INTERNATIONAL BUSINESS MANAGEMENT

LESSON 3:
INTERNATIONAL BUSINESS APPROACHES

International business approaches are similar to the stages of 2. Polycentric Approach

internationalization or globalization. Douglas Wind and The domestic companies, which are exporting to foreign
Pelmutter advocated four approaches of international business. countries using the ethnocentric approach, find at the latter stage
They are: that the foreign markets need an altogether different approach. .
1. Echnocentric Approach Then, the company establishes a foreign subsidiary company
The domestic companies normally formulate their strategies. and decentralists all the operations and delegates
Their product design and their operations towards the national decisionmaking and policy-making authority to its executives.
markets, customers and competitors. But, the excessive In fact, the company appoints executives and personnel
production more than the demand for the product, either due including a chief executive who reports directly to the Managing
to competition or due to changes in customer preferences push Director of the company. Company appoints the key personnel
the company to export the excessive production to foreign from the home country and the people of the host country fill
countries. The domestic company continues the exports to the all other vacancies.
foreign countries and views the foreign markets as an extension
to the domestic markets just like a new region. The executives at
the head office of the company make the decisions relating to
exports and, the marketing personnel of the domestic company
monitor the export operations with the help of an export
department.
The company exports the same product designed for domestic
markets to foreign countries under this approach. Thus,
maintenance of domestic approach towards international
business is called ethnocentric approach.

Managing
Director

Manager Manager Manager Manager Manager

R&D Finance Production Human Marketing
Resources

Assistant Manger Assistant Manager Assistant Manager

North India South India Exports

Organization structure of Ethnocentric company

This approach is suitable to the companies during the early days
of internationalization and also to the smaller companies.

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INTERNATIONAL BUSINESS MANAGEMENT

Managing
Director

CEO
Foreign Subsidiary
(Uganda)

Manager Manager Manager Manager Manager

R&D Finance Production Human Resource Marketing

Organization Structure Of Polycentric Company 4. Geocentric approach

3. Regiocentric Approach
The company after operating successfully in a foreign country,
thinks of exporting to the neighboring countries of the host
country. At this stage, the foreign subsidiary considers the
regions environment (for example, Asian environment like laws,
culture, policies etc.) for formulating policies and strategies.
However, it markets more or less the same product designed
Under this approach, the entire world is just like a single country
for the company. They select the employees from the entire
globe and operate with a number of subsidiaries. The head-
quarter coordinates the activities of the subsidiaries. Each
subsidiary functions like an independent and autonomous
company in formulating policies, strategies, product design,
human resource policies, operations etc.

Managing
Director

CEO
Foreign Subsidiary
(Uganda)

Manager Manager Manager Manager Manager

R&D Finance Production Human Resource Marketing

under polycentric approach in other countries of the region, but

with different market strategies.

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Fig 1.4 helps to understand the concept of geocentric approach
clearly.
Managing
Director
Manager Manager Manager
R&D Finance Production
Fig 1.4 Organization Structure of Geocentric Company
Theories Of International Business
The fundamental question that arises for most of us at this
juncture, is why should the business firms of one country
should go to the another country, when the industries of that
country also produce goods and market them. What is the basis
for international business? A number of theories have been
developed to explain the basis for international business
Comparative Cost Theory
It is quite common that some countries have the advantage of
producing some goods at a lower cost compared to other
countries. This is due to the availability of cheap labour, skilled
labour, cheap and qualitative raw materials, advanced technol-
ogy, competent management practices etc. Availability of these
factors enhances productivity and thereby reduces the cost of
production per unit. Similarly, other countries have this
advantage in producing other goods. For example, Japan has the
advantage in producing electronics at low cost whereas India has
similar advantage in producing textiles.
According to comparative cost theory the countries in the long
run will tend to specialize in the business (production and
marketing) of those goods in whose business they enjoy
comparative low cost advantage and import other goods in
which the countries have comparative cost disadvantage, if free
trade is allowed. This specialization helps for the mutual
advantage of the countries participating, in the international
business.
David Ricardo illustrated the Comparative Cost Theory in 1817.
He used a two country, two commodity model. The conclu-
sions of his model are:
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11.625.1
Business between two countries is profitable when a country
INTERNATIONAL BUSINESS MANAGEMENT
produces one good at a lower cost than other country and that
CEO
Foreign Subsidiary
(Uganda)
Manager Manager
Human Resource Marketing
other produces another good at a lower cost than the former
country.
Business between two countries is also profitable when one
country produces more than one product efficiently, but, when
it produces one of these products comparatively at greater
efficiency than the other product.
Both the nations can engage in international business when one
country specializes in the production in which it has greater
efficiency in production.
Assumptions of the Theory : The assumptions of the
comparative cost theory include:
• The only element of cost of production is, labour.
• Production is subject to the law of constant returns.
• There are no trade barriers.
• Trade is free from cost of transportation.
Derivates of the Theory: The advantages desired from this
theory are:
• Efficient allocation of global resources.
• Maximization of global production at the least possible cost.
• Product price, become more or less equal among world
markets.
• Demand for resources and products among world nations
will be optimized
Thus, we learn from this theory that, the basis for international
business is the comparative advantage of the nations to
produce certain products at lower cost than other countries.
The Opportunity Cost Theory
Another example is that, India produces textile garments by
utilizing its human resources worth of Rs I billion and exports
to the US in 1999. The opportunity cost of this project is, had
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 India developed software packages by utilizing the same human
INTERNATIONAL BUSINESS MANAGEMENT
resources and exported the same to USA in 1999, the worth of
the exports would have been Rs 10 billion.
Opportunity cost approach specifies the cost in terms of the
value of the alternatives, which have to be foregone in order to
fulfill a specific act.
Thus, this theory provides the basis for international business
in terms of exporting a particular product rather than other
products. The previous example suggests that it would be I
India to develop and export software packages rather than
textile garments to USA.
We slightly modify the previous example. For example, assume
that India earned Rs 15 billion by exporting the same software
packages to UK in 1999 rather than to USA. This theory
suggests that the opportunity cost of India’s software exports
to USA in 1999 is Rs 15 billion.
Thus, this theory also provides the basis for international
business of exporting a product to a particular country rather to
another country.
The Modern Theory of Factor
Endowments (Heckscher Ohlin Thesis)
Bertil Ohlin and Eli Heckscher explained the basis of interna-
tional business in terms of factor endowment. This theory
explains the reasons for comparative cost differences. They are:
Different prevailing endowments of the factors of production
and Different factors of production are to be used in different
degrees of intensity for producing different goods.
According to this theory a country will specialize in the produc-
tion and export of those goods whose ratio between capital
and other factors of production is higher than those in other
countries.
Assumptions: HeckscherOhlin theory is built on the following
assumptions:
Perfect competition is in existence for both product and
factors in both the countries.
Factors of production are fixed in each country.
Factors of production are of equal quality in both the
countries.
Factors of production have full employment in both the
countries
Factors endowments vary from one country to another
country.
Business between two countries is free from all barriers.
There is no cost of transportation,
Production in both the countries is subject to law of
returns
Factor intensity varies between goods.
Merits : Despite the assumptions, this theory enjoys the
following merits:
This theory provides more valid basis for the existence of
international business compared to the other theories.
• This theory is superior to the comparative cost theory as it
provides the reasons for the difference in cost of production
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in two countries in terms of differences in factor
endowments.
• The theory specifies that international business is an
extension to domestic or interregional trade.
Hence, this theory is viewed as the modern theory of
international business. This theory is also called General
Equilibrium Theory of international business as it deals
with the equilibrium between demand for and supply of the
products.
• This theory indicates the impact of international business on
product and factor prices.
Derivatives:
The ultimate conclusions we draw from this theory are:
• Price of the internationally traded products tend to be
equalized in all the countries of the globe and in all the
regions of each country. However, existence of the cost of
transportation and nonexistence of perfect competition are
the limitations to this conclusion.
• Prices of factors of production also tend to equalize across
the globe. However, existence of the cost of transportation
and the nonexistence of the perfect competition are the
limitations to this conclusion also.
Ultimately we can learn from this theory that the tendency of
equilibrium of product/service prices and the prices of factors
of production is the basis for international business.
Adam Smith’s Theory of Absolute Differences in Cost
According to Adam Smith, every country should specialize in
producing those products, which it can produce at less, cost
than that of other countries and exchange these products with
other products. These other products are produced absolutely at
less cost by other countries. According to Smith, “whether the
advantage which one country has over another be natural or
acquired, is in this respect of no consequence.”
Criticism: According to this theory every country should be able
to produce certain products at low cost compared to other
countries and should produce certain other products at
comparatively high price than other countries. International
trade takes place only under such condition. But, in reality most
of the developing countries do not have absolute advantage of
producing at lowest cost any commodity, yet they participate in
international business.
The Productivity Theory
It is criticised that the comparative cost theories are not
applicable to developing countries. Hence, H.Myint proposed
productivity theory and the vent for surplus theory.
The productivity theory points toward indirect and direct
benefits. This theory emphasises that the process of
specialisation involves adapting and reshaping the production
structure of a trading country to meet the export demands.
Countries increase productivity in order to utilise the gains of
exports. This theory encourages the developing countries to go
for cash crops, increase productivity by enhancing the efficiency
of human resources, adapting latest technology etc.
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Limitations: However, this theory has also certain limitations.

INTERNATIONAL BUSINESS MANAGEMENT

• Labour productivity did not increase after certain level
• Increase in working hours
• Increase in proportion of gainfully employed labour in
proportion to disguised unemployed Labour.
The Vent for Surplus Theory
International trade absorbs the output of unemployed factors.
If the countries produce more than the domestic requirements,
they have to export the surplus to other countries. Otherwise, a
part of the productive labour of the country must cease and the
value of its annual Produce diminishes.
Thus, in the absence of foreign trade, they would be surplus
productive capacity in the country. This surplus productive
capacity is taken by another country and in turn gives the benefit
under international trade.
Appropriateness of this Theory for Developing Countries:
According to this theory, the factors of production of develop-
ing countries are fully utilised. The unemployed labour of the
developing countries is profitably employed when the vent for
surplus is exported.
International trade permits for more efficient use of capital and
labour. Hence I.S. Mill described this theory as, “surving relic of
the Mercantile Theory.”
Mill’s Theory of Reciprocal Demand
Comparative cost advantage theories. do not explain the ratios
at which commodities are exchanged for one another. J.S. Mill
introduced the concept of ‘reciprocal demand’ to explain the
determinations of the equilibrium terms of trade. Reciprocal
demand indicates a country’s demand for one commodity in
terms of the other commodity; it is prepared to give up in
exchange. Reciprocal demand determines the terms of trade and
relative share of each country.
Equilibrium = Quality of a product exported by country A
Quality of another product exported by country B
Assumptions: Assumptions of this theory are: Existence of
two countries, trade in only two goods, both the goods are
produced under the law of constant returns, absence of
transportation Costs. Existence of perfect competition and
existence of full employment.
Tutorial
Questions for Discussion
Q1) What are the various approaches to International Business.
Q2) Distinguish between Absolute advantage theory and
Comparative Advantage Theory of International Trade
Q3) What do you understand by Heckscher Ohlin Theory of
International Trade. What are its assumptions/
Notes:

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