Approaches to international

Business
The various approaches to international business are:
• Ethnocentric Approach:
• a company operating its business activities in domestic market may
enter into the foreign market without any change in its marketing
strategies.

• The excessive production more than the demand for product may
compel the co to sell the product in the foreign market.

• The domestic co continues export to the foreign country and views

the foreign market as an extension to the domestic market just like a
new region.

• The top mgt of the company makes the decision relating to export
and the marketing personnel of the company monitor the export
operations with the help of export department. Such approach of
international business is called ethnocentric approach.
 Polycentric Approach
• Refers to the different approaches of marketing in
different countries. When a company has entered into
the foreign market and feels that its ethnocentric
approach is not effective to influence the consumers of
the other countries, then it is essential to make required
changes in the marketing mix. Instead of depending on
centralized policies, the company establishes a
subsidiary unit in the foreign country and decentralize all
the operations and delegates decision making authority
to its executives. The parent co appoints the required
staff in the foreign subsidiary. The co appoint key
personnel from the host country and other staff from the
host country. The staff members in consultation with the
MD takes necessary marketing decisions according to
the market requirement of the host country.
 Regiocentric Approach
• A co managing its business at international level
has successfully established in a foreign country
while it is using polycentric approach and feels
that regional environment of the neighbouring
countries is much similar to that of the host
country, the co may start exporting product to
the neighbour countries. This approach is known
as the regiocentric approach.
• As for example a Japan based co has
successfully established in India. This practice
will certainly be considered as the regiocentric
approach though the co market more or less the
same product, designed under the polycentric
approach, in other countries of the region, the
marketing strategies may be different for the
neighbouring countries.
 Geocentric Approach
•A Co. using the geocentric approach
considers the whole world as a single
country. The employees are selected in
different countries. The headquarter co-
ordinates the activities of each subsidiary
which function like an independent and
autonomous co in carrying out managerial
practices like strategy formulation, product
design HR policy formulation etc.
 FDI
• The investment made by a Co in new manufacturing and
or marketing facilities in a foreign country is referred to
as FDI. Investment made by Enron in power plant in
India is an example of FDI.
• The total investment made by company in foreign
country up to given time is called “ The stock of foreign
direct investment”
• US government statistics defines FDI as “ ownership or
control of 10% or more of an enterprise’s voting
securities or the equivalent interest in an unincorporated
US business”
• Generally it is stipulated that ownership of a minimum of
10- 25% of the voting share in a foreign co allows the
investment to be considered direct.
 Forms of FDI
• Purchase of existing assets in a foreign
country.
• New investment in property
• Participation in joint venture with a local
partner.
• Transfer of many assets like human
resource, system, technology
• Exports of goods for equity
 Factors influencing
•
FDI
Supply factors: production cost
• Logistics
• Resource availability
• Access to technology
• Demand factor: customer access
• Marketing advantages
• Exploitation of competitive advantages
• Customer mobility
• Political factor : avoidance of trade barriers
• Economic development incentives
 Reasons for FDI
• To increase sales and profits( Toyota, Suzuki
in US
• To enter fast growing markets (IBM in Japanese
laptop market 40%)
• To reduce costs (US firms in India)
• To consolidate trade blocs (to access wider
market)
• To protect domestic market
• To protect foreign market (British petroleum in
USA)
• To acquire technological and managerial know
how. ( US co Kodak invested in Japan to acquire
technology)
 Benefits of FDI
• Benefits to Home Country: inflow of foreign
currencies in the form of dividend interest.
Nissan’s profit repatriated to Japan are from FDI
in the UK. It helped Japan for positive BOP.
• FDI increases export of machinery, equipments,
technology from the home country to the host
country. This enhances the industrial activity of
home country.
• The increased industrial activity in the home
country enhances employment opportunities.
• The firm and other home country firms can learn
skills from its exposure to the host country and
transfer those skills to the industry in the home
country.
 Costs to Home Country
• Home country’s industry and employment
position are at stake when the firms enter
foreign market due to low cost labor. The
US textiles moved to central America. This
resulted in retrenchment in the USA.
• Current account position of the home
country suffers as FDI is a substitute for
direct exports.
 Benefits to host country
• Resource transfer effects
• Employment effect
• Balance of payment effect

• Costs to Host country: intensifying competition

• Negative effect on balance of payment:
• Co may repatriate their dividend to home
country.
• Imports the goods from its subsidiary
• National sovereignty and autonomy
 PH’s measures towards FDI
• Granting of automatic permission for foreign equity participation up to 51%
in high technology and high investment priority industries.

• Allowing foreign equity participation up to 51% in international trading co,

hotel industry and tourist industry.

• Constitution of a specialized empowered board in order to attract FDI by

negotiating with multinational co.

• Dispersing with the bureaucratic rules and regulation which caused delays
and created hurdles for the FDI

• Allowing the MNCs to use trade marks in India with effect from May14,1992.

• Allowing 100% foreign equity for setting up of power plants with free
repatriation of profits.

• Allowing 100% equity contribution by the NRI and the corporate bodies
owned by NRI in high priority industries
• The holding non banking financial co can hold foreign equity up
to100%
• Foreign investors are allowed to establish 100% operating
subsidiaries and should bring at least US $ 50 million for this
purpose.
• 100% FDI is permitted in B2B ecommerce power sector and oil
refining.
• Manufacturing activities in all special economic zones can have
100% automatic route except few.
• 74% FDI is allowed subject to licensing and security norms in
internet service providers and 74% in other telecommunication
• projects.
Off shore venture capital fund can use automatic route subject to
SEC regulations.
• Insurance co can have FDI upto 26% subject to IRDA
Regulations.
• 1oo% FDI in airports courier services hotels and tourism drugs and
• pharmaceutical
 Theories of International Trade
• Mercantilism is the oldest international trade theory that
formed the foundation of economic thought during about
1500 to 1800.

• According to this theory the holding of a country’s

treasure primarily in the form of gold constituted its
wealth. The theory specifies that countries should export
more than they import and receive the value of trade
surplus in the form of gold from those countries which
experience trade deficit.

• GOVT. imposed restriction on imports and encouraged

exports in order to prevent trade deficit and experience
trade surplus.
• Colonial powers like the British used to
trade with their colonies like India, Srilanka
etc. by importing the raw material from
and exporting the finished goods to
colonies.
• The colonies had to export less valued
goods and import more valued goods.
Thus colonies were from
manufacturing.
prevented
• This practice allowed the colonial power to
enjoy trade surplus and forced the
colonies to experience deficit.
• The mercantilism theory suggests for maintaining
favorable balance of trade in the form of import of gold
for export of goods and services. But the decay of gold
standard reduced the validity of theory. Consequently
this theory was modified in neo mercantilism.

• Neo mercantilism proposes that countries attempt to

produce more than the demand in the domestic market
in order to achieve a social objective like full employment
in the domestic country or a potential objective like
assisting a friendly country.

• The theory was criticized on the ground that the wealth

of nation is based on its available goods and services
rather than gold.

• Adam smith developed the theory of absolute cost

advantage which says that different countries can get the
advantage of international trade by producing certain
goods more efficiently than others .
 Absolute Cost Advantage Theory
• Adam smith, the Scottish economist viewed free trade
enables to country to produce a variety of goods and
services. Smith proposes the theory of absolute cost
advantage theory of international trade based on the
principle of division of labor.
• According to theory the principle of absolute cost
advantage will help the countries to specialize in the
production of those goods in which they have cost
advantage over others.
• According to theory every country should specialize in
producing those products at the cost less than that of
other countries.
• Trade between two countries takes place when one
country produces one product at less cost than that of
another country and having a cost advantage and vice
versa.
Skilled advantage and specialization advantage

• Countries have absolute cost advantage due to:

• Economies of scale
• Suitability of the skill of the labor of the country
in producing certain products.
• Specialization of labor in producing certain
products leads to higher productivity and less
labor cost per unit of output.
• Natural Advantage natural advantage is due to
climatic conditions and natural resources.
• Acquired Advantage acquired advantage is
due to technology and skill development.
 Assumption of the
• Tradetheory
is between two countries only

• Only two commodities are traded

• Free trade exists between the countries

• The only element cost of production

is labor
 Explanation of theory
Output per labor Japan India
for 1 day
pens 20 60
Tape recorder 6 2
• In the table given below two countries India and
Japan are two countries having advantage in
producing the pens and tape recorder.
• Ability of labor to produce different goods and
services in a day is known as production
possibility.
• In Japan one day of labor can produce 20 pens
or 6 audio recorder.
• In India one day of labor can produce either 60
pens or 2 tape recorders.
• Japan has an absolute advantage in the
production of audio tape recorder and India’s
advantage is in pens.
• Assume that Ph and Japan are able to
trade with one another, then both will get
the advantage. Suppose Japan agrees to
exchange 4 audio tapes for 40 pens.

• Two days of Japanese labor is needed to

produce 40 pens and only 0.67 days of
labor for 4 recorder. Thus Japan can save
1.33 days of labor(2 - 0.66) if it export tape
recorders to Ph and imports pens from
Ph
• Ph needs 2 days of labor to produce 4 audio
tape recorders and 0.67 days of labor is enough
to produce 40 pens. Ph can save 1.33 days of
labor (2 – 0.67) by exporting pens to Japan and
importing recorders
• Thus two countries can save labor by trading
with each other rather than by producing both
the products. The saved labor hours can be
used for the production of more audio recorder
by Japan and pens by Ph.
• Japan can consume more pens by allocating its
labor to produce tape recorders and by trading
with Ph and vice versa in case of Ph.
If countries produce both the
products
30

25

20

15

10

0
tape recor pens

Japan 3 10
Ph 1 30
Production possibility of countries

60

50

40

30

20

10

0
tape record. pens

japan 6 20
Ph 2 60
 Implications of theory
• By trading two countries can have more
quantities of both the products.
• Living standard of the people of both the
countries can be increased by trading between
the countries.
• Inefficiency in producing certain countries can
be avoided.
• Global efficiency and effectiveness can be
increased by trading.
• Global labor productivity and other resources
productivity can be maximized.
 Criticism of the
• theory
No absolute advantage

• Country size

• Variety of resources

• Transport cost

• Scale economies

• Absolute advantage for many products

 Comparative Cost Theory
• The comparative cost theory was first systematically
formulated by the English economist David Ricardo in
the principle of political economy and taxation in 1817. it
was later refined by J.S.Mill, Marshall, Taussig and
others.

• In a Nutshell the doctrine of comparative cost maintains

that if trade if left free, each country in the long run tends
to specialize in the production and export of those
commodities in whose production it enjoys a
comparative advantage in terms of real cost and to
obtain by import those commodities which could be
produced at home at a comparative disadvantage in
terms of real cost and that such specialization is to the
mutual advantage of the countries participating in it.
 Assumptions
• Labor is only element of cost of production.
• Goods are exchanged against one another
according to the relative amount of labor embodied
in them.
• Labor is perfectly mobile within the country
outside.
not
• Labor is homogeneous
• Production is subject to the law of constant return.
• Free trade and no trade barriers.
• No transportation cost
• There is full employment
• There is perfect competition
• There are only two
 Explanation
• The law of comparative advantage indicates that
a commodity should specialize in the production
of those goods in which it is more efficient and
leave the production of the other commodity to
the other country. The two countries will then
have more of both goods by engaging in trade.

• Ricardo in his two country two commodity model

has taken the hypothetical example of
production costs of cloth and wine in England
and Portugal to illustrate the comparative cost
theory.
Country No of units No of unit Exchange
of labor per of labor per ratio
unit of unit of
cloth wine
England 100 120 1 wine =
1.2 cloth

Portugal 90 80 1 wine = .
88 cloth
• From the above example it is evident that
Portugal has an absolute superiority of
production. However a comparison of the ratio of
the cost of wine production ( 80/120 ) with ratio
of the cost of cloth production (90/100) in both
the countries reveals that Portugal has an
advantage superiority in both the branches of
production. It will concentrate on the production
of wine in which it has comparative advantage
over England, while importing cloth from
England which has a comparative advantage in
cloth production. England will gain by
specialization in producing cloth and selling it to
Portugal in exchange for wine.
• In the event of trade taking place under
the assumption that within each country
labor is perfectly mobile between various
industries, Portugal will gain if it can get
anything more than .88 units of cloth in
exchange for one unit of wine and
England will gain if it has to part with less
than 1.2 units of cloth against one unit of
wine. Hence any exchange ratio between
0.88 units and 1.2 units of cloth against
one unit of wine represents a gain for both
the countries. The actual rate of exchange
will be determined by reciprocal demand
• Thus according to the comparative cost theory
free and unrestricted trade among countries
encourage specialization on a large scale. It
thereby tends to bring about:
• The most efficient allocation of world resources
as well as maximization of world production.
• A redistribution of relative product demands
resulting in greater equality of product prices
among trading nations and
• A redistribution of relative resource demands to
correspond with relative product demands,
resulting in relatively greater equality of resource
prices among trading nations.
 Implications of the theory
• Efficient allocation of global resources
• Maximization of global production at the
least possible cost
• Product prices become more or less
equal among world market
• Demand for resources and products
among world nations will be maximized
• It is better for the countries to specialize in those
products which they relatively do best and export
them
• It is better for the countries to buy other goods
from other countries who are relatively better at
producing them
• Comparative cost theory is really an
improvement over absolute cost
advantage. This theory is not only an
extension to the principle of division of
labor and specialization but applies the
opportunity cost concept. It is also argued
that lower labor cost need not be a source
of comparative advantage.
• However Ricardo fails to consider the
money value of cost of production.
• F.W.Taussig bridged this gap in
comparative cost advantage theory.
 Criticism of theory
• Two countries
• Transportation cost
• Two products
• Full employment
• Economic efficiency
• Division of gains
• Mobility servies
 Product life cycle theory
• Raymond Vermon of the Harvard Business
school developed the Product Life cycle theory.
International product life cycle theory traces the
roles of innovation market expansion
comparative advantage and strategic response
of global rivals in international manufacturing
trade and investment decision.
• International product life cycle consists of four
stages:
• New product innovation
• Growth
• Maturing stage
• decline
Basis Introduction Growth Maturity Decline

Product In innovating In innovating Multiple Mainly in LDCs

(usually and other countries
location industrial industrial
country countries

Market In country with Industrial Growth in LDCs Mainly in LDCs

Location some exports country
Some decrease Some LDCs
Shift in export in industrial exports
markets as countries
foreign
production
replaces export
in some
countries

Competitive Near monopoly Fast growing Overall Overall

factor situation demand stabilized declining
demand
 Sale based on No of No of Price is key
uniqueness competitors competitors weapon
rather than increases decreases No of producers
price continues to
Price cutting by Price is very decline
Evolving competitors important
product Product
characteristics become more
standardized

Production Short Capital input Long production Unskilled labor

production run increases runs using high on mechanized
technology capital inputs long
production
Evolving Methods more
runs
methods to standardized Highly
coincide with standardized
product
evolution
Less skilled
labor needed
High labor and
labor skill
relative to
capital input
 Explanation
• Introduction stage: firms innovate new
products based on needs and problems in
domestic country.

• Growth: attracting competitors

• Increased competitor
• Further innovation
• Shift manufacturing to foreign countries

• Maturity : standard product

• Large scale production and economies
• Low unit cost of production
• Shift manufacturing to developing countries
• Decline: location of manufacturing facilities
in developing countries
• Original innovating becomes
country importer. net
• Limitations of Theory :
• Production facilities do not move to foreign
countries to achieve cost reduction due to short
product life cycle consequent upon very rapid
innovation.
• Cost reduction has a little concern to the
consumer in case of luxury products.
• Export may not be in significant volume where
cost of transportation is very low.
• Non cost strategies like advertising may
nullify the opportunity to move to foreign
countries for cost minimization.
• Requirement of specialized knowledge
and expertise reduce the chances of
locating production facilities in foreign
countries.
• The rapid development may not shift the
production to various foreign countries.
 Global Strategic Rivalry Theory
• International trade takes
between/among companies based on
place
relative competitive advantage but not
countries competitive advantage.
• Companies acquire and develop
competitive advantage through a number
of means:
• Owing intellectual property rights
• Investing in research and development
• Achieving large scale economies
• Exploiting the experience curve.
 Porter’s National Competitive
Advantage Theory
• Companies get competitive advantage
or superiority from:
• Demand conditions
• Factor endowment
• Related and support industries
• Firm strategy, structure and rivalry