CHAPTER 2: GLOBALIZATION take over new opportunities in the global

Learning Objectives: marketplace.

At the end of the lesson, the students should be
able to: What are the benefits of globalization?
1. Understand the meaning of Globalization.
2. Appreciate the benefits of Globalization. Globalization impacts businesses in many
3. Realize the challenges in expanding across different ways. But those who decide to take on
borders international expansion find several benefits,
including:
GLOBALIZATION BENEFITS AND
CHALLENGES 1. Access to new cultures

Globalization is an established part of the Globalization makes it easier than ever to

modern world, so most of us do not realize the access foreign cultures, including food, movies,
benefits it brings to our everyday lives—such music, and art. This free flow of people, goods,
as easy access to a variety of different cuisines art, and information is the reason you can have
or new technologies developed by countries Thai food delivered to your apartment as you
half a world away. listen to your favorite U.K.-based artist or
stream a Bollywood movie.
Even though globalization makes our lives
better, it brings some challenges as companies 2. The spread of technology and innovation
start to grow and expand across borders.
Many countries around the world remain
Cultural differences around the world are constantly connected, so knowledge and
undeniable. These differences create hurdles technological advances travel quickly. Because
for businesses entering foreign markets and knowledge also transfers so fast, this means
necessitate changes to their daily business that scientific advances made in Asia can be at
operations, whether it’s employing workers in work in the United States in a matter of days.
a new region or communicating the value of
their product to a new audience. 3. Lower costs for products

What is globalization? Globalization allows companies to find lower-

cost ways to produce their products. It also
Before discussing the benefits and challenges increases global competition, which drives
of globalization, it’s essential to have a strong prices down and creates a larger variety of
understanding of what the term means. choices for consumers. Lowered costs help
people in both developing and already-
The official definition of globalization is the developed countries live better on less money.
process by which businesses or other
organizations develop international influence 4. Higher standards of living across the globe
or start operating on an international scale.
Developing nations experience an improved
More simply, globalization refers to an open standard of living—thanks to
flow of information, technology, and goods globalization. According to the World Bank,
among countries and consumers. This extreme poverty decreased by 35% since 1990.
openness occurs through various
relationships, from business, geopolitics, and The target of the first Millennium Development
technology to travel, culture, and media. Goal was to cut the 1990 poverty rate in half by
2015. This was achieved five years ahead of
Because the world is already so connected, schedule in 2010. Across the globe, nearly 1.1
most people don’t notice globalization at work billion people have moved out of extreme
every single day. But the world is getting poverty since that time.
smaller, and companies need to understand
what this means for the future of doing
5. Access to new markets
business. Companies that don’t embrace
globalization risk losing a competitive
Businesses gain a great deal from globalization,
advantage, which allows other businesses to
including new customers and diverse revenue
streams. Companies interested in these
benefits look for flexible and innovative ways 1B visas, and Brexit makes immigration to the
to grow their business overseas. U.K. difficult.

A global employer of record (EOR) makes it 3. Incurring tariffs and export fees
easier than ever to employ workers in other
countries quickly and compliantly. This means Another challenge leaders face when going
that, for many companies, there is no longer the global is incurring tariffs and export fees. For
need to establish a foreign entity to expand companies looking to sell products abroad,
overseas. getting those items overseas can be expensive,
depending on the market.
6. Access to new talent
4. Payroll and compliance challenges
In addition to new markets, globalization
allows companies to find new, specialized Another common global expansion obstacle
talent that is not available in their current is managing global payroll and maintaining
market. For example, globalization gives compliance with changing employment and tax
companies the opportunity to explore tech laws. This management task gets even more
talent in booming markets such as Berlin or difficult if you’re trying to manage operations
Stockholm rather than Silicon Valley. in multiple markets.

A global EOR allows companies to 5. Loss of cultural identity

compliantly employ talent overseas without
establishing an entity, making global hiring While globalization has made foreign countries
easier than ever. easier to access, it has also begun to meld
unique societies together. The success of
What are the challenges of globalization? certain cultures throughout the world caused
other countries to emulate them. But when
While globalization offers many benefits, it’s cultures begin to lose their distinctive features,
not without challenges. Some of the hurdles we lose our global diversity.
companies face when going global include:
6. Foreign worker exploitation
1. International recruiting
Lower costs do benefit many consumers, but it
A common challenge global leaders face when also creates tough competition that leads some
going global is international recruiting. companies to search for cheap labor sources.
Recruiting across borders creates unknowns Some Western companies ship their
for HR teams. production overseas to countries like China
and Malaysia, where lax regulations make it
First, companies create a plan for how they will easier to exploit workers.
interview and thoroughly vet candidates to
make sure they are qualified when thousands 7. Global expansion difficulties
of miles separate them from headquarters.
Next, companies need to know the market’s For businesses that want to go global and
demands for salaries and benefits to make discover the benefits of globalization, setting
competitive offers. To ensure successful hires, up a compliant overseas presence is difficult. If
HR teams must factor in challenges like time companies take the traditional route of setting
zones, cultural differences, and language up an entity, they need substantial upfront
barriers to find a good fit for the company. capital, sometimes up to $20,000, and costs of
$200,000 annually to maintain the business.
2. Managing employee immigration
Additionally, global businesses must keep up
Despite the benefits of global mobility, with different and ever-changing labor laws in
immigration is a top challenge companies face new countries. When expanding into new
when expanding overseas. Immigration laws countries, companies must be aware of how to
change often, and in some countries, it is navigate new legal systems and ensure global
extremely difficult to secure visas for compliance. Otherwise, missteps lead to
employees who are foreign nationals. The U.S., impediments and severe financial and legal
for example, is getting stricter with granting H- consequences.
8. Immigration challenges and local job loss 2. International employee expectations

The political climates in the U.S. and Europe Foreign employees have different expectations
show that there are different viewpoints on the when it comes to things like salary and benefits,
results of globalization. Many countries around as well as how they manage their daily work
the globe are tightening their immigration schedules. Companies that want to take
rules, and it is harder for immigrants to find advantage of globalization and hire foreign
jobs in new countries. workers need to accommodate them as much
as possible. HR teams must also ensure
This rise in nationalism is mainly due to anger their employee benefits offerings are
from the perception that foreigners fill competitive and on par with local expectations
domestic jobs or that companies move their during the hiring process.
operations abroad to save money on labor
costs. 3. Supporting foreign customers

For example, the Economic Policy Institute Similar to communication changes with
reports that the U.S. trade deficit with China (or employees, companies must also plan for how
the amount by which our imports exceed our they run customer service and support in new
exports) cost Americans 3.4 million jobs since countries. Customers in the new market where
2001. you offer your products or services might not
speak your native language or be close to your
How globalization changes your daily business time zone.
operations
4. Increased competition
Both the benefits and challenges of
globalization change how a business operates International companies have to adjust more
in different ways. When companies decide to go than internal operations. Going global opens up
global, they must be ready and willing to new revenue streams and increases availability
change internal processes. This helps to to talent. Because of these attractive benefits
accommodate new markets and make their and the ease of going global due to solutions
global workforce feel comfortable and like partnering with a global EoR, the global
accepted at work. marketplace is competitive.

Companies see many aspects of their As globalization becomes the norm, many
businesses change once they enter the global companies often seek the same foreign
marketplace. For example, globalization makes markets, which increases competition for
the workforce more diverse. This diversity is businesses.
an overall positive change, but it creates some
challenges, such as language barriers and 5. Marketing and communication changes
differences in cultural expectations.
Just like hiring employees in different countries
Some operational changes companies should creates internal communication challenges,
expect from globalization include: marketing your products or services to a
completely new audience creates obstacles for
1. Global communication challenges companies. Businesses need to adjust their
marketing strategies to communicate the
Before starting to branch out from benefits of their product in a way that
headquarters, firms have to put an established resonates with a foreign audience.
internal communication plan in place since
global employees likely work in a different time You cannot assume that a marketing campaign
zone and have a different native language. targeting an American audience (or wherever
your HQ location is) attracts consumers in
Software and other digital tools help smooth Europe, Asia, or any other popular market, as
global communication hurdles and allow teams the consumers there have very different wants
to connect easily. Zoom, Slack, and Google all and needs.
provide valuable tools for companies trying to
manage employees in multiple offices,
countries, and time zones.
 CHAPTER 3: INTERNATIONAL a firm, rather than a country, perspective.
These theories are referred to as modern and
TRADE THEORIES are firm-based or company-based. Both of
Learning Objectives: these categories, classical and modern, consist
of several international theories.
At the end of the lesson, the students should
be able to:
1. Understand international trade. Classical Modern Firm-
2. Compare and contrast different trade
theories. Country-Based Based
3. Determine which international trade theory Theories Theories
is most relevant today and how it continues
to evolve. Mercantilism Country Similarity
Topic Outline:
International Trade Theories
Classical or Country Based Trade Theories Absolute Advantage Product Life Cycle
Mercantilism
Absolute Advantage
Comparative Advantage Comparative
Factor Proportions Theory Advantage Global Strategic Rivalry
Modern or Firm-Based Trade Theories
Country Similarity Theory Hecksher-Ohlin Theory Porter's National
Product Life Cycle Theory (Factor Proportions Competetive
Theory) Advantage
Global Strategic Rivalry Theory
Porter’s National Competitive
Advantage Theory Classical or Country Based Trade Theories
Free Trade
Opposition to Free Trade Mercantilism – 16th century
Types of Trade Barriers
Tariffs Developed in the sixteenth
Non-Tariffs century, mercantilism was one of the earliest
efforts to develop an economic theory. This
International Trade Theories
theory stated that a country’s wealth was
determined by the amount of its gold and silver
International trade theories are simply
different theories to explain international holdings. In it’s simplest sense, mercantilists
trade. Trade is the concept of exchanging goods believed that a country should increase its
and services between two people or holdings of gold and silver by promoting
entities. International trade is then the concept exports and discouraging imports. In other
of this exchange between people or entities in words, if people in other countries buy more
two different countries. from you (exports) than they sell to you
(imports), then they have to pay you the
People or entities trade because they believe
difference in gold and silver. The objective of
that they benefit from the exchange. They may
need or want the goods or services. While at the each country was to have a trade surplus, or a
surface, this many sound very simple, there is a situation where the value of exports are greater
great deal of theory, policy, and business than the value of imports, and to avoid a trade
strategy that constitutes international trade. deficit, or a situation where the value of
imports is greater than the value of exports.
To better understand how modern global trade
has evolved, it’s important to understand how
A closer look at world history from the 1500s
countries traded with one another historically.
Over time, economists have developed theories to the late 1800s helps explain why
to explain the mechanisms of global trade. The mercantilism flourished. The 1500s marked
main historical theories are called classical and the rise of new nation-states, whose rulers
are from the perspective of a country, or wanted to strengthen their nations by building
country-based. By the mid-twentieth century, larger armies and national institutions. By
the theories began to shift to explain trade from increasing exports and trade, these rulers were
able to amass more gold and wealth for their In 1776, Adam Smith questioned the leading
countries. mercantile theory of the time in The Wealth of
Nations. Recent versions have been edited by
One way that many of these new nations scholars and economists. Smith offered a new
promoted exports was to impose restrictions trade theory called absolute advantage, which
on imports. This strategy is focused on the ability of a country to produce a
called protectionism and is still used today. good more efficiently than another nation.

Nations expanded their wealth by using their  Smith reasoned that trade between
colonies around the world in an effort to countries shouldn’t be regulated or
control more trade and amass more riches. The restricted by government policy or
British colonial empire was one of the more intervention.
successful examples; it sought to increase its
wealth by using raw materials from places  He stated that trade should flow
ranging from what are now the Americas and naturally according to market forces.
India. France, the Netherlands, Portugal, and
Spain were also successful in building large In a hypothetical two-country world, if Country
colonial empires that generated extensive A could produce a good cheaper or faster (or
wealth for their governing nations. both) than Country B, then Country A had the
advantage and could focus on specializing on
Although mercantilism is one of the oldest producing that good. Similarly, if Country B
trade theories, it remains part of modern was better at producing another good, it could
thinking. Countries such as Japan, China, focus on specialization as well.
Singapore, Taiwan, and even Germany still
favor exports and discourage imports through By specialization, countries would generate
a form of neo-mercantilism in which the efficiencies, because their labor force would
countries promote a combination of become more skilled by doing the same tasks.
protectionist policies and restrictions and Production would also become more efficient,
domestic-industry subsidies. Nearly every because there would be an incentive to create
country, at one point or another, has faster and better production methods to
implemented some form of protectionist policy increase the specialization.
to guard key industries in its economy.
Smith’s theory reasoned that with increased
While export-oriented companies usually efficiencies, people in both countries would
support protectionist policies that favor their benefit and trade should be encouraged. His
industries or firms, other companies and theory stated that a nation’s wealth shouldn’t
consumers are hurt by protectionism. be judged by how much gold and silver it had
Taxpayers pay for government subsidies of but rather by the living standards of its people.
select exports in the form of higher taxes.
Import restrictions lead to higher prices for Comparative Advantage – David Ricardo, 1817
consumers, who pay more for foreign-made
The challenge to the absolute advantage theory
goods or services. Free-trade advocates
was that some countries may be better at
highlight how free trade benefits all members
producing both goods and, therefore, have an
of the global community, while mercantilism’s
advantage in many areas. In contrast, another
protectionist policies only benefit select
country may not have any useful absolute
industries, at the expense of both consumers
advantages. To answer this challenge, David
and other companies, within and outside of the
Ricardo, an English economist, introduced the
industry.
theory of comparative advantage in 1817.
Absolute Advantage – Adam Smith, 1776 Ricardo reasoned that even if Country A had
the absolute advantage in the production
of both products, specialization and trade could endowed with such resources such as land,
still occur between two countries. labor and capital). They focused their attention
on how a country could gain comparative
Comparative advantage occurs when a country advantage by producing products that utilized
cannot produce a product more efficiently than factors that were in abundance in the country.
the other country; however, it can produce that Their theory is based on a country’s production
product better and more efficiently than it does factors—land, labor, and capital, which provide
the funds for investment in plants and
other goods. The difference between
equipment. They determined that the cost of
these two theories is subtle. Comparative any factor or resource was a function of supply
advantage focuses on the relative productivity and demand. Factors that were in great supply
relative to demand would be cheaper; factors
differences, whereas absolute advantage looks
in great demand relative to supply would be
at the absolute productivity.
more expensive. This theory stated that
countries would produce and export goods that
Let’s look at a simplified hypothetical example
required resources or factors that were in great
to illustrate the subtle difference between supply and, therefore, cheaper production
these principles. Miranda is a Wall Street factors. In contrast, countries would import
lawyer who charges $500 per hour for her legal goods that required resources that were in
services. It turns out that Miranda can also type short supply, but higher demand. Unlike
faster than the administrative assistants in her Ricardo’s theory, the Heckscher-Ohlin theory
office, who are paid $40 per hour. Even though argues that free trade is beneficial and that the
Miranda clearly has the absolute advantage in pattern of international trade is determined by
both skill sets, should she do both jobs? No. For differences in factor endowments, rather than
every hour Miranda decides to type instead of differences in productivity.
do legal work, she would be giving up $460 in Example:
income. Her productivity and income will be
highest if she specializes in the higher-paid The United States has long been a substantial
legal services and hires the most qualified exporter of agricultural goods, reflecting in
administrative assistant, who can type fast, part its unusual abundance of arable land. In
contrast, China excels in the export of goods
although a little slower than Miranda. By
produced in labor intensive manufacturing
having both Miranda and her assistant
industries such as textiles and footwear. This
concentrate on their respective tasks, their
reflects China’s relative abundance of low-cost
overall productivity as a team is higher. This is labor. The United States, which lacks abundant
comparative advantage. A person or a country low cost labor, has been a primary importer of
will specialize in doing what they these goods. Note that it is relative, not
do relatively better. In reality, the world absolute, endowments that are important; a
economy is more complex and consists of more country may have larger absolute amounts of
than two countries and products. Barriers to land and labor than another country, but be
trade may exist, and goods must be relatively abundant in one of them.
transported, stored, and distributed. However,
Modern or Firm-Based Trade Theories
this simplistic example demonstrates the basis
of the comparative advantage theory. In contrast to classical, country-based trade
theories, the category of modern, firm-based
Factor Proportions Theory - Hecksher-Ohlin, theories emerged after World War II and was
1900s developed in large part by business school
In the early 1900s, two Swedish professors, not economists. The firm-based
economists, Eli Heckscher and Bertil Ohlin, put theories evolved with the growth of the
forward a different explanation of comparative multinational company (MNC). The country-
advantage. They argued that comparative based theories couldn’t adequately address the
advantage arises from differences in national expansion of either MNCs or intraindustry
factor endowments (by factor endowments trade, which refers to trade between two
they meant the extent to which a country is countries of goods produced in the same
industry. For example, Japan exports Toyota It has also been used to describe how the
vehicles to Germany and imports Mercedes- personal computer (PC) went through its
Benz automobiles from Germany. product cycle. The PC was a new product in the
1970s and developed into a mature product
during the 1980s and 1990s. Today, the PC is in
Unlike the country-based theories, firm-based
the standardized product stage, and the
theories incorporate other product and service majority of manufacturing and production
factors, including brand and customer loyalty, process is done in low-cost countries in Asia
technology, and quality, into the understanding and Mexico.
of trade flows.
The product life cycle theory has been less able
Country Similarity Theory – Steffan Linder, to explain current trade patterns where
1961 innovation and manufacturing occur around
the world. For example, global companies even
conduct research and development in
The country similarity theory was
developing markets where highly skilled labor
developed by the Swedish economist Steffan and facilities are usually cheaper. Even though
Linder in 1961, as he tried to explain the research and development is typically
concept of intraindustry trade. Linder’s theory associated with the first or new product stage
proposed that consumers in countries that are and therefore completed in the home country,
in the same or similar stage of development these developing or emerging-market
would have similar preferences. countries, such as India and China, offer both
highly skilled labor and new research facilities
at a substantial cost advantage for global firms.
In this firm-based theory, Linder suggested
that companies first produce for domestic Global Strategic Rivalry Theory – Paul
consumption. When they explore exporting, Krugman and Kelvin Lancaster, 1980s
the companies often find that markets that look
similar to their domestic one, in terms of Global strategic rivalry theory emerged
customer preferences, offer the most potential in the 1980s and was based on the work of
for success. Linder’s country similarity theory economists Paul Krugman and Kelvin
then states that most trade in manufactured Lancaster. Their theory focused on MNCs and
goods will be between countries with similar their efforts to gain a competitive advantage
per capita incomes, and intraindustry trade against other global firms in their industry.
will be common. This theory is often most Firms will encounter global competition in
useful in understanding trade in goods where their industries and in order to prosper, they
brand names and product reputations are must develop competitive advantages. The
important factors in the buyers’ decision- critical ways that firms can obtain a sustainable
making and purchasing processes. competitive advantage are called the barriers
to entry for that industry. The barriers to
Product Life Cycle Theory – Raymond Vernon, entry refer to the obstacles a new firm may face
1960s when trying to enter into an industry or new
market. The barriers to entry that corporations
Raymond Vernon, a Harvard Business School may seek to optimize include:
professor, developed the product life cycle
theory in the 1960s. The theory, originating in
 research and development,
the field of marketing, stated that a product life
cycle has three distinct stages: (1) new  the ownership of intellectual property
product, (2) maturing product, and (3) rights,
standardized product. The theory assumed  economies of scale,
that production of the new product will occur  unique business processes or methods
completely in the home country of its as well as extensive experience in the
innovation. In the 1960s this was a useful
industry, and
theory to explain the manufacturing success of
the United States. US manufacturing was the  the control of resources or favorable
globally dominant producer in many industries access to raw materials.
after World War II.
Porter’s National Competitive Advantage To remain competitive, large global
Theory – Michael Porter, 1990 firms benefit from having strong,
efficient supporting and related
In the continuing evolution of industries to provide the inputs
international trade theories, Michael Porter of required by the industry. Certain
Harvard Business School developed a new industries cluster geographically,
model to explain national competitive which provides efficiencies and
advantage in 1990. Porter’s theory stated that productivity.
a nation’s competitiveness in an industry 4. Local firm characteristics.
depends on the capacity of the industry to Local firm characteristics include firm
strategy, industry structure, and
innovate and upgrade. His theory focused on
industry rivalry. Local strategy affects a
explaining why some nations are more
firm’s competitiveness. A healthy level
competitive in certain industries. To explain his
of rivalry between local firms will spur
theory, Porter identified four determinants innovation and competitiveness.
that he linked together. The four determinants
are (1) local market resources and capabilities,
In addition to the four determinants of the
(2) local market demand conditions, (3) local
diamond, Porter also noted that government
suppliers and complementary industries, and
and chance play a part in the national
(4) local firm characteristics.
competitiveness of industries. Governments
can, by their actions and policies, increase the
1. Local market resources and capabilities
competitiveness of firms and occasionally
(factor conditions).
Porter recognized the value of the entire industries.
factor proportions theory, which
considers a nation’s resources (e.g., Porter’s theory, along with the other modern,
natural resources and available labor) firm-based theories, offers an interesting
as key factors in determining what interpretation of international trade trends.
products a country will import or Nevertheless, they remain relatively new and
export. Porter added to these basic minimally tested theories.
factors a new list of advanced factors,
which he defined as skilled labor,
investments in education, technology,
and infrastructure. He perceived these
advanced factors as providing a
country with a sustainable competitive
advantage.
2. Local market demand conditions.
Porter believed that a sophisticated
home market is critical to ensuring
ongoing innovation, thereby creating a
sustainable competitive advantage.
Companies whose domestic markets
are sophisticated, trendsetting, and
demanding forces continuous
innovation and the development of
new products and technologies. Many
sources credit the demanding US
consumer with forcing US software
companies to continuously innovate,
thus creating a sustainable competitive
advantage in software products and
services.
3. Local suppliers and complementary
industries.
 CHAPTER 4: TRADE RISKS AND manager. Or it may be that the seller has agreed
RISK ASSESSMENT to terms that were previously used but are not
suitable in a new situation.
Learning Objectives:
Trade risks and risk assessment
At the end of the lesson, the students should International trade practices
be able to:
All forms of business contain elements of risk,
1. Identify and Understand the risks involved
in international trade but when it comes to international trade, the
2. Assess the effect of the trade risks in risk profile enters a new dimension.
conducting international trade. Internationally, you seldom have common laws
that can support the transaction, as would be
Topic Outline: the case within one country. Instead,
established trade practices and conventions
Trade risks and risk assessment are used to settle the undertakings made by the
International trade practices parties. The key to successful trade
Product risks transactions, therefore, depends on a
Commercial risks (purchaser risks) knowledge of these established practices and
Adverse business risks ensuring that the undertakings in the
Political risks individual contract are in line with such
Currency risks practices. This is why it is crucial for the seller
Financial risks to have started with a correct risk assessment
References: before finally entering into the transaction.
International Business. Hill. 2013.McGraw-Hill Sometimes, however, the circumstances in a
Education particular case are so obvious that one hardly
The Handbook of International Trade and thinks of it as a risk assessment, whereas in
Finance. Anders Grath, 2008. Bell & Bain Ltd, other situations a thorough risk assessment
Glasgow, Great Britain needs to be done.

INTRODUCTION The main sources for international trade

An international trade transaction, no matter practices are publications issued by the
how straightforward it may seem at the start, is International Chamber of Commerce (ICC). In
not completed until delivery has taken place, every new transaction one has to take it for
any other obligations have been fulfilled and granted that, from the outset, the parties will
the seller has received payment. This may seem have different views about various aspects of
obvious; however, even seemingly simple the terms of payment. This is quite logical since
transactions can, and sometimes do, go wrong. the most important function of these terms for
both seller and buyer is to minimize not only
There are many reasons why these things the risks involved, but also the cost of payment
happen, but behind them all is the basic fact and of the financing of the transaction.
that the risk assessment of the transaction
and/or the way these risks were covered went The negotiation process
wrong. An example is the risk assessment of the The seller will always try to get terms that will
customer, where exporters do not always fully maximize the outcome and minimize the risk.
realize that the larger countries may be divided However, they must also be prepared to
into regions, often with different cultures, accommodate reasonable demands from the
trade patterns and practices. In many buyer in order to match other competitors and
countries, signed contracts are sometimes reach a deal that is acceptable to both parties,
considered to be merely letters of intent, thereby also developing a good long-term
particularly if they have not been business relationship. Should the seller be
countersigned by a senior authorizing inflexible on this point, it could result in an
adverse competitive situation with the There are always potential drawbacks in trying
potential risk of losing the deal. to categorize such a general concept as trade
risks which could have so many different forms
On the other hand, demands from the buyer and shapes, but it also has great illustrational
that are too stringent can have the same result, advantages, particularly when they also
or be resolved by means of a higher price or coincide with commonly used business
some other amendment to the final agreement. expressions.
The outcome of these negotiations will depend
on past knowledge and experience, which is
The Figure below shows the main risk
even more important if the buyer bases their
structure in international trade, which will
request for tender on simplified or
affect both the seller’s and the buyer’s view of
standardized terms of payment, usually to their
the terms of payment.
own advantage. In many cases, such terms are
adapted to conditions that are not optimal for
the seller, compared with what the seller could
have reached if they were individually
negotiated. In such a case it is important to be
able to argue and convince the buyer that there
might be other solutions that can satisfy any
reasonable demands, in order to find the
optimal result for both parties.

There is, however, another – and in some

countries very common – way to bridge the gap
between the parties, if the seller has to abstain
from some demands in negotiations with the
buyer. The seller could approach a third party,
often a credit insurance company, in order to
Obviously, all these risks combined do not
reduce the commercial risk which could not be
often occur in one and the same transaction.
covered through the agreed terms of payment.
For example, a sale to a Norwegian customer in
USD may be just a matter of a straight
Finally, it should be noted that the business
commercial risk on the buyer, whereas
practices which have been established over
delivery of a tailor-made machine to Indonesia
time in different countries or regions also
has to be risk assessed in quite another way. In
create at least a common ground for both
quite general terms, the risk structure is
parties when starting their payment
directly linked to the obligations undertaken
negotiations, ie choice of currency, form of
by the seller. This assessment can often be
payment and terms of financing. Local banks,
made relatively simple as a commercial risk
trade councils and the chambers of commerce
only, but, in other cases, for example if the
in both the seller’s and the buyer’s country can
transaction also involves assembly,
draw on their experience and give impartial
installation, testing or a maintenance
advice on local business practice regarding
responsibility, the assessment has to involve
both the form of payment and the more specific
many other aspects as well.
terms of payment, while also taking the size,
commodity and other aspects of the potential
The question of risk is to a large degree a
transaction into account. Such considerations
subjective evaluation, but it is still important
can then be the starting point for negotiations
for both parties to have a good knowledge of
between the parties.
these matters in order to carry out a proper and
meaningful risk assessment. Only thereafter
Different forms of trade risk does the question arise about how to cover
these risks through the terms of payment from the seller to the buyer as specified by the
together with other limitations in the contract, terms of delivery; it is to be made either at that
if applicable, and together with separate credit particular time or at a specific time thereafter.
risk insurance or guarantees, as the case may This connection makes it necessary to outline
be. some basic facts about the different terms of
delivery.
It should also be noted that most export credit
insurance, taken by the seller as additional The standard rules of reference for the
security, could be impaired or even invalid interpretation of the most commonly used
should the seller themselves not have fulfilled trade terms in international trade are
– or been able to fulfill – their obligations Incoterms 2000 (International Commercial
according to the contract. This is another Terms), issued by the International Chamber of
reason why it is so important that the Commerce (ICC). These rules are now
obligations of the seller, according to the generally recognized throughout the world, so
contract, are always directly related to those of any other unspecified trading terms, which
the buyer. Otherwise the seller may end up in a may often have different meanings for
risk situation that is worse than anticipated at companies in different countries, should be
the time of entering into the contract. avoided.

When all the necessary evaluations have been The basic purpose of these rules is to define
done, the final decision as to whether the deal how each Incoterm, as agreed in the sales
is secure enough to be entered into has to be contract, should be dealt with in terms of
taken. The worst that can happen is finding, delivery, risks and costs, and specify the
after the contract has been signed, that it responsibility of the buyer and seller. For
contains risks that the seller was unaware of at example, who should arrange and pay freight,
that time. It is then often too late to make other transport charges, insurance, duties and
changes. taxes? These aspects are often referred to as
the critical points in international trade,
detailing at what point the risk is transferred
from the seller to the buyer and how the costs
involved should be split between the parties.

There are presently 13 defined Incoterms, split

into four groups, related to the seller’s
obligation to deliver the goods. Some
Incoterms can be used only for maritime
transport whereas others can be used for all
modes of transport; similarly, some are more
Terms of delivery and terms of payment suitable than others for use in combination
This chapter describes in detail the structure with terms of payment based on ‘clean
and design of the terms of payment as an payments’ in connection with open account
integral part of the contract. However, the trading, while others are used in combination
terms of delivery also have to be defined in with ‘documentary payments’.
order to determine when and where the seller
has fulfilled the obligations to deliver according These four groups are:
to the contract and what is needed in order to Group E – where the seller has to make the
do so. goods available at their premises. The only
example is EXW – Ex Works (named place),
There is a clear connection between these two where the seller must place the goods at the
sets of terms in so far as payment is mostly disposal of the buyer at the seller’s premises or
related to the point at which the risk passes
another named place not cleared for export and > the competitive situation, where the buyer
not loaded on any collecting vehicle. often suggests their preferred terms of
delivery and the seller has to evaluate these
Group F – where the seller must deliver the terms in relation to the risks involved.
goods to a carrier appointed by the buyer. For
example, FOB – Free on Board (named port of For a standard delivery between established
shipment), where the seller delivers the goods, trade partners, neighbouring countries or
cleared for export, when they pass the ship’s countries belonging to a common trading area,
rail at the named port of shipment (maritime this question is often easily agreed upon as a
transport only). matter of standard practice with only an
adjustment related to the actual freight and
Group C – where the seller themselves must insurance charges, often in connection with
contract for the carriage of the goods, but open account trading. In these cases, the
without assuming risk of loss of, or damage to, Incoterms Groups E and F are often used,
the goods or additional costs due to events where the buyer takes the main responsibility
occurring after shipment. For example, CIF – for transport and risk of the purchased goods.
Cost Insurance and Freight (named port of
destination), where the seller delivers the However, in other cases and when the seller
goods when they pass the ship’s rail in the port wants to have better control of the delivery
of shipment and must pay the costs and freight process and be able to select transport and/or
necessary to bring the goods to the named port insurance, the delivery terms C and D are more
of destination, but including also the frequently used (together with the FOB clause
procurement of insurance against the buyer’s which is sometimes also a requirement from
risk of loss of, or damage to, the goods during the buyer; see ‘Transport risks and cargo
carriage (maritime transport only). insurance’, page 16).

Group D – where the seller (apart from Group C The International Chamber of Commerce (ICC)
conditions) also has to bear all costs and risks The ICC (International Chamber of Commerce)
required to deliver the goods to the place of is the world’s only truly global business
destination. For example, DDP – Delivered Duty organization and is recognized as the voice of
Paid (named place of destination), where the international business. Based in Paris, its core
seller must deliver the goods to the buyer, services/activities include:
cleared for import, and not unloaded at the > practical services to business;
named place of destination. > working against commercial crime;
> being an advocate for international
When choosing the appropriate terms of business;
delivery, deciding factors (seen from the > spreading business expertise;
seller’s perspective) include: > promoting growth and prosperity;
> the transportation route, the buyer and the > setting rules and standards;
nature of the goods, including the mode of > promoting the multilateral trading system.
transport;
> standard practice, if any, in the buyer’s ICC membership groups thousands of
country or any regulation set by the companies of every size in over 130 countries
authorities of that country to benefit their worldwide, mainly through its national
own transport or insurance industry; committees. They represent a broad cross-
> procedures, where the seller should avoid section of business activity, including
terms of delivery, which are dependent on manufacturing, trade, services and the
obtaining import licences or clearance of professions. Through membership of the ICC,
goods to countries they cannot properly companies shape rules and policies that
judge; stimulate international trade and investment.
These companies in turn count on the prestige
and expertise of the ICC to get business views these cases there is often no other readily
across to governments and intergovernmental available buyer if the transaction cannot be
organizations, whose decisions affect completed, in which case the seller has to carry
corporate finances and operations worldwide. the cost of any necessary readjustment, if that
is even an option. Risks of this nature occur as
Product risks early as the product planning phase but may
Product risks are risks that the seller often be difficult to cover from that time owing
automatically has to accept as an integral part to the special nature of these products. But they
of their commitment. First, it is a matter of the also involve specific risks for the buyer, who
product itself, or the agreed delivery; for often has to enter into payment obligations at
example, specified performance warranties or an early stage but without the security of the
agreed maintenance or service obligations. product itself until it has been delivered and
There are many examples of how new and installed. In order to safeguard the interests of
unexpected working conditions in the buyer’s both parties, the terms of payment are often
country have led to reduced performance of the divided into part-payments related to the
delivered goods. It could be negligence production and delivery phases, in
concerning operating procedures or combination with separate guarantees, to
restrictions, careless treatment, lack of current cover the risks as they occur in different phases
maintenance, but also damage due to the of the transaction.
climate or for environmental reasons.
Matters of this nature may well lead to disputes Transport risks and cargo insurance
between the parties after the contract has been From a general risk perspective it is not only
signed and to increased cost for the delivery as the product but also the physical movement of
a whole. It is important for the seller to have the the goods from the seller to the buyer that has
contract, and specifically the terms of payment, to be evaluated, based on aspects such as the
worded in such a way that any such changes, nature of the product, size of delivery, the
which are directly or indirectly due to the buyer and their country, and the actual
actions of the buyer or originating within their transportation route. Most goods in
country, will automatically include international trade, apart from smaller and
compensation or corresponding changes in the non-expensive deliveries, are covered by cargo
seller’s commitments. This can be either in insurance, providing cover against physical
economic terms or in originally agreed time loss or damage whilst in transit, either by land,
limits, or both. It goes without saying that these sea or air, or by a combination of these modes
risks become even more complicated when it of transport.
comes to whole projects or larger and more The cover under a cargo or marine cargo policy
complex contracts. These are often completed is almost always defined by standard policy
over longer periods and involve many more wordings issued by the Institute of London
possible combinations of interrelated Underwriters (or the American Institute of
commitments between the commercial parties, Marine Underwriters). These are called
not only between the seller and the buyer, but Institute Cargo Clauses.
also often involving other parties in the buyer’s
country, both commercial and political. The question of who should arrange the
insurance is determined by the agreed terms of
Manufacturing risks delivery, as defined by the Incoterms 2000 and
The concept of product risk could also include described earlier. These terms also define the
some elements of the manufacturing process critical point during transport, where the risk
itself, even if in principle that subject falls is transferred from the seller to the buyer. That
beyond the scope of this handbook. This risk can be any given point between a named place
appears all too frequently when the product is at the seller’s location (Ex Works) and a named
tailor-made or has unique specifications. In place at the buyer’s location (Delivered Duty
Paid, DDP). That specified critical point
determines the seller’s and the buyer’s insurance covers the risk that the goods may
responsibility to arrange insurance, as arrive at their destination in a damaged
required. condition, resulting in the buyer’s refusal to
accept them (even if the risk was on their part
However, there is another aspect of risk according to the terms of delivery), or they may
coverage that the seller has to be particularly simply be unable or unwilling to pay for
aware of, and that is the potential risk of the commercial or political reasons, including
buyer arranging insurance according to some failure to produce a valid import license. In
of the terms of delivery. If such a term of such cases the insurance covers the physical
delivery is chosen, for example FOB (named loss of, or damage to, the goods, but it does not
port of shipment), and the buyer fails to insure cover the credit risk (commercial or political)
in a proper and agreed way, the goods may on the buyer, which has to be covered through
arrive at the destination in a damaged the terms of payment, in conjunction with any
condition and without adequate insurance other arrangements.
cover. If, at the same time, the terms of
payment allow for payment after delivery, this The seller should bear in mind that cargo
risk de facto becomes a risk for the seller, who insurance is a specialized business, where
may end up with unpaid for, uninsured and cover and conditions may vary according to the
damaged goods at the point of destination. commodity or goods to be shipped, the
Such a situation is obviously a consequence of transportation route and the mode of
the seller agreeing to terms of payment that did transport, which is a major reason why open
not cover the actual commercial risk, but the policy cover is the most common in
insurance risk involved could, in most cases, international trade. But normal risk
have been eliminated by separate seller’s management procedures will always apply:
interest contingency insurance, as described new and adverse conditions and/or additional
below. risks must be reported or approved by the
insurer, and the policy normally excludes loss
From the seller’s perspective, there are or damage due to willful misconduct or
basically three different ways to insure the insufficient, unsuitable or inadequate packing
cargo, either with an open insurance policy or container stowage by the assured party.
covering most or all shipments within the
seller’s basic trade as agreed in advance with Cargo insurance can be obtained directly from
the insurer, or with a specific insurance policy, an insurance company or, very often today,
covering specific shipments on an ad hoc basis directly through the transporting company or
or those which are outside the set criteria of the the forwarding agent handling the goods. In
open policy. The open policy is by far the most some countries it is also quite common to use
common in international trade, normally independent cargo insurance brokers, who
reviewed on an annual basis, and with a 30–60- may be more able to select the most cost-
day cancellation clause, should conditions efficient insurance package, based on specific
deteriorate substantially. The open cover is the conditions or the trade structure in each
most cost-effective alternative, but it also has individual case.
obvious administrative advantages and will
automatically secure the actual coverage of all However, the seller should always ensure that
individual shipments under the policy. the selected insurer has or is part of an
established international network for dealing
The third basic form of cargo insurance is with claims and settlement procedures. This is
seller’s interest contingency insurance, often also a requisite of the buyer, and if not
mentioned above, normally only offered as a explicitly agreed in the sales contract, such
complement to the open policy or as integral conditions may appear later on.
part of a specific policy, and on an undisclosed
basis as far as the buyer is concerned. This Commercial risks (purchaser risks)
Commercial risk, also called purchaser risk, is inexpensively and in a standardized manner on
often defined as the risk of the buyer going into the internet, but in other cases a more
bankruptcy or being in any other way researched profile is required.
incapable of fulfilling the contractual
obligations. One might first think of the buyer’s Each seller must have a policy for obtaining up-
payment obligations but, as seen above, it also to-date information about the commercial risk
covers all other obligations of the buyer, structure in connection with any new potential
according to the contract, necessary for the buyer or business and with outstanding export
seller to fulfill their obligations. receivables. How this is done may differ
depending on the volume and structure of the
How does the seller, therefore, evaluate the exports, but it is recommended at least to
buyer’s ability to fulfill their obligations? In review the business information systems
most industrialized countries within the offered by the larger providers and to choose
Organization for Economic Co-operation and an alternative that is optimal for the individual
Development (OECD) area, it is relatively easy seller as to the services and costs involved.
to obtain a fair picture of potential buyers,
either to study their published accounts or to The seller should, however, be aware that the
ask for an independent business credit report, contents and accuracy of the business
which is a more reliable way of dealing with information may vary, depending on the
customer risks. This will also give much registered information available about the
broader information about the buyer and their company. The contents can sometimes also be
business, and not simply some selected difficult to evaluate and questions always arise
economic figures from which the seller often about how up to date it really is, particularly
cannot draw any decisive conclusions. when dealing with customers outside the most
advanced industrialized countries.
Credit information
Export trade may be an important factor in the The information, if available, will be much
potential growth of business; however, the more difficult to evaluate and it will be harder
risks involved in carrying out international to assess how it has been produced and how it
business can also be high. In little more than a should be analyzed. In these cases, the
decade, the world of commerce has changed information probably has limited value
dramatically. In this commercial environment, anyway, because other risk factors, such as the
the global suppliers of credit information have political risk, may be greater – and terms of
become a vital source of knowledge and payment that reflect this combined risk have to
expertise, based on the great wealth of be chosen.
information that they maintain about
consumers and how they behave, about The seller may also be able to get assistance
businesses and how they perform, and about abroad through the export or trade council or
different markets and how they are changing. similar institutions in their country, and/or
from the commercial sections of embassies
The more the seller understands their abroad, which can assist with market surveys
customers, the more they are able to respond and other studies in that country. Even banks
to their individual needs and circumstances. can participate by issuing introductory letters
Credit information suppliers help the seller use to their branches or correspondents, enabling
information to reach new customers and to the seller to obtain more up-to-date
build, nurture and maximize lasting customer information about the local business
relationships. Credit information thus forms a conditions and form an opinion about the
vital part of establishing the structure of a buyer and their business in connection with the
potential export transaction and, in particular, contract negotiations.
the terms of payment to be used. In some cases
the information can be provided instantly, Adverse business risks
Adverse business risks include all business launder money. The seller should also be
practices of a negative nature, which are not particularly observant in the case of cash
only common but also almost endemic in some payments and be aware that new anti-money
parts of the world. This could have serious laundering regulations must be complied with
consequences for the individual transaction, for such payments in most countries.
but also for the general business and financial
standing of the seller, as well as their moral A reputable business adds respectability to any
reputation. organization being used for laundering
operations, and money launderers will try to
We are, of course, referring to all sorts of use any business, directly through ownership,
corrupt practices that flourish in many or indirectly by deceit. Developing nations are
countries, particularly in connection with particularly vulnerable to money launderers
larger contracts or projects: bribery, money because they usually have poorly regulated
laundering and a variety of facilitation financial systems. These provide the greatest
payments: opportunities to criminals.

Bribery in general can broadly be defined as In general terms, a suspicious transaction is

the receiving or offering of an undue reward by one that is outside the normal range of
or to any holder of public office or a private transactions from the seller’s point of view, in
employee designed to influence them in the particular in relation to new customers or
exercise of their duty, and thus to incline them where an old customer changes transaction
to act contrary to the known rules of honesty structure in an unusual way. It can include:
and integrity. - unusual payment settlements;
- unusual transfer instructions;
This quotation is taken from a UK government - secretiveness;
body, and even if it is not a legal definition, it - rapid movements in and out of
gives an accurate description of the problem. accounts;
- numerous transfers;
If bribery is generally a technique to press the - complicated accounts structures
seller for undue rewards, money laundering
often has the opposite purpose, which is to Any of the above should be considered
invite the seller to do a deal that may on the suspicious.
face of it seem very advantageous, but where
the true intention is to disguise or conceal the Bribery, money laundering and any other form
actual origin of the money involved. It covers of corrupt behaviour is bad for business; it
criminal activities, corruption and breaches of distorts the normal trade patterns and gives
financial sanctions. It includes the handling, or unfair advantages to those involved in it. It is
aiding the handling, of assets, knowing that also extremely harmful for the countries
they are the result of crime, terrorism or illegal themselves, owing to the damage it causes to
drug activities. the often fragile social fabric; it destroys the
economy and is strongly counterproductive for
Criminal and terrorist organizations generate trade and all forms of foreign investments into
large sums of cash, which they need to channel the country.
into the banking, corporate and trade financial In the long run, such practices also prevent
systems, and both banks and traders can social and economic stability and development,
innocently fall victim of such activity if not and it has an especially negative impact on the
exercising due diligence. A frequently used most disadvantaged parts of the population.
technique is over-invoicing or inflated Even within the countries where these
transactions, with or without payment to a practices are frequent among individual public
third party, where the seller may be completely and private employees, it is almost always
unaware that they could be part of a ruse to illegal, even if the countries lack the means and
the resources to tackle these problems to extort bribes from them or attempt to induce
effectively. them into any other form of corrupt practice.

The need for a strong policy Political risks

The World Bank and the OECD have put a great Political risk or country risk is often defined as:
deal of resources into combating corruption ‘the risk of a separate commercial transaction
worldwide, and in most countries corruption is not being realized in a contractual way due to
now illegal even when committed overseas. measures emanating from the government or
The companies also have full responsibility for authority of the buyer’s own or any other
the wrongdoings of their employees abroad foreign country’.
when acting for the company.
No matter how reliable the buyer may be in
As a consequence of the inclusion of anti- fulfilling their obligations and paying in local
corruption laws, it is also incorporated in the currency, their obligations to the seller
procedures of all government departments, for (according to the contract) are nevertheless
example in the rules of the respective export dependent on the current situation in their
credit agency (which will be described at own country – or along the route of transport
length later in this book). Any violation of the to that country.
anti-corruption statement that the seller has to
give when applying for such insurance could However, in practice, it may be difficult to
have serious implications for its validity. separate commercial and political risk because
political decisions, or other similar acts by local
It is often not even the threat of prosecution authorities, also affect the local company and
that should most worry the seller. There have its capabilities of honouring the contract. For
been a number of cases in which companies example, some countries may change taxes,
were allegedly involved in corrupt behaviour, import duties or currency regulations, often
but where the true circumstances were not with immediate effect, which could undermine
fully disclosed. The allegation could be the basis for contracts already signed.
damaging enough, sometimes based only on
rumours emanating from economic groups or Other common measures include import
political factions within the society (a restrictions or other regulations intended to
frequently used method), to stop or postpone a promote local industry and to save foreign
project or to favour another bidder. currency. Even with just the risks of such
actions, they all have the same negative
Such rumours, true or false, or involving either implications for the transaction and the buyer’s
smaller facilitation payments or large-scale possibility of fulfilling their part of the contract.
bribery to senior private or public officials, can Seen from a broader perspective, political risk
drag on for years, with economic and could be divided into different underlying
detrimental consequences for the company, causes, such as: - political stability;
both overseas and at home. - social stability; and
- economic stability.
Every company involved in overseas trade or
investments should have a clear anticorruption Political stability (ie local political structures
policy that is implemented and clearly and ideology combined with external relations
understood by all its employees, and with other countries) is often seen as an
supervised by the management in an important criterion of the real political risk.
appropriate way. Such a policy is also This stability indicates, in general terms, the
supported by local laws, which give both the likelihood or the probability of a country’s
company and its employees a much stronger involvement in, or being affected by, acts of
moral and legal defense against every attempt terror, war or internal violence from groupings
within the country or sanctions or blockades requirements – measures that could have a
from other nations. genuine purpose or be put in place partly to act
as trade barriers to promote sectors or
The constant risk of rapid and unexpected important industries within the country.
change in economic policy or in the form of Irrespective of the purpose, such actions, often
nationalization or similar measures as a called ‘non-tariff barriers’, could have a
consequence of political instability will have negative impact on the signed transaction.
the same effect; they are all extremely Other, more open measures are sometimes also
damaging for any private commercial implemented, often at short notice, as has been
economic activity in the country. seen within the European Union (EU), for
Unfortunately, there are presently numerous example, where the objective has often been to
examples of this political instability in many prevent a rapid increase in imports from some
parts of the world. emerging market countries, in order to protect
the EU’s own industry or allow more time to
The social stability of a country is also of great adapt to new trade patterns.
importance, mainly on a long-term basis.
However, the developments in many countries, But countries involved in the transit of goods
not only developing countries, show all too well have to be considered as well as countries
how unexpectedly and rapidly social instability related to subcontractors or suppliers of
(uneven income distribution and ethnic or crucial components. In these cases, perhaps it
religious antagonism) can turn into violence or is not the political risk as defined, but other
terrorist activity that can paralyse the country measures that are more important; for
or its economy. example, the risk of labor market conflicts in
the form of strikes or lockouts that could
Economic stability is equally important to interrupt delivery of components needed for
maintain the confidence of a country and its the timely execution of the agreed sales
economy. A weak infrastructure, dependence contract.
on single export or import commodities, a high
debt burden and lack of raw materials are Not least, the risk involved in ordinary force
critical factors that, together with other majeure clauses should be mentioned, even if
developments, can easily change economic the background is not political but caused by
stability in a short time. Even currency other factors outside the control of the
restrictions and other more indirect currency commercial parties themselves. When used by
regulations such as ‘pegging’ against other other parties, such clauses could, for example,
currencies, often USD, could have serious long- release a subcontractor from their delivery
term economic consequences, as seen in many obligations during the periods they are
countries. applicable, with corresponding effects for the
seller. Even bank guarantees and other
The turbulent situation in many developing obligations in favor of the seller could be of
countries is a constant reminder of the fragility limited value during such periods if, as is
of economic stability in many countries around normally the case, they only cover
the world. commitments according to a contract, which
may refer to such clauses. The same goes for
Other forms of political or similar risk presentation of documents under a letter of
Apart from the real political risks already credit, where the bank will not accept
discussed, there are other measures taken by documents that have expired during such
authorities in the buyer’s home country that interruption of the bank’s business.
can affect the buyer and their ability or
willingness to fulfill the transaction; for However, when used by the seller, such clauses
example, demands for product standards, new could protect them against actions for breach
or changed energy or environmental of contract, where performance of their
contractual obligations is prevented by currency and to the management of currency
incidents outside their control. This is often risk exposure.
referred to as ‘frustration of contract’ and a
typical clause might say: Assessment of currencies
Traditionally, currencies have been divided
The Company shall have no liability in respect into groups of ‘strong’ and ‘weak’ currencies,
of any failure or delay in fulfilling any of the and this view has affected the general
Company’s obligations to the extent that conception of preferred trade currencies, even
fulfilment thereof is prevented, frustrated, though the highest preference is often for the
impeded and/or delayed or rendered currency of the home country. Sterling (GBP),
uneconomic as a consequence of any fire, flood, the yen (JPY), the Swiss franc (CHF) and even
earthquake, other natural disaster or Act of the euro (EUR) and maybe some others would
God, industrial dispute or other circumstances probably be regarded as strong currencies,
or event beyond the Company’s reasonable while others would be seen as neutral, weak or
control (‘force majeure conditions’). unstable. An evaluation such as this may
perhaps have its justification in a longer
Currency risks perspective for currencies where the home
If payment is going to be made in a currency countries have maintained economic and
other than that in which the seller incurs their political stability over the years, together with
costs, a new currency risk will arise. In most a strong economy, low inflation and stable
cases, the seller’s main costs will be in local confidence in the future maintenance of this
currency, which automatically creates such a policy.
risk if invoicing in another currency. The size of
that risk will depend on the currency and the It should, however, be enough to look at the
outstanding period until payment. development of the USD, which has changed its
value vis-à-vis other large currencies
Since the introduction of the euro, invoicing in dramatically over the years (and often quite
that currency has become increasingly rapidly), to realize that such sweeping
common in European trade and also with statements can have their risks.
sellers outside the euro zone. This
development is likely to accelerate with Furthermore, for most parties it is not the long-
additional countries joining the euro zone. term currency development that is most
interesting, but rather the shorter perspective,
Traditionally, however, the USD has been the limited to the time-span during which current
preferred third-party currency. This applies deals are paid. Then the situation can be
particularly to raw materials and certain reversed, for in that shorter perspective, a
commodities in general, and for many other currency can have a development in complete
services such as freight and insurance. It is also contrast to its long-term trend.
commonly used in countries where the United
States maintains a strong economic or political In the shorter perspective, other factors, real or
influence. expected, may be more important, such as
interest rate changes, political news and larger
Available statistics do not usually show price movements in base commodities, central
currency distribution for international trade of bank currency interventions, statements and
goods and services, but it can generally be statistics. All these factors, combined with
expected that exports invoiced in smaller trade subjective evaluations by millions of
currencies are diminishing in favor of the participants in the currency markets, will
larger ones, and will probably continue to do together constantly create new short-term
so. Most exporters will therefore have to trends.
become accustomed to invoicing in foreign
For those who want to follow short-term
currency development, most banks and many Sometimes the interaction between the seller
other financial or currency institutions and the buyer can make it difficult to establish
publicize information via the internet or e-mail the exact cause for the delay in payment and
on a regular basis – both retrospectively and there are then fewer chances for the seller to
actual, together with analysis and evaluations refer to a specific breach of contract on the part
of future trends. of the buyer. On the other hand, if the seller has
paid enough attention when drafting the sales
Currency abbreviations contract, including the terms of payment, then
The International Organization for it is more likely that any reason for delays will
Standardization (ISO) has established official be possible to determine according to the
abbreviations for all currencies, which are now clauses of the contract. There could be
commonly used. The abbreviations for some of numerous reasons for such delays, for example
the most common trade currencies are as issuing a letter of credit too late, late changes in
follows: specification of the goods, late arrival of the
US dollar USD . vessel, congestion in port, changes in the
Euro EUR transport route, to name a few.
Pound sterling GBP
Swiss franc CHF The real risk also tends to increase with longer
Canadian dollar CAD and consequently more costly transport
Japanese yen JPY distances. Bureaucratic delays in many
Chinese yuan CNY1 countries, as well as delays in the banking
Swedish krona SEK system, will have the same result – the final
Hong Kong dollar HKD 1 payment to the seller will not be made as
anticipated according to the contract.
Financial risks
In practice, every international trade Apart from ordinary overdrafts during
transaction contains an element of financial production and delivery, the need for finance is
risk. Purchasing, production and shipment all also determined by the amount of credit that
place a financial burden on the transaction that the seller may have to offer as part of the deal.
forces the seller to determine how alternative If so, the financial risk is increased in line with
terms of payment would affect liquidity during the prolonged commercial and/or political
its different phases until payment – and how risk.
this should be financed. And, if the deal is not Figure: Risk Assessment Summary
settled as intended, an additional financial risk
occurs. In the case of subcontractors, who do
not share the risks of the transaction and are
paid according to separate agreements, the risk
increases accordingly and even more so should
the seller have to offer a supplier credit for a
shorter or longer period.

When it comes to larger and more complex

transactions, this financial risk aspect is even
more obvious. One of the major problems for
the seller could be to obtain bankable collateral
for the increased need for finance and
guarantees. Even after production and
delivery, the seller could still be financially
exposed in the case of unforeseen events and
delays until final payment.
 compromise by offering compensation to the
A careful risk assessment is the first important buyer for the increased bank charges and/or
step to a successfully completed transaction the additional costs incurred by the use of the
because it is the basis for the seller’s own buyer’s existing credit limits.
strategy, and for the final decision on what is
acceptable in the negotiations with the buyer in
order to minimize the risks involved.

Financial risk and cash management

Other forms of financial risk are more obvious
but have to be underlined in this context; for
example, if the seller misjudges the risks
involved in the transaction and becomes
exposed through terms of payment that do not
cover the real risk situation, or mistakenly
enters into the deal without proper risk
protection. It goes without saying that such
miscalculations can have serious financial
consequences, from delays in payment to loss
of capital.

The financial risks are generally intimately

connected to the structure of the terms of
payment. The safer they can be made, the more
the financial risk will automatically be reduced,
the timing of the payments will be more
accurate and the liquidity aspect of the
transaction better assessed – in fact, the very
essence of cash management.

The safer the terms of payment the parties

have agreed upon, the more costly they will
normally be. And, if they contain bank security,
such as a letter of credit or a bank guarantee,
that will also reduce available credit limits
within the buyer’s own bank.

However, the buyer is often not prepared to

accept higher costs and the use of their own
credit limits in order to satisfy what might be
seen as excessive demands from the seller,
involving methods of payments, which in their
opinion, are not normal practice in their
country or normally accepted by the company.
It is then up to the seller to evaluate the
transaction, including potential competition
from other suppliers.

Eventually, the seller may have to accept the

terms of payment offered and try to cover the
remaining risks in some other way or to find a