International Purchasing Environment Doc2

INTERNATIONAL PURCHASING ENVIRONMENT
The risks involved in overseas operations are of several kinds. The major risks faced by firms when dealing in international trade/and or international investment are;(i) (ii) (iii) (iv) (v) (vi) (vii) (viii) Political risk Cultural risk s Exchange risk Legal risks Financial risk Product and competitor risk Technological risks Market risk
Of course this is in addition to the usual risk faced by domestic company (i.e. business and financial risks)
(i) Political risk

Refers to the probability that a political event will impact adversely on the domestic firm This risk is always present since any firm doing business in foreign sovereign nations doe so only at the pleasure of the government on those nations. Each sovereign nation reserves the right to establish the rules and regulations to which the business within its jurisdiction must conform. The nation established its own: tax laws, anti trust laws, employment laws etc. The host government can interfere with the operation of a company in a number of ways ranging from non discriminatory interferences to wealth deprivation. They include: 1. Non discriminatory interferences It is mild and is aimed at domestic and foreign firms e.g interfering in transfer pricing and making the host country currently not freely convertible. 2. Discriminatory interference It is targeted at foreign firms e.g insisting on joint ventures with a certain percentage of shares of the foreign firms being held by national of host country, special tax rates on profits, dividends and interest of foreign firms etc. 3. Discriminatory sanctions These are more serious than the first two levels. They make it so difficult for the foreign firms to operate profitably that it may close down e.g ending the right to remit profits. 4. Wealth deprivation Involves takeover of the MNC with or without compensation 5. Others changes in tax laws
anti trust policies fiscal and monetary policies regulations on retention and repatriation of profits national polices may prohibit restrictions in workforce during periods of reduces sales or imported technology.
NB =Any of these actions, plus numerous others hampers the ability of the company to earn profits and to utilize them efficiently on a world wide basis. Expropriation is probably the most extreme form of political risk. When a national expropriate, it formally takes over the property of the firm with or without making payment. Although any firm faces the possibility importance to the country. Steps to prevent/minimize effects of political interferences/risks (i) Attempt to anticipate the interference i.e. the investment planning of a MC should always include forecasting of political interference. This must be done before and are making the investment. (ii) (iii) (iv) (v) (vi) (vii) Negotiate with the host government on the best possible terms before investing. The negotiations will depend on strength of the government and its political attitude. Make prior arrangement with regard to issues pertaining to remittance of dividends management fees transfer pricing, access to host country capital markets etc Pre-planned disinvestment i.e. explain to the host government the short and long term benefits of the investment and the firms plans to ease operations due to interference. Obtain investment insurance and guarantee e.g from multinational investment guarantee agency (MIGA) Joint venture with host government or individuals with political clout. Operating strategies to minimize political risk would cover such issues such as Location of investment The control of marketing Labour policy Employment Selling shares in host country Local supply of goods and materials Promotions Management contracts The control of transportation arrangements etc of expropriation, the risk is increased under certain circumstances. For example, some industries are more sensitive to expropriation because of their
(ii) Cultural risk

The management of normal business functions may be very frustrating when the manager is faced with a variety of business customs and cultures. Business people tend to think and act according to the norms of the culture in which they have been raised. When conducting business in a different culture, they frequently find themselves at a disadvantage. One of the biggest problem is international finance results from the need to deal with more than one currency. Exchange risk results from possible changes in the values of these currencies relative to each other. Changes in the exchange rate, which is price of one currency in terms of another, are of major concern to the financial manager responsible for raising funds and controlling overseas operation. Types of foreign exchange risk (exposure) Foreign exchange risk is present whenever some of a companys assets are not denominated in the currency of its home currency. There exists here major types of exchange risk (exposure). 1. transaction exposure 2. translation exposure 3. economic exposure 1. Transaction exposure This occurs when the value of future cash flow (in or out) is known with certainty and requires a foreign exchange transaction. For example, a Kenyan exporter who will receive Uganda shillings in 90 days as payment for a sale made today faces a transaction exposure. 2. Translation (Accounting) exposure This is the possibility that a multinational company may suffer a decrease in asset values due to devaluation of a foreign currency even if no foreign exchange transaction occurs. Accountants generally agree that translation exposure should be measured so that the financial statement reflect changes in value. 3. Economic exposure This is the probability that changes in foreign exchange rates will decrease the intrinsic (or capitalized) value of the firm Since the intrinsic value of the firm equals the sum of the present value of future cash flows discounted at the investors required rate of return, the risk contained in economic exposure (iii) Exchange risk
requires a determination of the effect of changes in the exchange rate on each of the expected cash flow. The measurement of economic exposure requires a detailed analysis of the effect of the exchange rate change on each of the future cash flows rather than on the present asset and liability structure.
(iv) Legal risk this consists of

Litigation by a customer on contracts Error and omissions in documentations of controls Security risk in lending or transactions Discovery risk where a legal jurisdiction grants the plaintiff the action to see internal files and records etc
v) Financial risk e.g

Counterparty risk e.g where other parties fail to honour their obligations e.g goods and services. Interest risk fluctuation in interest rates hence high fixed financing expenses Funding risk inability to access the local markets for financial resources.
vi) Product and competitor risk e.g

Duplication of product by competitor Decline in product demand in its conventional life cycle etc.
vii) Technological risk

New ways of doing things will reduce the demand of existing products Technological changes e.g use of e-commerce and its impact on business.
viii) Market risk

Exposure to an adverse change in the price of value of good traded in Also include liquidity risk inability to sell a commodity/security quickly or find a suitable buyer without loss of value. Hedging risk where a satisfactory hedge is not achieved due to errors or couldnt be arranged since the market cant provide such a hedge.

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What are the major risks faced by firms when dealing in international trade/and or international investment?

What are the three major types of exchange risk (exposure) faced by firms?

INTERNATIONAL PURCHASING ENVIRONMENT

(i) Political risk

(ii) Cultural risk

(iv) Legal risk this consists of

v) Financial risk e.g

vi) Product and competitor risk e.g

vii) Technological risk

viii) Market risk

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