theory of Comparative Cost Advantage

David Ricardo, the early nineteenth-century British economist solved the problem of the theory
of absolute cost advantage, by developing the theory of comparative cost advantage. The
theory of comparative cost advantage, states that a country should produce and export those
goods and services for which it is relatively more efficient than are other countries and import
those goods and services for which other countries are relatively more efficient than it.
Ricardo's Assumptions:Ricardo explains his theory with the help of following assumptions :1. There are two countries and two commodities.
2. There is a perfect competition both in commodity and factor market.
3. Cost of production is expressed in terms of labour i.e. value of a commodity is measured in
terms of labour hours/days required to produce it. Commodities are also exchanged on the basis
of labour content of each good.
4. Labour is the only factor of production other than natural resources.
5. Labour is homogeneous i.e. identical in efficiency, in a particular country.
6. Labour is perfectly mobile within a country but perfectly immobile between countries.
7. There is free trade i.e. the movement of goods between countries is not hindered by any
restrictions.
8. Production is subject to constant returns to scale.
9. There is no technological change.
10. Trade between two countries takes place on barter system.
11. Full employment exists in both countries.
12. There is no transport cost.
Merits of the theory: Free trade is the only way to achieve efficient production of goods and
services. It is how producers are able to find the lowest cost method of production in a global
economy. In the long run, consumers in both countries will be better off with trade than without
trade. All the advantages of specialization and free trade are the favorable points of the theory.
Ten problems of foreign trade and aid faced by developing countries of the world.
1. Primary Exporting:
Most of the developing countries, in its initial stage of development are exporting mostly
primary products and thus cannot fetch a good price of its product in the foreign market. In the
absence of diversification of its export, the developing countries have failed to raise its export
earnings.
2. Un-Favourable Terms of Trade:
Another problem of trade faced by these developing countries is that the terms of trade are
always going against it. In the absence of proper infrastructure and the quality enhancement
initiative, the terms of trade of these countries gradually worsened and ultimately went against
the interest of the country in general.
3. Mounting Developmental and Maintenance Imports:
The developing countries are facing the problem of mounting growth of its developmental
imports which include various types of machineries and equipments for the development of
various types of industries as well as a huge growth of maintenance imports for collecting

Subject- IB

Unit 1

By- K.R. Ansari

intermediate goods and raw materials required for these industries. Such mounting volume of
imports has been creating a serious problem towards round management of international trade.
4. Higher Import Intensity:
Another peculiar problem faced by the developing countries is the higher import intensity in the
industries development resulting from import intensive industrialisation process followed in
these countries for meeting the requirements of elitist consumption (viz., colour TVs, VCR,
Refrigerators, Motor cycle, cars etc.). Such increasing trend towards elitist consumption has been
resulting a huge burden of burgeoning imports in these developing countries, resulting serious
balance of payment of crisis.
5. BOP Crisis:
The developing countries are facing the problem of burgeoning imports and sluggish growth in
its exports resulting in growing deficit in its balance of payments position. In some countries,
this deficit has gone to such an extent at a particular point of time that ultimately it led to a
serious crisis in its international trade.
6. Lack of Co-ordination:
The developing countries are not maintaining a good co-ordination among themselves through
promotion of integration economies grouping, formation of union etc. Thus in the absence of
such co-ordination, the developing countries could not realize those benefits of foreign trade
which they could have realised as a result of such economic grouping.
7. Depleting Foreign Exchange Reserve and Import Cover:
The developing countries are sometimes facing the problems of depleting foreign exchange
reserves as a result of growing volume of imports and continuous balance of payment crisis.
Such depleting foreign exchange reserve results in shorter import cover for the country.
8. Steep Depreciation:
Steep depreciation of the currency with dollar and other currencies in respect of developing
countries has been resulting in a considerable increase in the value of its imports which
ultimately leads to huge deficit in its balance of trade.
9. Higher Prices of POL imports:
The worsening of the current account deficit in balance of payments of the developing countries
has been partly on account of higher price of POL imports charged by the oil producing countries
especially since the Gulf War.
10. International Liquidity Problem:
Most of the developing countries has been facing all the more serious international liquidity
problem. Accordingly, these countries are experiencing chronic deficiency of capital and
technology resulting heavy dependence on the developed countries for their scarce resources.
Accordingly, these countries require resources so as to cover their short-term balance of
payments, resources and also for meeting long-term capital requirements of economic growth.
Thus, have seen that the developing countries have been facing some serious problems relating
to their foreign trade. They are also making serious efforts to settle these problems either
bilateral or multi-lateral means.