INTERNATIONAL BUSINESS

1. INTERNATIONAL BUSINESS Risk and financial aspect of international business Matevž Rašković December 11th 2009

2. INTERNATIONAL BUSINESS AND RISK

3. Why is International business more risky? • International business is more prone to risk, because (Buckley, 2004): • Companies are operating and doing business in a less known socio-economic environment  they harder understand the cause-and-effect mechanisms in such environment (i.e. change of government) • Differences in language, culture and religion • Harder collection of important data and information about the environment and potential partners • Additional political and economic factors, i.e. changing currency rates • Longer physical distances (different transportation modes) • Higher transportation costs • Longer ‘time window’ for something to go wrong • Usually bigger transactions (in terms of size and value) • More complex logistics and management issues • Thus, companies must be aware of different • sources and types of risk and take measures • to minimize them!

4. But what is risk? • Risk connected with UNCERTAINTY, regarding FUTURE events, which can DECREASE the PROBABILITY of reaching SET / PLANNED goals and have an IMPACT on the company (Tayeb, 2000)! • POSITIVE vs. NEGATIVE RISK? www.youtube.com/watch?v=vNSLnIxvhnk&feature=related

5. Types of risk in Int. business COUNTRY RISK FINANCIAL RISK BUSINESS RISK • RISK ASSOCIATED • WITH ALL BUSINESS • PROCESS AND • ACTIVITIES: • Innovations • Product design • Marketing • HRM • Administration • Documentation • Transport… POLITICAL RISK ‘PAYMENT’ RISK ECONOMIC & LEGAL RISK SOURCES • MARKET RISK: • Currency risk • Interest risk • Price risk Source: Tayeb, 2000.

6. Risk type 1: COUNTRY RISK www.youtube.com/watch?v=kXpB5JwpJFk

7. Country risk • Country risk: all economic, political, legal, financial and social aspects, which impact doing business in an international environment • Key questions? • How to determine the key risk factors of country risk? • How to predict key country risk factors for the future? • Which country risk factors are more and which less important? • How to compare the country riskiness of two environments? • All is relative!!!

8. Analysis of country risk • Analysis of political risk: • Wars and political conflicts • Terrorism and kidnappings • Confiscation, expropriation and • nationalization • Corruption • Government policies • Monetary policies and so called • transfer risks • FOCUS: corruption • www.youtube.com/watch?v=oxlPyvRzMJM&feature=related • Macroeconomic risk: • Monetary policy • Fiscal policy • Currency exchange policy • Foreign trade policy • GDP growth • Inflation • Unemployment • FDIs… • Legal environment risk: • Intellectual rights • Ecology • Tariffs and regulation on trade • Taxes • Regulation of products and services • Accountability

9. Transparency int.: corruption perception index

10. Analysis of country risk 2 approaches in practice • In advanced prepared • country reports: • BERI index • Control Risk Group (CRG) • Euromoney • Economist Intelligence Unit (EIU) • Moody’s Investor Service and Risk & • Payment Review • Coface • Export Credit Agencies (ECAs) • Euromoney Country Assessment: • Political risk: 25% • Economic performance: 25% • Indebtedness: 10% • Servicing loans: 10% • Credit ratings: 10% • Access to various finance… • Own analysis: • PEST analysis • PESTL analysis • SWOT analysis • Porter’s 5 forces analysis (industry) • C-analysis • Other analysis important to firm and • industry specific

11. Example: Coface • www.coface-usa.com/CofacePortal/US_en_EN/pages/home/wwd/inform/Country_risk/Country%20Risk%20Assessment

12. Example: BERI index Very good Some risk High risk www.beri.com

13. Example: Doing business in… www.doingbusines.org

14. Protection / minimization of country risk • Insurance (ECAs, insurance agencies, etc) • Integration with the host environment • Building political support at home and abroad • Moving profits through transfer pricing • Alternative business transactions: • Barter • Compensation • Counterpurchase • Offset transactions • Switch trading • Swap deals….

15. Risk type 2: FINANCIAL RISK

16. Financial risks • All unexpected changes in value of assets and liabilities of an internationally active company! • Types of financial risks: FINANCIAL RISKS PAYMENT RISKS MARKET RISKS Buyer doesn’t pay Market change Commercial reasons (liquidity) Non-commercial reasons (conversion restr.) Change in currency rate Change in interest rate Change in prices

17. Protection against payment risk • Running a check on a customer’s financial health • Appropriate financial instrument • Insurance of liabilities (insurance company, ECAs, etc) • Following up and monitoring liabilities • Offering discounts for early payment • Maximum overdraft for different customer types • Compensation • Advanced forms of financing (factoring, forfeiting) • Also some simple procedures, like: • Calling one of the customer’s customers or suppliers • Reading their annual report • Asking for proof of sound financial health…

18. Examples of market risks • Example: currency rate changes • A Japanese computer manufacturer sells 1.000 PCs to a German retailer, for 500 EUR per PC. The arranged payment currency is EURO and the amount has to be paid in 30 days. • What happens if the EURO falls (depreciates) against the Yen in 30 days? • How does this change impact the German buyer? • How does this change impact the Japanese buyer? • Similar also holds for interest risk and price risk!

19. Protection against market risk • Use of special financial instruments: futures and forwards • Options • Insurance of currency rate change (but it costs money!) • Legal instruments: contractual clauses of foreign currency • Agreements of sharing the market risks • Swap transactions

20. Risk type 3: BUSINESS RISK Examples of two big business mistakes!

21. Business risks • May arise in all business processes, which take place in the functioning of the company, and can span from technological innovation mistakes, to product design mistakes, to marketing mistakes, to production mistakes, to HRM mistakes…. • Most common business risk in Int. business: • Risk associated with various types of documentation • Risks associated with pricing and calculations • Transportation risks • Manipulation risks • Marketing ‘faux pas’

22. Protection against business risks • Documentation: • Experienced staff • Systematic tracking and IT systems • Outside help • Pricing and calculations: • Knowing your cost structure • Knowing your Incoterms clauses • Negotiate not only on the price, but also currency, payment deadliness… • Transportation and manipulation: • Transport insurance • Lloyd's insurance policy • Packaging • Penalties… • Marketing: • Information is key to every marketer!!! • Analysis, analysis and analysis…

23. FINACIAL INSTRUMENTS IN INTERNATIONAL BUSINESS

24. Elements of financing Int. business • Currency: • Exporter’s currency • Importer’s currency • 3rd party currency • Time frame of financing: • A key dimension of price • Different value of money through time • Financial instruments: • Open account payment • Payment in advance or cash at order (full or partial) • Documents against payment (D / P) • Documents against acceptance (D / A) • Bill of exchange • Letter of credit (L / C) • Bank guarantee…

25. Risk as an important element SELLER’S RISK - EXPORTER BUYER’S RISK - IMPORTER HIGH LOW Open account payment Bill of exchange Documents against acceptance Documents against payment Letter or credit and bank guarantee Cash at order LOW HIGH

26. Bill of exchange • A negotiable financial instrument •  negotiable: ability to be sold or transferred to another party as a form of payment • Sometime referred to also as promissory note • Definition: An unconditional order issued by a person or business, which instructs the recipient to pay an agreed and fixed monetary amount to a third party on a future date.

27. Documents against payment (D / P) documents Also referred to as an ADVISING BANK SELLER’S BANK SELLER / EXPORTER documents Also referred to as an ISSUING BANK documents BUYER / IMPORTER BUYER’S BANK Similar for D / A, but the buyer doesn’t have to pay immediately, he only has to sign a bill of exchange (promissory note).

28. Letter of credit (L / C) • One of the most important financial instruments in foreign trade and Int. business • A safe, but costly(!) instrument that protects both sides involved • Key participants in the procedure: • Applicant for the credit (i.e. buyer or importer) • Issuing bank, principal (buyer’s bank) • Beneficiary (i.e. seller or exporter) • Advising bank (beneficiary's bank) • 2 possible additional participants: • Confirming bank (guarantees he beneficiary the money) • Nominated bank (pays the monetary amount to the beneficiary)

29. L / C scheme

30. L / C

31. Types of L / C • LORO (export) vs. NOSTRO (import) L/C • IRREVOCABLE / NON-IRREVOCABLE L / C • CONFIRMED / NON-CONFIRMED L / C • PAYMENT AT SIGHT L / C • DEFFERED PAYMENT L / C • TRANSFERABLE / NON-TRANSFERABLE L / C • BACK TO BACK CREDIT • REVOLVING L / C…

32. Pros and cons of L / C EXPORTER IMPORTER • Is guaranteed to get the money, • if he complies with all the contract • terms • Gets payment immediately • upon sending the goods and • turning over all the relevant • documentation • Assurance, that the exporter • will receive the money ONLY • upon total compliance! • Assurance of shipment of • goods. • Better negotiation position • for other elements of deal. • Has to prepare and process • the relevant documentation, • specified in the contract and L/C • agreement. Failing to comply, • he looses the money! • Impacts and reduces • the importer’s credit line!

33. Bank guarantee • An instrument for the insurance of liabilities • Not connected to the main business transaction • An irrevocable obligation of the bank to pay the guaranteed amount, if the beneficiary does not get the money • Bank guarantee protects mainly the seller (beneficiary of the contract) • Very expensive instrument, used for high value deals with significant risk • Different types of guarantees…

34. Factoring • One of the fastest growing financing types today • Financing, management and insurance of liabilities • Target segment: rapidly growing SMEs (need money, can’t wait) • Time frame of liabilities: short term, up to 60 (perhaps 90 days)

35. Forfeiting • Method of financing sales (export) deals • Sale of less liquid, medium-term liabilities (between 120 days to 1 year) • More abstract liabilities • Difference from factoring? • Time frame: short vs. medium-term • Financing vs. financing, management and insurance • Forfeiting – the liability is additionally insured by i.e. a bill of exchange… • Higher costs of financing • Less providers of such financing

36. Deciding on the right financial instrument… • Size of the deal • Size of the players? • Characteristics of the players? • Costs of the financial instrument (protection=costs) • First time deal or re-occurring deal? • How well do we know the other side? • Who initiated the deal? • Who has more at stake in the deal? • Legal environment and context of the deal? • Calculate different scenarios? • Negotiate different terms for different payment instruments • Be smart, take only calculated risks!