Understanding Political Risks(Political Environment of IB)

The following article clearly describes the possible political risks that an international firm might face in its overseas operations.

Defining "Political Risk"

by Daniel Wagner,AIG

The exercise of political power is the root cause of political risks in international business. How political power is exercised determines whether government action threatens a firm's value. For example, a dramatic political event may pose little risk to a multinational enterprise, while subtle policy changes can greatly impact a firm's performance. A student-led protest for political change may not change the investment climate at all, while a change in local tax law can erode a firm's profits very quickly. It is the task of the risk manager or company CFO to identify whether a government action poses a threat to a firm's financial well-being.

The first distinction that must be made is between firm-specific political risks and country-specific political risks. Firm-specific political risks are risks directed at a particular company and are, by nature, discriminatory. For instance, the risk that a government will nullify its contract with a given firm or that a terrorist group will target the firm's physical operations are firm-specific. By contrast, country-specific political risks are not directed at a firm, but are countrywide, and may affect firm performance. Examples include a government's decision to forbid currency transfers or the outbreak of a civil war within the host country.

Firms may be able to reduce both the likelihood and impact of firm-specific risks by incorporating strong arbitration language into a contract or by enhancing on-site security to protect against terrorist attacks. By contrast, firms usually have little control over the impact of country-level political risks on their operations. The only sure way to avoid country-level political risks is to stop operating in the country in question.

There is a second distinction to be made between types of political risk: government risks and instability risks. Government risks are those that arise from the actions of a governmental authority, whether that authority is used legally or not. A legitimately enacted tax hike or an extortion ring that is allowed to operate and is led by a local police chief may both be considered government risks. Indeed, many government risks, particularly those that are firm-specific, contain an ambiguous mixture of legal and illegal elements. Instability risks, on the other hand, arise from political power struggles. These conflicts could be between members of a government fighting over succession, or mass riots in response to deteriorating social conditions.

	Government Risks	Instability Risks
Firm-Specific Risks	Discriminatory regulations "Creeping" expropriation Breach of contract	Sabotage Kidnappings Firm-specific boycotts
Country-Level Risks	Mass nationalizations Regulatory changes Currency inconvertibility	Mass labor strikes Urban rioting Civil wars
Source: Robert Egge

The Impact on Firm Performance

The risk manager's ultimate challenge when assessing political risk is to determine whether a political event poses a threat to a firm's financial performance. A mass demonstration in a stable developed country may be less significant to a firm's performance than one occurring in an unstable developing country. Similarly, a worker strike for higher wages is very different from a nationwide strike to overthrow an incumbent government.

The nature of political risk varies most fundamentally by the category of investor (direct or portfolio) because their exposures to political risks differ. In general, portfolio investors are more likely to be affected by country-level risks, such as a sudden hike in interest rates or unanticipated currency devaluation, while direct investors tend to be affected more by firm-specific risks. It is therefore necessary to focus on those political dynamics that affect the overall business environment in a host country.

When assessing political stability, the focus should be on the legitimacy of state authority, the ability of that authority to impose and enforce decrees, the level of corruption that pervades the system of authority, and the degree of political fractionalization that is present. Where economic policy is concerned, the focus would be more along the lines of the degree of government participation in an economy, the government's external debt burden, and the degree to which interest groups can successfully obstruct the decision-making process. Effective political risk management requires distinguishing developments that pose true risks—a well-defined threat to corporate performance—from political events that are merely dramatic.

Risk Management

Although there are a number of ways to protect your firm against political risks, proper planning and due diligence are most important. Too many businesses begin operations in an unfamiliar country without having taken the time and devoted the resources necessary to ensure a better-than-average chance of success. Developing solid relations with relevant governing authorities is the preferred approach, but this may not always be possible or even desirable.

Another important component of creating a political-risk-friendly investment environment is to establish a good relationship with your workforce. Too often, foreign businesses are perceived as having uncaring managers who do not appreciate their workers. This can have dire consequences. One of the best ways to protect your assets is to generate a loyal workforce. Management can be replaced much more easily than can a workforce, and it is becoming more common for host governments to remove corporate managers and replace them with other experienced managers that will operate in accordance with government objectives.

Be alert to what is happening in your host country. This may sound sophomoric, but it is easy to lose track of the bigger political picture once an operation is established. After an operating environment has changed, it is often too late to do anything about it. Remain engaged with your local embassy and chambers of commerce. A collective voice is more powerful than that of an individual firm, even if the firm has a solid relationship with governing authorities.

Finally, don't underestimate the potential benefits of using Political Risk Insurance (PRI) to manage your political risks. There are now more PRI providers with greater capabilities than ever before. Whether you want to take out general coverage (against expropriation, currency inconvertibility, or political violence) or create coverage tailored to your specific needs, chances are good that one or more of the private-sector PRI providers can meet your needs. But remember to pursue coverage before a problem occurs; after it happens, coverage will be difficult to obtain.

Also check out the following link on scribd for further illustration:

http://www.scribd.com/doc/20489685/The-Political-and-Legal-Environment-Facing-Business

Legal Context of International Business

International Business is managed within the framework of a legal order. But the rules of this order are different from those of a domestic (national) legal system. Understanding these different rules is necessary for success in international business.

International Legal Order

To begin with, the international legal system lacks courts for adjudicating disputes. While occasionally ad hoc tribunals are established by interested governments to resolve isolated economic disputes between their nationals, the common alternative for settling international claims is arbitration pursuant to agreement of the parties. Furthermore, no international agency exists to enforce the arbitrators’ awards; the prevailing party has to rely on the enforcement machinery of the country where the losing side’s assets are located. Finally, often there is no international law for the arbitrators to apply. Instead, they frequently must refer to the domestic laws of the country designated by the parties.

The customs and usages which gradually emerge from commercial transactions generate the international legal norms. However, without a system of international courts to embody these norms in their rulings, they do not receive the force and mandate of precedents. There is another way for establishing binding legal rules: legislation by international conventions. The United Nations and other intergovernmental organizations originate the drafts of these conventions. But these drafts are rarely enacted into multinational legislation. While some noteworthy international conventions have finally been concluded --among them the conventions on contract for the international sale of goods; on several procedural aspects of civil litigation, such as the limitation period, service, discovery; and on enforcement of arbitration awards-- they are few in number and govern only the nationals of the states that adhere to them.

International rule-making is, therefore, left largely to private contracts between parties to international transactions. National governments, however, impose limits to their freedom of contract. Just as these risks are posed by the intrusive role of the nation-states in international trade, sometimes national governments render protection against them. Thus, government (or quasi-government) agencies, such as export-import banks and export development corporations, aim at insuring their nationals against certain risks of international commerce. Similarly, through trade agreements, governments attempt to remove the barriers to foreign markets facing their nationals. The beneficial prospects of such favorable interventions by the national governments must be taken into account in any international business plan. Because of these considerations, international commercial negotiations are inherently complicated. The process becomes even more complex when the parties manifest dissimilar expectations rooted in different cultural values.

Cultural Context of International Business

Culture is generally defined as a system of learned behavior within which the individual lives and works.Culture has to be lived, it can't be learned.

Elements of Culture include- language, religion, traditions, customs, values, social structure, education etc.

With each passing day, the world appears to become a smaller place. An increasingly intertwined global economy means that business transactions taking place in one nation could easily have an impact on the rest of the world.

Being able to operate in a multi cultural environment it is important to know and be aware of the cultural differences and peculiarities. It is obviously not enough to categorize Italians as people spending most of their time in the sun while eating pizza and drinking wine. There is more that has to be learned to become successful in a foreign market. A major challenge for managers is to overwhelm their myopic view. It takes time to develop an open attitude and a cultural sensitivity which enables managers to look carefully to the foreign market and point out the customers needs there and not transferring the domestic market needs.

In IB one has to deal with cultural diversity.There are two prominent approaches on this-

a)Globalization is a fact of life and business is business around the world.

b)Companies must tailor business to different cultures.

One has to choose the approach based on the target customer and the competition.

One of the distinguishing characteristics of culture is context orientation.  In high context cultures, the context of a communication is at least as important as what is actually being said.  In low context cultures, most information is contained explicitly in the words.  Unless one is aware of the difference, actions could easily be misunderstood.(Re:Czinkota)

When workers from high-context and low-context cultures have to work together often problems occur by the exchange of information. These problems can be categorized as differences in “direction”, “quantity” and “quality”. At differences in direction employees from high-context cultures like China and France adapt to their good friends, families and also to close colleagues (in-group members). They communicate with them intensively (quantity difference) and exchange specific/detailed information about many different topics.The result is that every in-group member is constantly up-to-date with the facts around the business.

In comparison to high-context cultures low-context cultures like USA and Germany orientate on many people of their daily life because they don’t differentiate as much as high-context cultures between in- and out-groups. So their direction of communication is orientated on personal personal characters and referred to situations (direction difference). They mostly communicate within their out-groups in a broad and diffuse way (quantity difference). Within communication they exchange information just to the necessary extent so that work can be done and they don’t discuss or exchange information constantly in their work environment and colleagues (quality difference).

In China communication tends to be very efficient because of their information-flow at work and in privacy. They discuss everything in advance and consider meetings as an official “ceremony” where the already commonly agreed decision will be announced. This is important in the way of “giving and keeping face”. The Americans and Germans in contrast inform the participating attendants in a meeting about the hard and necessary facts. The decission-making process takes place within the meeting. To French it is similar with their Asian counterparts. They are also well informed before they meet each other. Much explicit and detailed discussions would probably seen as an insult because everything is already clear.

High-context means that “most of the information is either in the physical context or initialized in the person, while very little is in the coded, explicit, transmitted part of the message.” (Hall, 1976, p 79). In comparison to the meaning of low-context communication is “the mass of information is vested in the explicit code” (p 70).

The following graph ranks major cultures according to their contextual orientation:

Interesting TitBits

Choose gifts with care.  While liquor makes a suitable gift in Japan, it is banned in Saudi Arabia.  Fine compasses - the direction for prayer - are welcome.  Avoid leather objects or snake images in India, and gifts that come in sets of four or nine in Japan.  The mainland Chinese don't like to receive anything that comes from Taiwan.

Assignment

1.Why couldn't Chevy sell the Nova in Spanish countries ? How far is the understanding of  culture of various countries important for international business? 

2.Analyze the current business environment of India.


-Assignment to be submitted by 9th Oct in the same format as you used to in the earlier semesters.

IB- difficulties and benefits

International firms operate in environments that are highly uncertain and where the rules of the game are often ambiguous, contradictory and subject to rapid changes(as compared to domestic firms).Global mangers need to learn the shifting factors unique to the playing field and identify new ways of doing business, catering to the changing priorities of foreign governments.It is important to include the international outlook into a firm's (that is going global) vision and mission along the broad parameters of products/ services offered,markets served,capabilities, quality and result.This helps focus the attention of managers on the opportunities and threats outside the domestic playing field.

1. Political and legal differences

2.Cultural  and Linguistic differences

3.Economic differences

4.Differnces in monetary system and regulation

5.Differences in marketing infrastructure

6.Differences in trade practices

Without foreign markets, most small firms would not have sufficient economies of scale to allow them to be competitive with larger economies.(e.g Hong Kong).International competition may not be a matter of choice when survival is at stake.

Developing countries inspite of economic and marketing problems are excellent markets.(strong economic growth in Latin America and Asia Pacific).Many large US companies have done well because of their overseas markets.( IBM,Compaq)Foreign markets also offer solution for variable demnds that fluctuate along cyclical factors(such as recession) or seasonal factors(such as climate) and help to stabilize business.Such markets also help to cutout fluctuations by providing outlets for excess production capacity.

While benefits for export are self evident, imports can also beneficial by constituting the reserve capacity for local community.Without imports there is no incentive for domestic firms to moderate their prices.Lack of balanced imports can result in inflation and excessive profits for local firms.

Unrestricted trade has been found to increase  GNP and employment in general.

International trade also allows countries and their people to have access to better standards of living.Without trade product/service shortages would force people to pay more for less.

Components & Analysis of International Business Environment

Definition of Business Environment:

The aggregrate of all conditions, events and influences that surround and affect business(David Keith)

International Business Environment

-Economic
-Political
-Legal
-Financial
-Technological

-Socio-Cultural

-Demographic

-Natural

Prospects of a business depend not only on the resources but also on the environment.Hence an analysis of the environment is required for policy formulation and strategy formulation.

Every business enterprise consists of a set of internal factors and ios confronted with a set of external factors.The internal factors are generally regarded as controllable,while the external factors are by and large beyond the control of the business.As environmental/external factors are beyond the control of a firm,its success depends to a large extent on the adaptability to the environment.( i.e its ability to design and adjust the internal controllable variables to take advantage of the opportunities and combat the threats in the environment.)

Thus the business environment comprises of both a micro and a macro environment.The former consists of actors in the immediate environment that affect the performance of the firm, such as suppliers,competitors, marketing intermediaries,customers etc. The macro environment consists of larger societal forces that affect the actors in the company's micro environment, such as demographic, economic, natural, legal, technical, political and cultural forces.

(for detailed understanding look up Francis Cherunilam/Aswathappa- International Business Environment)

Analysing aspects of international business environment

Environmental analysis is defined as "the process by which strategists monitor the economic, governmental, legal, market,competitive, supplier, technological,geographical and social settings to determine opportunities and threats to the firm."

TOOLS:

PEST

PEST analysis stands for “Political, Economic, Social, and Technological analysis” and describes a framework of macro-environmental factors used in the environmental scanning component of strategic management. Some analysts added Legal and rearranged the mnemonic to SLEPT;inserting Environmental factors expanded it to PESTEL or PESTLE, which is popular in the UK.The model has recently been further extended to STEEPLE and STEEPLED, adding education and demographic factors. It is a part of the external analysis when conducting a strategic analysis or doing market research, and gives an overview of the different macroenvironmental factors that the company has to take into consideration. It is a useful strategic tool for understanding market growth or decline, business position, potential and direction for operations.

Political Factors.

The political arena has a huge influence upon the regulation of businesses, and the spending power of consumers and other businesses. You must consider issues such as:

1.How stable is the political environment?

2.Will government policy influence laws that regulate or tax your business?

3.What is the government’s position on marketing ethics?

4. What is the government’s policy on the economy?

5. Does the government have a view on culture and religion?

6. Is the government involved in trading agreements such as EU, NAFTA, ASEAN, or others?

Economic Factors.

Marketers need to consider the state of a trading economy in the short and long-terms. This is especially true when planning for international marketing. You need to look at:

1. Interest rates.

2. The level of inflation Employment level per capita.

3. Long-term prospects for the economy Gross Domestic Product (GDP) per capita, and so on.

Sociocultural Factors.

The social and cultural influences on business vary from country to country. It is very important that such factors are considered. Factors include:

1.What is the dominant religion?

2.What are attitudes to foreign products and services?

3.Does language impact upon the diffusion of products onto markets?

4.How much time do consumers have for leisure?

5.What are the roles of men and women within society?

6.How long are the population living? Are the older generations wealthy?

7.Do the population have a strong/weak opinion on green issues?

Technological Factors.

Technology is vital for competitive advantage, and is a major driver of globalization. Consider the following points:

1. Does technology allow for products and services to be made more cheaply and to a better standard of quality?

2.Do the technologies offer consumers and businesses more innovative products and services such as Internet banking, new generation mobile telephones, etc?

3.How is distribution changed by new technologies e.g. books via the Internet, flight tickets, auctions, etc?

4.Does technology offer companies a new way to communicate with consumers e.g. banners, Customer Relationship Management (CRM), etc?

SWOT

SWOT analysis is a strategic planning method used to evaluate the Strengths, Weaknesses, Opportunities, and Threats involved in a project or in a business venture. It involves specifying the objective of the business venture or project and identifying the internal and external factors that are favorable and unfavorable to achieve that objective. The technique is credited to Albert Humphrey, who led a convention at Stanford University in the 1960s and 1970s using data from Fortune 500 companies.

The SWOT analysis provides information that is helpful in matching the firm’s resources and capabilities to the competitive environment in which it operates. As such, it is instrumental in strategy formulation and selection.

The SWOT Matrix

A firm should not necessarily pursue the more lucrative opportunities. Rather, it may have a better chance at developing a competitive advantage by identifying a fit between the firm’s strengths and upcoming opportunities. In some cases, the firm can overcome a weakness in order to prepare itself to pursue a compelling opportunity.

To develop strategies that take into account the SWOT profile, a matrix of these factors can be constructed. The SWOT matrix (also known as a TOWS Matrix) is shown below:

SWOT Analysis Framework

 Environmental Scan 

 /                                       \

Internal Analysis                                   External Analysis

              / \                                                                 / \

Strengths Weaknesses                          Opportunities Threats

  SWOT Matrix

Strengths: 

A firm’s strengths are its resources and capabilities that can be used as a basis for developing a competitive advantage. Examples of such strengths include:

patents,strong brand names ,good reputation among customers ,cost advantages from proprietary know-how ,exclusive access to high grade natural resources,favorable access to distribution networks.

Weaknesses:

The absence of certain strengths may be viewed as a weakness. For example, each of the following may be considered weaknesses:lack of patent protection ,

a weak brand name ,poor reputation among customers ,high cost structure ,

lack of access to the best natural resources ,lack of access to key distribution channels .

In some cases, a weakness may be the flip side of a strength. Take the case in which a firm has a large amount of manufacturing capacity. While this capacity may be considered a strength that competitors do not share, it also may be a considered a weakness if the large investment in manufacturing capacity prevents the firm from reacting quickly to changes in the strategic environment.

Opportunities:

The external environmental analysis may reveal certain new opportunities for profit and growth. Some examples of such opportunities include:an unfulfilled customer need ,arrival of new technologies ,loosening of regulations ,removal of international trade barriers

Threats:

Changes in the external environmental also may present threats to the firm. Some examples of such threats include:shifts in consumer tastes away from the firm’s products ,emergence of substitute products ,new regulations ,increased trade barriers

SWOT / TOWS Matrix

                              Strengths                 Weaknesses

Opportunities      S-O strategies          W-O strategies

Threats                S-T strategies              W-T strategies

S-O strategies pursue opportunities that are a good fit to the company’s strengths.

W-O strategies overcome weaknesses to pursue opportunities.

S-T strategies identify ways that the firm can use its strengths to reduce its vulnerability to external threats.

W-T strategies establish a defensive plan to prevent the firm’s weaknesses from making it highly susceptible to external threats.

  

 QUESTIONS FOR THE DAY:
 
1.Why couldn't Chevy sell the Nova in Spanish countries ?
 
2.Analyze the current business environment of India.

Stakeholders in IB

1.Employees –  within the organization’s country of origin and in other countries,and at all levels. Consideration of employees in the context of international business environment involves e.g. discussion of ‘sweat shop’ labour, existence of ‘export processing zones’etc.

2.Consumers – Discussion of consumers involves analysis of questions like  whether products and services delivered to consumers globally contribute to satisfying their needs and are to their advantage; and global implications of consumerism etc.

3.Society – Social factors influence international business environment but organizations operating within this environment also have an impact upon society and groups within it. Discussion of society in the context of international business environment involves issues like the relationship between internationalisation and globalization of business environment and social stratification;the emergence of ‘winners’ and ‘losers’ as a result of social and economic change,creation of new power blocs etc.

4.Business organizations – all organizations, regardless of their size, are affected by forces within international business environment. Understanding the role of business organizations in the contemporary environment involves discussion e.g. of the current status of MNEs; the extent of economic power of business organizations at an international and global level; and the links between commercial organizations and politics – nationally, internationally and globally.

5.Supranational institutions – the rules according to which international businesses operate are to a large extent stipulated by supranational institutions. Discussion of the impact of these institutions involves consideration of their role and objectives; the processes of decision making within them; and the consequences of their actions for a range of stakeholders within the international business environment.( e.g WTO, ILO etc)

6.Social movements – social movements are a diverse category of stakeholders who have an impact upon other actors within the international business environment. Discussion of social movements involves reflection upon which areas of activity they are mostly represented in and how they make a difference to the way in which the international business environment is changing.

Teacher's Day

First of all thanks to all of you on this teachers day for being such wonderful students.


I  was 23 when i joined  teaching.....not just as a means of living , but because I really felt attracted to the profession......It wasn't really a big deal giving up better salary package offers from companies, because I wanted to be in a profession that helped me grow everyday, stay in tune with the latest everyday and be young at heart.


There is a famous quote :


"The mediocre teacher tells. The good teacher explains. The superior teacher demonstrates. The great teacher inspires." - William Arthur Ward


I hope that I can atleast be a teacher whom the students will fondly remember for being honest to the profession and trying to improve every passing day.I strongly believe that a teacher's purpose is not to create students in his own image, but to develop students who can create their own image.I hope I have succeeded in awakening and satisfying the natural curiosity of your young minds to explore and understand the world within and beyond textbooks.

Teaching helps me remain a learner for life.......and thank you once again for teaching me many things in your own way.

Cheers!

Thoughts for the weekend

Dear friends,

It 's  weekend...so thought of leaving you with some questions to ponder over...these are questions that firms in IB are preoccupied with and need to find a solution to.

International Business Questions

• How will an idea, good, or service fit into the international market?

• Should trade or investment be used to enter a foreign market?

• Should supplies be obtained domestically or abroad?

• What product adjustments are necessary to be responsive to local conditions?

• What are the threats from global competitors, and how can these threats be counteracted?

Enjoy the weekend and take some time out to think about the above.

P.S> I am still waiting for comments/ discussions on the blog....otherwise it is becoming a monologue....

 

IB- Defining Key Terms

The economy now is global,with internationalization of markets and products, goods and services.

Let us now look into some key terms that are frequently used in IB:

International business (IB) – refers to any form of commercial exchange of materials, goods, services or any other resources that involves transfer across national boundaries.

Internationalization – internationalization of business and organizations refers to their expansion beyond their home nation through establishing relationships, transaction linkages or operations in one or more other countries.

Globalization – is subject to many interpretations. For some, it represents a natural, inevitable and largely unproblematic move towards a ‘borderless world’ and the end of the independent nation state. However, others read it as the spread of western social, economic and cultural values. Intertwined with this process, we see the imperative of multinational enterprises (MNEs) to configure and develop their value chains at a global level in the aim of making the most of their own efficiency and effectiveness in order to maximize their shareholder value.

International business environment – the external context in which organizations operate across the world. It is characterised by increased complexity and by expanding and deepening ties between the different stakeholder groups within it. To gain an understanding of the contemporary international business environment, some knowledge of global political economy is necessary.

International business is dominated by large companies that operate across borders.(Usually we can classify company operations under three environments: Domestic, Foreign and International.)Any company that is international can be classified under two heads- Multinational(MNC) and Global.The former consists of organizations with multi country affiliates , each of which has its own business strategy based on perceived market differences .A global company is one which seeks to standardize its operations ( manufacturing, marketing, distribution etc)in all functional areas across borders, but responds to national market differences where necessary.e.g. Mc Donalds

A global firm utilizes the accesibility to markets across borders for new market opportunities and cheaper resources.It scans the environment for possible threat of competition or differential national laws and regulations.