3.3 how a company decides on which country to target
1|Q u az i N a f i u l I sl a m – w w w . s t u d e n t t e c h .c o . c cHOW DOES A COMPANY DECIDE WHICHCOUNTRIES TO TARGET?OVERVIEW • Assessment of country markets o Geographic proximity Elementary my o Government policies & dear businessman exchange rates o Level of economic development (Ranking by GDP or HDI) o Political and legal system o Natural resources o Commodity prices o Potential labour force o Level of Technology o Return on investment • Comparative advantage and the role of specialised economies o Advantages for a company of trading with a country which can produce a good or service more cheaply through specialisation.ASSESSMENT OF COUNTRY MARKETSG EOGRAPHIC PROXIMITY • Common logic would dictate that the further the nation, the higher the transport costs. However sometimes, it takes less to transport thousands of miles through cargo ships than hundreds of miles through trucking. • But for normal manufacturing businesses, such as car manufacturers, it would be best to locate near their manufacturing plants, which would make transportation easier and faster. • Service oriented businesses will not find this a great problem, as there is little to transport.G OVERNMENT POLICIES AND EXCHANGE RATES • Taxes, Businesses will try to avoid paying high taxes, often maximising profits in low tax countries and minimising profits in high tax countries: They use tactics such as transfer pricing and asset movements to reduce the profits declared in countries with a higher rate of corporation tax and boost those in lower rate countries. HMRC are currently claiming that HSBC bank avoided paying £2bn in tax by such methods last year. They may well maximise profits in low tax economies to offset business in high-tax economies as well. Low taxes attract FDI. • Barriers to trade such as tariffs and quotas. • Ease of setting up a business; often with developing nations there is excessive red tape.
2|Q u az i N a f i u l I sl a m – w w w . s t u d e n t t e c h .c o . c c • Exchange rates; rates unstable exchange would cause uncertainty. Undervalued exchange rates would make foreign goods more expensive; some business chose to locate the business in the target market will have to offset added production cost with sales. • Grants and subsidies, this makes doing business cheaper for businesses. Often governments try to lure in businesses in poverty stricken areas in order to increase employment there. 160 140 120 100 2003 80 2004 60 40 2005 20 2006 0 2007 2008 2009 L EVEL OF ECONOMIC DEVELOPMENT (R ANKING BY GDP OR HDI) The HDI (Human Development Index) is a composite index made up of the per capita income, education and life expectancy of a country. The GDP (Gross Domestic Product) ������������������ = ������������������������������������������ ������������������������������������������������������������������ + ������������������������������ ������������������������������������������������������������ + ������������������������������������������������������������ ������������������������������������������������ + (������������������������������������������ − ������������������������������������������) Consumption is expenditure on goods and services by the consumer. High Medium LowFigure 1 - A map of HDI across the world. 0.9 – 1.0 : Very High Development 0.8 – 0.9 : High Development 0.5 – 0.8 : Medium Development 0.3 – 0.5 : Low Development
3|Q u az i N a f i u l I sl a m – w w w . s t u d e n t t e c h .c o . c c • Targeting areas of high HDI and GDP per capita will be good for most businesses as people there are healthy, educated and rich. This means the market should be able to cater for most businesses, but labour costs should be very expensive. • Strong Infrastructure should allow for businesses better communication as well as transportation of goods and services, allowing them to reach a larger number of consumers. • Businesses will need to seek out economies that meet their needs and at the same time provide the best competitive advantage due to its economic efficiencies.P OLITICAL AND LEGAL SYSTEM • Businesses will want stability in the economy, so that business can go on as usual and long term predictions on growth can be made. However often businesses have to take risks in order to make profits in volatile nations where there is much political instability and rampant corruption. o Often businesses will ingratiate themselves with corrupt political leaders in order to gain greater safety. • The legal systems in foreign nations are not always dependable. o Counterfeit software is a major concern in China. o If the legal system does not protect the business’ assets, then there will be a lot of risk involved in doing business in the country.N ATURAL RESOURCES AND COMMODITY PRICES • Natural resources are a big factor for location for mining and oil/gas companies. Chinese mining companies have invested heavily into Zimbabwe as it has many metal resources that China can avail of such as coal, chromium ore, asbestos, gold, nickel, copper, iron ore, vanadium, lithium, tin, platinum group metals. • High commodity prices for natural resources such as coal, oil and metals may give companies enough incentive to start doing business in volatile regions. Chinese companies have a lot of mining operations in Zimbabwe (which has a lot of political instability) because of the abundant mineral reserves and very cheap labour available there. Click here to view commodity prices→ • Commodity prices will affect a decision in a similar way to the level of other factor costs. Lower commodity prices make location there more attractive. However, by the widely traded nature of commodities, it is unlikely to be a major factor in location as they can simply be imported. Much depends on the importance of commodities as a raw material for the business in question.P OTENTIAL LABOUR FORCE AND LEVEL OF TECHNOLOGY • Different businesses will need different levels of skill. Businesses may often have to trade off additional training costs with low wages in certain countries, and low wages should provide a greater return on investment. • If a business wants to locate its R&D sector in a country, then it will have to have met its technology and human capital requirements. Infrastructure and good telecommunication should also be a key factor when deciding where to locate the R&D sector.R ETURN ON INVESTMENT • Businesses will make forecasts based on transportation, set-up and wage costs how much profit they are going to make. The profitability, which depends on all the aforementioned factors it also depends on what the business expects in the long term. o Many foreign businesses in China made a lot of losses to being with, but stayed for the long run as they believed that having a foot-hold in china would be a great advantage to them. o Low wages should lead to high return on investment in the long run, even if at the beginning investment needs to be made on training and other equipment, low wages can be a trade-off in the long run.
4|Q u az i N a f i u l I sl a m – w w w . s t u d e n t t e c h .c o . c cCOMPARATIVE ADVANTAGE AND THE ROLE OF SPECIALISATION IN ECONOMIESWhen businesses are tasked with producing something, they divide the workload into different parts, handled by different work-groups: the division of labour.As these groups work on their specific tasks more and more, they become better at what they do and thus increasing efficiency.This is called specialisation. Advantage Absolute Comparative CompetitiveA BSOLUTE ADVANTAGE Absolute advantage is the ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service. INVESTOPEDIAC OMPARATIVE ADVANTAGE Comparative advantage is a situation in which a country, individual, company or region can produce a good at a lower opportunity cost than a competitor. INVESTOPEDIAComparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it waswritten) is unnecessary in free trade. Popularized by David Ricardo, comparative advantage argues that free trade works even ifone partner in a deal holds absolute advantage in all areas of production - that is, one partner makes products cheaper, betterand faster than its trading partner.The primary fear for nations entering free trade is that they will be out-produced by a country with an absolute advantage inseveral areas, which would lead to imports, but no exports. Comparative advantage stipulates that countries should specialize ina certain class of products for export, but import the rest - even if the country holds an absolute advantage in all products. (Tolearn more, read What Is International Trade?)
5|Q u az i N a f i u l I sl a m – w w w . s t u d e n t t e c h .c o . c cThe essence of this law can be illustrated with a simple example. Imagine that you are a skilledcabinetmaker as well as a gifted painter. It takes you a day to build a cabinet or a day to paint apicture. In the local economy, paintings sell for $400 and cabinets go for $350. Yourneighbour also shares the same skill sets, but it takes him a day and a half to build acabinet and three days to complete a painting. You have an absolute advantage overyour neighbour in both areas, so you should try to out-produce him across the board,right? Wrong.Heres why: If you flip between painting and cabinetmaking over a six-day work week,you would produce three paintings and three cabinets worth $2,250. If your neighbourembarked upon the same work schedule, he would produce one painting and twocabinets worth $1,100. There would be a total of four paintings and five cabinetsproduced: a total of nine production units. If, however, you were to choose to focus onpainting, the area where you have the greatest comparative advantage and the most profit,and leave cabinetmaking to your neighbour, something magical would happen. You wouldproduce six paintings worth $2,400 per week, while your neighbour would produce four cabinetsworth $1,400, bringing the total to 10 production units. In real terms, both you and your neighbourwould be richer for specializing - and the local economy is one production unit the better for it.This example rings true on the level of international trade as well. Britain provided support for comparative advantage byessentially outsourcing its food growth (importing grains, meat, cheese, wine, etc.) and focusing on manufacturing goods forexport, thus, becoming the workshop of the world during the industrial revolution. This passage has been copied from InvestopediaC OMPETITIVE ADVANTAGEA competitive advantage is a particular advantage that a business has that enables it to perform better than its rivals. It isdifferent from absolute advantage which is essentially when a business or a country has a complete upper hand over their rival;competitive advantage is far more particular: it is when a business/country has a certain aspect or entity that gives them anupper hand over its rivals.