Lack of Trust - Discussion Assignment

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14-1 Explain the promises and risks associated with exporting.

14-2 Identify the steps managers can take to improve their firm’s export performance.

14-3 Identify information sources and government programs that exist to help exporters.

14-4 Recognize the basic steps involved in export financing.

14-5 Describe how countertrade can be used to facilitate exporting.

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I t is a little know fact that small firms comprise the majority of U.S. exporters. Business with fewer than 500 employees made up 97 percent of all U.S. exporters in 2012 according the U.S. Census Bureau. These small businesses generated $460 billion in foreign sales in 2012, an increase of $10 billion over 2011. In

total, companies with less than 500 employees accounted for 34 percent of all U.S. exports by value in 2012. Despite this, there is still significant room for growth. Only about 5 percent of small businesses actu- ally export.

One company that has illustrated the power of exporting for a small business is Sono-Tek Corp, a developer of ultrasonic spray coating technology in Milton, New York. Sono-Tek’s primary overseas customers include contract manufacturers for electronic and medical equipment firms. Some $6 million of Sono-Tek’s annual revenues now come from exports to customers in Europe, Southeast Asia, and Latin America. Sono-Tek’s CEO, Chris Coccio, believes that without exporting the company would be one-third of its current size.

Another New York company, Vision Quest Lighting, has had a similar experience. Vision Quest Lighting, which has around 30 employees, makes decorative lighting for retail chains, including Limited Brands, Ann Taylor, and Abercrombie and Fitch. As these brands expanded their international presence, Vision Quest Lighting grew with them. According to the company’s management, its international exposure helped the company to survive in the recessionary years of 2008–2009 when demand in the United States was very soft. Looking forward, Vision Quest Lighting sees great growth opportunities in China, where it has recently established a factory to produce products for the local market.

Both of these companies have found exporting to be challenging. Sono-Tek’s Chris Coccio notes that his biggest worries include recruiting foreign staff that understand the local market, the costs of business travel, problems associated with communicating with far-flung clients, and getting paid. He is not alone in this last worry. According to the Small Business Exporters Association, getting paid can be a major headache. In a recent survey conducted by the Association, 41 percent of respondents indicated that they worried about getting paid. The association urges small exporters to work with banks and to make sure

Growing Through Exports

Exporting, Importing, and Countertrade

–continued

398 Part Six International Business Functions

that they get letters of credit from foreign importers before shipping goods or performing services.

At Vision Quest Lighting, management notes that being successfully requires a bilingual agent or foreign employee who understands the business system, lives in country, and can help the foreign company to navigate its way through a culturally challenging environment. There is no substitute, according to the company, for someone with his or her feet on the ground who understands the local business culture. In Vision Quests’ case, for example, their business in China did not start to take off until they hired a local Chinese employee. • Sources: R. Colvin, “The Cost of Expanding Overseas,” The Wall Street Journal, February 26, 2014; John Grossman, “New Path for Trade: Selling in China,” The New York Times, January 23, 2013; and N. Levy, “LI Lighting Firm Learns the Ropes in China,” Newsday, October 20, 2013.

Introduction The previous chapter reviewed exporting from a strategic perspective. We considered exporting as just one of a range of strategic options for profiting from international expansion. This chapter is more concerned with the nuts and bolts of exporting (and importing). It looks at how to export. As the opening case makes clear, exporting is not just for large enter- prises; many small firms such as Sono-Tek and Vision Quest Lighting have benefited sig- nificantly from the moneymaking opportunities of exporting.

The volume of export activity in the world economy has increased as exporting has be- come easier. The gradual decline in trade barriers under the umbrella of GATT and now the WTO (see Chapter 7) along with regional economic agreements such as the European Union and the North American Free Trade Agreement (see Chapter 9) have significantly increased export opportunities. At the same time, modern communication and transporta- tion technologies have alleviated the logistical problems associated with exporting. Over the last two decades firms have increasingly used the Internet, toll-free phone numbers, and international air express services to reduce the costs of exporting. Consequently, it is not unusual to find thriving exporters among small companies.

Nevertheless, exporting remains a challenge for many firms. Smaller enterprises can find the process intimidating. The firm wishing to export must identify foreign market opportu- nities, avoid a host of unanticipated problems that are often associated with doing business in a foreign market, familiarize itself with the mechanics of export and import financing, learn where it can get financing and export credit insurance, and learn how it should deal with foreign exchange risk. The process can be made more problematic by currencies that are not freely convertible. Arranging payment for exports to countries with weak currencies can be a problem. Countertrade allows payment for exports to be made through goods and services rather than money. This chapter discusses all these issues with the exception of for- eign exchange risk, which was covered in Chapter 10. The chapter opens by considering the promise and pitfalls of exporting.

The Promise and Pitfalls of Exporting The great promise of exporting is that large revenue and profit opportunities are to be found in foreign markets for most firms in most industries. This was true for both Sono-Tek Corp. and Vision Quest Lighting in the opening case. The international market is normally so much larger than the firm’s domestic market that exporting is nearly always a way to increase the revenue and profit base of a company. By expanding the size of the market, exporting can enable a firm to achieve economies of scale, thereby lowering its unit costs.

LO 14-1 Explain the promises and risks associated with exporting.

Chapter Fourteen Exporting, Importing, and Countertrade 399

Firms that do not export often lose out on significant opportunities for growth and cost reduction.1

Consider the case of Marlin Steel Wire Products, a Baltimore manufacturer of wire bas- kets and fabricated metal items with revenues of about $5 million. Among its products are baskets to hold dedicated parts for aircraft engines and automobiles. Its engineers design custom wire baskets for the assembly lines of companies such as Boeing and Toyota. It has a reputation for producing high-quality products for these niche markets. Like many small businesses, Marlin did not have a history of exporting. However, in the mid-2000s, Marlin dipped its toe in the export market, shipping small numbers of products to Mexico and Canada. Marlin CEO Drew Greenblatt soon realized that export sales could be the key to growth. In 2008, when the global financial crisis hit and America slid into a serious recession, Marlin was exporting only 5 percent of its orders to foreign markets. Greenblatt’s strategy for dealing with weak demand from the United States was to aggressively expand international sales. By 2010, exports accounted for 17 percent of sales, and the company had set a goal of exporting half its output.2

Despite examples such as SteelMaster and Marlin, studies have shown that while many large firms tend to be proactive about seeking opportunities for profitable exporting— systematically scanning foreign markets to see where the opportunities lie for leveraging their technology, products, and marketing skills in foreign countries—many medium- size and small firms are very reactive.3 Typically, such reac- tive firms do not even consider exporting until their domestic market is saturated and the emergence of excess productive capacity at home forces them to look for growth opportunities in foreign markets. Also, many small and me- dium-size firms tend to wait for the world to come to them, rather than going out into the world to seek opportunities. Even when the world does come to them, they may not re- spond. An example is MMO Music Group, which makes sing-along tapes for karaoke machines. Foreign sales accounted for about 15 percent of MMO’s revenues of $8! million, but the firm’s CEO admits this figure would probably have been much higher had he paid attention to building international sales. Unanswered e-mails and phone messages from Asia and Europe often piled up while he was trying to manage the burgeoning domestic side of the busi- ness. By the time MMO did turn its attention to foreign markets, competitors had stepped into the breach, and MMO found it tough going to build export volume.4

Export Tutorials

Exporting, importing, and countertrade are the focus areas of Chapter 14. The exporting entry mode choice, also discussed in Chapter 13, is the most often used way to conduct cross-border trade for compa- nies. The vast majority of small and medium-sized enterprises, for example, use exporting as their way to expand to international mar- kets. But that begs the question of whether the company is ready to export and whether the product the company plans to export is ready to be exported. The “Export Tutorials” section of globalEDGE (http:// globaledge.msu.edu/reference-desk/export-tutorials) includes CORE

as a diagnostic tool to assess “company readiness to export.” The Export Tutorial section also has a lengthy set of questions and answers to the most common exporting-related questions in the cat- egories of government regulations, financial considerations, sales and marketing, and logistics. For example, one question deals with whether a company needs a license to export. Assume you are based in the United States. How can you identify the relevant commodity jurisdiction for a product?

For Which Product Is Autarky a Good Choice for Countries? The word autarky refers to the quality and belief that a country should be self-sufficient and avoid trade and/or external assis- tance with other nations. Many economists regard autarky as an idealistic, but impractical, goal of countries. Basically, it sounds like a nice idea to be self-sufficient and practice autarky. In real- ity, throughout history countries have tried to achieve autarky but soon discovered they could not produce the wide range of products and services customers in their population want and need. These countries also found out that manufacturing prod- ucts at competitive prices over the long term became a daunting task. In fact, those countries found themselves worse off eco- nomically than nations that engaged in international trade. So, a word to the wise; unless your country can efficiently produce everything it needs, the country needs to engage in international trade. A more logical and achievable possibility is to perhaps fo- cus on being self-sufficient in certain areas, for certain products or services. Which product or service do you think a country should strive to be self-sufficient in?

Source: J. Heathcote, “Financial Autarky and International Business Cycles,” Journal of Monetary Economics 49, no. 3 (2002), pp. 601-627.

400 Part Six International Business Functions

MMO’s experience is common, and it suggests a need for firms to become more proac- tive about seeking export opportunities. One reason more firms are not proactive is that they are unfamiliar with foreign market opportunities; they simply do not know how big the opportunities actually are or where they might lie. Simple ignorance of the potential opportunities is a huge barrier to exporting.5 Also, many would-be exporters, particularly smaller firms, are often intimidated by the complexities and mechanics of exporting to countries where business practices, language, culture, legal systems, and currency are very different from the home market.6 This combination of unfamiliarity and intimidation probably explains why exporters still account for only a tiny percentage of U.S. firms, less than 5 percent of firms with fewer than 500 employees, according to the Small Business Administration.7

To make matters worse, many neophyte exporters run into significant problems when first trying to do business abroad, and this sours them on future exporting ventures. Com- mon pitfalls include poor market analysis, a poor understanding of competitive conditions in the foreign market, a failure to customize the product offering to the needs of foreign customers, a lack of an effective distribution program, a poorly executed promotional cam- paign, and problems securing financing.8 Novice exporters tend to underestimate the time and expertise needed to cultivate business in foreign countries.9 Few realize the amount of management resources that have to be dedicated to this activity. Many foreign customers require face-to-face negotiations on their home turf. An exporter may have to spend months learning about a country’s trade regulations, business practices, and more before a deal can be closed. The accompanying Management Focus, which documents the experience of FCX

FCX Systems

Founded with the help of a $20,000 loan from the Small Business Ad- ministration, FCX Systems is an exporting success story. FCX makes power converters for the aerospace industry. These devices convert common electric utility frequencies into the higher frequencies used in aircraft systems and are primarily used to provide power to aircraft while they are on the ground. Today, the West Virginia enterprise gener- ates more than half its annual sales from exports to more than 75 countries. FCX’s prowess in opening foreign markets has earned the company several awards for export excellence, including a presidential award for achieving extraordinary growth in export sales.

FCX initially got into exporting because it found that foreigners were often more receptive to the company’s products than potential American customers. According to Don Gallion, president of FCX, “In the overseas market, they were looking for a good technical product, preferably made in the U.S., but they weren’t asking questions about ‘How long have you been in business? Are you still going to be here tomorrow?’ They were just anxious to get the product.”

In 1989, shortly after it had been founded, FCX signed on with an international distribution company to help with exporting, but Gallion became disillusioned with that company, and in 1994 FCX started to handle the exporting process on its own. At the time, exports repre- sented 12 percent of sales, but by 1997 they had jumped to more than 50 percent of the total, where they have stayed since.

In explaining the company’s export success, Gallion cites a number of factors. One was the extensive assistance that FCX has received over the years from a number of federal and state agencies, including

the U.S. Department of Commerce and the Development Office of West Virginia. These agencies demystified the process of exporting and pro- vided good contacts for FCX. Finding a good local representative to help work through local regulations and customs is another critical fac- tor, according to Gallion, who says, “A good rep will keep you out of trouble when it comes to customs and what you should and shouldn’t do.” Persistence is also very important, says Gallion, particularly when trying to break into markets where personal relationships are crucial, such as China.

China has been an interesting story for FCX. The company has been booking $2 million to $3 million in sales to China, but it took years to get to this point. China had been on Gallion’s radar screen since the early 1990s, primarily because of the country’s rapid modernization and its plans to build or remodel almost 200 airports. This constituted a poten- tially large market opportunity for FCX, particularly compared with the United States, where perhaps only three new airports would be built during the same period. Despite the scale of the opportunity, progress was very slow. The company had to identify airports and airline projects, government agencies, customers, and decision makers, as well as work through different languages—and make friends. According to Gallion, “Only after they consider you a friend will they buy a product. They be- lieve a friend would never cheat you.” To make friends in China, Gallion estimates he had to make more than 100 trips to China, but now that the network has been established, it is starting to pay dividends.

Sources: J. Sparshott, “Businesses Must Export to Compete,” The Washington Times, September 1, 2004, p. C8; “Entrepreneur of the Year 2001: Donald Gallion, FCX Systems,” The State Journal, June 18, 2001, p. S10; and T. Pierro, “Exporting Powers Growth of FCX Systems,” The State Journal, April 6, 1998, p. 1.

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Chapter Fourteen Exporting, Importing, and Countertrade 401

Systems in China, suggests that it may take years before foreigners are comfortable enough to purchase in significant quantities.

Exporters often face voluminous paperwork, complex formalities, and many potential delays and errors. According to a UN report on trade and development, a typical interna- tional trade transaction may involve 30 parties, 60 original documents, and 360 document copies, all of which have to be checked, transmitted, reentered into various information systems, processed, and filed. The United Nations has calculated that the time involved in preparing documentation, along with the costs of common errors in paperwork, often amounts to 10 percent of the final value of goods exported.10

Improving Export Performance Inexperienced exporters have a number of ways to gain information about foreign market opportunities and avoid common pitfalls that tend to discourage and frustrate novice ex- porters.11 In this section, we look at information sources for exporters to increase their knowledge of foreign market opportunities, we consider the pros and cons of using export management companies (EMCs) to assist in the export process, and we review various ex- porting strategies that can increase the probability of successful exporting. We begin, how- ever, with a look at how several nations try to help domestic firms export.

AN INTERNATIONAL COMPARISON One big impediment to exporting is the simple lack of knowledge of the opportunities available. Often, there are many markets for a firm’s product, but because they are in countries separated from the firm’s home base by culture, language, distance, and time, the firm does not know of them. Identifying export opportunities is made even more complex because more than 200 countries with widely dif- fering cultures compose the world of potential opportunities. Faced with such complexity and diversity, firms sometimes hesitate to seek export opportunities.

The way to overcome ignorance is to collect information. In Germany—one of the world’s most successful exporting nations—trade associations, government agencies, and commercial banks gather information, helping small firms identify export opportunities. A similar function is provided by the Japanese Ministry of International Trade and Industry (MITI), which is always on the lookout for export opportunities. In addition, many Japanese firms are affiliated in some way with the sogo shosha, Japan’s great trading houses. The sogo shosha have offices all over the world, and they proactively, continuously seek export oppor- tunities for their affiliated companies large and small.12

German and Japanese firms can draw on the large reservoirs of experience, skills, infor- mation, and other resources of their respective export-oriented institutions. Unlike their German and Japanese competitors, many U.S. firms are relatively blind when they seek export opportunities; they are information-disadvantaged. In part, this reflects historical dif- ferences. Both Germany and Japan have long made their living as trading nations, whereas until recently the United States has been a relatively self-contained continental economy in which international trade played a minor role. This is changing; both imports and exports now play a greater role in the U.S. economy than they did 20 years ago. However, the United States has not yet evolved an institutional structure for promoting exports similar to that of either Germany or Japan.

INFORMATION SOURCES Despite institutional disadvantages, U.S. firms can increase their awareness of export opportunities. The most comprehensive source of infor- mation is the U.S. Department of Commerce and its district offices all over the country. Within that department are two organizations dedicated to providing businesses with intel- ligence and assistance for attacking foreign markets: the International Trade Administration and the U.S. Commercial Service.

Those agencies provide the potential exporter with a “best prospects” list, which gives the names and addresses of potential distributors in foreign markets along with businesses they are in, the products they handle, and their contact person. In addition, the Department of

LO 14-2 Identify the steps managers can take to improve their firm’s export performance.

LO 14-3 Identify information sources and government programs that exist to help exporters.

MITI Japan’s Ministry of International Trade and Industry.

Sogo Shosha Japanese trading companies; a key part of the keiretsu, the large Japanese industrial groups.

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402 Part Six International Business Functions

Commerce has assembled a “comparison shopping ser- vice” for 14 countries that are major markets for U.S. ex- ports. For a small fee, a firm can receive a customized market research survey on a product of its choice. This survey provides information on marketability, the compe- tition, comparative prices, distribution channels, and names of potential sales representatives. Each study is conducted on-site by an officer of the Department of Commerce.

The Department of Commerce also organizes trade events that help potential exporters make foreign contacts and explore export opportunities. The department orga- nizes exhibitions at international trade fairs, which are held regularly in major cities worldwide. The department also has a matchmaker program, in which department rep- resentatives accompany groups of U.S. businesspeople abroad to meet with qualified agents, distributors, and customers.

Another government organization, the Small Business Administration (SBA), can help potential exporters (see the accompanying Management Focus for examples of the SBA’s work). The SBA employs 76 district interna- tional trade officers and 10 regional international trade officers throughout the United States as well as a 10-person international trade staff in Washington, D.C. Through its Service Corps of Retired Executives (SCORE) pro-

gram, the SBA also oversees some 11,500 volunteers with international trade experience to provide one-on-one counseling to active and new-to-export businesses. The SBA also co- ordinates the Export Legal Assistance Network (ELAN), a nationwide group of interna- tional trade attorneys who provide free initial consultations to small businesses on export-related matters.

In addition to the Department of Commerce and SBA, nearly every state and many large cities maintain active trade commissions whose purpose is to promote exports. Most of these provide business counseling, information gathering, technical assistance, and financing. Un- fortunately, many have fallen victim to budget cuts or to turf battles for political and finan- cial support with other export agencies.

A number of private organizations are also beginning to provide more assistance to would-be exporters. Commercial banks and major accounting firms are more willing to as- sist small firms in starting export operations than they were a decade ago. In addition, large multinationals that have been successful in the global arena are typically willing to discuss opportunities overseas with the owners or managers of small firms.13

UTILIZING EXPORT MANAGEMENT COMPANIES One way for first-time exporters to identify the opportunities associated with exporting and to avoid many of the associated pitfalls is to hire an export management company (EMC). EMCs are export specialists that act as the export marketing department or international department for their 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. In another type, start-up services are per- formed with the understanding that the EMC will have continuing responsibility for sell- ing the firm’s products. Many EMCs specialize in serving firms in particular industries and in particular areas of the world. Thus, one EMC may specialize in selling agricultural products in the Asian market, while another may focus on exporting electronics products to eastern Europe.

In theory, the advantage of EMCs is that they are experienced specialists that can help the neophyte exporter identify opportunities and avoid common pitfalls. A good EMC

LO 14-2 Identify the steps managers can take to improve their firm’s export performance.

Export Management Company (EMC) Export specialists who act as an export marketing department for client firms.

Is Chinese Exporting the Next Edge for the Country? With hundreds of television sets stacked high, Changhong Elec- tronics’ warehouse in Shunde resembles many other storage depots in southern China, but their destinations reveal an impor- tant shift in global trade patterns. While Changhong’s smaller sets are headed for Europe, its 50-inch plasma screens, which domi- nate the warehouse, will be shipped to South Africa. Fast growth in developing countries and sluggish Western economies are prompting these companies to abandon their obsession with the United States and Europe and to try and capitalize on rapidly growing markets in Asia, Africa, and Latin America. The so-called China price—a vastly lower price because of low labor costs and the low cost of capital for large government-owned companies— now applies to industrial goods, not just consumer goods. Experts believe that cheap Chinese exports could provide a boost to in- vestment in the developing world, just as they once did to con- sumption in the developed world. Can China boost investment in the developing world and also boost its own economy?

Source: R. Jacob, “Chinese Exporters Seek New Markets,” Financial Times, June 12, 2012.

Chapter Fourteen Exporting, Importing, and Countertrade 403

Exporting with a Little Government Help

Exporting can seem like a daunting prospect, but the reality is that in the United States, as in many other countries, many small enterprises have built profitable export businesses. For example, Landmark Sys- tems of Virginia had virtually no domestic sales before it entered the European market. Landmark had developed a software program for IBM mainframe computers and located an independent distributor in Europe to represent its product. In the first year, 80 percent of sales were attributed to exporting. In the second year, sales jumped from $100,000 to $1.4 million—with 70 percent attributable to exports. Landmark is not alone; government data suggest that in the United States, more than 97! percent of the 240,000 firms that export are small or medium-size businesses that employ fewer than 500 people. Their share of total U.S. exports has grown steadily and is around 30!percent today.

To help jump-start the exporting process, many small companies have drawn on the expertise of government agencies, financial institu- tions, and export management companies. Consider the case of Novi Inc., a California-based business. Company President Michael Stoff tells how he utilized the services of the U.S. Small Business Adminis- tration (SBA) Office of International Trade to start exporting:

“When I began my business venture, Novi Inc., I knew that my Tune- Tote (a stereo system for bicycles) had the potential to be successful in international markets. Although I had no prior experience in this area, I began researching and collecting information on international markets. I was willing to learn, and by targeting key sources for information and guidance, I was able to penetrate international markets in a short period of time. One vital source I used from the beginning was the SBA. Through SBA I was directed to a program that dealt specifically with

business development—the Service Corps of Retired Executives (SCORE). I was assigned an adviser who had run his own import/export business for 30 years. The services of SCORE are provided on a contin- ual basis and are free.”

“As I began to pursue exporting, my first step was a thorough mar- keting evaluation. I targeted trade shows with a good presence of in- ternational buyers. I also went to DOC [Department of Commerce] for counseling and information about the rules and regulations of export- ing. I advertised my product in Commercial News USA, distributed through United States embassies to buyers worldwide. I utilized DOC’s World Traders Data Reports to get background information on poten- tial foreign buyers. As a result, I received 60–70 inquiries about Tune- Tote from around the world. Once I completed my research and evaluation of potential buyers, I decided which ones would be most suitable to market my product internationally. Then I decided to grant exclusive distributorship. In order to effectively communicate with my international customers, I invested in a fax. I chose a U.S. bank to handle international transactions. The bank also provided guidance on methods of payment and how best to receive and transmit money. This is essential know-how for anyone wanting to be successful in foreign markets.”

In just one year of exporting, export sales at Novi topped $1 million and increased 40 percent in the second year of operations. Today, Novi Inc. is a large distributor of wireless intercom systems that exports to more than 10 countries.

Sources: Small Business Administration Office of International Trade, “Guide to Exporting,” www.sba.gov/oit/info/Guide-ToExporting/index.html; U.S. Department of Commerce, “A Profile of U.S. Exporting Companies, 2000–2001,” February 2003, report available at www.census.gov/foreign-trade/aip/index.html#profile; and The 2007 National Exporting Strategy (Washington, DC: U.S. International Trade Commission, 2007).

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will have a network of contacts in potential markets, have multilingual employees, have a good knowledge of different business mores, and be fully conversant with the ins and outs of the exporting process and with local business regulations. However, the quality of EMCs varies.14 While some perform their functions very well, others appear to add little value to the exporting company. Therefore, an exporter should review carefully a number of EMCs and check references. One drawback of relying on EMCs is that the company can fail to develop its own exporting capabilities.

EXPORT STRATEGY In addition to using EMCs, a firm can reduce the risks as- sociated with exporting if it is careful about its choice of export strategy.15 A few guidelines can help firms improve their odds of success. For example, one of the most successful ex- porting firms in the world, 3M (originally, Minnesota Mining & Manufacturing Company), has built its export success on three main principles—enter on a small scale to reduce risks, add additional product lines once the exporting operations start to become successful, and hire locals to promote the firm’s products (3M’s export strategy is profiled in the accompa- nying Management Focus). Another successful exporter, Red Spot Paint & Varnish Com- pany, emphasizes the importance of cultivating personal relationships when trying to build an export business.

The probability of exporting successfully can be increased dramatically by taking a hand- ful of simple strategic steps. First, particularly for the novice exporter, it helps to hire an

LO 14-2 Identify the steps managers can take to improve their firm’s export performance.

404 Part Six International Business Functions

Export Strategy at 3M

3M, which makes more than 40,000 products including tape, sand- paper, medical products, and the ever-present Post-it notes, is one of the world’s great multinational operations. Today, more than 60!percent of the firm’s revenues are generated outside the United States. Although the bulk of these revenues came from foreign- based operations, 3M remains a major exporter with more than $2 billion in exports. The company often uses its exports to establish an initial presence in a foreign market, only building foreign production facilities once sales volume rises to a level that justifies local pro- duction.

The export strategy is built around simple principles. One is known as “FIDO,” which stands for first in (to a new market) defeats others. The essence of FIDO is to gain an advantage over other exporters by getting into a market first and learning about that country and how to sell there before others do. A second principle is “make a little, sell a little,” which is the idea of entering on a small scale with a very modest investment and pushing one basic product, such as reflective sheeting for traffic signs in Russia or scouring pads in Hungary. Once 3M believes it has learned enough about the market to reduce the risk of failure to reasonable levels, it adds additional products.

A third principle at 3M is to hire local employees to sell the firm’s products. The company normally sets up a local sales subsid- iary to handle its export activities in a country. It then staffs this

subsidiary with local hires because it believes they are likely to have a much better idea than American expatriates of how to sell in their own country. Because of the implementation of this principle, fewer than 200 of 3M’s 40,000-plus foreign employees are U.S. expatriates.

Another common practice at 3M is to formulate global strategic plans for the export and eventual overseas production of its prod- ucts. Within the context of these plans, 3M gives local managers considerable autonomy to find the best way to sell the product within their country. Thus, when 3M first exported its Post-it notes, it planned to “sample the daylights” out of the product, but it also told local managers to find the best way of doing this. Local managers hired office cleaning crews to pass out samples in Great Britain and Germany; in Italy, office products distributors were used to pass out free samples; while in Malaysia, local managers employed young women to go from office to office handing out samples of the prod- uct. In typical 3M fashion, when the volume of Post-it notes was sufficient to justify it, exports from the United States were replaced by local production. Thus, after several years, 3M found it worth- while to set up production facilities in France to produce Post-it notes for the European market.

Sources: R. L. Rose, “Success Abroad,” The Wall Street Journal, March 29, 1991, p. A1; T. Eiben, “US Exporters Keep On Rolling,” Fortune, June 14, 1994, pp. 128–31; 3M Company, A Century on Innovation, 3M, 2002; and 2005 10K form archived at 3M’s website at www.3m.com.

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EMC or at least an experienced export consultant to identify opportunities and navigate the paperwork and regulations so often involved in exporting. Second, it often makes sense to initially focus on one market or a handful of markets. Learn what is required to succeed in those markets before moving to other markets. The firm that enters many markets at once runs the risk of spreading its limited management resources too thin. The result of such a shotgun approach to exporting may be a failure to become established in any one market. Third, as with 3M, it often makes sense to enter a foreign market on a small scale to reduce the costs of any subsequent failure. Most important, entering on a small scale provides the time and opportunity to learn about the foreign country before making significant capital commitments to that market. Fourth, the exporter needs to recognize the time and managerial commitment involved in building export sales and should hire additional personnel to over- see this activity. Fifth, in many countries, it is important to devote a lot of attention to build- ing strong and enduring relationships with local distributors and/or customers. Sixth, as 3M often does, it is important to hire local personnel to help the firm establish itself in a foreign market. Local people are likely to have a much greater sense of how to do business in a given country than a manager from an exporting firm who has previously never set foot in that country. Seventh, several studies have suggested the firm needs to be proactive about seek- ing export opportunities.16 Armchair exporting does not work! The world will not normally beat a pathway to your door. Finally, it is important for the exporter to retain the option of local production. Once exports reach a sufficient volume to justify cost-efficient local pro- duction, the exporting firm should consider establishing production facilities in the foreign market. Such localization helps foster good relations with the foreign country and can lead to greater market acceptance. Exporting is often not an end in itself, but merely a step on the road toward establishment of foreign production (again, 3M provides an example of this philosophy).

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Chapter Fourteen Exporting, Importing, and Countertrade 405

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. In this section, we examine the financial devices that have evolved to cope with this problem in the context of international trade: the letter of credit, the draft (or bill of exchange), and the bill of lading. Then we trace the 14 steps of a typical export-import transaction.17

LACK OF TRUST Firms engaged in international trade have to trust someone they may have never seen, who lives in a different country, who speaks a different language, who abides by (or does not abide by) a different legal system, and who could be very difficult to track down if he or she defaults on an obligation. Consider a U.S. firm exporting to a dis- tributor in France. The U.S. businessman might be concerned that if he ships the products to France before he receives payment from the French businesswoman, she might take delivery of the products and not pay him. Conversely, the French importer might worry that if she pays for the products before they are shipped, the U.S. firm might keep the money and never ship the products or might ship defective products. Neither party to the exchange completely trusts the other. This lack of trust is exacerbated by the distance be- tween the two parties—in space, language, and culture—and by the problems of using an underdeveloped international legal system to enforce contractual obligations.

Due to the (quite reasonable) lack of trust between the two parties, each has his or her own preferences as to how the transaction should be configured. To make sure he is paid, the manager of the U.S. firm would prefer the French distributor to pay for the products before he ships them (see Figure 14.1). Alternatively, to ensure she receives the prod- ucts, the French distributor would prefer not to pay for them until they arrive (see Figure 14.2). Thus, each party has a different set of preferences. Unless there is some way of establishing trust between the parties, the transaction might never occur.

The problem is solved by using a third party trusted by both—normally a reputable bank—to act as an intermediary. What happens can be summarized as follows (see Fig- ure! 14.3). First, the French importer obtains the bank’s promise to pay on her behalf, knowing the U.S. exporter will trust the bank. This promise is known as a letter of credit. Having seen the letter of credit, the U.S. exporter now ships the products to France. Title to the products is given to the bank in the form of a document called a bill of lading. In return, the U.S. exporter tells the bank to pay for the prod- ucts, which the bank does. The document for requesting this

LO 14-4 Recognize the basic steps involved in export financing.

How Trusting Can You Be? In Chapter 14, we discuss the fact that firms that are engaged in international trade have to trust someone they may have never seen, who lives in a different country, who speaks a different lan- guage, who abides by (or does not abide by) a different legal sys- tem, and who could be very difficult to track down if he or she defaults on an obligation. Basically, there is a lot of potential for unknown issues to arise and for complications to happen given the lack of established trust between trading partners. With more than 200 countries in the world, lots of cultural values and be- liefs, and many potential avenues to run into complications, how much trust would you place on a relationship that (1)!involved an organization from a country like yours (e.g., Swedish people doing business with Danish people) or (2) involved an organiza- tion from a country very different from yours (e.g., a Canadian doing business with someone from Turkey)?

14.1 FIGURE Preference of the U.S. Exporter

French Importer American Exporter

2 Exporter Ships the Goods after Being Paid

1 Importer Pays for the Goods

406 Part Six International Business Functions

payment is referred to as a draft. The bank, having paid for the products, now passes the title on to the French importer, whom the bank trusts. At that time or later, depending on their agreement, the importer reimburses the bank. In the remainder of this section, we examine how this system works in more detail.

LETTER OF CREDIT A letter of credit, abbreviated as L/C, stands at the center of international commercial transactions. Issued by a bank at the request of an importer, the letter of credit states that the bank will pay a specified sum of money to a beneficiary, nor- mally the exporter, on presentation of particular, specified documents.

Consider again the example of the U.S. exporter and the French importer. The French importer applies to her local bank, say, the Bank of Paris, for the issuance of a letter of credit. The Bank of Paris then undertakes a credit check of the importer. If the Bank of Paris is satisfied with her creditworthiness, it will issue a letter of credit. However, the Bank of Paris might require a cash deposit or some other form of collateral from her first. In addition, the Bank of Paris will charge the importer a fee for this service. Typically this amounts to between 0.5 and 2 percent of the value of the letter of credit, depending on the importer’s creditworthiness and the size of the transaction. (As a rule, the larger the trans- action, the lower the percentage.)

Assume the Bank of Paris is satisfied with the French importer’s creditworthiness and agrees to issue a letter of credit. The letter states that the Bank of Paris will pay the U.S. exporter for the merchandise as long as it is shipped in accordance with specified instructions and conditions. At this point, the letter of credit becomes a financial con- tract between the Bank of Paris and the U.S. exporter. The Bank of Paris then sends the letter of credit to the U.S. exporter’s bank, say, the Bank of New York. The Bank of New York tells the exporter that it has received a letter of credit and that he can ship the merchandise. After the exporter has shipped the merchandise, he draws a draft against

Letter of Credit Issued by a bank, indicating that the bank will make payments under specific circumstances.

14.2 FIGURE Preference of the French Importer

French Importer American Exporter

2 Importer Pays after the Goods Are Received

1 Exporter Ships the Goods

14.3 FIGURE The Use of a Third Party

French Importer American Exporter

3 Exporter Ships “to the Bank,” Trusting Bank's Promise to Pay

1 Importer Obtains Bank's Promise to Pay on Importer's Behalf

Bank

2 Bank Promises Exporter to Pay on Behalf of Importer

5 Bank Gives Merchandise to Importer

4 Bank Pays Exporter

6 Importer Pays Bank

Chapter Fourteen Exporting, Importing, and Countertrade 407

the Bank of Paris in accordance with the terms of the letter of credit, attaches the re- quired documents, and presents the draft to his own bank, the Bank of New York, for payment. The Bank of New York then forwards the letter of credit and associated docu- ments to the Bank of Paris. If all the terms and conditions contained in the letter of credit have been complied with, the Bank of Paris will honor the draft and will send payment to the Bank of New York. When the Bank of New York receives the funds, it will pay the U.S. exporter.

As for the Bank of Paris, once it has transferred the funds to the Bank of New York, it will collect payment from the French importer. Alternatively, the Bank of Paris may allow the importer some time to resell the merchandise before requiring payment. This is not unusual, particularly when the importer is a distributor and not the final consumer of the merchandise, since it helps the importer’s cash flow. The Bank of Paris will treat such an extension of the payment period as a loan to the importer and will charge an appropriate rate of interest.

The great advantage of this system is that both the French importer and the U.S. ex- porter are likely to trust reputable banks, even if they do not trust each other. Once the U.S. exporter has seen a letter of credit, he knows that he is guaranteed payment and will ship the merchandise. Also, an exporter may find that having a letter of credit will facili- tate obtaining pre-export financing. For example, having seen the letter of credit, the Bank of New York might be willing to lend the exporter funds to process and prepare the merchandise for shipping to France. This loan may not have to be repaid until the ex- porter has received his payment for the merchandise. As for the French importer, she does not have to pay for the merchandise until the documents have arrived and unless all con- ditions stated in the letter of credit have been satisfied. The drawback for the importer is the fee she must pay the Bank of Paris for the letter of credit. In addition, because the letter of credit is a financial liability against her, it may reduce her ability to borrow funds for other purposes.

DRAFT A draft, sometimes referred to as a bill of exchange, is the instrument nor- mally used in international commerce to effect 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. In the example of the U.S. exporter and the French importer, the exporter writes a draft that instructs the Bank of Paris, the French importer’s agent, to pay for the merchandise shipped to France. The person or business initiating the draft is known as the maker (in this case, the U.S. exporter). The party to whom the draft is presented is known as the drawee (in this case, the Bank of Paris).

International practice is to use drafts to settle trade transactions. This differs from do- mestic practice in which a seller usually ships merchandise on an open account, followed by a commercial invoice that specifies the amount due and the terms of payment. In domestic transactions, the buyer can often obtain possession of the merchandise without signing a formal document acknowledging his or her obligation to pay. In contrast, due to the lack of trust in international transactions, payment or a formal promise to pay is required before the buyer can obtain the merchandise.

Drafts fall into two categories, sight drafts and time drafts. A sight draft is payable on presentation to the drawee. A time draft allows for a delay in payment—normally 30, 60, 90, or 120 days. It is presented to the drawee, who signifies acceptance of it by writing or stamping a notice of acceptance on its face. Once accepted, the time draft becomes a prom- ise to pay by the accepting party. When a time draft is drawn on and accepted by a bank, it is called a banker’s acceptance. When it is drawn on and accepted by a business firm, it is called a trade acceptance.

Time drafts are negotiable instruments; that is, once the draft is stamped with an accep- tance, the maker can sell the draft to an investor at a discount from its face value. Imagine the agreement between the U.S. exporter and the French importer calls for the exporter to pres- ent the Bank of Paris (through the Bank of New York) with a time draft requiring payment

Bill of Exchange 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.

Draft An order written by an exporter telling an importer what and when to pay.

Sight Draft A draft payable on presentation to the drawee.

Time Draft A promise to pay by the accepting party at some future date.

408 Part Six International Business Functions

120 days after presentation. The Bank of Paris stamps the time draft with an acceptance. Imagine further that the draft is for $100,000.

The exporter can either hold onto the accepted time draft and receive $100,000 in 120!days or sell it to an investor, say, the Bank of New York, for a discount from the face value. If the prevailing discount rate is 7 percent, the exporter could receive $97,700 by selling it immediately (7 percent per year discount rate for 120 days for $100,000 equals $2,300, and $100,000 2 $2,300 5 $97,700). The Bank of New York would then collect the full $100,000 from the Bank of Paris in 120 days. The exporter might sell the accepted time draft immediately if he needed the funds to finance merchandise in transit and/or to cover cash flow shortfalls.

BILL OF LANDING The third key document for financing international trade is the bill of lading. The bill of lading is issued to the exporter by the common carrier trans- porting the merchandise. It serves three purposes: it is a receipt, a contract, and a document of title. As a receipt, the bill of lading indicates that the carrier has received the merchandise described on the face of the document. As a contract, it specifies that the carrier is obligated to provide a transportation service in return for a certain charge. As a document of title, it can be used to obtain payment or a written promise of payment before the merchandise is released to the importer. The bill of lading can also function as collateral against which funds may be advanced to the exporter by its local bank before or during shipment and be- fore final payment by the importer.

A TYPICAL INTERNATIONAL TRADE TRANSACTION Now that we have reviewed the elements of an international trade transaction, let us see how the pro- cess works in a typical case, sticking with the example of the U.S. exporter and the French importer. The typical transaction involves 14 steps (see Figure 14.4).

1. The French importer places an order with the U.S. exporter and asks the American if he would be willing to ship under a letter of credit.

Bill of Lading A document issued to an exporter by a common carrier transporting merchandise. It serves as a receipt, a contract, and a document of title.

14.4 FIGURE A Typical International Trade Transaction

American Exporter French Importer

2 Exporter Agrees to Fill Order

12 Bank Tells Importer Documents Arrive

Bank of New York Bank of Paris

6 Goods Shipped to France

1 Importer Orders Goods

14 Bank of New York Presents Matured Draft and Gets Payment

8 Bank of New York Presents Draft to Bank of Paris

9 Bank of Paris Returns Accepted Draft

4 Bank of Paris Sends Letter of Credit to Bank of New York

13 Importer Pays Bank

3 Importer Arranges for Letter of Credit

5 Bank of New York Informs Exporter of Letter of Credit

10 and 11 Exporter Sells Draft to Bank

7 Exporter Presents Draft to Bank

Chapter Fourteen Exporting, Importing, and Countertrade 409

2. The U.S. exporter agrees to ship under a letter of credit and specifies relevant information such as prices and delivery terms.

3. The French importer applies to the Bank of Paris for a letter of credit to be issued in favor of the U.S. exporter for the merchandise the importer wishes to buy.

4. The Bank of Paris issues a letter of credit in the French importer’s favor and sends it to the U.S. exporter’s bank, the Bank of New York.

5. The Bank of New York advises the exporter of the opening of a letter of credit in his favor.

6. The U.S. exporter ships the goods to the French importer on a common carrier. An official of the carrier gives the exporter a bill of lading.

7. The U.S. exporter presents a 90-day time draft drawn on the Bank of Paris in accordance with its letter of credit and the bill of lading to the Bank of New York. The exporter endorses the bill of lading so title to the goods is transferred to the Bank of New York.

8. The Bank of New York sends the draft and bill of lading to the Bank of Paris. The Bank of Paris accepts the draft, taking possession of the documents and promising to pay the now-accepted draft in 90 days.

9. The Bank of Paris returns the accepted draft to the Bank of New York. 10. The Bank of New York tells the U.S. exporter that it has received the accepted bank

draft, which is payable in 90 days. 11. The exporter sells the draft to the Bank of New York at a discount from its face value

and receives the discounted cash value of the draft in return. 12. The Bank of Paris notifies the French importer of the arrival of the documents. She

agrees to pay the Bank of Paris in 90 days. The Bank of Paris releases the documents so the importer can take possession of the shipment.

13. In 90 days, the Bank of Paris receives the importer’s payment, so it has funds to pay the maturing draft.

14. In 90 days, the holder of the matured acceptance (in this case, the Bank of New York) presents it to the Bank of Paris for payment. The Bank of Paris pays.

Export Assistance Prospective U.S. exporters can draw on two forms of government-backed assistance to help finance their export programs. They can get financing aid from the Export-Import Bank and export credit insurance from the Foreign Credit Insurance Association (similar pro- grams are available in most countries).

EXPORT-IMPORT BANK Export-Import Bank (Ex-Im Bank) is an inde- pendent 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 United States and other countries. In 2010, its financing activities were expanded from $4 billion to $6!billion following a push by the Obama administration to try to create some 2 million new jobs through exports. The Ex-Im Bank pursues its mission with various loan and loan-guarantee programs. The agency guarantees repayment of medium- and long-term loans U.S. commercial banks make to foreign borrowers for purchasing U.S. exports. The Ex-Im Bank guarantee makes the commercial banks more willing to lend cash to foreign enterprises.

Ex-Im Bank also has a direct lending operation under which it lends dollars to foreign borrowers for use in purchasing U.S. exports. In some cases, it grants loans that commercial banks would not if it sees a potential benefit to the United States in doing so. The foreign borrowers use the loans to pay U.S. suppliers and repay the loan to Ex- Im Bank with interest.

LO 14-3 Identify information sources and government programs that exist to help exporters.

Export–Import Bank (Ex-Im Bank) Agency of the U.S. government whose mission is to provide aid in financing and facilitate exports and imports.

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410 Part Six International Business Functions

EXPORT CREDIT INSURANCE For reasons outlined earlier, exporters clearly prefer to get letters of credit from importers. However, sometimes an exporter who insists on a letter of credit will lose an order to one who does not require a letter of credit. Thus, when the importer is in a strong bargaining position and able to play competing suppliers against each other, an exporter may have to forgo a letter of credit.18 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. If the customer defaults, the insurance firm will cover a major portion of the loss.

In the United States, export credit insurance is provided by the Foreign Credit Insur- ance Association (FCIA), an association of private commercial institutions operating un- der the guidance of the Export-Import Bank. The FCIA provides coverage against commercial risks and political risks. Losses due to commercial risk result from the buyer’s insolvency or payment default. Political losses arise from actions of governments that are beyond the control of either buyer or seller. Marlin, the small Baltimore manufacturer of wire baskets discussed earlier, credits export credit insurance with giving the company the confidence to push ahead with export sales. For a premium of roughly half a percent of the price of a sale, Marlin has been able to insure itself against the possibility of nonpay- ment by a foreign buyer.19

Countertrade Countertrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent. We first encountered countertrade in Chapter 10’s discussion of currency convertibility. A government may restrict the convert- ibility of its currency to preserve its foreign exchange reserves so they can be used to service international debt commitments and purchase crucial imports.20 This is problematic for exporters. Nonconvertibility implies that the exporter may not be paid in his or her home currency, and few exporters would desire payment in a currency that is not convertible. Countertrade is a common solution.21 Countertrade denotes a range of barterlike agree-

LO 14-5 Describe how countertrade can be used to facilitate exporting.

Countertrade The trade of goods and services for other goods and services.

Fred Hochber, chairman and president of the U.S. Export-Import Bank, speaks during their annual conference.

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Chapter Fourteen Exporting, Importing, and Countertrade 411

ments; its principle is to trade goods and services for other goods and services when they cannot be traded for money. Some examples of countertrade are:

• An Italian company that manufactures power-generating equipment, ABB SAE Sadelmi SpA, was awarded a 720 million baht ($17.7 million) contract by the Electricity Generating Authority of Thailand. The contract specified that the company had to accept 218 million baht ($5.4!million) of Thai farm products as part of the payment.

• Saudi Arabia agreed to buy ten 747 jets from Boeing with payment in crude oil, discounted at 10 percent below posted world oil prices.

• General Electric won a contract for a $150 million electric generator project in Romania by agreeing to market $150 million of Romanian products in markets to which Romania did not have access.

• The Venezuelan government negotiated a contract with Caterpillar under which Venezuela would trade 350,000 tons of iron ore for Caterpillar earthmoving equipment.

• Albania offered such items as spring water, tomato juice, and chrome ore in exchange for a $60 million fertilizer and methanol complex.

• Philip Morris ships cigarettes to Russia, for which it receives chemicals that can be used to make fertilizer. Philip Morris ships the chemicals to China, and in return, China ships glassware to North America for retail sale by Philip Morris.22

THE POPULARITY OF COUNTERTRADE In the modern era, 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 re- quired to purchase necessary imports. Today, reflecting their own shortages of foreign ex- change reserves, some successor states to the former Soviet Union and the eastern European communist nations periodically engage in countertrade to purchase their imports. Estimates of the percentage of world trade covered by some sort of countertrade agreement range from highs of 8 and 10 percent by value to lows of around 2!percent.23 The precise figure is unknown, but it is probably at the low end of these estimates, given the increasing liquidity of international financial markets and wider currency convertibility. However, a short-term spike in the volume of countertrade can follow periodic financial crises. For example, coun- tertrade activity increased notably after the Asian financial crisis of 1997. That crisis left many Asian nations with little hard currency to finance international trade. In the tight monetary regime that followed the crisis in 1997, many Asian firms found it very difficult to get access to export credit to finance their own international trade. Thus, they turned to the only option available to them—countertrade.

Given that countertrade is a means of financing international trade, albeit a relatively minor one, prospective exporters may have to engage in this technique from time to time to gain access to certain international markets. The governments of developing nations some- times insist on a certain amount of countertrade.24

TYPES OF COUNTERTRADE With its roots in the simple trading of goods and services for other goods and services, countertrade has evolved into a diverse set of

Is Countertrade an Appropriate Way of Trading Today? Countertrades can take many forms, and there are several examples of how it works internationally. For instance, the Malaysian government recently bought 20 diesel electric lo- comotives from General Electric. Officials of the government said that GE will be paid with palm oil supplied by a planta- tion company. The company will supply about 200,000 metric tons of palm oil over a period of 30 months. No money changed hands, and no third parties were involved. As an- other example, in order to save foreign exchange reserves, the Philippine government offered some creditors tinned tuna to repay part of a state $4 billion debt. In other examples, General Motors Corporation sold $12! million worth of loco- motive and diesel engines to Yugoslavia and took cash and $4 million in Yugoslavian cutting tools as payment. Plus, McDonnell Douglas agreed to a compensation deal with Thai- land for eight top-of-the-line F/A–18 strike aircraft. Thailand agreed to pay $578! million of the total cost in cash, and McDonnell Douglas agreed to accept $93 million in a mixed bag of goods, including Thai rubber, ceramics, furniture, fro- zen chicken, and canned fruit. To some, these types of trad- ing contracts are strange and to some they are normal, especially if we go back in time. But what about today? Should the global marketplace engage in these types of non- monetary trades?

Source: S. Rama, “Types of Counter Trade,” 2011, www.citeman.com/13236- types-of-counter-trade.html.

412 Part Six International Business Functions

activities that can be categorized as five distinct types of trading arrangements: barter, coun- terpurchase, offset, switch trading, and compensation or buyback.25 Many countertrade deals involve not just one arrangement, but elements of two or more.

Barter Barter is the direct exchange of goods and/or services between two parties with- out a cash transaction. Although barter is the simplest arrangement, it is not common. Its problems are twofold. First, if goods are not exchanged simultaneously, one party ends up financing the other for a period. Second, firms engaged in barter run the risk of having to accept goods they do not want, cannot use, or have difficulty reselling at a reasonable price. For these reasons, barter is viewed as the most restrictive countertrade arrangement. It is primarily used 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. Suppose a U.S. firm sells some products to China. China pays the U.S. firm in dollars, but in exchange, the U.S. firm agrees to spend some of its proceeds from the sale on textiles produced by China. Thus, although China must draw on its for- eign exchange reserves to pay the U.S. firm, it knows it will receive some of those dollars back because of the counterpurchase agreement. In one counterpurchase agreement, Rolls-Royce sold jet parts to Finland. As part of the deal, Rolls-Royce agreed to use some of the proceeds from the sale to purchase Finnish-manufactured TV sets that it would then sell in Great Britain.

Offset An offset is similar to a 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. From an exporter’s perspective, this is more attractive than a straight counterpurchase agreement because it gives the exporter greater flexibility to choose the goods that it wishes to purchase.

Switch Trading The term switch trading refers to the use of a specialized third- party trading house in a countertrade arrangement. When a firm enters a counterpur- chase 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. For example, a U.S. firm concludes a counterpurchase agreement with Poland for which it receives some number of counterpurchase credits for purchasing Polish goods. The U.S. firm cannot use and does not want any Polish goods, however, so it sells the credits to a third-party trading house at a discount. The trading house finds a firm that can use the credits and sells them at a profit.

In one example of switch trading, Poland and Greece had a counterpurchase agreement that called for Poland to buy the same U.S.-dollar value of goods from Greece that it sold to Greece. However, Poland could not find enough Greek goods that it required, so it ended up with a dollar-denominated counterpurchase balance in Greece that it was unwilling to use. A switch trader bought the right to 250,000 counterpurchase dollars from Poland for $225,000 and sold them to a European sultana (grape) merchant for $235,000, who used them to purchase sultanas from Greece.

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 partial payment for the contract. For example, Occidental Petroleum negotiated a deal with Russia under which Occidental

Barter The direct exchange of goods or services between two parties without a cash transaction.

Counterpurchase A reciprocal buying agreement.

Offset Agreement to purchase goods and services with a specified percentage of proceeds from an original sale in that country from any firm in the country.

Switch Trading Use of a specialized third-party trading house in a countertrade arrangement.

Buyback Agreement to accept a percentage of a plant’s output as payment for contract to build a plant.

Chapter Fourteen Exporting, Importing, and Countertrade 413

would build several ammonia plants in Russia and as partial payment receive ammonia over a 20-year period.

PROS AND CONS OF COUNTERTRADE Counter- trade’s main attraction is that it can give a firm a way to finance an export deal when other means are not available. Given the problems that many developing nations have in raising the foreign exchange necessary to pay for imports, countertrade may be the only option available when doing business in these countries. Even when coun- tertrade is not the only option for structuring an export transaction, many countries prefer countertrade to cash deals. 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.

In addition, a countertrade agreement may be required by the government of a country to which a firm is exporting goods or ser- vices. Boeing often has to accept to counterpurchase agreements to capture orders for its commercial jet aircraft. For example, in exchange for gaining an order from Air India, Boeing may be required to purchase certain component parts, such as air- craft doors, from an Indian company. Taking this one step further, Boeing can use its will- ingness to enter into a counterpurchase agreement as a way of winning orders in the face of intense competition from its global rival, Airbus. Thus, countertrade can become a strategic marketing weapon.

However, the drawbacks of countertrade agreements are substantial. Other things being equal, firms would normally prefer to be paid in hard currency. Countertrade contracts may involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profit- ably. For example, a few years ago, one U.S. firm got burned when 50!percent of the television sets it received in a countertrade agreement with Hungary were defective and could not be sold. In addition, even if the goods it receives are of high quality, the firm still needs to dispose of them profitably. To do this, countertrade requires the firm to invest in an in-house trading de- partment dedicated to arranging and managing countertrade deals. This can be expensive and time-consuming.

Given these drawbacks, countertrade is most attractive to large, diverse multinational enterprises that can use their worldwide network of contacts to dispose of goods acquired in countertrading. The masters of countertrade are Japan’s giant trading firms, the sogo shosha, which use their vast networks of affiliated companies to profitably dispose of goods acquired through countertrade agreements. The trading firm of Mitsui & Company, for example, has about 120 affiliated companies in almost every sector of the manufacturing and service in- dustries. If one of Mitsui’s affiliates receives goods in a countertrade agreement that it can- not consume, Mitsui & Company will normally be able to find another affiliate that can profitably use them. Firms affiliated with one of Japan’s sogo shosha often have a competitive advantage in countries where countertrade agreements are preferred.

Western firms that are large, diverse, and have a global reach (e.g., General Electric, Philip Morris, and 3M) have similar profit advantages from countertrade agreements. Indeed, 3M has established its own trading company—3M Global Trading Inc.—to de- velop and manage the company’s international countertrade programs. Unless there is no alternative, small and medium-size exporters should probably try to avoid countertrade deals because they lack the worldwide network of operations that may be required to profitably utilize or dispose of goods acquired through them.26

A subsea oil and gas tree is lowered into a testing pool at a GE plant in Montrose, UK. Large, diverse, global companies like GE can benefit from countertrade agreements.

MITI, p. 401 sogo shosha, p. 401

export management company (EMC), p.!402

letter of credit, p. 406 bill of exchange, p. 407

Key Terms

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414 Part Six International Business Functions

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 quickly be resold in the Philippines for a profit. Outline the steps the exporter should take to effect this export to the Philippines.

2. You are the assistant to the CEO of a small textile firm that manufactures 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?

Summary

This chapter examined the steps that firms must take to establish themselves as exporters. The chapter made the following points:

1. One big impediment to exporting is ignorance of foreign market opportunities.

2. Neophyte exporters often become discouraged or frustrated with the exporting process because they encounter many problems, delays, and pitfalls.

3. The way to overcome ignorance is to gather information. In the United States, a number of institutions, the most important of which is the Department of Commerce, can help firms gather information in the matchmaking process. Export management companies can also help identify export opportunities.

4. Many of the pitfalls associated with exporting can be avoided if a company hires an experienced export management company, or export consultant, and if it adopts the appropriate export strategy.

5. Firms engaged in international trade must do business with people they cannot trust and people who may be 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.

6. The problems arising from lack of trust between exporters and importers can be solved by using a third party that is trusted by both, normally a reputable bank.

7. A letter of credit is issued by a bank at the request of an importer. It states that the bank promises to pay a

beneficiary, normally the exporter, on presentation of documents specified in the letter.

8. A draft is the instrument normally used in international commerce to effect payment. It is 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.

9. Drafts are either sight drafts or time drafts. Time drafts are negotiable instruments.

10. A bill of lading is issued to the exporter by the common carrier transporting the merchandise. It serves as a receipt, a contract, and a document of title.

11. U.S. exporters can draw on two types of government- backed assistance to help finance their exports: loans from the Export-Import Bank and export credit insurance from the FCIA.

12. Countertrade includes a range of barterlike agreements. It is primarily used when a firm exports to a country whose currency is not freely convertible and may lack the foreign exchange reserves required to purchase the imports.

13. The main attraction of countertrade is that it gives a firm a way to finance an export deal when other means are not available. A firm that insists on being paid in hard currency may be at a competitive disadvantage vis-à-vis one that is willing to engage in countertrade.

14. The main disadvantage of countertrade is that the firm may receive unusable or poor-quality goods that cannot be disposed of profitably.

draft, p. 407 sight draft, p. 407 time draft, p. 407 bill of lading, p. 408

Export–Import Bank (Ex-Im Bank), p.!409 countertrade, p. 410 barter, p. 412

counterpurchase, p. 412 offset, p. 412 switch trading, p. 412 buyback, p. 412

Use the globalEDGE website (globaledge.msu.edu) to complete the following exercises:

1. One way that exporters analyze conditions in emerging markets is through the use of macroeconomic indicators. The Market Potential Index (MPI) is a yearly study conducted by the Michigan State University Center for International Business Education and Research (MSU-CIBER) to compare the market potential of emerging markets for U.S. exporters. Provide a description of the dimensions used in the index. Which of the dimensions would have greater importance for a company that markets wireless devices? What about a company that sells clothing?

2. You work in the sales department of a company that manufactures and sells medical implants. A Brazilian company contacted your department and expressed interest in purchasing a large quantity of your products. The Brazilian company requested an FOB price quote. One of your colleagues mentioned to you that FOB is part of a collection of international shipping terms called “Incoterms,” but that was all he knew. Find the Export Tutorials on the globalEDGE site, and find a more detailed explanation of Incoterms. For an FOB quote, what line items will you need to include in your price quote, in addition to the price your company will charge for the products?

Research Task http://globalEDGE.msu.edu

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 Ukraine?

4. How do you explain the use of countertrade? Under what scenarios might its use increase further

by 2020? Under what scenarios might its use decline?

5. How might a company make strategic use of countertrade schemes as a marketing weapon to generate export revenues? What are the risks associated with pursuing such a strategy?

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Al Merritt founded MD International in 1987. A former salesman for a med- ical equipment company, Merritt saw an opportunity to act as an export intermediary for medical equipment manufacturers in the United States. He chose to focus on Latin America and the Caribbean, a region that he already had experience in. Also, trade barriers were starting to fall through- out the region as Latin American governments embraced a more liberal economic ideology, creating an opening for entrepreneurs such as Merritt. Local governments were also expanding their spending on health care, creating an opportunity that Merritt was poised to exploit.

Merritt located his company in south Florida to be close to his mar- ket. Since then, the company has grown to become the largest interme- diary exporting medical devices to the region. Today, the company sells the products of more than 30 medical manufacturers to some 600 re- gional distributors. While many medical equipment manufacturers don’t sell directly to the region because of the sizable marketing costs, MD can afford to because it goes into those markets with a broad portfolio of products.

The company’s success is in part due to its deep-rooted knowledge and understanding of the Latin American market. MD works very closely with teams of doctors, biomedical engineers, microbiologists, and market-

ing managers across Latin America to understand their needs and what the company can do for them. The sale of products to customers is typi- cally only the beginning of a relationship. MD International also provides training to medical personnel in the use of devices and offers extensive after-sale service and support.

Along the way to becoming a successful exporter, MD International has leaned heavily upon export assistance programs established by the U.S. government. For example, a shipment to Venezuela was held up by the Venezuelan customs seeking proof that the medical devices were not in- tended for military use. Within two days, staff at the U.S. Export Assistance Center in Miami arranged for the U.S. embassy in Venezuela to have a let- ter written and delivered to the customs officials, assuring them that the products had no military applications, and the shipment was released. Merritt has also worked extensively with the Export–Import Bank to gain financing for its exports (the company needs to finance the inventory that it exports).

Despite these advantages, it has not all been easy going for MD Inter- national. Latin American economies have often been highly cyclical, and MD International has ridden those cycles with them. In the early 2000s, for example, after several years of solid growth, an economic crisis in both

MD International

Chapter Fourteen Exporting, Importing, and Countertrade 415

416 Part Six International Business Functions

Endnotes

1. R. A. Pope, “Why Small Firms Export: Another Look,” Journal of Small Business Management 40 (2002), pp. 17–26.

2. M. C. White, “Marlin Steel Wire Products,” Slate Magazine, November 10, 2010.

3. S. T. Cavusgil, “Global Dimensions of Marketing,” in Marketing, ed. P. E. Murphy and B. M. Enis (Glenview, IL: Scott, Foresman, 1985), pp. 577–99.

4. S. M. Mehta, “Enterprise: Small Companies Look to Culti- vate Foreign Business,” The Wall Street Journal, July 7, 1994, p. B2.

5. P. A. Julien and C. Ramagelahy, “Competitive Strategy and Performance of Exporting SMEs,” Entrepreneurship Theory and Practice, 2003, pp. 227–94.

6. W. J. Burpitt and D. A. Rondinelli, “Small Firms’ Motiva- tions for Exporting: To Earn and Learn?” Journal of Small Business Management, October 2000, pp. 1–14; and J. D. Mittelstaedt, G. N. Harben, and W. A. Ward, “How Small Is Too Small?” Journal of Small Business Management 41 (2003), pp. 68–85.

7. Small Business Administration, “The State of Small Business 1999–2000: Report to the President,” 2001; and D. Ransom, “Obama’s Math: More Exports Equals More Jobs,” The Wall Street Journal, February 6, 2010.

8. A. O. Ogbuehi and T. A. Longfellow, “Perceptions of U.S. Manufacturing Companies Concerning Exporting,” Journal of Small Business Management, October 1994, pp. 37–59; and U.S. Small Business Administration, “Guide to Export- ing,” www.sba.gov/oit/info/Guide-to-Exporting/index. html.

9. R. W. Haigh, “Thinking of Exporting?” Columbia Journal of World Business 29 (December 1994), pp. 66–86.

10. F. Williams, “The Quest for More Efficient Commerce,” Fi- nancial Times, October 13, 1994, p. 7.

11. See Burpitt and Rondinelli, “Small Firms’ Motivations for Exporting”; and C. S. Katsikeas, L. C. Leonidou, and N. A.

Morgan, “Firm Level Export Performance Assessment,” Academy of Marketing Science 28 (2000), pp. 493–511.

12. M. Y. Yoshino and T. B. Lifson, The Invisible Link (Cambridge, MA: MIT Press, 1986).

13. L. W. Tuller, Going Global (Homewood, IL: Business One– Irwin, 1991).

14. Haigh, “Thinking of Exporting?”

15. M. A. Raymond, J. Kim, and A. T. Shao. “Export Strategy and Performance,” Journal of Global Marketing 15 (2001), pp.! 5–29; and P. S. Aulakh, M. Kotabe, and H. Teegen, “Export Strategies and Performance of Firms from Emerg- ing Economies,” Academy of Management Journal 43 (2000), pp. 342–61.

16. J. Francis and C. Collins-Dodd, “The Impact of Firms’ Export Orientation on the Export Performance of High- Tech Small and Medium Sized Enterprises,” Journal of Inter- national Marketing 8, no. 3 (2000), pp. 84–103.

17. J. Koch, “Integration of U.S. Small Businesses into the Export Trade Sector Using Available Financial Tools and Resources,” Business Credit 109, no. 10 (2007), pp. 64–68.

18. For a review of the conditions under which a buyer has power over a supplier, see M. E. Porter, Competitive Strategy (New York: Free Press, 1980).

19. White, “Marlin Steel Wire Products.”

20. Exchange Agreements and Exchange Restrictions (Washington, DC: International Monetary Fund, 1989).

21. It’s also sometimes argued that countertrade is a way of re- ducing the risks inherent in a traditional money-for-goods transaction, particularly with entities from emerging econo- mies. See C. J. Choi, S. H. Lee, and J. B. Kim, “A Note of Countertrade: Contractual Uncertainty and Transactional Governance in Emerging Economies,” Journal of Interna- tional Business Studies 30, no. 1 (1999), pp. 189–202.

22. J. R. Carter and J. Gagne, “The Do’s and Don’ts of Interna- tional Countertrade,” Sloan Management Review, Spring 1988,

Argentina and Brazil, coupled with a slowdown in Mexico, resulted in losses for the year and forced Merritt to lay off one-third of his staff and cut the pay of others, which included a 50 percent pay cut for himself. Things started to improve by the mid-2000s, and a weak dollar at the time also helped to boost export sales. However, the global financial crisis of 2008–2009 ushered in another tough period. MD International not only survived the downturn, but came out stronger as weaker competitors fall by the wayside.

CASE DISCUSSION QUESTIONS 1. How does an intermediary such as MD International create value for

the manufacturers that use it to sell medical equipment in foreign markets? Why do they want to use MD International rather than export directly themselves?

2. Why did MD International focus on Latin America? What are the benefits of this regional approach? What are the potential drawbacks?

3. What would it take for MD International to start exporting to other regions, such as Asia or Europe? Given this, would you advise Al Merritt to continue his regional focus going forward or to add other regions?

4. How important has government assistance been to MD International? Do you think helping firms such as MD International represents a good use of taxpayer money?

Sources: J. Bussey, “Where Have All the Exporters Gone?” Miami Herald, September 30, 2005, p. C1; M. Chandler, “Dade Firm Seeks to Remake Health Care,” Miami Herald, June 15, 2000; and C. Cultice, “Exports with a Heart,” U.S. Department of Commerce, export success stories, at www.export.gov.

Chapter Fourteen Exporting, Importing, and Countertrade 417

pp. 31–37; and W. Maneerungsee, “Countertrade: Farm Goods Swapped for Italian Electricity,” Bangkok Post, July 23, 1998.

23. Estimate from the American Countertrade Association at www.countertrade.org/index.htm. See also D. West, “Coun- tertrade,” Business Credit 104, no. 4 (2001), pp. 64–67; and B. Meyer, “The Original Meaning of Trade Meets the Future of Barter,” World Trade 13 (January 2000), pp. 46–50.

24. Carter and Gagne, “The Do’s and Don’ts of International Countertrade.”

25. For details, see Carter and Gagne, “Do’s and Don’ts of Inter- national Countertrade”; J. F. Hennart, “Some Empirical Di- mensions of Countertrade,” Journal of International Business Studies, 1990, pp. 240–60; and West, “Countertrade.”

26. D. J. Lecraw, “The Management of Counter-Trade: Factors Influencing Success,” Journal of International Business Studies, Spring 1989, pp. 41–59.