International Business

BRIEF CONTENTS

1. Introduction to international business

2. The role, objectives and growth of firms

3. Cost, revenue and profit of the firm

4. Barriers to market entry and exit

5. Market failure, government intervention and government failure

6. The theory of contestable markets

7. International trade

8. Trade barriers

9. Investment

10. Price determination, pricing strategies and price discrimination

11. International marketing

12. Exchange rate determination

DETAILED CONTENTS

1 INTRODUCTION TO INTERNATIONAL BUSINESS
Meaning of international business
Features of international business
Forms of international business
Basic concepts of international business
Why do we study international business?
International business career opportunities
Why do firms/companies go international?
International business participants
Differences between domestic business and international business
Similarities between domestic business and international business
Drivers of international business
Benefits of international business
Challenges in international business
Globalisation
Features of globalisation
Globalisation: The beautiful side
Globalisation: The ugly side
Chapter summary
Key terms and concepts
Chapter questions

2 THE ROLE, OBJECTIVES AND GROWTH OF FIRMS
The role of firms
Objectives of firms
Growth of firms
How do firms grow?
Internal growth of firms
Merger
Takeover
Why do firms grow?
Demergers
Chapter summary
Key terms and concepts
Chapter questions

3 COST, REVENUE AND PROFIT OF THE FIRM
Calculation of the cost of the firm
Calculation of the revenue of the firm
Calculation of the profit of the firm
Chapter summary
Key terms and concepts
Chapter questions

4 BARRIERS TO MARKET ENTRY AND EXIT
Barriers to market entry
Barriers to market exit
Chapter summary
Key terms and concepts
Chapter questions

5 MARKET FAILURE, GOVERNMENT INTERVENTION AND GOVERNMENT FAILURE
Market failure
Types/sources/examples of market failure
Government intervention in correcting market failure
Government failure in correcting market failure
Chapter summary
Key terms and concepts
Chapter questions

6 THEORY OF CONTESTABLE MARKETS
Contestable market assumptions
Productive and allocative efficiency
Profits earned in contestable markets
Chapter summary
Key terms and concepts
Chapter questions

7 INTERNATIONAL TRADE
Meaning of international trade
Advantages of international trade
Disadvantages of international trade
Forms of international trade
Why do countries import?
Theories of international trade
Chapter summary
Key terms and concepts
Chapter questions

8 TRADE BARRIERS
Meaning of trade barriers
Trade barriers: The good aspects
Trade barriers: The bad aspects
Types of trade barriers
Forms of tariff trade barriers
Forms of non-tariff trade barriers
Chapter summary
Key terms and concepts
Chapter questions

9 INVESTMENT
Meaning of investment
Difference between gross investment and net investment
Types of investment spending
Theories of investment
Efficacy of investment theories in least developed countries (L.D.Cs)
Factors influencing investment decisions
Chapter summary
Key terms and concepts
Chapter questions

10 PRICE DETERMINATION, PRICING STRATEGIES AND PRICE DISCRIMINATION
Meaning of price
Price types
Determinants of customers’ price assessments
Determinants of pricing decision
Pricing methods
Price adjustments
Pricing objectives
Pricing policies and strategies
Price discrimination
Chapter summary
Key terms and concepts
Chapter questions

11 INTERNATIONAL MARKETING
Meaning of international marketing
Why do firms embark on international marketing?
International marketing strategies
International marketing research considerations
International market selection
International market entry methods
Determinants of the choice of market entry methods
Chapter summary
Key terms and concepts
Chapter questions

12 EXCHANGE RATE DETERMINATION
Meaning of exchange rate why do we need exchange rate?
How is exchange rate determined?
Sources of demand for foreign currency
Sources of supply of foreign currency
Determinants of exchange rate
Appreciation of a currency
Depreciation of a currency
Exchange rate system
Nominal exchange rate and real exchange rate
Chapter summary
Key terms and concepts
Chapter questions

1. INTRODUCTION TO INTERNATIONAL BUSINESS

Chapter objectives

This chapter will help reader to:
- know the meaning of international business
- understand the features and forms of international business
- understand the basic concepts of international business
- understand why we study international business
- know the career opportunities in international business
- know the participants and drivers in international business
- appreciate why companies embark upon internationalisation
- understand the differences and similarities between domestic business and international business
- grasp the benefits of international business
- bring out the challenges in international business
- understand globalisation and its inherent benefits and challenges

Meaning of international business

What is a business ?

A business, otherwise referred to as a firm or an enterprise, is any organisation that trades in goods or services or both in exchange for payment with the main objective of minimising cost and maximising profit. Some businesses are, however, non-profit oriented. A business is either domestic or international. It is domestic (national or home) when conducted within the boundary or frontier of a nation. It is international when its activities cross a political (national or territorial) border.

What is international business ?

International business refers to all commercial transactions such as investments, sales and transportation that are conducted between two or more countries. International business could be carried out by private firms or individuals or governments. Private firms primarily engage themselves in international business for profit motives while governments may or may not participate for profit reasons. Examples of international business include, importing goods such as television sets from a foreign country, exporting goods such as cocoa or coffee to a foreign nation, operating a manufacturing plant in a foreign country. So, a business becomes an international business the moment it crosses a country’s frontier.

Features of international business

International business has the following features or characteristics:
- Involvement of different nations
- High level of risk
- Payment in foreign currency
- High competition
- Large number of laws or rules
- Detailed documentation
- Large number of intermediaries

Involvement of different nations

Sellers and buyers are located in different nations as such they are far apart.

High level of risk

International business is associated with high risk as it concerns movement of goods and services to far destinations which may even involve going across seas or oceans. It is more precarious when goods are perishable. They may get damaged, spoilt or lost in the process.

Payment in foreign currency

Payment for goods and services across borders are made in foreign currencies since the transaction involves two or more countries. A country’s currency will not be used to pay for another country’s goods and services. For trade to occur between two countries, the buying country has the obligation to convert its currency into the currency of the selling country.

High competition

International business is highly competitive as it involves transactions or interactions between large numbers of sellers and buyers across the globe.

Large number of law or rules

International business is associated with several international laws, rules or procedures governing all transactions. A high knowledge of such laws is required.

Detailed documentation:

International business requires several documentations. This includes registration of the business itself, documents permitting exports and imports, etc.

Large number of intermediaries

International business is a complex process which requires the services of intermediaries (middlemen).

Forms of international business

Forms of international business include:
- Importing
- Exporting
- Management contracts
- Foreign direct investment
- Licensing
- Franchising
- International merger or integration

Importing

This is the process where goods produced in a foreign country are bought and brought into the home country. Such goods are called imports.

Exporting

Exporting is a form of international business in which goods manufactured in the home (domestic) country are sold to foreign countries. These goods are referred to as exports.

Management contracts

This is a form of international business where a company in one country agrees to offer series of management services to another company resident in another country for a reward agreed upon, be it financial or otherwise.

Foreign direct investment (FDI)

FDI refers to the physical investment of a company in a foreign country.

Licensing

Licensing is another form of international business. It is a formal agreement between two companies, the parent company (called licensor) and another (called licensee) in which the former permits the latter to utilize its intellectual property such as copy right, trade mark, brand name and patent for a given time period for which the former obtains benefits from the latter in the form of royalty/fee.

Franchising

Franchising is an official arrangement between the parent company (called franchiser) and another (called franchisee) in which the former grants the latter the right to use its name and products in an allowed form. Franchising is intimately related to licensing. They are different in that licensing is about a product or part of the business whereas franchising is about the whole business including trade secrets, business know-how etc.

International merger or integration

International merger is an association of two or more companies coming together from different countries for a common business goal. This form of international business is otherwise known as strategic international alliance or partnership.

Basic concepts of international business

Basic international business concepts include the following:
- Importing and exporting
- Exchange rate
- Balance of trade (trade balance)
- Balance of payments (payments balance)

Importing and exporting: (see the first-two forms of international business).

Exchange rate: (see topic 12)

Balance of trade (trade balance)

T rade balance is the difference between exports and imports.

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Trade balance is said to be favourable when a country’s exports exceed its imports. When exports are greater than imports, we say there exists a trade surplus which is good for a country’s balance of payments (BoP). On the other hand, trade balance is described as unfavourable when exports are less than imports. When this occurs, there will be trade deficit which is bad for a country’s BoP.

Balance of payments (BoP)

Balance of payments refers to a statistical record of all economic transactions between residents of the reporting country and residents of the rest of the world during a given period of time, usually a year. Put simple, BoP is the difference between money flowing into a country and money flowing out of a country. There is favourable BoP if money brought into a country outweighs that taken out of the country within a time frame of one year. If the reverse occurs, then BoP is unfavourable.

Why do we study international business?

The reasons for studying international business include the following:
- The study of international business helps students understand global markets and business practices.
- International business prepares students to work abroad especially with companies operating on a global scale.
- It helps students succeed at workplaces and in life by providing them with the necessary knowledge, skills and training.
- It prepares students for effective and efficient management of business transactions across international borders.
- It provides individuals or consumers with greater product choice.
- It provides students with open-mindedness and high degree of knowledgeability.
- It helps consumers to be extremely intelligent.
- It helps job seekers to be highly selective when faced with multiple jobs.

International business career opportunities

Students who successfully go through the international business programmes will obtain the following employment opportunities:
- International business consultant
- International marketing manager
- International financial analyst
- International product manager
- Business development manager
- Global business manager
- Manager in an import-export house
- Policy analyst
- Investment banking manager
- International business adviser
- Human resource professional
- Management analyst
- Marketing executive
- International business analyst
- Human resources officer
- Product manager
- Corporate investment banker
- Procurement manager
- Management consultant

Note: These job opportunities are dependent upon acquiring qualifications such as Master of Business Administration or Postgraduate Diploma in International Business.

Why do firms/ companies go international ?

Companies embark upon international business on the following grounds:
- Saturation of domestic market
- Customer relationship/satisfaction
- Sales and profit expansion
- Business diversification
- Competitive risk minimisation
- Resource acquisition
- Economies of scale (scale economies)
- Cost minimisation
- Government incentives

Saturation of domestic market

A market is said to be saturated if it contains too many producers/ suppliers supplying or chasing only too few buyers or customers. A market may embark on internationalisation if it becomes saturated or if it is too small (limited in size).

Customer relationship/ satisfaction

Customers are moving towards international orientation at a faster rate. Producers or suppliers also have to do same in order to be at pace with their customers. If what your customers need is not domestically available, you need to go international in order to maintain them, otherwise they will switch their loyalty to other suppliers who are internationally oriented

Sales and profit expansion

Companies increase their sales at a faster rate when their products land into international markets than thinking domestically. The products are usually sold at affordable prices. The consumer’s purchasing power (real income) and taste or interest in the product are the strong determinants of a company’s sales level. Things being equal, the company’s profit rises as sales rise.

Business diversification

Internationalisation enables companies to diversify their business operations across different countries for various reasons. One obvious reason why companies diversify their businesses is to spread the risk of slowing (decelerating) demand across multiple countries. Another reason is that the domestic firm may connive with a foreign supplier and take advantage of the raw materials and other resources in the domestic market. Internationalisation also gives companies access to a large and more diversified talent pool. Connections with a broader customer base could be enhanced by employing people who are aufait with different cultures and speak different international languages.

Competitive risk minimisation

There are always competitive risks in businesses as long as there are competitors in the market. Some companies would go international, obtain huge profits from the international market and decide to employ such profits selfishly and diabolically in the bid to acquire strong competitive position in the home market. This will not go down well with the other domestic companies. These aggrieved domestic companies will retaliate by also going to the international market to preclude the profit accrued companies (from domestic markets) from obtaining and exercising such advantages in the domestic market. They defend themselves against such competitive risks.

Resource acquisition

Internationalisation allows companies access resources in the form of human, capital or otherwise. Through the use of such resources, companies can improve the quality and quantity of their products. Companies may increase their market share and profit when they increase their product quality and especially if they have their products quite distinct from their rivals.

Economies of scale

Companies enter foreign markets in order to achieve economies of scale, defined as the per-unit cost advantage a company obtains upon expansion of its operations at least to a limit.

Cost minimisation

Many companies establish their businesses in the third world (developing) countries where they will find cheap labour. Cheap labour is translated into low production cost. By relocating closer to a supplier, a company may also reduce cost. This permits companies to save on transport and import costs.

Government incentives

Some governments invite inward investments by giving incentives such as low tax to foreign firms as a way of encouraging them. The presence of foreign firms in a domestic country facilitates job creation for citizens and other inhabitants.

International business participants

The participants in international business include the following:
- Firms/companies
- Governments
- Facilitators
- Channel distribution intermediaries

Firms/companies

Firms or companies participate in international business transactions irrespective of their sizes, types and the industries to which they belong. They are the initiators or pioneers of foreign commercial transactions.

Governments

Governments are active players or participants in international business. They are the regulators of international business transactions. They also buy from the foreign markets goods and services. They can buy goods such as police and military attires, arms and ammunition and medicines. Governments can hire the services of a foreign contractor or foreign military troop in the case where there exists a political mayhem that the domestic troop cannot easily handle.

Facilitators

These are professionals who provide their special expertise in such areas as law (lawyers), market research, banking, customs clearance and any other relevant service.

Distribution channel intermediaries

These are specialist firms in the international value chain that are charged with the responsibility of distribution of goods and logistics as well as marketing services.

Differences between domestic business and international business

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Similarities between domestic business and international business

- Profit maximisation and cost minimisation
- Satisfaction of the needs of the consumers
- Conduct of research and development
- Marketing techniques of non-human factors

Profit maximisation and cost minimisation

The aim of any business, whether at national or international level, is to maximise profit by minimising cost.

Satisfaction of the needs of the consumers

Customer satisfaction is key or supreme whether the business is domestic or foreign.

Conduct of research and development

Research and development activities are quite significant to any business (national or international) if product quality should be improved or existing product should be modified or new products should be introduced.

Marketing techniques of non-human factors

Non-human factors such as product and price should be well marketed whether the business is at national or international level.

Drivers of international business

Drivers of international business are factors that prompt companies or businesses to engage in international business. Such factors include the following:
- Limited domestic market
- Higher profit margins
- Excess production
- Political stability/instability
- Increased market share
- Liberalisation of economic policies
- Availability of raw materials
- Technology and communication
- Formation of trading blocs
- Disparities in tax systems
- Emerging markets

Limited domestic market

A market is described as limited when its population size is small or the consumers’ purchasing power (real income) is low or the company is matured in its domestic market or a combination of two or more. The occurrence of any of the above implies the revenue generated is inadequate to attract full manufacturing economies of scale. This drives companies to internationalise their operations.

Higher profit margins

The cardinal objective of a profit-oriented company is to obtain higher profit margins. If the home market is not profit promising enough, companies will be forced to either quit their home markets or reduce their home operations and enter foreign markets where the promise is higher.

Excess production:

Some companies produce outputs in excess of what their home markets can accommodate (purchase). When excess production occurs, home markets will be left with no option but to internationalise where the extra or surplus outputs would be sold and bought in order to avoid wastage.

Political stability/ instability

A country is considered politically stable where the same accepted government policies and procedures are maintained over an exceedingly long time period. On the other hand, a country is described as politically unstable when the reverse occurs, that is, when existing government policies last only a short period of time. Companies quit politically unstable countries and seek foreign markets in countries where there is political stability. Many African countries are full of political instability such as coup.

There were military coups in Sierra Leone and Mali in 1997 and 2020 respectively, to mention a few. The current coup in Mali has hurt companies to a greater extent especially economically. Close to general elections in most African countries, business firms either reduce their operations or shut down for fear of political riots until the political heat cools off, sometimes months after the election results are announced.

On the contrary, most developed countries including America, France, the Great Britain and Germany are politically stable. In such countries, general elections are conducted and results announced within few days without any form of violence or instability.

Increased market share

Increase or growth in market share is one of the drivers of international business. Firms would like to increase their customer base, hence market share, by expanding and intensifying their operations in foreign markets.

Liberalisation of economic policies

When countries liberalise their economies (and open their countries to the world), small or multinational companies will be attracted to such countries.

Availability of raw materials

The availability of raw material is a major driver of international business. Domestic countries are highly attracted to foreign countries endowed with such materials. They either import the raw materials (importation being a form of international business) or seek to settle and operate in countries where the raw materials are available.

Technology and communication

Technology is one of the major drivers of international business. Availability of advanced modern technology facilitates international business. Companies are attracted to markets or countries with technological amenities. Domestic companies can easily contact foreign markets through the application of advanced information technology such as the internet. Consumers too can reach businesses in foreign countries through www (world wide web). International businesses are now conducted through e-commerce or merely over phones. Today, one can get involved in international business without stepping their feet out of their country.

Formation of trading blocs

Formation of trading blocs, regional or international, has enhanced high degree of cooperation. The objective of the formation of trading blocs is to promote businesses within the framework of their powers by allowing the creation of free trade zones in which trade or investment barriers are removed.

Examples of trading blocs include, World Trade Organization (WTO), European Union (EU), North American Free Trade Agreement (NAFTA) and South Asian Free Trade Agreement (SAFTA). The removal of trade barriers drives international business.

Disparities in tax system

Companies are normally forced out of countries where high level of taxes are levied to countries where taxes imposed are nominal. Some countries adjust their tax systems in the bid to attract foreign direct investment.

Emerging markets

Emerging markets are untapped or unexplored markets with high potential and scope for business operationalisation. Companies that want to expand internationally would seek to operate in such markets.

Benefits of international business

The benefits of international business include the following:
- Increased government revenue
- Increased specialisation
- Employment opportunities
- Large economies of scale
- Wider market
- Reduced risks
- Consumer benefits
- Potential untapped markets
- Cultural development

Increased government revenue

Government realises revenue from international business by imposing duties on both imports and exports. Government obtains foreign exchange from export of goods and services.

Increased specialisation

International business brings about specialisation in the production of particular goods usually of high quality for both domestic and international consumption. Specialisation increases as firms’ engagement in international business increases.

Employment opportunities

International business creates job opportunities for individuals in both importing and exporting countries.

Large economies of scale

International business leads to large scale production which results in economies of scale. Economies of scale relate to the cost advantages a firm enjoys as it expands its operations. As firms increase their size or scale, average cost (per-unit cost) of production falls.

Wider market

International business widens the market as it involves sale of products or services across the globe. This attracts demand for companies’ products from multiple countries rather than depending on the demand for the products in a single country.

Reduced risks

International business reduces companies’ risks (political or commercial) as a result of the spread of operations in several countries.

Consumer benefits

International business benefits consumers by providing them with greater product choice (i.e. a variety of products). Consumers, therefore, have access to different types of imported goods at affordable prices. They can choose whatever goods they desire.

Potential untapped markets

International business allows firms to enter, explore and even exploit markets that are untapped. Such markets are usually willing to buy products at higher prices than home markets.

Cultural development

The benefits of international business are not only commercial (economic) but are also cultural in nature. International business allows countries to exchange their cultures and ideas.

Some counties imitate and emulate other countries in terms of dress, food, behaviour etc. So countries with greater diversities can share their cultures through international business.

Challenges in international business

Challenges faced in international business include the following:
- Language barriers
- High competition among nation
- Legal problems
- Exploitation of developing nations
- Dumping problem
- Scarcity of goods in the exporting nations
- Conversion of currency
- Cultural issues
- Tariff payment

Language barriers

Language barrier is one of the major problems or challenges in international business.

Different countries speak different languages. Establishing a business in a foreign country whose language you do not understand creates a significant communication problem. Such barrier impedes international trade.

High competition among nations

International business creates competition among countries.

Competition severely worries competitors as whether they would realise profits or not. Competitors are more worried about profit making than their employees’ work conditions. This prompts rivals into price cutting in the bid to actualise profit

Legal problems

Every country in the world has its own laws which dictate the activities of businesses.

Such laws prescribe the type or nature of business to be established, the tax level to be levied, the minimum wage rate, the product price level etc. Companies engaged in international business are governed by the laws of the country of operation. Companies going international may face significant operating difficulties if there exists immense disparity between domestic and foreign laws. Such companies may find it diametrically difficult to cope with the listed international laws.

Exploitation of developing nations

In international business, developed countries dominate and exploit developing countries since the former regulate the latter’s economies. Developed countries (or international markets) often control the exports of developing countries.

Dumping problem

International business creates problem of dumping in foreign countries. Dumping occurs when domestic companies produce a product in excess, sell part of the product in their domestic market at higher prices and sell the extra or surplus product to foreign countries at lower prices.

Companies do this in order to edge out companies in the importing country. These goods (exports) compete with the foreign country’s domestically produced goods. This has adverse effect on the importing country

Scarcity of goods in the exporting nations

Most companies choose to sell their products abroad leaving little or nothing in their home countries. By so doing, scarcity of goods will be created.

Conversion of currency

International business transactions require companies to convert their home currency into foreign currency. Cross-border activities are virtually impossible without currency conversion

Cultural issues

Culture could be defined in many ways. But for the purpose of this research, culture will be taken to mean the norms of a society or country. The term “norms” refers to people’s beliefs, way of life, values, attitudes etc. It relates to the social organisation of a particular group or country.

Norms differ from nation to nation, region to region. Most conspicuously, norms are reflective of people’s beliefs and attitudes about or towards particular goods/products and dress code. Products such as alcohol and pork are totally prohibited in any predominantly muslim countries or societies. In muslim dominated countries, people cover their heads.

Tariff payment

International business requires companies to pay tariff imposed by governments. Recall, tariffs are imposed on both imported and exported goods though largely imposed on imports. Tariffs are hardly imposed on exports because most countries encourage their exports in the bid to obtain encouraging balance of payments position through favourable trade balance.

Globalisation

What is globalisation ?

Globalisation refers to the process of establishing and increasing the interconnectedness and interdependence between or among nations in the world. It enhances a stronger integrated and interdependent world economy. It brings about world’s economic, social and cultural integration. Globalisation is increasing at an increasing rate.

Features of globalisation

The following are some of the features or charcteristics of globalisation.

- Borderlessness: Globalisation is a phenomenon that views the world as if it is without borders or boundaries or frontiers.
- Easy flow of goods (raw, semi-finished and finished) and services across borders.
- High interconnectedness and interdependence.
- Easy financial and information flow among nations.
- Exchange of cultural values.
- High exchange of knowledge between nations.
- Flow of resources (human and non-human) between countries.
- Advanced means of transportation from one nation to another (through land, air and sea).
- Advanced forms of communication including internet.
- Relatively easy movement and/or settlement of people away from their countries of origin.
- Creation of enabling environment for students to study in different countries.
- Easy access to foreign markets.

Globalisation: The beautiful side

Globalisation provides, among others, the following benefits or advantages:
- Globalsiation increases the world’s investment level.
- It drives away antiquated forms of technology and introduces modern ones at a faster rate.
- It facilitates the movement of goods from the place of production to the rest of the world.
- It encourages technological transfer between countries.

Globalisation: The ugly side

The following are, among others, the challenges or disadvantages of globalisation:
- Globalisation facilitates disease transfer.
- Through globlisation, harmful weapons and other demerit goods are transferred from one nation to another.
- Globalisation causes environmental such as pollution and deforestation as a result of the movement of big manufacturing companies across the globe.
- It creates fierce competition between domestic firms and imported companies in which case most home infant industries are driven out of the market and job losses become the order of the day.
- Globalisation creates economic calamities to some economies as a result of the collapse of just a single major economy. For example, if the economy of USA collapses, many countries and organisations will perish.

Chapter summary

- International business is any commercial activity that takes place across border. They are cross-border in nature. Domestic (home) business is one that occurs within the frontier of a nation.
- Domestic business differs from international business in several ways. The two forms of business are also similar in certain ways.
- The features of international business include, high level of risk, payment in foreign currency, high competition, large number of laws or rules, detailed documentation, and large number of intermediaries.
- Some forms of international business are, importing, exporting, management contracts, foreign direct investment, licensing, franchising and international merger.
- The basic concepts of international business are, importing and exporting, exchange rate, trade balance and balance of payments.
- We study international business for various reasons including, understanding international markets and business practices, preparing students to work overseas etc.
- Companies go international when they want to expand sales and profit, diversify their business, minimise competitive risk, acquire resources, obtain economies of scale, minimise cost and when their domestic markets are saturated.
- The following are the participants of international business: firms/ companies of any size, governments, facilitators and intermediaries.
- The following are the drivers of international business: limited domestic market, higher profit margins, excess production, political stability/instability, increased market share, liberalisation of economic policies, availability of raw materials, technology and communication, formation of trading blocs, disparity in tax systems and emerging market.
- International business yields the following benefits: increased government revenue, increased specialisation, employment opportunities, large economies of scale, wider market, consumer benefits, potential untapped markets and cultural developments
- Businesses that go international face the following challenges: language barriers, high competition, legal problems, dumping problem, cultural issues, payment of tariffs etc.
- Globalisation refers to the world’s economic, communication, environmental and cultural integration.
- Globalisation is both meritorious and demeritorious.

Key terms and concepts Balance of payments Career opportunities Domestic business Dumping Economies of scale Emerging markets Exchange rate Foreign direct investment Franchising Globalisation Integration Intermediaries International business Language barriers Legal problems Liberalisation Licensing Management contracts Merger Trade balance

Chapter questions

1.1 What is international business?
1.2 Why do we study international business?
1.3 Compare and contrast international business and domestic business.
1.4 Advance reasons why companies go international?
1.5 List and discuss the participants in international business.
1.6 Discuss the drivers of international business.
1.7 Mention 6 (six) challenges faced by businesses that go international.
1.8 What is meant by globalisation?
1.9 Discuss the features of globalisation.
1.10 What are the advantages and disadvantages of globalisation?

2 THE ROLE, OBJECTIVES AND GROWTH OF FIRMS

Chapter objectives

This chapter will help reader to:
- understand the role of the firm
- grasp the fact that there are other objectives of the firm apart from profit maximisation
- have the knowledge that firms can grow both internally and externally
- appreciate the reasons why firms grow
- understand the reasons why firms sometimes demerge

This topic focuses on the role firms play, what firms would like to achieve (objectives) and how and why firms grow (growth).

THE ROLE OF THE FIRM

The role of the firm is to combine the factors of production, otherwise referred to as factor inputs or productive inputs or productive resources, in a given form to obtain a given level of output. Output can be a good or service. Producers produce goods and services with the motive of maximising profit while minimising costs.

Factors of production

Factors of production are of four types, namely, land, capital, labour and entrepreneur. A factor of production could be in the form of either human or non-human resource. Hence, land and capital are non-human resources while labour and entrepreneur are human resources. There is reward for every factor of production.

Land: In ordinary sense, land means the area of the hard surface of the earth, like areas for farming, building and roads. This meaning does not suffice in economic sense. In economics, land, in addition to the hard surface of the earth, includes all natural resources (raw materials) such as trees, water, sand, diamond, stone, silver, gold, bauxite etc.

Land is a gift of nature in the sense that it is made by God and not by man. It bears no cost of production. Land is fixed in quantity but its quality is not fixed. Its quality will increase or improve with, say, the application of fertilizer.

A part of land can be moved from one place to another but land as a whole has a feature of immobility, that is, it cannot be moved from one region to another. The value of land can diminish (reduce) when it is over cultivated. The reward for land is rent.

Capital: People often misuse the word ‘ capital ’. They take capital to mean financial assets such as money. This is the view of lay men and this view is outside economic box. In economics, capital refers to goods which are acquired for the purpose of further production of a finished good. Office buildings, machinery, equipment, and tools are examples of capital goods. Capital goods are man-made and are not acquired for their own sake but for the production of other goods. They are durable goods.

Equipment, in combination with raw materials, can be used to produce, say, cement or other goods. When capital good is used over a given period, it gradually wears away and this wearing away is referred to as depreciation. The reward for capital is interest.

Labour: Labour refers to any effort applied by an individual in the production process. This can be in the form of physical effort or mental effort. If the effort expended is physical, then it is an unskilled labour while it is a skilled labour if mental effort is applied. Skilled labourers are of appreciable academic background and could gain employment as doctors, lawyers, economists, accountants, engineers etc. Unskilled labourers have little or no formal education. They contribute in production by expending a lot of energy. Examples of unskilled labourers are messengers, cleaners, security guards etc. and their salaries are usually very low compared to skilled labourers. The reward for labour is salaries or wages.

Entrepreneur: an entrepreneur, a factor of production, is one who combines other factors of production, namely, land, capital and labour in a bid to produce goods and services. Entrepreneur is a unique factor of production without which other factors of production cannot be combined. An entrepreneur is a risk taker, decision maker, organiser of other factors of production, researcher of public wants and needs and provider of such wants and needs. He is an innovator of new products.

An entrepreneur can, however, be a labourer at the same time in a given production process. The reward for entrepreneur is profit.

OBJECTIVES OF FIRMS

It is generally agreed that the main objective of a firm is to maximise profit. Have readers (or students) ever endeavoured to know the other objectives of firms? The term ‘ main objective ’ is clearly suggestive of the fact that there are other relevant objectives of firms. Other objectives of firms include:
- Survival of the firm
- Growth and expansion
- Building stakeholder value
- Sales maximisation
- Revenue maximisation
- Social and community objectives

Profit maximisation

Profit maximisation is the cardinal aim or objective of any profit making firm. This objective is supreme to all other objectives of a firm. The profit made by a firm determines the survival of that firm. Profit is maximised when marginal revenue (MR) equals marginal cost (MC)

(i.e. MR=MC). Put another way, profit will be maximised when the revenue obtained from selling the last unit of a product is exactly the same as the cost incurred in producing the last unit of the product. Production can be expanded if the firm’s profits are high and conversely, firms will cut down production if profits are small. Profit-maximising firms will always, therefore, seek to obtain, as much as possible, higher profits.

Note :

Marginal revenue (MR) is the additional revenue obtained from selling an extra unit of output (X).

Symbolically, where, TR is total revenue, TR is the change in total revenue which equals the difference between the new total revenue and the old total revenue. X is the change in output which represents the difference between the new output and the old output.

Marginal cost (MC) is the extra cost of producing one more unit of output (X). TC is total cost.

Symbolically, , where TC is the total cost, TC is the change in total cost. This is expanded as the difference between the old total cost and the new total cost. X is defined as before.

Survival of the firm

Another objective of a firm is to ensure that the firm survives and remains in existence. Once established, many newly established firms or businesses struggle to survive and are, therefore, described as having low survival rate. Such firms are characterised by under-capitalisation. As a result, the firms find it extremely difficult to withstand unforeseen circumstances owing to financial incapability. Another reason why new firms struggle to survive is that they normally face immense competition in the market. Their first year in business is usually a very tough exercise. It can easily be perceived that only new and small businesses struggle to survive.

This perception is romantically incorrect. Established firms which have existed for quite a while can still find it difficult to survive if they cannot maximise their profits. It is worth noting that a firm can maximise profit only if it minimises production costs. The survival aim of the firm is normally referred to as the going concern.

Growth and expansion

The concept of growth, expansion and domination of industry of operation is another objective of firms (medium-size and large). Firms want to grow and expand so that they can dominate the market and obtain substantial market share. A market share refers to the sales proportion acquired by a particular firm in a given market or industry. Market share can be gained when firms choose to sell their products or services at relatively low prices or employ the use of quality as an instrument to out-compete their competitors.

Building shareholder value

Building shareholder value is another objective of firms. Shareholder value, defined as the return on shares owned by shareholders, can be built up if substantial dividends are allocated to the shareholders and if the shares are attracted by high prices. Huge dividends will only be given to the owner(s) of a business if profit is maximised.

Sales maximisation

Another objective of a firm is to maximise its sales. Sales maximisation occurs when firms seek to sell their products as much as they can without incurring any loss. This situation obtains where average revenue and average cost are equal.

The firm’s market share increases as sales increase. In order to increase sales, the firm must lower its price. The firm has the option of lowering the price of its product until there is equality of the price (P) or average revenue (AR) and average cost (AC) [that is, P (AR) = AC]. This emphasizes the fact that the firm can produce and sell as much output as it can as long as it is covering its costs. As said under the objective of profit maximisation, a sales maximising firm can remain in business (continue to produce and sell any product) until the selling price of the last unit and the production cost of that unit are just equal. The sales maximising output level is Q. This explanation is supported by figure 2.1.

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Figure 2.1

Revenue maximisation

Another objective of firms is to maximise revenue. Revenue maximisation obtains when a firm opts to accrue as much revenue as possible. To achieve this purpose, firms are quite willing to sell their products until no revenue is obtained from selling the last unit. Beyond this, any further unit sold will directly lead to revenue reduction. Marginal revenue, defined as the addition to total revenue as a result of selling one more unit of a good, is expected to fall as the firm’s output expands.

Marginal revenue can be positive, zero or negative. Total revenue rises when marginal revenue is positive. It is constant (no change) when marginal revenue is zero. At this point, total revenue is maximised. Total revenue starts to fall when marginal revenue becomes negative. For a good illustration, see figure 2.2.

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Figure 2.2.

Social and community objectives

Some firms or organisations consider profit and sales maximisation as their top most objectives while others do not. Some schools, for example, do not have the objective of making large profits or having large numbers of students. Rather, they set out their objective of getting the best examination results. They prefer to have a national or global recognition that their schools produce the best results to profit maximisation. Other examples of organisations that do not consider profit maximisation as their main objective are local councils, civil society organisations etc. Their main objective is to meet the needs of local community and the society as a whole.

GROWTH OF FIRMS

This area is concerned about how and why firms grow. The two areas to consider are:
- How do firms grow
- Why do firms grow

How do firms grow?

Firms can grow in size (get bigger) in two different ways. They grow either internally or externally.

Internal growth of firms

Firms grow or expand internally when there is increase in their outputs, supported by an increase in sales or turnover either by increasing investment or labour force. When this happens, firms increase their market share by out-competing their competitors (rivals). The firm’s growth strategies can be, to certain extent, self-financed by using retained profits. Firms which have expanded can enjoy economies of scale. This opportunity reduces the total cost of production which renders the firm higher competitive advantage over and above its rivals. This is a source of further growth. Firms that successfully implement strategic growth policies may easily obtain extra funds from sources such as banks or stock markets.

External growth of firms

Firms can grow in size externally either by means of merger (amalgamation) or takeover.

Merger or amalgamation

Firms merge or amalgamate when two or more of them amicably join together to form one under common ownership. A merger occurs when, say, firms X and Y, agree to collaborate into one and even sometimes combining their names.

With the approval of shareholders, the board of directors of the two firms or companies will agree to merge their firms together.

Examples of merger:
- In Sierra Leone, two firms called Sierra Leone National Telecommunications and Sierra Leone external Telecommunications merged to form the Sierra Leone telecommunications, often called Sierratel.
- In the U.K., two banks, named, National Provincial Bank and Westminster Bank collaborated to form National Westminster, known as Nat West.

Takeover

A takeover occurs when a firm outrightly purchases another firm or accumulates a controlling interest of shares. There is a takeover when, say, firm X buys firm Y in which case firm Y becomes part of firm X. The mere wish to buy another firm is a takeover. A takeover may be amicable or hostile. If firm X wants to amicably takeover firm Y, it bids for firm Y. If the price offered by firm X is encouraging, the board of directors of firm Y will make a recommendation to its shareholders to accept the terms of the offer. On the other hand, firm Y’s board of directors will appropriately advise its shareholders to outrightly reject the offer terms if the takeover has an element of hostility.

Examples of takeover in Sierra Leone:
- A bank called Ecobank amicably took over another bank called Procredit Bank.
- A mobile phone company, named, Africell amicably took over another mobile phone company, called Tigo.

Types of merger

Three types of merger, otherwise known as integration, are identified by economists. These are horizontal, vertical and conglomerate merger.

- Horizontal merger

This form of merger occurs between two firms in the same industry operating at the same production stage. In other words, a horizontal merger is one which occurs between two firms or companies manufacturing similar products. Examples of horizontal merger or integration include:
- two banks (see the UK Nat West case),
- two telecommunications Companies (see the Sierra Leone – Sierratel case),
- two restaurants,
- two insurance companies,
- two shipping companies etc.

- Vertical merger

The vertical merger is concerned with the merging of two firms within the same industry but at different stages of production chain. Vertical merger could take the form of ‘ forward ’ or ‘ backward ’.

Forward merger or integration

Forward merger refers to the case where a supplier merges with one of its buyers. An example is a car manufacturer merging with one of its dealers.

Backward merger refers to a situation where a firm merges with one of its suppliers. An example is brewery merging with a supplier of raw materials, say, wheat.

- Conglomerate merger or integration

This type of merger is a merger that occurs between two firms from different industries without any common production interests. Here, firms from different industries, without anything in common, merge. The two firms produce different products or offer different services.

Common examples of this type of merger are: a bank merging with a restaurant, an insurance company merging with a fishing company, a tobacco company integrating with an audit firm, a clothing chain integrating with a supermarket chain, a brewerey merging with a photo studio etc.

This type of merger is also called lateral merger.

Advantages of Merger

Merger activity has the following advantages:
- It helps build up market share.
- It guides firms against competition.
- It enables firms to secure greater control over production process.

Disadvanges of Merger

- Merger activity increases monopoly power.
- It also reduces customer choice.

Why do firms grow?

Three fundamental reasons motivate profit maximising firms to grow in size. These are as follows:

Exploitation of economies of scale

One of the reasons why firms would like to grow in size is to exploit economies of scale.

Market control

The second reason why firms grow is that growth enables them to have full control of the market. Large firms try to out-compete their rivals in a bid to exploit market opportunities.

Risk reduction

Risk reduction is another reason why firms grow in size. Firms from different industries, otherwise called conglomerate firms, have merged and grown in size in a bid to reduce risk as some markets are characterised by high degree of fragility. Firms usually do well when economies boom and are hard hit during the period of recession. Demand, therefore, changes substantially when economies boom or recess. An insurance company, for instance, might decide to buy, say, a supermarket chain in order to reduce any market risk.

Demergers

A demerger occurs when a (large) firm decomposes into two or more separate firms. It is a possibility that the two or more new firms that emerge when a demerger takes place have approximately the same size. The term ‘demerger’ can sometimes be used to describe a situation where a small part of a firm (business) is sold to another business.

Reasons for demergers

The reasons for demergers are as follows:

Non-existence of synergies

A synergy is concerned with positive connection or relationship between two or more parts of a business or a system. Lack of synergies simply means that one part of a business has no effect on the other parts of the business. Firms should demerge when management realises that there are no synergies between the parts of the business. If one part of the business is efficient and profitable while another part is inefficient and unprofitable, demerger becomes imperative in a bid to remove that part of the business that is unprofitable. When there is no nexus between two or more businesses, any time spent by top management is said to be a waste and this consequently results in diseconomies of scale.

Price factor

Demerged firms tend to attract high price compared to the price of a single large firm. A firm valued, say, at Le100,000,000 on a stock exchange market, if decomposed into two, may be respectively valued at say, Le 70,000,000 and Le 60,000,000. The share price of an entire firm can be dragged down if one part of the firm performs relatively poorly even if the performance of other parts are quite encouraging.

Chapter summary

- The main objective of a firm is to maximise profit by minimising cost. In addition to profit maximisation, firms have other objectives which include: survival, growth and expansion, building shareholder value, revenue maximisation, sales maximisation, and social and community objectives.
- Firms can grow internally or externally. Internal growth occurs when the firm’s output and sales increase by increasing either the level of investment or number of workers. Firms grow externally by either merging with other firms or buying other firms called a takeover.
- Merger, also called integration, is of three types, namely, horizontal, vertical and conglomerate.
- A merger is said to be horizontal when two firms producing identical products in the same industry come together to operate as one. An example is the merging of two insurance companies.
- A merger is vertical when two firms operating at different production stages in the same industry merge. Vertical merger is of two forms: forward merger and backward merger. The merging of a supplier and one of its buyers is a form of forward merger. A suitable example of forward merger is a car producer merging with one of its dealers. A backward merger obtains when a firm and one of its suppliers merge. An example is a bread baker merging with a supplier of flour.
- Conglomerate merger, otherwise called lateral merger, forms when two firms or businesses producing different products or offering different services in different industries merge. An example is a bank merging with supermarket chain.
- The concept of merger is both good and bad. It is good in that it helps increase market share, guides firms against competition, and allows firms to obtain greater control over production process. It is bad in that it increases monopoly power and reduces the level of customer choice.
- Firms grow for three main reasons: to enjoy economies of scale, to have market control and to reduce risk.
- A demerger occurs when a large firm separates into two or more firms. One reason why firms demerge is where synergies do not exist. A synergy concerns a positive relationship or connection between two or more parts of a business. It talks about the positive impact on a firm. A firm should demerge if it lacks synergies, that is, if one component of the firm is profitable while the other component is quite unprofitable. The firm should demerge if there is no positive connection between the two components. One component has a negative impact on the other. Another reason why firms demerge is to attract high price compared to the price of a single firm.

Key terms and concepts

Amalgamation

Backward merger

Conglomerate merger

Demergers

Economies of scale

Forward merger

Growth of firms

Horizontal merger

Lateral merger

Merger

Objectives of firms

Price factor

Synergies

Takeover

Vertical merger

Chapter questions

2.1 Apart from profit maximisation, discuss five other objectives of firms.
2.2 How do firms grow?
2.3 Why do firms grow?
2.4 Distinguish between a takeover and a merger.
2.5 What is meant by a demerger? Discuss the reasons behind demergers.