The Countertrade - Essay Example

Countertrade Definition Countertrade is a term that covers a whole range of barter like agreements. It is used mainly when a company is exporting to countries whose currency is not freely convertible, and who may lack the foreign exchange reserves necessary to purchase the imports. The volume of countertrade is growing. In 1972, it was estimated that countertrade was used by business and governments in 15 countries. By some other estimates, countertrade accounted for 20% of world trade by volume in 1998. Presently it is growing around the world. Types of Countertrade Countertrade is classified under five divergent types namely; barter, counter purchase, offset, switch trading and buyback. There are five distinct types of countertrade -- barter, counter purchase, offset, switch trading, and buy back. Under this essay, we will focus on the meaning and the significance of each type in the international trade scenario. Barter Barter can be defined as a direct exchange of goods and services, or both, between two parties without a cash transaction. It involves exchange of goods for goods and does not involve cash payments or receipts. Although in theory barter appears to be the simplest arrangement, in practice it is not commonly applied or practically implemented. It can be said that the expansion of bartering in the US is mainly because of barter companies or barter exchanges. According to popular estimates, there were roughly 600 barter exchanges among which 500 acted as clearinghouses for the exchange of goods and services between their clients and 100 were corporate trade brokers that exchange trade credits for assets, and goods and services so as to make it a part trade and part cash transaction. In a manner, barter dealers or barter exchanges facilitate a common platform upon which members exchange goods and services either through pure barter or through mixture of barter and cash. The barter exchange generates its profits from membership and renewal fees and from certain commissions which are based on a percentage of the gross worth of each operation. The fees usually range between 5 to10 percent. Under certain arrangements, some barter exchanges also charge a monthly administrative fee. The most significant purpose of a barter exchange is to match the needs of potential traders. Counter Purchase Counter purchase is a form of mutual 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. Typically, there will be two distinct contracts. One of them will relate to the sale of goods/services by the trading company for which it will be paid a specified amount of hard currency. The other form will require the trading company to spend some proportion of this revenue to buy goods from a list provided by the importing country. The counter-purchase may vary in value between 10 and 100% of the original export order. The imports bought require not be related in any way to the goods/services exported. Generally, there is a specific time period (normally three years) within which the counter-purchase must be made. Thus, in this form of counter-trading (unlike pure barter), exports only partly finance the purchase of imports. In fact, they simply help balance costs on imports at a later date. In this manner, a counter-purchase transaction is not undertaken because of a lack of convertible currency or incapability to obtain credit. Nevertheless, it has often been used by planned economies as a tool for scheming foreign trade and ensuring that exports balance imports. Offset Offset is similar to counter purchase since the exporter is required to purchase goods and services with an agreed percentage of the proceeds from the original sale. The main difference is that the exporter can fulfill this obligation with any firm in the country to which the sale is being made. Certainly, its importance appears to be growing fast. It involves an agreement under which an exporter integrate into his final product, along with certain components and parts obtained from the foreign (importing) country. Offset is commonly used in the export of high-value goods such as civil or military aircraft or other types of military equipment. One term often used under the context of an offset is "switch trading". It refers to the use of a specialized third-party trading house in a countertrade arrangement. When a firm enters into a counter purchase or offset agreement with a country it often ends up with what are called "counter purchase credits". These should be used to purchase goods from that country. Switch trading occurs when a third party trading house buys the firm's counter purchase credits and sells them to another firm that can make better use of them. Buyback Buyback is another type of counter-trade involving the supplier of capital plant or equipment (usually to a developing country) being paid with part of the output. For example, a company belonging to a developed country which is supplying a manufacturing plant to a developing country may be paid with a right to part of the resultant output of the plant. Buyback deals are most common where the product exported takes the form of process plant or mining equipment. Usually they are for longer periods of time (typically ten to fifteen years) than other forms of counter-trading. In other words, 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. Advantages and Disadvantages The main appeal 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--vis one that is willing to engage in countertrade. Some other advantages are: It gives firms a way to finance an export deal when other means are unavailable Foreign governments may require it It helps countries that do not have sufficient foreign currency reserves Unwilling firms may lose an export opportunity and be at a competitive disadvantage Countertrade can become a strategic marketing weapon The main disadvantage of countertrade is that it may involve the exchange of unusable or poor quality goods that cannot be disposed off profitably. Countertrade accept alternative means of payment instead of hard currency It is the exchange of unusable or poor-quality goods that cannot be disposed profitably It increases expenses relating to maintaining an in-house trading department to arrange and manage countertrade deals As an option, countertrade is most attractive to large, diverse, multinational enterprises that can use their worldwide network of contacts to profitably dispose of goods acquired in a countertrade agreement. It is less attractive to small and medium sized exporters who lack a similar network. Role of Countertrade in the Global Market There are certain risks involved when the exchanged products do not find their way back to the original market at discount prices. Additionally, countertrade can entail complex and time-consuming negotiations with a low rate of success. Follow-up paperwork is more complex than for normal trade. Price setting also becomes difficult since all costs are not known at the time of exchange. This also causes the profit margins to be estimated at a reduced level. Exchange of technology and expertise occurring during countertrade can also be quite risky in the long run. Once a company acquires the countertrading firm's competence, the affiliation between the organizations can transfer from that of close trade associates to dominant competitors. This transfer of technology can increase the threat of increased competition in the market for the developer of that technology. However, despite these risks, a countertrade deal can significantly help solve the real price problem. Since countertrade involves the exchange of real goods, not financial instruments for real goods, it can solve the inflation risk involved in foreign currency procurements and interest rate risks. Thus it can sometimes provide a superior hedge to financial instruments. One of the main reasons to engage in countertrade is to meet certain requirements of foreign governments and traders. Countertrade also occurs when countries are lacking adequate hard currency, or when other types of market trade are either not possible or are not feasible. Hence, countertrade remains an intractable trade practice for many companies. Its potential as an aggressive marketing and procurement tool is still far from being realized. References Bartering accessed on February 26, 2006 http://www.referenceforbusiness.com/encyclopedia/Assem-Braz/Bartering.html Countertrade - Wikipedia, the free encyclopedia Accessed on February 26, 2006 http://en.wikipedia.org/wiki/Counter_trade Focus Study: Countertrade: Purchasing's Perceptions and Involvement Accessed on February 26, 2006 http://www.capsresearch.org/publications/pdfs-public/forker1991.htm Kreuze, Jerry G., International Countertrade1997:42-47 Nigel Grimwade, International Trade: New Patterns of Trade, Production & Investment, 2000, 186-190,417 Read More