Chapter Notes

Introduction

In today's world, national economies are no longer isolated. They are becoming increasingly interconnected, a phenomenon often described as living in a 'global village'. This shift is driven by advancements in communication, technology, and transportation, which have made it easier for countries to trade and invest across borders. As a result, businesses are no longer limited to their home country; they have numerous opportunities to grow and increase profits by operating internationally.

India has a long history of trading with other nations, but in recent years, it has accelerated its integration with the world economy. This process began significantly in 1991 when, facing a severe economic crisis, India approached the International Monetary Fund (IMF). The IMF provided funds on the condition that India liberalize its economic policies. This led to major reforms, opening up the Indian market to multinational corporations (MNCs) and encouraging Indian companies to expand their operations abroad.

Meaning of International Business

It's important to understand the difference between domestic and international business.

• Domestic Business (or Internal Business): This refers to business transactions that happen within the geographical boundaries of a single nation.
• International Business: This includes all business activities that take place across national borders.

Reason for International Business

The fundamental reason for international business is that no country can produce everything it needs efficiently or cheaply. This is due to:

• Unequal distribution of natural resources: Some countries have resources that others don't.
• Differences in productivity levels: Factors like labor, capital, and raw materials vary from one nation to another.

This leads to geographical specialisation. Countries focus on producing goods and services that they can make most efficiently and at a lower cost. They then trade their surplus with other countries to get what those nations produce more efficiently. This principle, known as territorial division of labour, is the same reason why different regions within a country specialize in certain products.

Firms engage in international business for similar reasons: to import goods available at lower prices and to export their products to countries where they can get better prices.

International Business vs. Domestic Business

Managing an international business is far more complex than a domestic one. Businesses must adapt their products, pricing, and strategies to fit the unique conditions of foreign markets. Key differences include:

• Nationality of Buyers and Sellers: In domestic business, buyers and sellers are from the same country, sharing a common language and culture. In international business, they come from different countries, which can create difficulties in communication and understanding.
• Nationality of Other Stakeholders: Stakeholders like employees, suppliers, and partners in a domestic business are typically from the same country. An international business must consider the values and expectations of stakeholders from multiple nations.
• Mobility of Factors of Production: Labor and capital move more freely within a country than between countries. International movement is often restricted by laws, as well as socio-cultural, geographical, and economic differences.
• Customer Heterogeneity Across Markets: International markets are highly diverse. Tastes, customs, languages, and buying habits differ significantly from one country to another, making it challenging to design products and marketing strategies.
• Differences in Business Systems: Countries vary in their economic development, infrastructure, and business practices. Firms must adapt their operations to fit these different systems.
• Political System and Risks: Each country has its own political system and associated risks. International businesses must navigate different political environments, which can change unexpectedly. A major risk is that foreign governments may favor domestic products over imported ones.
• Business Regulations and Policies: Laws, tax policies, and import rules (like tariffs and quotas) differ widely between nations and can sometimes discriminate against foreign products and companies.
• Currency Used in Business Transactions: International business involves multiple currencies. Fluctuating exchange rates (the price of one currency in terms of another) create risks and complicate pricing and payment.

Scope of International Business

International business includes several types of operations:

• Merchandise Exports and Imports: This is the trade of tangible goods—products that can be seen and touched. Exporting is sending goods abroad, while importing is bringing them into the country. This is also known as trade in goods.
• Service Exports and Imports: This involves the trade of intangibles, or services. Because services cannot be seen or touched, this is often called invisible trade. Major international services include tourism, transportation, banking, insurance, and professional consulting.
• Licensing and Franchising:
  • Licensing is when a firm (the licensor) allows a foreign firm (the licensee) to produce and sell goods using its patents, trademarks, or technology in exchange for a fee called a royalty.
  • Franchising is similar but typically applies to services. The franchiser grants a franchisee the right to use its brand, technology, and business model under strict rules. [!example] Coca-Cola uses a licensing system with local bottlers around the world. McDonald's operates globally through its franchising system.
• Foreign Investments: This involves investing funds abroad for a financial return. There are two main types:
  • Foreign Direct Investment (FDI): This is when a company directly invests in assets like plants and machinery in a foreign country to produce and market goods. This gives the investor a controlling interest in the foreign company.
  • Portfolio Investment: This is when a company invests in another company by buying its shares or providing loans. The investor earns income through dividends or interest but does not get directly involved in the company's operations.

Benefits of International Business

Engaging in international business offers significant advantages to both nations and individual firms.

Benefits to Countries

• Earning of Foreign Exchange: It helps a country earn foreign currency, which can be used to import essential goods like capital goods, technology, and petroleum products.
• More Efficient Use of Resources: By specializing and trading, countries can produce a larger total pool of goods and services, benefiting all trading partners.
• Improving Growth Prospects and Employment Potentials: Access to foreign markets allows countries to produce on a larger scale than their domestic market could support, leading to economic growth and job creation. Countries like Singapore, South Korea, and China have successfully used an 'export and flourish' strategy.
• Increased Standard of Living: International trade allows people to consume a wider variety of goods and services from around the world, improving their quality of life.

Benefits to Firms

• Prospects for Higher Profits: Firms can often earn more by selling products in countries where prices are higher than in their domestic market.
• Increased Capacity Utilisation: If a firm has excess production capacity, exporting allows it to use that capacity, leading to economies of scale, lower production costs, and higher profits.
• Prospects for Growth: When a domestic market becomes saturated, entering overseas markets can provide new opportunities for growth.
• Way Out of Intense Competition in Domestic Market: International expansion can be a solution for firms facing tough competition at home.
• Improved Business Vision: The decision to go international is often part of a larger strategic vision to grow, become more competitive, and diversify.

Modes of Entry into International Business

A company can enter international business in several ways. The best mode depends on the company's goals, resources, and risk tolerance.

Exporting and Importing

This is the simplest way to enter international markets. Exporting is sending goods and services to a foreign country, while importing is buying them from a foreign country. A firm can do this in two ways:

• Direct Exporting/Importing: The firm handles all the formalities itself, directly approaching overseas buyers or suppliers.
• Indirect Exporting/Importing: The firm uses middlemen, such as export houses, to handle most of the tasks.

Advantages

• It is the easiest and least complex way to enter international markets.
• It requires less investment of time and money compared to setting up foreign operations.
• There is little to no foreign investment risk.

Limitations

• It involves additional costs for packaging, transportation, and insurance. Tariffs and customs duties in the foreign country can make the product less competitive.
• It is not a viable option if the foreign country has import restrictions.
• Export firms operate from their home country and may have limited contact with foreign customers, putting them at a disadvantage compared to local firms.

Contract Manufacturing

Also known as outsourcing, contract manufacturing is when a firm hires a local manufacturer in a foreign country to produce components or assemble goods according to its specifications.

Advantages

• It allows for large-scale production without investing in new facilities.
• There is little or no investment risk in the foreign country.
• It can lead to lower production costs, especially in countries with cheaper labor and materials.
• The local producer benefits by utilizing idle capacity and getting involved in international business.

Limitations

• The local firm may not adhere to quality standards, creating problems for the international company.
• The local producer loses control over the manufacturing process.
• The local firm must sell the goods to the international company at a predetermined price, which may be lower than the open market price.

Licensing and Franchising

Licensing is a contractual agreement where one firm (the licensor) grants another foreign firm (the licensee) the right to use its patents, trademarks, or technology for a fee (royalty). Franchising is very similar but is used for services and is generally more stringent, with the franchiser setting strict rules for how the franchisee operates.

Advantages

• It is a low-cost way to enter international business, as the licensee/franchisee provides the investment.
• The licensor/franchiser faces very little risk, as they are paid a fee regardless of profits or losses.
• Since a local person manages the business, there is a lower risk of government intervention.
• The local partner has valuable market knowledge and contacts.

Limitations

• There is a risk that the licensee, after becoming skilled, could become a competitor by marketing a similar product under a different brand.
• Trade secrets could be leaked to competitors in the foreign market.
• Conflicts can arise over issues like royalty payments and quality standards.

Joint Ventures

A joint venture means establishing a firm that is jointly owned by two or more independent firms. This can happen in three ways: a foreign investor buys into a local company, a local firm buys into a foreign company, or both jointly form a new enterprise.

Advantages

• The financial burden is shared, as the local partner contributes equity capital.
• It allows firms to take on large projects that require significant capital and manpower.
• The foreign firm benefits from the local partner's knowledge of the host country's culture, language, and business systems.
• Costs and risks of entering a new market can be shared.

Limitations

• The foreign firm must share its technology and trade secrets with the local partner, risking disclosure.
• The dual ownership can lead to conflicts and battles for control between the partners.

Wholly Owned Subsidiaries

This mode is for companies that want full control over their foreign operations. The parent company establishes a subsidiary in a foreign country by making a 100% equity investment. This can be done by:

1. Setting up a new firm from scratch (a green field venture).
2. Acquiring an established firm in the foreign country.

Advantages

• The parent company has full control over its foreign operations.
• The parent firm does not have to share its technology or trade secrets.

Limitations

• It requires a 100% equity investment, which is not feasible for small or medium-sized firms.
• The parent company bears 100% of the losses if the foreign venture fails.
• Some countries are resistant to foreigners setting up wholly owned subsidiaries, leading to higher political risks.

Export-Import Procedures and Documentation

International trade is more complex than domestic trade due to cross-border movement of goods and foreign exchange regulations. Both exporting and importing involve a series of detailed steps and specific documents.

Export Procedure

The typical steps involved in an export transaction are as follows:

1. Receipt of Enquiry and Sending Quotations: A prospective buyer sends an enquiry. The exporter replies with a quotation, known as a proforma invoice, detailing the price, quality, and terms of sale.
2. Receipt of Order or Indent: If the terms are acceptable, the importer places an order, also called an indent.
3. Assessing Importer's Creditworthiness: The exporter checks the importer's ability to pay. To minimize risk, exporters often demand a letter of credit, which is a guarantee from the importer's bank to honor the payment.
4. Obtaining Export Licence: The exporter must obtain a license. This involves opening a bank account, getting an Import Export Code (IEC) number from the Directorate General Foreign Trade (DGFT), and registering with an export promotion council and the Export Credit and Guarantee Corporation (ECGC).
5. Obtaining Pre-shipment Finance: The exporter secures financing from a bank to procure raw materials, process goods, and transport them to the port.
6. Production or Procurement of Goods: The exporter manufactures or buys the goods as per the importer's specifications.
7. Pre-shipment Inspection: The Government of India requires compulsory inspection for certain goods to ensure quality. The Export Inspection Agency (EIA) issues an inspection certificate.
8. Excise Clearance: The exporter must clear excise duty payable on the manufactured goods. Often, the government exempts or refunds this duty for exported goods through a duty drawback scheme to make them more competitive.
9. Obtaining Certificate of Origin: This certificate proves that the goods were manufactured in the exporting country, which may allow the importer to get tariff concessions.
10. Reservation of Shipping Space: The exporter books space on a ship and the shipping company issues a shipping order.
11. Packing and Forwarding: Goods are packed, marked, and transported to the port. The railway issues a railway receipt, which is a title to the goods.
12. Insurance of Goods: The exporter insures the goods against the risk of loss or damage during transit at sea.
13. Customs Clearance: The exporter prepares a shipping bill, the main document for customs permission. This, along with other documents, is submitted to customs. An agent, known as a Clearing and Forwarding (C&F) agent, often handles these formalities.
14. Obtaining Mate's Receipt: After the cargo is loaded onto the ship, the ship's captain issues a mate's receipt.
15. Payment of Freight and Issuance of Bill of Lading: The C&F agent presents the mate's receipt to the shipping company, pays the freight charges, and receives the bill of lading. This document is evidence that the shipping company has accepted the goods for transport. For air transport, this document is called an airway bill.
16. Preparation of Invoice: An invoice is prepared stating the quantity of goods and the amount due from the importer.
17. Securing Payment: The exporter sends the necessary documents (invoice, bill of lading, insurance policy, etc.) through their bank to the importer's bank. These documents are released to the importer only after they accept a bill of exchange (an order to pay). The bill can be a sight draft (payment on presentation) or a usance draft (payment after a specified period).

Major Documents in an Export Transaction

Documents related to goods

• Export Invoice: The seller's bill for the goods.
• Packing List: Details the contents of each package.
• Certificate of Origin: Specifies the country where goods were produced.
• Certificate of Inspection: Confirms that the goods meet quality standards.

Documents related to shipment

• Mate's Receipt: A receipt from the ship's captain confirming goods are loaded.
• Shipping Bill: The main document for getting customs permission to export.
• Bill of Lading: A receipt from the shipping company and a document of title to the goods.
• Airway Bill: The equivalent of a bill of lading for goods sent by air.
• Marine Insurance Policy: The insurance contract for the goods.

Documents related to payment

• Letter of Credit (L/C): A guarantee of payment from the importer's bank.
• Bill of Exchange: An order from the exporter to the importer to pay a certain amount.
• Bank Certificate of Payment: A certificate confirming that payment has been received according to regulations.

Import Procedure

The process for importing goods into India involves these steps:

1. Trade Enquiry: The importer gathers information about potential exporters and sends an enquiry to request a quotation (proforma invoice).
2. Procurement of Import Licence: The importer checks if the goods require a license and obtains one if necessary. All importers must get an Import Export Code (IEC) number.
3. Obtaining Foreign Exchange: The importer applies to a bank authorized by the Reserve Bank of India (RBI) to get the necessary foreign currency for payment.
4. Placing Order or Indent: The importer places a detailed order with the exporter.
5. Obtaining Letter of Credit: If required, the importer obtains a letter of credit from their bank and sends it to the exporter.
6. Arranging for Finance: The importer arranges funds to pay for the goods upon arrival to avoid penalties (demurrage) for delays in clearing them from the port.
7. Receipt of Shipment Advice: The exporter sends a shipment advice to the importer with details about the dispatched goods.
8. Retirement of Import Documents: The exporter sends a set of documents through their bank. The importer's bank releases these documents to the importer after they either pay (for a sight draft) or accept to pay later (for a usance draft). This process is called retirement of import documents.
9. Arrival of Goods: The carrier (ship or airline) informs the port authorities of the goods' arrival by providing an import general manifest.
10. Customs Clearance and Release of Goods: This is a complex process often handled by a C&F agent. The importer must:
    • Obtain a delivery order from the shipping company.
    • Pay dock dues and get a port trust dues receipt.
    • Fill out a bill of entry form for customs duty assessment.
    • Pay the customs duty.
    • Present the bill of entry to the port authority to get a release order for the goods.

Major Documents in an Import Transaction

• Trade Enquiry: A request for information from the importer to the exporter.
• Proforma Invoice: A quotation from the exporter.
• Import Order or Indent: The official order placed by the importer.
• Letter of Credit: A payment guarantee from the importer's bank.
• Shipment Advice: A notification from the exporter that the goods have been shipped.
• Bill of Lading / Airway Bill: The document of title issued by the carrier.
• Bill of Entry: A form filled by the importer for customs clearance.
• Bill of Exchange (Sight Draft / Usance Draft): The instrument used for payment.
• Import General Manifest: A document provided by the carrier detailing the imported goods.
• Dock Challan: A form used for paying dock charges.