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chapter 14 Exporting, Importing, and Countertrade

LEARNING OBJECTIVES

1 Explain the promises and risks associated with exporting.

2 Identify the steps managers can take to improve their firm's export performance.

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

4 Recognize the basic steps involved in export financing.

5 Describe how countertrade can be used to facilitate exporting.

opening case SteelMaster Buildings

SteelMaster Buildings designs, manufactures, and supplies prefabricated arched steel structures that are used for anything from basic residential storage facilities to complex aircraft hangers. A small private company, SteelMaster first ventured into the export market in 2006. Its motivations were straightforward. Domestic competition was intense, and SteelMaster saw foreign markets as the best way of expanding sales. The company believed that its expertise in designing high-quality arched steel structures would serve it well in foreign markets where there were few indigenous competitors with the same capabilities. Moreover, by optimizing its manufacturing systems and logistics chain, SteelMaster was able to lower its cost structure and be competitive on pricing. The combination of high quality, the ability to produce customized designs, and competitive pricing helped to create demand for the company's products.

Today, export sales account for 15 percent of the company's revenues. The Virginia Beach company estimates that it has sold more than 40,000 buildings worldwide in more than 40 countries. Much of the growth is through a distribution network that now encompasses 50 countries. Not only do the distributors work to drive sales, they also provide in-country customer service and technical assistance. In addition, they are key to providing SteelMaster with feedback in specific markets.

One thing that helped SteelMaster grow its export business was to have someone who was dedicated to developing the international businesses. To fill this role, the company hired Emma Granada, whose fluency in Spanish and French has been a strong attribute. It also helped that the U.S. dollar has been relatively weak for some years now, increasing SteelMaster's price competitiveness.

To navigate its foray into the world of exporting, SteelMaster drew on a variety of resources, including the Virginia Economic Development Partnership and the U.S. Commercial Service. The U.S. Commercial Service invited the company to events where company executives met representatives from U.S. embassies around the world. SteelMaster quickly realized that there was a strong network in place to help small businesses export. According to the company, this resource helped the company to better understand the markets it was targeting for exports. Without such help, it would have been limited to cold-calling prospects.

On the marketing side, to supplement its in-country distributors, SteelMaster has used a website to reach more international prospects. In addition to English, the company has a Spanish language website and introductory pages in Arabic, French, Portuguese, Romanian, and Korean, among others. By bidding for key words on search engines such as Google and Bing, SteelMaster has found that it has been able to drive traffic to its website—and that enhances people's understanding of the product and can ultimately translate into sales.•

  Sources: L.L. Sowinski, “And the Winner Is…”, World Trade, January 2011, pp. 40–42; “Virginia Based Company Wins SBA/VISA Export Video Contest,” U.S. Newswire, November 7, 2011; and “UPS Honors SteelMaster with Global Trade Award,” Business Wire, January 12, 2011.

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 enterprises; many small firms such as SteelMaster have benefited significantly from the moneymaking opportunities of exporting.

The volume of export activity in the world economy has increased as exporting has become 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 transportation technologies have alleviated the logistical problems associated with exporting. Firms are increasingly using the World Wide Web, 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.

ANOTHER PERSPECTIVE Autarky: Not in the Vocabulary of Globalization!

The word autarky [italics added] refers to the belief that a country should be self-sufficient and avoid trade with other nations. Most economists regard autarky as an idealistic, but impractical, goal. Throughout history, countries have tried to achieve autarky, but soon discovered they could not produce the wide range of goods their population wants and make those goods available at competitive prices. In fact, those countries found themselves worse off economically than nations that engage in international trade. Word to the wise: Unless your country can efficiently produce everything it needs, it needs to trade.

  Source: “Economics A-Z,” www.economist.com.

Nevertheless, exporting remains a challenge for many firms. Smaller enterprises can find the process intimidating. The firm wishing to export must identify foreign market opportunities, 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 foreign 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

LEARNING OBJECTIVE 1

Explain the promises and risks associated with 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 SteelMaster, which was profiled 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. 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 baskets 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 its international sales. By 2010, exports accounted for 17 percent of sales, and the company has set a goal of exporting half of its output by 2014.2

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-sized and small firms are very reactive.3 Typically, such reactive 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 medium-sized 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 respond. 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 business. By the time MMO did turn its attention to foreign markets, other competitors had stepped into the breach, and MMO found it tough going to build export volume.4

MMO's experience is common, and it suggests a need for firms to become more proactive 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. Common 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, lack of an effective distribution program, a poorly executed promotional campaign, 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 Systems in China, suggests that it may take years before foreigners are comfortable enough to purchase in significant quantities.

MANAGEMENT FOCUS FCX Systems

Founded with the help of a $20,000 loan from the Small Business Administration, 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 generates more than half of its annual sales from exports to more than 70 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 represented 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 provided good contacts for FCX. Finding a good local representative to help work through local regulations and customs is another critical factor, 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. Recently, 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 some 179 airports between 1998 and 2008. This constituted a potentially 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 believe a friend would never cheat you.” To make friends in China, Gallion estimates he had to make more than 100 trips to China since the early 1990s, 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.

Exporters often face voluminous paperwork, complex formalities, and many potential delays and errors. According to a UN report on trade and development, a typical international 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

• QUICK STUDY

1. What are the benefits of exporting?

2. What are the risks and pitfalls associated with exporting?

Improving Export Performance

LEARNING OBJECTIVE 2

Identify the steps managers can take to improve their firm's 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 exporters.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 exporting strategies that can increase the probability of successful exporting. We begin, however, 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 differing cultures compose the world of potential opportunities. Faced with such complexity and diversity, firms sometimes hesitate to seek export opportunities.

ANOTHER PERSPECTIVE Chinese Exporters Seek New Markets

With hundreds of television sets stacked high, Changhong Electronics' warehouse in Shunde resembles many other storage depots in southern China, but their destinations reveal an important shift in global trade patterns. While Changhong's smaller sets are headed for Europe, its 50-inch plasma screens, which dominate 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 U.S. and Europe and to try and capitalize on rapidly growing markets in Asia, Africa and Latin America. Chinese exports to non-U.S., EU and Japanese markets rose 17 percent in May compared to a year earlier—a trend that has intensified over the past year. 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 cheap China exports could provide a boost to investment in the developing world, just as they once did to consumption in the developed world.

  Source: From the “Chinese Exporters Seek New Markets,” Financial Times, June 12, 2012. Copyright © The Financial Times Limited 2012. All rights reserved. www.ft.com/cms/s/0/4dc14e6c-b381-11e1-a3db-00144feabdc0.html#axzz1xtiWhRBd.

LEARNING OBJECTIVE 3

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

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 opportunities for their affiliated companies large and small.12

MITI

Japan's Ministry of International Trade and Industry.

Sogo Shosha

Japan's great trading houses.

German and Japanese firms can draw on the large reservoirs of experience, skills, information, 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 differences. 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 information 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 intelligence and assistance for attacking foreign markets: the International Trade Administration and the U.S. Commercial Service.

These 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 Commerce has assembled a “comparison shopping service” for 14 countries that are major markets for U.S. exports. 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 competition, comparative prices, distribution channels, and names of potential sales representatives. Each study is conducted on-site by an officer of the Department of Commerce.

Mitsubishi Corporation is one of the seven largest sogo shosha.

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

MANAGEMENT FOCUS 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 Systems 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-sized businesses that employ fewer than 500 people. Their share of total U.S. exports grew 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 institutions, 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 Administration (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 the 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 continual basis and are free.

“As I began to pursue exporting, my first step was a thorough marketing evaluation. I targeted trade shows with a good presence of international buyers. I also went to DOC (Department of Commerce) for counseling and information about the rules and regulations of exporting. I advertised my product in Commercial News USA, distributed through U.S. embassies to buyers worldwide. I utilized DOC's World Traders Data Reports to get background information on potential foreign buyers. As a result, I received 60 to 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; The 2007 National Exporting Strategy (Washington, DC: United States International Trade Commission, 2007).

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 international trade officers and 10 regional international trade officers throughout the United States as well as a 10-person international trade staff in Washington, DC. Through its Service Corps of Retired Executives (SCORE) program, 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 coordinates the Export Legal Assistance Network (ELAN), a nationwide group of international 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. Unfortunately, many have fallen victim to budget cuts or to turf battles for political and financial 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 assist 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

LEARNING OBJECTIVE 2

Identify the steps managers can take to improve their firm's export performance.

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 performed with the understanding that the EMC will have continuing responsibility for selling 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.

Export Management Company

Export specialists who act as an export marketing department for client firms.

MANAGEMENT FOCUS Export Strategy at 3M

The Minnesota Mining and Manufacturing Co. (3M), which makes more than 40,000 products including tape, sandpaper, 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 production.

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 subsidiary 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 of how to sell in their own country than American expatriates. 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 products. 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 product. 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 worthwhile 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.mmm.com.

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 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

LEARNING OBJECTIVE 2

Identify the steps managers can take to improve their firm's export performance.

In addition to using EMCs, a firm can reduce the risks associated 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 exporting firms in the world, the Minnesota Mining and Manufacturing Co. (3M), 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 accompanying Management Focus). Another successful exporter, Red Spot Paint & Varnish, emphasizes the importance of cultivating personal relationships when trying to build an export business (see the Management Focus at the end of this section).

The probability of exporting successfully can be increased dramatically by taking a handful of simple strategic steps. First, particularly for the novice exporter, it helps to hire an EMC or at least an experienced export consultant to help 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 on 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 importantly, 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 oversee this activity. Fifth, in many countries, it is important to devote a lot of attention to building strong and enduring relationships with local distributors and/or customers (see the Management Focus on Red Spot Paint for an example). 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 seeking 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 production, 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).

MANAGEMENT FOCUS Red Spot Paint & Varnish

Established in 1903 and based in Evansville, Indiana, Red Spot Paint & Varnish Company is, in many ways, typical of the companies that can be found in the small towns of America's heartland. The closely held company, whose CEO, Charles Storms, is the great-grandson of the founder, has 500 employees and annual sales of close to $90 million. The company's main product is paint for plastic components used in the automobile industry. Red Spot products are seen on automobile bumpers, wheel covers, grilles, headlights, instrument panels, door inserts, radio buttons, and other components. Unlike many other companies of a similar size and location, however, Red Spot has a thriving international business. International sales (which include exports and local production by licensees) now account for between 15 percent and 25 percent of revenue in any one year, and Red Spot does business in about 15 countries.

Red Spot has long had some international sales and once won an export award. To further its international business, Red Spot hired a Central Michigan University professor, Bryan Williams. Williams, who was hired because of his foreign-language skills (he speaks German, Japanese, and some Chinese), was the first employee at Red Spot whose exclusive focus was international marketing and sales. His first challenge was the lack of staff skilled in the business of exporting. He found that it was difficult to build an international business without in-house expertise in the basic mechanics of exporting. According to Williams, Red Spot needed people who understood the nuts and bolts of exporting—letters of credit, payment terms, bills of lading, and so on. As might be expected for a business based in the heartland of America, no ready supply of such individuals was in the vicinity. It took Williams several years to solve this problem. Now, Red Spot has a full-time staff of two who have been trained in the principles of exporting and international operations.

A second problem that Williams encountered was the clash between the quarter-to-quarter mentality that frequently pervades management practice in the United States and the long-term perspective that is often necessary to build a successful international business. Williams has found that building long-term personal relationships with potential foreign customers is often the key to getting business. When foreign customers visit Evansville, Williams often invites them home for dinner. His young children even started calling one visitor from Hong Kong “Uncle.” Even with such efforts, however, the business may not come quickly. Meeting with potential foreign customers yields no direct business 90 percent of the time, although Williams points out that it often yields benefits in terms of competitive information and relationship building. He has found that perseverance pays. For example, Williams and Storms called on a major German automobile parts manufacturer for seven years before finally landing some business from the company.

  Sources: R. L. Rose and C. Quintanilla, “More Small U.S. Firms Take Up Exporting with Much Success,” The Wall Street Journal, December 20, 1996, p. A1, A10; and interview with Bryan Williams of Red Spot Paint.

• QUICK STUDY

1. What steps can a company take to improve its export performance?

2. Outline the benefits and risks of using an export management company.

Export and Import Financing

LEARNING OBJECTIVE 4

Recognize the basic steps involved in export 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 will 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 distributor 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 between 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 products, 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.

FIGURE 14.1 Preference of the U.S. Exporter

FIGURE 14.2 Preference of the French Importer

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 Figure 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 products, which the bank does. The document for requesting this 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.

FIGURE 14.3 The Use of a Third Party

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, normally the exporter, on presentation of particular, specified documents.

Letter of Credit

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

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 transaction, 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 contract 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 the Bank of Paris in accordance with the terms of the letter of credit, attaches the required 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 documents to the Bank of Paris. If all of 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. exporter 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 facilitate 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 exporter 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 conditions 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 normally 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).

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

See Bill of exchange.

International practice is to use drafts to settle trade transactions. This differs from domestic 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 promise 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.

Sight Draft

A draft payable on presentation to the drawee.

Time Draft

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

Time drafts are negotiable instruments; that is, once the draft is stamped with an acceptance, 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 present the Bank of Paris (through the Bank of New York) with a time draft requiring payment 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 he can 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 − $2,300 = $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 LADING

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 transporting 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 before final payment by the importer.

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.

A TYPICAL INTERNATIONAL TRADE TRANSACTION

Now that we have reviewed the elements of an international trade transaction, let us see how the process 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).

FIGURE 14.4 A Typical International Trade Transaction

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.

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.

• QUICK STUDY

1. What is a letter of credit? Why is a letter of credit necessary for exporting?

2. What is a draft (or bill of exchange)?

3. What is the function of a bill of lading?

Export Assistance

LEARNING OBJECTIVE 3

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

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 programs are available in most countries).

EXPORT–IMPORT BANK

The Export–Import Bank , often referred to as Ex-Im Bank, 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 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.

Export–Import Bank

Agency of the U.S. government whose mission is to provide aid in financing and facilitate exports and imports; also referred to as the Ex–Im Bank.

The Export–Import Bank provides financial aid to companies that require assistance with imports, exports, and the exchange of commodities.

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.

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 Insurance Association (FCIA), an association of private commercial institutions operating under 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 nonpayment by a foreign buyer.19

Countertrade

LEARNING OBJECTIVE 5

Describe how countertrade can be used to facilitate exporting.

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 convertibility 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 whole range of barterlike agreements; 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:

Countertrade

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

• 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 10,747 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 INCIDENCE 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 required to purchase necessary imports. Today, reflecting their own shortages of foreign exchange 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 crisis. For example, countertrade 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.

ANOTHER PERSPECTIVE Types of Countertrade

Countertrades can take many forms, and there are several examples of how it works internationally. For instance recently the Malaysian government bought 20 diesel electric locomotives from General Electric. Officials of the government said that GE will be paid with palm oil supplied by a plantation company. The company will supply about 200,000 metric tons of palm oil over a period of 30 months. This was GE's first barter deal for palm oil and palm products although its division GE trading has several other countertrade agreements worldwide. No money changed hands, and no third parties were involved. As another 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 locomotive and diesel engines to Yugoslavia and took cash and $4 million in Yugoslavian cutting tools as payment. McDonnell Douglas agreed to a compensation deal with Thailand for eight top of the range 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, frozen chicken and canned fruit.

  Source: www.citeman.com/13236-types-of-counter-trade.html.

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 sometimes insist on a certain amount of countertrade.24 For example, all foreign companies contracted by Thai state agencies for work costing more than 500 million baht ($12.3 million) are required to accept at least 30 percent of their payment in Thai agricultural products. Between 1994 and mid-1998, foreign firms purchased 21 billion baht ($517 million) in Thai goods under countertrade deals.25

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 activities that can be categorized as five distinct types of trading arrangements: barter, counterpurchase, offset, switch trading, and compensation or buyback.26 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 without 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.

Barter

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

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 foreign 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.

Counterpurchase

A reciprocal buying agreement.

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.

Offset

A buying agreement similar to counterpurchase, but the exporting country can then fulfill the agreement with any firm in the country to which the sale is being made.

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 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. 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.

Switch Trading

The use of a specialized third-party trading house in a countertrade arrangement.

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

Buyback

When a firm builds a plant in a country and agrees to take a certain percentage of the plant's output as partial payment of the contract.

THE PROS AND CONS OF COUNTERTRADE

Countertrade'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 countertrade 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 services. Boeing often has to agree 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 aircraft doors, from an Indian company. Taking this one step further, Boeing can use its willingness to enter into a counterpurchase agreement as a way of winning orders in the face of intense competition from its global rival, Airbus Industrie. 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 profitably. 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 department 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 industries. If one of Mitsui's affiliates receives goods in a countertrade agreement that it cannot 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 develop and manage the company's international countertrade programs. Unless there is no alternative, small and medium-sized 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.27

• QUICK STUDY

1. When would a company want to engage in countertrade?

2. What are the drawbacks of countertrade?

Key Terms

MITI, p. 395

sogo shosha, p. 395

export management company, p. 396

letter of credit, p. 400

bill of exchange, p. 401

draft, p. 401

sight draft, p. 401

time draft, p. 401

bill of lading, p. 402

Export–Import Bank, p. 403

countertrade, p. 404

barter, p. 405

counterpurchase, p. 405

offset, p. 406

switch trading, p. 406

buyback, p. 406

Chapter 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.

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?

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 2015? 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?

Research Task http://globalEDGE.msu.edu

Exporting, Importing, and Countertrade

Use the globalEDGE Resource Desk (http://globaledge.msu.edu/Reference-Desk) to complete the following exercises:

1. The Internet is rich with resources that provide guidance for companies wishing to expand their markets through exporting. globalEDGE provides links through its Global Resource Directory under a category called Trade Tutorials. Identify three sources listed by globalEDGE and provide a description of the services available for new exporters through each of these sources.

2. You work for a pharmaceuticals company that hopes to provide products and services in New Zealand. After searching a resource that enumerates the import and export regulations for each country, outline the most important foreign trade barriers your firm's managers must keep in mind while developing a strategy for entry into New Zealand's pharmaceutical market.

closing case Vellus Products

Sharon Doherty founded Vellus Products in 1991 in Columbus, Ohio, to sell pet shampoo. Doherty's original insight was that shampoos for people don't work well on pets because the skin of most animals is more sensitive than that of humans and becomes easily irritated. As a competitive dog exhibitor, she knew that most existing pet shampoo left dog hair unmanageable and lacking the glamour needed for a dog show. Working with her nephew, who had a Ph.D. in chemistry, Doherty developed salon-type formulas that were specially suited to dogs (shampoo for horses was added later).

Doherty booked Vellus's first export sales in 1993 when a Taiwanese businessman, who had picked up Vellus shampoo in the United States, ordered $25,000 worth of products he wanted to try to sell through dog shows in Taiwan. Before long, Doherty was getting calls from people around the world—most of whom heard about Vellus products at dog shows—and a thriving export business was born.

As the volume of inquiries grew, Doherty realized she needed a better understanding of foreign markets, export potential, and financing options, so she contacted the U.S. Department of Commerce's Commercial Service offices in Columbus. “As business has grown, I have gone from ordering country profiles to requesting customized exporting and financing strategies tailored to maximize export potential,” she says. Today, Vellus exports to 32 nations, although the bulk of the firm's international business operates through distributors in Sweden, Finland, Britain, France, Germany, Australia, New Zealand, Canada, and Iceland, where the products are marketed at pet shows and exhibitions. The company has registered its trademark in 15 European countries, and international sales account for more than half the firm's total. “I credit the U.S. Commercial Service for helping me to expand my exports, as it would have been much more difficult on my own,” says Doherty.

Reflecting on her international success, Doherty has some advice for others who might want to go down the same road. First she says, know whom you are dealing with. Relationships are important to successful exporting. Doherty says she goes out of her way to give advice and guidance to her distributors, sharing her knowledge and helping them to be successful. Second, having been duped by a man who claimed he knew the pet market, when he didn't, she advocates doing background checks on potential business partners. “Gather as much information as you can,” she says. “Don't make any assumptions; the wrong choice can cost your business valuable time and money.” Third, Doherty believes that it is important to learn the local culture. Vellus products are adapted to best suit different grooming techniques in different countries, something that she believes has helped to make the company more successful. Finally, Doherty says, enjoy the ride! “I love exporting because it has enabled me to meet so many people from other cultures. Exporting has made me more broad-minded, and I have developed a great appreciation for other cultures and the way others live their lives.”

  Sources: U.S. Department of Commerce website, “Vellus Products Inc.,” www.export.gov; C. K. Cultice, “Best in Show: Vellus Products,” World Trade, January 2007, pp. 70–73; and C. K. Cultice, “Lathering up World Markets,” Business America,” July 1997, p. 33.

Case Discussion Questions

1. Why does Vellus export through local distributors rather than set up its own sales force in country? What are the risks associated with using local distributors? How can these risks be reduced?

2. Vellus's original entry into exporting was both reactive and serendipitous. Do you think this is the exception or the rule for small businesses? What might be done to make small firms more proactive with regard to exporting?

3. What lessons about successful exporting can be derived from the Vellus case?

4. How important has government assistance been to Vellus Products? Do you think helping firms such as Vellus represents good use o

(Hill 391-409)

Hill, Charles W. Global Business Today, 8th Edition. McGraw-Hill Learning Solutions, 09/2013. VitalBook file.