International Business

Block

4
FUNCTIONAL AREAS IN INTERNATIONAL BUSINESS

UNIT 10
Global Research and Development 1-26

UNIT 11
Global Human Resource Management 27-50

UNIT 12
Global Marketing and Supply Chain 51-72

UNIT 13
Accounting in the International Business 73-97

UNIT 14
Financial Management in International Business 98-123
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April, 2022. All rights reserved
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ii
BLOCK 4: FUNCTIONAL AREAS IN INTERNATIONAL
BUSINESS
The fourth block to the course on International business deals with global research and
development, global human resource management, global marketing and supply chain,
accounting in international business, and financial management in international business.
The block contains five units. The first unit gives an overview of global research and
development. The second unit discusses human resource management in the global context.
The third unit discusses globalization in international markets and how supply chains are
globalized. The fourth unit discusses how accounting is carried out in international
business. The fifth unit discusses the investment, financial, and money management
decisions in the context of international business.
The first unit, Global Research and Development discusses the concept of globalizing R&D
and the benefits and challenges of global R&D. It then goes on explaining the design and
structure of global R&D activities. It then discusses how multinational enterprises
(MNEs) manage their R&D operations. The unit finally discusses how technology
transfer takes place across borders.
The second unit, Global Human Resource Management defines strategic international
human resource management. It goes on to explain how staffing takes place in MNEs. It
then discusses the concept of expatriates; their selection and failure; how they are trained
and compensated; and recommendations on how expatriates should be compensated in
different cultures. The unit finally discusses the human resource problems faced by MNEs
in foreign affiliates.
The third unit, Global Marketing and Supply Chain discusses how the market potential
of a foreign country can be determined. It goes on to explain the concepts of globalization
and localization in international markets. The unit finally discusses how supply chains are
globalized.
The fourth unit, Accounting in the International Business discusses accounting standards
followed in different countries. It goes on to explain the national and international
standards. It then discusses the significance of consolidated financial statements, the
methods used for currency translation, and the concept of transaction exposure. It also
explains the concept of economic exposure. The unit finally discusses the different aspects
of accounting in control systems.
The fifth unit, Financial Management in International Business discusses the different
investment decisions firms take in international business. It goes on to explain the
various factors firms consider for financing in an international business. It then explains
the money management decisions firms take in international business. It also explains how
money management decisions help firms in achieving their tax objectives. It then discusses
the techniques used by international businesses for moving liquid funds across borders. The
unit finally discusses the techniques for global money management.

iii
 Unit 10
Global Research and Development
Structure
10.1 Introduction
10.2 Objectives
10.3 Globalizing R&D
10.4 Design and Structure of Global R&D
10.5 Management and Operations of Global R&D
10.6 Technology Transfer across Borders
10.7 Summary
10.8 Glossary
10.9 Self-Assessment Test
10.11 Suggested Readings/Reference Material
10.12 Answers to Check Your Progress Questions

“Research is creating new knowledge.”

- Neil Armstrong
10.1 Introduction
The previous block gave an overview of international strategy. It also dealt with
the organization of international business. It finally discussed entry strategies and
strategic alliances.
Many Multinational Enterprises (MNEs) are increasingly dedicating their human,
financial, and technological resources to global research and development (R&D)
in order to achieve sustained competitive advantages in the global marketplace.
Many western MNEs are extending their R&D activities in developed as well as
developing countries, especially emerging markets. Also MNEs from
industrialized nations such as South Korea, Hong Kong, Taiwan, and Singapore
have started relocating many R&D activities abroad.
This unit will discuss the concept of globalizing R&D and the benefits and
challenges of global R&D. It then goes on explaining the design and structure of
global R&D activities. It then discusses how multinational enterprises (MNEs)
manage their R&D operations. The unit finally discusses how technology transfer
takes place across borders.

10.2 Objectives
By the end of this unit, students should be able to:
 Explain the concept of globalizing R&D and the benefits and challenges of
global R&D.
Block 4: Functional Areas in International Business

 Discuss the design and structuring of global R&D activities.

 Describe the global view of MNEs in managing their research operations.
 Outline the concept of technology transfer across borders.

10.3 Globalizing R&D

Globalizing R&D is “a process of locating and operating R&D laboratories in
different countries, under a coordinated ad integrated system by the company’s
headquarters, in order to leverage the technical resources of each facility to further
the company’s overall technological capabilities and competitive advantage.”
Globalizing R&D differs from internalizing R&D. The former requires global
integration of geographically dispersed R&D units while internalizing R&D is an
early stage of globalizing R&D, which evolves as the international expansion of
a firm grows larger and complex in scope and scale. The R&D function serves as
the major avenue to build and sustain global competitive advantage of a company.
MNEs having a well-defined strategy on globalizing R&D tend to achieve
superior sales and profit performance.
R&D intensity has increased at a steady pace in many industries such as
pharmaceuticals, electronics, chemicals, and medical equipment. While American
MNEs lead in innovation in many high-technology industries such as computers,
software, automobiles, healthcare, and advanced materials, MNEs from Europe,
Japan, Canada, and newly industrialized countries such as Israel, Taiwan, and
Korea also demonstrate high level of R&D and incentive productivity. Of late, the
number of patents developed by MNEs worldwide has surged. The main thrust
for global firms has been to increase the patent output per unit of R&D spending.
Managing global R&D receives greater attention by international business
managers for three reasons: First, technology is recognized as a primary source of
competitive advantage. International R&D augments and expands the overall
R&D process of the firm. Second, the nature of technological innovation process
has changed. Technological innovations are a result of integration of technologies
from different disciplines. Countries differ in their competitive advantage and
globalizing R&D enables firms to tap these sources of strength. Third, time is a
critical competitive factor in many industries. R&D activities are decentralized
for accelerating the process of innovation and adaptation. Finally, the growth of
network and information exchange systems facilitates long-distance
communication, which lowers the costs of coordination that are associated with
globalization of R&D activities.
Globalizing R&D is a strategic response to changes in international markets.
Foreign customers demand customized products and higher levels of technical
service along with a shortened product life cycle in many industries. Targeting
and developing regional markets such as the Latin American Free Trade

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 Unit 10: Global Research and Development

Association (LAFTA) and European Union may offer greater rewards to modify
products for meeting market requirements. For gaining access to cutting-edge
technologies developed by foreign companies or improving the adaptations of
their own innovations, MNEs send their own scientists and engineers to onsite
laboratories. The globalization process moves up the R&D value chain from
technology support to product development and further to technology
development. This indicates the important role assumed by foreign facilities in
knowledge creation.

Example: Managing Global Research and Development at Nestle

Nestle SA (Nestle) is a research and development leader in the world’s food
industry. The company made substantial investments every year in R&D,
which was carried out at the Nestle Research Center (NESTEC) at Lausanne,
Switzerland and in 28 R&D centers worldwide.
The R&D activities were incorporated at NESTEC, which offered technical
assistance to all operating units of Nestle throughout the world. The company
has several researchers who worked in many disciplines such as bioscience,
food science, plant science, food safety, food technology, and nutrition.
R&D management set some research priorities that helped in determining
Nestle’s long-term competencies (category I projects), while Nestle’s strategic
business units (SBUs) were responsible for prioritizing and monitoring R&D
work linked to new process and product developments (category II projects).
The SBUs had close working relationships with the R&D network as well as
operating businesses, and take a multifunctional approach for setting priorities.
The R&D coordinators at the SBUs were responsible for assigning the related
research project to the most competent R&D group within the network and also
monitor the progress.
The R&D centers were instructed by NESTEC to take on additional
responsibility as product area managers for improving coordination across
various R&D centers working in the same product area. The product area
manager leads the R&D groups and also helped them in meeting their assigned
tasks and deadlines.
Compiled from various sources

10.3.1 Benefits and Challenges of Global R&D

The following benefits may arise from globalizing R&D:
The first benefit of globalizing R&D is that it may offer a vehicle for accessing
from extracting benefits from the technical resources local expertise, and
scientific talent of the target country. MNEs may also receive benefits such as low
interest financing and tax breaks offered by host governments when they establish
R&D centers overseas.

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Block 4: Functional Areas in International Business

Second, globalizing R&D may enhance the competitive advantage of a firm.

Setting up R&D facilities in host countries signals long-term commitment of a
firm to its local customers.
Finally, globalizing R&D may enable an MNE to enjoy benefits that arise from
international division of labor in R&D among multiple foreign countries or
regions. MNEs that are well-coordinated can allocate specific responsibilities to
different but integrated R&D subsidiaries based on their knowledge, expertise,
and external resources. This multilateral cooperation enables the firm to obtain a
more diverse flow of new ideas, processes, and products, providing greater input
into the innovation process of the firm. This also creates a synergy earned from
comparative advantage in R&D resources from all the participating nations.

Example
Phillips, a major consumer electronics company, has R&D locations in Europe,
the United States and Japan. The management wants them to be able to
participate in Japanese growth. Phillips has employed Japanese experts and
established relationships with Japanese businesses, universities and
government research institutes. It benefits from learning from and partnering
with extremely demanding Japanese customers and businesses. Here, multi-
lateral cooperation is the aspect of Globalizing R & D is illustrated in the case
of Phillips.
Multi-lateral cooperation enables Phillips to be benefitted from learning from
and partnering with extremely demanding Japanese customers and businesses.
Source: ICFAI Research Center

Globalizing R&D is a complex process that involves several challenges and

difficulties.
The first challenge of globalizing R&D is that maintaining minimum efficient
scale in foreign R&D operations is not easy always. It may be difficult to staff
the foreign laboratories with enough qualified people for achieving the minimum
efficient scale. In addition, splitting up the most qualified people of an MNE over
several international R&D sites may dilute the critical mass at the centralized
R&D facility based in the home country. Further, government controls and
political risks in the host country may increase the uncertainty of R&D
operations. It may create a rift between the motivations of an MNE and those of
the local government. In developing countries where import restrictions exist, it
may not be easy to import the essential research materials. Hiring of local people
can also be subject to government controls.
Second, the leakage of proprietary knowledge poses a serious threat when R&D
is globalized. This arises because of the presence of a foreign joint venture
partner, lax patent laws in the country, or due to foreign nationals being hired

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 Unit 10: Global Research and Development

by indigenous firms after they acquire MNE’s expertise. Maintaining the

confidentiality of technical knowledge and information is difficult and costly.

Example
When it came to the F-15 Eagle Fighter and the Boeing 767 aircraft, McDonald
Douglas and Boeing took chances by collaborating with Japanese companies.
It is tough and expensive to keep technological information and knowledge
private. Here, leakage of proprietary knowledge is the element of globalizing
R&D is this case. In this case of F-15 & Boeing, maintaining the confidentiality
of technical knowledge and information is difficult and costly.
Source: ICFAI Research Center

Finally, globalizing R&D inevitably increases coordination and control costs.

MNEs may face coordination issues such as allocating research tasks among
dispersed R&D centers, developing products that are responsive to market needs
in different countries, and exchanging information among different R&D centers.
The decentralized and distant MNE R&D facilities increase the coordination and
control costs. Lack of coordination and control can lead to costly duplication of
effort since different facilities may not be completely aware of what other
facilities are doing. In addition, the cultural and business differences between
home and host countries may intensify the difficulty in running R&D activities
abroad.
Despite these challenges, there is an increased globalization of R&D activities
as MNEs have become more internalized. The advantages of global R&D require
well- prepared design and structuring in the building phase and well-established
systems of coordination, management, communication, and control in the
operational phase. Managing global R&D activities is complex and difficult
while formulating strategies and policies that concern R&D dispersion and
control. The global R&D system of a firm should be structured to fulfill
organizational needs while taking advantage of external opportunities. Internally,
the R&D function has to face the ongoing task of coordinating and controlling
across the firm’s international network of R&D laboratories. Externally,
corporate R&D creates and manages technical cooperation with research
consortia, universities, and even competitors to stay abreast of lading edge
developments. A firm also has to essentially manage critical areas such as
coordination and communication, technology transfer, human resource
management, and collaboration with local firms. Without such management, the
economic return of R&D dispersion cannot be ensured.

10.4 Design and Structure of Global R&D

10.4.1 Types of Foreign R&D Units
The first step in globalizing R&D is defining the type of a planned R&D program.
With regard to the role of foreign R&D units, R&D subsidiaries can be

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Block 4: Functional Areas in International Business

categorized into corporate technology units specialized or regional technology

units, global technology units, technology transfer units, and indigenous
technology units.
A corporate technology unit is designed for generating basic, long-term
technology of exploratory nature to use by the parent company. A specialized
technology unit is set for developing specialized products, processes, or
technologies predefined by headquarters for serving either the regional or the
global market. A global technology unit is established to develop new products
and processes for major world markets. A technology transfer unit facilitates the
transfer of the corporate parent’s technology to a subsidiary and providing local
technical services. Finally, an indigenous technology is formed overseas for
developing new products specifically for the local market.

Example
Samsung Research is the advanced research and development (R&D) hub of
Samsung’s Consumer Electronics (CE) Division and IT & Mobile
Communications (IM) Division at its Corporate Head Quarters. Samsung
Research leads the development of the future technologies for Samsung’s
products and services with more than 10,000 researchers and developers
working in overseas R&D centers. However, the major decisions about the
technology or exploring various product features were made primarily at
Samsung’s advanced research and development (R&D) hub. Here, Corporate
Technology Unit is the type of R & D unit in this case.
In this case, Samsung Research is the advanced research and development
(R&D) hub of Samsung’s Consumer Electronics (CE) Division and IT &
Mobile Communications (IM) Division at its Corporate Head Quarters is the
corporate technology unit.
Source: ICFAI Research Center

Technology transfer units and indigenous technology units are locally adapting
laboratories. The function of these units is to help the production and marketing
facilities in a host country make use of the existing technology of the MNE. They
may also assist the technology transfer process by advising on necessary adaption
of the manufacturing technology. They may act as a technical service center
where they examine why a product may not satisfy a local market and how it can
be adapted to better meet the local needs. For instance Exxon used this technique
for in the development of products in the European market. When indigenous
technology units are designed for serving a foreign market, they become locally
integrated laboratories and involve some of the basis developmental activities.
The particular host-market may considerably be diverse, fast-growing, large, and
may need a nationwide R&D office for coordinating and integrating host-country
R&D activities.

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 Unit 10: Global Research and Development

Example
Labour arbitrage agreement between India and US made QuEST (US product-
engineering design firm) to offshore its Airbus engine design services to India.
An aircraft engine design supply chain cluster was set up in Karnataka, India,
for making precision engineering equipment/services. Airbus offered its
assistance along with approved component designs and integration procedures,
to the Indian engineers at the cluster, helping them to design everything as per
Airbus standards.
Source: ICFAI Research Center

Corporate technology units and global technology units are both globally
interdependent laboratories. These two laboratories provide inputs into a centrally
defined and coordinated R&D program with no essential connection with the
production operations of the host-country. The function of these units is to focus
on research and development as opposed to improvement and adaptation. They
do not link to local manufacturing but to corporate and divisional R&D. Examples
of successful corporate technology are Eastman Kodak’s R&D unit in Australia
and CPC International’s R&D affiliates in Japan and Italy. IBM is known for
establishing several global technology units worldwide for developing a product
or process that will have universal applicability in all major local and foreign
markets.
10.4.2 Selecting R&D Location
Selecting an R&D location is a crucial and complex decision because external
parameters such as resource availability, market conditions, and government
policies differ across countries and even at locations within a country. Once a
laboratory is built, switching costs from one location to another are enormous.
First, location selection depends on the strategic role of an R&D subsidiary that
is set by the parent company. If the subsidiary is designed to serve the home
market, managers should take into consideration the availability of scientific
knowledge and talent from foreign universities. For a subsidiary that targets the
world market, location factors include availability of adequate infrastructure and
universities and accessibility to foreign scientific communities. When the
subsidiary serves just as center for technology transfer, it should be located in
countries where the company already has made substantial investments in
manufacturing and/or marketing. In general, R&D follows manufacturing and
marketing in the globalization process. In cases where the laboratories are
established for performing basic research or developing new products for the
global market, they should be located in places in which there is a concentration
of technology resources and advanced innovation. This concentration is a vital
reason why MNEs tend to cluster their technology development centers into
numerous hot spots.

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Block 4: Functional Areas in International Business

Second, host government policies may have an influence on location decision.

The policies include: work permit regulations for expatriate scientists, engineers,
and managers; government requirements for increasing local technological
content of the activities of the firm; tax subsidies for supporting the R&D
activities of the foreign firm; and efficient patent laws.
Third, the local infrastructure and technological level of a foreign country are
vital. Technological capability must exist in the country to permit R&D to take
place. Some MNEs tap technologies that are more advanced. For instance,
Germany is a world leader in areas of chemistry, physics, metallurgy, and
medicine while Britain has spent heavily in pharmaceuticals and chemicals. The
presence of research universities or local firms with advanced technologies
becomes crucial in these circumstances.
Finally, sociocultural factors may affect location selection. MNEs prefer locating
R&D facilities in nations with a similar culture and language, considering the
difficulties associated with operating business in a different social and cultural
environment. The decision makers at the headquarters should consider the
attractiveness of the lifestyle of the foreign country to the staff assigned overseas.
If the location is undesirable, it may be difficult to find qualified people willing
to work abroad. As R&D largely depends on the creativity and efficiency of
human resources the living and working conditions abroad may determine the
incentives and commitments of the expatriates.
10.4.3 Structuring Global R&D Activities
To ensure global R&D success, MNEs should design an appropriate
organizational structure governing R&D activities. The two crucial factors
essential for structuring global R&D operations include (1) the level of authority
an MNE plans to offer to its foreign R&D activities and (2) the scope of the
geographical market to be covered. Based on these two axes (level of autonomy
and market breadth), five models can be identified. They are ethnocentric
centralized, polycentric decentralized, specialized lab, global central lab and the
globally integrated network. These models serve an organizational framework in
which different R&D units may be designed with different roles and types.
In the ethnocentric centralized R&D structure, all key R&D activities are
concentrated in one home country. This structure has a corporate technology unit
at home, and may also include a few technology transfer units for distributing
centralized R&D results to local operations. In this model, the core technologies
in the home country are viewed as national treasure, designing products that are
manufactured subsequently at other locations and are distributed worldwide.
Its disadvantage is lack of sensitivity to signals from overseas markets and
insufficient consideration of local market demands. MNEs select this structure
only if they manufacture global, standardized products and do not take into
consideration differentiating between foreign markets.

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 Unit 10: Global Research and Development

The polycentric decentralized R&D structure is characterized by a decentralized

alliance of R&D sites with no corporate R&D center for supervision. This
structure contains several indigenous technology units in major foreign markets.
Foreign R&D laboratories are highly autonomous with little incentive for sharing
information with central R&D or other R&D units. Foreign R&D laboratories
emphasize process or product development process in response to local consumer
demands and localization requests. In this structure efforts to preserve autonomy
and national identity may hinder cross-border coordination, and thus lead to
inefficiency on a corporate level and for duplication of R&D activities. The firm
may also lose its focus on a particular technology.
In the specialized laboratory structure, foreign R&D units are assigned global
directives. The aim is to enhance the global efficiency of the product development
process, concentrating in a single location the resources related to development
operations in a particular product category. This structure has specialized
technology units in respective product areas. When a leading market exists in
terms of size and presence of customers, the MNE assigns the global
responsibility to develop and manufacture the product to the laboratories and
plants in that country. This approach helps in achieving economies of scale in
R&D and for placing the product development operations close to the key
customers of the company. The global development laboratories are selected
based on the proximity to the manufacturing plants because there are costs in
transferring R&D to a manufacturing plant that is way from the R&D center.

Example
Due to poor quality, export of Vinca rosea (dry leaves) from India to Eli Lilly
(US based pharmaceutical firm formulating anti-tumour cancer drugs), was
stopped. Eli Lilly started its own plantation in Houston, US, resulting in pile up
of Indian stocks. Avra Laboratories Pvt Ltd (ALPL), affiliated to Cipla-an
Indian pharmaceutical firm, initiated a Government funded research unit, to
develop a new Vinca rosea based formulation. The research unit under the
guidance of Cipla developed an alternate formulation with a small team in a
year. This innovation was commercialized at both domestic and export
markets, by Cipla, giving a rare honour of entering the export market for the
first time.
Source: ICFAI Research Center

The global center lab structure is used for leveraging company’s centralized
technical resources for creating new global products. Though it is also centralized,
R&D under this structure covers a broader market domain than R&D in the
ethnocentric centralized model. In this structure, there can be more than one
global technology unit for generating worldwide innovation. In this model,
companies concentrate their technical resources in the country of origin. To make

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Block 4: Functional Areas in International Business

this structure work, it is crucial to create an effective market information network

that provides an information flow from the decentralized marketing or production
units to the parent company. This enables the central development laboratories
for generating products suitable for the global market and/or to adapt different
product versions to individual markets.
The globally integrated network structure may be filled with a number of foreign
R&D units with different types and roles, such as corporate technology unit,
indigenous technology unit, global technology unit, and specialized technology
unit. In this model, home R&D is not the center of control for all R&D activities
but rather one among many interdependent R&D units that are interconnected by
means of varied and flexible coordination mechanisms. A central coordinating
body exercises the needed supervision for preventing duplication and integrating
the diverse contributions. Development processes which can be exploited across
several markets involve resources from different facilities whose work is
coordinated according to a common plan. Each unit in the network specializes in
a particular component, product, or technology area, and set of core capabilities.
At times this unit takes over a lead role as a competence center and is then
responsible for the entire value generation process.

10.5 Management and Operations of Global R&D

The rapid dispersion of R&D laboratories in foreign markets have forced MNEs
to take a global view in managing their research operations through areas such as
human resource management, autonomy specification, global planning, and
communications improvement.
10.5.1 Human Resource Management
R&D human resources needs to be managed in such a way that they fulfill the
unique needs of global R&D. First, selection of key personnel must be linked to
the role or type of foreign R&D unit. For instance, if the laboratory belongs to an
indigenous technology then local talent that is well-qualified should be considered
for both management and R&D positions. If the lab belongs to a specialized or
global technology unit or is to accept technology from the parent company then
qualified expatriates are preferred. Second, personnel policies for foreign lab
should be standardized to the extent allowed by local customs and laws.
Promotions, titles and rewards and recognition programs should be as same as
possible. Because there needs to be frequent contact between home and overseas
laboratory personnel this uniformity of management positions and titles can help
make foreign laboratories feel that they are equal partners with parent
laboratories. Reward and recognition programs instilled at the headquarters
should be extended to include the global R&D personnel. Third, maintaining
some regular visits and contacts between foreign R&D units and home la center
is useful.

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 Unit 10: Global Research and Development

10.5.2 Autonomy Setting

Autonomy refers to the decision-making power of an R&D unit concerning R&D
activities. The autonomy of a foreign R&D unit largely depends on the role it
plays in the MNE network. For instance, managerial autonomy in a laboratory
that serves as a specialized center for global competence must be delegate greater
power. Generally autonomy should be higher if the technical resources in the
laboratory are scarce, should be located together in a center of excellence or
should be put to use where it could create more leverage for the company. When
a foreign R&D unit serves as a unit for technology transfer for the MNE network,
its autonomy will be low and the authority for decision making will be centralized
at the headquarters. In this situation the unit plays the role of an effective adopter
of new products and processes that are created by the parent company. If the unit
is indigenous, specialized technology laboratory, or global technology center, it
requires a low level of formalization (i.e. specifying the essential behaviors in the
form of rules procedures or programs) and a high level of autonomy. The
subsidiaries need increased degrees of freedom and more resources distributed by
the parent companies. Some R&D subsidiaries of companies such as ITT, Philips,
and Unilever enjoy considerable strategic and operational autonomy, though
headquarters exercises administrative control through financial reporting and
budgeting systems. These autonomous subsidiaries were found to be more
productive than other R&D units in these companies.

Example
NASA’s Space Shuttle Challenger (SSC), disintegrated over the Atlantic
Ocean immediately after 73 seconds of its launch, killing all the astronauts
onboard, due to O-ring failure. Allan McDonald, Director SSC, Rocket Motor
Project, had to testify before a Presidential commission, to explain cause of the
failure. During the hearing McDonald said, Morton Thiokol (Makers of O-
rings) had recommended (prior to the launch) that NASA not launch the shuttle
in temperatures below 53 degrees. But the advice was overruled and NASA
went ahead with the launch at 29 degrees, as it was already delayed.
Source: ICFAI Research Center

The autonomy of a foreign R&D unit is subordinating the strategic needs of an

MNE for global integration. There are positive associations between creating,
adopting and diffusing innovations by a subsidiary and the degree to which the
subsidiary is integrated with the parent company and shares its overall goals,
strategy, and values. Such integration results from a high degree of organizational
socialization and is achieved through extensive transfer and travel of managers
between the headquarters and the subsidiary and through joint work-in teams
committees, and task forces.

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Block 4: Functional Areas in International Business

Resource allocation is a significant vehicle in balancing global integration and

local autonomy to manage dispersed R&D units abroad. In general, resources
allocated to specialized technology units or global technology units may be those
involved in strategic and exploratory research core competency global market
coverage, or significant areas of investment. Resources that are likely to be
duplicated in regional R&D centers are the ones that focus chiefly on product
development as opposed to technology development. In addition to technological
factors geopolitical and financial factors play a major role in determining proper
allocation of resources. Finally, in resource allocation it is important to consider
the interface between physical resources and human resources in a new
information technology environment. Networks connecting the facilities of a
company worldwide enable researchers to work on one project from many
locations.
10.5.3 Global Planning
The corporate R&D office has the crucial task of coordinating the dispersed
global network of R&D laboratories. Global planning is a primary means of
information exchange among decentralized R&D laboratories and projects. In
the process of planning, corporate headquarters outline a strategic goal of
globalizing R&D and communicating it to foreign R&D units. For instance,
Matsushita build set up a three pillars blue print including:
 Construction of a tri-pole R&D network between laboratories in Europe and
North America and domestic research laboratories for establishing advanced
technological bases and creating products for the global market.
 Improved R&D efficiency through expansion of collaborative relationships
with international research institutions.
 Increased speed of globalization of R&D through superior management and
effective communication across borders.
R&D planning activities also contribute to learning throughout the MNE if they
request participation from scientists and technicians on a routine basis. Planning
can be transformed into an education process by the central R&D office. Planning
activities also help in global integration. Though budgeting is considered to be
difficult due to development cycles spanning five years or more, global planning
is easier due to the ability to disseminate information and establish priorities.
Planning helps in the alignment of technological and business strategies of a
company. Once the technology strategy is set, it can be carried into specific
project areas. A key aspect of alignment of R&D on the business objectives is
cross-functional planning and execution. With participation of manufacturing
marketing, and sales, R&D groups can optimize the process of project assessment,
selection, and project portfolio balancing. Progress on R&D projects can be
assessed on a regular basis and can be reported to multi-functional teams.

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 Unit 10: Global Research and Development

10.5.4 Communication Improvement

A major communication challenge across a network of international R&D
laboratories is posed by geographic distance. Cross-border communication
breakdowns lower productivity. Moreover, the role of informal communication
networks is important as much of the work can be accomplished in teams. An
effective communication system is essential not only within the R&D function
but also between R&D and other functional activities such as manufacturing,
marketing, and sales. For improving communication within a global R&D
network, international managers need to be aware of the following issues.
Rules and Procedures
For overseas laboratories, careful documentation and reporting of research
progress can help the R&D personnel be aware of research activity across the
company. Research progress reports supplement the communication flows related
to the planning cycle which can also serve the purpose of education.
Electronic Communication
Videoconferencing images, electronic mail facsimiles of visual and written
material and computer conferencing offer greater communication possibilities
than a simple telephone call. They provide an essential infrastructure for
communication across borders. However they cannot replace the informal face-
to-face communication that builds trust.
Boundary Spanners
The R&D staff at the headquarters often perform the role of boundary spanners
between the R&D laboratories that are dispersed. They travel to site location to
share development somewhere else in the global R&D network and for discussing
progress at the particular site. They may also divulge sensitive information across
the network about developments with joint venture partners, customers, or
suppliers.
Informal Network
Communicating through an informal network is an efficient means for teamwork.
Informal networks can be stimulated through central R&D group, which may be
created both inside and outside the company locally or internationally. An
external local network comprising local suppliers, customers, and research
institutions offer opportunity for learning from foreign environments. The central
office R&D group can put in place an external international network of academics
who work on company projects. Private conferences help in bringing these
academics together for presenting their research and for exchanging information.
The central office can supervise locating and funding outside academic
researchers. The internal network of an MNE can be activated with international
project teams. The project team members stay in their respective laboratories and
collaborate on projects using personnel transfers and electronic means.

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Block 4: Functional Areas in International Business

Cultural Adaptation
Global R&D projects need to overcome cultural differences. Though many
researchers speak in English there is no assurance that the members of a
multicultural R&D team understand each other. Research suggests that significant
cross-cultural differences exist among R&D professionals on the dimension of
power individualism risk avoidance and masculinity/feminity. An effective mean
to minimize cultural differences is to socialize R&D professionals through a wide
range of activities. International training seminars help in building in shared
corporate culture as well as a network of colleagues who can communicate on an
informal basis.

Example
Hanwang, a Chinese IT provider of pattern-recognition technology, licensed its
embedded Handwriting Recognition System (HRS) to Microsoft for
incorporation into Windows CE and Pocket PCs. As Chinese language
characters are complex, a research project exclusively dealing with Chinese
handwriting recognition was funded by the National Basic Science Foundation.
The research project’s firm was successful in developing pattern recognition
technology which had a national patent. The firm was named as Hanwang
Technologies Co. Ltd (HTCL). Most of the mobiles manufactured in China by
firms like Nokia, Samsung and Sony Ericsson incorporate Hanwang’s
recognition technology for providing their global language translation needs.
Source: ICFAI Research Center

Activity 10.1
JJ Ltd., a pharmaceutical company has it head office in the US. The company
had several R&D units that were spread across Europe and Asia. The
headquarters staff often traveled to each R&D unit to share development and
also monitor the progress at each site. Identify the role played by the
headquarters staff in managing their cross-border R&D operations. Also
discuss other issues international managers need to be aware of to improve
communication within a global R&D network.
Answer:

10.6 Technology Transfer across Borders

A common alternative for setting up a foreign-based R&D center or laboratory is
to collaborative agreements or technology transfers with foreign partners. This
approach is attractive to firms or projects in need of large investments which may
involve high uncertainties.

14
 Unit 10: Global Research and Development

International technology transfer is “a process by which one firm’s technology or

knowledge is passed on to another firm in a different country for economic
benefits.” Technology transfer helps a firm acquire needed knowledge or
technology from a foreign provider. The methods most often used for technology
transfer include international licensing turnkey operations, non-equity or equity
joint ventures and countertrade. In general firms that acquire technology through
international transfer seek increasing competitiveness by reducing development
costs increasing competitiveness, enhancing technological position in the market,
or reducing prices while not compromising on quality. If firms want to transfer
the technology they own to foreign firms, they need to consider factors such as
protection of proprietary technology, impact on the existing market power of the
firm, competition and earning royalties from remote markets.
Technology transfer is a complex and ongoing activity as demonstrated by the
fact that the license relationships have been in operations for over 50 years.
Moreover variations are prevalent across market lines, company or industry. Even
within a MNE network management and policies of technology transfer vary
according to subsidiaries, type of technologies, and stages of the technology life
cycle. As such, it would be inappropriate for a firm to try controlling it through
uniform rules.
A major problem with technology transfer across borders is that much of the
technological capability cannot be transferred easily from one partner to another.
This is because the successful operationalization of many technologies depends
on the experiences acquired and expertise of critical personnel including
engineers, equipment operators, key scientists suppliers, etc. The ways in which
interdependent technologies are tuned for working effectively in a complex
system are tacit or implicit in nature, relying on overall experiences
understandings, and skills that have they internalized or learned over time. Due to
this it is necessary to check the absorptive capability of a transferee. The
absorptive capability concerns the ability of a firm to integrate, assimilate,
acquire, and exploit skills and knowledge that are transferred from others. This
capability depends on the level of firm’s related skill or technology that are
already developed, the ability to combine the skills owned by the firm as well as
acquired from others, and the effectiveness of organizational learning systems.
Effective technology transfer, especially through a joint venture requires
coordinating mechanisms that link two parties which are labeled as bridges.
Bridges are of three categories – procedural bridges, human bridges, and
organizational bridges. Procedural bridges involve activities such as joint
planning and joint staffing particularly during technology transfer. Here the
emphasis is on collaboration through joint planning, problem solving, and
implementation. Human bridges rely on establishing direct interaction between
individuals belonging to different organizational areas typically through the
transfer and rotation of personnel. The personal contacts allow enthusiasm and
responsibility to be transferred from one person to another and it establishes a

15
Block 4: Functional Areas in International Business

common work-related and social context that facilitates more learning and
cooperation. Organizational bridges use dedicated transfer teams for establishing
more formal ties between organizational areas. These groups are formed for
building a more formal structure and common context for effective experience
transfer.

Activity 10.2
Tel Ltd., a British telecom company entered into a joint venture with US-based
AmPhones Ltd. for technology transfer. Both the companies noticed that there
were communication problems between both the companies. The companies
also had difficulty in finding who had the executive power in the company and
with whom they had to negotiate to make decisions. What can the companies
do for the teams to coordinate and make technology transfer? Also discuss the
problems associated with technology transfer across borders.
Answer:

Check Your Progress - 1

1. is a process of locating and operating R&D laboratories in

different countries, under a coordinated ad integrated system by the
company’s headquarters, in order to leverage the technical resources of each
facility to further the company’s overall technological capabilities and
competitive advantage.
a. Globalizing R&D
b. Internalizing R&D
c. Externalizing R&D
d. None of the above
2. The following benefits may generate from globalizing R&D:
a. Globalizing R&D may offer a vehicle for accessing from extracting
benefits from the technical resources local expertise, and scientific talent
of the target country.
b. Globalizing R&D may enhance the competitive advantage of a firm.
c. Globalizing R&D may enable an MNE to enjoy benefits that arise from
international division of labor in R&D among multiple foreign countries
or regions.
d. All of the above

16
 Unit 10: Global Research and Development

3. Globalizing R&D creates the following challenges.

a. Maintaining minimum efficient scale in foreign R&D operations is not
easy always.
b. The leakage of proprietary knowledge poses a serious threat when R&D
is globalized.
c. Globalizing R&D inevitably increases coordination and control costs.
d. All of the above
4. A is designed for generating basic, long-term technology of
exploratory nature to use by the parent company.
a. Specialized technology unit
b. Global technology unit
c. Technology transfer unit
d. Corporate technology unit
5. A/An is set for developing specialized products, processes, or
technologies predefined by headquarters for serving either the regional or the
global market.
a. Indigenous technology unit
b. Specialized technology unit
c. Technology transfer unit
d. Corporate technology unit
6. A/An is established to develop new products and processes for
major world markets.
a. Global technology unit
b. Technology transfer unit
c. Corporate technology unit
d. Indigenous technology unit
7. A facilitates the transfer of the corporate parent’s technology
to a subsidiary and providing local technical services.
a. Global technology unit
b. Specialized technology unit
c. Technology transfer unit
d. Corporate technology unit
8. A/An is formed overseas for developing new products
specifically for the local market.
a. Indigenous technology unit
b. Specialized technology unit
c. Global technology unit
d. Corporate technology unit

17
Block 4: Functional Areas in International Business

9. Location selection of an R&D subsidiary depends on which of the following

factors?
a. Location selection depends on the strategic role of an R&D subsidiary
that is set by the parent company.
b. Host government policies may have an influence on location decision.
c. The local infrastructure and technological level of a foreign country are
vital and sociocultural factors.
d. All of the above
10. In the R&D structure, all key R&D activities are concentrated in one
home country.
a. Ethnocentric centralized
b. Polycentric decentralized
c. Specialized laboratory
d. Global center lab
11. The R&D structure is characterized by a decentralized alliance
of R&D sites with no corporate R&D center for supervision.
a. Ethnocentric centralized
b. Global center lab
c. Polycentric decentralized
d. Specialized laboratory
12. In the structure, foreign R&D units are assigned global directives.
a. Specialized laboratory
b. Ethnocentric centralized
c. Polycentric decentralized
d. Global center lab
13. The structure is used for leveraging company’s centralized technical
resources for creating new global products.
a. Ethnocentric centralized
b. Specialized laboratory
c. Global center lab
d. Globally integrated network
14. In , home R&D is not the center of control for all R&D activities but
rather one among many interdependent R&D units that are interconnected by
means of varied and flexible coordination mechanisms.
a. Globally integrated network
b. Ethnocentric centralized
c. Specialized laboratory
d. Global center lab

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 Unit 10: Global Research and Development

15. The rapid dispersion of R&D laboratories in foreign markets have forced
MNEs to take a global view in managing their research operations through
areas such as
i. Human resource management
ii. Autonomy specification, global planning
iii. Communications improvement
iv. Financial management
v. Coordinating mechanism
a. i, ii and iii
b. ii, iii and iv
c. iii, iv, and v
d. i, iv, and v
16. For improving communication within a global R&D network, international
managers need to be aware of which of the following issues?
i. Rules and procedures
ii. Electronic communication
iii. Boundary spanners, Informal network
iv. Formal network
v. Cultural adaptation
a. i, ii, iii, and v
b. ii, iii, iv, and v
c. i, iii, iv, and v
d. ii, iii, iv, and v
17. is a process by which one firm’s technology or
knowledge is passed on to another firm in a different country for economic
benefits.
a. International technology transfer
b. External transfer
c. Internal transfer
d. None of the above
18. involve activities such as joint planning and joint
staffing particularly during technology transfer.
a. Organizational bridges
b. Procedural bridges
c. Human bridges
d. International bridges

19
Block 4: Functional Areas in International Business

19. rely on establishing direct interaction between

individuals belonging to different organizational areas typically through the
transfer and rotation of personnel. Procedural
a. Bridges Organizational
b. Bridges International
c. Bridges
d. Human bridges
20. use dedicated transfer teams for establishing more
formal ties between organizational areas.
a. Organizational bridges
b. Procedural bridges
c. Human bridges
d. None of the above

10.7 Summary
 Globalizing R&D involves several benefits. First, globalizing R&D may offer
a vehicle for accessing from extracting benefits from the technical resources
local expertise, and scientific talent of the target country. Second, globalizing
R&D may enhance the competitive advantage of a firm. Finally, globalizing
R&D may enable an MNE to enjoy benefits that arise from international
division of labor in R&D among multiple foreign countries or regions.
 Globalizing R&D is a complex process that involves several challenges and
difficulties. First, maintaining minimum efficient scale in foreign R&D
operations is not easy always. Second, the leakage of proprietary knowledge
poses a serious threat when R&D is globalized. Finally, globalizing R&D
inevitably increases coordination and control costs.
 With regard to the role of foreign R&D units, R&D subsidiaries can be
categorized into corporate technology units specialized or regional
technology units, global technology units, technology transfer units, and
indigenous technology units.
 Selecting an R&D location is a crucial and complex decision because external
parameters such as resource availability, market conditions, and government
policies differ across countries and even at locations within a country.
 The two crucial factors essential for structuring global R&D operations
include
i. The level of authority an MNE plans to offer to its foreign R&D activities and
ii. The scope of the geographical market to be covered.

20
 Unit 10: Global Research and Development

 The five models in structuring global R&D are ethnocentric centralized,

polycentric decentralized, specialized lab, global central lab and the globally
integrated network.
 The rapid dispersion of R&D laboratories in foreign markets have forced
MNEs to take a global view in managing their research operations through
areas such as human resource management, autonomy specification, global
planning, and communications improvement.
 A common alternative for setting up a foreign-based R&D center or
laboratory is to collaborative agreements or technology transfers with foreign
partners. This approach is attractive to firms or projects in need of large
investments which may involve high uncertainties.

10.8 Glossary
Autonomy setting - Refers to the decision-making power of an R&D unit
concerning R&D activities.
Boundary spanners – Refers to R&D staff at the headquarters who travel to site
locations to share development somewhere else in the global R&D network and
for discussing progress at the particular site. They may also divulge sensitive
information across the network about developments with joint venture partners,
customers, or suppliers.
Corporate technology unit – An R&D unit that is designed for generating basic,
long-term technology of exploratory nature to use by the parent company.
Ethnocentric centralized R&D structure – An R&D structure where all key
R&D activities are concentrated in one home country. This structure has a
corporate technology unit at home, and may also include a few technology
transfer units for distributing centralized R&D results to local operations.
Global planning - Coordinating the dispersed global network of R&D
laboratories to ensure information exchange among decentralized R&D
laboratories and projects
Global technology unit – This unit is established to develop new products and
processes for major world markets.
Globalizing R&D - It is a process of locating and operating R&D laboratories in
different countries, under a coordinated and integrated system by the company’s
headquarters, in order to leverage the technical resources of each facility to further
the company’s overall technological capabilities and competitive advantage.
Globally integrated network structure - Filled with a number of foreign R&D
units with different types and roles, such as corporate technology unit, indigenous
technology unit, global technology unit, and specialized technology unit.
Indigenous technology unit – An R&D unit that is formed overseas for
developing new products specifically for the local market.

21
Block 4: Functional Areas in International Business

International technology transfer - “A process by which one firm’s technology

or knowledge is passed on to another firm in a different country for economic
benefits.”
Polycentric decentralized R&D structure - It is characterized by a decentralized
alliance of R&D sites with no corporate R&D center for supervision. This
structure contains several indigenous technology units in major foreign markets.
Specialized laboratory structure – Global R&D structure that operates on
specialized technology units in respective product areas
Specialized technology unit – An R&D unit that is set for developing specialized
products, processes, or technologies predefined by headquarters for serving either
the regional or the global market.
Technology transfer unit – An R&D unit that facilitates the transfer of the
corporate parent’s technology to a subsidiary and providing local technical
services.

10.9 Self-Assessment Test

1. Define the concept of globalizing R&D. State the benefits and challenges of
global R&D.
2. Discuss the type of foreign R&D units. Also explain the factors for selecting
a location for global R&D.
3. Describe how the global R&D activities are structured.
4. Explain how the global R&D operations are managed.
5. Explain the concept of technology transfer across borders.

10.10 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education

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 Unit 10: Global Research and Development

Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d
2. IFRS Foundation. Use of IFRS standards around the world. 2018.
https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

10.11 Answers to Check Your Progress Questions

1. (a) Globalizing R&D
Globalizing R&D is a process of locating and operating R&D
laboratories in different countries, under a coordinated ad integrated
system by the company’s headquarters, in order to leverage the technical
resources of each facility to further the company’s overall technological
capabilities and competitive advantage.
2. (d) All of the above
The following benefits may generate from globalizing R&D:
 Globalizing R&D may offer a vehicle for accessing from extracting
benefits from the technical resources local expertise, and scientific
talent of the target country.
 Globalizing R&D may enhance the competitive advantage of a firm.
 Globalizing R&D may enable an MNE to enjoy benefits that arise
from international division of labor in R&D among multiple foreign
countries or regions.
3. (d) All of the above
Globalizing R&D creates the following challenges.
 Maintaining minimum efficient scale in foreign R&D operations is
not easy always.

23
Block 4: Functional Areas in International Business

 The leakage of proprietary knowledge poses a serious threat when

R&D is globalized.
 Globalizing R&D inevitably increases coordination and control
costs.
4. (d) Corporate technology unit
A corporate technology unit is designed for generating basic, long-term
technology of exploratory nature to use by the parent company.
5. (b) Specialized technology unit
A specialized technology unit is set for developing specialized products,
processes, or technologies predefined by headquarters for serving either
the regional or the global market.
6. (a) Global technology unit
A global technology unit is established to develop new products and
processes for major world markets.
7. (c) Technology transfer units
A technology transfer unit facilitates the transfer of the corporate
parent’s technology to a subsidiary and providing local technical
services.
8. (a) Indigenous technology units
An indigenous technology is formed overseas for developing new
products specifically for the local market.
9. (d) All of the above
Location selection of an R&D subsidiary depends on the following
factors:
 Location selection depends on the strategic role of an R&D
subsidiary that is set by the parent company.
 Host government policies may have an influence on location
decision.
 The local infrastructure and technological level of a foreign country
are vital.
 Sociocultural factors may affect location selection.
10. (a) Ethnocentric centralized
In the ethnocentric centralized R&D structure, all key R&D activities
are concentrated in one home country.

24
 Unit 10: Global Research and Development

11. (c) Polycentric decentralized

The polycentric decentralized R&D structure is characterized by a
decentralized alliance of R&D sites with no corporate R&D center for
supervision.
12. (a) Specialized laboratory
In the specialized laboratory structure, foreign R&D units are assigned
global directives.
13. (c) Global center lab
The global center lab structure is used for leveraging company’s
centralized technical resources for creating new global products.
14. (a) Globally integrated network
In globally integrated network structure, home R&D is not the center of
control for all R&D activities but rather one among many interdependent
R&D units that are interconnected by means of varied and flexible
coordination mechanisms.
15. (a) i, ii, and iii
The rapid dispersion of R&D laboratories in foreign markets have forced
MNEs to take a global view in managing their research operations
through areas such as human resource management, autonomy
specification, global planning, and communications improvement.
16. (a) i, ii iii, and v
For improving communication within a global R&D network,
international managers need to be aware of the following issues:
 Rules and procedures
 Electronic communication
 Boundary spanners
 Informal network
 Cultural adaptation
17. (a) International technology transfer
International technology transfer is a process by which one firm’s
technology or knowledge is passed on to another firm in a different
country for economic benefits.
18. (b) Procedural bridges
Procedural bridges involve activities such as joint planning and joint
staffing particularly during technology transfer.

25
Block 4: Functional Areas in International Business

19. (d) Human bridges

Human bridges rely on establishing direct interaction between
individuals belonging to different organizational areas typically through
the transfer and rotation of personnel.
20. (a) Organizational bridges
Organizational bridges use dedicated transfer teams for establishing
more formal ties between organizational areas.

26
 Unit 11
Global Human Resource Management
Structure
11.1 Introduction
11.2 Objectives
11.3 Strategic IHRM
11.4 Staffing a Multinational Enterprise
11.5 The Expatriate Workforce
11.6 HRM in Foreign Affiliates
11.7 Summary
11.8 Glossary
11.9 Self-Assessment Test
11.10 Suggested Readings/Reference Material
11.11 Answers to Check Your Progress Questions

“Human Resources isn’t a thing we do. It’s the thing that runs our business."
- Steve Wynn
11.1 Introduction
The previous unit discussed the concept of globalizing R&D and the benefits and
challenges of global R&D. It then explained the design and structure of global
R&D activities. It then discussed how multinational enterprises (MNEs) manage
their R&D operations. The unit finally discussed how technology transfer takes
place across borders.
International human resource management (IHRM) is “the procurement,
allocation, utilization, and motivation of human resources in the international
arena.” IHRM is crucial to the strategy and success of global operations. In
international business, multinational enterprises (MNEs) from different home
countries employ different strategies for staffing their subsidiaries. Expatriates
play a vital role in the operations of MNEs. International joint ventures and
wholly-owned subsidiaries face many staffing problems as any foreign venture.
This unit will define strategic international human resource management. It then
goes on to explaining how staffing takes place in MNEs. It then discusses the
concept of expatriates; their selection and failure; how they are trained and
compensated; and recommendations on how expatriates should be compensated
in different cultures. The unit finally discusses the human resource problems faced
by MNEs in foreign affiliates.
Block 4: Functional Areas in International Business

11.2 Objectives
By the end of this unit, students should be able to:
 Define strategic international human resource management.
 Explain how an MNE staff its operations.
 Describe how expatriates are selected, trained, and compensated.
 Discuss human resource problems in foreign affiliates.

11.3 Strategic IHRM

Strategic international human resource management (SIHRM) is defined as
“human resources, management issues, functions and policies and practices that
result from the strategic activities of MNEs and that impact the international
concerns and goals of these enterprises.” SIHRM is more complex than strategic
human resource management in a domestic context because it concerns multiple
employee groups and environments and because it needs to be aligned with the
multi-faceted considerations of the MNE. The SIHRM model has three
orientations:
 The adaptive system that imitates local human resource management (HRM)
practices.
 The exportive system that replicates the HRM system in the home country
and other affiliates.
 The integrative system that emphasizes on global integration while allowing
for some variations.
An optimal SIHRM has the capability to balance the different forces in the
environment of the firm, particularly the tension between local responsiveness
and global integration. The overall SIHRM strategy chosen by the parent in
conjunction with the specific conditions of the affiliate (e.g. the cultural distance
from the parent) determines the degree of similarity in SIHRM between the
headquarters and the affiliate. This in association with the criticality of the group
determines the similarity of HRM practices for each employee group.

11.4 Staffing the Multinational Enterprise

11.4.1 The Globalization of Board of Directors
In 1998-99, a survey was conducted by the Conference Board to assess how
globalization affected the composition of board of directors. The survey revealed
that between 1995 and 1998, the percentage of firms with non-national directors
had increased from 39 percent to 60 percent. Companies with three or more non-
national directors had an increase from 11 to 23 percent. By 1998, 10 percent of
the directors surveyed firms were non-national.

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 Unit 11: Global Human Resource Management

The survey also revealed that entering new markets and exposure to new demands
from investors and customers are the chief internal drivers to seek non-national
board members. The initiative comes from new managers who wish to expand
their international operations where the expertise and credibility of non-national
directors makes a difference.
Selecting Global Board Members
Firms seeking to internalize their boards commence by selecting someone who is
similar culturally to existing members but has an international perspective. In the
next phase, firms look for individuals with in-depth business and cultural
experience in a given part of the world. Even then, most of the appointments are
made among those who have experience of living or working in the country in
which the company is based.
Searches for non-national directors result on an average in 9 to 10 rejections for
one accepted. The extra commitment, language and culture, different time zones
are barriers to the appointment of non-national directors, as is the process of board
evaluation. The Conference Board recommends accommodation of non-nationals
by rotating locations, reducing the number of annual meetings, setting up
orientation programs, and widening the definition of non-national director for
including non-nationals living and working abroad who maintain closer ties with
their home country.
Another obstacle for non-national directors is representation. US institutional
investors are concerned with having non-national directors in domestic business
as well as with national directors in the non-US firms. As these institutions have
a fiduciary duty for protecting the interests of the shareholders, they need to
consider limited shareholders‟ representation in the decision to elect directors.
Representation is more difficult when vital shareholders sit on the board,
especially with board member of companies with significant cross-share-
holdings, board members of major suppliers, or labor or pension fund
representatives. While US shareholders are dispersed relatively, shareholders
with major control blocks are common in Asia, Latin America, and Europe.
11.4.2 Staffing the Ranks in an MNE
Factors affecting MNE staffing include strategy, organizational structure, and
subsidiary-specific factors such as duration of operations, technology, production
and marketing technologies, and host-country characteristics such as level of
economic and technology development, political stability, regulation, and culture.
MNEs can draw employees from the country where it is headquartered (parent
company nationals or PCNs) where the foreign operations are located (host-
country nationals or HCNs), or from a third country (third country nationals or
TCNs). Alternative staffing philosophies abroad are ethnocentric, polycentric,
regiocentric, and geocentric.

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Block 4: Functional Areas in International Business

In ethnocentric staffing, PCNs are chosen for key positions regardless of the
location. This approach is used by Japanese companies and Korean firms. For
instance, at Samsung, an all Korean management existed until 1999.

Example
Coke’s U.S. headquarters has HR policies related to labour, safety as well as
compensation. Those are applied across Coke’s affiliated country and regional
operations, in the same manner. The leadership positions in each subsidiary of
Coke have staff who are parent country nationals (PCNs). Local nationals are
recruited for more junior positions in order to maintain headquarters’ influence
as the primary.
Source: ICFAI Research Center

In polycentric staffing, HCNs are hired at the subsidiaries of key positions but not
at the corporate headquarters.
In regiocentric staffing, recruiting is done on a regional basis. In geocentric
staffing, the best managers are recruited worldwide regardless of their nationality.
The value of this approach is apparent in introducing new perspectives and modes
of operation.
Most MNE employees abroad are „foreign employees‟ or HCNs, for several
reasons. They are easier to employ administratively and legally. They are also
knowledgeable about the local environment. In case of developing and emerging
markets, HCNs are often cheaper to employ than home country nationals, even
without adjusting for expatriate terms.
The availability of qualified candidates is a decisive factor in selection of HCNs.
Foreign MNEs in Japan find it difficult to hire qualified Japanese employees. In
some countries, hiring requires a government-controlled labor bureau that may
assign employees to work for the MNE.
The cultural challenges go beyond staffing. A formal career planning system
where individuals are evaluated in terms of abilities, skills, and traits that will be
tested, scored, and computerized may appear to be impersonal in collective
cultures. Individualistic societies use cognitive testing because they emphasize
performance, individual rights, individual interests, whereas collective cultures
emphasize organizational compatibility and loyalty that cannot be evaluated via
cognitive tests.
Finally, the MNE is expected to monitor employment conditions at home as well
as at its subsidiaries. For instance, Wal-Mart has been accused of buying from
vendors that use child labor in Bangladesh.
11.4.3 Country Specific Issues
As in other functional realms, the need for adjustment in corporate practices and
policies is anchored in the variation of employment conditions and labor markets.

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In transition economies, older employees who are accustomed to a central

planning system face difficulties adjusting to the higher productivity expected in
an MNE. Despite, overall high employment in such economies, skilled are usually
in short supply due to lack of educational infrastructure. For instance, in China,
the biggest problem faced by MNEs is very high employee turnover, which
undermines investment in recruitment and training. To overcome this problem,
MNEs in China customize solutions. For instance, Ford Motor Company offered
retention incentives to its Chinese workers such as tuition to pursue an MBA
degree or a housing loan that is forgiven after a worker completes seven years of
service. Ford also has deviated from its worldwide policy of not rehiring
employees who had left the company.

Example
UNESCO pays Danger pay (a non-pensionable allowance) to staff members
who are required to work in duty stations where very dangerous conditions
prevail / non-protected environments where medical staff are specifically at
risk to their life when deployed to deal with public health emergencies as
declared by WHO. As per the UN Classification, the list of countries/duty
stations where payment of danger pay has been approved, with effect from 1
July through 30 September 2015 - Afghanistan, Central African Republic,
Congo, Democratic Republic of Katanga Province, North Kivu Province, South
Kivu Province, ETHIOPIA (selected Somali Regions), GUINEA (to work in
the Ebola Virus Disease (EVD) operations), Iraq - entire country excluding
Kurdistan Region, Kenya, Republic North Eastern Province, LIBYA etc. The
Chairman of International Civil Service Commission (ICSC) is responsible for
authorizing the application of danger pay to a duty station based on the
recommendations from the United Nations Department of Safety and Security
(DSS) and WHO.
Source: ICFAI Research Center

Activity 11.1
ABC Auto Ltd. (ABC), an Indian automaker had its operations in Thailand
and China. The company had to recruit staff for senior positions in
Thailand. The company employed a senior manger from its Chinese operations
to occupy the same level of positions in Thailand. The company at its
headquarters in India continued to have parent country nationals at all
managerial levels. Identify the staffing approach used by ABC. Also discuss
other staffing approaches employed by multinational enterprises.
Answer:

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Block 4: Functional Areas in International Business

11.5 The Expatriate Workforce

11.5.1 Expatriates: Types and Distribution
There are different types of expatriates. The traditional expatriate, older and
experienced is selected for his/her managerial and technical skills for on to five
years. International cadres are individuals moving from one foreign assignment
to another. They seldom return to their home country and sometimes become
permanent expatriates who stay in foreign assignments for extended periods of
time or even permanently. Young, inexperienced expatriates are sent on local hire
terms for six months to five years. Temporaries go on short on short assignments
for up to a year. Another type is expatriate trainee, who is placed overseas for the
purpose of training as part of initiation into an MNE. The virtual expatriate takes
on foreign assignment without relocating physically. The virtual expatriate uses
telecommunications and videoconferencing to stay in touch.

Example
Suresh has completed his MBA in 2021 and joined a Chennai-based IT
company as an "Analyst" through Campus Recruitment. Prior to this, he had
less than 6 - months of experience with a Fintech company. Suresh was deputed
to the client office in the Philippines for a period of 3 years while continuing to
be on the payroll of Chennai based company. He was not paid anything by the
client company in the Philippines. In this case, Suresh is the inexperienced
expatriate.
In this case, with less than 6 months of experience & having been deployed to
the client in Office in the Philippines with the remuneration paid by the
Chennai-based company reflects that Suresh is an inexperienced expatriate.
Source: ICFAI Research Center

115.2 Expatriates: Pros and Cons

MNEs use expatriates “to get the business off the ground, put in the infrastructure,
and, more importantly, have a plan to change the mix of expatriates versus
nationals.” Expatriates contribute essential knowledge and experience; serve as a
mechanism for control, and as a way to transmit corporate culture and goals.
Expatriation creates a global perspective and is necessary for knowledge and
technology transfer.
Expatriates are not used by firms as they block promotion of the local workforce.
The local workforce may also feel deprived due to their lower wage levels
compared to that of the expatriates. An expatriate can also rob a company of its
insights, skills, and initiative of local nationals. Another reason for not using
expatriates is their high rates of failure.

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11.5.3 Expatriate Failure

Expatriate failure occurs when the assignee returns prematurely to the home
country or when his/her performance does not meet expectations. Japan and
China show the highest failure rates for US expatriates.
The cost of expatriate failure is substantial, ranging from US$ 55,000 to US$
150,000 in direct costs. However, the real cost of expatriate failure is
considerably higher. It includes cost of selection, training, preparation, and
moving, in addition to the consequences of poor performance in lower revenues,
damage to the firm’s reputation, and lost business opportunities. All these may
undermine the future ventures in the host country.
There are numerous reasons for expatriate failure. They may include a spouse’s
unhappiness, inability to cope with the responsibilities and stress posed by
overseas work, inability to adjust to an unfamiliar physical and cultural
environment, personality or emotional immaturity, and lack of technical
competence. Lack of motivation to work overseas when a firm attaches low value
to an overseas assignment is also a problem.

Activity 11.2
JK Ltd., a chemical company based in India is considering setting up a
subsidiary in Thailand. The company felt that training some of its employees
would be better prior to it establishing a subsidiary in Thailand. Thus, the
company placed some of its new executive recruits in Thailand for the purpose
of training. Identify the type of expatriate. Also discuss other types of
expatriates.
Answer:

11.5.4 Expatriates Selection

MNEs look for several attributes in an expatriate including cultural empathy,
language skills, adaptability and flexibility, education, maturity, motivation, and
leadership. Adler specifies these competencies: local responsiveness, a global
perspective, transition and adaptation, synergetic learning, cross-cultural
interaction, collaboration, and foreign experiences. The ability of exercising
discretion in choosing when to engage in global integration and when to be locally
responsive is another crucial factor.
Successful expatriates need three sets of skills – (1) personal skills, that facilitate
emotional and mental well-being, for instance, reinforcement, stress orientation,
substitution, technical competence, physical mobility, dealing with isolation,

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Block 4: Functional Areas in International Business

alienation, realistic expectation prior to departure; (2) people skills such as

willingness to communicate, relational abilities, non-verbal communication,
respect for others, and empathy for other; and (3) perception skills, namely the
cognitive process that helps executives understand the foreigners‟ behaviors.
Being culturally adventurous and extroversion are crucial for expatriate success
in culturally distant cultures.

Example
PepsiCo uses a tool to help the employee and his family assess their ability to
adapt to new cultures and environments. The cost and complexity of an
international assignment makes it essential that PepsiCo selects the most
suitable candidate. It encourages employee and spouse to take the SAGE
(Self-Assessment for Global Endeavors) screening test which is available
in the International Assignment track of the Cultural Wizard site:
http://pepsico.culturewizard.com. This screening test assesses the employee
and the spouse on aspects like cultural sensitivity, flexibility and desire for new
experiences
Source: ICFAI Research Center

Expatriate Selection Instruments

Several instruments assist in expatriate selection. The Prospector evaluates the
potential of aspiring international executives on 14 dimensions: cultural
sensitivity, integrity, business knowledge, motivational ability, courage, insight,
commitment, seeking feedback, using feedback, risk taking, culturally
adventurous, seeking learning opportunities, flexibility, and open to criticism.
Another instrument is the Overseas Assignment Inventory (OAI) developed by
Tucker International. This instrument uses success predictors on a foreign
assignment: open-mindedness, trust in people, expectations, respect for others‟
beliefs, locus of control, tolerance, patience, flexibility, social adaptability,
initiative, risk taking, sense of humor, and spouse communication.
Another popular selection tool is role-based simulation. They are either generic
or specific.
11.5.5 Preparing for Foreign Assignment
Expatriates entering a foreign country should adjust to the new environment,
including a new culture, and job responsibilities. The first phase of adjustment is
anticipatory and takes place before departure. This is followed by in-country
adjustment. Adjustment varies by organizational culture, organization
socialization, individual factors (self-efficacy, perception skills, and relation),
job-related factors (role discretion, role novelty, role clarity, role conflict, and
non-work factors such as culture novelty and family-spouse adjustment.
Adjustment is also influenced by language fluency and previous assignments.

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Five determinants of cross-cultural adjustment include: previous overseas

experience; pre-departure cross-cultural training; multiple candidate, multiple-
criteria selection; individual skills, and perceptual skills; and non-work factors
such as cultural distance and spouse and family adjustment.
Expatriate Training
Training for an overseas assignment has two components – information giving
and experiential learning. Information-giving consists of practical information on
living conditions in the destination country, area studies, which includes facts
about the country’s macro-environment, and cultural awareness information.
Experiential learning combines cognitive and behavioral techniques. The goal is
to acquire intercultural effectiveness skills including relationship building, stress
management, cross-cultural communication, and negotiation techniques.
Effective cross-cultural training requires an integrated approach which includes
both general orientation and specific cultural development. Yoshida and Brislin
list five guidelines for cultural training: (1) identify – become aware of the skills
needed to function in the target culture; (2) understand – know why, where, when,
to whom, and how the behavior is appropriate; (3) use cultural informants for
understanding specifics – observe and consult people from the target culture to
ensure that the behaviors are used in the proper context and are delivered
appropriately, (4) practice –practice helps in gaining proficiency in a new skill;
and (5) deal with emotions –trainees should anticipate new behaviors they use as
well as strong emotional reactions to cultural differences.

Example
Fred is a Sales Team Manager working in the UK and the management has
deputed him to Beijing to lead the new team over there. While there will be a
translator to assist him, the question arose about whether Chinese clients think
about working with a British without cultural fluency.
In this case, the guidelines of cultural training pertains to ‘Identify target
culture’. Language is the basic skill required to identify with the Chinese
people. Fred does not know the Chinese language. Hence, it was felt how
Chinese team members would identify with Fred.
Source: ICFAI Research Center

Harrison proposed a two-stage cultural orientation. The first stage focuses on

trainees‟ attention and prepares them for cross-cultural encounters. This stage
involves self- assessment of factors and cultural awareness. The second stage
specific cultural orientation is designed to develop the ability of trainees to
interact effectively within the specific culture he/she is assigned. This stage
includes two phases: knowledge acquisitions and skill training.

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Choosing a Training Method

Tung proposed a contingency framework to determine the nature and level of
training rigor based on the cultural distance between the expatriate’s native and
new culture and the degree of interaction required in the overseas position. If the
cultural distance is low and the expected interaction between the HCNs and
expatriates is low, training should focus on task-related issues as opposed to
cultural issues, and the level of rigor required is low. If the cultural distance and
expected interaction is high, training should focus on cross-cultural skill
development as well as on the new task and on the new culture, and the level of
rigor should be moderate to high.
Another training model is based on social learning theory, where rigor is defined
as the degree of cognitive involvement by the trainee. The model distinguishes
between participative modeling, which involves observing and participating in the
modeled behavior, and process-symbolic modeling, which involves observation
of modeled behavior.
If the level of interaction and cultural distance is low, training should be less than
a week. If the individual is going overseas for 2 to 12 months, the training should
be for four weeks. If the individual is going for a novel culture and the expected
degree of interaction is high, the level of training rigor should be high and training
should be given for two months. Some field experiences and sensitivity training
would be appropriate.
11.5.6 Compensation
MNE compensation programs focus on attracting and retaining qualified
employees, facilitating transfer between the headquarters and the affiliates, and
creating consistency and equity in compensation, and maintaining
competitiveness. Compensation systems are derived from MNE international
strategies as well as its organizational and/or product life cycle. They also reflect
laws, regulations, and cultural traditions of the host country.
An effective compensation system begins with an accurate performance appraisal.
In case of expatriates, difficulties include the choice of the evaluator, differences
in performance perceptions between the home and host countries, inadequate
recording of performance objectives, communication difficulties with
headquarters, parent-country ethnocentrism, and indifference to the foreign
experience of the expatriate. Other problems include difficulties in balancing local
responsiveness and global integration, environmental variations across
subsidiaries, and non-comparability of data from different regions/subsidiaries.
Decisions are made related to raters’ location, their expatriate experience, and
regarding the use of standard, hybrid or customized evaluation forms.
Cost and Elements of Expatriate Compensation
The cost of hiring an expatriate is 3 to 5 times higher than the domestic salary of
a local hire.

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Expatriate compensation comprises the following elements:

Salary: Base pay plus incentives determined through competency-based plans or
job evaluation. Incentives in the form of cash or deferred payment may be based
on home-country plans or host-country plans or both.
Housing: Most MNEs offer housing allowances to expatriates for maintaining
expatriates‟ living standards at their home country level.
Services allowance and premiums: These are paid to compensate for differences
in expenditures between home and host countries. Allowances are offered for
higher cost of living in the host country, home leave, education, and relocation.
The purchasing power of the employees in the home and the host country can be
equalized using the balance sheet approach. It also offsets qualitative differences
between locations.
Tax equalization: Expatriates face income tax liability in the home and the host
country. Tax equalization adjusts the expatriates pay to reflect taxes in the home
country.

Example
Ragha Midhilesh is transferred to Denmark for a year to complete a project at
the client location. His Indian employer assured him that he would continue to
receive the same salary that he would have received had he not been relocated
to Denmark. In the given case, the expatriate compensation is linked to tax
equalization.
In this case, Ragha being assured of receiving the same salary as he gets in
India is an indication that the tax liability beyond what he is liable in India will
be taken care of by the company & this is tax equalization.
Source: ICFAI Research Center

Approaches to Expatriate Compensation

There are three approaches to expatriate compensation – home-based, host-based,
and hybrid.
A home-country compensation system links base salary of an expatriate to the
home country salary structure. For instance, the salary of a US executive
transferred to Japan would be based on US as opposed to Japanese level.
In a host country-based compensation system, expatriate base salary is linked to
the host country pay structure. However, supplemental compensation provisions
are linked to the home-country salary structure.
A hybrid compensation system blends features from the home as well as host-
based approaches. The purpose of this compensation system is to create an
international expatriate workforce that while not coming from one location is paid
as if it were. The simplest form of hybrid system assumes that all expatriates,

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regardless of the country f origin, belong to one nationality. Other forms include
applying identical cost-of-living allowances to all nationalities, uniform housing,
uniform premium, and other local allowances.
Other compensation approaches include lump-sum/cafeteria and negotiation
approaches. In lump-sum/cafeteria approach, salary is set according to the home-
country system. Firms allow a total allowance package instead of breaking
compensation into component parts and expatriates make their own choices. The
negotiation approach means that the employer and the employee find a mutually
acceptable package. This approach is common in smaller firms with very few
expatriates.
11.5.7 Culture and Compensation
The performance of a business improves when HRM practices are consistent with
the national culture. In masculine cultures, work units with merit-based reward
practices performed better while in feminine cultures, work units with fewer
merit-based reward practices performed better. The propensity to use both skill-
based and seniority-based compensation systems was positively correlated with
uncertainty avoidance. Compensation practices based on individual performance
were correlated with individualism. High masculinity is associated with lesser use
of flexible benefits, career break schemes, child care programs, and maternity-
leave programs. High collectivism is negatively related to equity-based and
individual reward and merit- based promotion system.
The following recommendations are made vis-à-vis compensation in different
cultures:
 In high-power distance cultures, MNEs need to pursue hierarchical
compensation for local managers. Pay and benefits should be tied to the
position of the local managers.
 In high individualism cultures, extrinsic and performance-based rewards are
important. In low individualism cultures, group-based pay and
compensation packages that reflect seniority and family needs are more
acceptable.
 In cultures with high masculinity, MNEs need to pursue a compensation
strategy for local managers that recognizes and rewards dominance,
aggressiveness, and competitiveness. In cultures with low masculinity,
compensation should focus on quality of work life, equity, and social benefits.
 In high uncertainty avoidance cultures, consistent and structured pay plans
are preferable. In low uncertainty avoidance cultures, pay should be linked to
performance.
 In masculine cultures with moderate to high uncertainty avoidance, policies
designed to protect job security are preferred.

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 In feminine cultures with moderate to high uncertainty avoidance, polices

designed to protect income security are preferred.
 Employees in low-power distance and low individualistic cultures prefer
flexible benefits program.
 Training and performance evaluation also varies across cultures.
Management by objectives (MBO), where superiors and subordinates
develop goals that can be measured, miserably fails in high-power distance
culture.
11.5.8 Repatriation
Repatriation represents an adjustment equally if not more than the foreign
assignment. Most returning employees are dissatisfied with the process of
repatriation. Most of the US firms do not provide a written guarantee that the
employee were reassigned prior to departure, and most returnees are not aware of
what their next assignment will be prior to repatriation. Most of the firms do not
offer spouse career counseling or other forms of family repatriation assistance.
Thus it is evident from the fact that one quarter of repatriated employees leave
their firm within a year of repatriation, and that many decline to accept subsequent
foreign assignments.

Example
As of April 2017, Monsanto is a global provider of agricultural products with
revenues in excess of $4 billion and 10,000 employees. At Monsanto,
employees and their sending and receiving managers, or sponsors, develop an
agreement about how this assignment will fit into the firm’s business
objectives. The focus is on why employees are going abroad to do the job, and
what their contribution to Monsanto will be when they return. Sponsoring
managers are expected to be explicit about the kind of job opportunities the
expatriates will have once they return home. Once they arrive back in their
home country, expatriate managers meet with cross-cultural trainers during
debriefing sessions. They are also given the opportunity to showcase their
experiences to their peers, subordinates, and superiors in special information
exchange program that focuses on business as well as family’s re-entry. This is
why Monsanto offers returning employees an opportunity to work through
personal difficulties. About three months after they return home, expatriates
meet for three hours at work with several colleagues of their choice. The
debriefing session is a conversation aided by a trained facilitator who allows
the employee to share important experiences and to enlighten managers,
colleagues and friends about his or her expertise so others within the
organization can use some of the global knowledge.
Source: ICFAI Research Center

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11.6 HRM in Foreign Affiliates
The issues and problems related to human resources (HR) vary depending on the
type of foreign affiliate involved. Though wholly-owned subsidiaries (WOSs)
employ three employee groups including host-country nationals (HCNs), third
country nationals (TCNs), and expatriates; international joint ventures (IJVs)
employ multiple groups such as (1) foreign parent(s) expatriates (i.e. nationals of
the country where the headquarters of the foreign partner(s) are located, assigned
by that parent to the affiliate; (2) host parent(s) transferees (i.e. HCNs employed
by the host parents and transferred to the affiliated either through the host-parents
headquarters or one of its subsidiaries); (3) HCNs (i.e. nationals of the host
country employed by the affiliate; (4) Third-country expatriates of the host
parents (i.e. TCNs assigned by the host parents to work in the affiliate); (5) Third-
country expatriates of the foreign parents ((i.e. TCNs assigned by the foreign
parents to work in the affiliate); (6) Third-country expatriates of the affiliate (i.e.
TCNs recruited by the affiliate); (7) foreign headquarters executive (i.e.
policymakers at foreign parents‟ headquarters who are board members of the
affiliate or play a key role in the functioning of the affiliate at headquarters); and
(8) Host headquarters executives (i.e. policymakers ate the host parents‟
headquarters, who are board members of the affiliate or play a key role in the
functioning of the affiliate at headquarters).
11.6.1 HR Problems in Foreign Affiliates
The following HR problems can be expected in WOSs and IJVs:
Staffing friction: As a control measure, parent companies prefer to appoint their
own transferees or expatriates for major positions in the affiliate. If the staffing
policy is not specified contractually friction arises. Sometimes, friction develops
regarding the level of staffing. In WOSs as well as IJVs, HCNs are deprived of
opportunities for staffing the senior most positions.
Blocked promotion: In WOs and IJVs, the lack of promotion opportunities
frustrate the local employees if senior positions are reserved for outsiders‟. The
local employees may be reluctant to join, stay, or contribute their best to the
affiliate, when such outsiders are abundant.
Exile syndrome and reentry difficulties: Feeling exiled in a foreign assignment
due to fear of interruption in the career track in the home country occurs in both
WOSs and IJVs. Exile syndrome can proved to be damaging for the foreign
affiliate as employee may bypass their superiors in the affiliate, report only
achievements leaving behind failures, and taking a short-term perspective.
Split loyalty: This problem is unique to IJVs. Employees recruited by the host or
the foreign parent may remain loyal to that parent rather that shifting their loyalty
to the IJV. This results in suspicion and low level of cooperation that prevents the
IJV from attaining its goals.
 Unit 11: Global Human Resource Management

Compensation gaps: The compensation gap problems (i.e. HCNs receiving

much lower pay than expatriates) occurs in both WOSs and IJVs. For example,
many US-based executives of foreign MNEs earn more than their seniors in Asia
or Europe. IJVs face an additional problem of relative deprivation where
employees are compensated based on affiliation with a particular parent or IJV
rather than on universal criteria, such as skills, experience, etc. Every employee
has a compensation policy where differences are significant. Moreover each
employee group has a different perception about the desired compensation
package. The result is a feeling of deprivation resulting in reduced morale and
motivation.
Blocked communication: Effective communication between a parent and an
affiliate and among parents can be hampered by cultural differences and varying
organizational norms and procedures. Such communication blockages can impede
decision making. This problem is serious in IJVs with a 50:50 equity distribution.
Limited delegation: Many parent companies maintain control of their affiliate
by limiting the decision making power and scope of authority delegated by them.
This is true when parents have conflicting goals, when they feel that the staff of
the affiliate is loyal to the other parent, and when they depend on the affiliate for
scarce and vital resources. Under these conditions, the management of the affiliate
finds it difficult to operate effectively, especially in a fast-changing environment.
Information screening: Most of the firms hesitate to pass information and
technology to an affiliate, especially in an IJV whose partner could be a current
or future competitor. The venture may thus operate ineffectively.
Unfamiliarity: In most cases, expatriates joining a foreign affiliate are unfamiliar
with the environment in which the venture operates. In case of IJVs, employees
are unfamiliar with the unique organization structure and with its conflict-prone
nature.
Research suggests that the HR problems can be alleviated by organization
development training for working in an IJV, interpersonal and negotiation skills
vital in IJV systems, identifying and rewarding leadership, opening up
communication channels among parent and venture organizations, and career
planning.

Check Your Progress - 1

1. is defined as human resources, management issues,
functions and policies and practices that result from the strategic activities of
MNEs and that impact the international concerns and goals of these
enterprises.
a. Strategic human resource management
b. International human resource management
c. Strategic international human resource management
d. Performance management

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2. The SIHRM model has which of the following orientations?

i. The exportive system
ii. The adaptive system
iii. The integrative system
iv. The effective system
v. All of the above
a. ii, iii, and iv
b. i, ii, and iii
c. v
d. i, ii, and iv
3. Factors affecting MNE staffing include strategy, , and
subsidiary-specific factors.
a. Organizational structure
b. Organization development
c. Organizational culture
d. Training and development
4. In , PCNs are chosen for key positions regardless of the
location.
a. Polycentric
b. Ethnocentric
c. Regiocentric
d. Geocentric
5. In , HCNs are hired at the subsidiaries of key positions but
not at the corporate headquarters.
a. Ethnocentric
b. Regiocentric
c. Polycentric
d. Geocentric
6. In , recruiting is done on a regional basis.
a. Regiocentric
b. Geocentric
c. Polycentric
d. Ethnocentric
7. In , the best managers are recruited worldwide regardless of
their nationality.
a. Polycentric
b. Geocentric
c. Ethnocentric
d. Regiocentric

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8. The , older and experienced is selected for his/her managerial

and technical skills for on to five years.
a. Traditional expatriate
b. International cadres
c. Temporaries
d. Expatriate trainee
9. ________are individuals moving from one foreign assignment to another.
a. Virtual expatriate
b. Temporaries
c. International cadres
d. expatriate Trainee
10. _______expatriates are sent on local hire terms for six months to five years.
a. Temporaries
b. Young, inexperienced
c. Virtual
d. Traditional
11. ___________go on short on short assignments for up to a year.
a. Young, inexperienced expatriates
b. Temporaries
c. Virtual expatriates
d. None of the above
12. _________is placed overseas for the purpose of training as part of initiation
into an MNE.
a. Traditional expatriate
b. Virtual expatriate
c. Expatriate trainee
d. Young, experienced expatriates
13. The takes on foreign assignment without relocating physically.
a. Temporaries
b. Expatriate trainee
c. Virtual expatriate
d. None of the above
14. Successful expatriates need which sets of skills?
a. Personal skills
b. People skills
c. Perception skills
d. All of the above

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15. Expatriate compensation comprises which of the following elements?

i. Salary
ii. Housing
iii. Services allowance and premiums
iv. Tax equalization
v. Fringe benefits
a. i, ii, iii, and iv
b. ii, iii, iv and v
c. i, ii, iv, and v
d. i, iii, iv and v
16. A compensation system links base salary of an expatriate to
the home country salary structure.
a. Host-country-based
b. Home-country-based
c. Hybrid
d. None of the above
17. In a compensation system, expatriate base salary is linked to the host
country pay structure.
a. Hybrid
b. Host-country
c. Home-country
d. None of the above
18. A compensation system blends features from the home as well as
host-based approaches.
a. Host-country
b. Hybrid
c. Home-country
d. None of the above
19. In approach, salary is set according to the home-country system.
a. Host-country
b. Lump-sum/cafeteria
c. Home-country
d. Negotiation
20. The approach means that the employer and the employee find
a mutually acceptable package.
a. Host-country
b. Negotiation
c. Lump/sum cafeteria
d. Home-country

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21. HR problems that can be expected in WOSs and IJVs include

i. Staffing friction, blocked promotion, exile syndrome and reentry
difficulties
ii. Split loyalty, compensation gaps, blocked communication
iii. Limited delegation, information screening, and unfamiliarity
iv. Data analysis
v. Performance appraisal
a. i, ii, and iv
b. iii, iv, and v
c. i, ii, and iii
d. i, iv, and v

11.7 Summary
 Strategic International Human Resource Management (SIHRM) is defined as
human resources, management issues, functions and policies and practices
that result from the strategic activities of MNEs and that impact the
international concerns and goals of these enterprises.
 Firms seeking to internalize their boards commence by selecting someone
who is similar culturally to existing members but has an international
perspective. In the next phase, firms look for individuals with in-depth
business and cultural experience in a given part of the world.
 There are different types of expatriates such as the traditional expatriate;
international cadres; young, inexperienced expatriates; temporaries;
expatriate trainee; and virtual expatriate.
 MNEs use expatriates to get the business off the ground, put in the
infrastructure, and, more importantly, have a plan to change the mix of
expatriates versus nationals.
 Expatriate failure occurs when the assignee returns prematurely to the home
country or when his/her performance does not meet expectations.
 MNEs look for several attributes in an expatriate including cultural empathy,
language skills, adaptability and flexibility, education, maturity, motivation,
and leadership.
 Five determinants of cross-cultural adjustment include: previous overseas
experience; pre-departure cross-cultural training; multiple candidate,
multiple-criteria selection; individual skills, and perceptual skills; and non-
work factors such as cultural distance and spouse and family adjustment.

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Block 4: Functional Areas in International Business

 MNE compensation programs focus on attracting and retaining qualified

employees, facilitating transfer between the headquarters and the affiliates,
and creating consistency and equity in compensation, and maintaining
competitiveness.
 There are three approaches to expatriate compensation – home-based, host-
based, and hybrid.
 HR problems that can be expected in WOSs and IJVs include staffing friction,
blocked promotion, exile syndrome and reentry difficulties, split loyalty,
compensation gaps, blocked communication, limited delegation, information
screening, and unfamiliarity.

11.8 Glossary
Adaptive system – A SIHRM Model that imitates local human resource
management (HRM) practices.
Ethnocentric staffing – Parent company nationals or PCNs) are chosen for key
positions regardless of the location.
Expatriate failure – It occurs when the assignee returns prematurely to the home
country or when his/her performance does not meet expectations.
Expatriate trainee – A trainee who is placed overseas for the purpose of training
as part of initiation into an MNE.
Experiential learning training – It combines cognitive and behavioral
techniques with the goal to acquire intercultural effectiveness skills including
relationship building, stress management, cross-cultural communication, and
negotiation techniques.
Exportive system - A SIHRM Model that that replicates the HRM system in the
home country and other affiliates.
Geocentric staffing – Recruiting of best managers worldwide regardless of their
nationality
Home-country compensation system – This form of expatriate compensation
system links base salary of an expatriate to the home country salary structure.
Host country-based compensation system – In this form of expatriate
compensation system expatriate base salary is linked to the host country pay
structure.
Hybrid compensation system - Blends features from the home as well as host
based approaches. The purpose of this compensation system is to create an
international expatriate workforce that while not coming from one location is
paid as if it were.
Information giving training - Consists of practical information on living
conditions in the destination country, area studies, which includes facts about the
country’s macro-environment, and cultural awareness information.

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 Unit 11: Global Human Resource Management

Integrative system – A SIHRM Model that emphasizes on global integration

while allowing for some variations.
International cadres - Individuals moving from one foreign assignment to
another who seldom return to their home country and sometimes become
permanent expatriates
International human resource management (IHRM) - Refers to the
procurement, allocation, utilization, and motivation of human resources in the
international arena.
Lump-sum/cafeteria approach - Salary is set according to the home country
system. Firms allow a total allowance package instead of breaking compensation
into component parts and expatriates make their own choices.
Optimal SIHRM - Strategy chosen by the parent in conjunction with the specific
conditions of the affiliate that determines the degree of similarity in SIHRM
between the headquarters and the affiliate.
Overseas Assignment Inventory (OAI) - Developed by Tucker International,
this instrument uses success predictors on a foreign assignment: open-
mindedness, trust in people, expectations, respect for others‟ beliefs, locus of
control, tolerance, patience, flexibility, social adaptability, initiative, risk taking,
sense of humor, and spouse communication.
Polycentric staffing – Host country nationals or HCNs are hired at the
subsidiaries of key positions but not at the corporate headquarters.
Regiocentric staffing – In this type of staffing, recruiting is done on a regional
basis
Strategic international human resource management (SIHRM) - Defined as
“human resources, management issues, functions and policies and practices that
result from the strategic activities of MNEs and that impact the international
concerns and goals of these enterprises.”
The negotiation approach - Means that the employer and the employee find a
mutually acceptable package.
Traditional expatriate - Older and experienced expatriate selected for his/her
managerial and technical skills for on to five years.
Virtual expatriate – Takes on foreign assignment without relocating physically.
The virtual expatriate uses telecommunications and videoconferencing to stay in
touch.

11.9 Self-Assessment Test

1. Define strategic international human resource management.
2. Explain how an MNE staff its operations.
3. Describe the concept of expatriate workforce.
4. Describe human resource problems in foreign affiliates.

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11.10 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education

Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d
2. IFRS Foundation. Use of IFRS standards around the world. 2018.
https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

11.11 Answers to Check Your Progress Questions

1. (c) Strategic international human resource management
Strategic international human resource management (SIHRM) is defined
as human resources, management issues, functions and policies and
practices that result from the strategic activities of MNEs and that impact
the international concerns and goals of these enterprises.

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2. (b) i, ii, and iii

The SIHRM model has three orientations:
 The adaptive system
 The exportive system
 The integrative system
3. (a) Organizational structure
Factors affecting MNE staffing include strategy, organizational
structure, and subsidiary-specific factors
4. (a) Ethnocentric
In ethnocentric staffing, PCNs are chosen for key positions regardless of
the location.
5. (c) Polycentric
In polycentric staffing, HCNs are hired at the subsidiaries of key
positions but not at the corporate headquarters.
6. (a) Regiocentric
In regiocentric staffing, recruiting is done on a regional basis.
7. (b) Geocentric
In geocentric staffing, the best managers are recruited worldwide
regardless of their nationality.
8. (a) Traditional expatriate
The traditional expatriate, older and experienced is selected for his/her
managerial and technical skills for on to five years.
9. (c) International cadres
International cadres are individuals moving from one foreign assignment
to another.
10. (b) Young, inexperienced
Young, inexperienced expatriates are sent on local hire terms for six
months to five years.
11. (b) Temporaries
Temporaries go on short on short assignments for up to a year.
12. (c) Expatriate trainee
Expatriate trainee is placed overseas for the purpose of training as part
of initiation into an MNE.

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Block 4: Functional Areas in International Business

13. (c) Virtual expatriate

The virtual expatriate takes on foreign assignment without relocating
physically.
14. (d) All of the above
Successful expatriates need three sets of skills – personal skills, people
skills, and perception skills.
15. (b) i, ii, iii, and iv
Expatriate compensation comprises the following elements:
Salary, housing services allowance and premiums, and tax equalization.
16. (b) Home country-based
A home-country compensation system links base salary of an expatriate
to the home country salary structure.
17. (b) Host country-based
In a host country-based compensation system, expatriate base salary is
linked to the host country pay structure.
18. (b) Hybrid
A hybrid compensation system blends features from the home as well as
host-based approaches.
19. (b) Lump/sum cafeteria
In lump-sum/cafeteria approach, salary is set according to the home-
country system.
20. (b) Negotiation
The negotiation approach means that the employer and the employee
find a mutually acceptable package.
21. (c) i, ii, and iii
HR problems that can be expected in WOSs and IJVs include staffing
friction, blocked promotion, exile syndrome and reentry difficulties,
split loyalty, compensation gaps, blocked communication, limited
delegation, information screening, and unfamiliarity.

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 Unit 12
Global Marketing and Supply Chain
Structure
12.1 Introduction
12.2 Objectives
12.3 The International Marketing Challenge
12.4 Globalization and Localization in International Markets
12.5 The Global Supply Chain
12.6 Summary
12.7 Glossary
12.8 Self-Assessment Test
12.9 Suggested Readings/Reference Material
12.10 Answers to Check Your Progress Questions

“Good company will meet needs; great companies will create markets”
– Philip Kotler
12.1 Introduction
The previous unit defined strategic international human resource management. It
then explained how staffing takes place in MNEs. It then discussed the concept
of expatriates; their selection and failure; how they are trained and compensated;
and recommendations on how expatriates should be compensated in different
cultures. The unit finally discussed the human resource problems faced by MNEs
in foreign affiliates.
International markets are more complex but offer vast opportunities for firms with
a product or a service potentially in demand abroad. Newness, appropriate
marketing strategies, and cultural attractiveness welcome a product in
international markets.
Globalization forces include emergence of global brands, potential savings in
costs, technological advances, and lower trade barriers. Localization forces
include country level factors that affect product introduction and adaptation.
In recent years, supply chains have undergone substantial globalization with firms
consolidating sourcing and distribution operations.
This unit will discuss how the market potential of a foreign country can be
determined. It then goes on to explaining the concepts of globalization and
localization in international markets. The unit finally discusses how supply chains
are globalized.
Block 4: Functional Areas in International Business

12.2 Objectives
By the end of this unit, students should be able to:
 Discuss how market potential of a foreign country is assessed.
 Explain the concepts of globalization and localization in the context of
international marketing.
 Outline how supply chains are globalized.

12.3 The International Marketing Challenge

The essence of international marketing, especially in global industries is that
competition can come from anywhere on the globe. The country in which the
product originates can help but is no guarantee of success.
Success in international markets depends on many skills such as accurate
assessment of market potential; selection of the right product mix, and appropriate
adjustments in pricing, packaging, advertising, and distribution. Cultural values
and social customs, rules and regulations, economic conditions and political
realities constitute the context within which international marketing takes place.

Example
According to a study conducted by KPMG, 85% of Indian consumers in post
COVID-19 started saving money despite a 10% fall in income. 78% of
Generation X (born between 1965 -1980) and 70% of millennials (born
between 1980-1995) are more concerned about their finances. Here the
international marketing challenge pointed out is economic conditions.
Source: ICFAI Research Center

12.3.1 Assessing Market Potential

For assessing market potential, firms seek to identify aggregate demand for a
product or a service and estimate the costs associated with product introduction
and distribution. In deciding market priority, profitability, accessibility, and
market size play a major role. The size of the population reveals a little about
short-term market potential.
Population growth offers a coarse estimate of future market potential. For
instance, Japan and many European Union countries face low and negative
population growth forecasts whereas most of the Asian countries show a rapid
population growth. The single most indicator of market potential is economic
development and its correlate of disposable income. The consumer’s ability to
afford certain products and services are found by nominal income figures.
Purchasing power parity (PPP) is “an index used to adjust nominal figures to the
purchasing power of local consumers.”

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Market potential is also influenced by consumption patterns. The French drink six
times more wine than the British do. Consumption patterns are dynamic and
current patterns need to be interpreted with caution. Often consumption is driven
by factors different than those in domestic markets. For instance, BCG research
indicates that in some developed economies such as Colombia or the Philippines,
Coca-Cola is a substitute for non-drinkable water.
To assess market potential within the context of corporate strategy, firms carry
out marketing research. The research aims at finding solutions to questions
such as (a) what are the objectives to be pursued by firms in foreign markets?;
(b) what foreign markets segments to be pursued?; (c) Which are the best product,
distribution, pricing, and promotion strategies; and (d) what must be the product-
market-company-mix be for taking advantage of the available foreign marketing
opportunities?

12.4 Globalization and Localization in International Markets

Striking a balance between globalization and localization is a key challenge. Lack
of marketing globalization had proved detrimental to performance, however, the
same stands true for indiscriminate standardization of marketing practices without
any attention to localization factors.
In the marketing sense, globalization is “the standardization of products (or
services), brands, marketing, advertising, and the supply chain across countries
and regions.” In contrast, localization is “the adjustment of one or more of the
above elements to be idiosyncratic characteristics of a given national market.”
 The major challenge for the MNE is fine-tuning the globalization-localization
balance.
 Globalization forces
 The function of marketing can be coordinated increasingly on a global basis.
12.4.1 Global Brands
Behind the trend of globalization, there is an assumption that many consumer and
industrial products can be standardized. For instance, Kellogg designated Special
K, Corn Flakes, Frosted Flakes, Nutri-Grain bars, and Fruit Loops as “global
brands”.
Global products are products that are recognized worldwide and are unaltered in
terms of appearance and brand when sold abroad. To be designated global,
products should be sold throughout the world under the same brand name with
over US$ 1 billion in sales and over 5 percent of those sales coming from outside
the home market.
The primary motivation toward product and service globalization is to gain scale
economies. Selling the same product using the same distribution channel and

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Block 4: Functional Areas in International Business

promotional message reduces cost. Globalization allows firms to leverage the

experience they gain in one market toward another, using communication
technologies, for facilitating integration and coordination. Moreover, the appeal
of a global product can be a crucial selling point for some customers.
12.4.2 Marketing Repercussions of a Global Approach
Some of the key ramifications of globalizing the marketing function are described
below:
 Rapid roll-out of new products across major markets, preventing competitors
from introducing similar products in new markets.

Example:
Nothing, a London-based TWS (True Wireless Stereo) company
established in 2020, launched its first product ear (1) in 2021 in India. After
getting the success, it planned to launch new products aggressively back-
to-back in 2022 and thereby not giving room to its competitors to chase.
Rapid roll-out of new products is the key ramifications of globalizing
marketing is highlighted in the given case. Here, the aggressive rollout of
new products is the ramification for competitors, which prevent from
introducing new products. The case of Nothing highlighted the ramification
of globalizing marketing by rapid rollout of new products that prevent
competitors from introducing similar products.
Source: ICFAI Research Center

 Prioritizing and targeting a product across markets, limiting local product

offerings.
 Uniform branding and advertising globally creates a consistent message,
reassures customers with global reach, and reducing cost and duplication.
This enhances entering the crowded shelves of retailers that display only best-
selling brands.
 Manufacturing relatively standardized products to scale economies.
Transferring of marketing best practices across borders.
A by-product of the increased globalization of the function of marketing is erosion in
the authority of country managers. Country managers have less control over
pricing, marketing budget, and other key marketing decisions. Though they
usually maintain control over local brands and have some say in new product
development, their influence over the marketing of global brands in their country
of jurisdiction is on the decline. National brand managers are rare, and frequently
report directly to a global marketing group as opposed to the country manager.
While marketing globalization is evident worldwide, there are significant
differences in how MNEs approach it from different countries.

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12.4.3 Localization Forces

Localization forces represent pressures toward adjustment in product marketing
or distribution for making it more appealing or for meeting requirements
particular to a foreign market.
Following a spate of alleged product contamination in foreign markets, Coca-Cola
executives noted that the firm’s motto “think globally and act locally” need to be
changed to “think locally and act locally”. Despite globalization, local conditions
and content remain vital.
Cross-national variations have a major impact on marketing. The income level
differences create different consumer requirements. Diverse regulatory regimes
put different constraints on product design, packaging and promotion. Even in the
European Union, where trademarks and logotype are relatively standardized,
pricing, promotion, and media-mix are far from uniform. Public opinion and
social attitudes also make a difference. For instance, Kellogg’s Nutri-Grain was
successful in the US but did not do as well in the UK, where health consciousness
was not strained at that time.
Another major influence is culture. Cultures on high uncertainty avoidance and
power distance emphasizes on appearance for reaffirming one’s status and for
reducing uncertainty regarding others‟ positions. Culture also has an influence on
sale practices. In high-power distance cultures, a sales pitch is made in a formal
manner whereas it is likely to be personalized individualistic countries.
Cultural and social customs also shape the context in which the product is utilized.
For instance, McDonald’s restaurants in mainland China, Hong Kong, and
Taiwan serve as bases for social activity in late mornings for seniors and in
afternoons for school children.
12.4.4 Product Adaptation
Facing a foreign market with different characteristics, a firm may choose not to
offer a product or a service in that market, to offer the same product it offers in
other markets, or adapt it to country or regional markets. Firms use benefit/cost
and user/needs for making decisions. Benefit/cost models evaluate the advantages
and disadvantages of a product or a distribute mode in a given market. User/need
models test the needs of prospective customers, including the circumstances in
which the product or service may be used. The analysis yields a decision for
customizing or standardizing the product and/or promotion and distribution.
For the MNE, a fine balance is required for global marketing. While making
adjustments to local tastes and customs, it is equally important for the MNE to
leverage its global reputation and name recognition.
The challenge of adaptation exceeds to all aspects of marketing. OfficeMax and
Office Depot launched their outlets in Japan as replicas of their US-based large,
warehouse type discount stores. They discovered that the global efficiencies

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Block 4: Functional Areas in International Business

derived were insufficient to compensate for local rents and unwillingness to buy
in an impersonal, warehouse-type store. Accordingly, the firms changed their
strategies.
12.4.5 Country-of-origin Effect
Country-of-origin effect is “the influence of the country of manufacturing image
on the buying decision.” The effect comprises dimensions such as innovativeness,
namely using new technology and engineering advances; design, namely style,
appearance, color, and variety; prestige, brand name reputation, status, and
workmanship, including reliability, durability, craftsmanship, and manufacturing
quality. The country-of-origin has an influence on the perception of the buyers.
The impact has more to do with perception than reality. For instance, British firms
are not associated with many strong products and innovations they have created
actually.
Overtime, the country-of-origin effect changes. In the 1960s, Japanese products
had a reputation of substandard quality and it was decades before the country set
a reputation for quality manufacturing. As products from developed nations tend
to receive higher evaluation, a country moving into the ranks of developed
economies may also enhance their products‟ reputation. Firms from emerging
economies also engage in activities that enhance reputation of their products.
Leveraging Positive Country Image
Country image differs across product categories. German automakers take
advantage of the country’s reputation for advanced engineering, reliability, and
quality. Some countries may be noted for a single product. For instance, Russian
caviar or Iranian carpets.
A positive country image minimizes customization that is not inherent to product
use. To highlight the national origin of the product, the original appearance and
packaging will be preserved to the extent permitted by law.
Leveraging Nationalist Sentiments
Country-of-origin might serve as a patriotic appeal for buying domestic products.
Many countries carry out campaigns that urge customers to buy local products in
order to support the local industry and employment.
At times, supporting domestic products may extend to disparagement of foreign
products. Japanese farmers place ads in local newspapers accusing orange
growers in the US of spreading Agent Orange on their fruit. (Agent Orange is a
chemical used by the US armed forces in Vietnam for retarding vegetation
growth).
Some foreign firms make attempts to disarm nationalist sentiment by emphasizing
the local content in their product. Local content is “the portion of a product (or
service) that includes locally made and procured inputs.” For instance, Airbus in
its ads outlines its US suppliers.

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 Unit 12: Global Marketing and Supply Chain

Others may downplay the foreign origin of the product, using packaging and
brand names reflecting local heritage. In Russia, the “the beloved taste of real
Russian butter” appears on the package of butter from New Zealand.
Often MNEs point out that local firms do not essentially suffer from entry. For
instance, an Israeli burger chain, Burger Ranch, continued to prosper following
the entry of Burger King and McDonald’s, which greatly increased the overall
market.
12.4.6 Branding
Branding is “the process of creating and supporting positive perceptions
associated with a product or service.” Branding is complex in global markets,
especially given varying demand and environmental characteristics.

Example
Mercedes Benz attempted to promote its range of cars in China by translating
its name into the Chinese language. By mistake, it translated the word Benz to
Bensi. This made Chinese customers nervous as the word Bensi means ‘rush to
die’. Later, Mercedes changed the word from Bensi to Benchi, which means
‘run quickly as flying’.
In the given case, branding as an element of globalization and localization is
showcased. Mercedes Benz had a mistake while translating its brand into the
Chinese language to give a local touch.
Source: ICFAI Research Center

12.4.7 Channel Decisions

Channel decisions involve the length (the number of intermediaries or levels
employed in the process of distribution) and width (the number of firms in each
level) of the channel used to link manufacturers to consumers. In business-to-
business sales, channel decisions are more important than brand name, pricing,
and advertising. Localization is pronounced especially among affiliates in the UK,
perhaps due to the assumption of cultural similarity.
Intermediation
Most of the international sales are not made by firms directly but through export
intermediaries. Export intermediaries are firms mediating between firms,
especially Small and Medium Sized International Enterprises (SMIEs) and their
export markets, by offering, logistics, documentation and related services. For
smaller firms, intermediaries play a key role, though some MNEs prefer
outsourcing of this function.
Direct Marketing
Direct marketing involves direct sales to customers through individual agents who
make a commission on their sales, in addition on the sales by agents recruited by

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them. The pioneers of the direct marketing system are Avon and Mary Kay. It was
adopted eventually by manufacturers of other products.
The image of direct selling is quite low especially in Asia. In Japan, Avon found
that its system of making sales to random groups was ineffective as people were
reluctant to invite strangers into their home. However, the direct marketing
prospered after it started relying on groups of friends or acquaintances.
Niche Marketing
Niche marketing is directed in a narrow manner toward a pre-defined market
segment. In international markets, niche marketing maybe directed toward not
only to a product category but also to a geographical or an ethnic segment.
Convencao, a small soft-drink company in Brazil cut into the market share of
beverage industry giants Coca-Cola and Pepsi, by offering lower-priced products
in its home market. A niche may also serve as a base for expansion, however,
Timberland, originally known for its weather-proofed boots, exported casual wear
to over 50 countries, including Italy.
12.4.8 Pricing
Pricing is the process and decision to set a price for a product or a service.
In international markets, pricing is more complex due to varying cost structures
(e.g. tariffs, transportation costs) and market positioning.
Price differentials facilitate market segmentation that allows firms to position
their products differentially in different markets. Where there is little competition
and consumer resistance to price increases is low, firms increase the price of their
products. Or firms may price a brand higher so they can position it as “premium”.
Price consistency is not easy to achieve. For example, some subsidiaries offer a
higher service level than others. Host government decisions also have an influence
over price. The Turkish government imposes an 80 percent import tax on all
vehicle imports thus protecting domestic manufacturers as well as the
international firms manufacturing in Turkey.
Predatory Pricing
Predatory pricing is the selling of goods at prices that are below the real cost in
order to drive competition out of the market. For instance, it was alleged that
Matsushita priced its Panasonic TV sets below cost in the US, subsidizing sales
with its high margins in the Japanese market and driving US manufacturers out of
business.
12.4.9 Promotion
Globalization can yield substantial savings in promotion. General Motors Europe
uses a unified promotional approach to drive brand identity. However, the
company recognizes the need for adaptation in some markets.

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Advertising
Advertising needs to be adjusted to local tastes, regulations, and norms to make it
effective in international markets. When Lego exported its successful advertising
in the US to Japan, it flopped. Lego discovered that moving advertising across
borders is difficult linguistically, socially, and culturally.
The standardization of advertising can be considerable. Standardization provides
a consistent and coherent message and greatly reduces production cost by
spreading it across multiple markets. For instance, Coca-Cola, Benetton, and Ford
have launched global advertising campaigns.
As the firms globalize their marketing, firms increasingly seek advertising
agencies with global reach for providing a one-stop shop. For instance, Kellogg
assigned responsibilities for of its global brands to J Walter Thompson and Leo
Burnett.

Activity 12.1
RS Steel Ltd. (RS Steel), a Brazilian steel company is a leading player in the
steel industry. Of late, the company faced competition from a local steel
manufacturer, XYZ Steel Co. To add to its troubles, a US-based steel company,
ABC Steels was also capturing a significant share in the Brazilian steel market.
To regain its market share, RS Steel decreased the price of its steel below the
real cost. Identify the practice adopted by RS Steel. Also discuss other channel
decisions taken by firms.
Answer:

12.4.10 Marketing Alliances

International strategic alliances are a major venue for market entry. Such alliances
and mergers and acquisitions allow a firm to quickly establish itself in a foreign
market. Interbrew based in Leuven, Belgium grew from a smaller family-owned
brewery to the second largest brewer in the world and the owner of hundreds of
brands though acquisitions. Marketing alliances can also be formed between large
firms.
All marketing alliances do not prosper. For instance, Timex established an
alliance with Titan in India. Timex offered low-end watches, whereas Titan
offered high-end luxury watches. Titan shops serviced Timex watches while
Timex had access to Titan‟s dealers and showrooms. In return, Titan has access
to low-cost mass production market through Timex. With the changing of market
conditions, the firms decided to enter other segments and in 1997 they eventually
decided to break up the alliance.

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12.5 The Global Supply Chain

Global supply chain covers both logistics and operations. It includes activities
such as sourcing, procurement, order processing, manufacturing, warehousing,
inventory control, servicing and warranty, custom cleaning, wholesaling, and
distribution. In a firm‟s global strategy, supply chain management plays a key
component, influencing key decisions such as plant and service location.
The costs of logistics have declined in recent years. The decline reflects increasing
efficiencies such as the incorporation of Just-in-time and the resulting decrease in
inventory levels.
Issues such as international shipping costs, currency translation, language,
customs documentation, and cross-border financial settlement are beginning to be
addressed.
12.5.1 The Globalization of Supply Chains
Firms increasingly consolidate production and distribution in some strategic
locations for ensuring effective delivery of a product or a service. The shift from
domestic to global supply chains is due rapidly escalating capital costs and
enhanced technologies as well as regional integration. The evolution of flexible
manufacturing systems had enabled mass customization for meeting demands of
the consumers at reasonable costs. Consolidation of transport industry facilitates
seamless transportation. Developments in management information systems
permit accurate tracking of material flow and variable customer demands.
Where integration has progressed as in the EU, standardized regulations have
replaced local rules, enhancing consolidation. With nations being increasingly
served with logistic centers in other countries, geographic designs become less of
an option for MNEs. Other repercussions of globalization of supply chain are
increased transportation from and to transportation centers, extended supply and
distribution chains, and more small-volume transactions.

Box 1: The Challenge for SMIEs

SMIEs do not have the necessary economies for justifying a specialized
facility. Mutualization is one solution where the logistic facilities are shared by
two or more partners. Some SMIEs form alliances with local firms as the local
partner may already have the logistic component or a long-term logistic
provider, which makes the foreign firms to consolidate its supply chain locally.
Another solution for SMIEs is sourcing logistic services from third parties. In
such alliances, the shipper leads strategy formulation while the provider leads
day-to-day operations. There exists a sole key provider with whom the
manufacturers establish a close working relationship.
Compiled from various sources.

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12.5.2 Global Sourcing

Global sourcing is “the procurement of production or service inputs or
components in international markets.” Global sourcing provides an opportunity
to the MNE for leveraging its scale and competitive advantage in spotting
opportunities for procurement worldwide for use in its various locations and
divisions. For instance, Wal-Mart, because of its scale, uses its huge volume for
extracting lower prices from its customers.
MNEs are also increasingly using outsourcing or buying the inputs outside their
network. Some firms may even outsource the logistic function itself.
Logistic Providers
While one-stop international provision of logistic provision continues to be the
ultimate goal, national services may be replaced by regional providers. For
instance, Texas Instruments Semiconductors Group contracts with a key logistic
provider for managing forwarding and distribution in each region of the world.
12.5.3 Customizing the Supply Chain
As the globalization of supply chain proceeds, several factors require continuous
attention to localization and customization. Localization is supported by three
factors – variation among national environments, product customization that
triggers logistic adjustments, and existence of national borders that impede the
free flow of goods and services thus limiting global solutions. Advantages such
as the incorporation of suppliers‟ input at the phase of product design heighten
dependencies and logistic challenges accompanying the need to control and
coordinate them.
National Variation
World regions vary in size, terrain, and other characteristics that have an impact
on the supply chain. For instance, the land area of NAFTA is over six time than
that of the EU. Quality of supplies, skill level, availability of process equipment
and technologies, and the level of transportation and communications differ
substantially among regions. Asia, large parts of the Middle East, Africa, and
Latin America suffer from poor infrastructure. Though Asian infrastructure is
relatively weak, Singapore has superb infrastructure in terms of both shipping and
air.
Conditions often vary even among developed nations. For instance, in the US, it
takes three weeks for breakfast cereals to reach the retailers‟ shelves from the
time of manufacturing but it takes eleven weeks in France. This explains why
domestic supply chains continue to dominate the transfer of goods. In addition,
increased foreign direct investment in local production base creates even more
reliance on domestic supply chains. A great number of intermediaries and
fragmented supply chains add to the problem.

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Product and Logistic Customization

Product customization challenges the characteristics of supply chain management
as it impacts modularity, packaging, transportation, shipping, tracking, and
distribution. A postponement strategy designed for delaying customization to the
latest value-adding phase is not feasible always without compromising on product
variety. For instance, Meritor which used to provide several automotive parts in
North America, now manufactures only suspension systems, roofs, and doors but
provides them to car manufacturers across the globe.
12.5.4 Packaging
Standardization in packaging appeals for logistics ease and also promotes brand
recognition. Coca-Cola uses similar color and logo to enhance its brands.
Standardization in packaging results in savings in design and promotion costs.
Packaging size must also be adapted as well. Where space is scarce, bulk
packaging is less attractive, for instance, Japanese households.
Some adaptations are essential for logistic reasons. For instance, sturdier
packaging is required to shield the product from outside elements in a harsh
environment. Other adaptations are needed to meet legal requirements. Various
laws govern safety requirements.
The new German Packaging Act (VerpackG) entered into force on 1st January
2019. The aim of the law is to reduce the negative impacts of packaging waste on
the environment and to significantly increase recycling rates. (Source:
https://deutsche-recycling.com/packaging-regulation/)
In most of the countries, labels should be printed in the local language, adding
time and cost to distribution. The US requires all food products to carry labels
indicating their nutritional value. Many countries also require clear labeling of the
product’s country source. In the US, US content should be disclosed on textiles,
cars, wool, and fur products.
Some packaging adaptations are essential for cultural or religious reasons. For
instance, Hogla-Kimberly, a joint venture between an Israeli manufacturer and
Kimberly Clark, sell diaper to the orthodox segment in Israel in a specially
designed, easy-to-prop open packaging that met the religious requirements for
doing no work on the Sabbath.

Activity 12.2
KK Foods Ltd., a US-based snacks company has operations in many countries
throughout the world. In order to save costs, the company standardized its
packaging while printing labels in the local language where it distributed its
food products. However, in the US, the company had display nutritional value
of each food item. Explain why packaging cannot be standardized in some
countries and also state various reasons why adaptations in packaging are
needed.

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Answer:

12.5.5 Transportation Modes

Customer demands can be met in a timely and cost-effective manner by effective
modes of transportation. One of the driving forces behind intermodal
transportation is globalization. Intermodal transportation is a term that denotes
“the combination of ocean vessels (including short sea shipping), river transport,
rail, road links, and air transport within a seamless supply chain.” However,
intermodality represents many challenges. Comparing prices of alternative modes
of transportation is difficult because price is based on several products (e.g. value,
weight, space) and non-product (e.g. custom administrative procedures, port of
the shipment) factors. Intermodality also requires standardization and modularity
to permit frequent transfer of goods from one mode to another. Other obstacles to
intermodality and seamless logistics lie at the political and legal level. For
instance, regulations in Thailand require warehousing and transport to be handled
by separate companies.
Maritime Transportation
Over 90 percent of the international trade is served by maritime transportation.
Most of the US-Mexico trade was handled by 9 ports, of the 29 border crossing
points between the US and Mexico.
Impediments to further globalization of maritime transport include the issuance
of “flags of convenience” that is registering ships in countries with less stringent
regulations such as Panama and Liberia. Such registries less stringent safety
standards and confer labor and tax benefits but they do not raise opposition in
some of the countries in which the MNEs operate.
Port Facilities

Port facilities represent a vital ingredient in the convenience and cost of maritime
transport. According to a report by Conference Board, the most competitive
ports offer low cost, speed processing, and superb intermodal links. Ports are of
four types –
(1) The maritime hub – dedicated to transshipment from an ocean vessel to a
feeder or another vessel; (2) The gateway port – an interchange between the
maritime hub and maritime and/or land transport; (3) The logistic-industrial
port – interchange between modes of transport combined with logistic support;
and (4) The trade port – logistic activities together with other value-added
international trade services.

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Singapore and Hong Kong are the two largest container ports in the world, which
together have 44 percent of the container lifts in the world. Non-hub ports can
compete by adopting niche strategies. One port strategy is to specialize in a
particular product line in order to achieve economies of scale.
Ports as key links in the global supply chain face the challenge to accommodate
local distribution. For instance, to integrate domestic and international shipping
for accommodating situations such as when the final destination is closer to the
port as opposed to rail transportation.
The Inland Port
In central Ohio, “Port Columbus” is an inland port. It utilizes 86 million square
feet of warehousing and distribution facilities on the grounds of a former air force
base. The port has arteries to highways, airports, and rail and coastal port access
through agreements with the ports of Los Angeles, New York/New Jersey, and
Virginia. Countries with vast underdeveloped hinterland show immense interest
in the inland port concept in a bid to improve access to less developed regions.
Trucking
Trucking plays an important role in international trade in geographically
contiguous areas such as Texas/Mexico and Hong Kong/Shenzhen in southern
China as in Europe, where distances are relatively short. Trucks are also vital in
the domestic distribution of products delivered internationally by rail, air, or ship.
The utilization of containers had made such intermodality substantially easier.
While Europe, the US, and other developed countries have standardized safety
and other regulations related to motor vehicles, there remained substantial
impediments to the globalization and standardization of truck transportation. For
example, there are different conventions regarding the use of rentals,
manufacturers’ fleet, and so forth.
Traffic congestion is costly to trucking in terms of high energy costs, delayed
shipments, deteriorating service quality, and lower productivity of vehicles and
workforce. Developing countries such as Iran and China have less congestion
problems but a higher proportion of unpaved roads in the US and other developed
countries impose serious constraints on the domestic transportation of goods.
Rail
Rail transportation is considered to be an attractive mode of transportation
domestically and internationally due to its competitive time to cost ratio as well
as road and sky congestion. For instance, nearly half of the grain exports from the
US are transported to Mexico by rail. Where rails are not contiguous, railways
can still play a crucial role as part of intermodal transportation.
Air Transport
Air transportation was initially confined to high value or perishable items. It is
now increasingly used when logistics infrastructure is in place and speed of

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transportation is vital. A major impediment to globalization of air transport is the

stringent safety standards imposed by developed nations, especially the EU and
the US, vis-à-vis the lax regimes common in most of the developing countries. If
the safety standards are not complied, the US does not permit the landing of
foreign aircraft.
Crossing National Borders
A seamless supply chain spanning national borders is difficult to be established.
Customs inspection, processing, and other barriers associated with crossing
borders create unpredictable and costly delays.
The NAFTA agreement offers for substantial non-tariff movement of goods
across the US, Canada, and Mexico, on the condition that goods originate from
one of these three countries. For this to take place, substantial documentation is
essential for establishing country-of-origin source. Moreover, shortage of border-
crossing points, rails, docks, and bridges undermine traffic expansion.
In the aftermath of the September 11, 2001 terrorist attacks in the US, border
delays have worsened considerably in many parts of the world, including major
borders such as the US and Canada. Though the delays since then have shortened,
they show that global logistics is vulnerable to the problem of overlapping
international boundaries and the expected contingencies that characterize the
global supply chain and other facets of international business.

Check Your Progress - 1

1. is an index used to adjust nominal figures to the purchasing
power of local consumers.
a. Purchasing power parity
b. Income levels
c. Consumption patterns
d. National income
2. is the standardization of products (or services), brands,
marketing, advertising, and the supply chain across countries and regions.
a. Localization
b. Globalization
c. Customization
d. Standardization
3. is the adjustment of one or more of the above elements to
be idiosyncratic characteristics of a given national market.
a. Globalization
b. Glocalization
c. Localization
d. None of the above

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4. evaluate the advantages and disadvantages of a product or

a distribute mode in a given market.
a. User/need models
b. Benefit/cost model
c. Customized model
d. Standardized model
5. test the needs of prospective customers, including the
circumstances in which the product or service may be used.
a. Customized model
b. User/need models
c. Benefit/cost model
d. None of the above
6. Branding is the process of creating and supporting positive perceptions
associated with a product or service.
a. Pricing
b. Packaging
c. Branding
d. Promotion
7. involves direct sales to customers through individual agents
who make a commission on their sales, in addition on the sales by agents
recruited by them.
a. Niche marketing
b. Direct marketing
c. Online marketing
d. None of the above
8. is directed in a narrow manner toward a pre-defined market
segment.
a. Online marketing
b. Niche marketing
c. Direct marketing
d. Advertising
9. is the process and decision to set a price for a product or a
service.
a. Marketing
b. Packaging
c. Promotion
d. Pricing

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10. is the selling of goods at prices that are below the

real cost in order to drive competition out of the market.
a. Pricing
b. Niche marketing
c. Predatory pricing
d. None of the above
11. activities such as sourcing, procurement, order
processing, manufacturing, warehousing, inventory control, servicing and
warranty, custom cleaning, wholesaling, and distribution.
a. Global sourcing
b. Domestic supply chain
c. Local sourcing
d. Global supply chain
12. is the procurement of production or service inputs
or components in international markets.
a. Global supply chain
b. Local sourcing
c. Niche marketing
d. Global sourcing
13. Localization is supported by which of the following factors?
i. Variation among national environments
ii. Product customization that triggers logistic adjustments
iii. Variation among regional environments
iv. Existence of national borders that impede the free flow of goods and
services
v. All of the above
a. v
b. i, iii, and iv
c. ii, iii, and iv
d. i, ii, and iv
14. Which of the following are types of ports?
i. The maritime hub
ii. The gateway port
iii. The logistic-industrial port
iv. The trade port
v. The customized port

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a. i, iii, iv, and v

b. ii, iii, iv, and v
c. i, ii, iii and iv
d. i, ii, iv, and v
15. is considered to be an attractive mode of
transportation domestically and internationally.
a. Air
b. Trucking
c. Rail
d. None of the above

12.6 Summary
 Success in international markets depends on many skills such as accurate
assessment of market potential; selection of the right product mix, and
appropriate adjustments in pricing, packaging, advertising, and distribution.
 For assessing market potential, firms seek to identify aggregate demand for a
product or a service and estimate the costs associated with product
introduction and distribution.
 Globalization is the standardization of products (or services), brands,
marketing, advertising, and the supply chain across countries and regions. In
contrast, localization is the adjustment of one or more of the above elements
to be idiosyncratic characteristics of a given national market.
 Country-of-origin effect comprises dimensions such as innovativeness,
namely using new technology and engineering advances; design, namely
style, appearance, color, and variety; prestige, brand name reputation, status,
and workmanship, including reliability, durability, craftsmanship, and
manufacturing quality.
 Channel decisions involve the length (the number of intermediaries or levels
employed in the process of distribution) and width (the number of firms in
each level) of the channel used to link manufacturers to consumers.
 Pricing is the process and decision to set a price for a product or a service.
 Advertising needs to be adjusted to local tastes, regulations, and norms to
make it effective in international markets.
 International strategic alliances are a major venue for market entry. Such
alliances and mergers and acquisitions allow a firm to quickly establish itself
in a foreign market.

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 Global supply chain covers both logistics and operations. It includes activities
such as sourcing, procurement, order processing, manufacturing,
warehousing, inventory control, servicing and warranty, custom cleaning,
wholesaling, and distribution.
 Global sourcing provides an opportunity to the MNE for leveraging its scale
and competitive advantage in spotting opportunities for procurement
worldwide for use in its various locations and divisions.
 As the globalization of supply chain proceeds, several factors require
continuous attention to localization and customization. Localization is
supported by three factors – variation among national environments, product
customization that triggers logistic adjustments, and existence of national
borders that impede the free flow of goods and services thus limiting global
solutions.
 Standardization in packaging appeals for logistics ease and also promotes
brand recognition.
 Customer demands can be met in a timely and cost-effective manner by
effective modes of transportation.
 A seamless supply chain spanning national borders is difficult to be
established. Customs inspection, processing, and other barriers associated
with crossing borders create unpredictable and costly delays.

12.7 Glossary
Branding - Branding is the process of creating and supporting positive
perceptions associated with a product or service.
Country-of-origin effect - Country-of-origin effect is the influence of the country
of manufacturing image on the buying decision.
Direct marketing - Direct marketing involves direct sales to customers through
individual agents who make a commission on their sales, in addition on the sales
by agents recruited by them.
Global sourcing - Global sourcing is the procurement of production or service
inputs or components in international markets.
Intermodal transportation - Intermodal transportation is a term that denotes the
combination of ocean vessels (including short sea shipping), river transport, rail,
road links, and air transport within a seamless supply chain.
Pricing - Pricing is the process and decision to set a price for a product or a
service.
Predatory pricing - Predatory pricing is the selling of goods at prices that are
below the real cost in order to drive competition out of the market.

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Block 4: Functional Areas in International Business

Purchasing power parity - Purchasing power parity (PPP) is an index used to

adjust nominal figures to the purchasing power of local consumers
Global supply chain - Covers both logistics and operations. It includes activities
such as sourcing, procurement, order processing, manufacturing, warehousing,
inventory control, servicing and warranty, custom cleaning, wholesaling, and
distribution.
Niche marketing - Marketing directed in a narrow manner toward a pre-defined
market segment. In international markets, niche marketing maybe directed toward
not only to a product category but also to a geographical or an ethnic segment.
Channel decisions - Involve the length and width of the channel used to link
manufacturers to consumers.
Globalization - In marketing sense, it is “the standardization of products (or
services), brands, marketing, advertising, and the supply chain across countries
and regions.”
Localization - In marketing sense, it is “the adjustment of one or more of the
marketing elements to be idiosyncratic characteristics of a given national market.”

12.8 Self-Assessment Test

1. Explain the need for assessing market potential in the context of
international marketing.
2. Briefly explain the various concepts involved in globalization and
localization in international markets.
3. Describe in brief how supply chains are globalized and customized in
international marketing.
4. Explain the different types of intermodal transportation.

12.9 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education

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Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d
2. IFRS Foundation. Use of IFRS standards around the world. 2018.
https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

12.10 Answers to Check Your Progress Questions

1. (a) Purchasing power parity
Purchasing power parity (PPP) is an index used to adjust nominal figures
to the purchasing power of local consumers.
2. (b) Globalization
Globalization is the standardization of products (or services), brands,
marketing, advertising, and the supply chain across countries and
regions.
3. (c) Localization
Localization is the adjustment of one or more of the above elements to
be idiosyncratic characteristics of a given national market.
4. (b) Benefit/cost models
Benefit/cost models evaluate the advantages and disadvantages of a
product or a distribute mode in a given market.
5. (b) User/need models
User/need models test the needs of prospective customers, including the
circumstances in which the product or service may be used.
6. (c) Branding
Branding is the process of creating and supporting positive perceptions

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Block 4: Functional Areas in International Business

associated with a product or service.

7. (b) Direct marketing
Direct marketing involves direct sales to customers through individual
agents who make a commission on their sales, in addition on the sales
by agents recruited by them.
8. (b) Niche marketing
Niche marketing is directed in a narrow manner toward a pre-defined
market segment.
9. (d) Ricing
Pricing is the process and decision to set a price for a product or a
service.
10. (c) Predatory pricing
Predatory pricing is the selling of goods at prices that are below the real
cost in order to drive competition out of the market.
11. (d) Global supply chain
Global supply chain activities such as sourcing, procurement, order
processing, manufacturing, warehousing, inventory control, servicing
and warranty, custom cleaning, wholesaling, and distribution.
12. (d) Global sourcing
Global sourcing is the procurement of production or service inputs or
components in international markets.
13. (d) i, ii, and iv
Localization is supported by three factors – variation among national
environments, product customization that triggers logistic adjustments,
and existence of national borders that impede the free flow of goods and
services thus limiting global solutions.
14. (c) i, ii, iii, and iv
Ports are of four types the maritime hub, the gateway port, the logistic-
industrial port, the trade port.
15. (c) Rail transportation
Rail transportation is considered to be an attractive mode of
transportation domestically and internationally.

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 Unit 13
Accounting in the International Business
Structure
13.1 Introduction
13.2 Objectives
13.3 Accounting Standards: Country Differences
13.4 National and International Standards
13.5 Multinational Consolidation, Currency Translation, and Transaction
Exposure
13.6 Accounting Practice and Economic Reality
13.7 Accounting Aspects of Control Systems
13.8 Summary
13.9 Glossary
13.10 Self-Assessment Test
13.11 Suggested Readings/Reference Material
13.12 Answers to Check Your Progress Questions

“Don't ever let your business get ahead of the financial side of your business.
Accounting, accounting, accounting. Know your numbers.”
- Tilman J. Fertitta

Introduction
The previous unit discussed how the market potential of a foreign country can be
determined. It then explained the concepts of globalization and localization in
international markets. The unit finally discussed how supply chains are
globalized.
Accounting information is the means by which firms communicate their financial
position to the providers of capital, investors, creditors, and government. It
enables the capital providers to evaluate the value of their investments or the
security of their loans and for making decisions about future resource allocations.
International businesses confront many accounting problems that are not
confronted in domestic businesses. The lack of consistency in accounting
standards of different countries is a major problem. Thus international standards
are formed to standardize accounting practices. Multinational enterprises (MNEs)
make use of consolidated financial statements and methods of foreign currency
translation to correctly report their financials. Control system is also a crucial
aspect of accounting in international business.
Block 4: Functional Areas in International Business

This unit will discuss country differences in accounting standards. It then goes on
to explaining the national and international standards. It then discusses the
significance of consolidated financial statements, the methods used for currency
translation, and the concept of transaction exposure. It also explains the concept
of economic exposure. The unit finally discusses the different aspects of
accounting in control systems.

Objectives
By the end of this unit, students should be able to:
 Discuss differences in accounting standards in different countries. understand
why national and international standards are established.
 Explain the significance of consolidated financial statements, the methods
used for currency translation, and the concept of transaction exposure.
 Outline the concept of economic exposure.
 Discuss the different aspects of accounting in control systems.

Accounting Standards: Country Differences

different
Accounting is shaped by the environment in which it operates. Countries have
accounting systems just as they have different economic systems, political
systems, and cultures. The accounting system has evolved in each country in
response to the demands for accounting information.
An example of differences in accounting conventions concerns employee
disclosures. In many European countries, government regulations require firms to
publish detailed information about their employment and training policies. Such
requirement does not exist in the US. Another difference is treatment of goodwill.
The goodwill of a firm is any advantage such as brand name or a trademark that
enables firms to earn profits higher than its competitors. When one company
acquires another company, the goodwill value is calculated as the amount paid for
a firm above its book value, which is often substantial. Under accounting rules
that are prevalent in many countries, acquiring firms have been allowed to deduct
the goodwill value from the amount of equity or net worth reported on their
balance sheet.
Despite several attempts to harmonize standards by developing internationally
acceptable conventions differences between national accounting systems still
remain. Though many factors can influence the development of an accounting
system in a country, there appear five main variables:
 The relationship between business and capital providers;
 Political and economic ties with countries;
 The inflation level;
 The level of economic development of a country;
 The prevailing culture in a country.

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 Unit 13: Accounting in the International Business

13.3.1 Relationship between Business and Capital Providers

The three main sources of external capital for business enterprises are individual
investors, banks, and government. In most advanced countries, all three sources
are crucial. For instance, in the US, business firms can raise capital by selling
shares and bonds to individual investors through the bond market and stock
market. They can borrow capital from banks and in some cases from the
government. The importance of each capital source varies from country to
country. In some countries, such as the US, individual investors are the major
capital source; in others; banks play a greater role; in still others, the government
is the major capital provider. The accounting system of a country tends to reflect
the relative importance of these three constituencies as capital providers.

Example

A report in Statista dated 18th March 2022 has reported that in 2020, 55% of
adults in the United States invested in the stock market. This figure has
remained steady over the last few years and is the highest across the developed
countries. The accounting system of the USA tends to reflect relative
importance and is oriented toward offering individual investors the information
they require to make decisions about selling or purchasing corporate stocks or
bonds. The factor that influenced the development of the accounting system in
the USA is the relationship between business and capital providers.
The USA has well-developed stock and bond markets in which firms can raise
capital by selling stocks and bonds to individual investors. The accounting
system of the USA tends to reflect relative importance and is oriented toward
offering individual investors the information they require to make decisions
and so is the accounting system as well.

Source: ICFAI Research Center

Consider the case of Britain and the US. Both have well-developed stock and bond
markets in which firms can raise capital by selling stocks and bonds to individual
investors. Most individual investors purchase a very small proportion of the total
outstanding stocks or bonds of a firm. The investors leave the task to professional
managers. But due to their lack of contact with the management of the firms in
which they invest, individual investors may not have the information needed for
evaluating how well the companies are performing. Individual investors generally
lack the ability to get information on management demand because of their small
stake in firms. The financial accounting system in both Britain and the US evolved
to cope with this problem. In both countries, the financial accounting system is
oriented toward offering individual investors with the information they require to
make decisions about selling or purchasing corporate stocks or bonds.

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In countries such as Japan, Switzerland, and Germany, a few large banks satisfy
most of the capital needs of business enterprises. In these countries, the role of the
banks has been so important that a bank’s officers often have seats on the boards
of firms to which it lends capital. In such circumstances, the information needs of
the providers of capital are satisfied in a straightforward manner through direct
visits, personal contacts, and information provided at board meetings.
Consequently, though firms do prepare financial reports, as government
regulations in these countries mandate some public disclosure of the financial
position of the firm, the reports historically tend to contain less information than
those of the US or British firms. Because banks are major capital providers,
financial accounting practices are oriented toward protecting a bank’s investment.
Hence, assets are valued conservatively and liabilities are overvalued to offer a
cushion for the bank in the event of default.
In still other countries, the national government has been a crucial capital
provider, and this has influenced accounting practices. This is the case in Sweden
and France, where the national government has often stepped in to make loans or
invest in firms whose activities are deemed in national interest. In these countries,
financial accounting practices are oriented toward the needs of government
planners.

13.3.2 Political and Economic Ties with Countries

Similarities in the accounting systems of countries are sometimes due to the close
political and economic ties between countries. For instance, the accounting
system in the US has influenced the accounting practices in Mexico and Canada,
and since passage of NAFTA, the accounting systems in these countries has
converged on a common set of norms. Another significant force in accounting
worldwide has been the British system. A majority of former colonies of the
British Empire have accounting practices modeled after Britain’s. Similarly, the
European Union (EU) has also made attempts to harmonize accounting practices
in its member countries. The accounting systems of EU members have converged
to the norms of the International Accounting Standards Board.

13.3.3 Inflation Accounting

In many countries, including the US, Japan, and Germany, accounting is based on
the historic cost principle. This principle assumes “the currency unit used to report
financial results is not losing its value due to inflation.” Firms record sales,
purchases, and the like at original price of the transaction and make no
adjustments in the amounts later. The historic cost principle affects accounting
most significantly in the area of asset valuation. If the inflation is high, the historic
cost principle underestimates the assets of a firm so the depreciation charges based
on these underestimates can be inadequate for replacing worn out or obsolete
assets.

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The appropriateness of this principle inversely varies with the inflation level in a
country. During the 1970s and 1980s, the high level of price inflation in many
industrialized countries created a need for new accounting methods that could
adjust inflation. Many industrialized countries adopted new practices. In 1980, an
approach called current cost accounting was adopted in Britain. Current cost
accounting adjusts all items in a financial statement – assets, liabilities, revenues,
and costs in order to factor out the effects of inflation. The method makes use of
a general price index for converting historic figures into current values. However,
the standard was not made compulsory and once the inflation rate fell in the 1980s
in Britain, most of the firms stopped proving the data.

13.3.4 Level of Development

Developed nations have large, complex organizations, whose accounting
problems are complicated than those of small organizations. They also have
sophisticated capital markets in which business organizations raise funds from
investors and banks. The capital providers require comprehensive reports of the
financial activities of an organization they invest in. The workforces of developed
nations tend to be highly skilled and educated and can perform complex
accounting functions. These reasons make accounting in developed countries
more sophisticated than accounting in less developed countries, where the
accounting standards may be moderately primitive. In most of the developed
nations, the accounting system used is inherited from colonial powers. For
instance, many African nations have accounting practices based on either the
French or British models. These models may not be applicable to small businesses
in a poorly developed economy. Another problem in poorer countries of the world
is lack of trained accountants.

13.3.5 Culture
The culture of a country has a major impact upon the nature of its accounting
system. Researchers have found that the degree to which a culture is characterized
by uncertainty avoidance has an impact on the accounting system. Uncertainty
avoidance refers to “the extent to which cultures socialize their members to accept
ambiguous situations and tolerate uncertainty.” Members belonging to a high
uncertainty avoidance cultures give importance to career patterns, job security,
retirement benefits, etc. They also have a strong need for rules and regulations;
the manager is expected to give clear instructions and the initiatives of the
subordinates are controlled tightly. Lower uncertainty avoidance cultures are
characterized by an increase readiness to take risks and less emotional resistance
to change. Research indicates that countries with low uncertainty avoidance
cultures tend to have strong independent auditing professions that audit the
accounts of the firms to ensure that they comply with generally accepted
accounting regulations.

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National and International Standards

Accounting standards are “rules for preparing financial statements.” They define
what is useful accounting information. Auditing standards specify the rules for
performing an audit – the technical process through which an independent person
(the auditor) gathers evidence to determine if financial accounts conform to
required accounting standards and also if they are reliable.

13.4.1 Lack of Comparability

An adverse result of national differences in accounting and auditing standards has

been a general lack of comparability of financial reports from one country to
another. For example, Dutch standards favored the use of current value for
replacement assets; Japanese law prescribed historic cost and generally prohibited
revaluation; in Britain, capitalization of financial leases was a required practice,
but was not practiced in France; in the US, R&D costs must be written off in the
year they were incurred but in Spain it could deferred as an asset and may not be
amortized as long as benefits covering them were expected to arise in the future.
Such differences would not have mattered much if there was a little need for a
firm headquartered in one country for reporting its financial results to citizens of
another country. However, a striking development has been the growth of the
capital markets. A growth of both transnational financing and transnational
investment has also been noticed.
Transnational financing takes place when a firm based in one country enters the
capital market of another country for raising capital from the sale of stocks or
bonds. A German firm raising capital by selling stock through the London Stock
Exchange is an example of transnational financing. Large firms have been
increasingly making use of transnational financing by gaining listings, and
ultimately issuing stock, on foreign stock exchanges, particularly the London and
the New York stock exchanges.

Example

Live mint dated 6th January 2022 has reported that Reliance Industries Ltd.,
(RIL) has raised $4 billion through transnational financing, the largest ever
foreign currency bond issuance.

Source: ICFAI Research Center

Transnational investment takes place when an investor based in one country

enters another nation’s capital market for making investments in stocks or bonds
of a firm based in that country. An investor based in Britain buying stock of
General Motors through the New York stock exchange is an example of
transnational investment.

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The rapid expansion of transnational financing and transnational investment is

accompanied by a corresponding growth in transnational financial reporting. For
instance, a Danish firm raising capital in London should issue Danish financial
reports, in addition to the financial reports that serve the needs of its British
investors. However, a lack of comparability between accounting standards in
different nations can cause confusion. For instance, the German firm that issues
two sets of financial reports, one prepared under German standards and the other
under US standards, may find that its financial position shows a significant
difference in the two reports, and its investors may have difficulty in identifying
the true worth of a firm.
In addition to problems related to lack of incomparability, faced by the investors,
the firm has to explain its investors why its financial position looks so different
in the two accountings. Also, an international business may find it difficult
to evaluate the financial positions of key foreign suppliers, customers, and
competitors.
13.4.2 International Standards
Many companies raise money from capital providers across national borders. The
providers demand consistency in the way in which financial reports are reported
for making informed decisions. Also adoption of common accounting standards
will facilitate the development of global capital markets, since more investors will
be willing to make investments across borders, and the end result will be to lower
the cost of capital and stimulate economic growth. Thus, accounting standards
were standardized across national borders in the best interests of the participants
in the world economy.
Formed in March 2001, the International Accounting Standards Board (IASB) has
emerged as a proponent of standardization. The IASB replaced the International
Accounting Standards Committee (IASC), which was established in 1973. The
IASB is responsible for formulating new international financial reporting
standards. By 2005, the IASC and the IASB had issued 41 international
accounting standards. For issuing a new standard, 75 percent of the members of
the IASB must agree. It can be difficult to get three-quarters agreement as
members come from different cultures and legal systems. The IASB offers two
acceptable alternatives to get around this problem.
Another hindrance to the development of international accounting standards is
that compliance is voluntary; the IASB has no power to enforce the standards.
Despite this, the support for IASB and recognition of its standards has been
growing.
The impact of IASB standards has been least noticeable in the US as most of the
IASB standards were consistent with opinions already articulated by the US
Financial Accounting Standards Board (FASB). The FASB writes the generally
accepted accounting principles (GAAP) by which the financial statements of US

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firms should be prepared. By contrast, the IASB standards had a significant

impact in many other countries as they eliminated a commonly used alternative.
EU also has substantial influence on the harmonization of accounting standards.
The EU mandates its accounting principles in its member countries.

Multinational Consolidation, Currency Translation, and

Transaction Exposure
A consolidated financial statement combines the different financial statements of
two or more firms to yield a single set of financial statements as if the individual
companies were a single entity. Most of the multinational firms comprise a parent
company with several foreign subsidiaries located in various countries. Such
firms issue consolidated financial statements, which merge the accounts of the
parent company as well as its subsidiaries as opposed to issuing individual
financial statements for the parent company and each subsidiary.
13.5.1 Consolidated Financial Statements
Many firms find it beneficial to organize as a set of separate legal entities. For
example, a firm may incorporate the various business components separately for
limiting its total legal liability or for taking advantage of corporate tax regulations.
Multinationals often required by the countries in which they carry out their
business to set up a separate company. Thus a Multinational comprises a parent
company and several subsidiaries located in different countries, most of which are
wholly-owned by the parent company. Though the subsidiaries may be separate
legal entities, they are not separate economic entities. Economically, all the
companies in a corporate group are interdependent. For instance, if the Brazilian
subsidiary of a US parent company experiences considerable losses that drain off
the corporate funds, the cash available for investment in that subsidiary, the parent
company in the US, and other subsidiary companies will be limited. Hence, the
purpose of consolidated financial statements is to provide accounting information
about a group of companies that recognize their economic interdependence.
Transactions that take place among members of the corporate family are not
included in consolidated financial statements; only assets, liabilities, revenues,
and expenses with external third parties are shown. However, by law, separate
legal entities need to maintain their own accounting records and prepare their own
financial statements. Thus transactions with other members of a corporate group
should be identified in separate statements so they can be excluded during the
preparation of consolidated statements. The process involves adding up individual
assets, liabilities, revenues, and expenses reported on the separate financial
statements and then eliminating the ones in the intragroup.
Preparing consolidated statements has become a norm for multinational firms.
Investors realize that in the absence of a consolidated financial statement, a
multinational can conceal losses in an unconsolidated subsidiary, thereby hiding
the economic status of the entire corporate group.

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13.5.2 Currency Translation

The concept of exposure refers to “the degree to which the company is affected
by exchange rate changes.” Accounting exposure arises from the need, for the
purpose of reporting and consolidation, to convert the financial statements of
foreign operations from the local currencies to the home currencies. If the
exchange rates change since the last reporting period, this translation or
restatement, of the revenues, expenses, assets, liabilities, gains, and losses, that
are denominated in foreign currencies would result in foreign exchange gains or
losses. The extent of these gains or losses is measured by the translation exposure
figures. The rules governing these translations are devised by the FASB in
association with the government of the parent company or by the company itself.
Normally, foreign subsidiaries keep their accounting records and prepare their
financial statements in the currency of the country in which they are located.
When an MNE prepares its consolidated records, it should convert all these
financial statements in the home country’s currency. If the currency value
changes, gains or losses in the foreign exchange translation may result. Assets and
liabilities translated at the current (postchange) exchange rate are considered to
be exposed while those translated at a historical (prechange) exchange rate will
maintain their historic home currency values and therefore are regarded as not
exposed. Translation exposure is “the difference between exposed assets and
exposed liabilities.” The controversies among accountants center on which assets
and liabilities are exposed and on when the foreign exchange accounting-derived
gains or losses should be recognized. A vital point to realize is that the gains or
losses are of an accounting nature and no cash flows are necessarily involved.
Four main methods that determine what exchange rate should be used by firms
when translating financial statement currencies are the current/noncurrent
method, monetary/non monetary method, the current rate method, and the
temporal method.
Current/Noncurrent Method
In the current/noncurrent method, all the assets and liabilities of the foreign
subsidiary are translated into the home currency at the current exchange rate. The
noncurrent assets and liabilities are translated at the historical exchange rate;
i.e. at the rate that was in effect when the asset was acquired or the liability
incurred. Hence a foreign subsidiary with positive-currency working capital will
result in a translation loss (gain) from a devaluation (revaluation) with the
current/noncurrent method and vice versa when the working capital is negative.

Example
Bharat Apparels Pvt. Ltd. (BAPL) is a decade-old garment manufacturing
company in Ahmedabad. The company has set up a subsidiary in London in
2020.
Contd….

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While finalizing the consolidated financial statement, BAPL has converted the
inventories, working capital finance, receivables, etc., at its London subsidiary
into ₹ at the spot rate and fixed assets, long-term loans at the historical
exchange rate for the year ended 2021-22. Here, current/noncurrent method is
the exchange rate method that was adopted by BAPL while translating the
assets and liabilities of its London subsidiary.
Source: ICFAI Research Center

Monetary/Nonmonetary Method
The monetary/nonmonetary method differentiates between differentiates between
monetary assets and liabilities i.e. those items that represent an obligation to pay,
a claim to receive, a fixed amount of foreign currency units and nonmonetary, or
physical assets and liabilities. Monetary items such as cash, long-term debt,
accounts receivable and payable are translated at the current rate and nonmonetary
items such as long-term investments, fixed assets, and inventory are translated at
historical rates.
Current rate Method
In the current rate method, the exchange rate at the balance sheet date is used for
translating the foreign subsidiary’s financial statements into the MNE‟s home
currency. Though this seems logical, it is incompatible with the historic cost
principle, which is a generally accepted principle in accounting followed in many
countries. For instance, a US firm invests US$ 100,000 in a subsidiary in
Malaysia. Assume the exchange rate at that time is 1 US$ = 5 Malaysian ringgit.
The subsidiary converts the US$ 100,000 into ringgit to make it 500,000 ringgits
and buys land with this money. Subsequently, if the dollar rate depreciates
against the ringgit, so that by year end 1US$ = 4 ringgit. If this exchange rate
is used for converting the value of the land in dollars for preparing consolidated
accounts, the land will be valued at US$ 125,000. The land value appears to be
increased by US$ 25,000, though in reality the increase will be a function of
change in the exchange rate. Therefore, the consolidated accounts present a
misleading picture.
Temporal Method
Under the temporal method, inventory is usually translated at the historical rate
but it can be translated at the current rate if the inventor is shown on the balance
sheet at market values. The temporal method avoids the problem encountered in
the current rate method. The temporal method translates the value of the assets
in a foreign currency into the currency of the home country using the exchange
rate that exists when the assets are purchased. Though the temporal method
ensures that the dollar value of the land does not fluctuate due to changes in
exchange rates, it has its own problems. As the various assets of the subsidiary

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will in all probability be acquired at different points of time and because exchange
rates rarely remain stable for a long time, different exchange rates would need to
be used for translating the foreign assets into the MNE‟s home currency.

Example
As per a report in ET dated 11th April 2019, Amazon Inc, a US based
e-commerce giant. has invested $631 million (₹4,472.50 crore) into its Indian
subsidiaries, which includes Amazon Seller Services, Amazon Pay and
Amazon Retail for the year 2018-19 at an exchange rate of ₹ 70.88/USD. As
on the date of balance sheet (31.03.2019) of the subsidiary, the exchange rate
stood at 71.20 and in terms of Indian currency, the investments stood at ₹
4492.72 crores showing an increased investment of 20.22 crores in the
consolidated financials of Amazon Inc .
Source: ICFAI Research Center

13.5.3 Current US Practice

On January 1, 1976, Statement of Financial Accounting Standards No. 8 (FASB-
8), which was based on the temporal method became effective. Immediately after
adoption a controversy ensued over FASB-8 that all reserves for currency losses
be disallowed. Thus in 1981, a new translation standard was established -
Statement of Financial Accounting Standards No. 52 (FASB-52). According to
FASB-52, firms should use the current rate method to translate foreign-currency
denominated assets and liabilities into dollars. US-based multinationals should
follow the requirements of FASB-52. Under FASB-52, a foreign subsidiary is
classified as either as an autonomous, self-sustaining subsidiary or as integral to
the activities of the parent firm.

Example
As per a report in Business Standard dated 02.08.2019, there has been a spurt
in imports of aluminum scap by 2.3 million tonnes from SE Asian countries as
India has free trade agreements (FTAs) with them. Vedanta, one of the largest
aluminum manufacturers imports over 2 million tonnes a year for its two
smelters. The Company on import converts the value of the imported stock
from foreign currency into INR based on the exchange rate on the date of
import in its books.
Source: ICFAI Research Center

FASB-52 differentiates between the functional currency and the reporting

currency. The functional currency of an affiliate is the currency of the primary
economic environment in which case is generated and expended by an affiliate. If
the operations of an enterprise are self-contained and integrated within a particular
country, the functional currency would generally be the currency of that country.

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An instance of this case is an English affiliate manufacturing and selling most of

its output in England. On the other hand, if the operations of a foreign affiliate are
a direct and integral component or extension of the operations of the parent
company, the functional currency would be the US dollar. An instance of this case
would be a China assembly plant for radios that sources the components in the
US and sells the assembled radios in the US. The functional currency sometimes
may not be a local currency nor the dollar but rather a third currency.
The reporting currency is the currency in which the parent company prepares its
own financial statements i.e. US dollars for a US firm. FASB-52 requires that
the foreign unit’s financial statements be first stated in the functional currency
using the GAAP. At each balance-sheet date, any assets and liabilities
denominated in any currency other than the functional currency of the recording
entity should be adjusted to reflect the current exchange rate on that date.
Transactions gains and losses resulting from the adjustment of assets and
liabilities denominated in a currency other than the functional currency or from
settlement of such items, should generally appear on the income statement of the
foreign unit.
13.5.4 Transaction Exposure
As part of their accounting exposure, companies often include transaction
exposure. Transaction exposure stems from the prospects of incurring future
exchange gains or losses on transactions that are already entered into and are
denominated in a foreign currency. For instance, if Dell sells a computer to some
company in England, it will not be paid until a later date. If that sale is priced in
pounds, Dell has a pound transaction exposure.
The transaction exposure of a company is measured currency by currency and
equals the difference between contractually fixed future cash inflows and
outflows in each currency.

Accounting Practice and Economic Reality

To respond to increased currency volatility, many multinationals have devoted
more resources to the foreign exchange risk management. For developing an
effective strategy for managing currency risk, management needs to first
determine what is at risk. This determination requires an appropriate definition of
foreign exchange risk. however, a major discrepancy exists between accounting
practice and economic reality in terms of measuring exposure.
Accounting measures of exposure have their focus on the effect of currency
changes on the firm’s previous decisions as reflected in the book values of the
assets acquired and liabilities incurred in the past. However, book values
representing historical costs and market values reflecting future cash flows – of
assets and liabilities differ. Hence retrospective accounting techniques cannot
truly account for the economic effects of the revaluation or devaluation of a firm
as these effects are prospective in nature.

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Since the change in accounting net worth produced by movements in exchange

rates has little relationship to the changes in the firm’s market value, information
derived from a historical method of cost accounting can offer a misleading picture
about the true economic exposure of a firm. Here, economic exposure is defined
as “the extent to which the value of the firm – as measured by the present value
of its expected cash flows – will change when exchange rates change.” Though
items on the balance sheet of a firm represent cash flows, not all future flows
appear here. In addition, these items are not adjusted for reflecting the distorting
effect of inflation and relative changes in price on their associated with future cash
flows.
Based on the market value, the definition of exposure assumes that the goal of the
management is to maximize the firm’s value. Whether management believes in
this has been debated vigorously. Some managers may want to pursue other
objectives. Nevertheless, the assumption that management aims to maximize
(risk-adjusted) cash flows remains standard in the financial literature. Moreover,
the principle of maximizing wealth of the stock holders offers a rational guide to
financial decision making.

Activity 13.1
XYZ Oil Ltd., a petroleum company has its subsidiary in Japan. The company’s
financial year ended on December 31. At the end of the year, the company had
to prepare its consolidated accounts. While preparing this account, the
company converted its earnings from the Japanese subsidiary from Yen to US
dollars using the exchange rate when the consolidated account is prepared.
Which method is the company using? What problems would it encounter using
that method? How can the company overcome these problems?
Answer:

Accounting Aspects of Control Systems

The role of corporate headquarters is to control subunits within the organization
in order to ensure that they achieve the best possible performance. Typically, the
control process is annual and involves three steps:
 The head office in conjunction with the subunit management determines
subunits goals for the coming year.
 The head office monitors the performance of the subunit against the agreed
goals.
 In case any subunit fails to achieve its goals, the head office intervenes to
learn the reason for the shortfall and also takes corrective action when
appropriate.

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In this process, the accounting function plays a critical role. Most of the subunit
goals are expressed in financial terms and are embodied in budget of the subunit
for the coming year. The main instrument for financial control is the budget. The
budget is usually prepared by the subunit but has to be approved by the
management at the headquarters.
During the budget approval process, the managements at the headquarters as well
as the subunit debate the goals that need to be incorporated in the budget. A
function of the headquarters‟ management is to ensure that the budget of the
subunit contains challenging but realistic goals. After the budget is approved,
accounting information systems collect the data throughout the year in order to
evaluate the sub-units performance against the goals set in the budget.
In international business, most of the subunits of the firm are foreign subsidiaries.
Thus the performance goals for the coming year are set by negotiation between
corporate management and the managers of foreign subsidiaries. The most
important criterion for evaluating foreign subsidiary’s performance is comparing
the actual profits with the budgeted profits. This is closely followed by a
comparison of actual sales to budgeted sales and its return on investment. The
same criteria can be used for evaluating the performance of the subsidiary
managers.
13.7.1 Exchange Rate Changes and Control Systems
Most of the international businesses require all budgets and performance data
within the firm to be expressed in the corporate currency, which is normally the
home currency. For instance, the Malaysian subsidiary of a multinational firm in
the US would submit its budget in US dollars as opposed to the Malaysian ringgit
and performance data would be reported to the headquarters in US dollars. This
enables comparisons between subsidiaries in different countries and makes things
easier for the management at the headquarters. However, it also allows changes
in exchange rates to introduce substantial distortions. For instance, the profit goals
may not be achieved by the Malaysian subsidiary not due to any problems in
performance but merely due to a decline in the value of ringgit against the dollar.
The opposite can also occur making the performance of the foreign subsidiary
look better than it actually is.
The Lessard-Lorange Model
A research by Donald Lessard and Peter Lorange suggest that several methods are
available to international businesses for dealing with this problem. Lessard and
Lorange point out three exchange rates for translating foreign currencies into the
corporate currency in setting budgets and in performance tracking:
 The initial rate, which is the spot exchange rate when the budget is adopted.
 The projected rate, which is the spot exchange rate forecast for the end of the
budget period (i.e. forward rate).
 The ending rate, which is the spot exchange rate when the budget is compared
with performance.

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Lessard and Lorange recommend firms to use the projected spot exchange rate
for translating both the budget and the performance figures into the corporate
currency. The projected rate will be the forward exchange rate as determined by
the foreign exchange market or some company-generated forecast of future spot
rates, referred to as the internal forward rate. The internal forward rate might vary
from the forward rate quoted by the foreign exchange market if the firm wishes
to bias its business against or in favor of the particular foreign currency.
13.7.2 Transfer Pricing and Control Systems
The global strategy and the transnational strategy give rise to a globally dispersed
web of productive activities. Firms that pursue these strategies disperse each value
creation activity to its optimal location in the world. Thus a product can be
designed in one country, some of its components can be manufactured in a second
country, other components can be manufactured in a third country, assembled in
a fourth country, and then sold across the globe.
The intra-firm transaction volumes will be very high in such companies. The firms
ship component parts and finished goods between subsidiaries in different
countries on a continuous basis. “The price at which such goods and services are
transferred is referred to as the transfer price.”

Example
Royal Pens Pvt., Ltd., (RPPL) an Indian pen company manufacturing pens
located in Kolkata, has its subsidiary in Dacca Bangladesh namely Royal Pens
(Bangladesh) Pvt., Ltd. The parent company manufactures the pens at Rs. 3 per
piece and bills it at Rs 8 each to its subsidiary in Bangladesh, which in turn
sells the pens at Rs. 15 per piece after incurring Rs. 2 per pen as marketing and
distribution expenses. Thus the company’s total profit amounts to Rs. 10 per
pen. Transfer Pricing is the pricing policy adopted by the parent company with
its subsidiary in Bangladesh.
Transfer pricing is the price at which goods and services are transferred
between entities within the firm is referred to as the transfer price which is what
we see in case of RPPL.
Source: ICFAI Research Center

The choice of transfer price may have a critical affect on the performance of two
subsidiaries that exchange goods or services. When budgets are set and
performance of the subsidiary is reviewed, corporate headquarters need to keep
in mind the distorting effect of transfer prices.
International businesses manipulate their transfer prices often for minimizing
import duties, for minimizing their worldwide tax liability, and for avoiding
government restrictions on capital flows.

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13.7.3 Separating Subsidiary and Manager Performance

In many international businesses, the same quantitative criteria are used for
evaluating the performance of both the foreign subsidiary and its managers.
However, many accountants argue that while it is legitimate to compare
subsidiaries against each other based on return on investment (ROI) or other
indicators of profitability, it may not be suitable to use these to compare and
evaluate the managers belonging to different subsidiaries. Foreign subsidiaries
operate in an environment that has different political, social, and economic
conditions that have an influence on the costs of doing business in a country and
the profitability of the subsidiary. Thus it is suggested that evaluation of a
subsidiary should be separated from the evaluation of its managers. The
evaluation of the managers should take into consideration how benign or hostile
the country’s environment is for that business. Also, managers should be
evaluated in terms of local currency after making allowances for items over which
they do not have any control (e.g. tax rates, interest rates, transfer prices, inflation
rates, and exchange rates).

Activity 13.2
AS Pharma Co. Ltd. (AS Pharma), a US-based pharmaceutical company has
its subsidiaries in several parts of India. The Indian subsidiary AS India Pharma
Ltd. reported its performance after converting Indian National Rupees (INR)
into US dollars. This was done so that the parent company can report its
financials in the form of consolidated financial statements. The slowdown in
the US market had affected the company’s business in the US and thus the dollar
value decreased against the INR. The accountants at AS Pharma noted that the
Indian subsidiary’s performance declined not due to any shortage in
performance but due to the decline in dollar value against the INR. Suggest
some methods that are available to international businesses for dealing with
this problem. Also discuss them in detail.
Answer:

Check Your Progress - 1

1. Which of these variables can influence the development of an accounting

system in a country?
i. The relationship between business and capital providers
ii. Political and economic ties with countries

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iii. The inflation level

iv. Social ties in a country
v. The level of economic development of a country; the prevailing culture
in a country
a. i, ii, iii, and iv
b. ii, iii, iv, and v
c. i, ii, iii, and v
d. i, iii, iv, and v
2. The main sources of external capital for business enterprises include:
a. Individual investors
b. Banks,
c. Government
d. All of the above
3. adjusts all items in a financial statement – assets, liabilities,
revenues, and costs in order to factor out the effects of inflation.
a. Current cost accounting
b. Future cost accounting
c. Financial accounting
d. Budget
4. refers to the extent to which cultures socialize their
members to accept ambiguous situations and tolerate uncertainty.
a. Accounting system
b. Power distance
c. Cultural issues
d. Uncertainty avoidance
5. are rules for preparing financial statements.
a. Financial standards
b. Auditing standards
c. National standards
d. Accounting standards
6. specify the rules for performing an audit.
a. Auditing standards
b. Accounting standards
c. Control systems
d. None of the above

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7. takes place when a firm based in one country enters the

capital market of another country for raising capital from the sale of stocks or
bonds.
a. Transnational investment
b. Transnational financing
c. Capital investment
d. Capital growth
8. takes place when an investor based in one country
enters another nation’s capital market for making investments in stocks or
bonds of a firm based in that country.
a. Transnational financing
b. Capital market
c. Transnational investment
d. None of the above
9. The is responsible for formulating new international financial
reporting standards.
a. International Accounting Standards Committee
b. International Accounting Standards Board
c. Financial Accounting Standards Board
d. None of the above
10. A combines the different financial statements of two or more
firms to yield a single set of financial statements as if the individual
companies were a single entity.
a. Consolidated income statement
b. Consolidated financial statement
c. Consolidated profit and loss statement
d. Budget
11. The concept of refers to the degree to which the company is affected by
exchange rate changes.
a. Transaction currency
b. Fluctuation
c. Exposure
d. Financial management
12. In the , the exchange rate at the balance sheet date is used for translating
the foreign subsidiary’s financial statements into the MNE‟s home currency.
a. Temporal method
b. Current rate method
c. Capital rate method
d. None of the above

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13. The translates the value of the assets in a foreign currency into the
currency of the home country using the exchange rate that exists when the
assets are purchased. capital
a. Rate method temporal
b. Rate method current
c. Rate method
d. None of the above
14. In the method, all the assets and liabilities of the foreign
subsidiary are translated into the home currency at the current exchange rate.
a. Current rate
b. Current/noncurrent
c. Temporal
d. None of the above
15. Which currency translation method differentiates between differentiates
between monetary assets and liabilities?
a. Current/noncurrent
b. Temporal
c. Monetary/nonmonetary
d. Current rate
16. The of a company is measured currency by currency and equals
the difference between contractually fixed future cash inflows and outflows
in each currency.
a. Economic exposure
b. Translation exposure
c. Transaction exposure
d. None of the above
17. is defined as the extent to which the value of the
firm – as measured by the present value of its expected cash flows – will
change when exchange rates change.
a. Transaction exposure
b. Economic exposure
c. Financial exposure
d. Translation exposure
18. The main instrument for financial control is the ______.
a. Assets
b. Liabilities
c. Revenues and expenses
d. Budget

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19. The is the spot exchange rate when the budget is adopted.
a. projected rate
b. ending rate
c. final rate
d. initial rate
20. The is the spot exchange rate forecast for the end of the budget period.\
a. Initial rate
b. Ending rate
c. Projected rate
d. None of the above
21. The is the spot exchange rate when the budget is compared with
performance.
a. Ending rate
b. Projected rate
c. Initial rate
d. None of the above
22. The price at which such goods and services are transferred is referred to as
the .
a. Cost price
b. Market price
c. Selling price
d. Transfer price

Summary
 Accounting is shaped by the environment in which it operates. Countries have
different accounting systems just as they have different economic systems,
political systems, and cultures.
 An adverse result of national differences in accounting and auditing standards
has been a general lack of comparability of financial reports from one country
to another.
 Adoption of common accounting standards facilitates the development of
global capital markets, since more investors will be willing to make
investments across borders, and the end result will be to lower the cost of
capital and stimulate economic growth. Thus, accounting standards were
standardized across national borders in the best interests of the participants in
the world economy.

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 A consolidated financial statement combines the different financial

statements of two or more firms to yield a single set of financial statements
as if the individual companies were a single entity.
 Two main methods that determine what exchange rate should be used by
firms when translating financial statement currencies are the current rate
method and the temporal method.
 The role of corporate headquarters is to control subunits within the
organization in order to ensure that they achieve the best possible
performance.

Glossary
Accounting information - It is the means by which firms communicate their
financial position to the providers of capital, investors, creditors, and government.
Accounting standards - A set of rules, practices and policies that are used to
systematize bookkeeping and other accounting functions across firms and over
time.
Auditing standards: Auditing standards specify the rules for performing an audit
– the technical process through which an independent person (the auditor) gathers
evidence to determine if financial accounts conform to required accounting
standards and also if they are reliable.
Consolidated financial statement - It combines the different financial statements
of two or more firms to yield a single set of financial statements as if the individual
companies were a single entity.
Current rate method - the exchange rate at the balance sheet date is used for
translating the foreign subsidiary’s financial statements into the MNE‟s home
currency.
Current/noncurrent method – Under this method, all the assets and liabilities
of the foreign subsidiary are translated into the home currency at the current
exchange rate.
Exposure - The concept of exposure refers to “the degree to which the company
is affected by exchange rate changes.
Historic cost principle - This principle assumes “the currency unit used to report
financial results is not losing its value due to inflation.”
Inflation Accounting - The method makes use of a general price index for
converting historic figures into current values.
Lessard-Lorange model – This model points out three exchange rates for
translating foreign currencies into the corporate currency in setting budgets and
in performance tracking: The initial rate, which is the spot exchange rate when
the budget is adopted. The projected rate, which is the spot exchange rate forecast
for the end of the budget period (i.e. forward rate) and the ending rate, which is
the spot exchange rate when the budget is compared with performance.

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Monetary/Nonmonetary method - differentiates between monetary assets and

liabilities i.e. those items that represent an obligation to pay, a claim to receive, a
fixed amount of foreign currency units and nonmonetary, or physical assets and
liabilities.
Temporal method - inventory is usually translated at the historical rate but it can
be translated at the current rate if the inventory is shown on the balance sheet at
market values.
Transaction exposure – This exposure stems from the prospects of incurring
future exchange gains or losses on transactions that are already entered into and
are denominated in a foreign currency.
Transfer price - The price at which such goods and services are transferred
between entities within a firm
Translation exposure - It is “the difference between exposed assets and exposed
liabilities.”

Self-Assessment Test
1. Explain country differences in accounting standards.
2. Define accounting standards. Explain why there is lack of comparability of
financial reports from one country to another.
3. State the reasons for establishing international standards.
4. Explain why multinationals make use of consolidated financial statements to
report their financials.
5. Explain the methods used by multinationals for currency translation.
6. Explain the different aspects of accounting in control systems.

Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education

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Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d
2. IFRS Foundation. Use of IFRS standards around the world. 2018.
https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T
Answers to Check Your Progress Questions
1. (c) i, ii, iii, and v
The following variables can influence the development of an
accounting system in a country:
 The relationship between business and capital providers;
 Political and economic ties with countries;
 The inflation level;
 The level of economic development of a country;
 The prevailing culture in a country.
2. (d) All of the above
The three main sources of external capital for business enterprises are
individual investors, banks, and government.
3. (a) Current cost accounting
Current cost accounting adjusts all items in a financial statement – assets,
liabilities, revenues, and costs in order to factor out the effects of
inflation.
4. (d) Uncertainty avoidance
Uncertainty avoidance refers to the extent to which cultures socialize
their members to accept ambiguous situations and tolerate uncertainty.

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5. (d) Accounting standards

Accounting standards are rules for preparing financial statements.
6. (a) Auditing standards
Auditing standards specify the rules for performing an audit – the
technical process through which an independent person (the auditor)
gathers evidence to determine if financial accounts conform to required
accounting standards and also if they are reliable.
7. (b) Transnational financing
Transnational financing takes place when a firm based in one country
enters the capital market of another country for raising capital from the
sale of stocks or bonds.
8. (a) Transnational investment
Transnational investment takes place when an investor based in one
country enters another nation’s capital market for making investments
in stocks or bonds of a firm based in that country.
9. (b) International Accounting Standards Board
The IASB is responsible for formulating new international financial
reporting standards.
10. (b) Consolidated financial statement
A consolidated financial statement combines the different financial
statements of two or more firms to yield a single set of financial
statements as if the individual companies were a single entity.
11. (c) Exposure
The concept of exposure refers to the degree to which the company is
affected by exchange rate changes.
12. (b) Current rate method
In the current rate method, the exchange rate at the balance sheet date is
used for translating the foreign subsidiary’s financial statements into the
MNE‟s home currency.
13. (b) Temporal method
The temporal method translates the value of the assets in a foreign
currency into the currency of the home country using the exchange rate
that exists when the assets are purchased.
14. (b) Current/noncurrent
In the current/noncurrent method, all the assets and liabilities of the
foreign subsidiary are translated into the home currency at the current
exchange rate.

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15. (c) Monetary/nonmonetary method

The monetary/nonmonetary method differentiates between differentiates
between monetary assets and liabilities.
16. (c) Transaction exposure
The transaction exposure of a company is measured currency by
currency and equals the difference between contractually fixed future
cash inflows and outflows in each currency.
17. (b) Economic exposure
Economic exposure is defined as the extent to which the value of the
firm – as measured by the present value of its expected cash flows – will
change when exchange rates change.
18. (b) Budgets
The main instrument for financial control is the budget.
19. (d) Initial rate
The initial rate is the spot exchange rate when the budget is adopted.
20. (c) Projected rate
The projected rate, which is the spot exchange rate forecast for the end
of the budget period (i.e. forward rate).
21. (a) Ending rate
The ending rate is the spot exchange rate when the budget is compared
with performance.
22. (d) Transfer price
The price at which such goods and services are transferred is referred to
as the transfer price.

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Financial Management in International Business

Structure
14.1 Introduction
14.2 Objectives
14.3 Investment Decisions
14.4 Financing Decisions
14.5 Global Money Management: The Efficiency Objective
14.6 Global Money Management: The Tax Objective
14.7 Moving Money across Borders
14.8 Techniques for Global Money Management
14.9 Summary
14.10 Glossary
14.11 Self-Assessment Test
14.12 Suggested Readings/Reference Material
14.13 Answers to Check Your Progress Questions

“Stop thinking about what your money can buy. Start thinking about what your
money can earn.”
- J. L. Collins

14.1 Introduction

The previous unit discussed country differences in accounting standards. It then

explained the national and international standards. It then discusses the
significance of consolidated financial statements, the methods used for currency
translation and the concept of transaction exposure. It also explained the concept
of economic exposure. The unit finally discussed the different aspects of
accounting in control systems.
The financial management in international business includes three sets of
decisions –investment decisions, decisions regarding what activities are to be
financed; financing decisions; decisions regarding how to finance those activities;
and money management decisions; decisions regarding how to efficiently manage
the financial resources of a firm.
Good financial management enables a firm to both reduce costs of value creation
and add value by improving customer service.
 Unit 14: Financial Management in International Business

This unit will discuss the different investment decisions firms take in international
business. It then goes on to explaining the various factors firms consider for
financing in an international business. It then explains the money management
decisions firms take in international business. It also explains how money
management decisions help firms in achieving their tax objectives. It then
discusses the techniques used by international businesses for moving across
borders. The unit finally discusses the techniques for global money management.

14.2 Objectives
By the end of this unit, students should be able to:
 Explain how investment decisions are taken in international business.
 Describe how financing decisions are taken in international business.
 Discuss the money management decisions taken by firms in international
business.
 Describe the techniques used by international businesses to transfer liquid
funds across borders.
 Discuss the money management techniques that help firms in managing their
global cash resources.

14.3 Investment Decisions

A decision to make investment in activities in any country should consider many
political, economic, cultural, and strategic variables. A significant role of the
financial managers in international business is to make attempts to quantify the
various benefits, costs, and risks that may flow from an investment in a given
location. This can be done by making use of capital budgeting techniques.
14.3.1 Capital Budgeting
The benefits, costs, and risks of an investment can be quantified using capital
budgeting techniques. This helps managers to compare different alternatives of
investment within and across countries in order to make informed choices about
where the firm should invest its scarce financial resources. The theoretical
framework used in capital budgeting for a foreign project is as same as that of the
domestic project, that is, the firm should estimate the cash flows with the project
over time. In most cases, the cash flows will be negative first because the firm
heavily invests in production facilities. However, after some time period, the cash
flows will become positive as revenues grow and investment costs decline. After
estimating the cash flows, they should be discounted in order to know the net
present value using an appropriate discount rate. The commonly used discount
rate is either the cost of capital of the firm or some other required rate of return.
If the net present value of the discounted cash flows is greater than zero, the firm
should go ahead with the project.

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Capital budgeting is a complex process. The factors complicating the process for
international businesses include:
 A distinction should be made between cash flows to the parent company and
cash flows to the project.
 Economic and political risks, including risks associated with foreign
exchange, can significantly change the foreign investment value.
 The connection between the source of financing and cash flows to the parent
company needs to be recognized.
14.3.2 Parent and Project Cash Flows
A theoretical argument exists for analyzing any foreign project from the parent
company’s perspective because cash flows to the project are essentially not the
same thing as cash flows to the parent company. The project may not have the
ability to remit all the cash flows to the parent company for several reasons. For
instance, cash flows may be blocked from repatriation by the government of the
host-country, they must be taxed at an unfavorable rate, or, the host government
may require a certain percentage of the cash flows from the project to be
reinvested within the host country. Though these restrictions do not affect the
project’s net present value, they do affect the net present value of the project to
the parent company as they limit the cash flows that can be remitted to it from the
project.
When a parent firm evaluates a foreign investment opportunity, it should be
interested in the cash flows it would receive as opposed to the cash flows
generated by the project because those are the basis for dividends to stockholders,
repayment of worldwide corporate debt, investment somewhere else in the world,
etc. Stockholders do not perceive blocked earnings as contributing to the value of
the firm, and creditors do not count those earnings when calculating the ability of
the parent to service its debt.
The issue of blocked earnings is not very serious. The greater acceptance of free
market economics has reduced the number of countries in which governments
may prohibit the foreign multinational’s affiliates from remitting cash flows to
their parent companies.
14.3.3 Adjusting for Political and Economic Risk
When analyzing a foreign investment opportunity, firms should consider the
politic and economic risks stemming from the foreign location.
Political Risk
Political risk is defined as “the likelihood that political forces will cause drastic
changes in a country’s business environment that hurt the profit and other goals
of a business enterprise.” Political risk is greater in countries that experience

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social unrest or disorder and in countries where the fundamental nature of the
society makes the probability of high social unrest. When political risk is high,
there is a high probability that change will take place in the political environment
of a country that will endanger the foreign firms there.
Political and social unrest may sometimes result in economic collapse, which can
render assets of a firm to be worthless. In less extreme cases, political changes
may result in increased tax rates, the imposition of price controls, the imposition
of exchange controls that limit or block the ability of a subsidiary for remitting
earnings to its parent company, and interference of government in existing
contracts.
Many firms pay considerable attention to political risk analysis and to quantify
political risk. The problem with forecasting political risk is that the firms try to
predict a future and in most cases the guesses are wrong.
Economic Risk
Economic risk can be defined as “the likelihood that economic mismanagement
will cause drastic changes in a country’s business environment that hurt the profit
and other goals of a business enterprise.” The biggest problem arising from
economic mismanagement is inflation. Price inflation leads to a drop in the value
of the currency of a country on the foreign exchange market. This can be a major
problem for foreign firms with assets in that country as the value of the cash flows
the firm receives from those assets will fall as the currency of the country
depreciates on the foreign exchange market. This decreases the attractiveness of
foreign investment in that country.

Example
As per a report in Bloomberg news dated October 15, 2019, China faced a
precarious situation where its factory output slowed, falling raw material prices
and its domestic slowdown further added its owes. Further the increased price
of pork has propped up its consumer inflation higher thereby affecting the
household spending power adding to the already uncertainty caused by the
U.S.-China dispute.
Source: ICFAI Research Center

There have been many attempts to quantify the economic risk of a country and
longterm movements in their exchange rates. There have been several empirical
studies of the relationship between inflation rates of countries and their
currencies’ exchange rates. The studies showed a long-run relationship between
the country’s relative rates of inflation and exchange rate changes. However, the
relationship is not reliable in the short-run and totally unreliable in the long-run.
So as with political risks, the attempts to quantify economic risk were tempered
with healthy skepticism.

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13.3.4 Risk and Capital Budgeting

When analyzing a foreign investment opportunity, the additional risk stemming
from its location can be handled in at least two ways. The first method is to treat
all kinds of risks as one problem by increasing the discount rate that is applicable
to foreign projects in countries where political and economic risk are perceived
to be high. The higher the discount rate, the higher the projected net cash flows
should be for any investment to have a positive net present value.
The second method is adjusting discount rates for reflecting the riskiness of a
location. For instance, several studies of large US multinationals have found that
many of them add a premium percentage for risk to the discount rate they used in
the evaluation of potential foreign investment projects. For any investment
decisions, the political and economic risk being evaluated is not of immediate
possibilities, but rather at some discount in the future. Thus, it can be argued that
rather than using a high discount rate to evaluate such risky projects, it is better to
revise future cash flows from the project downward to reflect the possibility of
adverse political or economic changes sometime in the future.

Activity 14.1
CH Mobile, a China-based mobile company is planning to make investments
in the Indian telecom industry. Before making any investment, the managers of
the company conducted some research in order to quantify the benefits, risks,
and costs ensuing from the investments in the country. What are the decisions
the company is planning to take? Suggest the technique the company can take
when taking such decisions in international business. Also explain the benefits
of that technique.
Answer:

14.4 Financing Decisions

An international business should take into consideration some factors when
considering its options for financing. The first factor is how the foreign
investment will be financed. If the firm requires external financing, it should
decide whether to borrow from host-country’s sources or tap the global capital
market for funds. The second factor is how to configure the financial structure of
the foreign affiliate.
14.4.1 Financing Decisions and the Global Capital Market
A capital market brings together those who want to make investments and those
who want to borrow money. Corporations with surplus cash, non-bank financial

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institutions, and individuals make investments in the capital market. Individuals,

companies, and governments borrow money from the capital market. The global
capital market benefits borrowers by increasing the supply of funds available for
borrowing, which lowers the cost of capital of the firm.
Capital market loans offered to corporations are either equity loans or debt loans.
An equity loan is made when a corporation sells its stock to investors. The money
the corporation receives in return for its stock can be used for purchasing plants
and equipment, pay wages, fund R&D projects, etc. A share of stock gives a
holder a claim to the profit stream of the firm. The claim is honored by
corporations by paying dividends to stockholders. The dividend amount is not
fixed in advance rather it is determined by management based on the profits made
by the corporation. Investors purchase stock for yielding dividends and in
anticipation of gains in the stock price, which in theory reflects future dividend
yields. Thus investors purchase equity in firms that do not currently issue
dividends to stockholders because they anticipate that the firm will do at some
point. Stock prices increase when a corporation is projected to have higher
earnings in the future, which increases the probability that it will increase
dividend payments in future.
A debt loan requires the corporation to repay a predetermined portion of the loan
amount at regular intervals regardless of how much profit the corporation is
making. Management has no discretion as to the amount it will pay its investors.
Debt loans include cash loans from banks and funds raised from the sale of
corporate bonds to investors. When a corporate bond is purchased by an investor,
he/she purchases the right to receive a specified fixed income stream from a
corporation for some specific number of years i.e. until the bond matures.
Lowering Capital Costs
In a domestic capital market, the pool investors are limited to the country
residents. This places an upper limit on the funds supply available to borrowers
i.e. the liquidity of the market is limited. A global capital market, which has a
larger pool of investors, offers a larger supply of funds for borrowers to draw on.
Perhaps the most crucial drawback of the limited liquidity of a domestic capital
market is that the cost of capital tends to be higher than it is in an international
market. The cost of capital is “the price of borrowing money, which is the rate of
return that borrowers must pay investors.” This is the rate of interest on debt loans
and the dividend yield and expected capital gains on equity loans. The limited
pool of investors in a domestic market implies that borrowers should pay more in
order to persuade investors to lend them their money. The larger pool of investors
in an international market implies that borrowers will be able to pay less. The
greater pool of resources in the global capital market leads to greater liquidity.
Thus the global capital market lowers the cost of capital for borrowers.

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Growth of the Global Capital Market

The global capital market is growing rapidly increasing the opportunities for firms
to lower their capital costs by accessing the market.
The international capital market boomed in the 1980s due to advances in
information technology and government deregulation. The financial services
industry is information-intensive, drawing on large volumes of information about
markets, risks, interest rates, exchange rates, credit worthiness, etc. This
information is used by the financial services industry to make decisions about
what to invest where, how much the borrowers should be charged, how much
interest should be paid to the depositors, and the value and riskiness of several
financial assets including stocks, corporate bonds, currencies, and government
securities.
Financial services industry is the most tightly regulated industry of all industries.
Governments worldwide have kept financial services firms of other countries
from entering capital markets. In some cases, they also have restricted the
overseas expansion of their domestic financial services firms. In many countries,
the domestic financial services industry is segmented by law. For instance, in the
US commercial banks were prohibited to perform the functions of investment
banks and vice versa. Historically, many countries have limited foreign investors’
ability to purchase significant equity positions in domestic companies.
Many of these restrictions have been reducing since the early 1980s with a series
of changes that allowed foreign banks to enter the US capital market and domestic
banks to expand to expand their operations overseas.
14.4.2 Source of Financing
When a firm seeks external financing for a project, it will want to borrow funds
from the lowest-cost capital source available. Firms are increasingly moving
toward the global capital market to finance their investments. The cost of capital
in global capital markets is low by virtue of its size and liquidity, than in domestic
capital markets, especially those that are small and relatively illiquid. For
instance, a US firm making an investment in Denmark may finance the investment
by borrowing through the London-based Eurobond market as opposed to the
Danish capital market.
Despite the trends toward deregulation of financial services, in some cases, the
restrictions of the host-country’s government may rule out this option. The
governments of some countries prefer foreign multinationals to finance projects
in their country by local sales of equity or local debt financing. In countries where
there is limited liquidity, this increases the cost of capital used for financing a
project. Thus, in capital budgeting decisions, the discount rate needs to be
adjusted in order to reflect this. However, some governments court foreign
investment by providing foreign firms low-interest loans, lowering the capital

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cost. Accordingly, in capital budgeting decisions, the discount rate should be

revised downward in such cases.
In addition to the impact of host-government policies on financing decisions and
the cost of capital, the firm may consider local debt financing for investments in
countries where the local currency is expected to depreciate on the foreign
exchange market. When a country’s currency depreciates, the amount of local
currency needed to meet interest payments and retire principal on local debt
obligations is not affected. However, if the foreign debt obligations have to be
served, the amount of local currency needed for doing this will increase as the
currency depreciates, and this effectively raises the cost of capital. Thus, though
the initial capital costs may be greater with local borrowing, it might be better to
borrow locally in case the local currency is expected to be depreciated on the
foreign exchange market.
14.4.3 Financial Structure
Different countries have a different financial structure for firms. Financial
structure refers to “the mix of debt and equity used to finance a business.” For
instance, Japanese firms rely more on debt financing than most of the US firms.
A possible explanation for why financial structures of firms vary across countries
is that different tax regimes determine the relative attractiveness of equity and
debt in a country. However, empirical research shows that country differences in
financial structure are not related to systematically to country differences in tax
structure. Another possibility is that the country differences may reflect cultural
norms.
International businesses should decide whether it should conform to local capital
structure norms. A significant advantage for conforming to debt norms of the
host-country is that management can more easily evaluate its return on equity
relative to local competitors in the same industry. Conforming to host-country
debt norms can also enhance the foreign affiliates’ image that operates with too
little debt and thus appearing sensitive to local monetary policy. The best
recommendation is that an international business needs to adopt a financial
structure for each foreign affiliate that minimizes its cost of capital irrespective of
whether that structure is consistent with local practice.

14.5 Global Money Management: The Efficiency Objective

Money management decisions make attempts to manage the global cash resources
of a firm – most efficiently its working capital. This involves minimizing cash
balances and reducing transaction costs.
14.5.1 Minimizing Cash Balances
A firm should hold certain cash balances for any given period. This is essential
for serving any accounts and notes payable during that period and as a
contingency against unexpected cash demands. The firm invests its cash reserves

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in money market accounts in order to earn interest on them. However, it should

be easily able to withdraw money freely from those accounts. Such accounts offer
low rates of interest. In contrast, a firm can earn higher interest rate if it invests
its cash resources in longer-term financial instruments. However, the problem
with longer-term financial instrument is that the firm cannot withdraw its money
before the instruments mature without bearing a financial penalty.
14.5.2 Reducing Transaction Costs
Transaction costs are “the cost of exchange.” Every time a firm changes cash from
one currency to another, it bears a transaction cost – the commission fee a firm
pays to foreign exchange dealers to perform the transaction. Most banks also
charge a transfer fee for moving cash from one location to another. This is another
transaction cost.

14.6 Global Money Management: The Tax Objective

Different countries have different tax regimes. Many nations follow the
worldwide principle that they have the right to tax income earned outside their
boundaries by entities based in their country. When the income of a foreign
subsidiary is taxed by the host country’s government and by the parent company’s
home country, double taxation occurs. Double taxation can be mitigated to some
extent by tax credits, tax treaties, and the deferral principle.
A tax credit “allows an entity to reduce the taxes paid to the home government by
the amount of taxes paid to the foreign government. A tax treaty is “an agreement
between two countries specifying what items of income will be taxed by the
authorities of the country where the income is earned.” A deferral principle
“specifies that parent companies are not taxed on foreign source income until they
actually receive a dividend.”

Example
Standertrade.com dated 15th January 2022 has reported that there has been a
robust investment through acquisitions in ICT (software and hardware) and
construction-supported FDI. Cross-border mergers and acquisitions increased
by 83% to USD 27 billion, with large deals involving ICT, healthcare,
infrastructure and energy. Major transactions included the acquisition of Jio
Platforms by Jaadhu (US) for USD 5.7 billion, the acquisition of Tower
Infrastructure Trust by Brookfield (Canada) and GIC (Singapore) for USD 3.7
billion and the sale of Larsen & Toubro India's electrical and automation
division for USD 2.1 billion. The merger of Unilever India with
GlaxoSmithKline Consumer Healthcare India for USD 4.6 billion also
contributed. In case these investors have not been taxed in their respective
foreign countries till they receive the dividends, then ‘deferral principle’ will
be used to depict the transaction.
Source: ICFAI Research Center

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For the international business with activities spread across many countries, the
various tax regimes and tax treaties have crucial implications for how the firm
should structure its internal payments system among the parent company and the
foreign subsidiaries. Firms can use transfer prices and fronting loans for
minimizing its global tax liability. In addition, the form in which income is
remitted from a foreign subsidiary to the parent company can be structured in
order to minimize the global tax liability of the firm.
Some firms use tax havens such as the Bermuda and Bahamas for minimizing
their tax liability. A tax haven is “a country with exceptionally low, or even
no, income tax.” International businesses avoid or defer income taxes by setting
up a wholly- owned non-operating subsidiary in the tax haven. The tax haven
subsidiary owns the common stock of the operating foreign subsidiaries, which
allows for transferring funds from foreign subsidiaries to the parent company by
funneling through the tax haven subsidiary. The tax levied on foreign source
income by the home government of the firm can be deferred under the deferral
principle until the tax haven subsidiary pays the dividend to the parent. This
dividend payment can be indefinitely postponed if foreign subsidiaries continue
to grow and require new internal financing from the tax haven affiliate.

14.7 Moving Money across Borders

Pursuing the objectives of utilizing the cash resources of a firm efficiently and
minimizing the global tax liability requires the firm to be able to transfer funds
from one location to another across the globe. International businesses use many
techniques for transferring liquid funds across borders. These include dividend
remittances, royalty payments and fees, transfer prices, and fronting loans.
Some firms rely on more than one of these techniques for transferring funds
across borders – a practice known as unbundling. Unbundling helps
international businesses to recover funds from its foreign subsidiaries without
piquing sensitivities of the host-country with large “dividend drains.”
A firm’s ability to select a particular policy is limited when a foreign subsidiary
is partly-owned either by a local joint venture or by local stakeholders.
14.7.1 Dividend Remittances
The most common method for transferring funds from foreign subsidiaries to the
parent company is payment of dividends. The dividend policy differs in each
subsidiary depending on factors such as tax regulations, age of the subsidiary,
extent of local equity participation, and foreign exchange risk.
14.7.2 Royalty Payments and Fees
Royalties represent remuneration paid to the owners of patents, trade names, or
technology for the right to manufacture/sell products under those patens or trade
names or use that technology. Parent companies charge its foreign subsidiaries
royalties for patents, trade names, or technology as it transfers them. Royalties

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may be levied as a fixed monetary amount per unit of the product sold by the
subsidiary or a percentage of the gross revenues of the subsidiary.
A fee is compensation for expertise or professional services supplied by the parent
company or another subsidiary to a foreign subsidiary. Fees are differentiated into
“technical fees” for guidance in technical matters and “management fees” for
advice and general expertise. Fees are levied as fixed charges for the services
provided.
Royalties and fees have some tax advantages over dividends, particularly when
the corporate tax rate is higher in the host country than in the home country.
Royalties and fees are tax-deductible locally, so arranging for payments in
royalties and fees educes the tax liability of the foreign subsidiary. If a foreign
subsidiary provides the parent company dividend payments as compensation,
local income taxes need to be paid before the dividend distribution, and
withholding taxes should be paid on the dividend itself. Though the parent
company can offer a tax credit for the local withholding and income taxes it has
paid, a portion of the benefit would be lost is the combined tax rate of the
subsidiary is higher than the parent’s.
14.7.3 Transfer Prices
In any international business, a large number of goods and services transfer
between the parent company and foreign subsidiaries and between subsidiaries.
This usually happens in firms pursuing global and transnational strategies because
these firms are likely to have dispersed their value creation activities to various
locations around the globe. “The price at which goods and services are transferred
between entities within the firm is referred to as the transfer price.”

Example
As per a report in Economic Times dated 6th January 2020, the largest Chinese
automobile company manufacturing SUV’s, “The Great Wall Motors” has
entered into a formal agreement with General Motors, in Pune India and is
acquiring the manufacturing facility of General Motors for about $ 250 to 300
million. The company has plans to shift its manufacturing operations and the
Pune facility will become its subsidiary. The company may face higher import
duty in shifting the semi finished components from China to India for final
assembly of the SUV. To avoid this, the company can adopt transfer pricing
technique while pricing such semi finished products?
Source: ICFAI Research Center

Transfer prices can be used for positioning funds within an international

business. For instance, funds can be moved out of a country by setting high
transfer prices for goods and services that are supplied to a subsidiary in
that country and by setting low transfer prices for the goods and services
sourced from that subsidiary. On the other hand, funds can be positioned in a

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country by setting low transfer prices for goods and services sourced from that
subsidiary and setting high transfer prices for the goods and services sourced
from that subsidiary. This movement of funds takes place between the
subsidiaries of the firm or between the parent company and a subsidiary.
Benefits of Manipulating Transfer Prices
The benefits derived from manipulating transfer prices include:
1. The firm can reduce its tax liabilities by making use of transfer prices for
shifting earnings from a high-tax country to a low-tax country.
2. Firms use transfer prices for moving funds out of a country where significant
devaluation in currency is expected, thereby reducing its exposure to foreign
exchange risk.
3. Firms use transfer prices for moving funds from a subsidiary to the parent
company when financial transfers in the form of dividends are blocked or
restricted by polices of the host government.
4. Firms can use transfer prices for reducing the import duties it has to pay when
an ad valorem tariff is in force – tariff that is assessed as a percentage of value.
In such cases, low transfer prices on goods and services being imported into
the country are required. Since this lowers the value of the goods or services,
it lowers the tariff.
Problems of Transfer Pricing
Significant problems are associated with transfer pricing policies. When transfer
prices are used for reducing the tax liabilities or import duties for a firm,
governments feel that they are being cheated of their legitimate income. When
transfer prices are manipulated for circumventing government restrictions on
capital flows, governments perceive this as breaking the spirit if not the law. Many
governments impose limits on the ability of international businesses to manipulate
transfer prices. The US has strict regulations governing transfer prices. According
to Section 482 of the Internal Revenue Code, the Internal Revenue Service (IRS)
can reallocate gross income, credits, deductions, or allowances between related
corporations for preventing tax evasion or for reflecting proper income allocation.
According to IRS guidelines, the correct transfer price is arm’s-length price – “the
price that would prevail between unrelated firms in a market setting.”
Another problem associated with transfer pricing is that it is inconsistent with a
policy of treating each subsidiary in a firm as a profit center. When transfer prices
are manipulated and deviate from the arm’s-length price significantly, the
performance of the subsidiary depends much on transfer prices. A subsidiary told
to charge a higher transfer price on goods supplied to another subsidiary appear
to do better than it actually does while the subsidiary purchasing the good appears
to be doing worse. Unless this is recognized during performance evaluation,
serious distortions in management incentives can occur.

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Despite these problems, research indicates that all international businesses do not
use arm’s-length pricing but instead use some cost-based system for transfer
pricing among their subunits.
14.7.4 Fronting Loans
A fronting loan is “a loan between a parent and its subsidiary channeled through
a financial intermediary, usually a large multinational bank.” In a direct intrafirm
loan, the parent company lends cash to the foreign subsidiary directly, and the
subsidiary later repays the loan. In a fronting loan, the parent company deposits
funds in an international bank, and the bank lends the same amount deposited to
the foreign subsidiary. From the bank’s viewpoint, the loan is free from risks as
it has 100 percent collateral in the form of deposit of the parent company. The
bank “fronts” for the parent, hence the name. The bank profits by paying the
parent company a lower interest rate on its deposit than it charges the foreign
subsidiary on the funds borrowed.
Fronting loans are used by firms for two reasons. First, fronting loans can
circumvent restrictions of the host-country on funds remittance from a foreign
subsidiary to the parent company. A host government may impose restrictions on
a foreign subsidiary regarding loan repayment to its parent for preventing the
foreign exchange reserves of a country, but it is less likely to restrict the ability of
a subsidiary to repay a loan to a large international bank. International businesses
sometimes make use of fronting loans when they want to lend funds to a
subsidiary based in a country with high probability of political turmoil that may
lead to capital flow restrictions. A fronting loan also provides tax advantages.

Example
Central banking.com dated 30th July 2021 has reported that China’s capital
controls will continue as it is critical for China to grow economically. The
report adds that while domestic households are restricted from investing abroad
and foreign investors are restricted from accessing financial markets, funds are
kept safe within China’s borders. Further, there are restrictions on funds
remittance from a foreign subsidiary in its country to the parent company.
Assuming that Lorvin Power (India) Pvt., Ltd., has established its subsidiary in
China Lorvin Power (China). The company wants to expand its activities and
the parent company deposits funds in an international bank and the bank lends
the same amount deposited to its foreign subsidiary. The subsidiary repays the
loans to the bank thereby overcoming the regulatory restrictions of the host
government. Here, fronting loan is the method adopted by Lorvin Power (India)
through its banker.
The parent company can circumvent restrictions of the host country on funds
remittance from a foreign subsidiary to the parent company which is the policy
adopted by Lorvin Power (India) Pvt. Ltd.
Source: ICFAI Research Center

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Activity 14.2
XYZ Ltd., a US-based company sold vacuum cleaners under the brand name
“Power Cleaners”. The company achieved huge sales due to its unique vacuum
cleaning technology. This prompted the company to expand its operations in
other countries. After conducting some market research, the company found
that there was lot of demand for vacuum cleaners in the UK. Subsequently, the
company started its operations in the UK. As the foreign subsidiary use XYZ’s
technology and expertise, the subsidiary had to compensate the parent company
for using its technology patent and brand name. Which technique can the
foreign subsidiary use in order to transfer funds from the UK to the US? Also
discuss other techniques used in international business for transferring funds
across national borders.
Answer:

14.8 Techniques for Global Money Management

Firms make use of several money management techniques for managing their
global cash resources efficiently. They are discussed below:
14.8.1 Centralized Cash Management versus Decentralized Cash
Management
Multinationals with different subsidiaries in different parts of the world have cash
flows in several currencies and countries. It can either leave cash management to
an individual subsidiary, which may be called decentralized cash management.
When the cash management is left to the affiliates, each subsidiary has to take on
the entire responsibility of cash management, including short-term borrowing,
short-term investment and currency exposure management. In other words, the
entire cash management is from the view of the subsidiary. Thus there is no need
to monitor cash flows between affiliates and between an affiliate and the parent
company for ensuring the success of the MNCs cash management system.
Under the centralized cash management, the cash management of the entire MNC
is vested in a centralized cash depository. The centralized cash depository acts as
a netting center as well as a repository of surplus funds of a subsidiary unit. The
depository pools the excess cash from all the subsidiaries and pays it to the
subsidiary units as when a need arises. As different subsidiaries have excess cash
in different currencies, the centralized cash management maintains a separate cash
pool for each currency. When an affiliate needs cash in a particular currency,
the cash pool can pay to the affiliate in that currency. The centralized cash

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management also undertakes market borrowing or undertakes investment of

surplus funds on behalf of the entire MNC. This system takes on the responsibility
of exchange risk management for the entire MNC. Thus the centralized cash
management reduces the burden of cash management at each subsidiary and this
in turn helps the subsidiaries to concentrate on their major operations.
Why Centralized Depositories are Preferred?
Firms generally prefer to hold cash balances at a centralized depository for three
reasons. First, by centrally pooling the cash reserves, the firm can deposit larger
amounts. Usually cash balances are deposited in liquid accounts such as overnight
money market accounts. As interest rates on such deposits increase with the size
of the deposit, the firm should be able to earn a higher interest rate than it would
if each subsidiary managed its own cash balances.
Second, if the centralized depository is located in a major financial center such as
in London, Tokyo, or New York, it should have access to information about good
short-term investment opportunities that are lacking in a typical foreign
subsidiary. The financial experts at the centralized depository must have the
ability to develop investment skills and know-how that are lacking in managers
in a typical foreign subsidiary. Hence, the firm should make better investment
decisions if it pools its cash reserves at a centralized depository.
Third, pooling cash reserves helps a firm in reducing the total size of the cash pool
it should hold in highly liquid accounts, which enables the firm to invest cash
reserves in large amounts in longer-term, less liquid financial instruments that
earn a high rate of interest.
The ability of a firm to set up a centralized depository that can serve short-term
cash needs may be limited by restrictions imposed by governments on flow of
capital across borders. The advantages of this system are also limited by
transaction costs of moving money into and out of different currencies. Despite
this, many firms hold precautionary cash reserves at the centralized depository,
having each subsidiary hold its own day-to-day-needs cash balance. The trends
likely to increase the use of centralized depositories are globalization of the world
capital market and the general removal of barriers for free cash flow across
borders.
Advantages of Centralized Cash Management
A major advantage of a centralized cash management is that the cash balances of
all the affiliates can be pooled and the excess cash can be invested at advantageous
rates. Another advantage is that cash deficits can be taken care of by undertaking
market borrowing at favorable rates. The centralized cash management can ensure
adequate liquid funds in the system with smaller cash holdings in comparison to
a decentralized cash management system. The funds are also maintained in
currencies which are highly needed. The centralized cash management has an

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investment policy for investing surplus funds in marketable securities that are
denominated in international currencies. This also helps in meeting payables in
future. Under the centralized cash management, foreign exchange risk could be
easily diversified by holding cash or marketable securities in different currencies.
Disadvantages of Centralized Cash Management
The centralized cash management also has some disadvantages. There can be
unpredictable delays in moving funds to affiliates. This may pose a serious
problem if an affiliate has to meet an unforeseen expenditure on an immediate
basis. To meet such needs, affiliates may need to keep some excess cash with
them but this goes against the principle of centralized cash management. Thus the
MNC has to decide the appropriate degree of centralization of cash management.
It can also clearly state which aspects of cash management can be centralized or
decentralized. The system should also take into consideration taxes, political
risks, and liquidity preferences while deciding the currencies in which the cash
balances should be held and also the quantum of such cash balances. It should
also keep in view the nature of operations of the subsidiaries and their locations.
Information technology helps centralized cash management to receive timely
information about each subsidiary’s cash position. This continual information
facilitates the centralized cash management to take right and timely decisions
regarding borrowing, investment, and exposure coverage.
14.8.2 Multilateral Netting
Multilateral netting allows a multinational firm to reduce its cost of transaction
that arises when many transactions take place between its subsidiaries. These
transaction costs are the commissions paid to foreign exchange dealers for foreign
exchange transactions and the fees charged by banks for transferring cash between
locations. The volume of such transactions is high in firms that have a globally
dispersed web of independent value creation activities. Multilateral netting
reduces the costs of transaction by reducing the number of transactions.
Multilateral netting is an extension of bilateral netting. Under bilateral netting, if
a French subsidiary owes US$ 6 million to a Mexican subsidiary and the Mexican
subsidiary owes US$ 4 million to the French subsidiary, a bilateral settlement will
be made with a single payment of US$ 2 million from the French subsidiary to
the Mexican subsidiary cancelling the remaining debt.

Example
As per a report in Economic Times dated 31.12.2019, there has been an
increase of global sales of Toyota's cars by 2 % in November 2019 at 9,24,352
units. Toyota, one of the largest Japanese car manufacturer has plants across
the world notably in Australia, Brazil, Canada, Bangladesh, India and USA.
Contd….

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Due to global operations, there can be high volume transactions across the
various subsidiaries globally and the company has to incur commissions paid
to foreign exchange dealers for foreign exchange transactions and the fees
charged by banks for transferring cash between locations. Such costs can be
reduced through multilateral netting.
Source: ICFAI Research Center

Under multilateral netting, the transactions take place between multiple

subsidiaries within an international business. Consider a firm establishing
multilateral netting among four Asian subsidiaries based in China, Taiwan,
South Korea, and Japan. These subsidiaries trade with each other and at the end
of the month a large transaction volume needs to be settled. If US$ 43,000 is
required to flow among the subsidiaries, the amount can be reduced by
multilateral netting. The firm can determine the payments to be made among its
subsidiaries for settling these obligations. Multilateral netting reduces the
transactions to just three; the Korean subsidiary pays US3 million to the
subsidiary in Taiwan; and the Chinese subsidiary pays US$ 1 million to the
Japanese subsidiary and US$ 1 million to the Taiwanese subsidiary. The total
funds are reduced to just US$ 5 million from US$ 43 million, and the transaction
costs are reduced to US$ 50,000, a savings of US$ 380,000 is achieved through
multilateral netting.

Check Your Progress - 1

1. The benefits, costs, and risks of an investment can be quantified using _____.
a. Political risks
b. Economic risks
c. Project cash flows
d. Capital budgeting techniques
2. When analyzing a foreign investment opportunity, firms should consider the
_______and economic risks stemming from the foreign location.
a. Social
b. Political
c. Technical
d. None of the above
3. ________is the likelihood that political forces will cause drastic changes in a
country’s business environment that hurt the profit and other goals of a
business enterprise.
a. Economic risk
b. Social unrest
c. Technical issues
d. Political risk

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4. _______is the likelihood that economic mismanagement will cause drastic

changes in a country’s business environment that hurt the profit and other
goals of a business enterprise.
a. Economic slowdown
b. Political risk
c. Economic risk
d. None of the above
5. Which of the following make investments in the capital market?
a. Corporations with surplus cash
b. Individuals
c. Non-bank financial institutions
d. All of the above
6. Which of the following borrow money from the capital market?
a. Individuals
b. Companies
c. Governments
d. All of the above
7. Capital market loans offered to corporations are either equity loans or______.
a. Debt loans
b. Mortgage loans
c. Personal loans
d. None of the above
8. A/An is made when a corporation sells its stock to investors.
a. Debt loan
b. Equity loan
c. Auto loan
d. Mortgage loan
9. A/An requires the corporation to repay a predetermined portion
of the loan amount at regular intervals regardless of how much profit the
corporation is making. equity
a. Loan unsecured
b. Loan secured
c. Loan
d. Debt loan
10. __________include cash loans from banks and funds raised from the sale of
corporate bonds to investors.
a. Credit card debt
b. Debt loans

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c. Equity loans
d. None of the above
11. The is the price of borrowing money, which is the rate of return
that borrowers pay investors.
a. Cost of capital
b. Financial structure
c. Financial assets
d. Financing costs
12. including stocks, corporate bonds, currencies, and
government securities.
a. Financial structure
b. Liabilities
c. Financial assets
d. Loans
13. _________refers to the mix of debt and equity used to finance a business.
a. Equity loans
b. Debt loans
c. External financing
d. Financial structure
14. Under the , the cash management of the entire MNC is vested in a
centralized cash depository.
a. Decentralized cash management
b. Netting
c. Centralized cash management
d. None of the above
15. __________involve minimizing cash balances and reducing transaction costs.
a. Investment decisions
b. Money management decisions
c. Financial decisions
d. None of the above
16. A allows an entity to reduce the taxes paid to the home
government by the amount of taxes paid to the foreign government.
a. Tax haven
b. Tax treaty
c. Deferral principle
d. Tax credit

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17. A is an agreement between two countries specifying what

items of income will be taxed by the authorities of the country where the
income is earned.
a. Tax treaty
b. Tax credit
c. Tax haven
d. None of the above
18. A specifies that parent companies are not taxed on foreign source
income until they actually receive a dividend.
a. Dividends remittance
b. Deferral principle
c. Arm’s length price
d. Tax treaty
19. A is a country with exceptionally low, or even no, income tax.
a. Tax treaty
b. Tax credit
c. Tax haven
d. Deferral principle
20. The most common method for transferring funds from foreign subsidiaries to
the parent company is __________.
a. Fronting loans
b. Dividend payments
c. Royalties
d. Fees
21. ___________represent remuneration paid to the owners of patents, trade
names, or technology for the right to manufacture/sell products under those
patens or trade names or use that technology.
a. Royalties
b. Dividend payments
c. Fronting loans
d. Transfer price
22. A is compensation for expertise or professional services supplied by the
parent company or another subsidiary to a foreign subsidiary.
a. Royalty
b. Fee
c. Transfer price
d. None of the above

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23. The price at which goods and services are transferred between entities within
the firm is referred to as the .
a. Transfer price
b. Arm’s-length price
c. Tax credit
d. Bilateral netting
24. ________is the price that would prevail between unrelated firms in a market
setting.
a. Deferral principle
b. Transfer price
c. Royalties
d. Arm’s-length price
25. A is a loan between a parent and its subsidiary channeled through a
financial intermediary, usually a large multinational bank.
a. Fronting loan
b. Fee
c. Dividend
d. None of the above
26. Firms make use of two money management techniques for managing their
global cash resources efficiently – centralized depositories and _________.
a. Bilateral netting
b. Multilateral netting
c. Royalties and fees
d. Transfer price

14.9 Summary
 A decision to make investment in activities in any country should consider
many political, economic, cultural, and strategic variables.
 An international business should take into consideration some factors when
considering its options for financing. The first factor is how the foreign
investment will be financed. The second factor is how to configure the
financial structure of the foreign affiliate.
 Money management decisions make attempts to manage the global cash
resources of a firm – most efficiently its working capital. This involves
minimizing cash balances and reducing transaction costs.
 Different countries have different tax regimes. Many nations follow the
worldwide principle that they have the right to tax income earned outside their
boundaries by entities based in their country.

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 International businesses use many techniques for transferring liquid funds

across borders. These include dividend remittances, royalty payments and
fees, transfer prices, and fronting loans.
 Multinationals with different subsidiaries in different parts of the world have
cash flows in several currencies and countries. It can either leave cash
management to an individual subsidiary, which may be called decentralized
cash management.
 Under the centralized cash management, the cash management of the entire
MNC is vested in a centralized cash depository. The centralized cash
depository acts as a netting center as well as a repository of surplus funds of
a subsidiary unit.
 Multilateral netting allows a multinational firm to reduce its cost of
transaction that arises when many transactions take place between its
subsidiaries.

14.10 Glossary
Arm’s-length price - Arm’s-length price is the price that would prevail between
unrelated firms in a market setting.
Cost of capital - The cost of capital is the price of borrowing money, which is the
rate of return that borrowers must pay investors.
Deferral principle - A deferral principle specifies that parent companies are not
taxed on foreign source income until they actually receive a dividend.
Economic risk - “the likelihood that economic mismanagement will cause drastic
changes in a country’s business environment that hurt the profit and other goals
of a business enterprise.”
Economic risk - Economic risk is the likelihood that economic mismanagement
will cause drastic changes in a country’s business environment that hurt the profit
and other goals of a business enterprise.
Financial structure - Financial structure refers to the mix of debt and equity used
to finance a business.
Fronting loan: - A fronting loan is a loan between a parent and its subsidiary
channeled through a financial intermediary, usually a large multinational bank.
Multilateral netting - It allows a multinational firm to reduce its cost of
transaction that arises when many transactions take place between its subsidiaries.
Political risk - Political risk is the likelihood that political forces will cause
drastic changes in a country’s business environment that hurt the profit and other
goals of a business enterprise.
Tax credit - A tax credit allows an entity to reduce the taxes paid to the home
government by the amount of taxes paid to the foreign government.

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Tax haven - A tax haven is a country with exceptionally low, or even no, income
tax.
Tax treaty - A tax treaty is an agreement between two countries specifying what
items of income will be taxed by the authorities of the country where the income
is earned.

14.11 Self-Assessment Test

1. Explain in detail the factors complicating the capital budgeting process for an
international business.
2. Explain in detail the factors an international business should take into
consideration when considering its options for financing.
3. Money management decisions involve minimizing cash balances and
reducing transaction costs. Explain them in detail.
4. Explain how the money management decisions help firms in achieving their
tax objective.
5. International businesses use many techniques for transferring liquid funds
across borders. Explain those techniques in detail.
6. Describe the money management techniques that help firms in managing their
global cash resources.

14.12 Suggested Readings/Reference Material

1. Charles W L Hill and G Thomas M Hult (2021). International Business –
Competing in the Global Marketplace. 12th edition, McGraw Hill India.
2. Oded Shenkar, Yadong Luo, Tailan Chi (2021). International Business, 4th
edition, Routledge
3. Alan C Shapiro (2019). Multinational Financial Management, 11th Edition,
Wiley
4. Prakash G Apte (2017). International Financial Management, 8th edition,
McGraw-Hill India
5. H.G.Mannu (2018). International Economics. Vikas Publishing House
6. Francis Cheunilam (2020). International Business – Text and Cases. 6th
edition. Prentice Hall India Learning Private Limited
7. John Wild and Kenneth Wild (2019). International Business – The Challenges
of Globalization. Pearson Education

Additional References:
1. Serenity Gibbons. How to expand your business internationally without
compromising your core model. Forbes (2020).
https://www.forbes.com/sites/serenitygibbons/2020/03/24/how-to-expand-a-
business-internationally-without-compromising-your-core-
model/?sh=66335a6f741d

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2. IFRS Foundation. Use of IFRS standards around the world. 2018.

https://cdn.ifrs.org/-/media/feature/around-the-world/adoption/use-of-ifrs-
around-the-world-overview-sept-2018.pdf
3. Brett Steenbarger. Why diversity matters in the world of Finance. 2020.
https://www.forbes.com/sites/brettsteenbarger/2020/06/15/why-diversity-
matters-in-the-world-of-finance/?sh=36dba0637913
4. IFC. Social and Green Bonds.
https://www.ifc.org/wps/wcm/connect/corp_ext_content/ifc_external_corpor
ate_site/about+ifc_new/investor+relations/ir-products/socialbonds
5. Business Insider. Global ecommerce market report: ecommerce sales trends
and growth statistics for 2021. https://www.businessinsider.com/global-
ecommerce-2020-report?IR=T

14.13 Answers to Check Your Progress Questions

1. (d) Capital budgeting techniques
The benefits, costs, and risks of an investment can be quantified using
capital budgeting techniques.
2. (b) Political risks
When analyzing a foreign investment opportunity, firms should consider
the political and economic risks stemming from the foreign location.
3. (d) Political risk
Political risk is the likelihood that political forces will cause drastic
changes in a country’s business environment that hurt the profit and
other goals of a business enterprise.
4. (c) Economic risk
Economic risk is the likelihood that economic mismanagement will
cause drastic changes in a country’s business environment that hurt the
profit and other goals of a business enterprise.
5. (d) All of the above
Corporations with surplus cash, non-bank financial institutions, and
individuals make investments in the capital market.
6. (d) All of the above
Individuals, companies, and governments borrow money from the
capital market.
7. (a) Debt loans
Capital market loans offered to corporations are either equity loans or
debt loans.

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8. (b) Equity loan

An equity loan is made when a corporation sells its stock to investors.
9. (d) Debt loan
A debt loan requires the corporation to repay a predetermined portion of
the loan amount at regular intervals regardless of how much profit the
corporation is making.
10. (b) Debt loans
Debt loans include cash loans from banks and funds raised from the sale
of corporate bonds to investors.
11. (a) Cost of capital
The cost of capital is the price of borrowing money, which is the rate of
return that borrowers must pay investors.
12. (c) Financial assets
Financial assets including stocks, corporate bonds, currencies, and
government securities.
13. (d) Financial structure
Financial structure refers to the mix of debt and equity used to finance a
business.
14. (c) Centralized cash management
Under the centralized cash management, the cash management of the
entire MNC is vested in a centralized cash depository.
15. (b) Money management decisions
Money management decisions involves minimizing cash balances and
reducing transaction costs.
16. (d) Tax credit
A tax credit allows an entity to reduce the taxes paid to the home
government by the amount of taxes paid to the foreign government.
17. (a) Tax treaty
A tax treaty is an agreement between two countries specifying what
items of income will be taxed by the authorities of the country where the
income is earned.
18. (b) Deferral principle
A deferral principle specifies that parent companies are not taxed on
foreign source income until they actually receive a dividend.

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19. (c) Tax haven

A tax haven is a country with exceptionally low, or even no, income tax.
20. (b) Dividend payments
The most common method for transferring funds from foreign
subsidiaries to the parent company is payment of dividends.
21. (a) Royalties
Royalties represent remuneration paid to the owners of patents, trade
names, or technology for the right to manufacture/sell products under
those patens or trade names or use that technology.
22. (b) Fee
A fee is compensation for expertise or professional services supplied by
the parent company or another subsidiary to a foreign subsidiary.
23. (a) Transfer price
The price at which goods and services are transferred between entities
within the firm is referred to as the transfer price.
24. (d) Arm’s-length price
Arm’s-length price is the price that would prevail between unrelated
firms in a market setting.
25. (a) Fronting loan
A fronting loan is a loan between a parent and its subsidiary channeled
through a financial intermediary, usually a large multinational bank.
26. (b) Multilateral netting
Firms make use of two money management techniques for managing
their global cash resources efficiently – centralized depositories and
multilateral netting.

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Course Structure

Block 1: An Overview of International Business

Unit 1 International Business and Globalization
Unit 2 International Trade Theories and Application
Unit 3 Country Differences
Block 2: Global Markets and Institutions
Unit 4 International Monetary System
Unit 5 Foreign Exchange Markets
Unit 6 International Economic Integration and Institutions
Block 3: International Business Strategy and Structure
Unit 7 The Strategy of International Business
Unit 8 The Organization of International Business
Unit 9 Entry Strategies and Strategic Alliances
Block 4: Functional Areas in International Business
Unit 10 Global Research and Development
Unit 11 Global Human Resource Management
Unit 12 Global Marketing and Supply Chain
Unit 13 Accounting in the International Business
Unit 14 Financial Management in International Business
Block 5: Emerging Issues in International Business
Unit 15 Implementation and Control in International Business
Unit 16 Global Internet and e-Commerce
Unit 17 Ethics in International Business