SOM 354 Final Review Practice Short Answer Questions
Briefly describe the pegged exchange rate regime
Under a pegged exchange rate regime, a country will peg the value of its currency to that of a major currency so that, for example, as the United States dollar rises in value, its own currency rises too. -Pegged exchange rates are popular among many of the world's smaller nations. -As with a full fixed exchange rate regime, the great virtue claimed for a pegged exchange rate regime is that it imposes monetary discipline on a country and leads to low inflation. -Evidence shows that adopting a pegged exchange rate regime moderates inflationary pressures in a country. -Many countries operate with only a nominal peg and in practice are willing to devalue their currency rather than pursue a tight monetary policy. -It can be very difficult for a smaller country to maintain a peg against another currency if capital is flowing out of the country and foreign exchange traders are speculating against the currency.
Differentiate between a free trade area and a customs union. Provide an example of each form of economic integration.
-In a free trade area, all barriers to the trade of goods and services among member countries are removed. -In a theoretically ideal free trade area, no discriminatory tariffs, quotas, subsidies, or administrative impediments are allowed to distort trade between member nations. -Each country, however, is allowed to determine its own trade policies with regard to nonmembers. -A customs union eliminates trade barriers between member countries and adopts a common external policy. -Though countries in both free trade areas and customs unions are committed to removing all barriers to the free flow of goods and services between each other, those in the former pursue independent external trade policies while those in the latter commit to pursue a common external trade policy.
What is an experience curve? What is its strategic significance?
The experience curve refers to systematic reductions in production costs that have been observed to occur over the life of a product. -A product's production costs decline by some quantity about each time cumulative output doubles. -Two things explain this: ((((learning effects)))) and ((((economies of scale)))) -Learning effects refer to cost savings that come from learning by doing. -Economies of scale refer to the reductions in unit cost achieved by producing a large volume of a product. -Moving down the experience curve allows a firm to reduce its cost of creating value and increase its profitability. -The firm that moves down the experience curve most rapidly will have a cost advantage as compared to its competitors.
Discuss the significance of value creation. According to Michael Porter, what are two primary strategies for creating value?
The way to increase the profitability of a firm is to create more value. -The amount of value a firm creates is measured by the difference between its costs of production and the value that consumers perceive in its products. -Michael Porter has argued that (((((low cost))))) and (((((differentiation))))) are two basic strategies for creating value and attaining a competitive advantage in an industry. -According to Porter, superior profitability goes to those firms that can create superior value, and the way to create superior value is to drive down the cost structure of the business and/or differentiate the product in some way so that consumers value it more and are prepared to pay a premium price.
Define trade creation and trade diversion with respect to regional economic integration.
Trade creation occurs when high-cost domestic producers are replaced by low-cost producers within the free trade area. -It may also occur when higher-cost external producers are replaced by lower-cost external producers within the free trade area. Trade diversion occurs when lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. -A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amount it diverts.
Despite its advantages, FDI has been described as an "expensive" and "risky" international growth strategy. Why is FDI expensive and risky when compared to licensing and exporting?
-FDI is expensive because a firm must bear the costs of establishing production facilities in a foreign country or of acquiring a foreign enterprise. -FDI is risky because of the problems associated with doing business in a different culture where the rules of the game may be very different. -Relative to indigenous firms, there is a greater probability that a foreign firm undertaking FDI in a country for the first time will make costly mistakes due to its ignorance. -When a firm exports, it need not bear the costs associated with FDI, and it can reduce the risks associated with selling abroad by using a native sales agent. -Similarly, when a firm allows another enterprise to produce its products under license, the licensee bears the costs or risks.
What is meant by carry trade? Why is it risky? Explain with an example.
A kind of speculation that has become more common in recent years is known as the carry trade. -The carry trade involves borrowing in one currency where interest rates are low, and then using the proceeds to invest in another currency where interest rates are high. -The speculative element of this trade is that its success is based upon a belief that there will be no adverse movement in exchange rates (or interest rates for that matter) that will make the trade unprofitable.
Describe the localization strategy.
A localization strategy focuses on increasing profitability by customizing the firm's goods or services so that they provide a good match to tastes and preferences in different national markets. -Localization is most appropriate when there are substantial differences across nations with regard to consumer tastes and preferences, and where cost pressures are not too intense. -By customizing the product offering to local demands, the firm increases the value of that product in the local market. -On the downside, because it involves some duplication of functions and smaller production runs, customization limits the ability of the firm to capture the cost reductions associated with mass-producing a standardized product for global consumption. -The strategy may make sense, however, if the added value associated with local customization supports higher pricing, which enables the firm to recoup its higher costs, or if it leads to substantially greater local demand, enabling the firm to reduce costs through the attainment of some scale economies in the local market. -At the same time, firms still have to keep an eye on costs. -Firms pursuing a localization strategy still need to be efficient and, whenever possible, to capture some scale economies from their global reach.
In the context of the internalization theory, explain why licensing may not be an attractive option.
According to internalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities: 1) First, licensing may result in a firm's giving away valuable technological know-how to a potential foreign competitor. 2) Second, licensing does not give a firm the tight control over manufacturing, marketing, and strategy in a foreign country that may be required to maximize its profitability. -With licensing, control over manufacturing, marketing, and strategy are granted to a licensee in return for a royalty fee. -However, for both strategic and operational reasons, a firm may want to retain control over these functions. 3) A third problem with licensing arises when the firm's competitive advantage is based not as much on its products as on the management, marketing, and manufacturing capabilities that produce those products. -The problem is that such capabilities are often not amenable to licensing.
Describe flexible manufacturing and mass customization as important factors in location decisions.
Central to the concept of economies of scale is the idea that the best way to achieve high efficiency, and hence low unit costs, is through the mass production of a standardized output. -The trade-off implicit in this idea is between unit costs and product variety. Producing greater product variety from a factory implies shorter production runs, which in turn implies an inability to realize economies of scale. -Wide product variety makes it difficult for a company to increase its production efficiency and thus reduce its unit costs. -According to this logic, the way to increase efficiency and drive down unit costs is to limit product variety and produce a standardized product in large volumes. -This view of production efficiency has been challenged by the rise of flexible manufacturing technologies. The term flexible manufacturing technology—or lean production, as it is often called —covers a range of manufacturing technologies designed to (1) reduce setup times for complex equipment, (2) increase the utilization of individual machines through better scheduling, and (3) improve quality control at all stages of the manufacturing process. -Flexible manufacturing technologies allow the company to produce a wider variety of end products at a unit cost that at one time could be achieved only through the mass production of a standardized output.
Describe the entry modes that a firm with core competency in technological know-how can choose.
If a firm's competitive advantage (its core competence) is based on control over proprietary technological know how, licensing and joint-venture arrangements should be avoided if possible to minimize the risk of losing control over that technology. -Thus, if a high-tech firm sets up operations in a foreign country to profit from a core competency in technological know-how, it will probably do so through a wholly owned subsidiary. -Sometimes a licensing or joint-venture arrangement can be structured to reduce the risk of licensees or joint-venture partners expropriating technological know-how. -Another exception exists when a firm perceives its technological advantage to be only transitory, such as when it expects rapid imitation of its core technology by competitors. In such cases, the firm might want to license its technology as rapidly as possible to foreign firms to gain global acceptance for its technology before the imitation occurs. -By licensing its technology to competitors, the firm may deter them from developing their own, possibly superior, technology. -Further, by licensing its technology, the firm may establish its technology as the dominant design in the industry. -However, the attractions of licensing are frequently outweighed by the risks of losing control over technology, and if this is a risk, licensing should be avoided.
What is a wholly owned subsidiary? List its advantages.
In a wholly owned subsidiary, the firm owns 100 percent of the stock. -Establishing a wholly owned subsidiary in a foreign market can be done two ways. ((((The firm either can set up a new operation in that country, often referred to as a greenfield venture)))) or it can ((((acquire an established firm in that host nation and use that firm to promote its products))))) There are several clear advantages of wholly owned subsidiaries. 1) First, when a firm's competitive advantage is based on technological competence, a wholly owned subsidiary will often be the preferred entry mode because it reduces the risk of losing control over that competence. -Many high-tech firms prefer this entry mode for overseas expansion. 2) Second, a wholly owned subsidiary gives a firm tight control over operations in different countries. This is necessary for engaging in global strategic coordination. 3) Third, a wholly owned subsidiary may be required if a firm is trying to realize location and experience curve economies. When cost pressures are intense, it may pay a firm to configure its value chain in such a way that the value added at each stage is maximized. -Thus, a national subsidiary may specialize in manufacturing only part of the product line or certain components of the end product, exchanging parts and products with other subsidiaries in the firm's global system. -Establishing such a global production system requires a high degree of control over the operations of each affiliate. The various operations must be prepared to accept centrally determined decisions as to how they will produce, how much they will produce, and how their output will be priced for transfer to the next operation. Because licensees or joint-venture partners are unlikely to accept such a subservient role, establishing wholly owned subsidiaries may be necessary. Finally, establishing a wholly owned subsidiary gives the firm a 100 percent share in the profits generated in a foreign market.
In terms of monetary policy autonomy, how does a floating exchange rate system differ from a fixed system?
It is argued that under a fixed system, a country's ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity. -Monetary expansion can lead to inflation, which puts downward pressure on a fixed exchange rate. -Similarly, monetary contraction requires high interest rates (to reduce the demand for money). -Higher interest rates lead to an inflow of money from abroad, which puts upward pressure on a fixed exchange rate. -Thus, to maintain exchange rate parity under a fixed system, countries were limited in their ability to use monetary policy to expand or contract their economies. -Advocates of a floating exchange rate regime argue that removal of the obligation to maintain exchange rate parity would restore monetary control to a government. -If a government faced with unemployment wanted to increase its money supply to stimulate domestic demand and reduce unemployment, it could do so unencumbered by the need to maintain its exchange rate. -While monetary expansion might lead to inflation, this would lead to a depreciation in the country's currency. -If the purchasing power parity (PPP) theory is correct, the resulting currency depreciation on the foreign exchange markets should offset the effects of inflation. -Although under a floating exchange rate regime, domestic inflation would have an impact on the exchange rate, it should have no impact on businesses' international cost competitiveness due to exchange rate depreciation. -The rise in domestic costs should be exactly offset by the fall in the value of the country's currency on the foreign exchange markets. -Similarly, a government could use monetary policy to contract the economy without worrying about the need to maintain parity.
How does a firm's decision regarding the location of its production facilities vary based on the availability of flexible manufacturing technologies?
Other things being equal, when fixed costs are substantial, the minimum efficient scale of production is high, and/or flexible manufacturing technologies are available, the arguments for concentrating production at a few choice locations are strong. -This is true even when substantial differences in consumer tastes and preferences exist between national markets because flexible manufacturing technologies allow the firm to customize products to national differences at a single facility. -Alternatively, when fixed costs are low, the minimum efficient scale of production is low, and flexible manufacturing technologies are not available, the arguments for concentrating production at one or a few locations are not as compelling. In such cases, it may make more sense to manufacture in each major market in which the firm is active if this helps the firm better respond to local demands. -This holds only if the increased local responsiveness more than offsets the cost disadvantages of not concentrating manufacturing. With the advent of flexible manufacturing technologies and mass customization, such a strategy is becoming less attractive.
In terms of international business, briefly describe pioneering costs.
Pioneering costs are costs that an early entrant has to bear that a later entrant can avoid. -Pioneering costs arise when the business system in a foreign country is so different from that in a firm's home market that the enterprise has to devote considerable effort, time, 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 major mistakes. -Pioneering costs also include the costs of promoting and establishing a product offering, including the costs of educating customers. -These can be significant when the product being promoted is unfamiliar to local consumers. In contrast, later entrants may be able to ride on an early entrant's investments in learning and customer education by watching how the early entrant proceeded in the market, by avoiding costly mistakes made by the early entrant, and by exploiting the market potential created by the early entrant's investments in customer education.
What are the sources of pressures for local responsiveness?
Pressures for local responsiveness arise from national differences in consumer tastes and preferences, infrastructure, accepted business practices, and distribution channels, and from host-government demands. 1) Differences in Customer Tastes and Preferences: Strong pressures for local responsiveness emerge when customer tastes and preferences differ significantly between countries, as they often do for deeply embedded historic or cultural reasons. In such cases, a multinational's products and marketing message have to be customized to appeal to the tastes and preferences of local customers. 2) Differences in Infrastructure and Traditional Practices: Pressures for local responsiveness arise from differences in infrastructure or traditional practices among countries, creating a need to customize products accordingly. Fulfilling this need may require the delegation of manufacturing and production functions to foreign subsidiaries. 3) Differences in Distribution Channels: A firm's marketing strategies may have to be responsive to differences in distribution channels among countries, which may necessitate the delegation of marketing functions to national subsidiaries. 4) Host Government Demands: Economic and political demands imposed by host-country governments may require local responsiveness.
How do the purchasing power parity theory and the law of one price relate the prices of commodities to exchange rate movements?
Purchasing power parity (PPP) theory and the law of one price help us understand how prices relate to exchange rate movements. -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. -According to the PPP theory, if the law of one price were true for all goods and services, the PPP exchange rate could be found from any individual set of prices. -By comparing the prices of identical products in different currencies, it would be possible to determine the PPP exchange rate that would exist if markets were efficient. -In essence, PPP theory predicts that changes in relative prices will result in a change in exchange rates.
How do firms respond to low cost pressures and low pressures for local responsiveness?
Sometimes, multinational firms find themselves in the fortunate position of being confronted with low cost pressures and low pressures for local responsiveness. -Many of these enterprises pursue an international strategy, taking products first produced for their domestic market and selling them internationally with only minimal local customization. -The distinguishing feature of many such firms is that they are selling a product that serves universal needs, but they do not face significant competitors, and thus unlike firms pursuing a global standardization strategy, they are not confronted with pressures to reduce their cost structure.
Describe the pros and cons of greenfield ventures.
The advantage of establishing a greenfield venture in a foreign country is that it gives the firm a much greater ability to build the kind of subsidiary company that it wants. -For example, it is much easier to build an organization culture from scratch than it is to change the culture of an acquired unit. -Similarly, it is much easier to establish a set of operating routines in a new subsidiary than it is to convert the operating routines of an acquired unit. -This is a very important advantage for many international businesses, where transferring products, competencies, skills, and know-how from the established operations of the firm to the new subsidiary are principal ways of creating value. -Set against this significant advantage are the disadvantages of establishing a greenfield venture. Greenfield ventures are slower to establish. -They are also risky. -As with any new venture, a degree of uncertainty is associated with future revenue and profit prospects. -However, if the firm has already been successful in other foreign markets and understands what it takes to do business in other countries, these risks may not be that great. -A final disadvantage is the possibility of being preempted by more aggressive global competitors who enter via acquisitions and build a big market presence that limits the market potential for the greenfield venture.
"Firms prefer to acquire existing assets rather than undertake greenfield investments while contemplating FDI." Explain the reasons that support this argument.
There are several factors that dictate that acquiring existing assets rather than undertaking greenfield investments is a more profitable way to enter a foreign market: 1) First, mergers and acquisitions are quicker to execute -This is an important consideration in the modern business world where markets evolve very rapidly. Many firms apparently believe that if they do not acquire a desirable target firm, then their global rivals will. 2) Second, foreign firms are acquired because those firms have valuable strategic assets -such as brand loyalty, customer relationships, trademarks or patents, distribution systems, production systems, and the like. -It is easier and perhaps less risky for a firm to acquire those assets than to build them from the ground up through a greenfield investment. 3) Third, firms make acquisitions because they believe they can increase the efficiency of the acquired unit -by transferring capital, technology, or management skills.
What is meant by the term foreign investment?
-Foreign direct investment (FDI) occurs when a firm invests directly in facilities to produce or market a product in a foreign country. -According to the U.S. Department of Commerce, FDI occurs whenever a U.S. citizen, organization, or affiliated group takes an interest of 10 percent or more in a foreign business entity. -Once a firm undertakes FDI, it becomes a multinational enterprise. The flow of foreign direct investment refers to the amount of FDI undertaken over a given period (normally a year). -The stock of foreign direct investment refers to the total accumulated value of foreign-owned assets at a given time.
Describe the advantages and disadvantages of acquisitions.
Acquisitions have three major points in their favor. 1) First, they are quick to execute. -By acquiring an established enterprise, a firm can rapidly build its presence in the target foreign market. 2) Second, in many cases firms make acquisitions to preempt their competitors. The need for preemption is particularly great in markets that are rapidly globalizing, such as telecommunications, where a combination of deregulation within nations and liberalization of regulations governing cross-border foreign direct investment has made it much easier for enterprises to enter foreign markets through acquisitions. -Such markets may see concentrated waves of acquisitions as firms race each other to attain global scale. 3) Third, managers may believe acquisitions to be less risky than greenfield ventures. When a firm makes an acquisition, it buys a set of assets that are producing a known revenue and profit stream. Acquisitions fail for several reasons: 1) First, the acquiring firms often overpay for the assets of the acquired firm. 2) Second, many acquisitions fail because there is a clash between the cultures of the acquiring and acquired firm. 3) Third, many acquisitions fail because attempts to realize synergies by integrating the operations of the acquired and acquiring entities often run into roadblocks and take much longer than forecast. Finally, many acquisitions fail due to inadequate pre-acquisition screening.
Explain how investor psychology and bandwagon effects impact the movement in exchange rates.
Empirical evidence suggests that neither the purchasing power parity theory nor the international Fisher effect is particularly good at explaining short-term movements in exchange rates. -One reason may be the impact of investor psychology on short-run exchange rate movements. -Evidence reveals that various psychological factors play an important role in determining the expectations of market traders as to likely future exchange rates. In turn, expectations have a tendency to become self-fulfilling prophecies. -When traders move like a herd, all in the same direction and at the same time, in response to each others' perceived actions, it is known as the bandwagon effect. -According to a number of studies, investor psychology and bandwagon effects play an important role in determining short-run exchange rate movements. -However, these effects can be hard to predict. Investor psychology can be influenced by political factors and by micro-economic events, such as the investment decisions of individual firms, many of which are only loosely linked to macroeconomic fundamentals, such as relative inflation rates. -Also, bandwagon effects can be both triggered and exacerbated by the idiosyncratic behavior of politicians.
Briefly describe the benefits of the euro.
Europeans decided to establish a single currency in the European Union (EU) for a number of reasons. 1) First, they believe that businesses and individuals realize significant savings from having to handle one currency, rather than many. -These savings come from lower foreign exchange and hedging costs. 2) Second, and perhaps more importantly, the adoption of a common currency makes it easier to compare prices across Europe. -This has been increasing competition because it has become easier for consumers to shop around. 3) Third, faced with lower prices, European producers have been forced to look for ways to reduce their production costs to maintain their profit margins. The introduction of a common currency, by increasing competition, has produced long-run gains in the economic efficiency of European companies. 4) Fourth, the introduction of a common currency has given a boost to the development of a highly liquid pan-European capital market. -Over time, the development of such a capital market should lower the cost of capital and lead to an increase in both the level of investment and the efficiency with which investment funds are allocated. -This could be especially helpful to smaller companies that have historically had difficulty borrowing money from domestic banks. 5) Finally, the development of a pan-European, euro-denominated capital market increases the range of investment options open to both individuals and institutions.
What are the advantages and disadvantages of exporting as a mode of entry into foreign markets?
Exporting has two distinct advantages. 1) First, it avoids the often substantial costs of establishing manufacturing operations in the host country. 2) Second, exporting may help a firm achieve experience curve and location economies. Exporting has a number of drawbacks. 1) First, exporting from the firm's home base may not be appropriate if lower-cost locations for manufacturing the product can be found abroad (i.e., if the firm can realize location economies by moving production elsewhere). -Thus, particularly for firms pursuing global or transnational strategies, it may be preferable to manufacture where the mix of factor conditions is most favorable from a value creation perspective and to export to the rest of the world from that location. 2) A second drawback to exporting is that high transport costs can make exporting uneconomical, particularly for bulk products. -One way of getting around this is to manufacture bulk products regionally. This strategy enables the firm to realize some economies from large-scale production and at the same time to limit its transport costs. Another drawback is that tariff barriers can make exporting uneconomical. Similarly, the threat of tariff barriers by the host-country government can make it very risky. A fourth drawback to exporting arises when a firm delegates its marketing, sales, and service in each country where it does business to another company. This is a common approach for manufacturing firms that are just beginning to expand internationally. The other company may be a local agent, or it may be another multinational with extensive international distribution operations. Local agents often carry the products of competing firms and so have divided loyalties. In such cases, the local agent may not do as good a job as the firm would if it managed its marketing itself. Similar problems can occur when another multinational takes on distribution.
What are the different types of competitive pressures that firms competing in a global marketplace face? How can firms respond to such pressures?
Firms that compete in the global marketplace typically face two types of competitive pressure that affect their ability to realize location economies and experience effects, to leverage products and transfer competencies and skills within the enterprise. -They face pressures for cost reductions and pressures to be locally responsive. -These competitive pressures place conflicting demands on a firm. -Responding to pressures for cost reductions requires that a firm try to minimize its unit costs. -But responding to pressures to be locally responsive requires that a firm differentiate its product offering and marketing strategy from country to country in an effort to accommodate the diverse demands arising from national differences in consumer tastes and preferences, business practices, distribution channels, competitive conditions, and government policies.
What are the different ways in which a firm can benefit from global expansion?
Firms that operate internationally are able to: 1) Expand the market for their domestic product offerings by selling those products in international markets. 2) Realize location economies by dispersing individual value creation activities to those locations around the globe where they can be performed most efficiently and effectively. 3) Realize greater cost economies from experience effects by serving an expanded global market from a central location. 4) Earn a greater return by leveraging any valuable skills developed in foreign operations and transferring them to other entities within the firm's global network of operations.
Describe the global standardization strategy.
Firms that pursue a global standardization strategy focus on increasing profitability and profit growth by reaping the cost reductions that come from economies of scale, learning effects, and location economies; that is, their strategic goal is to pursue a low-cost strategy on a global scale. -The production, marketing, and R&D activities of firms pursuing a global standardization strategy are concentrated in a few favorable locations. -Firms pursuing a global standardization strategy try not to customize their product offering and marketing strategy to local conditions because customization involves shorter production runs and the duplication of functions, which tends to raise costs. -Instead, they prefer to market a standardized product worldwide so that they can reap the maximum benefits from economies of scale and learning effects. -They also tend to use their cost advantage to support aggressive pricing in world markets.
How do foreign exchange markets benefit international businesses?
International businesses have four main uses of foreign exchange markets: 1) First, the payments a company receives for its exports, the income it receives from foreign investments, or the income it receives from licensing agreements with foreign firms may be in foreign currencies. -To use those funds in its home country, the company must convert them to its home country's currency. 2) Second, international businesses use foreign exchange markets when they must pay a foreign company for its products or services in its country's currency. 3) Third, international businesses also use foreign exchange markets when they have spare cash that they wish to invest for short terms in money markets. -Currency speculation is another use of foreign exchange markets. -Currency speculation typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.
Describe the disadvantages of licensing as a mode of entry into the foreign market.
Licensing, a mode of entry into a foreign market, has three serious drawbacks. 1) First, it does not give a firm the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies. -Licensing typically involves each licensee setting up its own production operations. This severely limits the firm's ability to realize experience curve and location economies by producing its product in a centralized location. When these economies are important, licensing may not be the best way to expand overseas. 2) Second, competing in a global market may require a firm to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another. -By its very nature, licensing limits a firm's ability to do this. A licensee is unlikely to allow a multinational firm to use its profits (beyond those due in the form of royalty payments) to support a different licensee operating in another country. 3) A third problem is the risk associated with licensing technological know-how to foreign companies. -Technological know-how constitutes the basis of many multinational firms' competitive advantage. Most firms wish to maintain control over how their know-how is used, and a firm can quickly lose control over its technology by licensing it. Many firms have made the mistake of thinking they could maintain control over their know-how within the framework of a licensing agreement
How do country-specific factors affect a country's attractiveness as a manufacturing base?
Political and economic systems, culture, and relative factor costs differ from country to country. -Due to differences in factor costs, some countries have a comparative advantage for producing certain products. -Differences in political and economic systems—and national culture—influence the benefits, costs, and risks of doing business in a country. -Other things being equal, a firm should locate its various manufacturing activities where the economic, political, and cultural conditions, including relative factor costs, are conducive to the performance of those activities. -Also important in some industries is the presence of global concentrations of activities at certain locations. -Other country-specific factors play a role in location decisions, including formal and informal trade barriers and rules and regulations regarding foreign direct investment. -Another country factor is expected future movements in currency exchange rates. -Adverse changes in exchange rates can quickly alter a country's attractiveness as a manufacturing site. -Currency appreciation can transform a low-cost location into a high-cost location
Describe the factors that explain the failure of the purchasing power parity theory to predict exchange rates accurately.
Several factors explain the failure of PPP theory to predict exchange rates accurately. 1) PPP theory assumes away transportation costs and barriers to trade. -In practice, these factors are significant and they tend to create significant price differentials between countries. 2) Transportation costs are certainly not trivial for many goods. -Government intervention in cross-border trade, by violating the assumption of efficient markets, weakens the link between relative price changes and changes in exchange rates predicted by PPP theory. 3) In addition, the PPP theory may not hold if many national markets are dominated by a handful of multinational enterprises that have sufficient market power to be able to exercise some influence over prices, control distribution channels, and differentiate their product offerings between nations. 4) Another factor of some importance is that governments also intervene in the foreign exchange market in attempting to influence the value of their currencies. 5) One more factor explaining the failure of PPP theory to predict short-term movements in foreign exchange rates is the impact of investor psychology and other factors on currency purchasing decisions and exchange rate movements.
What are the 3 benefits of FDI to the home (source) country?
The benefits of FDI to the home (source) country arise from three sources: 1) First, the home country's balance of payments benefits from the inward flow of foreign earnings. -FDI can also benefit the home country's balance of payments if the foreign subsidiary creates demands for home-country exports of capital equipment, intermediate goods, complementary products, and the like. 2) Second, benefits to the home country from outward FDI arise from employment effects. -As with the balance of payments, positive employment effects arise when the foreign subsidiary creates demand for home-country exports. 3) Third, benefits arise when the home-country MNE learns valuable skills from its exposure to foreign markets that can subsequently be transferred back to the home country. -This amounts to a reverse resource-transfer effect. -Through its exposure to a foreign market, an MNE can learn about superior management techniques and superior product and process technologies. -These resources can then be transferred back to the home country, contributing to the home country's economic growth rate.
What are the consequences of an international firm entering a foreign market on a significant scale?
The consequences of entering on a significant scale—entering rapidly—are associated with the value of the resulting strategic commitments. -A strategic commitment has a long-term impact and is difficult to reverse. -Deciding to enter a foreign market on a significant scale is a major strategic commitment. -Strategic commitments, such as rapid large-scale market entry, can have an important influence on the nature of competition in a market. -Significant strategic commitments are neither unambiguously good nor bad. -Rather, they tend to change the competitive playing field and unleash a number of changes, some of which may be desirable and some of which will not be. -It is important for a firm to think through the implications of large-scale entry into a market and act accordingly. -Of particular relevance is trying to identify how actual and potential competitors might react to large-scale entry into a market. -Also, the large-scale entrant is more likely than the small-scale entrant to be able to capture first-mover advantages associated with demand preemption, scale economies, and switching costs. -The value of the commitments that flow from rapid large-scale entry into a foreign market must be balanced against the resulting risks and lack of flexibility associated with significant commitments.
Define minimum efficient scale of output. How does this influence the location decisions of production activities?
The level of output at which most plant-level scale economies are exhausted is referred to as the minimum efficient scale of output. -This is the scale of output a plant must operate to realize all major plant-level scale economies. The implications of this concept are as follows: -The larger the minimum efficient scale of a plant relative to total global demand, the greater the argument for centralizing production in a single location or a limited number of locations. -Alternatively, when the minimum efficient scale of production is low relative to global demand, it may be economical to manufacture a product at several locations. -The low level of minimum efficient scale in relation to total global demand makes it economically feasible for a company in multiple locations. -As in the case of low fixed costs, the advantages of a low minimum efficient scale include allowing the firm to accommodate demands for local responsiveness or to hedge against currency risk by manufacturing the same product in several locations.
Briefly describe the benefits of inward FDI for a host country that arise from employment effects and balance-of-payment effects
The main benefits of inward FDI for a host country are the (1) resource-transfer effects, (2) the employment effects, (3) the balance-of-payments effect, and (4) effects on competition and economic growth. -A beneficial employment effect claimed for FDI is that it brings jobs to a host country that would otherwise not be created there. -The effects of FDI on employment are both direct and indirect. -Direct effects arise when a foreign MNE employs a number of host-country citizens. Indirect effects arise when jobs are created in local suppliers as a result of the investment and when jobs are created because of increased local spending by employees of the MNE. -The indirect employment effects are often as large as, if not larger than, the direct effects. -FDI's effect on a country's balance-of-payments accounts is an important policy issue for most host governments. -Governments typically prefer to see a current account surplus than a deficit. -The only way in which a current account deficit can be supported in the long run is by selling off assets to foreigners. -Because national governments invariably dislike seeing the assets of their country fall into foreign hands, they prefer their nation to run a current account surplus. -There are two ways in which FDI can help a country to achieve this goal: -First, if the FDI is a substitute for imports of goods or services, the effect can be to improve the current account of the host country's balance of payments. -A second potential benefit arises when the MNE uses a foreign subsidiary to export goods and services to other countries.
What are the important strategic objectives of an international firm's production and logistics functions?
The production and logistics functions of an international firm have a number of important strategic objectives. 1) One is to ensure that the total cost of moving from raw materials to finished goods is as low as possible for the value provided to the end-customer. Dispersing production activities to various locations around the globe where each activity can be performed most efficiently can lower costs. Costs can also be cut by managing the global supply chain efficiently so as to better match supply and demand. Efficient supply chain management reduces the amount of inventory in the system and increases inventory turnover, which means the firm has to invest less working capital in inventory and is less likely to find excess inventory on hand that cannot be sold and has to be written off. 2) A second strategic objective shared by production and logistics is to increase product (or service) quality by establishing process-based quality standards, and eliminating defective raw material, component parts, and products from both the supply chain and the manufacturing process.
How has the volatility of the current global exchange rate regime affected international businesses? How can the problem be tackled?
The volatility of the current global exchange rate regime presents a conundrum for international businesses. -Exchange rate movements are difficult to predict, and yet their movement can have a major impact on a business's competitive position. -It is also difficult if not impossible to get adequate insurance coverage for exchange rate changes that might occur several years in the future. -The forward market tends to offer coverage for exchange rate changes a few months—not years—ahead. -Given this, it makes sense to pursue strategies that will increase the company's strategic flexibility in the face of unpredictable exchange rate movements—that is, to pursue strategies that reduce the economic exposure of the firm. -Maintaining strategic flexibility can take the form of dispersing production to different locations around the globe as a real hedge against currency fluctuations. -Another way of building strategic flexibility and reducing economic exposure involves contracting out manufacturing. -This allows a company to shift suppliers from country to country in response to changes in relative costs brought about by exchange rate movements. -However, this kind of strategy may work only for low-value-added manufacturing (e.g., textiles), in which the individual manufacturers have few if any firm-specific skills that contribute to the value of the product. -International Monetary Fund (IMF) policies typically include anti-inflationary monetary policies and reductions in government spending. In the short run, such policies usually result in a sharp contraction of demand. -International businesses selling or producing in countries that have borrowed from the IMF need to be aware of this and plan accordingly.
Discuss the two basic strategies for locating production facilities. When is it most appropriate to centralize production?
There are two basic strategies for locating production facilities: concentrating them in a centralized location and serving the world market from there, or decentralizing them in various regional or national locations that are close to major markets. -The appropriate strategy is determined by various country-specific, technological, and product factors. -Concentration of manufacturing makes most sense when: (1) differences between countries in factor costs, political economy, and culture have a substantial impact on the costs of manufacturing in various countries, (2) trade barriers are low (3) externalities arising from the concentration of like enterprises favor certain locations, (4) important exchange rates are expected to remain relatively stable, (5) the production technology has high fixed costs and high minimum efficient scale relative to global demand, or flexible manufacturing technology exists, (6) the product's value-to-weight ratio is high, and (7) the product serves universal needs.
Differentiate between a floating exchange rate and a pegged exchange rate.
When the foreign exchange market determines the relative value of a currency, we say that the country is adhering to a floating exchange rate regime. -Four of the world's major trading currencies —the U.S. dollar, the European Union's euro, the Japanese yen, and the British pound—are all free to float against each other. -Thus, their exchange rates are determined by market forces and fluctuate against each other. A pegged exchange rate means the value of the currency is fixed relative to a reference currency, such as the U.S. dollar, and then the exchange rate between that currency and other currencies is determined by the reference currency exchange rate.
