Globalization

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What Is Globalization?

The world is moving away from self-contained national economies toward an interdependent, integrated global economic systemGlobalization refers to the shift toward a more integrated and interdependent world economy

Globalization has two facets:

1) the globalization of markets

2) the globalization of production

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The Globalization Of Markets

The globalization of markets refers to the merging of historically distinct and separate national markets into one huge global marketplaceIn many industries, it is no longer meaningful to talk about the “German market” or the “American market”Instead, there is only the global market

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The Globalization Of Markets

Falling trade barriers make it easier to sell internationallyThe tastes and preferences of consumers are converging on some global normFirms help create the global market by offering the same basic products worldwide

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Drivers Of Globalization

Two macro factors underlie the trend toward greater globalization:the decline in barriers to the free flow of goods, services, and capital that has occurred since the end of World War IItechnological change

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The Globalization Debate

Is the shift toward a more integrated and interdependent global economy a good thing?Supporters believe that increased trade and cross-border investment mean lower prices for goods and services, greater economic growth, higher consumer income, and more jobsCritics worry that globalization will cause job losses, environmental degradation, and the cultural imperialism of global media and MNEs

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Globalization, Jobs, And Income

Globalization critics argue that falling barriers to trade are destroying manufacturing jobs in advanced countriesSupporters of globalization contend that the benefits of this trend outweigh the costs—that countries will specialize in what they do most efficiently and trade for other goods—and all countries will benefit

Foreign Direct Investment

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Introduction

Foreign direct investment (FDI) occurs when a firm invests directly in new facilities to produce and/or market in a foreign countryOnce a firm undertakes FDI it becomes a multinational enterprise

FDI can be:greenfield investments - the establishment of a wholly new operation in a foreign countryacquisitions or mergers with existing firms in the foreign country

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Foreign Direct Investment In The World Economy

The flow of FDI refers to the amount of FDI undertaken over a given time period The stock of FDI refers to the total accumulated value of foreign-owned assets at a given time Outflows of FDI are the flows of FDI out of a countryInflows of FDI are the flows of FDI into a country

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Trends In FDI

There has been a marked increase in both the flow and stock of FDI in the world economy over the last 30 years

FDI has grown more rapidly than world trade and world output because:firms still fear the threat of protectionism the general shift toward democratic political institutions and free market economies has encouraged FDIthe globalization of the world economy is having a positive impact on the volume of FDI as firms undertake FDI to ensure they have a significant presence in many regions of the world

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The Direction Of FDI

Most FDI has historically been directed at the developed nations of the world, with the United States being a favorite target FDI inflows have remained high during the early 2000s for the United States, and also for the European UnionSouth, East, and Southeast Asia, and particularly China, are now seeing an increase of FDI inflowsLatin America is also emerging as an important region for FDI

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The Direction Of FDI

Gross fixed capital formation summarizes the total amount of capital invested in factories, stores, office buildings, and the like All else being equal, the greater the capital investment in an economy, the more favorable its future prospects are likely to be So, FDI can be seen as an important source of capital investment and a determinant of the future growth rate of an economy

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The Source Of FDI

Since World War II, the U.S. has been the largest source country for FDIThe United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries

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The Form Of FDI: Acquisitions Versus Greenfield Investments

Most cross-border investment is in the form of mergers and acquisitions rather than greenfield investments

Firms prefer to acquire existing assets because: mergers and acquisitions are quicker to execute than greenfield investmentsit is easier and perhaps less risky for a firm to acquire desired assets than build them from the ground upfirms believe that they can increase the efficiency of an acquired unit by transferring capital, technology, or management skills

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The Shift To Services

FDI is shifting away from extractive industries and manufacturing, and towards services

The shift to services is being driven by: the general move in many developed countries toward servicesthe fact that many services need to be produced where they are consumeda liberalization of policies governing FDI in servicesthe rise of Internet-based global telecommunications networks

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Theories Of Foreign Direct Investment

Why do firms invest rather than use exporting or licensing to enter foreign markets?Why do firms from the same industry undertake FDI at the same time?How can the pattern of foreign direct investment flows be explained?

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Why Foreign Direct Investment?

Why do firms choose FDI instead of:exporting - producing goods at home and then shipping them to the receiving country for sale

or licensing - granting a foreign entity the right to produce and sell the firm’s product in return for a royalty fee on every unit that the foreign entity sells

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Why Foreign Direct Investment?

An export strategy can be constrained by transportation costs and trade barriers Foreign direct investment may be undertaken as a response to actual or threatened trade barriers such as import tariffs or quotas

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Why Foreign Direct Investment?

Internalization theory (also known as market imperfections

theory) suggests that licensing has three major drawbacks:licensing may result in a firm’s giving away valuable technological know-how to a potential foreign competitorlicensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitabilitya problem arises with licensing when the firm’s competitive advantage is based not so much on its products as on the management, marketing, and manufacturing capabilities that produce those products

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The Pattern Of Foreign Direct Investment

Firms in the same industry often undertake foreign direct investment around the same time and tend to direct their investment activities towards certain locationsKnickerbocker looked at the relationship between FDI and rivalry in oligopolistic industries (industries composed of a limited number of large firms) and suggested that FDI flows are a reflection of strategic rivalry between firms in the global marketplaceThe theory can be extended to embrace the concept of multipoint competition (when two or more enterprises encounter each other in different regional markets, national markets, or industries)

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Benefits And Costs Of FDI

Government policy is often shaped by a consideration of the costs and benefits of FDI

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Host-Country Benefits

There are four main benefits of inward FDI for a host

country:

1. resource transfer effects - FDI can make a positive contribution to a host economy by supplying capital, technology, and management resources that would otherwise not be available

2. employment effects - FDI can bring jobs to a host country that would otherwise not be created there

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Host-Country Benefits

3. balance of payments effects - a country’s balance-of-payments account is a record of a country’s payments to and receipts from other countries. The current account is a record of a country’s export and import of goods and servicesGovernments typically prefer to see a current account surplus than a deficit FDI can help a country to achieve a current account surplus if the FDI is a substitute for imports of goods and services, and if the MNE uses a foreign subsidiary to export goods and services to other countries

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Host-Country Benefits

4. effects on competition and economic growth - FDI in the form of greenfield investment increases the level of competition in a market, driving down prices and improving the welfare of consumersIncreased competition can lead to increased productivity growth, product and process innovation, and greater economic growth

The Foreign Exchange Market

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Introduction

A firm’s sales, profits, and strategy are affected by events in the foreign exchange marketThe foreign exchange market is a market for converting the currency of one country into that of another countryThe exchange rate is the rate at which one currency is converted into another

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The Functions Of The Foreign Exchange Market

The foreign exchange market:is used to convert the currency of one country into the currency of anotherprovide some insurance against foreign exchange risk (the adverse consequences of unpredictable changes in exchange rates)

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Currency Conversion

International companies use the foreign exchange market when: the payments they receive for exports, the income they receive from foreign investments, or the income they receive from licensing agreements with foreign firms are in foreign currencies they must pay a foreign company for its products or services in its country’s currency they have spare cash that they wish to invest for short terms in money markets they are involved in currency speculation (the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates)

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Insuring Against Foreign Exchange Risk

The foreign exchange market can be used to provide insurance to protect against foreign exchange risk (the possibility that unpredicted changes in future exchange rates will have adverse consequences for the firm)A firm that insures itself against foreign exchange risk is hedging

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Insuring Against Foreign Exchange Risk

The spot exchange rate is the rate at which a foreign exchange dealer converts one currency into another currency on a particular daySpot rates change continually depending on the supply and demand for that currency and other currencies

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Insuring Against Foreign Exchange Risk

To insure or hedge against a possible adverse foreign exchange rate movement, firms engage in forward exchangesA forward exchange occurs when two parties agree to exchange currency and execute the deal at some specific date in the future A forward exchange rate is the rate governing such future transactionsRates for currency exchange are typically quoted for 30, 90, or 180 days into the future

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Insuring Against Foreign Exchange Risk

A currency swap is the simultaneous purchase and sale of a given amount of foreign exchange for two different value datesSwaps are transacted between international businesses and their banks, between banks, and between governments when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange rate risk

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The Nature Of The Foreign Exchange Market

The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems—it is not located in any one place The most important trading centers are London, New York, Tokyo, and SingaporeThe markets is always open somewhere in the world—it never sleeps

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The Nature Of The Foreign Exchange Market

High-speed computer linkages between trading centers around the globe have effectively created a single market—there is no significant difference between exchange rates quotes in the differing trading centersIf exchange rates quoted in different markets were not essentially the same, there would be an opportunity for arbitrage (the process of buying a currency low and selling it high), and the gap would closeMost transactions involve dollars on one side—it is a vehicle currency along with the euro, the Japanese yen, and the British pound

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Economic Theories Of Exchange Rate Determination

Exchange rates are determined by the demand and supply for different currencies.

Three factors impact future exchange rate movements: a country’s price inflation a country’s interest rate market psychology

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Prices And Exchange Rates

The law of one price states that in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in terms of the same currency Purchasing power parity (PPP) theory argues that given relatively efficient markets (markets in which few impediments to international trade and investment exist) the price of a “basket of goods” should be roughly equivalent in each countryPPP theory predicts that changes in relative prices will result in a change in exchange rates

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Prices And Exchange Rates

A positive relationship between the inflation rate and the level of money supply exists When the growth in the money supply is greater than the growth in output, inflation will occur PPP theory suggests that changes in relative prices between countries will lead to exchange rate changes, at least in the short runA country with high inflation should see its currency depreciate relative to othersEmpirical testing of PPP theory suggests that it is most accurate in the long run, and for countries with high inflation and underdeveloped capital markets

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Interest Rates And Exchange Rates

There is a link between interest rates and exchange ratesThe International Fisher Effect states that for any two countries the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between two countries In other words:

(S1 - S2) / S2 x 100 = i $ - i ¥ where i $ and i ¥ are the respective nominal interest rates in two countries (in this case the US and Japan), S1 is the spot exchange rate at the beginning of the period and S2 is the spot exchange rate at the end of the period

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Summary

Relative monetary growth, relative inflation rates, and nominal interest rate differentials are all moderately good predictors of long-run changes in exchange rates So, international businesses should pay attention to countries’ differing monetary growth, inflation, and interest rates

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Exchange Rate Forecasting

Should companies use exchange rate forecasting services to aid decision-making?

The efficient market school argues that forward exchange rates do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of moneyThe inefficient market school argues that companies can improve the foreign exchange market’s estimate of future exchange rates by investing in forecasting services

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Approaches To Forecasting

There are two schools of thought on forecasting:Fundamental analysis draw upon economic factors like interest rates, monetary policy, inflation rates, or balance of payments information to predict exchange ratesTechnical analysis charts trends with the assumption that past trends and waves are reasonable predictors of future trends and waves

Entry Strategy and

Strategic Alliances

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Introduction

Firms expanding internationally must decide: which markets to enter when to enter them and on what scale which entry mode to use

Entry modes include: exporting licensing or franchising to a company in the host nation establishing a joint venture with a local company establishing a new wholly owned subsidiary acquiring an established enterprise

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Introduction

Several factors affect the choice of entry mode including: transport costs trade barriers political risks economic risks costs firm strategy

The optimal mode varies by situation – what makes sense for one company might not make sense for another

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Basic Entry Decisions

Firms entering foreign markets make three basic decisions:

1. which markets to enter

2. when to enter those markets

3. on what scale to enter those markets

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Which Foreign Markets?

The choice of foreign markets will depend on their long run profit potential

Favorable markets are politically stable developed and developing nations with free market systems and relatively low inflation rates and private sector debt

Less desirable markets are politically unstable developing nations with mixed or command economies, or developing nations with excessive levels of borrowing

Markets are also more attractive when the product in question is not widely available and satisfies an unmet need

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Timing Of Entry

Once attractive markets are identified, the firm must consider the timing of entry

Entry is early when the firm enters a foreign market before other foreign firms

Entry is late when the firm enters the market after firms have already established themselves in the market

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Timing Of Entry

First mover advantages are the advantages associated with entering a market early

First mover advantages include: the ability to pre-empt rivals and capture demand by

establishing a strong brand name the ability to build up sales volume in that country and

ride down the experience curve ahead of rivals and gain a cost advantage over later entrants

the ability to create switching costs that tie customers into products or services making it difficult for later entrants to win business

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Timing Of Entry

First mover disadvantages are disadvantages associated with entering a foreign market before other international businesses

First mover disadvantages include: pioneering costs - arise when the foreign business system is so

different from that in a firm’s home market that the firm must devote considerable time, effort and expense to learning the rules of the game

Pioneering costs include: the costs of business failure if the firm, due to its ignorance of the

foreign environment, makes some major mistakes the costs of promoting and establishing a product offering, including

the cost of educating customers

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Scale Of Entry And Strategic Commitments

After choosing which market to enter and the timing of entry, firms need to decide on the scale of market entry

Entering a foreign market on a significant scale is a major strategic commitment that changes the competitive playing field

Firms that enter a market on a significant scale make a strategic commitment to the market (the decision has a long term impact and is difficult to reverse)

Small-scale entry has the advantage of allowing a firm to learn about a foreign market while simultaneously limiting the firm’s exposure to that market

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Entry Modes

These are six different ways to enter a foreign market:1. exporting2. turnkey projects3. licensing4. franchising5. establishing joint ventures with a host country firm6. setting up a new wholly owned subsidiary in the host

country

Managers need to consider the advantages and disadvantages of each entry mode

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Selecting An Entry Mode

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