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Global Marketing

Warren J. Keegan Mark C. Green

Political, Legal and Regulatory Environments

Chapter 5

Learning Objectives

Understand how a political environment impacts marketing

Know how international law differs over the world

Which business issues lead to legal problems

How conflicts can be resolved in the EU

5-3

Political Risk

Risk of change in political environment or government policy that would adversely affect a company’s ability to operate effectively and profitably

When perceived political risk is high, a country will have

a difficult time attracting foreign direct investment.

Executives often fail to understand political risk because they have not studied political science. Businesspeople need to study the political environment through reading publications like The Economist, Financial Times or consulting web-based sources like the Business Environment Risk Intelligence (www.beri.com) or the PRS Group (www.prs.com).

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Political Risk

Some examples of political risk include:

War

Social unrest

Politically-motivated violence

Transparency

Social conditions (population density and wealth distribution)

Corruption, nepotism

Crime

Labor costs

Tax discrimination

Former Russian President Boris Yeltsin’s political maneuverings created a high level of political risk. His successor, Vladimir Putin is enacting reforms and strengthening intellectual and property law in an effort to gain membership into the WTO and attract foreign investment. Still, Russia is viewed as having high political risk.

Companies can buy insurance to protect against political risk. The U.S. government agency, the Overseas Private Investment Corp. (OPIC; www.opic.gov), offers insurance to companies doing business abroad. Japan, Germany, France, Canada, and Britain offer similar protection.

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Taxes

Government taxation policies

High taxation can lead to black market growth and cross-border shopping

Corporate taxation

Companies attempt to limit tax liability by shifting location of income

Governments rely on tax revenues to generate funds necessary for social services, the military, and other expenditures. Unfortunately, government taxation policies on the sale of goods and services frequently motivate for companies and individuals to profit by not paying taxes. In China, for example, even though import duties have dropped since it joined the WTO, many imports are subject to double-digit duties plus a 17 percent value-added tax. As a result, significant quantities of oil, cigarettes, photographic film, personal computers, and other products are smuggled into China. It is estimated that 90% of cigarettes are smuggled into China. Companies can still profit. For Philip Morris, this means annual sales of $100 million to Hong Kong distributors! Cross-border shopping can be spurred on by high excise and VAT taxes. It is estimated that British citizens who travel to France by car return home with 80 bottles of wine.

Corporate taxation is another issue. The high level of political risk currently evident in Russia can be attributed in part to excessively high taxes on business operations. High taxes encourage many enterprises to engage in cash or barter transactions that are off the books and sheltered from the eyes of tax authorities. This, in turn, has created a liquidity squeeze that prevents companies from paying wages to employees. Unpaid, disgruntled employees can contribute to political instability. Putin’s government is pursuing a tough new tax policy in order to shrink Russia’s deficit and qualify for IMF loans.

“Earnings stripping” refers to the practice of foreign companies making loans to U.S. affiliates rather than using direct investment to finance U.S. activities. The U.S. subsidiary can deduct interest on these loans and reduce its tax burden. It is estimated that tax minimization costs the U.S. government billions a year.

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Seizure of Assets

Expropriation–governmental action to dispossess a foreign company or investor

Compensation should be provided in a “prompt, effective, and adequate manner”

Confiscation occurs when no compensation is provided

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Seizure of Assets

Nationalization–a government takes control of some or all of the enterprises in an entire industry

Acceptable according to international law if:

satisfies public purpose

includes compensation

Castro’s Cuban government nationalized property of American sugar companies. The government offered Cuban bonds for compensation, which was all that was required under Cuban law. Viewed as inadequate by the U.S. State Department

Hugo Chavez of Venezuela seized the public electric company and paid AES Corp. $739.3 million; Verizon got $572 for its stake in CANTV.

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Seizure of Assets

Creeping expropriation–limits economic activities of foreign firms

May include:

Limits on repatriation of profits, dividends, or royalties

Technical assistance fees

Increased local content laws

Quotas for hiring local nationals

Price controls

Discriminatory tariff and nontariff barriers

Discriminatory laws on patents and trademarks

In the mid-1970s, Johnson & Johnson and other foreign investors in India had to submit to a host of government regulations to retain majority equity positions in companies already established. Many of these rules were copied by Malaysia, Indonesia, the Philippines, Nigeria, and Brazil. By the late 1980s, after a “lost decade” in Latin America characterized by debt crises and low GNP growth, lawmakers reversed many of these restrictive and discriminatory laws. The end of the Cold War contributed significantly to these changes.

It is difficult to reclaim expropriated property. U.S. courts will not get involved if foreign governments are involved. Companies can seek recourse through the World Bank Investment Dispute Settlement Center. It is possible to purchase expropriation insurance from private companies or a government agency such as OPIC.

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International Law

The rules and principles that nation-states consider binding among themselves

Disputes between nations are issues of public international law

World Court or International Court of Justice (ICJ)

Judicial arm of the United Nations

Roots of international law can be traced to the 17th century Peace of Westfalia. Early laws were concerned with war and peace and political issues. As trade increased, issues of commercial affairs grew in importance.

If a nation refuses to accept a decision against it made by the World Court, it can appeal to the Security Council of the U.N.

International Court of Justice

Judicial arm of the United Nations founded in 1947

Settles disputes between nations

International conventions

International custom

General principles of law

Peace Palace, ICJ, The Hague, Netherlands

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Common Law vs. Civil Law

The Napoleonic Code of 1804 drew on the Roman legal system and is the basis for continental European law today. Code law is also known as civil law.

U.S. law is rooted in English common law.

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Common Law vs. Civil Law

Common Law

Disputes are decided by reliance on the authority of past judicial decisions

Companies are legally incorporated by state authority

Code law is used in only a few areas; the U.S. Uniform Commercial Code

Civil Law

Legal system reflects the structural concepts and principles of the Roman Empire

Companies are formed by contract between two or more parties who are fully liable for the actions of the company

Asian countries are split. India, Pakistan, Malaysia, Singapore, and Hong Kong are common-law countries. Japan, Korea, Thailand, Indochina, Taiwan, Indonesia, and China are civil-law jurisdictions. Scandinavian countries use parts of both systems. The majority of countries today have civil-law systems. Many countries that were colonized up Europeans continue the legal systems imposed upon them. i.e., Singapore and Hong Kong were British colonies and have a common law system. Former French colonies, like Niger and Guyana have civil law systems.

In post-communist Eastern and Central Europe, consultants from both civil and common law countries are trying to influence the process. Central Europe relies on the German civil law system while Russia looks to the U.S. system. Germans think that U.S. law is too complicated and the U.S. response is that the German system is outdated.

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Islamic Law

Legal system in many Middle Eastern countries

Sharia–a comprehensive code governing Muslim conduct in all areas of life, including business

Koran–Holy Book; like code law

Hadith–like common law

Based on life, sayings, and practices of Muhammad

Identifies forbidden practices “haram”

Any Westerner doing business in Malaysia and in the Middle East should have, at minimum, a rudimentary understanding of Islamic law and its implications for commercial activities. Brewers, for example, must refrain from advertising beer on billboards or in local-language newspapers.

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Sidestepping Legal Issues

Get expert legal help

Prevent conflicts

Establish jurisdiction

Protect intellectual property

Protect licenses and trade secrets

Avoid bribery

5-15

Jurisdiction

Refers to a court’s authority to rule on particular types of issues arising outside of a nation’s borders or to exercise power over individuals or entities from different countries.

Employees of foreign companies should understand the extent to which they are subject to the jurisdiction of host-country courts.

Courts have jurisdiction if it can be demonstrated that the company is doing business in the state the court sits.

Revlon sued a British company, UOL, for breach of contract in a federal court in New York. UOL claimed the court lacked jurisdiction. Revlon cited the presence of UOL’s name on an office building in the city in which the company had 50% ownership. The judge ruled against the motion to dismiss.

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Intellectual Property

Intellectual property must be registered in each country where business is conducted

Patent–gives an inventor exclusive right to make, use, and sell an invention for a specified period of time

Trademark–distinctive mark, motto, device, or emblem used to distinguish it from competing products

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Infringement of Intellectual Property

Counterfeiting–unauthorized copying and production of a product

Associative Counterfeit/Imitation–product name differs slightly from a well-known brand

Piracy–unauthorized publication or reproduction of copyrighted work

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Intellectual Property

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Protecting Intellectual Property

In the U.S., registration is with the Federal Patent Office

In Europe, applicants use the European Patent Office or register country-by-country

Soon the Community Patent Convention will cover 27 countries

European patents are expensive because of the need to translate technical documents into all of the languages of the EU.

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Protecting Intellectual Property

World Intellectual Property Organization

Governed by the Madrid Agreement and the Madrid Protocol

Allows trademark owners to seek protection in as many as 74 countries with a single application and fee

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Protecting Intellectual Property

International Convention for the Protection of Industrial Property

Paris Convention

Honored by 100 countries

Facilitates multi-country patent registration, ensures that once a company files, it has a “right of priority” in other countries for one year from that date

Patent Cooperation Treaty

European Patent Convention

International concern about intellectual property issues in the 19th Century resulted in two important agreements. The first is the International Convention for the Protection of Industrial Property. Also known as the Paris Union or Paris Convention, the convention dates to 1883 and is now honored by nearly 100 countries. This treaty facilitates multi-country patent registrations by ensuring that, once a company files in a signatory country, it will be afforded a “right of priority” in other countries for one year from the date of the original filing. A U.S. company wishing to obtain foreign patent rights must apply to the Paris Union within one year of filing in the United States or risk a permanent loss of patent rights abroad.

The Patent Cooperation Treaty (PCT) has more than 100 signatories, including Australia, Brazil, France, Germany, Japan, North Korea, South Korea, the Netherlands, Switzerland, Russia and other former Soviet states, and the United States. The members constitute a union that provides certain technical services and cooperates in the filing, searching, and examination of patent applications in all member countries. The European Patent Office administers applications for the European Patent Convention, which is effective in the EU and Switzerland. An applicant can file a single patent application covering all of the convention states; the advantage is that the application will be subject to only one procedure of grant. Although national patent laws remain effective under this system, approved patents are effective in all member countries for a period of 20 years from the filing date.

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U.S. Companies Receiving the Most Patents, 2009

5-23

Antitrust

Laws are designed to combat restrictive business practices and to encourage competition

Enforced by FTC in the U.S., Fair Trade Commission in Japan, European Commission in European Union

The Sherman Act of 1890 prohibits certain restrictive business practices including fixing prices, limiting production, allocating markets, or any other scheme designed to limit or avoid competition. Law applies to U.S. companies outside U.S. borders and to foreign companies operating in the U.S.

Although antitrust laws are on the books in many countries, they are often weak or loosely enforced.

A recent rash of antitrust actions brought in the United States against foreign companies has raised concerns that the United States is violating international law as well as the sovereignty of other nations. The U.S. antitrust laws are a legacy of the nineteenth-century trust-busting era and are intended to maintain free competition by limiting the concentration of economic power.

There have been calls for the EU to revamp its approach to antitrust issues and reduce its caseload. Any proposed changes will pit modernists against traditionalists. As one European attorney complained, “The commission is putting resources into regulating cases that don’t actually restrict competition, which means that the cases that do need to be looked at are not being resolved efficiently.”

Antitrust Rulings

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Licensing and Trade Secrets

Licensing is a contractual agreement in which a licensor allows a licensee to use patents, trademarks, trade secrets, technology, and other intangible assets in return for royalty payments or other forms of compensation

Important considerations

What assets may be licensed

How to price assets

The rights granted

The licensor may limit the licensee to sell only in its home country in order to avoid direct competition. The licensee may also be required to stop using the technology after the license has expired.

The U.S. courts ruled that S.C. Johnson and Co. could not license an insecticide from the German company, Bayer AG. To do so would have allowed Johnson to monopolize the $450 million home market.

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Licensing and Trade Secrets

Trade secrets are confidential information or knowledge that has commercial value and is not in the public domain and for which steps have been taken to keep it secret

To prevent disclosure, use confidentiality contracts

The Uniform Trade Secrets Act has been adopted by most U.S. states

TRIPS, Trade-Related Aspects of Intellectual Property Rights signed by members of GATT

In the U.S. states have jurisdiction over trade secrets. Several countries adopted trade secret law for the first time during the 1990s. Mexico (1991), China (1993).

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Bribery and Corruption

Foreign Corrupt Practices Act

Requires publicly held companies to institute internal accounting controls that would record all transactions

Makes it a crime for a U.S. corporation to bribe an official of a foreign government or political party to obtain or retain business

Prohibits payments to third parties when there is reason to believe it may be channeled to foreign officials

Omnibus Trade and Competitiveness Act

Allows for “grease” payments to cut red tape; i.e., getting shipments trough customs, getting permits

History does not record a burst of international outrage when Charles M. Schwab, head of Bethlehem steel at the beginning of the 20th century, presented a $200,000 diamond and pearl necklace to the mistress of Czar Alexander III’s nephew. In return for that consideration, Bethlehem Steel won the contract to supply the rails for the Trans-Siberian railroad. Things have changed. However, companies doing business in Central and Eastern Europe, the Middle East, and other parts of the world find that corruption and bribery are widespread.

The Foreign Corrupt Practices Act (FCPA) is a legacy of the Watergate scandal during Richard Nixon’s presidency. In the course of his investigation, the Watergate special prosecutor discovered that more than 300 American companies had made undisclosed payments to foreign officials totaling hundreds of millions of dollars. The act was unanimously passed by Congress and signed into law by President Jimmy Carter on December 17, 1977.

After U.S. companies complained that their activities abroad were severely curtailed, President Reagan signed the OTCA in 1988.

Penalties for violating the law: 1-5 years in jail and fines in excess of $1 million. Critics say that the law puts American companies at a disadvantage. In 1994, bribes offered by non-U.S. companies were a factor in 100 business deals valued at $45 million of which 80% were awarded to non-U.S. firms. Bribery is legal and tax-deductible in some European countries.

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2010 Corruption Rankings

Transparency International (www.transparency.org) compiles an annual report ranking countries by Corruption Perceptions Index.

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Conflict Resolution

Litigation

Formal arbitration

Settles disputes outside of court

Groups agree to abide by panel’s decision

1958 United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention)

Most important treaty regarding international arbitration signed by 107 countries

The United States has more lawyers than any other country in the world and is arguably the most litigious nation on earth. In part, this is a reflection of the low-context nature of American culture and the spirit of confrontational competitiveness. Other factors can contribute to differing attitudes toward litigation. For example, in many European nations, class action lawsuits are not allowed. Also, European lawyers cannot undertake cases on a contingency fee basis. However, change is in the air, as Europe experiences a broad political shift away from the welfare state.

The N.Y. Convention is important because:

Signatory countries can require companies to use arbitration if those companies have a contract that provides for international arbitration

Signatories can enforce the award

Arbitration organizations:

International Chamber of Commerce (oldest and in Paris)

American Arbitration Association

Swedish Arbitration Institute of the Stockholm Chamber of Commerce

The U.N. Conference on International Trade Law

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The Regulatory Environment

Agencies, both governmental and non-governmental, that enforce laws or set guidelines for conducting business

Marketing activities affected by international and regional economic organizations

WTO

Global companies are realizing they need to hire lobbyists to represent their interests and influence the direction of the regulatory process. In the early 1990s, McDonald’s, Nike, and Toyota did not have a single representative in Brussels, home of the European Commission. Today they have several. Overall, there are about 15,000 lobbyists representing 1,400 companies and nonprofits from around the world there.

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Looking Ahead to Chapter 6

Global Information Systems and Market Research