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The Euro Is Here: Is Your Company Prepared?

Published on Friday, January 01, 1999

On January 1, 1999, the euro became the official currency of 11 of the 15 European Union (EU) member states participating in the European Economic and Monetary Union (EMU).

These countries are responsible for a large share of world trade — and may be essential to your bottom line. Unfortunately, many small and medium-size U.S. companies are unprepared for the euro, or unfamiliar with its financial and legal impact. To help you, we’ve answered many of the questions you’ll need to know.

Who Are the Euro Participants and Will More Countries Join?

Referred to as Euroland, the Euroarea or the Eurozone, euro participants include Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.

Remaining EU members, such as Denmark, Sweden and the United Kingdom, may join at a later date. Greece, although willing to participate now, was temporarily denied Euroland membership because it did not meet the strict economic criteria.

Many other European countries have asked to join the EU. Should all Eastern and Western European countries eventually become members over the next several decades, the EU’s population would swell to approximately 850 to 900 million consumers. And, as these countries are admitted, many will wish to adopt the euro as their official currency.

How Is the Euro Phased In?

During the three-year transitional period, January 1, 1999 through December 31, 2001, businesses are free to use either the euro or the national currency unit for non-cash transactions. On January 1, 2002, euro notes and coins will be made available. Participants’ national currency units will be gradually withdrawn and will cease to exist as of July 1, 2002, resulting in the euro as their only legal currency.

Although euro notes and coins will not be available until 2002, political pressure is already building for their earlier use.

How Does the Euro Affect Financial Obligations?

The International Chamber of Commerce (ICC), the recognized world business organization based in Paris, has published euro guidelines relating to international commercial practices, including transactions under the UCP 500 (www. iccwbo.org/). According to the ICC’s report on the euro’s impact, the European single currency “shall not have the effect of altering, discharging or excusing performance under any instrument subject to ICC Rules.”

The report spells out currencies to use for letters of credit (L/Cs) on contracts existing before, during and after the transitional period. For details, refer to the ICC webpage: www.iccwbo.org/Commissions/Banking/Impact_of_euro.htm.

The ICC also recommends that you add language to your L/Cs to ensure they are subject to the Uniform Customs and Practices for Documentary Credits that concerns euros. To determine what’s best for you, consult with your banker and/or lawyer.

What Costs and Challenges Exist?

With the advent of the euro, many U.S. companies will need to invest in new software, training, consulting, dual documentation systems, etc., to deal effectively with two currency denominations.

The euro also could bring calculation problems. Official conversion rates have six significant figures, which could make calculations complex. Rounding off could pose problems. And, prices that end in “9” to achieve a psychological advantage will be lost when converted.

But, more importantly, consumers will more likely perceive the 11 euro participant markets as one, forcing local companies into greater competition. As a result, Eurozone companies will more aggressively pursue local marketshare at the expense of non-euro participants, including U.S. exporters.

What Are the Euro’s Benefits?

As the level of financial integration among EU members increases, intra-EU trade barriers will decrease. For many U.S. companies, exporting to one, larger single market and transacting in dollars or euros is less complex than exporting to several markets with different rules, regulations, and currencies. And, to some extent, this may counter the advances of more aggressive European companies. Furthermore, utilizing a single currency means the elimination of exchange rate uncertainty. And that’s not all.

According to a European Commission, transaction costs related to the existence of different currencies in the EU amounted to approximately 0.5% of gross domestic product (GDP). Other studies have estimated this cost closer to 1%.

These savings, combined with greater macroeconomic stability and reduced governmental deficits, are anticipated to result in economically stronger euro participant economies. In turn, this is expected to result in greater imports from the United States.

According to an International Monetary Fund study, the impact of the euro on participating member economies will be an increase GDP growth of .2% in the year 2000, .9% in 2001, 1% in 2002, 1.1% in 2003, and 2.9% in 2010. The economies of non-European G-7 and developing countries are predicted to grow by .1% and .2%, respectively, in 2003.

On-Line Resources

To convert euros into dollars, or other currencies, click on CNN’s Euro Conversion Calculator (cnnfn.com worldbiz/europe/9812/29/calculator/). For answers regarding business and legal questions, visit Monetary Union For Business, a website by the Association for the Monetary Union of Europe (www.eubusiness. com/emu/euroamue.htm).

Other must-see sites include: ENUNet, a site run by a London-based organization comprised of academicians and politicians (www.euro-emu.co.uk); The European Central Bank (www.ecb.int); the official euro site of the European Commission (www. europa.eu.int/euro/html/home5.html?lang=5); and Dossier Euro (www.strategic-road.com/dossiers/eurofr.htm).

Contact Us for More Details

For more information on the euro or how we can help you achieve your international goals, contact your Treasury client manager.

The Impact of Trade Agreements

Published on Friday, January 01, 1999

Trade agreements have a major impact on trade and investment worldwide. In fact, they are responsible for shaping business relationships among companies across the globe. In order to succeed in the international environment, small business exporters need to be aware of the impact trade agreements have had and will have on their businesses. Likewise, lenders must be familiar with trade agreements in order to better understand the needs and financial concerns of their customers. But why are trade agreements flourishing? The answer lies in their broad array of benefits.

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Barriers to Trade

Published on Friday, January 01, 1999

If the exporter categorizes the product incorrectly, a common error, the importing country’s custom agent may reclassify the goods — often resulting in a higher duty rate. This could change the terms of the deal and cause the importer to reject it. Consequently, it is important that the exporter and banker understand the challenges, be familiar with the barriers to trade, and limit the risks from the beginning.

Tariff Barriers

Tariff barriers are taxes or duties levied on imports of foreign products. Originally, U.S. tariffs were established to provide revenue for the federal government, predating income or property taxes. Today, however, they are viewed differently. In effect, tariffs increase the product price which discourages its demand and thereby insulates, to a degree, domestic producers from foreign competition. Each country places higher tariffs on goods determined to be import sensitive.

The most common form of duty or tariff is the ad valorem: a tax assessed on merchandise value. If not specified, the duty or tariff applied is usually ad valorem. In many countries, ad valorem taxes are applied to the value of merchandise, plus the cost of insurance and freight. As a result, when issuing an invoice to the foreign buyer, it is important to itemize these individual costs.

In addition to ad valorem duties, other types exist. Specific duties are those charged by weight, volume, length or any other unit (e.g., charging 10 cents per square yard on fabric). If the duty is assessed by weight, it is important to know if the packaging weight is included in that figure. If so, packaging weight must be kept to a minimum. Compound duties call for both an ad valorem and a specific duty on the same product. Alternative duties are those in which the custom official calculates the ad valorem duty and the specific duty and applies whichever is higher.

Countries apply tariffs in different ways. In Mexico, for example, additional taxes are assessed on top of the duties. These include a processing fee and a value-added tax (VAT). The customs processing fee is similar to the U.S. customs user fee, also referred to as a merchandise processing fee. The VAT is similar to the Canadian Goods and Services Tax (GST). The United States does not assess a VAT. The following example illustrates how a 10 percent ad valorem duty and a customs processing fee are calculated, and their effect on the final U.S. exporter’s price to Mexico versus a local Mexican manufacturer’s price in the Mexican market. It is important to note that a Mexican customs processing fee is assessed on the cost, insurance and freight (CIF) value of the good. A national VAT of 15 percent is typically applied to the CIF value, duty and customs processing fee. In the past, Mexico has applied a VAT of 0 percent on basic foodstuffs, 6 percent on certain food items in specific regions, 20 percent on luxury goods and a general rate of 15 percent on all other goods.

The following compares the costs of U.S. exports to Mexico and Mexican domestic goods before and after tariffs:

• Invoice value (including CIF on export): $ 10,000(U.S.), $ 10,000(Mexico)
• Ad valorem duty (10%): $ 1,000 , n/a
• Customs processing fee (.8%): $80, n/a
• VAT (15%): $ 1,662, $ 1,500
• Total cost: $ 12,742, $ 11,500

In addition to the above fees, an import processing fee, harbor tax, and other taxes, if assessed further, will increase the exporter’s costs. Also, it is wise to be careful when calculating the VAT, as the foreign customs service is likely to assess the VAT on top of the duty, effectively increasing the VAT rate.

Non-Tariff Barriers

Non-tariff barriers are often hidden, and are not necessarily quantifiable or measurable. They typically include quotas, boycotts, licenses, standards, local content requirements, restrictions on foreign investment, domestic government purchasing policies, exchange controls and subsidies. Non-tariff barriers often are used to inhibit the importation of products. In many sectors, it is predicted that environmental, labor, competitive policy and investment issues increasingly will be used in an abusive manner to discourage imports.

At a time when it appears that foreign government subsidies for industry are decreasing, assistance by other means may be increasing. According to Ron Brown, the late Secretary of the U.S. Department of Commerce, the Europeans, Japanese, and even the emerging markets are investing more and more of their resources to do battle with U.S. companies. In a sampling of about 200 overseas competitive projects tracked during an eight year period, it was estimated that U.S. firms lost approximately one-half of these due in part to government pressure — a hidden and non-quantifiable barrier to trade. And foreign governments may increase their efforts whenever they wish.

As a result, when calculating the total exporting costs, which is necessary to price a product, it is essential to consider the resources necessary to ensure that any non-tariff barriers applied to the exporter’s product are satisfied. If not, the exporter’s ability to perform may be adversely affected.

Quotas are a very common non-tariff barrier which are used extensively under the Multi-Fiber Arrangement (MFA). The importation of a product is limited to a specific quantity over a designated time period, usually a year. This method artificially stimulates consumption of the domestic substitute that may be more expensive and/or of lower quality. The domestically produced substitute becomes more attractive, preserving or attaining a greater share of the domestic market.

Three types of quotas exist: absolute quotas, tariff-rated quotas, and voluntary restraint agreements (VRAs). Absolute quotas effectively cut off further importation of a product into the host country when a specific quantity is reached. Quotas may apply to imports from all countries or certain countries. Tariff-rated quotas allow for a specific quantity of a product to be imported at a reduced duty rate. Once this quantity is reached, a higher duty becomes applicable. VRAs are informal bilateral or multilateral agreements in which exporting countries voluntarily limit the quantity of exports of a certain product to a particular country. This avoids the imposition of import restrictions, but effectively acts as a quota.

Government or industry boycotts against imports from particular countries have been implemented for political or economic reasons. For example, U.S. imports from Cuba are banned on political grounds; in the 1980s, the U.S. steel industry urged users to purchase domestic steel products and terminate imports. Licenses are required by importers in many countries prior to product importation. In the past, Mexico maintained license requirements on virtually every product; however, with the advent of the North American Free Trade Agreement (NAFTA), these demands have been drastically reduced or eliminated.

Standards are used to ensure a degree of quality in accordance with national regulations, including standards to protect health, safety and product quality. However, they are sometimes used in an unduly stringent or discriminating way for the sole purpose of restricting trade. The United States, Canada and Mexico all require many foreign products to meet the requirements set forth by each country’s respective regulatory bodies. For example, foreign electrical equipment requires authorization from the U.S. Underwriters Laboratory (UL), Canadian Standards Association (CSA), and Norma Oficial Mexicana (NOM) of Mexico prior to its importation.

Local content requirements dictate that a product must embody a particular percentage of local material or components prior to its importation. For example, under NAFTA rules of origin, a minimum product content requirement must exist in order for the good to be considered of U.S., Canadian or Mexican origin and enter with free trade status. If this content level is not obtained, the product normally will be allowed entry under a higher duty applicable to the newly defined country of origin.

Many countries inherently favor domestic suppliers over foreign suppliers. “Buy domestic” policies have been prevalent in many countries for years. In fact, as previously noted, in a sampling of about 200 overseas competitive projects tracked during an eight year period, it is estimated that U.S. firms lost approximately one-half of potential foreign contracts due partially to government pressure favoring non-foreign firms.

Subsidies are indirect forms of consideration granted by national governments to domestic producers for various reasons, which effectively enhance their product price competitiveness vis-à-vis foreign producers. Subsidies may be extended in the form of outright cash disbursements, reduced interest rates on bank loans, tax exemptions, preferential exchange rates, governmental contracts with special privileges, or any other form of favorable treatment.

The Case of Brazil

In some countries, the government may deny importers access to foreign currencies, effectively creating a non-tariff barrier for the purpose of reducing imports. Thus, when a country experiences either a temporary or prolonged severe balance of trade problems, its government has several options to remedy the situation. Three very effective measures include a gradual or abrupt devaluation of the currency in order to make imports more expensive, the tightening up on the issuance of import licenses, or the raising of duties. Brazil, which had been experiencing imbalances in its external trade for some time, decided on a different course of action. In an attempt to restrict Brazilian imports, in March 1997, the Brazilian government implemented measures that required Brazilian importers to provide advance payment for imports financed on credit terms of 360 days or less. Shipments to Brazilian importers on terms of up to 180 days required full payment in local currency upon arrival of the goods. Shipments on credit terms from 181 days to 360 days were required to be paid in local currency to a designated commercial bank 180 days prior to the instrument’s maturity date. At that time, a foreign exchange contract would be issued and foreign currency would be made available to pay the foreign creditor on the due date. Exemptions to these regulations included imports with repayment terms in excess of 360 days, oil imports, oil by-products, and imports valued at less than $10,000.

As a result, it was assumed that most Brazilian importers would have to come up with cash in advance. To achieve this, they likely would have to borrow from local Brazilian banks — an unlikely scenario for most Brazilian importers since local financing costs were often prohibitive.

The Impact of Trade Barriers

As foreign markets are liberalized, allowing firms to export more goods and services, domestic markets generally incur greater foreign competition. As this occurs, the tendency to protect an industry becomes heightened. Although this is beneficial in some instances for certain periods of time, numerous studies have indicated that this approach does have severe negative consequences.

Commenting on a report released in August 1993 by the General Agreement on Tariffs and Trade (GATT) depicting the true costs to consumers of protectionism, Peter Sutherland, former Director General of GATT, stated, “It is high time that governments made clear to consumers just how much they pay — in the shops and as taxpayers — for decisions to protect domestic industries from import competition. Virtually all protection means higher prices. And someone has to pay; either the consumer or, in the case of intermediate goods, another producer. The result is a drop in real income and an inability to buy other products and services.”

Mr. Sutherland continued, “Maybe consumers would feel better about paying higher prices if they could be assured it was an effective way of maintaining employment. Unfortunately, the reality is that the cost of saving a job, in terms of higher prices and taxes, is frequently far higher than the wage paid to the workers concerned. In the end, in any case, the job often disappears as the protected companies either introduce new labor-saving technology or become less competitive. A far better approach would be to use the money to pay adjustment costs, like retraining programs and the provision of infrastructure.”

To a large extent, the U.S. textile and apparel industry has been protected on a global basis by the Multi-Fiber Arrangement (MFA). Now being phased out, the MFA established quotas on behalf of industrialized countries and directed against textile and apparel exports from developing countries. The Institute for International Economics estimated that in 1986, the MFA raised textile and apparel costs in the United States by an average of 28 percent and 53 percent, respectively, with annual consumer losses of $2.8 billion and $17.6 billion. The net welfare cost to the nation, after subtracting the benefits to producers and workers, exceeded $8 billion. The consumer costs to maintain each U.S. textile and apparel manufacturing job, the study contended, were $135,000 and $82,000, respectively. As a result, the lowest 20 percent of U.S. households, ranked according to income, experienced a decline of 3.6 percent in their standard of living.

According to the GATT report released in August 1993, studies conducted during the 1980s indicated that protection costs a four-person household an additional $200-$420 per year in the United States, $130 per year in the U.K. and $220 per year in Canada.

Many leaders of industry and scholars alike have argued that even if protectionism were implemented to a greater extent, low technology jobs would still disappear. Robert Reich, former U.S. Secretary of Labor, stated that “Even if millions of workers in developing nations were not eager to do these jobs [low-technology jobs] at a fraction of the wages of U.S. workers, such jobs would still be vanishing. Domestic competition would drive companies to cut costs by installing robots, computer integrated manufacturing systems, or other means of replacing the work of unskilled Americans with machinery that can be programmed to do much the same thing.”

Strategic Options for Global Expansion

Published on Friday, January 01, 1999

In order for lenders to obtain a full appreciation of the exporter’s mindset, it is important to understand some of his/her considerations prior to obtaining an overseas order. One of the first issues confronting an exporter is deciding what markets to pursue. In doing so, exporters should determine each country’s market size, its rate of growth, U.S. market share and whether that market share is increasing or decreasing. In addition, he/she should calculate whether or not the firm can be competitive in the selected markets. Trade barriers (tariffs, as well as standards, regulations, quotas, labeling requirements, etc.) in each selected market must be identified. If excessive, these barriers may make the exporter’s product too expensive and limit his/her exports. If the barriers are deemed manageable, the next step would involve investigating whether any vested interests can bar the exporter’s product from the market.

The exporter must also conduct research to become informed about competitors’ products, prices, distribution methods and commitments to after-sale service, as well as target customers. If intense competition exists, the exporter may decide to look at smaller markets that may be unattractive for multinationals, but big enough for a small firm.

Sensitivity to foreign cultures is not only polite, it’s good business. As a result, the exporter also must be concerned with the customer’s culture and tastes. If the products and designs will not suit the target market, the exporter will need to make changes or choose another market. In addition, other factors to be considered include the degree of foreign intellectual property protection, environmental standards, an understanding of the legal system and how it works, and the comprehensiveness, or lack of, commercial legislation. The absence of civil, commercial and criminal codes can be a major constraint. And confusing and burdensome bureaucratic requirements can tie up valuable time. As a result of the effort up to this point, it is not uncommon for the exporter to grow fatigued, give up, or abandon the objective.

There are many strategies from which a company can choose to expand internationally. These include direct exporting, indirect exporting, establishing a joint venture or strategic alliance in a foreign market, acquiring a firm through direct investment, or licensing technology abroad. In order to understand the exporter’s needs, it is important for lenders to grasp these strategies. The benefits and risks associated with each method are contingent on many factors, including the type of product or service, the need for support, and the foreign economic, political, business, and cultural environment the exporter is seeking to penetrate. The best strategy will depend on the firm’s level of resources and commitment, and degree of risk it is willing to incur.

A number of questions must be answered before committing to a particular strategy. Experienced international executives often say the company contemplating international expansion must be very familiar with the environment it is seeking to penetrate and understand how to do business there. What it will take to be successful, to staff appropriately, integrate distribution, finance operations, and remedy currency risks should be analyzed ahead of time. A primary concern frequently expressed is the need to know how to terminate an agreement if the arrangement does not work. Additionally, seasoned executives indicate it is essential to determine the potential for political risk and the propensity for business disruption in each country under consideration.

Indirect Exporting

Should the client decide not to get involved in exporting, he/she may consider selling the product to an intermediary located in the United States. Indirect exporting demands little or no knowledge of foreign markets. The advantages to small- and medium-size firms are that indirect exporting requires less international experience, less commitment of resources, and less risk. In addition, firms often can enter foreign markets more quickly through indirect exporting. The disadvantages include less control over the marketing of the product, less information about the buyers and generally less profit because of the greater number of intermediaries involved. These intermediaries include foreign buying agents, brokers and agents, export management and export trading companies, piggyback marketing, and foreign trading companies.

Foreign buying agents, also known as commission agents, are locators and purchasers of merchandise for foreign firms or governments. They are compensated by the foreign entity. Brokers and agents, also known as import-export brokers, act as independent intermediaries who facilitate international transactions by coordinating activities of buyers and sellers of particular products. Brokers and agents receive commissions based on the value of the transaction. In some instances, a broker or agent may prefer to keep the identity of the buyer or seller confidential to prevent compromising his/her position in future dealings. In this case, the broker or agent would retain ownership of the merchandise for a limited period of time, receiving his/her compensation from the final price of the product. In some instances, a broker or agent will provide documentation, labeling, packaging, and marketing services.

Both export management companies (EMCs) and export trading companies (ETCs) serve as indirect exporting intermediaries by providing export-related services. EMCs act as the export department for one or several manufacturers of non-competitive products, pursuing overseas orders in the name of the manufacturer. A long-term contractual relationship typically exists between the EMC and manufacturer. Most EMCs can be viewed as manufacturers’ sales representatives for export. Compensation packages vary. EMCs may receive a commission based on sales, a combination of retainer plus commission, or they may purchase and mark-up the product for export. They usually specialize in particular products or country markets and work closely with well-established networks of foreign distributors. They are familiar with the necessary formalities in packaging, documentation and shipping.

ETCs typically act as independent brokers, international distributors or wholesalers, with no long-term obligation to the manufacturer. ETCs take title to the merchandise, paying the manufacturer directly. Both ETCs and EMCs can provide immediate access to foreign markets and are used extensively by many small businesses.

Piggyback marketing is an arrangement in which one manufacturer or service firm distributes another company’s product or service abroad. The most common example is when a manufacturer complements its product line with other non-competing, ancillary products, such as TVs and VCRs.

Foreign trading companies, also known simply as trading companies, were important in the colonial movement and still are important today. Trading companies are very popular in Japan and to a lesser extent in Korea, Taiwan, China, Germany, the Netherlands, Sweden, England, and the larger Latin American nations. They tend to focus on a particular market or product line. Dealing with a trading company is similar to dealing with a domestic distributor. Terms may include a limited or exclusive territory involving one, several or all foreign countries. The manufacturer may be expected to maintain a certain level of support in inventory, turnaround time, advertising, packaging, pricing, and financing. In turn, the trading company normally will agree to achieve a certain level of export sales in a specific time period.

Direct Exporting

Direct exporting offers several advantages over indirect marketing. These include:

• Partial or full control over the foreign marketing strategy, including distribution, pricing, promotion, and product services;
• Direct and unadulterated feedback from the foreign market, allowing the manufacturer improved insight and the ability to respond faster to changing market conditions to alter or improve the product;
• Better protection of trademarks, patents and goodwill; and
• Fewer intermediaries with which to share profits.

Although direct exporting involves greater risk, it often yields greater profits. Generally, it is the best choice for companies that expect international business to produce a significant portion of their profits.

Before commencing the export program, it is important to advise the exporter to meet with potential end-users, distributors, agents, and U.S. government trade representatives, including U.S. Export Assistance Centers (USEACs), (see Chapter Five). It is just as important to develop a first-hand insight into the country as it is to build a distribution network. Before committing significant resources, the exporter should test the market in order to determine product receptivity.

Foreign private sector import channels usually include direct sales, distributors, sales agents, and retail distribution. Direct sales to most foreign retail establishments, corporations, institutions or government agencies involve contractual terms and conditions often similar to those in the United States.

Distributors, also known as importing distributors or foreign distributors, play an important role for many U.S. exporters. Distributors in developing countries, for example, tend to purchase less sophisticated and less expensive products to complement their preferred, more expensive and sophisticated lines, which they then distribute, acting as agents for foreign firms. Factors that should be considered when choosing a distributor include the following: regions covered, lines handled, track record, rapport with local banks, after-sales service, firm size, knowledge of product, level of cooperation, reputation, relations with local government officials, willingness and ability to inventory, conditions of facilities, and average percentage added to product price.

A common method of selling is through agents who solicit business in the foreign country on behalf of their U.S. principals. Foreign sales agents, like U.S. sales representatives, do not take title of the goods. This method is well suited for the sale of capital goods directly to end-users. Contracts between exporters and agents in most countries usually are not subject to government regulations. However, the exporter’s relationship with the agent should be clearly defined so it is not misconstrued by the foreign government to be an employee-employer relationship, which could subject the exporter to tax and labor law obligations.

The agent relationship can be very beneficial depending on the exporter’s interests. Developing a close working relationship between the exporter and the foreign sales representative is crucial. Personal contact is vital to developing a foreign business relationship. Similar to a distributor, the factors that should be considered when choosing an agent are regions covered, lines handled, knowledge of product, track record, size and quality of sales staff, after-sales service, reputation, level of cooperation, length of contract, and commission required. On the downside, U.S. firms must also be aware of the commitment they incur when signing an agent or distributor agreement. Foreign regulations are different and can be more difficult to sever.

Over the past decade, foreign marketing techniques and distribution channels have become more sophisticated. Although small mom-and-pop retailers still dominate many foreign sectors in terms of numbers, larger retail chains and discount stores are playing an increasing role in the distribution of products to consumers. For example, in Mexico and in many other developing countries, large retail chains have been established. Many of them have adopted American-style marketing techniques, such as automated checkout systems. This has resulted in more efficient business operations and may require a reassessment of the agent/distributor expectations.

Joint Ventures and Strategic Alliances

A joint venture is a cooperative business venture established by two or more companies. Prior to commencing operations, partners usually allocate resources, consign risks and potential rewards, and delegate operational responsibilities to each other while preserving autonomy. Upon completion of the project, the joint venture is usually disbanded. However, it also may be a permanent relationship, maintaining, for example, a long-term production schedule.

An international joint venture enables a firm to establish a marketing or manufacturing presence abroad with the assistance of a local foreign partner. The partner may provide knowledge of government workings, regulations, internal markets and distribution know-how. This knowledge may be particularly valuable to an exporter in unfamiliar territory.

A strategic alliance is similar to a joint venture in many ways— yet very different. An alliance may be formed when one organization grants another the authority to exploit technology, research and development knowledge, marketing rights and so forth, but does not create a separate entity. A typical example of a strategic alliance is the basic manufacturer - foreign independent sales representative relationship. To solidify this informal arrangement, a handshake or simple written agreement may suffice. A strategic alliance, often less formal, is a preliminary step to creating a joint venture. Consequently, both allow a company quickly to respond to a changing environment and contribute complementary strengths to seize opportunities quickly. In some foreign markets, such as China, a joint venture with a Chinese partner may be the only legal way to enter the market, except under very special circumstances.

A small company with limited capital and manpower, and the need to reduce and share risks, may find a joint venture an ideal entry strategy in an overseas market. By utilizing the management skills, experience and knowledge of the foreign market by the local partner, a firm significantly can reduce its learning curve and share its risks with a partner that has a similar agenda. A joint venture is also safer than a full-scale acquisition should an unfamiliar host government legislate adverse policies affecting foreign investment. Or, as a result of social unrest, the host country becomes embroiled in violence, resulting in property damage and the disruption of business. Many smaller companies favor joint ventures over other methods of expansion because they allow companies to target the exact activity for which they are looking rather than tie up capital in areas in which they have no interest. And from a tax perspective, partners can form a structure so their income crosses the fewest possible borders.

While there are significant potential advantages associated with joint ventures, there are also limitations. For example, in a typical joint venture the profits are shared. Additionally, there are many factors that can lead to disagreements between the partners, such as a dispute over efforts and marketing strategies, differences in management philosophies, etc. The ability to compromise and work together is essential, regardless of cultural differences. A complaint often heard by veteran executives is that many smaller companies do not invest the necessary level of commitment to understanding the culture or developing a strong personal relationship with their joint venture or strategic alliance partners abroad. This, many say, is key to a successful partnership.

From the outset, the level of compatibility between potential partners is difficult to assess. Many auto analysts speculated that the joint venture between Toyota and General Motors that created New United Motors Manufacturing, Inc. in the United States in 1984 would not succeed due to differences in management styles. It appears, however, that the analysts’ predictions were wrong. Conflicts can often arise with regard to interests in second markets. For example, assume a U.S.-Mexican joint venture in Mexico sells its fabrics to Argentina. Should the U.S. partner wish to establish a second joint venture in Argentina with an Argentinean partner, the second joint venture would compete with the first. This can, and has, resulted in many disputes.

Jerald Blumberg, Executive Vice President for DuPont, Wilmington, Delaware, believes it’s imperative to have an operating and marketing presence in the markets one wishes to pursue. He stated that DuPont’s lycra spandex business, one of the company’s most global businesses, has 70 percent of its sales outside the United States. “We operate 10 plants in 10 different countries, and no region or country is favored. There is no ‘home region.’” Importantly, he said the business is able to provide customers with the product they need, when they need it, anywhere in the world.

The company has sought joint ventures and alliances as a way to expand abroad. “Many times we’ve found this to be the safest, best and most practical way to establish a presence and credibility in emerging and evolving markets,” Blumberg said. However, this approach may not work in places like Russia, where operating manufacturing plants and an understanding of the consumer are limited. Blumberg claims a diverse business team who can serve customers in local markets is vital. “It is simply not possible for a cadre of expatriates from the home country to master the language and cultural differences in this diverse world.”

Licensing Technology

Through a strategic alliance or joint venture, a U.S. producer may wish to license its technology, know-how or designs to a foreign company for use in a geographic area for a limited period of time. This may include patents, trademarks, production techniques, and technical, marketing and managerial expertise.

Licensing is particularly attractive to small- and medium-size firms because it affords international expansion while significantly limiting risks. It rarely requires capital investment and neither requires the parties to work closely together nor demands continuous attention. Generally, small firms do not have the expertise, staff or resources to satisfy requirements demanded by other methods of expansion. In many cases, licensing is the only viable strategy for any size firm to securely enter a foreign market that lacks hard currency, severely restricts the repatriation of profits and foreign direct investment, maintains unreasonable trade barriers, and/or is economically or politically unstable.

As with each market-entry method, licensing has its disadvantages. For example, the licensor loses control over the quality, distribution and marketing policies, as well as the essential support services employed for the purpose of selling the product or technology. If compensation is based on sales volume, the licensor must rely on the honesty of the licensee to report units sold. Additionally, earnings are usually less than those provided by most other entry methods.

A typical licensing agreement may call for an up-front fee, royalties based on a percentage of future earnings, and consulting and training assistance. Many licensing agreements evolve into joint ventures, while some joint ventures or strategic alliances are eventually converted to simple licensing agreements when one party’s interests diverge from the original purpose.

Foreign Acquisitions

Through foreign direct investment, a company can acquire an interest in another firm located abroad. This decision is often part of a company’s long-term strategy to strengthen its foreign presence. Most often, a company will complete a foreign acquisition once a market is proven, usually after years of exporting or when a high degree of success has been experienced through a preexisting joint venture.

The degree of ownership desired is often a choice of whether the foreign operation is to be wholly owned (either as a branch or separate subsidiary) or partially owned. If the investor or group of investors desire controlling interests, the stock purchase will range from 51 to 100 percent. If the company is successful, the revenue generated can often exceed profits obtained through other types of international expansion methods.

Controlling interests will provide full authority over all policies, including marketing strategies, financing, cost cutting, expansion programs, production, and quality control. A foreign acquisition can also position the investor to accept host government incentives. Although the greater degree of control may allow the new owners to dictate management policy, trade experts often advise clients to respect and value the input provided by existing managers. A very successful acquisition strategy is one where the new owners study preexisting management styles and seek to understand what management thinks of proposed policy changes, and then incorporate this input.

Nationalist consumers tend to favor goods produced in their country. As a result, it sometimes makes sense to establish a manufacturing presence in the host country through an acquisition to achieve this benefit. In addition to this, both acquisitions and joint ventures allow for more effective servicing of products in distant markets, often leading to more satisfied customers. Many Japanese automobile manufacturers, for example, service the European market through their manufacturing facilities in the United Kingdom. The savings in response time and shipping costs alone can make this type of venture worthwhile, ultimately benefiting the customer.

Establishing a foreign base to service a particular region is also beneficial for cultural reasons. For example, it’s predicted that more U.S. companies operating in Mexico will use the country as a base to service smaller Latin American countries. The cultural affinity among the Mexicans and Central and South Americans can make assimilation less difficult and sales easier.

Foreign acquisitions usually require an abundance of resources, and the exposure to risk is considerably higher, as compared to other methods of foreign market entry. As a result, large companies are usually better suited for this type of undertaking. Changes in government policy can subject these resources to great risk. For example, transfer risk, arising from adverse government policies can restrict the transfer of capital, payments, products, technology, and persons into or out of the host country. Operational risk can constrain the management and performance of local operations in production, marketing, finance, and other business functions. These types of risks, and others, can financially ruin a foreign acquisition.