Lecture 03

International business approaches are similar to the stages of internationalization or globalization. Douglas Wind and Pelmutter advocated four approaches of international business. They are:

2. Polycentric Approach

1. Echnocentric Approach

Then, the company establishes a foreign subsidiary company and decentralists all the operations and delegates decisionmaking and policy-making authority to its executives. In fact, the company appoints executives and personnel including a chief executive who reports directly to the Managing

The domestic companies normally formulate their strategies. Their product design and their operations towards the national markets, customers and competitors. But, the excessive production more than the demand for the product, either due to competition or due to changes in customer preferences push the company to export the excessive production to foreign countries. The domestic company continues the exports to the foreign countries and views the foreign markets as an extension to the domestic markets just like a new region. The executives at the head office of the company make the decisions relating to exports and, the marketing personnel of the domestic company monitor the export operations with the help of an export department.

The domestic companies, which are exporting to foreign countries using the ethnocentric approach, find at the latter stage that the foreign markets need an altogether different approach. .

Director of the company. Company appoints the key personnel from the home country and the people of the host country fill all other vacancies.

The company exports the same product designed for domestic markets to foreign countries under this approach. Thus, maintenance of domestic approach towards international business is called ethnocentric approach.

Managing Director

Manager R&D

Manager Finance

Manager Production

Assistant Manger North India

Manager Human Resources

Assistant Manager South India

Manager Marketing

Assistant Manager Exports

Organization structure of Ethnocentric company This approach is suitable to the companies during the early days of internationalization and also to the smaller companies.

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INTERNATIONAL BUSINESS MANAGEMENT

LESSON 3: INTERNATIONAL BUSINESS APPROACHES

INTERNATIONAL BUSINESS MANAGEMENT

Managing Director

CEO Foreign Subsidiary (Uganda)

Manager R&D

Manager Finance

Manager Production

Manager Human Resource

Manager Marketing

Organization Structure Of Polycentric Company

4.

3. Regiocentric Approach

Under this approach, the entire world is just like a single country for the company. They select the employees from the entire globe and operate with a number of subsidiaries. The headquarter coordinates the activities of the subsidiaries. Each subsidiary functions like an independent and autonomous company in formulating policies, strategies, product design, human resource policies, operations etc.

The company after operating successfully in a foreign country, thinks of exporting to the neighboring countries of the host country. At this stage, the foreign subsidiary considers the regions environment (for example, Asian environment like laws, culture, policies etc.) for formulating policies and strategies. However, it markets more or less the same product designed

Geocentric approach

Managing Director

CEO Foreign Subsidiary (Uganda)

Manager R&D

Manager Finance

Manager Production

Manager Human Resource

Manager Marketing

under polycentric approach in other countries of the region, but with different market strategies.

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Business between two countries is profitable when a country produces one good at a lower cost than other country and that

Managing Director

CEO Foreign Subsidiary (Uganda)

Manager R&D

Manager Finance

Manager Production

Fig 1.4 Organization Structure of Geocentric Company

Theories Of International Business The fundamental question that arises for most of us at this juncture, is why should the business firms of one country should go to the another country, when the industries of that country also produce goods and market them. What is the basis for international business? A number of theories have been developed to explain the basis for international business

Comparative Cost Theory It is quite common that some countries have the advantage of producing some goods at a lower cost compared to other countries. This is due to the availability of cheap labour, skilled labour, cheap and qualitative raw materials, advanced technology, competent management practices etc. Availability of these factors enhances productivity and thereby reduces the cost of production per unit. Similarly, other countries have this advantage in producing other goods. For example, Japan has the advantage in producing electronics at low cost whereas India has similar advantage in producing textiles. According to comparative cost theory the countries in the long run will tend to specialize in the business (production and marketing) of those goods in whose business they enjoy comparative low cost advantage and import other goods in which the countries have comparative cost disadvantage, if free trade is allowed. This specialization helps for the mutual advantage of the countries participating, in the international business. David Ricardo illustrated the Comparative Cost Theory in 1817. He used a two country, two commodity model. The conclusions of his model are:

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Manager Human Resource

Manager Marketing

other produces another good at a lower cost than the former country. Business between two countries is also profitable when one country produces more than one product efficiently, but, when it produces one of these products comparatively at greater efficiency than the other product. Both the nations can engage in international business when one country specializes in the production in which it has greater efficiency in production. Assumptions of the Theory : The assumptions of the comparative cost theory include:

• • • •

The only element of cost of production is, labour. Production is subject to the law of constant returns. There are no trade barriers. Trade is free from cost of transportation.

Derivates of the Theory: The advantages desired from this theory are:

• Efficient allocation of global resources. • Maximization of global production at the least possible cost. • Product price, become more or less equal among world markets.

• Demand for resources and products among world nations will be optimized Thus, we learn from this theory that, the basis for international business is the comparative advantage of the nations to produce certain products at lower cost than other countries.

The Opportunity Cost Theory Another example is that, India produces textile garments by utilizing its human resources worth of Rs I billion and exports to the US in 1999. The opportunity cost of this project is, had

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INTERNATIONAL BUSINESS MANAGEMENT

Fig 1.4 helps to understand the concept of geocentric approach clearly.

INTERNATIONAL BUSINESS MANAGEMENT

India developed software packages by utilizing the same human resources and exported the same to USA in 1999, the worth of the exports would have been Rs 10 billion. Opportunity cost approach specifies the cost in terms of the value of the alternatives, which have to be foregone in order to fulfill a specific act. Thus, this theory provides the basis for international business in terms of exporting a particular product rather than other products. The previous example suggests that it would be I India to develop and export software packages rather than textile garments to USA. We slightly modify the previous example. For example, assume that India earned Rs 15 billion by exporting the same software packages to UK in 1999 rather than to USA. This theory suggests that the opportunity cost of India’s software exports to USA in 1999 is Rs 15 billion. Thus, this theory also provides the basis for international business of exporting a product to a particular country rather to another country.

The Modern Theory of Factor Endowments (Heckscher Ohlin Thesis) Bertil Ohlin and Eli Heckscher explained the basis of international business in terms of factor endowment. This theory explains the reasons for comparative cost differences. They are: Different prevailing endowments of the factors of production and Different factors of production are to be used in different degrees of intensity for producing different goods. According to this theory a country will specialize in the production and export of those goods whose ratio between capital and other factors of production is higher than those in other countries. Assumptions: HeckscherOhlin theory is built on the following assumptions: Perfect competition is in existence for both product and factors in both the countries. Factors of production are fixed in each country. Factors of production are of equal quality in both the countries. Factors of production have full employment in both the countries Factors endowments vary from one country to another country. Business between two countries is free from all barriers. There is no cost of transportation, Production in both the countries is subject to law of returns Factor intensity varies between goods. Merits : Despite the assumptions, this theory enjoys the following merits: This theory provides more valid basis for the existence of international business compared to the other theories.

• This theory is superior to the comparative cost theory as it

in two countries in terms of differences in factor endowments.

• The theory specifies that international business is an extension to domestic or interregional trade. Hence, this theory is viewed as the modern theory of international business. This theory is also called General Equilibrium Theory of international business as it deals with the equilibrium between demand for and supply of the products.

• This theory indicates the impact of international business on product and factor prices. Derivatives: The ultimate conclusions we draw from this theory are:

• Price of the internationally traded products tend to be equalized in all the countries of the globe and in all the regions of each country. However, existence of the cost of transportation and nonexistence of perfect competition are the limitations to this conclusion.

• Prices of factors of production also tend to equalize across the globe. However, existence of the cost of transportation and the nonexistence of the perfect competition are the limitations to this conclusion also. Ultimately we can learn from this theory that the tendency of equilibrium of product/service prices and the prices of factors of production is the basis for international business. Adam Smith’s Theory of Absolute Differences in Cost According to Adam Smith, every country should specialize in producing those products, which it can produce at less, cost than that of other countries and exchange these products with other products. These other products are produced absolutely at less cost by other countries. According to Smith, “whether the advantage which one country has over another be natural or acquired, is in this respect of no consequence.” Criticism: According to this theory every country should be able to produce certain products at low cost compared to other countries and should produce certain other products at comparatively high price than other countries. International trade takes place only under such condition. But, in reality most of the developing countries do not have absolute advantage of producing at lowest cost any commodity, yet they participate in international business. The Productivity Theory It is criticised that the comparative cost theories are not applicable to developing countries. Hence, H.Myint proposed productivity theory and the vent for surplus theory. The productivity theory points toward indirect and direct benefits. This theory emphasises that the process of specialisation involves adapting and reshaping the production structure of a trading country to meet the export demands. Countries increase productivity in order to utilise the gains of exports. This theory encourages the developing countries to go for cash crops, increase productivity by enhancing the efficiency of human resources, adapting latest technology etc.

provides the reasons for the difference in cost of production 12

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INTERNATIONAL BUSINESS MANAGEMENT

Limitations: However, this theory has also certain limitations.

• Labour productivity did not increase after certain level • Increase in working hours • Increase in proportion of gainfully employed labour in proportion to disguised unemployed Labour. The Vent for Surplus Theory International trade absorbs the output of unemployed factors. If the countries produce more than the domestic requirements, they have to export the surplus to other countries. Otherwise, a part of the productive labour of the country must cease and the value of its annual Produce diminishes. Thus, in the absence of foreign trade, they would be surplus productive capacity in the country. This surplus productive capacity is taken by another country and in turn gives the benefit under international trade. Appropriateness of this Theory for Developing Countries: According to this theory, the factors of production of developing countries are fully utilised. The unemployed labour of the developing countries is profitably employed when the vent for surplus is exported. International trade permits for more efficient use of capital and labour. Hence I.S. Mill described this theory as, “surving relic of the Mercantile Theory.” Mill’s Theory of Reciprocal Demand Comparative cost advantage theories. do not explain the ratios at which commodities are exchanged for one another. J.S. Mill introduced the concept of ‘reciprocal demand’ to explain the determinations of the equilibrium terms of trade. Reciprocal demand indicates a country’s demand for one commodity in terms of the other commodity; it is prepared to give up in exchange. Reciprocal demand determines the terms of trade and relative share of each country. Equilibrium = Quality of a product exported by country A Quality of another product exported by country B Assumptions: Assumptions of this theory are: Existence of two countries, trade in only two goods, both the goods are produced under the law of constant returns, absence of transportation Costs. Existence of perfect competition and existence of full employment.

Tutorial Questions for Discussion Q1) What are the various approaches to International Business. Q2) Distinguish between Absolute advantage theory and Comparative Advantage Theory of International Trade Q3) What do you understand by Heckscher Ohlin Theory of International Trade. What are its assumptions/ Notes:

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