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Types of International Business

    Types of International Business

    Countertrade

    Countertrade is a system of exchange in which goods and services are used as payment rather than money.

    LEARNING OBJECTIVES

    Explain the various methods of countertrading

    KEY TAKEAWAYS

    Key Points

    • Countertrade is the exchange of goods or services for other goods or services. This system can be typified as simple bartering, switch trading, counter purchase, buyback, or offset.
    • Switch trading: Party A and B are countertrading salt for sugar. Party A may switch its obligation to pay Party B to a third party, known as the switch trader. The switch trader gets the sugar from Party B at a discount and sells it for money. The money is used as Party A’s payment to Party B.
    • Counter purchase: Party A sells salt to Party B. Party A promises to make a future purchase of sugar from Party B.
    • Buyback: Party A builds a salt processing plant in Country B, providing capital to this developing nation. In return, Country B pays Party A with salt from the plant.
    • Offset agreement: Party A and Country B enter a contract where Party A agrees to buy sugar from Country B to manufacture candy. Country B then buys that candy.

    Key Terms

    • barter: The exchange of goods or services without involving money.
    • counter purchase: Sale of goods and services to one company in another country by a company that promises to make a future purchase of a specific product from the same company in that country.
    • Switch trading: Practice in which one company sells to another its obligation to make a purchase in a given country.

    Countertrade means exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money. A monetary valuation can, however, be used in counter trade for accounting purposes. Any transaction involving exchange of goods or service for something of equal value.

    A newspaper illustration in Harper's Weekly where two men engaging in a barter. One man offers chickens in exchange for his yearly newspaper subscription.

    Bartering: Bartering involves exchanging goods or services for other goods or services as payment.

    There are five main variants of countertrade:

    1. Barter: Exchange of goods or services directly for other goods or services without the use of money as means of purchase or payment.
    2. Switch trading: Practice in which one company sells to another its obligation to make a purchase in a given country.
    3. Counter purchase: Sale of goods and services to one company in aother country by a company that promises to make a future purchase of a specific product from the same company in that country.
    4. Buyback: This occurs when a firm builds a plant in a country, or supplies technology, equipment, training, or other services to the country, and agrees to take a certain percentage of the plant’s output as partial payment for the contract.
    5. Offset: Agreement that a company will offset a hard currency purchase of an unspecified product from that nation in the future. Agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation.

    Countertrade also occurs when countries lack sufficient hard currency or when other types of market trade are impossible. In 2000, India and Iraq agreed on an “oil for wheat and rice” barter deal, subject to UN approval under Article 50 of the UN Persian Gulf War sanctions, that would facilitate 300,000 barrels of oil delivered daily to India at a price of $6.85 a barrel, while Iraq oil sales into Asia were valued at about $22 a barrel. In 2001, India agreed to swap 1.5 million tonnes of Iraqi crude under the oil-for-food program.

    Direct Investment

    FDI is practiced by companies in order to benefit from cheaper labor costs, tax exemptions, and other privileges in that foreign country.

    LEARNING OBJECTIVES

    Explain the effects of foreign direct investment (FDI) for the investor and the host country

    KEY TAKEAWAYS

    Key Points

    • FDI is the flow of investments from one company to production in a foreign nation, with the purpose of lowering labor costs and gaining tax incentives.
    • FDI can help the economic situations of developing countries, as well as facilitate progressive internal policy reforms.
    • A major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions.

    Key Terms

    • Foreign direct investment: investment directly into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.

    Foreign direct investment (FDI) is investment into production in a country by a company located in another country, either by buying a company in the target country or by expanding operations of an existing business in that country.

    FDI is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges, such as tax exemptions, offered by the country as an incentive to gain tariff-free access to the markets of the country or the region. FDI is in contrast to portfolio investment which is a passive investment in the securities of another country, such as stocks and bonds.

    One theory for how to best help developing countries, is to increase their inward flow of FDI. However, identifying the conditions that best attract such investment flow is difficult, since foreign investment varies greatly across countries and over time. Knowing what has influenced these decisions and the resulting trends in outcomes can be helpful for governments, non-governmental organizations, businesses, and private donors looking to invest in developing countries.

    Paulista Avenue in Sao Paulo, Brazil.

    Sao Paulo, Brazil: Sao Paulo, Brazil, is home to a growing middle class and significant direct investments.

    A study from scholars at Duke University and Princeton University published in the American Journal of Political Science, “The Politics of Foreign Direct Investment into Developing Countries: Increasing FDI through International Trade Agreements,” examines trends in FDI from 1970 to 2000 in 122 developing countries to assess what the best conditions are for attracting investment. The study found the major contributing factor to increasing FDI flow was internal policy reform relating to trade openness and participation in international trade agreements and institutions. The researchers conclude that, while “democracy can be conducive to international cooperation,” the strongest indicator for higher inward flow of FDI for developing countries was the number of trade agreements and institutions to which they were party.

    Franchising

    Franchising enables organizations a low cost and localized strategy to expanding to international markets, while offering local entrepreneurs the opportunity to run an established business.

    LEARNING OBJECTIVES

    Examine the benefits of international franchising

    KEY TAKEAWAYS

    Key Points

    • A franchise agreement is defined as the franchiser granting an entrepreneur or local company (the franchisee ) access to its brand, trademarks, and products.
    • Franchising is designed to enable large organizations rapid access to new markets with relatively low barriers to entry.
    • Advantages of franchising (for the franchiser) include low costs of entry, a localized workforce (culturally and linguistically), and a high speed method of market entry.
    • Disadvantages of franchising (for the franchiser) include loss of some organizational and brand control, as well as relatively lower returns than other strategic entry models (albeit, with lower risk ).

    Key Terms

    • franchisee: A holder of a franchise; a person who is granted a franchise.
    • franchiser: A franchisor, a company or person who grants franchises.

    What is Franchising?

    In franchising, an organization (the franchiser) has the option to grant an entrepreneur or local company (the franchisee) access to its brand, trademarks, and products.

    In this arrangement, the franchisee will take the majority of the risk in opening a new location (e.g. capital investments ) while gaining the advantage of an already established brand name and operational process. In exchange, the franchisee will pay a certain percentage of the profits of the venture back to the franchiser. The franchiser will also often provide training, advertising, and assistance with products.

    Why Franchise

    Lower Barriers to Entry

    Franchising is a particularly useful practice when approaching international markets. For the franchiser, international expansion can be both complex and expensive, particularly when the purchase of land and building of facilities is necessary. With legal, cultural, linguistics, and logistical barriers to entry in various global markets, the franchising model offers and simpler, cleaner solution that can be implemented relatively quickly.

    Localization

    Franchising also allows for localization of the brand, products, and distribution systems. This localization can cater to local tastes and language through empowering locals to own, manage, and employ the business. This high level of integration into the new location can create significant advantages compared to other entry models, with much lower risk.

    Speed

    It is also worth noting that franchising is a very efficient, low cost and quickly implemented expansionary strategy. Franchising requires very little capital investment on behalf of the parent company, and the time and effort of building the stores are similar outsources to the franchisee. As a result, franchising can be a way to rapidly expand both domestically and globally.

    A chart that shows how various forms of strategic alliance can rapidly increase rates of expansion.

    Starbucks’ Expansion: Starbucks operates with a wide variety of strategic alliances, including a franchising program.

    Downsides to Franchising

    Franchising has some weaknesses as well, from a strategic point of view. Most importantly, organizations (the franchisers) lose a great deal of control. Quality assurance and protection of the brand is much more difficult when ownership of the franchise is external to the organization itself. Choosing partners wisely and equipping them with the tools necessary for high levels of quality and alignment with the brand values is critical (e.g., training, equipment, quality control, adequate resources).

    It is also of importance to keep the risk/return ratio in mind. While the risk of franchising is much lower in terms of capital investment, so too is the returns derived from operations (depending on the franchising agreement in place). While it is a faster and cheaper mode of entry, it ultimately results in a profit share between the franchiser and the franchisee.

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