Commercial Risk in International Business

What is International business ?

International business is a term used to collectively describe all commercial transactions (private and governmental, sales, investments, logistics, and transportation) that take place between two or more nations. Usually, private companies undertake such transactions for profit; governments undertake them for profit and for political reasons.

A multinational enterprise (MNE) is a company that has a worldwide approach to markets and production or one with operations in more than a country. An MNE is often called multinational corporation (MNC) or transnational company (TCN). Well known MNCs include fast food companies such as McDonald’s and Yum Brands, vehicle manufacturers such as General Motors, Ford Motor Company and Toyota, consumer electronics companies like Samsung, LG and Sony, and energy companies such as ExxonMobil, Shell and BP. Most of the largest corporations operate in multiple national markets.

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Areas of study within this topic include differences in legal systems, political systems, economic policy, language, accounting standards, labor standards, living standards, environmental standards, local culture, corporate culture, foreign exchange market, tariffs, import and export regulations, trade agreements, climate, education and many more topics. Each of these factors requires significant changes in how individual business units operate from one country to the next.

The conduct of international operations depends on companies’ objectives and the means with which they carry them out. The operations affect and are affected by the physical and societal factors and the competitive environment.

Objectives of International Business: sales expansion, resource acquisition, risk minimization.

What are Risk In International Business ?

Companies doing business across international borders face many of the same risks as would normally be evident in strictly domestic transactions. For example,

* Buyer insolvency (purchaser cannot pay);

* Non-acceptance (buyer rejects goods as different from the agreed upon specifications);

* Credit risk (allowing the buyer to take possession of goods prior to payment);

* Regulatory risk (e.g., a change in rules that prevents the transaction);

* Intervention (governmental action to prevent a transaction being completed);

* Political risk (change in leadership interfering with transactions or prices); and

* War and Acts of God.

* The risks that exist in international trade can be divided into two major groups:

Economic risks

. Risk of insolvency of the buyer,

. Risk of protracted default – the failure of the buyer to pay the amount due within six months after the due date

. Risk of non acceptance

. Surrendering economic sovereignty

* Political risks

. Risk of cancellation or non renewal of export or import licences

. War risks

. Risk of expropriation or confiscation of the importer’s company

. Risk of the imposition of an import ban after the shipment of the goods

. Transfer risk – imposition of exchange controls by the importer’s country or foreign currency shortages

. Surrendering political sovereignty

· Exchange rates

* Price for which the currency of a country can be exchanged for another country’s currency.

Factors that influence exchange rate include

(1) interest rates,

(2) inflation rate,

(3) trade balance,

(4) political stability,

(5) internal harmony,

(6) high degree of transparency in the conduct of leaders and administrators,

(7) general state of economy, and

(8) quality of governance.

Risks in international trade can be divided under several types, such as:

Economic risks:

* Risk of concession in economic control

* Risk of insolvency of the buyer

* Risk of non-acceptance

* Risk of protracted default i.e. the failure of the buyer to pay off the due amount after six months of the due date

* Risk of Exchange rate

* Political risks:

* Risk of non- renewal of import and exports licenses

* Risks due to war

* Risk of the imposition of an import ban after the delivery of the goods

* Surrendering of political sovereignty

Buyer Country risks

* Changes in the policies of the government

* Exchange control regulations

* Lack of foreign currency

* Trade embargoes

Commercial risk:

* A bank’s lack of ability to honor its responsibilities

* A buyer’s failure pertaining to payment due to financial limitations

* A seller’s inability to provide the required quantity or quality of goods

Others Risks :

* Cultural differences e.g., some cultures consider the payment of an incentive to help trading is absolutely lawful

* Lack of knowledge of overseas markets

* Language barriers

* Inclination to corrupt business associates

* Legal protection for breach of contract or non-payment is low

* Effects of unpredictable business environment and fluctuating exchange rates

* Sovereign risk – the ability of the government of a country to pay off its debts

* Natural risk – due to the various kinds natural catastrophes, which cannot be controlled

There are many other risks which are the following.

(1) Strategic Risk

(2) Operational Risk

(3) Political Risk

(4) Country Risk

(5) Technological Risk

(6) Environmental Risk

(7) Economic Risk

(8) Financial Risk

(9) Terrorism Risk

Strategic Risk:

The ability of a firm to make a strategic decision in order to respond to the forces that are a source of risk. These forces also impact the competiveness of a firm. Porter defines them as: threat of new entrants in the industry, threat of substitute goods and services, intensity of competition within the industry, bargaining power of suppliers, and bargaining power of consumers.

Operational Risk:

This is caused by the assets and financial capital that aid in the day-to-day business operations. The breakdown of machineries, supply and demand of the resources and products, shortfall of the goods and services, lack of perfect logistic and inventory will lead to inefficiency of production. By controlling costs, unnecessary waste will be reduced, and the process improvement may enhance the lead-time, reduce variance and contribute to efficiency in globalization.

Political Risk:

The political actions and instability may make it difficult for companies to operate efficiently in these countries due to negative publicity and impact created by individuals in the top government. A firm cannot effectively operate to its full capacity in order to maximize profit in such an unstable country’s political turbulence. A new and hostile government may replace the friendly one, and hence expropriate foreign assets.

Country Risk:

The culture or the instability of a country may create risks that may make it difficult for multinational companies to operate safely, effectively, and efficiently. Some of the country risks come from the governments’ policies, economic conditions, security factors, and political conditions. Solving one of these problems without all of the problems (aggregate) together will not be enough in mitigating the country risk.

Technological Risk:

Lack of security in electronic transactions, the cost of developing new technology, and the fact that these new technology may fail, and when all of these are coupled with the outdated existing technology, the result may create a dangerous effect in doing business in the international arena.

Environmental Risk:

Air, water, and environmental pollution may affect the health of the citizens, and lead to public outcry of the citizens. These problems may also lead to damaging the reputation of the companies that do business in that area.

Economic Risk:

This comes from the inability of a country to meet its financial obligations. The changing of foreign-investment or/and domestic fiscal or monetary policies. The effect of exchange-rate and interest rate make it difficult to conduct international business.

Financial Risk:

This area is affected by the currency exchange rate, government flexibility in allowing the firms to repatriate profits or funds outside the country. The devaluation and inflation will also impact the firm’s ability to operate at an efficient capacity and still be stable. Most countries make it difficult for foreign firms to repatriate funds thus forcing these firms to invest its funds at a less optimal level. Sometimes, firms’ assets are confiscated and that contributes to financial losses.

Terrorism Risk:

These are attacks that may stem from lack of hope; confidence; differences in culture and religious philosophy, and/or merely hate of companies by citizens of host countries. It leads to potential hostile attitudes, sabotage of foreign companies and/or kidnapping of the employers and employees. Such frustrating situations make it difficult to operate in these countries.

CASES

* October 2006 – International Risk – North Korea – Future Implications

International Risk has drawn up a report which explores the strategic thinking of the North Korean regime and their logic for conducting nuclear tests. The report outlines the likely future implications for Asia.

* September 2005 – International Risk Assessment: INDIA BUSINESS – RISK & OPPORTUNITIES

India continues to establish itself as an emerging global force attracting increasing foreign direct investment. In response to the ever changing business climate, companies need to develop strategies to increase competitiveness and improve profitability. When expanding into new and developing markets, there are various elements that help make the endeavour successful as well as risks which can lead to severe disappointment. With India being touted as the new market and global player, it is critical that companies understand and appreciate both the opportunities and challenges faced by foreign investors. In short, provided companies take appropriate action to, India works. It represents a huge opportunity for the investor who has the appetite for detail, is patient and looks to the long term.

International Risk, the premier international risk mitigation and investigation company, provides a strategic assessment on the risks and opportunities for foreign investors entering this exciting market.

* May 2005 – International Risk – Macau Strategic Risk Assessment

In the five years since its return to Chinese sovereignty, the former Portuguese colony of Macau has witnessed unprecedented economic growth, driven by huge investment inflows into its gaming and tourist industries and an explosion in visitor arrivals, particularly from the mainland. Whilst there are positive indications as to Macau continuing its growth as a regional gaming centre, much like its new role model – Las Vegas, there are nevertheless uncertainties and risks arising from its chequered past as much as from its future under Beijing’s current benevolent oversight. Understanding these factors is crucial if foreign investors are to mitigate this risk.

International Risk, the premier international risk mitigation and investigation company has developed a strategic review of the challenges facing Macau, the opportunities it presents investors, and the risks they could encounter. International Risk has considerable experience in discreetly assisting foreign investors who seek to enter this colorful, yet exciting environment.

* April 2005 – International Risk Report on China-Japan

§ Political and strategic frictions between China and Japan have been growing over the past few years because of deep-seated historical distrust and an accelerating rivalry for regional power and influence between the two countries. But these tensions were previously contained and offset by close economic ties and the sharing of many issues of mutual interest, such as concerns over the rise of a nuclear North Korea.

§ This calm in China-Japan relations has been damaged by a ‘perfect storm’ of controversies that has unleashed pent-up passions among Chinese city-dwellers across the country. The history text-book issue over Japan’s war-time activity in China, Japan’s bid for a permanent UN Security Council seat and Tokyo’s decision to allocate drilling rights in disputed territorial waters are all highly charged emotional issues that strike at the very heart of Chinese popular nationalism.

§ While these controversies have propelled Chinese onto the streets in their thousands, the Chinese leadership’s decision to allow these anti-Japanese protests to take place is driven by deeper structural issues that suggest China-Japan ties are likely to remain volatile in the longer term.

Managing the Risks of International Trade

This guide provides information that will help you to put procedures in place to minimise the risks involved in international trade. You should read it if you are responsible for planning and delivering the export strategy in your company. You should make sure that the information in this briefing is read by your sales and marketing force, your finance management team, your credit manager and the sales ledger controller.

What types of risks will I have to manage?

Customer Risk

You will need an assessment of the credit worthiness of your customer. This should include checking the following:

• The identity of your customer. Do they exist as a legally established business in the country of import? Are you dealing with someone who has the authority to bind your customer;

• The usual period of credit offered in your customer’s country;

• The credit limit you are prepared to offer your customer;

• The trading history of your customer. Are they a prompt payer? Have there been any changes to their normal payment patterns?

• Are your exports compatible with your customer’s normal business profile?

• Can your customer pay the bill?

• Insolvency. Remember that a customer’s insolvency can involve you in a pre credit risk, where losses can occur if your customer becomes insolvent during the manufacturing process or at any time before or after the despatch of the export consignment. You can obtain the information needed to carry out these checks either yourself or through a reputable credit agency or credit insurer.

Country Risk

As well as your customer, their country can pose separate risks that you will need to manage.

Country risks traditionally fall into five areas:

• Sovereign:

The willingness or ability of the government to pay its debts. This is affected by the political climate within the country, internal and external threats to the country; international trading performance including balance of payments record; the level of national debt and the amount of foreign exchange reserves. Other political decisions can also frustrate your export sales; these include the imposition of embargoes, tariff or other quotas, and import or export restrictions.

• Private:

The ability of the private sector to pay for its imports. This situation is affected by the 2 SITPRO Management Guide: Managing the Risks of International Trade state of the domestic economy, the commercial institutions in the country, and the competence of banking and financial services sector.

• Natural:

Some regions of the world suffer from regular climactic catastrophes (for example annual flooding, drought, earthquakes and other disasters). When these occur they can severely disrupt the operations of both the business sector and the government.

• Fashion and Finance:

International trading patterns often create a fashionable region or country as an export market. In these circumstances trade finance is often readily available, allowing you to offer good credit terms to your export customers. However, fashions change and countries can quickly go out of favour for both exports and trade finance.

• Other:

These include transfer risks such as the inconvertibility of the local currency; transaction risks such as late or non-payment, and transition risks for emerging markets where the threats are the effectiveness of the liberalisation programme, failure to complete economic structural reforms and any possible destabilising influences.

You can obtain information about country risks by visiting the country and/or by speaking to other knowledgeable organisations such as UK Trade & Investment, your local chamber of commerce or one of the major banks.

Credit Risk

Perhaps the first question you should ask is ‘Can I afford to give my customers credit?’ To decide how much credit you are prepared to advance you must consider:

• The amount of credit outstanding in your trading accounts, both overseas and domestic;

• What do you know about your customer and what is the maximum amount of credit you should NOT exceed;

• Can you carry any financial shortfall? What will be the impact on your business if your customer delays payment or does not pay at all?

• How will you finance the credit period you offer? This means do you have sufficient money to allow you to offer credit terms in export sales contracts as part of your business cycle.

Foreign Exchange Risk

When you trade internationally you will most likely be dealing in more than one currency. This means you are exposed to fluctuations in the foreign exchange market. You can learn how to manage this risk by referring SITPRO’s guide on The Foreign Exchange Market.

Other risks

If you manufacture goods to order you must include in your export strategy a contingency that will help you manage the risk of a frustrated export – this is when your customer refuses the goods. You should have a plan to either resell the product to another market or realise a salvage value for your goods.

Managing the Risks of International Trade:

You must also have procedures in place for the collection of your invoice amount. Under your contract you may have to collect your money in your customer’s country. This does have its risks as collection maybe more uncertain or expensive, so you will have to consider the legal system in their country. Your contract may, however, allow you to take legal steps to recover your debt in another country, including your own.

How do I manage these risks?

You can do the job yourself or employ the services of a comprehensive credit management and insurance provider. If you decide, for sound business reasons, to do the job ‘in house’ then you must have the resources and knowledge to:

• gather credit and other trade information about existing, and potential, customers;

• research the country and associated risks;

• examine the need for credit insurance, identify the most appropriate policy and investigate competitive products and services;

• manage the credit insurance policy and maximise any benefits

If you decide to go down this route, you will have to consider the financial and other impacts on your business. These include senior management ownership of the credit management strategy;

The allocation of sufficient time, resource and money to do the job, and a review of your export catalogue prices. You must remember to include the costs of ‘in house’ risk management and extending credit terms in your export quotes. Otherwise, a profit can soon turn into a loss as administrative costs eat into your bottom line.

What types of risk management and insurance services are available?

Classically, these are the approaches adopted by the business sector, based on the pattern of trade of the exporter.

Type of business

• Supplying goods to markets and customers on a regular basis;

• A large ‘one-off’ sales contract;

• The supply of capital or semi-capital goods for major overseas projects;

• The provision of services such as surveys or feasibility studies;

• Smaller or new exporters.

Products and services

Depending on your type of business, the following products and services are available to you:

• A partnership with a Credit Insurer to identify and assess your business prospects and cover the risks on your exports. The service can be tailored to meet your needs, by covering all Managing the Risks of International Trade. Your sales ledger, or just your accounts with larger customers, or by having a geographic limit, or by product line, or indeed in many other ways;

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• A specific insurance policy structured for a particular deal. Such a policy will take into account any factors unique to the sales contract which is being covered. Specific policies are ideal for contracts whose size or duration fall outside the normal pattern of your trade. Also they are suitable for the sale of capital or semi capital goods on extended credit. Insurance for individual contracts can be obtained from credit insurance companies but the main supplier of this service, particularly for capital goods contracts, is the Export Credits Guarantee Department (ECGD);

• Smaller or new exporters can use a Managed Credit Insurance scheme as a way of contracting-out the credit control functions (obtaining country information, checking customer details and credit limits, chasing overdue payments and making claims). The cost of these services are often included in the premium for the scheme.

Where do I obtain these services?

You can approach specialist credit management and insurance providers, or your insurance adviser (broker, agent or intermediary). A list of credit insurance companies can be obtained from Association of British Insurers. Details of specialist advisers can be obtained from organisations such as the British Insurance Brokers Association.

With their worldwide networks credit insurance companies have years of experience and expertise in analysing and covering the risks involved in international trade. In addition to covering commercial debts and indemnifying you if your customer fails to pay, they can provide you with guaranteed cover which could improve your cash-flow, provide confidence to maximize your export sales and may enhance your borrowing power. The use of credit insurance imposes on your company a disciplined and professional approach to trade risk management. Adopting this solution can help reduce your bad debts, improve your competitiveness in the global marketplace and increase your profitability.

Are there any other options open to me?

There are other financial solutions to you credit management risks:

• do nothing, and carry the risk yourself. The extent of the risk you are prepared to take will determine if this option is appropriate;

• Factoring or invoice discounting;

• Forfaiting.;

• Secured payment terms (for example, Letters of Credit);

• Insurance-backed financial packages.

Managing the Risks of International Trade

How much will it cost me?

Like all insurance cover (premises, employer’s liability, business interruption) you will have to pay for your risk management and insurance services. Policies based on a specific risk are available and premium is usually on a ‘one-off’ basis. Premium is calculated according to the specific risk in question, credit period offered, your customer’s country and the duration of the risk from the insurer’s perspective.

There are also credit insurance policies and managed schemes that will cover all of your export turnover. Premium is usually annual and assessed against your estimated insurable turnover (the sales on credit covered). With your credit insurer you will have to agree your target export turnover for any one year. Typically, you can expect to pay between 0.35% and 0.65% for this type of policy, dependent on your products, the number of customers and range of your export markets, your export trading experience, and your own credit management system. As with all insurance cover, you should spend time researching the market and getting quotes from a range of credit insurance providers.

The costs quoted are based on typical policies available for small or new exporters wishing to cover sales with fairly short delivery and payment profiles. Costs will rise for specific policies where the horizon of risk for the insurer might be 2 or 3 years as in the case of ECGD cover for capital goods projects.

Conclusion

Credit insurance is an important risk management tool to help you protect the payment of your overseas accounts and unlock the full potential of your export business. You should carefully consider including it in your global trading strategy.

What are the major risks for business?

1. Political risk

2. Economic risk

3. Financial risk

What is the risk in the following Countries..?

INDIA :

In India or country risk tier (CRT) is categories in three types of risks.

Political, economical & financial risks.

* Poverty reduction in India is heavily reliant upon high levels of economic growth, which is likely to return in 2010/11.

Political Risk: High

• Income disparity in India is significant, as approximately one third of the population lives in poverty.

• National security has become a focus in India as some of the major cities have been the scene of terrorist bombings.

• The bilateral relationship with Pakistan is strained, and receives worldwide attention. Efforts in recent years to make reparations have been interrupted repeatedly by acts of violence.

Financial System Risk: Moderate

• The insurance industry is regulated by the Insurance Regulatory and Development Authority (IRDA).

• The Indian government is working to align its regulatory and accounting standards with international best practices.

• The Indian financial system has fared relatively well during the global financial crisis.

Economic Risk: Moderate

• India, with a massive population exceeding one billion, is home to the world’s 12th largest economy as measured by gross domestic product (GDP).

• India’s information technology sector and business services sector have been drivers of growth as the government has supported development with improvements in infrastructure and regulation.

• A notable point of weakness for the Indian economy is the worsening government budget balance. The deficit will likely reach -7.0% of GDP in 2008/09.

CANADA:

Economic Risk: Very Low

• Canada’s economy is developed, with services and manufacturing accounting for the majority of the country’s output.

• International trade is vital to the economy as exports represent about 40% of GDP with nearly 80% of those exports going to the United States.

• Economic growth in Canada began to contract in the fourth quarter of 2008 and will continue to contract until 2010.

Political Risk: Very Low

• Canada is a high income country with significant natural resources and an established legal system.

• Canada’s economy is inexorably linked to that of the United States due to the latter country’s geographic proximity, cultural similarities and economic size.

• Canada’s budget has moved into deficit as the government uses fiscalpolicy to help stimulate the economy.

Financial System Risk: Very Low

• Insurance companies in Canada can be licensed at a national and/or provincial level.

• Federal companies are registered under the Insurance Companies Act of Canada and are regulated by the Office of the Superintendent of Financial Institutions of Canada.

USA:

Economic Risk: Very Low

• The United States economy is the largest and most advanced in the world with gross domestic product (GDP) of more than USD 14 trillion.

• The United States has the dual advantage of being rich in natural resources, both agricultural and mineral, but also capable of producing high-end products such as computers and peripherals, medical equipment, pharmaceutical products and military equipment.

• The U.S. economy is currently experiencing its worst economic contraction since at least the early 1980’s with unemployment expected to reach double digits and GDP reaching negative 3% in 2009. Political Risk: Very Low

• The United States has a stable democratic political system and a strong legal system.

• The United States is currently involved in armed combat in Iraq and Afghanistan which has put strain on the relationships between the U.S. and much of the international community.

• The U.S. is currently using expansionary fiscal policy to stimulate the economy and this has led to a substantial increase in the budget deficit.

Financial System Risk: Very Low

• Insurance regulation in the United States is decentralized and handled on a state by state basis.

• The financial system in the U.S. is going through a tumultuous period with the government intervention with large corporations such as Bear Stearns, Citigroup and AIG.

UK:

Economic Risk: Very Low

• The United Kingdom (UK) has the second largest economy in Europe behind Germany. Service industries represent three quarters of economic production, particularly financial services and real estate activities. London is a global financial center and businesses there account for nearly half of the country’s financial services industry.

• The UK economy entered into a recession in the second half of 2008 as the country has been hit hard by the financial crisis and a declining housing market. The economy is not expected to recover until mid to late 2010 at the earliest.

Political Risk: Very Low

• The United Kingdom is a member of the European Union. However, the United Kingdom, along with Denmark, obtained special opt-outs from the Maastricht Treaty which allows them to not adopt the euro unless they wish.

• The UK government has taken steps to counteract the effects of the current financial crisis. These steps include partial nationalization of the banking system and implementing several stimulus packages.

Financial System Risk: Very Low

• The Financial Services Authority (FSA) regulates the UK financial services industries, including insurance.

• The UK is widely seen as a major center for international insurance and reinsurance and is home to the London Market, a wholesale market that writes risk around the world. Lloyd’s of London accounts for over half of the business on the London Market.

JAPAN:

Economic Risk: Low

• Japan, an industrialized and advanced country, is home to the second largest economy in the world behind that of the United States.

• Gross domestic product (GDP) growth, which had been weak over the past 20 years, will fall sharply in 2009 as domestic demand and exports contract. The government is responding to the crisis with aggressive expansionary fiscal policies that should result in a return to modest growth in 2010.

• Inflation, however, is expected to remain negative until 2011.