Exporting, Importing, and Countertrade

Exporting, Importing, and Countertrade
13 chapter Exporting, Importing, and Countertrade McGraw-Hill/Irwin Global Business Today, 5e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Chapter 13: Exporting, Importing, and Countertrade
INTRODUCTION Both large and small firms stand to benefit from exporting The volume of export activity in the world economy is increasing as exporting has become easier The decline in trade barriers under the WTO along with regional economic agreements such as the European Union and the North American Free Trade Agreement have increased export opportunities Firms wishing to export must identify export opportunities, avoid a host of unanticipated problems that are often associated with doing business in a foreign market, become familiar with the mechanics of export and import financing , learn where to get financing and export credit insurance, and learn how to deal with foreign exchange risk Internet Extra: Exporting is often the first step in a company’s international expansion. Some companies may feel that while opportunities for exporting exist, they are not ready to begin the process themselves. Export. Gov { offers a site where companies can explore their export readiness. Go to the site and click on Are You Export Ready. This will bring you to an online quiz where you can see some of the questions a firm should answer prior to beginning the export process. Take the quiz using either an imaginary company as your basis, or a company that you are familiar with. What do your results tell you? How might you help your company be a successful exporter?

THE PROMISE AND PITFALLS OF EXPORTING The potential benefits from exporting can be great--the rest of the world is a much larger market than the domestic market Larger firms may be proactive in seeking out new export opportunities, but many smaller firms are reactive and only pursue international opportunities when the customer calls or knocks on the door Many novice exporters have run into significant problems when first trying to do business abroad, souring them on following up on subsequent opportunities

Common pitfalls include: poor market analysis poor understanding of competitive conditions lack of customization for local markets, poor distribution arrangements, bad promotional campaigns a general underestimation of the differences and expertise required for foreign market penetration The tremendous paperwork and formalities that must be dealt with can be also be overwhelming for exporters.

IMPROVING EXPORT PERFORMANCE An International Comparison One big impediment to exporting is the simple lack of knowledge of the opportunities available The way to overcome ignorance is to collect information Both Germany and Japan have developed extensive institutional structures or promoting exports Japanese exporters can also take advantage of the knowledge and contacts of sogo shosha, the country’s great trading houses

Information Sources The most comprehensive source of information for U.S. firms to increase their awareness of export opportunities is the U.S. Department of Commerce

Utilizing Export Management Companies Export management companies are export specialists that act as the export marketing department or international department for client firms. EMCs normally accept two types of export assignments: they start exporting operations for a firm with the understanding that the firm will take over operations after they are well established they start services with the understanding that the EMC will have continuing responsibility for selling the firm’s products The advantage of EMCs is that they are experienced specialists who can help the neophyte exporter identify opportunities and avoid common pitfalls However, there is a large variation in the quality of EMCs, so a careful review of a number of companies should be conducted Management Focus: Exporting with a Little Government Help Summary This feature describes the challenges faced by small firms as they seek to expand their sales through exports. The case notes that there are a number of agencies, institutions, and export management companies that provide assistance to small exporters. The following questions can be helpful in directing the discussion. Suggested Discussion Questions 1. Foreign market expansion can be a daunting prospect, especially for a small company with no international experience. Discuss how Novi, Inc became such a success story in such a short time. What lessons can other companies learn from Novi’s experiences? 2. As a small business owner facing saturated domestic markets, how would you approach foreign markets? Develop a strategic plan outlining how you would research markets, get your product to potential customers, handle the financing side of the business, and grow your sales. Include information on what resources are available to help with this process.

Export Strategy Firms can reduce the risks associated with exporting if they are careful about their choice of exporting strategy. It helps to hire an EMC, or at least an experienced export consultant, to help with the identification of opportunities and navigate through the tangled web of paperwork and regulations so often involved in exporting It often makes sense to initially focus on one, or a few, markets It may make sense to enter a foreign market on a fairly small scale in order to reduce the costs of any subsequent failures Management Focus: Exporting Strategy at 3M Summary This feature explores the Minnesota Mining and Manufacturing Company’s (3M) export strategy. 3M generates more than half its revenues from outside the U.S. The company often uses exports to establish an initial presence in a foreign market, only building foreign production facilities once sales volume rises to a level where local production is justified. Discussion of the feature can begin with the following questions. Suggested Discussion Questions 1. Discuss why 3M initially enters on a small scale. How does the firm’s strategy fit with the philosophy that exporting is not an end in itself, but merely a step on the road toward establishment of foreign production? 2. Explain the three principles that make 3M so successful. Why was it important for 3M to hire local personnel?

The exporter needs to recognize the time and managerial commitment involved in building export sales, and should hire additional personnel to oversee this activity In many countries it is important to devote a lot of attention to building strong and enduring relationships with local distributors and customers It is important to hire local personnel to help the firm establish itself in a foreign market It is important for the exporter to keep the option of local production in mind Management Focus: Red Spot Paint Varnish Summary This feature focuses on Red Spot paint Varnish, a company that produces paints for plastic components used in automobiles. The company relies on foreign markets for some 15-25% of its annual revenue. Generating its foreign sales has not been an easy task according to one employee. The company has found it difficult to hire managers with appropriate international experience and has also struggled with pressures to achieve quick results. The following questions provide a starting point for discussion of this feature. Suggested Discussion Questions 1. How has the Internet made it easier for companies to not only get export assistance but also to find the experienced talent necessary to build an international staff? How has Red Spot Paint been able to capitalize on foreign market opportunities while similar competitors have not? 2. In an era of “time is money,” how can the trusting relationships that are so often critical to the success of a foreign venture be achieved? How important was the establishment of trust between Red Spot Paint and its local distributors and customers to the success of the company?

EXPORT AND IMPORT FINANCING Mechanisms for financing exports and imports have evolved over the centuries in response to a problem that can be particularly acute in international trade: the lack of trust that exists when one must put faith in a stranger.

Lack of Trust Firms engaged in international trade have to trust someone who may be very difficult to track down if they default on an obligation Due to the lack of trust, each party to an international transaction has a different set of preferences regarding the configuration of the transaction The problems arising from a lack of trust between exporters and importers can be solved by using a third party who is trusted by both - normally a reputable bank

Letter of Credit A letter of credit is issued by a bank at the request of an importer and states the bank will pay a specified sum of money to a beneficiary, normally the exporter, on presentation of particular, specified documents

Draft A draft, also called a bill of exchange, is the instrument normally used in international commerce for payment A draft is simply an order written by an exporter instructing an importer, or an importer's agent, to pay a specified amount of money at a specified time A sight draft is payable on presentation to the drawee while a time draft allows for a delay in payment - normally 30, 60, 90, or 120 days

Bill of Lading The bill of lading is issued to the exporter by the common carrier transporting the merchandise. It serves three purposes: it is a receipt it is a contract it is a document of title

Classroom Performance System An order written by an exporter instructing an importer to pay a specified amount of money at a specified time is A letter of credit A draft A bill of lading A confirmed letter of credit Classroom Performance System Answer: b

A Typical International Transaction The entire process for conducting an export transaction is summarized in Figure 13.4.

Classroom Performance System A bill of lading serves all of the following purposes except It is a receipt It is a contract It is a document of title It is a form of payment Classroom Performance System Answer: d

EXPORT ASSISTANCE Prospective U.S. exporters can draw on two forms of government-backed assistance to help their export programs: they can get financing aid from the Export-Import Bank they can get export credit insurance from the Foreign Credit Insurance Association

Export-Import Bank The Export-Import Bank (Eximbank) is an independent agency of the U.S. government Its mission is to provide financing aid that will facilitate exports, imports, and the exchange of commodities between the U.S. and other countries Export Credit Insurance In the U.S., export credit insurance is provided by the Foreign Credit Insurance Association (FICA) FICA provides coverage against commercial risks and political risks

Countertrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent Countertrade refers to a range of barterlike agreements that facilitate the trade of goods and services for other goods and services when they cannot be traded for money

The Incidence of Countertrade Countertrade arose in the 1960s as a way for the Soviet Union and the Communist states of Eastern Europe, whose currencies were generally nonconvertible, to purchase imports During the 1980s, the technique grew in popularity among many developing nations that lacked the foreign exchange reserves required to purchase necessary imports There was a notable increase in the volume of countertrade after the Asian financial crisis of 1997

Types of Countertrade Countertrade can be categorized into five distinct types of trading arrangements: barter counterpurchase offset switch trading compensation or buyback

Barter Barter is a direct exchange of goods and/or services between two parties without a cash transaction Barter is the most restrictive countertrade arrangement It is used primarily for one-time-only deals in transactions with trading partners who are not creditworthy or trustworthy Counterpurchase Counterpurchase is a reciprocal buying agreement It occurs when a firm agrees to purchase a certain amount of materials back from a country to which a sale is made

Offset Offset is similar to counterpurchase insofar as one party agrees to purchase goods and services with a specified percentage of the proceeds from the original sale The difference is that this party can fulfill the obligation with any firm in the country to which the sale is being made

Switch Trading Switch trading refers to the use of a specialized third-party trading house in a countertrade arrangement When a firm enters a counterpurchase or offset agreement with a country, it often ends up with what are called counterpurchase credits, which can be used to purchase goods from that country Switch trading occurs when a third-party trading house buys the firm’s counterpurchase credits and sells them to another firm that can better use them

Compensation or Buybacks A buyback occurs when a firm builds a plant in a country—or supplies technology, equipment, training, or other services to the country—and agrees to take a certain percentage of the plant’s output as a partial payment for the contract

Classroom Performance System The use of a specialized third-party trading house in a countertrade arrangement is called Buyback Offset Counterpurchase Switch trading Classroom Performance System Answer: d

The Pros and Cons of Countertrade Countertrade’s main advantage is that it can give a firm a way to finance an export deal when other means are not available If a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement A countertrade arrangement may be required by the government of a country to which a firm is exporting goods or services

The drawbacks of countertrade are substantial: countertrade contracts may involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profitably countertrade is most attractive to large, diverse multinational enterprises that can use their worldwide network of contacts to dispose of goods acquired in countertrading

Classroom Performance System Which of the following is not an advantage of countertrade? It may involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profitably It can give a firm a way to finance an export deal when other means are not available It can be a strategic marketing weapon It can give a firm an advantage over firms that are unwilling to engage in countertrade arrangements Classroom Performance System Answer: a

CRITICAL THINKING AND DISCUSSION QUESTIONS 1. A firm based in Washington State wants to export a shipload of finished lumber to the Philippines. The would-be importer cannot get sufficient credit from domestic sources to pay for the shipment but insists that the finished lumber can be quickly resold in the Philippines for a profit. Outline the steps the exporter should take to effect this export to the Philippines. Answer: The exporter should recommend to the importer that the importer apply to Eximbank for a loan. Eximbank has a direct lending operation under which it lends dollars to foreign borrowers for use in purchasing U.S. exports. The foreign borrowers use the loans to pay U.S. suppliers and repay the loan to Eximbank with interest.

CRITICAL THINKING AND DISCUSSION QUESTIONS 2. You are the assistant to the CEO of a small textile firm that manufactures high-quality, premium-priced, stylish clothing. The CEO has decided to see what the opportunities are for exporting and has asked you for advice as to the steps the company should take. What advice would you give the CEO? Answer: This question is designed to stimulate classroom discussion and/or to encourage your students to “think” about the export process in completing a written answer for this question. There are a number of approaches that can be pursued in answering this question. The first step might be to tap into some of the government information sources that are available, free of charge, to see if international markets are available for the company’s product. There are also a number of resources on the Internet, mentioned throughout the text that can assist companies in learning about the foreign market potential of their products. Another approach would be to contact an export management company for assistance. While this approach may involve some cost, it may be the fastest way to get “up and running” in regard to initiating an export program.

CRITICAL THINKING AND DISCUSSION QUESTIONS 3. An alternative to using a letter of credit is export credit insurance. What are the advantages and disadvantages of using export credit insurance rather than a letter of credit for exporting (a) a luxury yacht from California to Canada, and (b) machine tools from New York to the Ukraine? Answer: Exporters prefer to get letters of credit from importers. However, when the importer is in a strong bargaining position and able to play competing suppliers off against each other, an exporter may have to forgo a letter of credit. The lack of a letter of credit exposes the exporter to the risk that the foreign importer will default on payment. The exporter can insure against this possibility by buying export credit insurance. Students may suggest that in the case of the luxury yacht, should the importer fail to make payment, the clearly defined laws of Canada would make it easier to go after the importer than would be the case with the machine tools in the Ukraine, and that therefore a letter of credit is less important for the yacht exporter. On the other hand, students may note that there is probably more competition in machine tools as compared to luxury yachts and that the exporter of machine tools may lose the sale if the exporter insists on a letter of credit.

CRITICAL THINKING AND DISCUSSION QUESTIONS 4. How do you explain the popularity of countertrade? Under what scenarios might its popularity increase still further by the year 2010? Under what scenarios might its popularity decline? Answer: This question requires students to speculate on the future state of global trade. As trade between developing and developed countries, and trade among developing countries continues to grow, many students will predict that the popularity of countertrade will increase by the year Some students may predict a decline in the popularity of countertrade by 2010 as countries from the former Soviet Union and Eastern European Communist bloc either become members of the EU an adopt the fully convertible euro as their currency, or develop their own fully convertible currency.

CRITICAL THINKING AND DISCUSSION QUESTIONS 5. How might a company make strategic use of countertrade schemes as a marketing weapon to generate export sales revenues? What are the risks associated with pursuing such a strategy? Answer: Counterrtrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent. The governments of developing countries sometimes insist on a certain amount of countertrade. Thus, if a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement. Companies that are willing to entertain countertrade as a means of financing, will have an advantage over those firms that prefer traditional forms of financing. Firms engaging in countertrade must be willing to invest in an in-house trading department dedicated to arranging and managing countertrade deals, and must be aware of the quality of the products received in countertrade deals.

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