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Some examples of external areas analyzed here are external variables, government
policies, geo-cultural and political/legal environments, and market opportunities.
This second area looks into how international business strategies will be affected by
things outside the company’s control. Although the items identified during the inter-
corporate analysis are not immediately controllable by the company, they can take
action that will enable them to adjust to these factors.
A. Anatomy of a corporation
There are promoters and sponsors.
1. The promoters or founders create the corporation. They have the ideas of type of
industry, products, no liability unless corporation once formed assumes it.
2. The sponsors back the ideas of the promoters and incur no liability.
Three requirements must be met to form a corporation:
1. The Charter of the Corporation must be written
2. The Articles of the Corporation, stating the relation between the corporation and
the State. This must be filed with the Secretary of the State.
3. The by-laws, constitution and regulations of the corporation.
Then the corporation comes into existence.
A. Anatomy of a corporation:
The composition of industry differs. It differs in the domestic market vs. the
international market and it differs among businesses. We will use Ohio as the home
state of incorporation. A domestic corporation is any business that is incorporated
within the state of Ohio. A foreign corporation is any business outside the state of
Ohio (for example, California). An international corporation is any business outside
of the United States.
B. Definitions of multinationals:
An understanding of international financial management is crucial to not only the
large MNCs with numerous foreign subsidiaries but also to the small firms that
conduct international business. Many small U.S. firms generate more than 20
percent of their sales in foreign markets, for example, Ferro and BPL International
(Ohio). The small U.S. firms that conduct international business tend to focus on the
niches that have made them successful in the United States. They tend to penetrate
specialty markets where they will not have to compete with large firms that could
capitalize on economies of scale, for example, specialized computer chips and
products for small markets such as computers for disable consumers. While some of
the small firms have established subsidiaries, many of them use exporting to
penetrate foreign markets. Seventy-five percent of U.S. firms that export have
fewer than 100 employees. This s more prominent today with e-commerce.
International business is even important to companies that have no intention of
engaging in international business, since these companies must recognize how their
foreign competitors will be affected by movements in exchange rates, foreign
interest rates, labor costs, and any other type of short run macroeconomic
fluctuations such as inflation. Such economic characteristics can affect the foreign
competitors' cost of production and pricing policy.
Companies must also recognize how domestic competitors that obtain foreign
supplies or foreign financing will be affected by economic conditions in foreign
countries. If these domestic competitors are able to reduce their costs by
capitalizing on opportunities in international markets, they may be able to reduce
their prices without reducing their profit margins. This could allow them to increase
market share at the expense of the purely domestic companies.
Global Corporation: operates beyond national borders and in more than one
country, sees the globe as one single market without borders, and earns profits in a
global basis. It pursues integrated activities on a worldwide scale, sees the whole
globe as one market and moves products, manufacturing, capital and even
personnel wherever they can gain advantages. They operate with resolute
consistency with relative price as if the whole world or large areas are single ones.
They sell the commodity the same way everywhere that is a standardized
commodity.
They usually have strong base on economic regions such as the Pacific Rim,
NAFTA, and EU. Products are developed for the entire globe market and the
company gives changes in order to be able to move from regional to product line
based on profits. Centers and senior executives are from different countries. For
example; GE, Texas Instruments, Hitachi, ICI British Chemical, Daewoo, and
Hyundai.
Financial Control
Any business corporation must evaluate its operations and functions periodically to
better allocate resources and increase income and in general to acquire its goals
and objectives. The financial management of a multinational corporation involves
exercising control over foreign operations. The responsible individuals at the parent
office or headquarters review financial reports from foreign subsidiaries with a view
toward modifying operations and assessing the performance of foreign managers.
Typical control systems are based on setting standards with regard the to sales,
profits, inventory, or other specific variables and then examining many financial
statements and reports to evaluate the achievement of such goals. There is no
"correct" system of control. Methods vary across industries and even across
corporations in a single industry. All methods have the common goal of providing
management with a means of monitoring the performance of the corporation's
operations, new strategies, and goals as conditions change. However, establishing a
useful control system is more difficult for a multinational corporation than for a
purely domestic corporation. For instance, should foreign subsidiary profits be
measured and evaluated in foreign currency or the domestic currency of the parent
corporation? The answer to this question depends on whether foreign managers are
to be held responsible for currency translation gains or losses.
If top management wants foreign managers to be involved in currency management
and international financing issues, then the domestic currency of the parent would
be a reasonable choice.
On the other hand, if top management wants foreign managers to concern
themselves with production operations and functions, and behave as other
managers (managers not themselves a part of a foreign multinational) in the foreign
country would, then the foreign currency would be the appropriate currency for
evaluation.
Some multinational corporations prefer a decentralized management structure in
which each subsidiary has a great deal of autonomy and makes most financing and
production decisions subject only to general parent company guidelines. In this
management setting, the foreign manager may be expected to operate and think as
the stockholders of the parent corporation would want obtain goals and objectives,
so the foreign manager makes decisions aimed at increasing the parent's domestic
currency value of the subsidiary. The control mechanism in such corporations is to
evaluate foreign managers based on a their ability to increase that value. Other
corporations prefer more centralized management in which financial managers at
the parent make most of the decisions. They choose to move funds among divisions
based on a system wide view rather than what is best for a single subsidiary. A
highly centralized system would have foreign managers evaluated on their ability to
meet goals established by the parent for key variables like sales or labor costs.
The parent-corporation managers assume responsibility for maximizing the value of
the corporation, with foreign managers basically responding to directives from the
top. Therefore, the appropriate control system is largely determined by the
management style of the parent.
Considering the discussion to this point, it is clear that managers at foreign
subsidiaries should be evaluated only on the basis of things they control. Foreign
managers often may be asked by the parent corporation to follow policies and
relations with other subsidiaries of the corporation that the managers would never
follow if they sought solely to maximize their subsidiary's profit. Actions of the
parent that lower a subsidiary's profit should not result in a negative view of the
foreign manager. In addition, other actions beyond the foreign manager's control
such as changing tax laws, foreign exchange controls, or inflation rates that could
result in reducing foreign profits through no fault of the foreign manager. The
message to parent company managers is to place blame fairly where the blame
lies. In a dynamic world, corporate fortunes may rise and fall because of events
entirely beyond any manager's control.
Cash Management
Cash management involves utilizing the corporation's cash as efficiently as possible.
Given the daily uncertainties of economics and business, corporations must
maintain some liquid resources. Liquid assets are those that are readily spent. Cash
is the most liquid asset. But since cash (and traditional checking accounts) earns no
interest, the corporation has a strong incentive to minimize its holdings of cash.
There are highly liquid short-term securities that serve as good substitutes for
actual cash balances and yet pay interest. The corporate treasurer is concerned
with maintaining the correct level of liquidity at the minimum possible cost.
The multinational faces the challenge of managing liquid assets denominated in
different currencies. The challenge is compounded by the fact that subsidiaries
operate in foreign countries where financial market regulations, banking,
accounting, monetary policies, and institutions differ.
When a subsidiary receives a payment and the funds are not needed immediately
by this subsidiary, the managers at the parent headquarters must decide what to do
with the funds. For instance, suppose a U.S. multinational's Costa Rican subsidiary
receives 500 million colons. Should the colons be converted to dollars and invested
in the United States, or placed in Costa Rican colons investments, or converted into
any other currency in the world? The answer depends on the current needs of the
corporation as well as the current regulations in Costa Rica. If Costa Rica has strict
foreign exchange controls in place, the 500 million colons may have to be kept in
Costa Rica and invested there until a future time when the Costa Rican subsidiary
will need them to make a payment.
Even without legal restrictions on foreign exchange movements, we might invest
the colons in Costa Rica for 30 days if the subsidiary faces a large payment in 30
days and we have no need for the funds in another area of the corporation, and if
the return on the Costa Rican investment is comparable to what we could earn in
another country on a similar investment (which interest rate parity would suggest).
By leaving the funds in colons we do not incur any transaction costs for converting
colons to another currency now and then going back to colons in 30 days. In any
case, we would never let the funds sit idly in the bank for 30 days.
There are times when the political, legal, or economic situation in a country is so
unstable that we keep only the minimum possible level of assets in that country.
Even when we will need colons in 30 days for the Costa Rican subsidiary's payables,
if there exists a significant threat that the government or Central Bank could
confiscate or freeze bank deposits or other financial assets, we would incur the
transaction costs of currency conversion to avoid the political risk associated with
leaving the money in Costa Rica.
Multinational cash management involves centralized management. Subsidiaries and
liquid assets may be spread around the world, but they are managed from the
home office of the parent corporation. Through such centralized coordination, the
overall cash needs of the corporation are lower. This occurs because subsidiaries do
not all have the same pattern of cash flows. For instance, one subsidiary may
receive a dollar payment and finds itself with surplus cash, while another subsidiary
faces a dollar payment and must obtain dollars. If each subsidiary operated
independently, there would be more cash held in the family of multinational foreign
units than if the parent headquarters directed the surplus funds of one subsidiary to
the subsidiary facing the payable.
Centralization of cash management allows the parent to offset subsidiary payments
and receivables in a process called netting. Netting involves the consolidation of
payables and receivables for one currency so that only the difference between them
must be bought or sold. For example, suppose Ohio Instruments in the United
States sells $2 million worth of car phones to its European sales subsidiary and buys
$3 million worth of computer frames from its European manufacturing subsidiary.
If the payment and receivable both are due on the same day, then the $2 million
receivable can be used to fund the $3 million payable, and only $l million must be
bought in the foreign exchange market. Rather than buy $3 million to settle the
payable and sell the $2 million to convert the receivable into dollars, incurring
transaction costs twice on the full $5 million, the corporation has one foreign
exchange transaction for $l million.
Had the two European operations not been subsidiaries, the financial managers
would still practice netting but on a corporate wide basis, buying or selling only the
net amount of any currency required after aggregating the receivables and
payables of all subsidiaries over all currencies. Effective netting requires accurate
and timely reporting of transactions by all divisions of the corporation.
The parent financial managers determine the net payer or receiver position of each
subsidiary for the weekly netting. Only these net amounts are transferred within the
corporation. Netting could still occur by leading or lagging currency flows. Leads
and lags increase the flexibility of parent financial managers, but require excellent
information flows between all divisions and headquarters.
Intra-corporation Transfers
Since the multinational corporation is made up of subsidiaries located in different
political and economic jurisdictions, transferring funds among divisions of the
corporation often depends on what governments will allow. Beyond the transfer of
cash, the corporation will have goods and services and resources moving between
subsidiaries. The price that one subsidiary charges another subsidiary for internal
goods transfers is called a transfer price. The setting of transfer prices can be a
sensitive internal corporate issue because it helps to determine how total
corporation profits are allocated across divisions. Governments are also interested
in transfer pricing since the prices at which goods are transferred will determine
tariff and tax revenues in those economies.
The parent corporation always has an incentive to minimize taxes by pricing
transfers in order to keep profits low in high-tax countries and by shifting profits to
subsidiaries in low-tax countries. This is done by having intra-corporation purchases
by the high-tax subsidiary made at artificially high prices, while intra-corporation
sales by the high-tax subsidiary are made at artificially low prices. Governments
often restrict the ability of multinationals to use transfer pricing to minimize taxes.
The U.S. Internal Revenue Code, for example, requires “arm 's-length pricing”
between subsidiaries charging prices that an unrelated buyer and seller would
willingly pay. When tariffs are collected on the value of trade, the multinational has
the incentive to assign artificially low prices to goods moving between subsidiaries.
Customs officials may determine that a shipment is being "under-invoiced" and may
assign a value that more truly reflects the market value of the goods.
Transfer pricing may also be used for "window-dressing", that is, to improve the
apparent profitability of a subsidiary. This may be done to allow the subsidiary to
borrow at more favorable terms, since its credit rating will be upgraded as a result
of the increased profitability. The higher profits can be created by paying the
subsidiary artificially high prices for its products in intra-corporation transactions.
The corporation that uses transfer pricing to shift profits from one subsidiary to
another introduces an additional problem for financial control. It is important that
the corporation be able to evaluate each subsidiary on the basis of its contribution
to corporate income. Any artificial distortion of profits should be accounted for so
that corporate resources are efficiently allocated. Multinational corporations are
frequently called upon by tax authorities to justify the prices they use for internal
transfers.
Capital Budgeting
Capital budgeting refers to the evaluation of prospective investment alternatives
and the commitment of funds to preferred projects. Long- term commitments of
funds expected to provide cash flows extending beyond one year are called capital
expenditures. Capital expenditures are made to acquire capital assets, like
machines or factories or whole companies. Since such long-term commitments
often involve large sums of money, careful planning is required to determine which
capital assets to acquire. Plans for capital expenditures are usually summarized in a
capital budget.
Multinational corporations considering foreign investment opportunities face a more
complex problem than do corporations considering only domestic investments.
Foreign projects involve foreign exchange risk, political risk, control, and foreign tax
regulations. Comparing projects in different countries requires a consideration of
how all factors will change over countries.
There are several alternative approaches to capital budgeting. A useful approach for
multinational corporations is the adjusted present value approach. We work with
present value because the value Qf a dollar to be received today is worth more than
a dollar to be received in the future, say one year from now. As a result, we must
discount future cash flows to reflect the fact that the value today will fall depending
on how long it takes before the cash flows are realized.
For multinational corporations, the adjusted present value approach is presented
here as an appropriate tool for capital budgeting decisions. The adjusted present
value (APV) measures total present value as the sum of the present values of the
basic cash flows estimated to result from the investment (operations flows) plus all
financial effects related to the investment.
Capital budgeting is an imprecise science, and forecasting future cash flows is
sometimes viewed as more art than science. The typical corporation experiments
with several alternative scenarios to test the sensitivity of the budgeting decision to
different assumptions. One of the key assumptions in projects considered for
unstable countries is the level of political risk that must be accounted for. Cash
flows should be adjusted for the threat of loss resulting from government
expropriation or regulation.
Impact of Management Control
The magnitude of agency costs can vary with the management style of the MNC. A
centralized management style can reduce agency costs because it allows managers
of the parent to control foreign subsidiaries and therefore reduces the power of
subsidiary managers. However, the parent's managers may make poor decisions for
the subsidiary if they are not as informed as subsidiary managers about financial
characteristics of the subsidiary.
The alternative style of organizing an MNC's management is a decentralized
management style. This style is more likely to result in higher agency costs because
subsidiary managers may make decisions that do not focus on maximizing the
value of the entire MNC. Yet, this style gives more control to those managers who
are closer to the subsidiary's operations and environment.
To the extent that subsidiary managers recognize the goal of maximizing the value
of the overall MNC and are compensated in accordance with that goal, the
decentralized management style may be more effective.
Given the obvious tradeoff between centralized and decentralized management
styles, some MNCs attempt to achieve the advantages of both styles. That is, they
allow subsidiary managers to make the key decisions about their respective
operations, but the decisions are monitored by the parent's management to ensure
that they are in the best interests of the entire MNC.
1. Structure refers to the number of countries in which the MNE operates. Also
refers to the nature of corporate ownership. Examples: Suzuki owned by GM,
Gillette is U.S. owned, an Mitsubishi is owned by Japan, even though GM owns a
large percentage. For the majority of MNEs, the ownership of the corporation is
maintained in the parent country, even though they might list shares of stock and
have ownership in different countries. For example: Kereitsus in Japan, Chaebols in
South Korea such as Samsung, Lucky Star and Daewoo, and mergers in the U.S.
2. Polycentric MNE: is an MNE that places local nationals in key positions and
allows these managers to appoint and develop their own people as long as the
operations are sufficiently profitable. For example, East Asia, Australia and in
general, markets where the expatriates tend to be not expensive for the
corporations.
It will do the training of employees relying on local management to assure
responsibility of seeing that the training function is carried out.
Sales expansion: The larger the sales, the more profitable the company is in the
long run. Japan, for example has sales growth. Japan sacrificed profit in the short
term for many years to build a large market share in the long run (e.g., 200 years).
The United States is more concerned with short term profits. Companies produce
for the larger market to reduce costs by increasing efficiency and using machines to
full capacity.
Political Risk: any change in the political environment that may adversely affect
the value of the firm’s business activities. Political risk is not only the threat of
political upheaval but also the likelihood of arbitrary and discriminatory
governmental policies and actions that will result on financial loss or competitive
disadvantage;, for example, increase prices, tariffs, quotas, price controls, content
requirements, and measures directly to the MNE such as partial divestment of
ownership, local content, remittance restrictions, expatriate employment, and
limitations on export requirements.
Examples of political risk:
1. Expropriation; impact on loss of future profits
2. Confiscation; impact on loss of future profits and assets
3. Campaigns against foreign goods; impact on loss of sales and increase
in cost of public relations
4. Mandatory labor benefits legislation ? increase in operating costs
5. Kidnap - Terrorism - Civil Wars and disruption of production, increased security
costs, increased management costs, lower productivity, destructions of supplies,
lost sales
6. Inflation; higher operating cost
7. Currency Devaluations and currency risks; reduced value of repatriated
earnings
8. Tax; decreased profits; subsidization, abatements and dumping.
Macro political; Civil Wars, i.e., Somalia, Bosnia, Middle East, decreased in
Rwanda in 90's, Congo, Zaire
Micro political; Euro-currency, 1970's oil embargo, Financial crash of ‘89.
Euro-Disney by French farmers, Chinese operations
Nine reasons:
1. Larger market, market power, production possibilities, geographic, product
or both. Check population and income as determinants of market size. The
corporation will attain greater profits from foreign markets than those received
locally.
Horizontal expansion occurs when a company goes abroad at the same level
in the value chain as its domestic operation. Horizontal integration occurs when
the company integrates its own operations and avoid buying and selling to other
companies in the same area or industry or licensing technology to them i.e., Xerox
manufactured and sold copiers in Mexico.
The Vertical approach involves movement along the value chain, (i.e., Alcoa’s
participation in ownership of bauxite production facilities in Australia). Downstream
or Backward Vertical, (i.e., Alcoa’s control over supplies that it needs for its
aluminum production in United States). Alcoa acquires a Central American plant to
make aluminum cans from its United States-made aluminum. Forward or upstream
integration.
Horizontal integration may be difficult culturally when the rules of the game are
different or you have trouble acquiring or operating. For example, Eastern Europe
(Hungary) exporting or licensing is unavailable. There are advantages, however, in
transportation costs, market imperfections, following the costumers, product life
cycles, and location.
E. What a company wants to do, and whether to enter or not. One can
make things happen by making an active decision. Some considerations include
moral codes and customer operational variables.
F. Set up objectives. Stretch the goals of the corporation. The objectives must be
practical and attainable, yet somewhat difficult to achieve, (i.e, for your corporation,
a piece of cake, but for the competitors, it must be a challenge).
4. World economy. Must decide which world economy to participate in, and
which is more successful. One can minimize risk with countries that have the same
economic system as ours.
Three key economic indicators of countries same as ours to check into are:
a. GDP (per capita income). Economic growth and economic development.
b. Quality of life - measured by life expectancy.
c. Percentage of GDP generated from agriculture, minerals (extractive) vs.
percentage of GDP generated from services and manufacturing.
5. Products to sell and produce with regards to the level of income and distribution
of income. Inferior, superior or normal goods and services. Decisions and
operational variables.
The level of income determines how wealth is distributed among the countries
of the world. Brunei is the wealthiest with a GDP per capita of $2,000,000.00.
Distribution of income - how wealth is distributed within the country. In the
U.S., 42% of the wealth is owned by 68% of the people. In Latin America, 2% owned
90% of the wealth in past decades, now 12% own about 74% of wealth, and now,
with the new economic systems, the distribution is about 18% of the population
owing 43% of wealth.
Leading Indicators:
Indicators that tell us what is likely to happen within twelve to fifteen months.
4. Average workweek for production workers on manufacturing
2. Average weekly claims for unemployed insurance
3. Net orders for consumer goods and materials
4. Vendor performance, measured as a percentage of companies reporting slower
deliveries from suppliers
5. Index of Consumer expectations
6. New orders from non defense capital goods
7. Number of new building permits issued for private housing units
8. Stock prices of 50 common stocks
9. Interest rate spread in ten year bond less federal fund rates
10. Money supply as M2 = currency and demand deposits plus time deposits of
less than $1,000,000.00
4. Balance of payments - what we owe to the rest of the world with respect to
what the rest of the world owes us. Categories in balance of payments: current
accounts, balance of trade, capital (short term and long term) accounts, gold, errors
and omissions.
5. External debt - Latin American nations (Mexico, and Brazil), and Africa nations
are debtor nations. Large portions of export earnings go toward servicing debt. The
U.S. was a creditor nation, but became a debtor nation in the 1970's, however it still
has the highest productivity in the world.
There are seven tasks firms have to perform in order to be successful in selecting
the market or country:
1. Study its prospective buyers. Where and who are they?
2. Develop products and services that satisfy the customers' needs and wants.
3. Set prices and terms on the product - to get a reasonable profit and be
reasonable to the buyers.
4. Distribution of product in the market
5. Inform the market about the product and persuade the buyers to get
interested.
6. To win with the product, give implied warranties and after-sales services.
7. Monitor the market activity of competitors (domestic and international) and
develop long term strategies
Firms need information systems to identify factors in the international market. They
need to consider:
1. International economic factors
2. Legal and political factors
3. Degree of competition
In making decisions, corporations need to study the international studies and
cultural research. They need to rank the markets in making the decisions.
How to enter the country/market: There are four stages:
1. Selection process
2. Channels of distribution
3. Coordination of global logistics
4. Forms of financing
Direct Investment
1. Foreign or overseas distributors. Distributor has exclusiveness for a foreign
market.
2. Direct sellers or users
3. Establish own sales office in the foreign market
Overcome disadvantages by:
1. Modifying product
2. Revise the product description so it is subject to lower tariffs.