The Development of International Trade - Essay Example

Introduction

For any business, profitability and increasing the shareholder value is one of the important objectives, and this means that the business has to focus on strategies that improve on these two important aspects. Businesses have achieved these objectives by strategically positioning their activities in the market to capture particular target markets, while also establishing their presence in emerging markets around the world. Local markets are sometimes saturated with the trade/business that an organization is looking to establish. This brings the need to diverge to international markets, and opens up international trade.

International trade/business is seen as any instance where production or distribution of goods and services transcends borders. The cross border activity may involve exchange of goods and services or even resources such as intellectual property, liabilities, or contractual assets (Carpenter and Dunung, 2012). Regardless of the form of international trade that an organization may be dealing with, strategic management and entrepreneurship form the basis of the success of the international ventures. Further, capital and financing of the international trade determines the success and progression of the ventures in the new markets. The development of international trade has been closely linked to the aspect of globalization that has eased trade flows and subsided certain barriers likely to affect international trade (Trefler, 2014).

Even with the ease with which businesses are now operating in the international markets, they are faced with certain threats that are beyond threats in the local markets, while there are also opportunities above those in the local markets. Identification of the threats and opportunities in international markets is a function of strategic management that involves assessment of the new market and the business’ suitability to operate in the market. In addition, strategic management helps analyze the financial implications of the new trade approaches and how the organization can benefit in such environments. In understanding how firms can make use of the available financial techniques in the international market, the paper will first overview likely threats and opportunities. The following is a discussion of the threats and opportunities in international trade, and the financial techniques that help the organization achieve profitability.

Threats in international trade

A SWOT analysis of the organization in the new market highlights the likely opportunities and existing and potential threats that the business will deal with in the international market. The threats that a business is likely to face beyond those in the local markets can be classified within economic, political, cultural, and commercial threats.

Economic Threats

Economic threats to a business refer to the macroeconomic aspects and circumstances that the organization is likely to encounter in the international market. The macro-economic aspects become threats when they impede the organization’s ability to maximize its profitability (Almotairi, Alam, and Gaadar, 2013). In the international market, likely economic threats are such as fluctuations in conversion rates, administration regulation or political constancy and economic growth fluctuation (Gianni, Honohan, and Ize, 2013). Other economic threats that a business may face are such as increased interest rates and raising of taxes once the business is established in the new market. A country with a fluctuating economic growth means that the organization has no market assurance, and this serves as an economic threat (Love and Lattimore, 2009).

Political threats

Political threats are closely linked to economic threats, as the action/influences of the political sphere will have an impact on the economy. One predominant political threat in international market is the threat of political instability that affects the ability to conduct business and further investments in the country. Political instability slows down the economy and affects consumer confidence as well as the spending by the business and the consumers. Government policies and regulations may also fall within political threats likely to hurt the economy and the ability to achieve maximum profitability. Trade treaties within regions and across countries may favor trade, but the severing of such treaties is a political threat that brings about non-favorable terms for the businesses in the particular market.

Socio-Cultural Threats

A business is also likely to experience socio-cultural threats concerning the acceptability of the organization’s products or services in the particular market, or the likely attitude from the locals. Prior to establishing a presence in a particular market, the organization is expected to assess the cultural views and attitudes towards consumerism. Misjudging these socio-cultural aspects or any changes in the socio-cultural attributes becomes a threat to the business as changes may affect buying behavior (Alemanno et al., 2012). Another socio-cultural aspect that may become a threat is the business practices associated with different markets. Failure to understand these practices may lead to a misjudging of the market, which later becomes a threat due to non-conformance to such practices.

Legal threats

A business may also encounter threats from a legal perspective, where changes in laws and regulations in a particular market may affect the ability for continued profitability or growth in the organization. A legal threat also refers to the frequency with which laws and regulations associated with businesses change, and the regulatory compliance costs that come with these changes (Maria, 2015). As an example, regulators in Europe have asked for the consideration to have Coca-Cola give shelf space in its coolers to competing products. The acceptance of such a regulation becomes a threat to the company’s dominance and strategic positioning in the market. Further, profitability will be affected by the fact that consumers have more choice.

Opportunities in international trade

While the international markets have threats likely to affect the business’ ability to achieve maximum profitability, there still exists opportunities that the business can capitalize on. Economic opportunities in the international markets are such as a country’s growing economy or its status as an emerging market (Donohoe, McGill, and Outslay, 2012). An emerging market is seen as one transitioning to a free market economy that has increasing economic freedom, an expanding middle class, improving living standards, social stability a gradual integration in the global marketplace (Kvint, 2008). Organizations establish their presence in such markets to capitalize on the impeding growth that becomes an opportunity for expansion and growth. Other economic opportunities existent in an international market are such as the trade treaties enforced by regions, where such treaties create favorable cross-border business conditions. Trade treaties may also fall within political factors that facilitate growth and expansion in a market, as they are a result of political negotiations for business facilitation.

Reduced labor costs

Another opportunity in international trade comes from likely reduced labor costs in the new market. For profitability purposes, businesses wish to reduce their costs while increasing their productivity, and this means that a market with low labor costs provides opportunities for business growth and expansion. Low labor costs in international markets have been the reason behind large incidences of off-shoring in the global market (Czinkota, and Ronkainen, 2009). Asian markets such as India have been associated with low labor costs and hence are destination markets for off-shoring firms.

Low tariffs and quotas

Some of the political factors that pose as opportunities for businesses in international trade are low tariffs and quotas in some markets (Slaughter, 2004). Low tariffs and quotas imply that the business will not incur increased costs during trading. Import and export licensing and low custom duties also facilitate growth in a new market and are thus opportunities for growth in these new markets. With regards to fluctuating of exchange rates, some markets have laws directed towards currency control which means that exchange rates remain stable for some time.

Socio-cultural opportunities

Socio-cultural factors may also provide opportunities for a business depending on the type of industry, and the cultural views and attitudes towards the business/industry. Businesses can learn the cultural norms and preferences of the target markets and structure their products and services to fit the needs of such a market (Srinivasan, 2015). Through such an approach, socio-cultural norms and attitudes become a prelude and an opportunity for growth with the right strategic management by the organization.

Some markets are more technologically advanced than others are, and this presents an opportunity for strategic positioning to capitalize on the technological development of the market. Technology as an opportunity in international markets makes it possible to cheaper production of goods and services, as well as standardization of quality (Rosenberg, 2012). The opportunities in such a market are such as the likelihood for cost effective production of goods and delivery of services, as well as provision of innovative services such as remote working and online trading. With cost-effectiveness comes the ability to maintain profitability in the market.

The environment is also an opportunity factor in international markets. Some organizations require continuous and close proximity to raw materials, and this means that easier access to raw materials in a particular market is an opportunity for business growth and expansion (Rodriguez and Dani, 2010). Environmental factors may also refer to the associated costs of waste management where low costs imply an opportunity for the organization to establish its presence in the market.

The threats and opportunities discussed above are relevant only in the international trade, and have an impact on the organization’s profitability. Strategic management allows organizations to strategically align their capabilities in ways that maximize on available opportunities while countering the likely threats. In this regard, maximizing on opportunities require financial commitment by the organization in its establishment in the international market. Organizations make use of the available financial techniques in international trade to enhance their profitability. The financing techniques have an effect on profitability by supporting on-time payment while minimizing associated risks and accommodating the needs of buyers.

Financing international trade

In the financing of international trade, banks at both sides of the buyer and sellers play a role in financing the trade. There are different approaches to financing of international trade, and organizations can capitalize on these techniques for favorable profitability. Some of the approaches used as trade financing methods are such as accounts receivable, letters of credit, factoring, Banker’s acceptance, countertrade, forfeiting/ medium term capital goods financing, and working capital financing. An organization can manipulate each of these financing techniques to achieve profitability and minimize liability and risks associated with international trade.

On accounts receivable financing, a goods exporter may ship goods to the buyer without the need for a payment assurance from the bank. The transaction may be in the form of a time draft or an open account shipment. Before the shipment, the organization/exporter needs to have assessed the creditworthiness of the importer or buyer (Rosenberg and Birdzell, 2014). Should the exporter be willing to wait for the payment to take place, a credit will be extended to the buyer. The accounts receivable financing comes in where the exporter/organization may be in need of immediate funds and it sources for a loan from the bank against the accounts receivable. The loan as extended by the bank does not only depend on the buyer, but also the creditworthiness of the exporter, where the exporter will be responsible for the loan should the buyer default on payment. In legally enhancing profitability, the organization maintains trust with the buyer for purposes of long-term business engagement, while it can still access funds from the bank for current engagements. As such, profitability is maintained by having continual operations in the organizations on account of the loan while establishing trust and business relationships with the buyer for future business.

On shipping goods prior to payments, an exporter increases its accounts receivable balance. In cases where the exported does not source for a loan from the bank, he becomes the initial financier of the transaction and hence must constantly monitor its accounts receivables. The exporter is always aware of the danger of non-payment from the buyer, and this brings about the need to extend the risk to a third party referred to as the factor. The approach is referred to as the factoring financing where the factor assumes all the risks, responsibilities, and credit exposure associated with colleting the payment from the buyer. A credit approval is done on the buyer prior to the factoring process, while the purchasing of the receivables is at a discount above the flat processing fee. As a financing approach, factoring is beneficial to the organization/exporter in different ways such that the organization foregoes administrative duties in monitoring its accounts receivables, the organization does not suffer credit exposure, and there is an instant cash flow following factoring (Blouin, Robinson, and Seidman, 2012). The organization is able to maintain profitability from this approach by reducing the administrative costs, foregoing the risk of non-payment, and continued organizational functions from available cash flow. Further the trust created between the buyer and the seller is an assurance of future business and the derivation of long term value from the relationship.

Letter Of Credit

A letter of credit is another form of international trade financing that is one of the oldest financing techniques still available. The letter of credit has been a crucial part of international financing as it is beneficial to both the importer and the exporter. The financing technique usually involves making of payments by the bank to a beneficiary on behalf of another party and under specified conditions (U.S. Department of Commerce, 2007. Usually, the selling organization or the exporter receives the payments on presentation of the required documents that should be in compliance with the terms in the letter of credit. The financing technique has to involve the buyer and seller’s banks as the seller’s bank is substituting its credit for that of the buyer (Samuelson, 2014). An organization can use the letter of credit to enhance profitability by having the assurance of payment and the availability of cash flow even before the buyer has paid for the products. The organization/exporter’s concern is that the buyer’s bank may be restricted from making payments when exchange controls or any other restrictions against payment by the bank are issued by the government. The letters of credit help maintain the flow of trade between organizations and countries without any credit risk (Saxonhouse, 2008). Banks become guarantors that the buyer will pay for the goods and this assures the traders that the monetary obligations will be met. As such, an organization reduces the risk of non-payment from the buyer and there is continued business flow despite non-payment. The letters of credit fall within revocable and irrevocable letters of credit, where the revocable credit letter can be cancelled without notifying the beneficiary. The revocable letters of credit are rarely used in the market today.

Banker’s Acceptance

A banker’s acceptance is another financing technique that is usually a time draft or bill of exchange accepted by the bank. As a draft, banker’s acceptance means that it is the obligation of the accepting bank to pay the draft holder the amount of money stated in the draft at maturity. In the creation of a banker’s acceptance, a buyer requests for goods from the exporter, where the buyer later requests the bank to issue a letter of credit that allows the exporter to draw a time draft in payment for the sold goods. The selling organization/ exporter presents the time draft to its bank, where the exporter’s bank send the draft to the buyer’s bank. Once the buyer’s bank accepts the time draft, there is the creation of the banker’s acceptance. Should the exporter be willing to cash in on the time draft prior to the maturation of payment, he can request for the selling of the draft in the money market. Although the money obtained from the money market will be less than the amount specified in the time draft, selling the draft provides a quick access to cash for other organizational functions. Profitability comes about from the fact that the organization will not undergo losses from non-payment, while selling of the draft provides resources to concentrate on other organizational functions that drive profitability.

Working Capital Financing

Another financing technique in international trade is the working capital financing that is similar to the banker’s acceptance. A working capital financing refers to the provision of funds by the bank or any financial institution to an organization for continuation of its trade activities. On working capital financing, the bank provides the organization with a loan by which to facilitate trade activities prior to the payment by the buyers. As such, the working capital financing may refer to the loan given to an organization while the buyer is yet to remit payments to the seller. A working capital financing helps propel profitability by even extending the loan period beyond the period stipulated in the banker’s acceptance, thus reducing the strain of loan payment by the organization (Gordon, and Hines, 2012). Further, the working capital ensures continued activities in the organization despite being yet to receive payments from the buyer. The implication is that the organization will continue to meet its obligation that includes the provision of goods and services to other clients.

Medium-Term Capital Goods Financing

Forfeiting or medium-term capital goods financing is a technique used when a buyer does not intend to make payments for capital goods in a short period due to the expensive nature of the goods (Jacobs, 2013). The expensive nature of capital goods call for a long-term financing approach in a trade finance approach referred to as forfaiting. Forfaiting is used in reference to the purchase of financial obligations that include promissory notes and bills of exchange without the exporter experiencing any recourse (Lee, 2013). The promissory note comes from the buyer/importer who promises to pay the seller over a period of three to seven years. The exporter then may sell the promissory note to a forfaiting institution and has no recourse should the buyer fail to pay. In such a technique, the organization has the ability to maximize on profitability by gaining the resources for continued business operations after selling the note, while also reducing any risk associated with non-payment.

Countertrading

Countertrading is another financing technique applicable in the international trade financing. The term refers to the different types of foreign trade transactions where sales of goods is linked to the purchase of goods in the same country. Examples of countertrade are such as barter trade, compensation, and counter purchase (Asselt, Versluis and Vos, 2013). Barter trade refers to exchange of goods without the usage of currency and may be governed by a contract. In compensation, the buying of goods by an individual or organization is compensated by buying back certain products from the initial buyer. Compensation may be partial or full compensation. A counter purchase involves the exchange of goods by two parties but under distinct contracts that are expressed in monetary value. Countertrading is regarded as economically inefficient but is fueled by debt problems in some countries, a foreign currency shortage, and payment disequilibrium (Madura, 2007, 574). By adopting such an approach, an organization can maintain its profitability when market forces are against the maximization of monetary output from a transaction. The organization avoids potential losses in non-payment or reduced value of products from the buyer.

International transfer pricing

Transfer pricing refer to the setting of price for services and goods that are sold between legal or controlled entities in an enterprise. Organizations in international trading have subsidiary companies where there is transfer of goods and their monetary value between the subsidiary and the parent company (Bakker and Levey, 2012). Transfer pricing is used as a profit allocation approach by organizations, but government agencies have issues with transfer pricing when unrealistic prices are used to lower the firm’s profits in countries with high income taxes. On the other hand, organizations use the transfer pricing approach to raise profits in countries regarded as tax havens due to low income taxes.

Organizations can use the transfer pricing strategy to influence their organizational output when trading in countries with low income taxes. Although such approaches have evoked controversies, there exists no rules that determine the appropriate transfer price in any international transaction (PWC, 2013). Considering that there are no define rules, the organization has the discretion of using the transfer pricing approach to its advantage and influence the organization’s profitability. As such, international trading in countries with low income taxes presents the opportunity for organizations to manipulate its transfer pricing to achieve higher profitability. The consideration of the advantages of transfer pricing should not only be from a manipulative perspective, but also the opportunities available in decentralizing of an organization’s operations (Klassen, 2014).

As much as transfer pricing helps organizations improve their profitability with regards to filing low or high returns and decentralization of operations, there is the threat associated with the controversies around manipulation of transfer pricing (Hassett and Newmark, 2008). From a financial perspective, the controversies around transfer pricing are time-consuming and expensive, and may at times result in double taxation. Organizations need to be aware of the associated risks in manipulation of transfer pricing to achieve profitability.

Legislation with regard to transfer pricing has enabled greater scrutiny into how organizations manipulate transfer pricing. The Internal Revenue Service in the US increased its staffing and created a Director of Transfer Pricing in 2010 as a way of increasing scrutiny on organizations and their activities (Ossi and Shepherd, 2010). Other countries are formulating and implementing policies meant to control transfer pricing, and the implication is that there is a lot of dynamism with regards to transfer pricing (Scholes and Wolfson, 2012). Organizations that are trading internationally have to be aware of the increasing legislation from the financial and non-financial areas and structure their operations to align with established policies.

Conclusion

International trading is one approach used by organizations to increase their profitability by capitalizing on new markets and available opportunities to spur the growth of their organizations. In this respect, organizations strategically position their operations to minimize the inherent threats in these markets while using their strengths to maximize on the opportunities. The different financing techniques in the international market further the firm’s profitability by providing resources for continued operations, while also helping minimize the associated risks of trading in international markets. As another aspect that influences international trading, transfer pricing has been used to decentralize operations while also manipulating the organization’s prices to file low returns and maximize on profitability. The risks of transfer pricing are inherent in the continued regulation meant to curb the manipulation of prices in the international markets. Regardless, the international markets provide growth opportunities for firms engaging in these markets.