Competing in World Markets

Why Nations Trade

As domestic markets mature and sales growth slows, companies in every industry recognize the increasing importance of efforts to develop business in other countries. Walmart operates stores in Mexico, Boeing sells jetliners in Asia, and Apple sells iPads in Germany. These are only a few of the thousands of U.S. companies taking advantage of large populations, substantial resources, and rising standards of living abroad to boost sales of their goods and services. Likewise, the U.S. market, with the world's greatest purchasing power, attracts thousands of foreign companies looking to increase their sales.

INTERNATIONAL SOURCES OF FACTORS OF PRODUCTION

Business decisions to operate abroad depend on the availability, price, and quality of labor, natural resources, capital, and entrepreneurship—the basic factors of production—in the foreign country. For example, Indian colleges and universities produce thousands of highly qualified computer scientists and engineers each year. To take advantage of this talent, many U.S. computer software and hardware firms have set up operations in India, and many others are outsourcing information technology and customer service jobs there.

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 off in one country, the company may still enjoy strong demand in other nations. Companies such as Kellogg's and IKEA have long used international sales to offset lower domestic demand.

SIZE OF THE INTERNATIONAL MARKETPLACE

As developing nations expand their involvement in global business, the potential for reaching new groups of customers dramatically increases. Firms looking for new revenue are inevitably attracted to giant markets such as China and India, with respective populations of about 1.3 billion and 1.2 billion. However, people alone are not enough to create a market. Consumer demand also requires purchasing power. As TABLE 4.1 shows, population size is no guarantee of economic prosperity. Of the ten most populous countries, only the United States appears on the list of those with the highest per-capita GDPs.

Although people in developing nations have lower per-capita incomes than those in the highly developed economies of North America and Western Europe, their huge populations do represent lucrative markets. Even when the higher-income segments are only a small percentage of the entire country's population, their sheer numbers may still represent significant and growing markets.

In addition to large populations, many developing countries have posted high rates of annual GDP growth. In the United States, GDP generally averages between 2 and 4 percent growth per year. By contrast, GDP growth in less developed countries is much greater—China's GDP growth rate averaged nearly 10 percent over a recent three-year period, and India's averaged 8.2 percent.³ These markets represent opportunities for global businesses, even though their per-capita incomes lag behind those in more developed countries. Many firms are establishing operations in these and other developing countries to position themselves to benefit from local sales driven by expanding economies and rising standards of living. Walmart is one of those companies. As the world's largest retailer, Walmart employs 2.2 million workers worldwide. Walmart International is growing fast, with more than 5,300 stores and 740,000 employees in 27 countries as far-ranging as Lesotho and Swaziland in Africa.⁴

The United States trades with many other nations. As FIGURE 4.1 shows, the top five U.S. trading partners are Canada, China, Mexico, Japan, and Germany. With the United Kingdom, South Korea, France, Brazil, and Saudi Arabia, they represent nearly two-thirds of U.S. imports and exports every year.⁵ Within the United States, foreign trade makes up a large portion of the business activity in many individual states. Texas exports more than $206 billion of goods annually, and California exports more than $143 billion. Other big exporting states include Florida, Illinois, New York, and Washington.⁶

ABSOLUTE AND COMPARATIVE ADVANTAGE

Few countries can produce all the goods and services their people need. For centuries, trading has been the way that countries can meet consumer demands. If a country focuses on producing what it does best, it can export surplus domestic output and buy foreign products that it lacks or cannot efficiently produce. The potential for foreign sales of a particular item depends largely on whether the country has an absolute advantage or a comparative advantage.

A country has an absolute advantage in making a product if it can maintain a monopoly in the production of that product or if it can consistently produce the product at a lower cost than any competitor. For example, China enjoyed an absolute advantage in silk production. The fabric was woven from fibers recovered from silkworm cocoons, making it a prized raw material in high-quality clothing. Demand among Europeans for silk led to establishment of the famous Silk Road, a 5,000-mile link between Rome and the ancient Chinese capital city of Xian.

A nation can develop a comparative advantage if it can supply its products more efficiently—at a lower price—than it can supply other goods. Today China is profiting from its comparative advantage in producing textiles for the export market. China can produce them more efficiently than other products it could manufacture, thereby giving it a comparative advantage in textiles to other types of products it could manufacture—say, automobiles. Beyond the production of goods, ensuring that its people are well educated is another way a nation can develop a comparative advantage. For example, India offers the services of its educated tech workers at a lower wage.

To see the differences between a comparative and absolute advantage, consider the following example. An accountant operates a CPA firm where she bills $200 per hour doing accounting work. In addition to being an excellent accountant, she is also a pretty good typist able to type 80 words per minute. As her business grows, she decides to hire an administrative assistant specifically to help with the typing. To find suitable candidates she posts an ad on Craigslist: “Wanted: administrative assistant for growing CPA firm. Pay $20 per hour.” After interviewing several candidates, she finds that the best candidate can type only 40 words per minute. Should she hire this person?

It is clear that the accountant has an absolute advantage in typing compared to her administrative assistant candidate. However, the administrative assistant has a comparative advantage when it comes to typing. This is true because of the accountant's opportunity cost (the difference between what she could earn doing accounting work versus what she saves by doing her own typing). Even though she can type twice as fast as the assistant, she is much better off focusing on accounting work and letting her assistant handle the typing. And so it goes with international trade, where comparative advantages and opportunity costs form the basis for most trade between nations.

Measuring Trade between Nations

Clearly, engaging in international trade provides tremendous competitive advantages to both the countries and individual companies involved. But how do we measure global business activity? To understand what the trade inflows and outflows mean for a country, we need to examine the concepts of balance of trade and balance of payments. Another important factor is currency exchange rates for each country.

A nation's balance of trade is the difference between its exports and imports. If a country exports more than it imports, it achieves a positive balance of trade, called a trade surplus. If it imports more than it exports, it produces a negative balance of trade, called a trade deficit. The United States has run a trade deficit for years. Despite being one of the world's top exporters, the United States has an even greater appetite for foreign-made goods, which creates a trade deficit.

A nation's balance of trade plays a central role in determining its balance of payments—the overall flow of money into or out of a country. Other factors also affect the balance of payments, including overseas loans and borrowing, international investments, profits from such investments, and foreign aid payments. To calculate a nation's balance of payments, subtract the monetary outflows from 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 U.S. EXPORTS AND IMPORTS

The United States, with combined exports and imports of about $3.8 trillion, leads the world in the international trade of goods and services. As listed in TABLE 4.2, the leading categories of goods exchanged by U.S. exporters and importers range from machinery and vehicles to crude oil and chemicals. Strong U.S. demand for imported goods is partly a reflection of the nation's prosperity and diversity.

With annual imports of over $2.3 trillion, the United States is by far the world's leading importer. American tastes for foreign-made goods for everything from clothing to consumer electronics show up as huge trade deficits with the consumer goods–exporting nations of China and Japan.

Although the United States imports more goods than it exports, the opposite is true for services. U.S. exporters sell more than $600 billion in services annually. Much of that money comes from travel and tourism—money spent by foreign nationals visiting the United States.⁷ U.S. service exports also include business and technical services such as engineering, financial services, computing, legal services, and entertainment, as well as royalties and licensing fees. Major service exporters include Citibank, Walt Disney, Allstate Insurance, and Federal Express, as well as retailers such as McDonald's and Starbucks.

Businesses in many foreign countries want the expertise of U.S. financial and business professionals. Accountants are in high demand in Russia, China, the Netherlands, and Australia—Sydney has become one of Asia's biggest financial centers. Entertainment is another major growth area for U.S. service exports. The Walt Disney Company already has theme parks in Europe and Asia and is building Shanghai Disney Resort, a multi-billion-dollar park in China.⁸

EXCHANGE RATES

The value of a nation's currency is an important “thermometer” reflecting the state of a nation's economic health. A country with a strong currency can generally purchase more goods and services in the international market than ones with a weaker currency. An exchange rate is a measure of the strength of the local currency as a nation's money is exchanged for the currencies of other nations. For example, roughly 13 Mexican pesos are needed to exchange for one U.S. dollar. A Canadian dollar can be exchanged for approximately $1 in the United States. The euro, the currency used in most of the European Union (EU) member countries, has made considerable moves in exchange value during its few years in circulation. European consumers and businesses now use the euro to pay bills by check, credit card, or bank transfer. Euro coins and notes are also used in many EU member-countries.

Foreign exchange rates are influenced by a number of factors, including domestic economic and political conditions, central bank intervention, 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 international market. In this system of floating exchange rates, currency traders create a market for the world's currencies based on each country's relative trade and investment prospects. In theory, this market permits exchange rates to vary freely according to supply and demand. In practice however, exchange rates do not float in total freedom: national governments often intervene in currency markets to adjust their exchange rates.

Exchange rate changes can quickly create—or wipe out—a competitive advantage, so they are important factors in decisions about whether to invest abroad. In Europe, a declining dollar means that a price of ten euros is worth more, so companies are pressured to lower prices. Devaluation describes a drop in a currency's value relative to other currencies or to a fixed standard. At the same time, if the dollar falls it makes European vacations less affordable for U.S. tourists because their dollars are worth less relative to the euro.

Currencies that owners can easily convert into other currencies are called hard currencies. Examples include the euro, the U.S. dollar, and the Japanese yen. The Russian ruble and many central European currencies are considered soft currencies because they cannot be readily converted to other currencies. Exporters trading with these countries sometimes prefer to barter, accepting payment in oil, timber, or other commodities that they can resell for hard currency.

The foreign currency market is the largest financial market in the world, with a daily volume of about $4 trillion in U.S. dollars.⁹ This is about ten times the size of all the world's stock markets combined, so the foreign exchange market is one of the largest most efficient financial markets in the world.

Barriers to International Trade

Whether they sell only to local customers or trade in international markets, all business encounter challenges—barriers—to their operations. For example, countries such as Australia and New Zealand regulate the hours and days retailers may be open. International companies may have to reformulate their products to accommodate different tastes in new locations. Some of the challenges shown in FIGURE 4.2 are easily overcome, but others require major changes in a company's business strategy. To successfully compete in global markets, companies and their managers must understand not only how these barriers affect international trade but also how to overcome them.

SOCIAL, CULTURAL, AND ECONOMIC 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 critical to international business success. Businesspeople with knowledge of host countries' cultures, languages, social values, and religious attitudes and practices are well equipped for the marketplace and the negotiating table. Sensitivity to such elements as local attitudes, forms of address, and expectations regarding dress, body language, and timeliness also helps them win customers and achieve their business objectives.

LANGUAGE

Understanding a business colleague's primary language may prove to be the difference between closing an international business transaction and losing the sale to someone else. Company representatives operating in foreign markets must not only choose correct and appropriate words but also translate words correctly to convey the intended meanings. Firms may also need to rename products or rewrite slogans for foreign markets.

VALUES

U.S. society places a higher value on business efficiency and low unemployment than does European society, where employee benefits are more valued. The U.S. government does not regulate vacation time, and in the U.S. employees typically have limited or no paid vacation during their first year of employment, then two weeks vacation, and eventually up to three or four weeks if they stay with the same employer for many years. In contrast, the EU mandates a minimum paid vacation of four weeks per year, and most Europeans get five or six weeks. In these countries, a U.S. company that opens a manufacturing plant would not be able to hire any local employees without offering vacations in line with a nation's business practices.

ECONOMICS

Business opportunities are flourishing in densely populated countries such as China and India, as local consumers eagerly buy Western products. Although such prospects might tempt American firms, managers must first consider the economic factors involved in doing business in these markets. A country's size, per-capita income, and stage of economic development are among the economic factors to consider when evaluating it as a candidate for an international business venture. Tata Motors, for instance, has an eye on Western auto buyers, even as it markets its low-priced Nano car for the home market in India.

POLITICAL AND LEGAL DIFFERENCES

Like social, cultural, and economic differences, legal and political differences in host countries can pose barriers to international trade. To compete in today's world marketplace, managers involved in international business must be well versed in legislation that affects their industries. Some countries impose general trade restrictions. Others have established detailed rules that regulate how foreign companies can operate. An important factor in any international business investment is the stability of the political climate. The political structures of many nations promote stability similar to that in the United States. Other nations, such as Indonesia, Congo, and Bosnia, feature quite different—and frequently changing—structures. Host nations often pass laws designed to protect their own interests, sometimes at the expense of foreign businesses.

LEGAL ENVIRONMENT

When conducting business internationally, managers must be familiar with three dimensions of the legal environment: U.S. 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 the United States. Others dictate actions allowed for U.S. companies doing business in foreign countries.

The Foreign Corrupt Practices Act forbids U.S. companies from bribing foreign officials, political candidates, or government representatives. Although the law has been in effect since 1977, in the past few years the U.S. government has increased its enforcement, including major proceedings in the pharmaceutical, medical device, and financial industries. The United States, United Kingdom, France, Germany, and 36 other countries have signed the Organization for Economic Cooperation and Development Anti-Bribery Convention. Still, corruption continues to be an international problem. Its pervasiveness, combined with U.S. prohibitions, creates a difficult obstacle for U.S. businesspeople who want to do business in many foreign countries. Chinese pay huilu, and Russians rely on vzyatka. In the Middle East, palms are greased with baksheesh.

TYPES OF TRADE RESTRICTIONS

Trade restrictions such as taxes on imports and complicated administrative procedures create additional barriers to international business. They may limit consumer choices while increasing the costs of foreign-made products. Trade restrictions are also imposed to protect citizens' security, health, and jobs. A government may limit exports of strategic and defense-related goods to unfriendly countries to protect its security, ban imports of insecticide-contaminated farm products to protect health, and restrict imports to protect domestic jobs in the importing country.

Other restrictions are imposed to promote trade with certain countries. Still others protect countries from unfair competition. Regardless of the political reasons for trade restrictions, most take the form of tariffs. In addition to tariffs, governments impose a number of nontariff—or administrative—barriers. These include quotas and embargoes.

TARIFFS

A tax, surcharge, or duty on foreign products is referred to as a tariff. Governments may assess two types of tariffs—revenue and protective tariffs—both of which make imports more expensive for domestic buyers. Revenue tariffs generate income for the government. Upon returning home, U.S. leisure travelers who are out of the country more than 48 hours and who bring back goods purchased abroad may pay import taxes on the goods' value depending on the country of origin. This duty goes directly to the U.S. Treasury. The sole purpose of a protective tariff is to raise the retail price of imported products to match or exceed the prices of similar products manufactured in the home country. In other words, protective tariffs seek to limit imports and provide advantages for domestic competitors.

NONTARIFF BARRIERS

Nontariff, or administrative, trade barriers restrict imports in more subtle ways than tariffs. These measures may take such forms as quotas on imports, restrictive standards for imports, and export subsidies. Because many countries have recently substantially reduced tariffs or eliminated them entirely, they increasingly use nontariff barriers to control flows of imported products.

A quota limits the amount of a particular product that countries can import during specified time periods. Limits may be set as quantities, such as number of cars or bushels of wheat, or as values, such as dollars' worth of cigarettes. Governments regularly set quotas for agricultural products and sometimes for imported automobiles. The United States, for example, sets a quota on imports of sugar. Imports under the quota amount are subject to a lower tariff than shipments above the quota. However, sugar and related products imported at the higher rate may enter the country in unlimited quantities.¹⁰

Quotas help prevent dumping. In one form of dumping, a company sells products abroad at prices below its cost of production. In another, a company exports a large quantity of a product at a lower price than the same product in the home market and drives down the price of the domestic product. Dumping benefits domestic consumers in the importing market, but it hurts domestic producers. It also allows companies to gain quick entry to foreign markets.

More severe than a quota, an embargo imposes a total ban on importing a specified product or even a total halt to trading with a particular country. The United States has a long-standing trade embargo with Cuba.

Reducing Barriers to International Trade

Although tariffs and administrative barriers still restrict trade, overall the world is moving toward free trade. Several types of organizations ease barriers to international trade, including groups that monitor trade policies and practices and institutions that offer monetary assistance. Another type of federation designed to ease trade barriers is the multinational economic community, such as the European Union. This section looks at the roles these organizations play.

ORGANIZATIONS PROMOTING INTERNATIONAL TRADE

For the 60-plus years of its existence, the General Agreement on Tariffs and Trade (GATT), an international trade accord, sponsored a series of negotiations, called rounds, which substantially reduced worldwide tariffs and other barriers. Major industrialized nations founded the multinational organization in 1947 to work toward reducing tariffs and relaxing import quotas. The last set of completed negotiations—the Uruguay Round—cut average tariffs by one-third, in excess of $700 billion; reduced farm subsidies; and improved protection for copyright and patent holders. In addition, international trading rules now apply to various service industries. Finally, the new agreement established the World Trade Organization (WTO) to succeed GATT. This organization includes representatives from 153 countries.

WORLD TRADE ORGANIZATION

Since 1995, the WTO has monitored GATT agreements among the member-nations, mediated disputes, and continued the effort to reduce trade barriers throughout the world. Unlike provisions in GATT, the WTO's decisions are binding on parties involved in disputes.

The WTO has grown more controversial in recent years as it issues decisions that have implications for working conditions and the environment in member nations. Concerns have been expressed that the WTO's focus on lowering trade barriers encourages businesses to keep costs down through practices that may increase pollution and human rights abuses. Particularly worrisome is the fact that the organization's member-countries must agree on policies, and developing countries tend not to be eager to lose their low-cost advantage by enacting stricter labor and environmental laws. Other critics claim that if well-funded U.S. firms such as fast food chains, entertainment companies, and Internet retailers can freely enter foreign markets, they will wipe out smaller foreign businesses serving the distinct tastes and practices of other country's cultures.

WORLD BANK

Shortly after the end of World War II, industrialized nations formed an organization to lend money to less developed and developing countries. The World Bank primarily funds projects that build or expand nations' infrastructure such as transportation, education, and medical systems and facilities. The World Bank and other development banks also provide advice and assistance to developing nations. Often, in exchange for granting loans, the World Bank imposes requirements intended to build the economies of borrower nations.

Although the World Bank provides many benefits to developing countries, it is not without its critics. For example, it has been criticized for making loans with conditions that ultimately hurt the borrower nations. When developing nations are required to balance government budgets, they are sometimes forced to cut vital social programs. Critics also say that the World Bank should consider the impact of its loans on the environment and working conditions. One controversial project funded by the World Bank is the Gibe III dam in Ethiopia. Once it is complete, this dam will provide water for irrigation and hydroelectric power for Ethiopia but will cause the removal of hundreds of thousands of residents from the Lower Omo Valley river basin.¹¹

INTERNATIONAL MONETARY FUND

Established a year after the World Bank, the International Monetary Fund (IMF) was created to promote trade through financial cooperation and, in the process, eliminate barriers. The IMF makes short-term loans to member nations that are unable to meet their expenses. It operates as a lender of last resort for troubled nations. In exchange for these emergency loans, IMF lenders frequently require significant commitments from borrowing nations to address the problems that led to the crises. These steps may include curtailing imports or even devaluing currencies. Throughout its existence, the IMF has worked to prevent financial crises by warning the international business community when countries encounter problems meeting their financial obligations. Often, the IMF lends to countries to keep them from defaulting on prior debts and to prevent economic crises in particular countries from spreading to other nations.

INTERNATIONAL ECONOMIC COMMUNITIES

International economic communities reduce trade barriers and promote regional economic integration. In the simplest approach, countries may establish a free-trade area in which they trade freely among themselves without tariffs or trade restrictions. Each maintains its own tariffs for trade outside this area. A customs union sets up a free-trade area and specifies a uniform tariff structure for members' trade with nonmember nations. In a common market, or economic union, members go beyond a customs union and try to bring all of their trade rules into agreement.

One example of a free-trade area is the North American Free Trade Agreement (NAFTA) enacted by the United States, Canada, and Mexico. Other examples of regional trading blocs include the MERCOSUR customs union (joining Brazil, Argentina, Paraguay, Uruguay, Chile, and Bolivia) and the ten-country Association of South East Asian Nations (ASEAN).

NAFTA

NAFTA became effective in 1994, creating the world's largest free-trade zone with the United States, Canada, and Mexico. With a combined population of more than 463 million and a total GDP of more than $18 trillion, North America represents one of the world's most attractive markets. By eliminating all trade barriers and investment restrictions among the United States, Canada, and Mexico over a 15-year period, NAFTA opened more doors for free trade. The agreement also eased regulations governing services, such as banking, and established uniform legal requirements for protection of intellectual property. The three nations can now trade with one another without tariffs or other trade barriers, simplifying shipments of goods across the partners' borders. Standardized customs and uniform labeling regulations create economic efficiencies and smooth import and export procedures. Trade among the partners has increased steadily, more than doubling since NAFTA took effect.

CAFTA-DR

The Central America–Dominican Republic Free Trade Agreement (CAFTA-DR) created a free-trade area among the United States, Costa Rica, the Dominican Republic (the DR of the title), El Salvador, Guatemala, Honduras, and Nicaragua. The agreement—the first of its kind between the United States and these smaller developing economies—ends tariffs on the nearly $40 billion in products traded between the United States and its Latin American neighbors. Agricultural producers such as corn, soybean, and dairy farmers stand to gain under the relaxed trade rules. Overall, CAFTA-DR's effects have increased both exports and imports substantially, much as NAFTA did.¹²

EUROPEAN UNION

Perhaps the best-known example of a common market is the European Union (EU). The EU combines 28 countries, over 503 million people, and a total GDP of roughly $15.39 trillion to form a huge common market. FIGURE 4.3 shows the member countries. Current candidates for membership are Iceland, Montenegro, Serbia, Turkey, and the former Yugoslav Republic of Macedonia.¹³

The EU's goals include promoting economic and social progress, introducing European citizenship as a complement to national citizenship, and giving the EU a significant role in international affairs. To achieve its goal of a borderless Europe, the EU is removing barriers to free trade among its members. This highly complex process involves standardizing business regulations and requirements, standardizing import duties and taxes, and eliminating customs checks so that companies can transport goods from England to Italy or Poland as easily as from New York to Boston.

Unifying standards and laws can contribute to economic growth. But just as NAFTA sparked fears in the United States about free trade with Mexico, some people in Western Europe worried that opening trade with such countries as Poland, Hungary, and the Czech Republic would cause jobs to flow eastward to lower-wage economies.

The EU also introduced the euro to replace currencies such as the French franc and Italian lira. For the 17 member-states that have adopted the euro, potential benefits include eliminating the economic costs of currency exchange and simplifying price comparisons.

Going Global

While expanding into overseas markets can increase profits and marketing opportunities, it also introduces new complexities to a firm's business operations. Before deciding to go global, a company faces a number of key decisions, beginning with the following:

• determining which foreign market(s) to enter
• analyzing the investment required to enter a new market
• deciding the best way to organize the overseas operations

These issues vary in importance depending on the level of involvement a company chooses. Education and employee training in the host country would be much more important for an electronics manufacturer building an Asian factory than for a firm that is simply planning to export American-made products.

The choice of which markets to enter usually follows extensive research focusing on local demand for the firm's products, availability of needed resources, and ability of the local workforce to produce world-class quality. Other factors include existing and potential competition, tariff rates, currency stability, and investment barriers. A variety of government and other sources are available to facilitate this research process. A good starting place is the CIA's World Factbook, which contains country-by-country information on geography, population, government, economy, and infrastructure.

U.S. Department of Commerce counselors working at district offices offer a full range of international business advice, including computerized market data and names of business and government contacts in dozens of countries. As TABLE 4.3 shows, the Internet provides access to many resources for international trade information.

LEVELS OF INTERNATIONAL INVOLVEMENT

After a firm has completed its research and decided to do business overseas, it can choose one or more strategies:

• exporting or importing
• entering into contractual agreements such as franchising, licensing, and subcontracting deals
• direct investment in the foreign market through acquisitions, joint ventures, or establishment of an overseas division

Although the company's risk increases with the level of its involvement, so does its overall control of all aspects of producing and selling its goods or services.

IMPORTERS AND EXPORTERS

When a firm brings in goods produced abroad to sell domestically, it is an importer. Conversely, companies are exporters when they produce—or purchase—goods at home and sell them in overseas markets. An importing or exporting strategy provides the most basic level of international involvement, with the least risk and control.

Firms engage in exporting of two types: indirect and direct. A company engages in indirect exporting when it produces a product, such as an electronic component, that becomes part of another product that is ultimately sold in foreign markets. The second method, direct exporting, occurs as the name implies when a company directly sells its products in markets outside its own country. Often the first step for companies entering foreign markets, direct exporting is the most common form of international business. Firms that succeed at this may then move to other strategies.

CONTRACTUAL AGREEMENTS

One type of contractual agreement, subcontracting, involves hiring local companies to produce, distribute, or sell goods or services. This move allows a foreign firm to take advantage of the subcontractor's expertise in local culture, contacts, and regulations. Many companies simply modify their domestic business strategies by translating promotional brochures and product-use instructions into the languages of the host nations.

Subcontracting works equally well for mail-order companies, which can farm out order fulfillment and customer service functions to local businesses. Manufacturers practice subcontracting to save money on import duties and labor costs, and businesses go this route to market products best sold by locals in a given country. Some firms, such as Maryland-based Pacific Bridge Medical, help medical manufacturers find reliable subcontractors and parts suppliers in Asia.

A key disadvantage of subcontracting is that companies cannot always control their subcontractors' business practices. Several major U.S. companies have been embarrassed by reports that their subcontractors used child labor to manufacture clothing. Additionally, when a U.S. firm provides the subcontractor with the know-how to produce a product for them, there is the chance that they will use this intellectual property to aid a competitor.

INTERNATIONAL DIRECT INVESTMENT

Investing directly in production and marketing operations in a foreign country is the ultimate level of global involvement. Over time, a firm may become successful at conducting business in other countries through exporting and contractual agreements. Its managers may then decide to establish manufacturing facilities in those countries, open branch offices, or buy ownership interests in local companies. Making the decision to directly invest in another country can carry significant risks for the investing company. Political instability, currency devaluation, and changes in the competitive environment are but a few of the issues that a firm must consider before making a direct investment.

One type of direct investment is the joint venture, which allows companies to share risks, costs, profits, and management responsibilities with one or more host country nationals. By setting up such an arrangement, a company can conduct a significant amount of its business overseas while reducing the risk of “going it alone” in a foreign country.

FROM MULTINATIONAL CORPORATION TO GLOBAL BUSINESS

A multinational corporation (MNC) is an organization with significant foreign operations. As TABLE 4.4 shows, firms headquartered in the United States make up half the list of the world's largest multinationals. Brazil, China, the Netherlands, and the United Kingdom make up the other half. Note that the two top industries are banking and oil and gas.

Many U.S. multinationals, including Nike and Walmart, have expanded their overseas operations because they believe that domestic markets are peaking and foreign markets offer greater sales and profit potential. Other MNCs are making substantial investments in developing countries in part because these countries provide low-cost labor compared with the United States and Western Europe. In addition, many MNCs are locating high-tech facilities in countries with large numbers of technical school graduates.

NOTES

1. Chester Dawson, “Toyota Again World's Largest Autor Maker,” The Wall Street Journal, January 28, 2013, http://online.wsj.com; Chris Isidore, “Toyota Motor Set to Reclaim ‘Top Car Maker’ Spot from GM,” CNN Money, December 26, 2012, http://money.cnn.com.

2. World Factbook, “United States,” https://www.cia.gov, accessed April 9, 2013.

3. Organization Web site, http://data.worldbank.org, accessed April 9, 2013.

4. Company Web site, http://walmartstores.com, “International,” accessed April 9, 2013.

5. U.S. Census, “Top Ten Countries with Which the U.S. Trades, for the Month of December 2011,” http://www.census.gov, accessed April 9, 2013.

6. U.S. Census, “Origin of Movement of U.S. Exports of Goods by State by NAICS-Based Product Code Groupings, Not Seasonally Adjusted, 2010,” http://www.census.gov, accessed April 9, 2013.

7. U.S. Bureau of Economic Analysis, “U.S. International Trade in Goods and Services,” press release, February 10, 2012, http://www.bea.gov.

8. Company Web site, http://en.shanghaidisneyresort.com.cn/en, accessed April 9, 2013; Shanghai Disney Resort, “First Steel Column of the Shanghai Disney Resort Project Administration Building Installed,” press release, November 22, 2012, http://en.shanghaidisneyresort.com.cn.

9. Bank for International Settlements, http://www.bis.org, accessed April 9, 2013.

10. U.S. Department of Agriculture, Foreign Agriculture Service, “U.S. Sugar Import Program,” http://www.fas.usda.gov, accessed April 9, 2013.

11. John Vidal, “Ethiopia Dam Project Is Devastating the Lives of Remote Indigenous Groups,” The Guardian, February 6, 2013, http://www.guardian.co.uk; John Vidal, “Ethiopia Dam Project Rides Roughshod over Heritage of Local Tribespeople,” The Guardian, February 23, 2012, http://www.guardian.co.uk.

12. Office of the United States Trade Representative, “CAFTA-DR,” http://www.ustr.gov, accessed April 9, 2013.

13. European Union Web site, “Countries,” http://europa.eu, accessed April 9, 2013; World Factbook, www.cia.gov, accessed April 9, 2013.