INTERNATIONAL BUSINESS MANAGEMENT
LESSON 32
OPERATION AND LOGISTICS ACTIVITIES-INTRODUCTION, GEOGRAPHIC STRATEGY
Objective Learning:
• To discuss company strategies for sequencing the penetration
of countries and for committing resources
• To Explain how clues from the environmental climate can
help managers limit geographic alternatives
• To examine the major variables a company should consider
when deciding whether and where to expand abroad
• To provide an overview of method and problems when
collecting and comparing information internationally
• To describe some simplifying tools for determining a global
geographic strategy
• To introduce how managers make final investment,
reinvestment, and divestment decisions
Case Study
Carrefour, which opened its first store in 1960, is now the
largest retailer in Europe and Latin America and the second
largest worldwide. Its stores depend on food for about 60
percent of its sales and on a wide variety of nonfood items for
the rest. In 2001, Carrefour derived 51 per-cent of its sales and
33 percent of its profits outside France, its home country. The
Institute of Grocery Distribution ranks Carrefour as the world’s
most global retailer, based on foreign sales, number of coun-
tries with operations, and ratio of foreign sales to total sales. As
of June 2002, Carrefour owned 5,341 stores and franchised
another 4,064; of which only 3,389-a little over a third-were in
France. Nevertheless, France accounted for 49 percent of its sales
and 67 percent of its operating profit.
In the near future, Carrefour plans to open more than 400 new
stores a year and spend nearly $3 bil-lion per year on new stores,
remodeling, and expansion. Thus, its management must decide
in what coun-tries to open these stores and where in each
country to locate them. (Recently, Carrefour has placed about
three-quarters of capital expenditures outside France.) Manage-
ment also must decide where to buy the merchandise its stores
sell.
Carrefour sells in five types of stores: hypermarkets, supermar-
kets, hard discount stores, cash-and-carry stores, and
convenience stores. For 2001, it made 59.2 percent of its sales in
hypermarkets, which are in more countries than are Carrefour’s
other types of retail operations. In 1963, Carrefour invented
and opened the first hypermarket, an enormous commercial
establishment that combines a department store and a super-
market. Whereas a typical supermarket might have 40,000 square
feet, a hypermarket might have 330,000. A vice president of
Progressive Grocer magazine explained the size difference: “A
grocery store is like a family farm, a supermarket is like a big
corporate farm, and a hypermarket is like the whole state of
Iowa.” As a rule of thumb, a hypermarket requires 500,000
households within a 20-minute drive to derive sufficient
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business. Carrefour’s supermarkets carry less variety than its
hypermarkets and accounted in 2001 for 19.8 percent of sales.
Its hard discount stores, cash-and-carry stores, and conve-nience
stores collectively accounted for 21 percent of sales. The hard
discount stores sell fewer different items than supermarkets sell-
mainly food products in fairly austere stores at discounted
prices. The cash--and-carry stores cater strictly to the trade, such
as restaurant owners and hoteliers. Its convenience stores (more
than 95 percent are franchise operations) are still smaller and
carry fewer items. One of Carrefour’s key contributions to
franchisees is selecting locations for their stores.
Carrefour’s French hypermarket operation was a success from
the beginning, an by 2002, Carrefour operated 177 hypermarkets
in France. The timing for introducing the hypermarket concept
was perfect. Supermarket operations were not yet well devel-
oped in France, and French consumers generally shopped for
food items in different outlets-for example, bread, meat, fish,
cheese, and fresh vegetables in differ-ent specialty stores or open
markets. Few retailers had convenient or free parking, so
customers had to shop long hours and make frequent trips to
stores. 110wever, by 1963, more French families had cars, more
had refrigerators large enough to store a week’s supply of fresh
products, and more had high dis-posable incomes that they
could spend on nonfood items. Further, more women were
working, and they wanted one-stop shopping. Thus, French
consumers flocked to Carrefour’s suburban hypermarkets,
which offered free parking and discounted prices on a very wide
selection of merchandise.
However, Carrefour and other hypermarket operators have faced
obstacles to French expansion. Government authorities at times
have restricted new hypermarket permits to safeguard town
centers, pro-tect small businesses, and prevent visual despolia-
tion of the countryside. As a consequence, Carrefour decided
early on to expand internationally. Figure 11.1 shows both the
countries where it now operates and when it entered those
countries. Its first two foreign entries, both with hypermarkets,
were to neigh-boring countries, Belgium and Spain. Carrefour
managed these ventures without difficulty because its French
suppliers initially provided much of the stores’ stock and
because its managers from France could travel easily to Belgium
and Spain to oversee the operations. When Carrefour entered
Belgium and Spain the consumers of those two countries were
going through lifestyle changes similar to those that helped
assure the company’s earlier success in France. Since then, one of
the principal factors guiding Carrefour’s international expansion
has been countries’ economic evolution. Its CEO, Daniel
Bernard said, “We car start with a developing country at the
bottom of the economic curve and grow within the country to
the top of the curve.”
Nevertheless, Carrefour has not always followed this location
strategy, and the deviation has influenced its failure in some
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markets. It expanded into the United States and the United
Kingdom in the mid-1980s after both of these countries had
gone through the economic transitions that helped assure
success in other locales and after other distributors had satisfied
the changed consumer needs. Carrefour later pulled out of both
markets. Bernard said later, “There is a race and a lot of
companies are qualified for the race. To go global, you need to
be early enough. Generally, in new countries you need to be the
first in for the first win. -When you arrive as number three or
four, it is too late.” However, some additional factors caused
problems for Carrefour in the United States and the United
Kingdom. In the United States distributors have had scant
success with hypermarkets. Their introduction came well after
the growth of supermarkets and smaller-scale mixed merchan-
dise retailers, such as a typical Wal-Mart store. U.S. customers
have simply not wanted to spend the time it takes to shop in a
hypermarket. For example, Carrefour’s Philadelphia store had 61
check-out counters, and customers had to pass all of them
before they even reached the first aisle. In the United Kingdom
Carrefour did well on sales of food items but not on durables;
consumers preferred to shop v these in city centers where they
could compare the products offered by different distributors.
Figure 11.1 Carrefour’s Store Location By Country Dates of
Entering Those Markets
Another factor influencing the choice for country expansion has
been the ability to find a viable partner familiar with local
operating needs. Carrefour has teamed with the Maus group in
Switzerland, President Enterprise in Taiwan, the Sabanci group
in Turkey, and Harbor Power Equipment in China. Such
partnering has enabled Carrefour to avoid some of the errors
Wal-Mart made when entering markets alone, such as stocking
American footballs at its Brazilian stores (even though Brazil-
ians play soccer instead) and introducing a stock-handling
system in Brazil that did not fit Brazilian pallet sizes. However,
Wal-Mart entered Mexico well before Carrefour and teamed with
the best local partner, Cifra. A few years later, Carrefour part-
nered with Gigante, but the latter lacked sufficient resources to
expand as rapidly as Carrefour desired, so Carrefour ultimately
had to buy Gigante’s interest in the joint operation. In Japan,
Carrefour established operations in 2001 without a partner. In
essence, management felt no need for a partner because
traditional operating costs were so much lower than those of
Carrefour’s Japanese rivals. Time will tell if Carrefour can
succeed in Japan without a partner; however, a retail analyst has
said, “Their [Carrefour’s] chances of success are zero.”
Why would another company want to partner with Carrefour?
Aside from financial resources, Carrefour brings to a partnership
expertise on store layout, clout in dealing with global suppliers
(for example, it runs a global sales campaign, “Most Awaited
Month,” in which the largest manufacturers of global consumer
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goods provide its stores worldwide with lower prices for a one-
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month sale), direct e-mail links with suppli-ers that substantially
reduce buying personnel and inventories, and the ability to
export unique bargain items from one country to another.
MAP 5.2 number of Carrefour Retailers by Country, 2002
The figures show the number of Carrefour retailers per country
as of June 2002 and include franchise operations. The figures
do not include 57 franchise operations in Europe that are not
specified on the Carrefour Web site.
Source: Information is taken from the carrefour web site
(September 26, 2002): http://www.carrefour.com/english.
Carrefour also considers whether a country or regional location
within a country can justify sufficient additional store expansion
to gain economies of scale in buying and distribution. To help
gain these economies, Carrefour and some of its competitors
have recently been on acquisition sprees. For example, Carrefour
bought Promodes, Montlaur, Euromarche, and Comptoirs
stores in France, Supermercados Norte in Argentina, and a stake
in Super Stock in Spain. It entered Hong Kong in 1996, but it
closed operations four years later because it could not secure
enough suitable sites for expansion. It also sold three hyper-
markets in northern Mexico to a Mexican retailer, Soriana,
because it lacked the opportunity to amass enough retail
operations in the area to justify investing in a large distribution
center. Likewise, some ana-lysts feel that Carrefour may be
expanding retail operations to too many countries and will not
be able to build sufficient presence in each to gain necessary
economies of scale. For example, Tesco, a British retailer, is
expanding to fewer countries but is building a large presence in
each one. In the six countries where both Tesco and Carrefour
operate, Tesco is bigger in four of them. Map 5.1 shows the
countries where Carrefour operates and the number of stores in
each country.
Carrefour depends primarily on locally produced goods, using
manufacturers’ trademarks or no trade-marks at all. This
strategy Contrasts with such retailers as Tesco and Marks &
Spencer, another British retailer, which depend heavily on own-
label products. Thus, consumers can easily compare prices of
most Carrefour products with those of competitors because
few of its products have unique labels. Nevertheless, Carrefour
has recently been pushing global purchasing. For example,
much of the merchandise it sells in its Chilean stores is duty-
free from Brazil because of Chile’s associate membership in
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 MERCOSUR. Further, when stores in one country find an
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exceptional supplier, the management passes on the informa-
tion to Carrefour’s mer-chandising group in Brussels, which
then seeks markets within Carrefour stores in other countries.
The Malaysian operation, for example, found a good local
supplier of disposable gloves, and Carrefour now sells them in
its stores worldwide.
Although mass retailers sell most of the consumer goods in
industrial countries, they sell much less in most developing
countries. For example, chain stores probably account for less
than 3 percent of retail sales in China and India. On the one
hand, this might indicate that Carrefour should be putting
most of its expan-sion efforts into developing countries. On
the other hand, some analysts feel that Carrefour will never
become the world’s largest retailer without a significant presence
in the United States and the United Kingdom. In fact, newspa-
pers have reported rumors that Carrefour is looking for
acquisitions to penetrate those markets. These rumors for the
United States have included Kmart, Target, and Costco.
Carrefour actu-ally has a minority interest in Costco.
Companies must consider both opperortunity and risk when
deciding whether where to operate abroad. The photo shows a
guard with Ronald Mc Donald protecting a McDonald’s facility
from rioting and looking in Jakarta, Indonesia.
Introduction
Companies seldom have enough resources to take advantage of
all international opportuni-ties. Committing human, technical,
and financial resources to one locale may mean forgoing projects
in other areas. So managers must be choosy. They must know
how to pick the best location for their business interests.
Figure 11.2 repeats the framework and highlights the fact that
the choice of where to operate is a big part of carrying out a
business strategy. The figure also shows that external factors
influence country selection. A company should look to those
countries with economic, political, cultural, and geographic
conditions that mesh with its strengths. Managers might ask,
“Where can we best leverage our already developed competen-
cies?” and, “Where can we go to best sustain, improve, or
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extend our competencies?” A company needs to determine the
order of entry into potential countries and to set the allocation
of resources and rate of expansion among them.
Choosing Marketing and Production Sites, and
Geographic Strategy
Companies must determine where to sell and where to
produce. In so doing, managers will need to answer two basic
questions: “Which markets should we serve?” and “Where
should we place production to serve those markets?” The
answers to these questions can be one and the same, particularly
if transport costs or government regulations mean that local
production is necessary for serving the chosen market. Many
service industries, such as hotels, construction, and retailing
(recall the Carrefour case), must locate facilities near their foreign
customers, so decisions on market and production location are
connected. If a company develops a product that consumers
find attractive, it must still find means to produce and transport
the product cheaply enough so that consumers will buy it.
Finding the right production location, which may be abroad,
allows the company to sustain a long-term competitive edge.
Decisions on market and production locations may be highly
interdependent for other reasons. A company may have excess
production capacity already in place that will influence its ability
to serve markets in different countries. Or it may find a given
market very attractive but it will forgo sales there because it is
unwilling to invest in needed production locations.
Figure 11.2 Place of Location Decisions in International
Business Operations
A company’s choice of countries for its operations should be
determined by the interaction of its objectives, competencies,
and comparative environmental fit with conditions within
different countries.
The process of determining an overall geographic strategy must
be flexible because coun-try conditions change. A plan must let
a company both respond to new opportunities in dif-ferent
locations and withdraw from less profitable ones. Unfortu-
nately, there is little agree-ment on a comprehensive theory or
technique for choosing the best location, one that helps
companies get the most out of their resources. Further, it is
hard for companies to formulate strategies when they have to
make assumptions about factors in the foreign environment,
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such as future costs and prices, competitors’ reactions, and
technology. - they perform a more detailed feasibility study.
Nevertheless, managers can use several geographic strategies. A
company may expand its international sales by marketing more
of its existing product line, by adding products to its line, or by
some combination of these two. Most companies begin by
asking, “Where can we sell more of our products?” Alterna-
tively, they can ask, “What new product can we make to
maximize sales in a given market?” In this chapter, we assume
that for the most part, the company has pursued the first
question. In essence, a company needs to decide where to
operate and what portion of operations to place within each
location. Figure 11.3 shows the major steps international
business managers must take in making these decisions. The
fol-lowing discussion examines these steps in depth.
Figure 11.3 Flowchart for Choosing Where to Operate
Scan For Alternative Locations
To compare countries, managers use scanning techniques based
on broad variables that indi-cate opportunities and risks. That
way, decision makers can perform a detailed analysis of a
manageable number of geographic locations. Scanning is like
weeding out-it is useful insofar as a company might otherwise
consider too few or too many possibilities.
A company can easily overlook or disregard some promising
options. Some locations may be skipped rather than rejected,
simply because managers either never think of them or because
they eliminate consideration of a whole region without
considering differences with in the region. Or a company may
decide to go where “everyone else has gone.” For example, the
former vice chairman of Chrysler said, “The chief executive who
gets asked repeatedly by the press and Wall Street analysts the
same question-’Why are you so slow on your China strategy?’-
quickly gets the idea he’s missing something and orders a China
strat-egy. These ‘forced’ actions, taken because of ‘peer pressure,’
almost always result in disaster.”
A detailed analysis of every alternative might result in maxi-
mized sales or a least-cost pro-duction location, but the cost of
so many studies would erode profits. A company with 1,000
Products that might locate in any of 150 countries would need
150,000 different studies. Plus, other alternatives must be
considered as well, such as whether to export or to set up a
foreign production unit. Companies should examine any
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conditions that would enhance the weeding out process before
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Choose and Weight Variables
When scanning, managers will take the environmental climate
into consideration. The envi-ronmental climate is the external
conditions in a host country that could significantly affect the
success or failure of a foreign business enterprise. It can
determine whether a company will make a detailed study as well
as the terms under which it will initiate a project. The environ-
mental climate reveals both opportunities and risks.
Opportunities
Managers make investment decisions after weighing opportuni-
ties against risks. Opportunities are determined by revenues less
costs. From a broad scanning perspective, there are variables that
indicate the amount of revenue, cost factors, and risk that
might be forthcoming from one country to another.
The factors that have the most influence on the placement of
marketing and production emphasis are market size, ease and
compatibility of operations, costs, resource availability, and red
tape. Some of these variables are more important for the
market-location decision; others are more important for the
production-location decision. Some variables affect both.
Market Size Sales potential is probably the most important
variable managers use when determining where and whether to
make an investment. The assumption, of course, is that sales
will occur at a price above cost, so that where there are sales,
there are profits.
In some cases, a company can obtain past and current sales
figures on a country-by-country basis for the type of product it
wants to sell. In many cases, however, such figures are unavail-
able. Nevertheless, management must make projections about
what will happen to future sales. Often, data such as GNP, per
capita income, growth rates, population, and level of industrial-
ization are also good indicators of market size and future sales.
Of course, managers should examine how incomes and wealth
are distributed. For example, Indonesia’s per capita income is
low; however, there are enough millionaires to buy luxury
sports cars. Further, demographic factors other than income
influence potential demand, such as age, gender, religion, and
ethnic background. For example, Pollo Campero, a Guatema-
lan-based fast-food chain, successfully entered the United States
by going to cities with large Central American populations.
Another technique for making rough estimates of market size
is to base projections on a similar or complementary product
for which sales figures are available, such as projections of flat
screen television sales potential based on DVD sales data.
Ease and Compatibility of Operations Managers prefer to go
where they perceive it’s easier to operate. Thus, Carrefour’s
managers chose their first international expansions in neighbor-
ing Belgium and Spain. Likewise, U.S. companies put earlier and
more emphasis on Canada, the United Kingdom, and Mexico
than would be indicated by those countries ecol1omic sizes.
These companies rank Canada and Mexico high because of
geographical proximity, which makes it easier and cheaper for
the companies to ship merchandise to and to control their
foreign subsidiaries. Moreover, since the advent of NAFTA,
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 U.S. companies encounter fewer border restrictions for their
INTERNATIONAL BUSINESS MANAGEMENT
operations in Canada and Mexico than they do for most other
locales. Also, at the early stages of international expansion,
managers feel uncomfortable doing business in a dissimilar
language, culture, and legal system, and this helps explain why
U.S. companies’ prefer to operate in Canada and the United
Kingdom as opposed to, say, Russia. Language and cultural
similarities may also keep operating costs and risks low because
of greater ease in understanding employees and customers.
Finally, economic similarity influences where initial foreign
operations will reside. Both Canada and the United Kingdom
have high per capita incomes that are similar to those in the
United States.
After companies pare alternatives to a reasonable number, they
must prepare much more detailed feasibility studies. These
studies can be expensive. The more time and money companies
invest in examining an alternative, the more likely they are to
accept it regardless of its merits, a situation known as an
escalation of commitment. A feasibility study should have clear
cut decision points, points at which managers can cut the
commitment before it escalates.
Proposals for expansion may originate almost anywhere within
a company, but top-level managers should have the final say in
whether they are approved because a company needs to, put its
limited resources to the best possible use. To this end, Eastman
Kodak now has head quarters approve projects that used to be
handled by overseas managers? They should give precedence to
those that fit the organization’s motives, limitations, and
policies. For example, Blockbuster failed in Germany because it
could not duplicate the successful formula it uses elsewhere. In
the United States, Blockbuster depends on evening, Sunday,
and holiday rentals, when people decide at the last minute to fill
their leisure time. But laws in Germany prevented Blockbuster
from operating at these times. Further, Blockbuster creates a
store environment in the United States that attracts the whole
family. However, consume in Germany prefer to see family
entertainment in a movie house and seek pornographic ml
from video stores.
Companies may limit consideration of proposals to locales that
will permit them to operate with product types and plant sizes
familiar to the managers. From a policy standpoint, manage-
ment may find it useful to ensure that its proposal group
includes personnel with backgrounds in each functional area
marketing, finance, personnel, engineering, and production.
From a policy standpoint, many companies further limit
consideration of proposals to only those countries that permit
them to own an acceptable percentage of operations and that
allow sufficient remittance of profits.
Companies also consider local availability of resources in
relation to their needs. Many foreign operations require local
resources, a requirement that may severely restrict the feasibility
of given locales. For example, the company may need to find
local personnel or a viable local partner who understand its type
of business and technology. Or it may need to add- local capital
to what it is willing to bring in. If local equity markets are
poorly developed and if local borrowing is expensive, the
company may consider locating in a different country.
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248
Costs and Resource Availability So far, we have discussed
market-seeking operations. However, companies also go abroad
to secure resources that are either unavailable or expensive in
their home countries. Often, a company considers making a
product or component abroad ;or sale where it produces that
item or for export into other markets. It must examine labor
costs, raw material inputs, capital requirements, utilities, real
estate costs, taxes, and transportation costs in relation to
productivity. Before collecting all this information in a final
feasibility study, the company can narrow the alternative
locations by examining a few key indicators.
Labor compensation is an important cost of manufacturing for
most companies. Thus, Figure 11.4 illustrates companies’
continual search for cheaper labor. However, capital inten-sity is
growing in most industries, which reduces labor costs as a
percentage of total costs and reduces the differences in produc-
tion costs from one location to another. At any rate, com-panies
can examine current labor market size, labor costs, trends in
those costs, and unem-ployment rates to approximate labor
availability and cost differences among countries. Labor,
however, is not homogeneous. If a country’s labor force lacks
the specific skill levels required, a company may have to train,
redesign production, or add supervision-all of which are
expensive. In the case of specialized units, such as an R&D lab,
the existing availability of specific skills is almost essential.
Further, there may be sector differences in wage rates. For
example, Mexican tire wages are twice those of Mexican auto
wages and five times the Mexican industrial wage. This has
caused tire companies, such as Goodyear and Michelin, to shift
much of their tire production from Mexico to Brazil. Further,
labor availability and cost may change rapidly. For example,
about a quarter of the labor force in South Africa is infected
with HIV; which may drastically reduce the labor force over the
next 10 to 15 years. Travel restrictions because of the Asian
SARS outbreak limited MNEs’ ability to send management
from headquarters to control Asian operations.
When companies move into emerging economies because of
labor-cost differences, their advantages may be short-lived
because:
• Competitors follow leaders into low-wage areas.
• There is little first-in advantage for this type of production
migration.
• Will Companies Keep Finding New Source of Cheap Labor?
Source: 1997 Joel Pett, Lexington Herald- Leader. All Right
Reserved.
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Foreign costs rise quickly as a result of pressure on wage or
exchange rates.
As a result, some companies, especially those with rapidly
evolving technologies, seek to locate production close to
product-development activities. Doing this allows for a tight
link between product and process technologies (for example,
making smaller disk drives is as -much a manufacturing
problem as it is a technical one), a faster market entry with new
prod-ucts, and unique production technologies that cannot be
easily copied by competitors. These factors tend to push more
of a company’s production into industrial countries, a: which
most R&D occurs. However, a geographically isolated country,
such as New Zealand does not fit as easily into a company’s
global process-product integration strategy because of transpor-
tation time and cost. At the same time, companies seeking to
integrate different parts of their production-for example, by
producing components in different countries to save on labor
rates-prefer to locate activities in countries with few trade
restrictions so that they are better assured of having a continu-
ous flow of components where they need them.
Increasingly, companies need to be near suppliers and custom-
ers in an area where the infrastructure will allow them to move
supplies and finished products efficiently. Regional headquarters
should reside near specialized private and public institutions
such as banks, financing firms, insurance groups, public
accountants, freight forwarders, customs brokers, and consular
offices, all of which handle international functions. If a
company is looking for production location that will serve sales
in more than one country, the ease of moving goods into and
out of the country is very important. The company may
compare countries in terms of their port facilities and trade
liberalization agreements with other countries. The company
may also compare alternative transportation costs from
production to market locations in case the usual transport
means becomes unavailable. For example, U.S. toy com-panies
such as Hasbro and Mattel depend on Asian production and
ocean freight. However they cannot afford to use airfreight in
the event of a prolonged shipping strike.
Corporate tax rates on income also affect location decisions by
MNEs, especially within regional trading groups because in such
groups, companies can serve the entire region from any of
several countries.
Companies should add any other important costs specific to
their own operations into their analysis. If precise data are
unavailable, companies may use proxies on operating condi-
tions. For example, if a country’s infrastructure is well
developed and components can be eas-ily imported, operating
costs are likely to be low. If the country already turns out
competitive products containing inputs similar to those
required for the production being considered, management can
conclude that labor costs will be sufficiently low.
The continuous development of new production technologies
makes cost comparisons among countries more difficult. As the
number of ways in which the same product can be made
increases, a company must compare the cost of producing with
a large labor input in a low-wage country with that of produc-
ing with capital intensity in a high-wage country. For example,
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Volkswagen moved production of its Golf Syncro from
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Germany to Slovakia and switched from a highly automated,
capital-intensive assembly line to a labor-intensive plant because
the low Slovakian wages and high productivity cut costs from
those in Germany. A company might have to compare large-
scale production with reducing fixed costs per unit by -serving
multicountry markets and the latter has the advantage of
multiple smaller-scale pro-duction units; the former has the
advantage of reducing transport and inventory costs.
Because of other considerations, a company may not necessarily
opt for the least-cost production location. For example, BMW
calculated that Mexico would be the least-cost location for
North American production. However, the company chose a
U.S. location because it feared that a Mexican-made vehicle
would lack the same luxury image. Similarly, BMW feared for
many years that foreign consumers would balk at buying
vehicles made in its South African plants, but it is now success-
fully exporting its 3-series sedans from South Africa to Japan
and the United States. 17 However, in a sense, the decisions
based on production image are least cost, because a company
may have to incur high marketing expenses to con-vince
consumers of quality.
Red Tape Companies frequently compare the degrees of red
tape needed to operate in given countries because red tape
increases their operating costs. Red tape includes the diffi-culty
of getting permission to operate; bringing in expatriate
personnel; obtaining licenses to produce and sell certain goods;
and satisfying government agencies on such matters as taxes,
labor conditions, and environmental compliance. For example,
Vietnam has thousands of government employees who have
the power to cause trouble for foreign businesses. Their dons
reflect not only what they think is the national interest, but also
their desire to pro-tect friends and state companies from
competition and to receive bribes for favors. As a result, such
companies as Raytheon and Sheraton Hotels have closed their
Vietnamese operations. The degree of red tape is not directly
measurable, so companies commonly rate countries subjectively
on this factor.
Risks
Is a projected rate of return of 9 percent in Bolivia the same as a
projected rate of 9 percent in France? Should a company
calculate return on investment (ROI) on the entire earnings of a
foreign subsidiary or just on the earnings that can be remitted
to the parent? Does it make sense for a company to accept a low
return in one country if doing so will help the company’s
competitive position elsewhere? Is it ever rational for a company
to invest in a country that has an uncertain political and
economic future? These are out a few of the unresolved ques-
tions that companies must consider when making international
capital-investment decisions.
Risk and Uncertainty Companies use a variety of financial
techniques to compare potential projects, including discounted
cash flow, economic value added, payback period, net present
value, return on sales, return on assets employed, internal rate
of return, accounting rate of return, and return on equity. The
differences among these techniques is best explained in a finance
course; however, the international implications of all of them
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 are roughly the same. We will refer only to ROI as a means of
INTERNATIONAL BUSINESS MANAGEMENT
explaining risk considerations in international business.
Given the same expected return, most decision makers prefer a
more certain outcome to a less certain one. To calculate an
estimated ROI, a company averages the various returns it deems
possible for investments. Table 9.1 shows that two identical
projected ROls may have very different certainties of achieve-
ment as well as different probabilities. In the table, the certainty
of a 10 percent-projected ROI is higher for investment B than
for investment A (40 percent versus 30 percent). Further, the
probability of earning at least 10 percent is also higher for B (.40
+. 30 = .70 or 70 percent) than for A (.30 + .20 + .15 = .65 or
65 percent).
Table 9.1comparison Of Roi Certainty
To determine the estimated return on investment, (1) multiply each ROI as a percentage by its
probability to derive a weighted value and (2) add the weighted values. (The weighted value is
probability X percentage.)
Investment A Investment B
———————————————————————————
ROI AS WIGHTED
PERSENTAGE PROBABLITY VALUE PROBABLITY
0 .15 0 0
5 .20 1.0 .30
10 .30 3.0 .40
15 .20 3.0 .30
20 .15 3.0 0 0.0
Estimated 10.0%
ROI
Experience shows that most, but not all, investors will choose
alternative B over alternative A In fact, as uncertainty increases,
investors may require a higher estimated ROI.
Often, companies may reduce risk or uncertainty by insuring.
However, insuring against nonconvertibility of funds or
expropriation is apt to be costly. In the initial process of
scanning to develop a manageable number of alternatives, the
company should give some weight to the elements of risk and
uncertainty. At the later and more detailed stage of the feasibility
study management should determine whether the degree of
risk is acceptable so that it does not incur additional costs. If it
is not, management needs to calculate an ROI that includes
expendi-tures-for example, for insurance-to increase the
outcome certainty of the operation.
When a company operates abroad, it usually has higher
uncertainty than at home because the foreign operations are in
environments with which it is less familiar. As a company gains
experience in operating in a particular country or in similar
countries, it improves its assess-ments of consumer, competi-
tor, and government actions-thereby reducing its uncertainty.. In
fact, foreign companies have a lower survival rate than local
companies for many years after they begin operations, a
situation known as the liability of foreignness. However, those
foreign companies that learn about their new environments and
manage to overcome their early problems have survival rates
comparable to those of local companies in later years. The
learning process also helps explain why companies often
evaluate reinvestments or expanded investments within a
country very differently from investments in a country where
they lack experience.
250
Competitive Risk A company’s innovative advantage may be
short-lived. Even when it has a substantial competitive lead
time, the time may vary among markets. One strategy for
exploiting temporary innovative advantages is known as the
imitation lag. To pursue this strategy, a company moves first to
those countries most likely to adapt and catch up to the
innovative advantage, and later to other countries. Those
countries apt to catch up more rapidly are the ones whose
companies invest a great deal in technology and whose govern-
ments offer little protection for the innovator’s intellectual
property rights. If the country also offers import protection, a
local producer can, despite inefficiencies, gain a cost advan-tage
over imported goods.
Companies also may develop strategies to find countries in
which there is least likely to be significant competition. For
example, in the opening case, we illustrated how Carrefour tries
to gain first-entry advantage in markets likely to grow. By being
the first major com-petitor in a market, it can gain the best
partners, best locations, and best suppliers. Similarly, a company
WIGHTED may reduce risk by avoiding overcrowded markets. For example,
VALUE
0 by 2002, 10 for-eign automobile companies had invested in
1.5
4.0 Chinese production. Although GM estimates that by 2025,
4.5 China will be the world’s third largest automobile market,
10.0% analysts agree that the market cannot sustain 10 manufacturers.
However; companies may gain advantages in locating where
competitors are. To begin with, the competitors may have
performed the costly task of evaluating locations, so a follower
may get a “free ride.” Moreover, there are clusters of competi-
tors (sometimes called agglomeration) in various
locations-think of all the computer firms in California’s Silicon
Valley. More recently, hundreds of high-tech computer compa-
nies from allover the work has located in Dubai. These clusters
attract multiple suppliers and personnel with specialized skills.
They also attract buyers who want to compare potential
suppliers but don’t want to travel great distances between them.
Companies operating in the cluster area may also gain better
access to information about new developments because they
frequently come in con-tact with personnel from the other
companies.
Monetary Risk If a company’s expansion occurs through
direct investment abroad, exchange rates on and access to the
invested capital and earnings are key considerations. The concept
of liquidity preference is a common theory that helps explain
companies’ cap- ital budgeting decisions in general and can be
applied to their international expansion decisions.
Liquidity preference is the theory that investors usually want
some of their holdings to be in highly liquid assets, on which
they are willing to take a lower return. Liquidity is needed ill part
to make near-term payments, such as paying out dividends; in
part to cover unex-pected contingencies, such as stockpiling
materials if a strike threatens supply; and in part to be able to
shift funds to even more profitable opportunities, such as
purchasing materials at a discount during a temporary price
depression.
Sometimes companies want to sell all or part of their equity in a
foreign facility so that the funds may be used for other types of
expansion endeavors. However, the ability to find local buyers
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varies substantially among countries and among industries,
depending largely on the existence of a local capital market and
on the potential for the operation being sold. For example, the
Mexican conglomerate, Grupo Carso, spun off its stake in
CompUSA, a process facilitated by CompUSA’s potential profits
and the developed U.S. capital market. However, when Nike
canceled a contract with an Indonesian-Korean joint venture in
Indonesia, the partners simply had to close the operation.
Assuming a company does find a purchaser for its foreign
facility, chances are that it intends to use the funds in another
country. If the funds are not convertible, the selling com-pany
will be forced to spend them in the host country. Of more
pressing concern for most investors is both the ability to
convert earnings from operations abroad and the cost of doing
so. It is not surprising that investors may be willing to accept a
lower projected ROI for pro-jects in countries with strong
currencies than for those in countries with weak currencies.
Present capital controls and recent exchange-rate stability are
useful indicators of countries’ monetary situation. Additionally,
companies need to predict countries’ likely future exchange rate
deterioration and exchange controls. Some indicators of future
problems are countries’ negative trade balances, declining official
reserves, high inflation, and government budget deficits.
Political Risk Political risk occurs because of changes in
political leaders’ opinions and policies, civil disorder, and
animosity between the host and other countries-particularly
with the company’s home country. It may cause property
takeovers as well as damage property, disrupt operations, and
cause a change in the rules governing business. Further, it may
create expensive operational adjustments. Recently, for example,
Unilever has encountered difficulty in attracting foreign execu-
tives to work in Pakistan because of security concerns,
Occidental Petroleum has had to dedicate funds to protect its
Colombian pipeline from rebel attacks, and Coca-Cola has had
interrupted services (police protection of its trucks and tele-
phone connections) in Angola because of its policy against
paying bribes. Managers use three approaches to predict political
risk: analyzing past patterns, using expert opinion, and
examining the social and economic conditions that might lead
to such risk.
Companies cannot help but be influenced by past patterns of
political risk. However, pre-dicting the risk on that basis holds
many dangers. Political situations may change rapidly for better
or worse as far as foreign companies are concerned. For
example, foreign direct investment into the United States fell
sharply after the 2001 terrorist attack in New York because
foreign firms saw the United States as less safe than before. In a
broader sense, expropriation of property occurred frequently in
the 1970s and early 1980s, but it has been negligible in recent
years. Nevertheless, companies continue to worry sufficiently
about takeovers so that many still seek insurance against them.
Substantial variations in political risk frequently exist within
countries as well. With the exception of a few countries,
government takeovers of companies have been highly selective.
Similarly, unrest that leads to property damage and disruption
of supplies or sales may not endanger the operations of all
foreign companies. This may be because of the limited
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geographic focus of the unrest. For example, companies
INTERNATIONAL BUSINESS MANAGEMENT
suffered no property damage or business disruption in Slovenia
after the breakup of Yugoslavia; however, they did experience
prob-lems in other areas in the former Yugoslavia.
Asset takeover or property damage does not necessarily mean a
full loss to investors Governments have preceded most
takeovers with a formal declaration of intent and have followed
with legal processes to determine the foreign investor’s compen-
sation. Companies may examine past settlement patterns as an
indicator of whether and how they may be compensated. In
addition to the asset’s book value, other factors may determine
the adequacy of compensation. First, the compensation may
earn a different return elsewhere. Second, other agreements
(such as purchase and management contracts) may create
additional benefits fir the former investor. In analyzing political
risk, managers should predict the likely loss if political prob-
lems occur.
Companies may also rely on experts’ opinions about a country’s
political situation, with the purpose of ascertaining how
influential people may sway future political events affecting
business. The first step is reading statements made by political
leaders both in and out of -office to determine their philoso-
phies on business in general, foreign input to business, the
means of effecting economic changes, and their feelings toward
given foreign countries. Modern technology has improved
access to press reports in foreign countries. Online services
include full-text reports from newspapers and television from
major parts of the world, and reports are sometimes available
within hours of the original publication or broadcast. However,
published statements may appear too late for a company to
react. The second Step is for managers to visit the country and
“listen” to a cross-section of opinions. Embassy offi-cials and
foreign and local businesspeople are useful sources of opinions
about the probabil-ity and direction of change. Journalists,
academicians, middle-level local government author-ities, and
labor leaders usually reveal their own attitudes, which often
reflect changing political conditions that may affect the business
sector. These attitudes are particular important in countries
without a well-defined and transparent legal system. For
example many U.S. companies have shied away from making
investments in Russia because Russia.:. tax and regulatory laws
are so unstable and unpredictable.
Companies may determine opinions more systematically by
relying on analysts with experience in a country. These analysts
might rate a country on specific political conditions that could
lead to problems for foreign businesses, such as the fractional-
ization of political parties that could cause disruptive changes in
government. A company also may rely on commercial risk-
assessment services, such as those published by Business
International, Economist Intelligence Unit, Euromoney,
Political Risk Services (PRS), Bank of American World Informa-
tion Services, Control Risks Information Services (CRIS),
Institutional Investor, Moody’s Investors Service, S. J. Rundt &
Associates, Standard & Poor’s Ratings Group, and Business
Environment Risk Information (BERI). In fact, companies
have been relying more on these services rather than on their
internal generation of risk analyses. In essence, their reports
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 generated internally are often too lengthy or abstract to be
INTERNATIONAL BUSINESS MANAGEMENT

useful. Further, they are often not seen as credible by manage-

ment decision makers.
Finally, companies may examine countries’ social and economic
conditions that could lead to political instability. However, there
is no general consensus as to what constitutes dangerous
instability or how such instability can be predicted. The lack of
consensus is illustrated by the diverse reactions of companies to
the same political situations. For example, before the coali-tion
forces defeated Iraq’s Hussein government in 2003 most MNEs
shunned investing in Iraq because of political uncertainty-U.S.
companies were not allowed to invest-but some com-panies
made large foreign investments there. Further, different
nationalities of companies may perceive risks to be different for
the same locales, generally because of differences in their
familiarity with the locales. Other uncertainties include the time
lag between a political event and an investor’s ability to react.
However, similar symptoms of political instability may result in
different consequences for business in different countries. At
times, political parties may change rapidly with little effect on
business; at other times, sweeping changes for business may
occur without a change in government. Rather than political
stability itself, the direction of change in government seems to
be very important. But even if a company accurately pre-dicts
the direction of change in government that will affect business,
it will still be uncertain at to the time lag between the change
and its effect.
Frustration occurs when there is a difference between a country’s
level of aspirations and its level of welfare and expectations-the
higher the difference, the higher the level of frustration. If there
is a great deal of frustration in a country, groups may disrupt
business by calling general strikes and destroying property and
supply lines. They might also replace government leaders.
Moreover, frustrated groups and political leaders might try to
blame problems on foreigners and make threats against foreign
governments as well as expropriate foreign properties or change
the rules for foreign-owned companies. But what is frustration?
It is dis-satisfaction as a result of unfulfilled needs. One cannot
measure frustration directly. Nor can it be said that one country
has higher frustration than another simply because it is poorer.
People in the poorer country may either be aspiring for less, or
they may expect their aspira-tions to be fulfilled with present
political directions. Companies may examine growth in
urbanization, literacy, televisions per capita, advertising expendi-
tures, and labor unionization as indicators of growing
aspirations. Such companies may examine infant survival rates.
Caloric consumption, hospital beds per capita, piped water
supply per capita, and income per capita as indicators of welfare.
They may then compare the indicators of aspirations with
indicators of welfare to gain a sense of frustration levels.

Notes -

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