Chap 1 International Business

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CHAP 1 International Business
Cost Accounting (Bangalore University)
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INTERNATIONAL BUSINESS
UNIT - I
INTRODUCTION TO INTERNATIONAL BUSINESS

Meaning and Definition of International Business – Nature of International Business, forms of
international business, approaches of international business, theories of international trade,
modes of entry to international business
WHAT IS INTERNATIONAL BUSINESS?
Any business that involves operations in more than one country can be called an international
business. International business is related to the trade and investment operations done by entities across
national borders.
International Business Management Firms may assemble, acquire, produce, market, and
perform other value-addition operations on international scale and scope. Business organizations may
also engage in collaborations with business partners from different countries. Apart from individual
firms, governments and international agencies may also get involved in international business
transactions. Companies and countries may exchange different types of physical and intellectual assets.
These assets can be products, services, capital, technology, knowledge, or labor.
MEANING AND DEFINITION OF INTERNATIONAL BUSINESS
International business is defined as commercial transactions that occur across country

borders. When a company sells products in the US, Japan and throughout Europe, this is an
example of international business.
The exchange of goods and services among individuals and businesses in multiple
countries. A specific entity, such as a multinational corporation or international business
company that engages in business among multiple countries. International Business conducts
business transactions all over the world. These transactions include the transfer of goods,
services, technology, managerial knowledge, and capital to other countries.
International business involves exports and imports. International Business is also

known, called or referred as a Global Business or an International Marketing.
‘Acc to international business journal’
International business is a commercial enterprise that performs economic

activity beyond the bounds of its location, has branches in 2 or more foreign countries and
makes use of economic, cultural, political, and other differences between countries.
CHAPTER 1 – INTRODUCTION TO I B Page 1

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INTERNATIONALIZATION OF BUSINESS
Let’s try to explore the reasons why a business would like to go global. It is important to
note that there are many challenges in the path of internationalization, but we’ll focus on the
positive attributes of the process for the time-being. There are five major reasons why a
business may want to go global:
 First-mover Advantage: It refers to getting into a new market and enjoys the
advantages of being first. It is easy to quickly start doing business and get early adopters by
being first.
 Opportunity for Growth: Potential for growth is a very common reason of

internationalization. Your market may saturate in your home country and therefore you may set
out on exploring new markets.
 Small Local Markets: Start-ups in Finland and Nordics have always looked at
internationalization as a major strategy from the very beginning because their local market is
small.
 Increase of Customers: If customers are in short supply, it may hit a company’s

potential for growth. In such a case, companies may look for internationalization.
 Discourage Local Competitors: Acquiring a new market may mean discouraging other
players from getting into the same business-space as one company is in.
FEATURES OF INTERNATIONAL BUSINESS
1. Large scale operations: In international business, all the operations are conducted on a very
huge scale. Production and marketing activities are conducted on a large scale. It first sells its
goods in the local market. Then the surplus goods are exported.
2. Integration of economies: International business integrates (combines) the economies of

many countries. This is because it uses finance from one country, labour from another country,
and infrastructure from another country. It designs the product in one country, produces its
parts in many different countries and assembles the product in another country. It sells the
product in many countries, i.e. in the international market.
3. Dominated by developed countries and MNCs : International business is dominated by

developed countries and their multinational corporations (MNCs). At present, MNCs from USA,
Europe and Japan dominate (fully control) foreign trade. This is because they have large
financial and other resources. They also have the best technology and research and
development (R & D). They have highly skilled employees and managers because they give very
high salaries and other benefits. Therefore, they produce good quality goods and services at low
prices. This helps them to capture and dominate the world market.

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4. Benefits to participating countries : International business gives benefits to all participating

countries. However, the developed (rich) countries get the maximum benefits. The developing
(poor) countries also get benefits. They get foreign capital and technology. They get rapid
industrial development. They get more employment opportunities. All this results in economic
development of the developing countries. Therefore, developing countries open up their
economies through liberal economic policies.
5. Keen competition: International business has to face keen (too much) competition in the
world market. The competition is between unequal partners i.e. developed and developing
countries. In this keen competition, developed countries and their MNCs are in a favorable
position because they produce superior quality goods and services at very low prices.
Developed countries also have many contacts in the world market. So, developing countries find
it very difficult to face competition from developed countries.
6. Special role of science and technology: International business gives a lot of importance to
science and technology. Science and Technology (S & T) help the business to have large-scale
production. Developed countries use high technologies. Therefore, they dominate global
business. International business helps them to transfer such top high-end technologies to the
developing countries.
7. International restrictions: International business faces many restrictions on the inflow and
outflow of capital, technology and goods. Many governments do not allow international
businesses to enter their countries. They have many trade blocks, tariff barriers, foreign
exchange restrictions, etc. All this is harmful to international business.
8. Sensitive nature: The international business is very sensitive in nature. Any changes in the
economic policies, technology, political environment, etc. have a huge impact on it. Therefore,
international business must conduct marketing research to find out and study these changes.
They must adjust their business activities and adapt accordingly to survive changes.
NATURE OF INTERNATIONAL BUSINESS
1. Accurate Information
2. Information not only accurate but should be timely
3. The size of the international business should be large
4. Market segmentation based on geographic segmentation
5. International markets have more potential than domestic markets
SCOPE OF INTERNATIONAL BUSINESS

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1. International Marketing
2. International Finance and Investments
3. Global HR
4. Foreign Exchange
NEED FOR INTERNATIONAL BUSINESS
1. To achieve higher rate of profits
2. Expanding the production capacity beyond the demand of the domestic country
3. Severe competition in the home country
4. Limited home market
5. Political conditions
6. Availability of technology and managerial competence
7. Cost of manpower, transportation
8. Nearness to raw material
9. Liberalization, Privatization and Globalization (LPG)
10. To increase market share
11. Increase in cross border business is due to falling trade barriers (WTO), decreasing costs in
telecommunications and transportation; and freer capital markets
REASONS FOR RECENT INTERNATIONAL BUSINESS GROWTH
1. Expansion of technology
2. Business is becoming more global because
•Transportation is quicker
•Communications enable control from afar
•Transportation and communications costs are more conducive for international operations
3. Liberalization of cross-border movements

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4. Lower Governmental barriers to the movement of goods, services, and resources enable
Companies to take better advantage of international opportunities
INTERNATIONAL BUSINESS APPROACHES / EPRG frame work
The foreign marketing involvement of a manufacturing company may widely vary from a state of
no direct involvement to a state of total involvement. Several types of involvement are generally
observed, even though they are not mutually exclusive nor sequentially progressive. Depending
on the kind and degree of its involvement in foreign marketing, a firm has to re-orient and
reorganize its activities to cope with different levels of operational responsibilities inherent in
such involvement. To throw some light on the issue, some guidelines are available from what is
called EPRG orientation. The EPRG framework attempts, four broad types of orientation of a
firm towards foreign marketing. They are:
1. ETHNOCENTRIC ORIENTATION: The ethnocentric orientation of a firm considers that the

products, marketing strategies and techniques applicable in the home market are equally so in
the overseas market as well. In such a firm, all foreign marketing operations are planned and
carried out from home base, with little or no difference in product formulation and
specifications, pricing strategy, distribution and promotion measures between home and
overseas markets. The firm generally depends on its foreign agents and exportimport merchants
for its export sales.
2. REGIOCENTRIC ORIENTATION: In regiocentric approach, the firm accepts a regional

marketing policy covering a group of countries which have comparable market characteristics.
The operational strategies are formulated on the basis of the entire region rather than
individual countries. The production and distribution facilities are created to serve the whole
region with effective economy on operation, close control and coordination.
3. GEOCENTRIC ORIENTATION: In geocentric orientation, the firms accept a world wide

approach to marketing and its operations become global. In global enterprise, the management
establishes manufacturing and processing facilities around the world in order to serve the
various regional and national markets through a complicated but well co-ordinated system of
distribution network. There are similarities between geocentric and regiocentric approaches in
the international market except that the geocentric approach calls for a much greater scale of
operation.
4. POLYCENTRIC OPERATION: When a firm adopts polycentric approach to overseas markets, it

attempts to organize its international marketing activities on a country to country basis. Each
country is treated as a separate entity and individual strategies are worked out accordingly.

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Local assembly or production facilities and marketing organizations are created for serving
market needs in each country. Polycentric orientation could be most suitable for firms seriously
committed to international marketing and have its resources for investing abroad for fuller and
long-term penetration into chosen markets. Polycentric approach works better among countries
which have significant economic, political and cultural differences and performances of these
tasks are free from the problems created primarily by the environmental factors.
CONCLUSION: The involvement decision is conditioned by a variety of internal and external

factors such as firms' export policy, resources and product range, volume of export business,
regulatory and procedural conditions to be fulfilled both from exporting and importing angle.
From the foregoing, it will be evident that the scope of international marketing for a firm will be
determined by its decisions regarding the means of entry into foreign markets as well as by the
kind of involvement the firm wishes to have in its international marketing operations. It cannot
be said that one kind of operation/orientation is better than the other, as each has its own
advantage and disadvantage depending on the operating environmental factors.
However, a firm can adopt a policy of common or differential approaches in respect of different
marketing decision areas.
PROBLEMS IN INTERNATIONAL BUSINESS
1. Political factors
2. High foreign investments and high cost
3. Exchange instability
4. Entry requirements
5. Tariffs, quota etc.
6. Corruption and bureaucracy
7. Technological policy
FORMS OF INTERNATIONAL BUSINESS
1. Exporting: Exporting means producing/procuring in the home market and selling in the
foreign market. Exporting is not an activity just for large multinational enterprises; small firms
can also make money by exporting. In recent days, exporting has become easier though it
remains a challenge for many firms.

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2. Licensing: A licensing is an agreement whereby a licensor grants the rights to intangible

property (patents, intentions, formulas, processes, designs, copyrights and trademarks) to
another entity (licensee) for a specified period and in return the licensor receives a royalty/fee
from the licensee.
3. Franchising: Franchising is basically o specialized form of licensing in which the franchiser not
only sells intangible property to the franchisee but also insists that the franchisee agrees to
abide by strict rules as to how it does business.
4. Joint venture: A joint venture entails establishing a firm that is jointly owned by two or more
independent firms.
5. Management Contracts: A firm in one country agrees to operate facilities or provide other
management services to a firm in another country for an agreed upon fees.
6. Turnkey projects: In a turnkey project, the contractor agrees to handle every details of the
project for a foreign client, including the training of operating personnel. At completing of the
contract the foreign client handles the ‘key’ of a plant that is ready for full operation
7. Strategic international alliances: A strategic international alliance is a business relationship

established by two or more companies to cooperate out of mutual need and to share risk in
achieving a common objective.
8. Direct foreign investment: Direct foreign investment is another important form of

international business. Companies may manufacture locally to capitalize on low cost labor, to
avoid high import taxes, to reduce the high cost of transportation to market, to gain access to
raw materials or gaining market entry.
MAIN DIFFERENCE BETWEEN DOMESTIC AND INTERNATIONAL BUSINESS ARE AS FOLLOWS :
International Business Domestic Business

It is extension of Domestic Business and . It is extension of Domestic Business and
Marketing Principles remain same. Marketing Principles remain same.
Difference is customs, cultural factors No such difference. In a large countries
languages like India, we have many
languages.
Conduct and selling procedure changes Selling Procedures remain unaltered
Working environment and management No such changes are necessary
Practices change to suit local conditions.
Will have to face restrictions in trade These have little or no impact on
practices, licenses and government rules. Domestic trade.
. Long Distances and hence more Short Distances, quick business is
transaction time. possible.

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Currency, interest rates, taxation, Currency, interest rates, taxation,

inflation and economy have impact on inflation and economy have little or no
trade. impact on Domestic Trade.
. MNC’s have perfected principles, No such experience or exposure
procedures and practices at international
level
MNCs take advantage of location No such advantage once plant is built it
economies wherever cheaper resources cannot be easily shifted.
available.
Large companies enjoy benefits of It is possible to get this benefit through
experience curve collaborators.
High Volume cost advantage .. Cost Advantage by automation, new
methods etc.
Global Standardization No such advantage
Global business seeks to create new No such advantage
values and global brand image.
Can Shift production bases to different No such advantage and get competition
countries whenever there are problems in from some spurious or SSI Unit who get
taxes or markets patronage of Government
MODES OF ENTRY INTO INTERNATIONAL BUSINESS
Modes of entry into an International Business:-
There are some basic decisions that the firm must take before foreign expansion like: which
markets to enter, when to enter those markets, and on what scale. Which foreign markets? -The
choice based on nation’s long run profit potential.-Look in detail at economic and political
factors which influence foreign markets.-Long run benefits of doing business in a country
depends on following factors:- Size of market (in terms of demographics)- The present wealth of
consumer markets (purchasing power)- Nature of competition By considering such factors firm
can rank countries in terms of their attractiveness and long-run profit.
Modes of entry:--
1. Exporting
2. Licensing
3. Franchising
4. Turnkey Project
5. Mergers & Acquisitions

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6. Joint Venture
7. Acquisitions & Mergers
8. Wholly Owned Subsidiary
1. Exporting: It means the sale abroad of an item produced ,stored or processed in the
supplying firm’s home country. It is a convenient method to increase the sales. Passive exporting
occurs when a firm receives canvassed them. Active exporting conversely results from a
strategic decision to establish proper systems for organizing the export functions and for
procuring foreign sales.
Advantages of Exporting
a. Need for limited finance; If the company selects a company in the host country to distribute
the company can enter international market with no or less financial resources but this amount
would be quite less compared to that would be necessary under other modes.
b. Less Risks; Exporting involves less risk as the company understands the culture, customer and
the market of the host country gradually. Later after understanding the host country the
company can enter on a full scale.
c. Motivation for exporting: Motivation for exporting are proactive and reactive. Proactive
motivations are opportunities available in the host country. Reactive motivators are those
efforts taken by the company to export the product to a foreign country due to the decline in
demand for its product in the home country.
2. Licensing: In this mode of entry, the domestic manufacturer leases the right to use its
intellectual property (ie) technology, copy rights, brand name etc to a manufacturer in a foreign
country for a fee. Here the manufacturer in the domestic country is called licensor and the
manufacturer in the foreign is called licensee. The cost of entering market through this mode is
less costly. The domestic company can choose any international location and enjoy the
advantages without incurring any obligations and responsibilities of ownership, managerial,
investment etc.
Advantages
1. Low investment on the part of licensor.
2. Low financial risk to the licensor
3. Licensor can investigate the foreign market without much effort on his part.4. Licensee gets
the benefits with less investment on research anddevelopment5. Licensee escapes himself from
the risk of product failure.

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Disadvantages
1. It reduces market opportunities for both
2. Both parties have to maintain the product quality and promote the product. Therefore one
party can affect the other through their improper acts.
3. Chance for misunderstanding between the parties.
4. Chance for leakages of the trade secrets of the licensor.
5. Licensee may develop his reputation
6. Licensee may sell the product outside the agreed territory and after the expiry of the
contract.
3. Franchising
Under franchising an independent organization called the franchisee operates the business
under the name of another company called the franchisor under this agreement the franchisee
pays a fee to the franchisor. The franchisor provides the following services to the franchisee.
1. Trade marks
2. Operating System
3. Product reputation
4. Continuous support system like advertising ,employee training ,reservation services
quality assurances program etc.
Advantages:
1. Low investment and low risk
2. Franchisor can get the information regarding the market culture, customs and environment of
the host country.
3. Franchisor learns more from the experience of the franchisees.
4. Franchisee get the benefits of R& D with low cost.
5. Franchisee escapes from the risk of product failure.
Disadvantages:
1. It may be more complicating than domestic franchising.
2. It is difficult to control the international franchisee.
3. It reduce the market opportunities for both
4. Both the parties have the responsibilities to maintain product quality and product promotion.
5. There is a problem of leakage of trade secrets.

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4. Turnkey Project :A turnkey project is a contract under which a firm agrees to fully design ,
construct and equip a manufacturing/ business/services facility and turn the project over to the
purchase when it is ready for operation for a remuneration like a fixed price , payment on cost
plus basis. This form of pricing allows the company to shift the risk of inflation enhanced costs
to the purchaser. Eg nuclear power plants , airports, oil refinery , national highways , railway line
etc. Hence they are multiyear project.
5. Mergers & Acquisitions: A domestic company selects a foreign company and merger itself
with foreign company in order to enter international business. Alternatively the domestic
company may purchase the foreign company and acquires it ownership and control. It provides
immediate access to international manufacturing facilities and marketing network.
Advantages
1. The company immediately gets the ownership and control over the acquired firm’s factories,
employee, technology, brand name and distribution networks.
2. The company can formulate international strategy and generate more revenues.
3. If the industry already reached the stage of optimum capacity level or overcapacity level in
the host country. This strategy helps the host country.
Disadvantages:
1. Acquiring a firm in a foreign country is a complex task involving bankers, lawyers regulation,
mergers and acquisition specialists from the two countries.
2. This strategy adds no capacity to the industry.
3. Sometimes host countries imposed restrictions on acquisition of local companies by the

foreign companies.
4. Labour problem of the host country’s companies are also transferred to the acquired
company.
6. Joint Venture
Two or more firm join together to create a new business entity that is legally separate and
distinct from its parents. It involves shared ownership. Various environmental factors like social,
technological economic and political encourage the formation of joint ventures. It provides
strength in terms of required capital. Latest technology required human talent etc. and enable
the companies to share the risk in the foreign markets. This act improves the local image in the
host country and also satisfies the governmental joint venture.
Advantages

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1. Joint venture provides large capital funds suitable for major projects.
2. It spread the risk between or among partners.
3. It provides skills like technical skills, technology, human skills, expertise, marketing skills.
4. It makes large projects and turn key projects feasible and possible.
5. It synergy due to combined efforts of varied parties.
Disadvantages:
1. Conflict may arise
2. Partner delay the decision making once the dispute arises. Then the operations become
unresponsive and inefficient.
3. Life cycle of a joint venture is hindered by many causes of collapse.
4. Scope for collapse of a joint venture is more due to entry of competitor’s changes in the
partner’s strength.
5. The decision making is slowed down in joint ventures due to the involvement of a number of
parties.
7. Acquisitions & Mergers: A mergers is a voluntary and permanent combination of business

whereby one or more firms integrate their operations and identities with those of another and
henceforth work under a common name and in the interests of the newly formed
amalgamations.
Motives for acquisitions

1. Removal of competitor
2. Reduction of the Co failure through spreading risk over a wider range of activities.
3. The desire to acquire business already trading in certain markets & possessing certain
specialist employees &equipments.
4. Obtaining patents, license & intellectual property.
5. Economies of scale possibly made through more extensive operations.
6. Acquisition of land, building & other fixed asset that can be profitably sold off.
7. The ability to control supplies of raw materials.
8. Expert use of resources.
9. Tax consideration.

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10. Desire to become involved with new technologies &management method particularly in
high risk industries.
8. Wholly Owned Subsidiary: Subsidiary means individual body under parent body. This
Subsidiary or individual body as per their own generates revenue. They give their own rent,
salary to employees, etc. But policies and trademark will be implemented from the Parent body.
There are no branches here. Only the certain percentage of the profit will be given to the parent
body. A subsidiary, in business matters, is an entity that is controlled by a bigger and more
powerful entity. The controlled entity is called a company, corporation, or limited liability
company, and the controlling entity is called its parent (or the parent company).
The reason for this distinction is that alone company cannot be a subsidiary of any
organization; only an entity representing affections a separate entity can be a subsidiary. While
individuals have the capacity to act on their own initiative, a business entity can only act
through its directors, officers and employees. The most common way that control of a
subsidiary is achieved is through the ownership of shares in the subsidiary by the parent. These
shares give the parent the necessary votes to determine the composition of the board of the
subsidiary and so exercise control. This gives rise to the common presumption that 50% plus
one share is enough to create a subsidiary. There are, however, other ways that control can
come about and the exact rules both as to what control is needed and how it is achieved can be
complex (see below).
A subsidiary may itself have subsidiaries, and these, in turn, may have subsidiaries of their own.
A parent and all its subsidiaries together are called a group, although this term can also apply to
cooperating companies and their subsidiaries with varying degrees of shared ownership.
Subsidiaries are separate, distinct legal entities for the purposes of taxation and regulation. For
this reason, they differ from divisions, which are businesses fully integrated within the main
company, and not legally or otherwise distinct from it. Subsidiaries are a common feature of
business life and most if not all major businesses organize their operations in this way. Examples
include holding companies such as Berkshire Hath away, Time Warner , or Citi group as well as
more focused companies such as IBM, or Xerox Corporation. These, and others, organize their
businesses into national or functional subsidiaries, sometimes with multiple levels of
subsidiaries
THEORIES OF INTERNATIONAL BUSINESS
1] Mercantilism Theory
Mercantilism contained many interlocking principles. Precious metals, such as gold and
silver, were deemed indispensable to a nation’s wealth. If a nation did not possess mines or
have access to them, precious metals should be obtained by trade. It was believed that trade

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balances must be “favorable,” meaning an excess of exports over imports. Colonial possessions
should serve as markets for exports and as suppliers of raw materials to the mother country.
Manufacturing was forbidden in colonies, and all commerce between colonies.
Viewpoints
 A country becomes rich if its exports are more than its imports.
 It says that nation’s wealth depends on its accumulated treasure.
 More accumulation of precious metals means richer and more powerful nations.
 Countries should maximize its exports by providing subsidies and restricts imports by
imposing high tariffs and quotas.
 Wealth of country is measured by its stock of metals.
Criticisms
 Failure to understand other theory

 Impossibility to maintain trade balance
 Rent seeking critique.
2) Absolute Advantage Theory: In economics, the principle of absolute advantage refers to the
ability of a party (an individual, or firm, or country) to produce more of a good or service than
competitors, using the same amount of resources. Adam Smith first described the principle of
absolute advantage in the context of international trade, using labor as the only input.
Definition of 'Absolute Advantage' -The ability of a country, individual, company or region to

produce a good or service at a lower cost per unit than the cost at which any other entity
produces that good or service.
Investopedia explains 'Absolute Advantage' - Entities with absolute advantages can produce
something using a smaller number of inputs than another party producing the same product. As
such, absolute advantage can reduce costs and boost profits.
Since absolute advantage is determined by a simple comparison of labor productivities, it is

possible for a party to have no absolute advantage in anything;[7] in that case, according to the
theory of absolute advantage, no trade will occur with the other party.[8] It can be contrasted
with the concept of comparative advantage which refers to the ability to produce a particular
good at a lower opportunity cost.
Origin of the theory - The main concept of absolute advantage is generally attributed to Adam
Smith for his 1776 publication An Inquiry into the Nature and Causes of the Wealth of Nations in
which he countered mercantilist ideas. Smith argued that it was impossible for all nations to

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become rich simultaneously by following mercantilism because the export of one nation is
another nation’s import and instead stated that all nations would gain simultaneously if they
practiced free trade and specialized in accordance with their absolute advantage.
Features of this theory: A country that has an absolute advantage produces greater output of a
good or service than other countries using the same amount of resources. Smith stated that
tariffs and quotas should not restrict international trade; it should be allowed to flow according
to market forces. Contrary to mercantilism Smith argued that a country should concentrate on
production of goods in which it holds an absolute advantage. No country would then need to
produce all the goods it consumed. The theory of absolute advantage destroys the mercantilist
idea that international trade is a zero-sum game. According to the absolute advantage theory,
international trade is a positive-sum game, because there are gains for both countries to an
exchange.
Condition: The theory that trade occurs when one country, individual, company, or region is
absolutely more productive than another entity in the production of a good. A person, company
or country has an absolute advantage if its output per unit of input of all goods and services
produced is higher than that of another entity producing that good or service.
Problems of Absolute Advantage: There is a potential problem with absolute advantage. If

there is one country that does not have an absolute advantage in the production of any
product, will there still be benefit to trade, and will trade even occur? The answer may be found
in the extension of absolute advantage, the theory of comparative advantage.
Example -The principle was described by Adam Smith in the context of international trade. Now
I am describing some of them below:
A country has an absolute advantage over another in producing a good, if it can produce
that good using fewer resources than another country. For example if one unit of labor in India
can produce 80 units of wool or 20 units of wine; while in Spain one unit of labor makes 50 units
of wool or 75 units of wine, then India has an absolute advantage in producing wool and Spain
has an absolute advantage in producing wine. India can get more wine with its labor by
specializing in wool and trading the wool for Spanish wine, while Spain can benefit by trading
wine for wool. (Adam Smith, Wealth of Nations, Book IV, Ch.2.) The benefits to nations from
trading are the same as to individuals: trade permits specialization, which allows resources to
be used more productively.
3) Comparative Advantage Theory:

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Definition of 'Comparative Advantage’: The ability of a firm or individual to produce goods

and/or services at a lower opportunity cost than other firms or individuals. A comparative
advantage gives a company the ability to sell goods and services at a lower price than its
competitors and realize stronger sales margins.
Investopedia explains 'Comparative Advantage’:Having a comparative advantage - or

disadvantage - can shape a company's entire focus. For example, if a cruise company found that
it had a comparative advantage over a similar company, due ito its closer proximity to a port, it
might encourage the latter to focus on other, more productive, aspects of country.
Origins of the theory - The idea of comparative advantage has been first mentioned in Adam
Smith's Book The Wealth of Nations: "If a foreign country can supply us with a commodity
cheaper than we ourselves can make it, better buy it of them with some part of the produce of
our own industry, employed in a way in which we have some advantage." But the law of
comparative advantages has been formulated by David Ricardo who investigated in detail
advantages and alternative or relative opportunity in his 1817 book On the Principles of Political
Economy and Taxation in an example involving England and Portugal.
Ricardo's Theory of Comparative Advantage -David Ricardo stated a theory that other things
being equal a country tends to specialize in and exports those commodities in the production of
which it has maximum comparative cost advantage or minimum comparative disadvantage.
Similarly the country's imports will be of goods having relatively less comparative cost
advantage or greater disadvantage.
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 labor i.e. value of a commodity is measured in

terms of labor hours/days required to produce it. Commodities are also exchanged on the basis
of labor content of each good.
4. Labor is the only factor of production other than natural resources.
5. Labor is homogeneous i.e. identical in efficiency, in a particular country.
6. Labor is perfectly mobile within a country but perfectly immobile between countries.

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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. Perfect occupational mobility of factors of production - resources used in one industry can
be switched into another without any loss of efficiency
13. Perfect occupational mobility of factors of production - resources used in one industry can
be switched into another without any loss of efficiency
14. Constant returns to scale (i.e. doubling the inputs in each country leads to a doubling of
total output)
15. No externalities arising from production and/or consumption
16. Transportation costs are ignored
17. If businesses exploit increasing returns to scale (i.e. economies of scale) when they
specialize, the potential gains from trade are much greater. The idea that specialization should
lead to increasing returns is associated with economists such as Paul Romerand Paul Ormerod.
Ricardo's Example:- On the basis of above assumptions, Ricardo explained his comparative cost
difference theory, by taking an example of England and Portugal as two countries &Wine and
Cloth as two commodities. As pointed out in the assumptions, the cost is measured in terms of
labor hour. The principle of comparative advantage expressed in labor hours by the following
table.
1 unit of wine 1 unit of cloth

England 120 100
Portugal 80 90
Portugal requires less hours of labor for both wine and cloth. One unit of wine in Portugal is
produced with the help of 80 labor hours as above 120 labor hours required in England. In the
case of cloth too, Portugal requires less labor hours than England. From this it could be argued
that there is no need for trade as Portugal produces both commodities at a lower cost. Ricardo
however tried to prove that Portugal stands to gain by specializing in the commodity in which it

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has a greater comparative advantage. Comparative cost advantage of Portugal can be expressed
in terms of cost ratio.
Effects on the economy -Conditions that maximize comparative advantage do not automatically
resolve trade deficits. In fact, many real world examples where comparative advantage is
attainable may require a trade deficit.
Criticism of theory
1. Applicability- Economist Ha-Joon Chang criticized the comparative advantage principle,

contending that it may have helped developed countries maintain relatively advanced
technology and industry compared to developing countries
2. Assumption rather than discovery - Philosopher and Professor of Evolutionary Psychology

Bruce Charlton has argued that comparative advantage is a metaphysical assumption, rather
than a discovery. In addition to falsifiable nature of the principle, he notes that the principle
relies on several assumptions that are not necessarily operative.
Comparative advantage exists when a country has a margin of superiority in the production of a
good or service i.e. where the opportunity cost of production is lower.
Ricardo's theory of comparative advantage was further developed by Heckscher, Ohlin and
Samuelson who argued that countries have different factor endowments of labor, land and
capital inputs. Countries will specialize in and export those products which use intensively the
factors of production which they are most endowed.
Worked example of comparative advantage .Consider the data in the following table:
Pre specialization CD player Personal computers

UK 2000 500
Japan 4000 2000
Total output 6000 2500
To identify which country should specialize in a particular product we need to analyses the
internal opportunity cost for each country. For example, were the UK to shift more resources
into higher output of personal computers, the opportunity cost of each extra PC is four CD
players. For Japan the same decision has an opportunity cost of two CD players. Therefore,
Japan has a comparative advantage in PCs.

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Determinants of comparative advantage
Comparative advantage is a dynamic concept. It can and does change over time. Some
businesses find they have enjoyed a comparative advantage in one product for several years
only to face increasing competition as rival producers from other countries enter their markets.
For a country, the following factors are important in determining the relative costs of
production:
 The quantity and quality of factors of production available: If an economy can improve
the quality of its labor force and increase the stock of capital available it can expand the
productive potential in industries in which it has an advantage.
 Investment in research & development (important in industries where patents give some
firms significant market advantage .An appreciation of the exchange rate can cause
exports from a country to increase in price. This makes them less competitive in
international markets.
 Long-term rates of inflation compared to other countries. For example if average
inflation in Country X is 4% whilst in Country B it is 8% over a number of years, the goods
and services produced by Country X will become relatively more expensive over time.
This worsens their competitiveness and causes a switch in comparative advantage.
 Import controls such as tariffs and quotas that can be used to create an artificial
comparative advantage for a country's domestic producers- although most countries
agree to abide by international trade agreements.
 Non-price competitiveness of producers (e.g. product design, reliability, quality of after-
sales support)
Interpreting the Theory of Comparative Advantage
A better way to state the results is as follows. The Ricardian model shows that if we want to
maximize total output in the world then,
First, fully employ all resources worldwide;
Second, allocate those resources within countries to each country's comparative advantage
industries; and
Third, allow the countries to trade freely thereafter.
Importance: The good in which a comparative advantage is held is the good that the country
produces most efficiently. Therefore, if given a choice between producing two goods (or
services), a country will make the most efficient use of its resources by producing the good with

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the lowest opportunity cost, the good for which it holds the comparative advantage. The
country can trade with other countries to get the goods it did not produce.
4) The Heckscher-Ohlin Trade Model
The Heckscher-Ohlin (HO hereafter) model was first conceived by two Swedish economists, Eli
Heckscher (1919) and Bertil Ohlin. Rudimentary concepts were further developed and added
later by Paul Samuelson and Ronald Jones among others. There are four major components of
the HO model:
1. Factor Price Equalization Theorem,
2. Stolper-Samuelson Theorem,
3. Rybczynski Theorem, and
4. Heckscher-Ohlin Trade Theorem.
Definition: Heckscher–Ohlin theorem is one of the four critical theorems of the Heckscher–
Ohlin model. It states that a country will export goods that use its abundant factors intensively,
and import goods that use its scarce factors intensively. In the two-factor case, it states: "A
capital-abundant country will export the capital-intensive good, while the labor-abundant
country will export the labor-intensive good."
The critical assumption of the Heckscher–Ohlin model is that the two countries are identical,
except for the difference in resource endowments. Initially, when the countries are not trading:
 The price of capital-intensive good in capital-abundant country will be bid down relative
to the price of the good in the other country,
 The price of labor-intensive good in labor-abundant country will be bid down relative to
the price of the good in the other country.
Features of the model - The Heckscher–Ohlin model (H–O model) is a general equilibrium
mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the
Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage
by predicting patterns of commerce and production based on the factor endowments of a
trading region. The model essentially says that countries will export products that use their
abundant and cheap factor(s) of production and import products that use the countries' scarce
factor(s).
Theoretical development of the model - The Ricardian model of comparative advantage has
trade ultimately motivated by differences in labor productivity using different technologies.
Heckscher and Ohlin didn't require production technology to vary between countries, so (in the

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interests of simplicity) the H-O model has identical production technology everywhere. Ricardo
considered a single factor of production (labor) and would not have been able to produce
comparative advantage without technological differences between countries. The H-O model
removed technology variations but introduced variable capital endowments, recreating
endogenously the inter-country variation of labor productivity that Ricardo had imposed
exogenously.
Assumptions of the theory
Heckscher-Ohlin's theory explains the modern approach to international trade on the basis of
following assumptions:-
1. There are two countries involved.
2. Each country has two factors (labor and capital).
3. Each country produce two commodities or goods (labor intensive and capital intensive).
4. There is perfect competition in both commodity and factor markets.
5. All production functions are homogeneous of the first degree i.e. production function is
subject to constant
returns to scale.
6. Factors are freely mobile within a country but immobile between countries.
7. Two countries differ in factor supply.
8. Each commodity differs in factor intensity.
9. The production function remains the same in different countries for the same commodity. For
e.g. If commodity A requires more capital in one country then same is the case in other country.
10. There is full employment of resources in both countries and demand are identical in both
countries.
11. Trade is free i.e. there are no trade restrictions in the form of tariffs or non-tariff barriers.
5. The Product Life-Cycle Theory
• 1960′s, Raymond Vernon – attempts to explain global trade patterns. First, new products are
introduced in the United States. Then, as demand grows in the U.S., it also appears in other
developed nations, to which the U.S. exports. Then, other developed nations begin to produce
the product as well, thus causing U.S. companies to set up production in those countries as well,

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and limiting exports from the U.S. Then, it all happens again, but this time production comes
online in developed nations. Ultimately, the U.S. becomes an importer of the product that was
initially introduced within its borders.
• Weakness – Not all new products are created in the United States. Many come from other
countries first, such as video game consoles from Japan, new wireless phones from Europe, etc.
Several new products are introduced in several developed countries simultaneously
Vernom gave the theory of international product life cycle model. The theory he addresses the stages of
production of a product and ‘know-how’ (knowledge how to make). A product is found by its Research
and Development activities by a parent company. The product is then pushed for production to its
subsidiary company overseas. The product is then pushed for production to its subsidiary company
overseas. Thereafter, the product is marketed to anywhere in the world to produce and market. The
product and manufacturing know how goes where it’s cost of production is lowest. International product
life cycle has 4 stages: a. New Product Development b. Maturing Stage c. Standardised Product d.
Declining Stage. New product initially will have high premium and sell to those who are willing to pay. As
production exceed exports start. In mature stage of product life cycle increasing export takes place. In
standardised stage the technology is known to many. Production shifts to low cost countries. The original
manufacturer tries to differentiate the product or bad the product to retain his market.
7. National Competitive Advantage – Porter’s Diamond
• 1990, Michael Porter – seeks to answer the question of why a nation achieves international
success in a particular industry. Based on four attributes:
 Factor endowments
 Basic factors – natural resources, climate, location, demographics
 Advanced factors – communication infrastructure, sophisticated and skilled labor,
research facilities, and technological know-how
 Advanced factors are a product of investment by individuals, companies, and
governments
 Porter argues that advanced factors are the most significant for competitive advantage
 Demand conditions – if customers at home are sophisticated and demanding,
companies will have to produce innovative, high quality products early, which leads to
competitive advantage
 Relating and supporting industries – If suppliers or related industries exist in the home
country that are themselves internationally competitive, this can result in competitive
advantage in the new industry.
 Firm strategy, structure, and rivalry
 Different nations are characterized by different management ideologies, which can
either help or hurt them in building competitive advantage

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 If there is a strong domestic rivalry, it helps to create improved efficiency, making those
firms better international competitors
DIFFICULTIES IN INTERNATIONAL BUSINESS
What make international business strategy different from the domestic are the
differences in the marketing environment. The importance special problems in international
marketing are given below:
1. POLITICAL AND LEGAL DIFFERENCES The political and legal environment of foreign
markets is different from that of the domestic. The complexity generally increases as the
number of countries in which a company does business increases. It should also be noted that
the political and legal environment is not the same in all provinces of many home markets. For
example, the political and legal environment is not exactly the same in all the states of India.
2. CULTURAL DIFFERENCES The cultural differences, is one of the most difficult problems
in international marketing. Many domestic markets, however, are also not free from cultural
diversity.
3. ECONOMIC DIFFERENCES The economic environment may vary from country to

country.
4. DIFFERENCES IN THE CURRENCY UNIT The currency unit varies from nation to nation.
This may sometimes cause problems of currency convertibility, besides the problems of
exchange rate fluctuations. The monetary system and regulations may also vary.
5. DIFFERENCES IN THE LANGUAGE An international marketer often encounters

problems arising out of the differences in the language. Even when the same language is used in
different countries, the same words of terms may have different meanings. The language
problem, however, is not something peculiar to the international marketing. For example: the
multiplicity of languages in India.
6. DIFFERENCES IN THE MARKETING INFRASTRUCTURE The availability and nature of

the marketing facilities available in different countries may vary widely. For example, an
advertising medium very effective in one market may not be available or may be
underdeveloped in another market.
7. TRADE RESTRICTIONS A trade restriction, particularly import controls, is a very

important problem, which an international market faces.

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8. HIGH COSTS OF DISTANCE When the markets are far removed by distance, the
transport cost becomes high and the time required for affecting the delivery tends to become
longer. Distance tends to increase certain other costs also.
9. DIFFERENCES IN TRADE PRACTICES Trade practices and customs may differ between
two countries.

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CHAP 1 International Business

Cost Accounting (Bangalore University)

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INTRODUCTION TO INTERNATIONAL BUSINESS

WHAT IS INTERNATIONAL BUSINESS?

MEANING AND DEFINITION OF INTERNATIONAL BUSINESS

International business is defined as commercial transactions that occur across country

International business involves exports and imports. International Business is also

‘Acc to international business journal’

International business is a commercial enterprise that performs economic

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 Opportunity for Growth: Potential for growth is a very common reason of

 Increase of Customers: If customers are in short supply, it may hit a company’s

FEATURES OF INTERNATIONAL BUSINESS

2. Integration of economies: International business integrates (combines) the economies of

3. Dominated by developed countries and MNCs : International business is dominated by

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4. Benefits to participating countries : International business gives benefits to all participating

NATURE OF INTERNATIONAL BUSINESS

2. Information not only accurate but should be timely

3. The size of the international business should be large

4. Market segmentation based on geographic segmentation

5. International markets have more potential than domestic markets

SCOPE OF INTERNATIONAL BUSINESS

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2. International Finance and Investments

NEED FOR INTERNATIONAL BUSINESS

1. To achieve higher rate of profits

3. Severe competition in the home country

4. Limited home market

6. Availability of technology and managerial competence

7. Cost of manpower, transportation

8. Nearness to raw material

9. Liberalization, Privatization and Globalization (LPG)

10. To increase market share

REASONS FOR RECENT INTERNATIONAL BUSINESS GROWTH

2. Business is becoming more global because

•Communications enable control from afar

3. Liberalization of cross-border movements

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INTERNATIONAL BUSINESS APPROACHES / EPRG frame work

1. ETHNOCENTRIC ORIENTATION: The ethnocentric orientation of a firm considers that the

2. REGIOCENTRIC ORIENTATION: In regiocentric approach, the firm accepts a regional

3. GEOCENTRIC ORIENTATION: In geocentric orientation, the firms accept a world wide

4. POLYCENTRIC OPERATION: When a firm adopts polycentric approach to overseas markets, it

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CONCLUSION: The involvement decision is conditioned by a variety of internal and external

PROBLEMS IN INTERNATIONAL BUSINESS

2. High foreign investments and high cost

5. Tariffs, quota etc.

6. Corruption and bureaucracy

FORMS OF INTERNATIONAL BUSINESS

CHAPTER 1 – INTRODUCTION TO I B Page 6