This article was written by Jeffrey P. Graham and R. Barry Spaulding and originally appeared on the now defunct Citibank international business portal. Copyright © Citibank. All Rights Reserved.

Understanding Foreign Direct Investment (FDI)

Definition

Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firm’s home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property, In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privitazation of many industries, has probably been been the most significant catalyst for FDI’s expanded role.

The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970’s to a yearly average of less than $20 billion in the 1980’s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998 (Source: UNCTAD)

Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker economies and can drive out much local competition. The truth lies somewhere in the middle.

For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities. In the past 15 years, the classic definition of FDI as noted above has changed considerably. This notion of a change in the classic definition, however, must be kept in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of direct investment restrictions in many markets and decreasing communication costs means that newer, non-traditional forms of investment will play an important role in the future. Many governments, especially in industrialized and developed nations, pay very close attention to foreign direct investment because the investment flows into and out of their economies can and does have a significant impact. In the United States, the Bureau of Economic Analysis, a section of the U.S. Department of Commerce, is responsible for collecting economic data about the economy including information about foreign direct investment flows. Monitoring this data is very helpful in trying to determine the impact of such investments on the overall economy, but is especially helpful in evaluating industry segments. State and local governments watch closely because they want to track their foreign investment attraction programs for successful outcomes.

How Has FDI Changed in the Past Decade?

As mentioned above, the overwhelming majority of foreign direct investment is made in the form of fixtures, machinery, equipment and

buildings. This investment is achieved or accomplished mostly via mergers & acquisitions. In the case of traditional manufacturing, this has been the primary mechanism for investment and it has been heretofore very efficient. Within the past decade, however, there has been a dramatic increase in the number of technology startups and this, together with the rise in prominence of Internet usage, has fostered increasing changes in foreign investment patterns. Many of these high tech startups are very small companies that have grown out of research & development projects often affiliated with major universities and with some government sponsorship. Unlike traditional manufacturers, many of these companies do not require huge manufacturing plants and immense warehouses to store inventory. Another factor to consider is the number of companies whose primary product is an intellectual property right such as a software program or a software-based technology or process. Companies such as these can be housed almost anywhere and therefore making a capital investment in them does not require huge outlays for fixtures, machinery and plants.

In many cases, large companies still play a dominant role in investment activities in small, high tech oriented companies. However, unlike in the past, these larger companies are not necessarily acquiring smaller companies outright. There are several reasons for this, but the most important one is most likely the risk associated with such high tech ventures. In the case of mature industries, the products are well defined. The manufacturer usually wants to get closer to its foreign market or wants to circumvent some trade barrier by making a direct foreign investment. The major risk here is that you do not sell enough of the product that you manufactured. However, you have added additional capacity and in the case of multinational corporations this capacity can be used in a variety of ways.

High tech ventures tend to have longer incubation periods. That is, the product tends to require significant development time. In the case of software and other intellectual property type products, the product is constantly changing even before it hits the marketplace. This makes the investment decision more complicated. When you invest in fixtures and machinery, you know what the real and book value of your investment will be. When you invest in a high tech venture, there is always an element of uncertainty. Unfortunately, the recent spate of dot.com failures is quite illustrative of this point.

Therefore, the expanded role of technology and intellectual property has changed the foreign direct investment playing field. Companies are still motivated to make foreign investments, but because of the vagaries of technology investments, they are now finding new vehicles to accomplish their goals. Consider the following:

Licensing and technology transfer. Licensing and tech transfer have been essential in promoting collaboration between the academic and business communities. Ever since legal hurdles were removed that allowed universities to hold title to research and development done in their labs, licensing agreements have helped turned raw technology into finished products that are viable in competitive marketplaces. With some help from a variety of government agencies in the form of grants for R&D as well as other financial assistance for such things as incubator programs, once timid college researchers are now stepping out and becoming cutting edge entrepreneurs. These strategic alliances have had a serious impact in several high tech industries, including but not limited to: medical and agricultural biotechnology, computer software engineering, telecommunications, advanced materials processing, ceramics, thin materials processing, photonics, digital multimedia production and publishing, optics and imaging and robotics and automation. Industry clusters are now growing up around the university labs where their derivative technologies were first discovered and nurtured. Licensing agreements allow companies to take full advantage of new and exciting technologies while limiting their overall risk to royalty payments until a particular technology is fully developed and thus ready to put new products into the manufacturing pipeline. Reciprocal distribution agreements. Actually, this type of strategic alliance is more trade-based, but in a very real sense it does in fact represent a type of direct investment. Basically, two companies, usually within the same or affiliated industries, agree to act as a national distributor for each other’s products. The classical example is to be found in the furniture industry. A U.S.-based manufacturer of tables signs a reciprocal distribution agreement with a Spanish-based manufacturer of chairs. Both companies gain direct access to the other’s distribution network without having to pay distributor support payments and other related expenses found within the distribution channel and neither company can hurt the other’s market for its products. Without such an agreement in place, the Spanish manufacturer might very well have to invest in a national sales office to coordinate its distributor network, manage warehousing, inventory and shipping as well as to handle administrative tasks such as accounting, public relations and advertising. Joint venture and other hybrid strategic alliances. The more traditional joint venture is bi-lateral, that is it involves two parties who are within the same industry who are partnering for some strategic advantage. Typical reasons might include a need for access to proprietary technology that might tip the competitive edge in another competitor’s favor, desire to gain access to intellectual capital in the form of ultra-expensive human resources, access to heretofore closed channels of distribution in key regions of the world. One very good reason why many joint ventures only involve two parties is the difficulty in integrating different corporate

cultures. With two domestic companies from the same country, it would still be very difficult. However, with two companies from different cultures, it is almost impossible at times. This is probably why pure joint ventures have a fairly high failure rate only five years after inception. Joint ventures involving three or more parties are usually called syndicates and are most often formed for specific projects such as large construction or public works projects that might involve a wide variety of expertise and resources for successful completion. In some cases, syndicates are actually easier to manage because the project itself sets certain limits on each party and close cooperation is not always a prerequisite for ultimate success of the endeavor. Portfolio investment. Yes, we know that you’re paying attention and no we’re not trying to trip you up here. Remember our definition of foreign direct investment as it pertains to controlling interest. For most of the latter part of the 20th century when FDI became an issue, a company’s portfolio investments were not considered a direct investment if the amount of stock and/or capital was not enough to garner a significant voting interest amongst shareholders or owners. However, two or three companies with "soft" investments in another company could find some mutual interests and use their shareholder power effectively for management control. This is another form of strategic alliance, sometimes called "shadow alliances". So, while most company portfolio investments do not strictly qualify as a direct foreign investment, there are instances within a certain context that they are in fact a real direct investment.

Why is FDI important for any consideration of going global?

The simple answer is that making a direct foreign investment allows companies to accomplish several tasks:

Avoiding foreign government pressure for local production. Circumventing trade barriers, hidden and otherwise. Making the move from domestic export sales to a locally-based national sales office. Capability to increase total production capacity. Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc;

A more complete response might address the issue of global business partnering in very general terms. While it is nice that many business writers like the expression, “think globally, act locally”, this often used cliché does not really mean very much to the average business executive in a small and medium sized company. The phrase does have significant connotations for multinational corporations. But for executives in SME’s, it is still just another buzzword. The simple explanation for this is the difference in perspective between executives of multinational corporations and small and medium sized companies. Multinational corporations are almost always concerned with worldwide manufacturing capacity and proximity to major markets. Small and medium sized companies tend to be more concerned with selling their products in overseas markets. The advent of the Internet has ushered in a new and very different mindset that tends to focus more on access issues. SME’s in particular are now focusing on access to markets, access to expertise and most of all access to technology.

What would be some of the basic requirements for companies considering a foreign investment?

Depending on the industry sector and type of business, a foreign direct investment may be an attractive and viable option. With rapid globalization of many industries and vertical integration rapidly taking place on a global level, at a minimum a firm needs to keep abreast of global trends in their industry. From a competitive standpoint, it is important to be aware of whether a company’s competitors are expanding into a foreign market and how they are doing that. At the same time, it also becomes important to monitor how globalization is affecting domestic clients. Often, it becomes imperative to follow the expansion of key clients overseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some stage, export of product or service reaches a critical mass of amount and cost where foreign production or location begins to be more cost effective. Any decision on investing is thus a combination of a number of key factors including:

assessment of internal resources competitiveness, market analysis

market expectations

From an internal resources standpoint, does the firm have senior management support for the investment and the internal management and system capabilities to support the set up time as well as ongoing management of a foreign subsidiary? Has the company conducted extensive market research involving both the industry, product and local regulations governing foreign investment which will set the broad market parameters for any investment decision? Is there a realistic assessment in place of what resource utilization the investment will entail? Has information on local industry and foreign investment regulations, incentives, profit retention, financing, distribution, and other factors been completely analyzed to determine the most viable vehicle for entering the market (greenfield, acquisition, merger, joint venture, etc.)? Has a plan been drawn up with reasonable expectations for expansion into the market through that local vehicle? If the foreign economy, industry or foreign investment climate is characterized by government regulation, have the relevant government agencies been contacted and concurred? Have political risk and foreign exchange risk been factored into the business plan?

Outside of the analysis of internal resources, a vast amount of information is needed to assess the viability and ultimate method of foreign investment as outlined above. Much of this information is available online through a range of websites and portals

.

Trade leads are a very important aspect of the import-export segment of international business. Until very recently, gaining access to reliable sources of trade leads was a very expensive and time consuming proposition for many small and medium sized companies (SME's). In the United States, the Department of Commerce was the sole purveyor of trade leads. Oh there were several so called "sources" for trade leads, but most originated with the Department of Commerce. As the individual States became more dependant upon international trade and investment for their own economic development, their international divisions began soliciting trade leads independently of the US Department of Commerce. In either case, companies paid a monthly subscription fee in order to gain access to what was available, whether it was appropriate or not. With the

proliferation of trade lead sources available on the World Wide Web (WWW), access to trade leads is no longer a problem. What has not changed, however, is the time involved in handling trade leads.

Enthusiastic proponents of the Internet will always tell anybody willing to suspend common sense that more is better. What is wrong with this concept, as is wrong with all Internet hype, is the assumption that the additional information provided by the Internet can be easily assimilated into a business enterprise and made useful without any cost whatsoever. Therefore, the proliferation of trade leads now available on the World Wide Web and in Usenet Groups should translate into more and better opportunities for everybody. Nothing could be further from the truth because the real problem with trade leads, is that most of them are of questionable value.

First of all, for purposes of this discussion, let me define what I mean by a trade lead. A trade lead is a specific offer to buy or sell a particular product or service or a request for participation in a business venture which is then posted for worldwide dissemination, either to a government agency or a private group. A trade lead usually implies a specific intent to conclude a transaction within a reasonable amount of time. The time factor and intent to conclude a transaction is what supposedly differentiates a trade lead from a company announcement or advertisement. Trade leads can be categorized into two groups: 1)foreign government tenders and 2) general procurement.

1) When a foreign government is going to purchase some equipment for a project or possibly some services such as engineering or planning, it issues a tender offer for the products or services involved. Foreign firms wishing to bid on such offers usually have to pay a fee to get a copy of the offer and the company requirements. While this fee may be reasonable, it starts to become expensive if you bid on several tenders. Often a performance bond must be posted as well. For those of you who thought that English was the international business language, tell that to the foreign government agencies who require that their tender offer bids be completed in the language of their country.

What most SME's do not know is that usually foreign tenders require the participation of a local company. What happens to many SME's is that they spend good money only to find out that they are actually not eligible to bid on the tender even though they might be really capable of providing the good or service. Often, the tender offer is not really well circulated outside of the country until the last

possible moment. What usually happens then is that a number of companies in that country will solicit their overseas contacts with a letter stating that their company is participating in this tender and has an excellent chance of winning the bid with your company's assistance. You are asked to provide an itemized quote including the manufacturer's name and brochures and then you are required to add a 10-15% commission for the company.

One experience in particular demonstrated for me why pursuing foreign tenders is not very easy. Several years ago, while working as an export manager for a global trading company, I was mandated to pursue a foreign tender whose value I thought to be questionable. However, the new owner of the company knew nothing about international trade and was certain that I was wrong. He felt it was important to pursue every lead. In this instance, there were only three companies in the entire world which could provide the equipment as specified in the tender offer. Two of those refused to give me a price quotation because they recognized the tender offer and did not wish to pursue it. In both cases, the export managers told me that they would be happy to work with a trading company, especially in markets where they had no representation, but that they generally did not bid on foreign government tender offers because they were not comfortable with the commission structure. The third company cheerfully gave me a price quotation which they sent by fax. One page was missing and I had to call to request it. The clerk who responded apologized profusely and then told me that she was glad that I had caught her mistake because the previous ten companies who made the exact same request for quotation had not. The foreign government finally chose two local companies to compete as the project's agent. They both called the third company asking for a large commission which was refused. The project was finally dropped.

Foreign tender offers often tend to generate very large commissions for local companies who are in good standing with the government agency making the purchase. One reason for making the tender is to lower the prices or obtain more favorable terms for the foreign government agency which is actually the real buyer. It makes sense to participate in a foreign tender offer as a subcontractor to the publicly acknowledged bid winner. Estimate what it will cost you to answer an RFQ (request for quotation) and any associated expense in inventory maintenance or initial work up, whatever the case may be, and then have the bid winner post a cash performance bond, if it is a domestic company or open a letter of credit in your favor if the company is foreign. This eliminates the possibility of your company wasting its time with pretenders. If a

company is serious enough to post a performance bond or open a letter of credit, then and only then are you on safe ground. If you already have an existing relationship with a distributor in a country and that distributor wants to bid on part of a tender and makes a special request for quotation, you should , of course respond.

Most foreign tender offers involve huge projects of one kind or another and by default they eliminate most SME's because they are only capable of providing small parts of the whole project. We do not think it is wise for export trading companies or the export departments of small or medium sized companies to pursue foreign government tenders unless they are dealing directly with an established distributor in that market who already handles their products or as a sub-contractor to the publicly announced contract winner with a performance bond/purchase order from a domestic company or a letter of credit from a foreign company. We recognize that these offers often seem very appealing but they can present complex business issues which need to be resolved by competent international business professionals. Unless a company has this talent in house, it can be a very expensive proposition to just evaluate a deal without any chance of closing a transaction.

Note to our foreign readers: We would give you the very same advice about pursuing state and federal contracts in the United States.

2) General procurement trade leads are usually posted for three reasons: a) to advertise a company, b)to put price pressure on a local distributor or c) to begin negotiating for a later purchase or participation in a business venture. Prior to the proliferation of WWW sites and Usenet groups dedicated to this activity, companies in the US paid the Dept. of Commerce to access its BBS for trade leads. Many companies which entered the export business in the 80's were very surprised to find out just how inaccurate and unusable were many of these trade leads. According to my own business contacts, the situation was very similar in many foreign countries as well.

Many trade leads contain more information about the company's business activity than they do about the particular transaction being identified. Others ask for manufacturers brochures and contact information and quite a bit of other information.

Who places trade leads? Foreign distributors know exactly where to go when they want to buy something for resale. They do not have to place a trade lead to procure anything except in very rare cases.

If a foreign distributor is placing a trade lead, it might be looking for a new relationship or thinking about adding a new product to its line. Most distributors will be straightforward and say that they are looking for new relationships. End users tend to be more unwilling to divulge their interest as they are often competing with distributors in their home market.

If you talk to people who actually sell in foreign markets, they will privately tell you that their best leads are the ones which they generate themselves usually by direct mail.

So that my foreign readers are not offended and my American readers clearly understand the message which I am trying to convey, trade leads can be valuable information but they must be interpreted properly. I am not implying that foreigners or Americans are being deceptive when they post trade leads. I am saying that newbies to foreign trade who read a couple of magazine articles and think that they are ready to immediately jump into import-export trade are fooling themselves. And it is these people who often make the most serious mistakes about responding to trade leads. A trade lead means something quite different to any experienced international trader who understands how business transactions are concluded in foreign markets.

The Internet presents troubling issues even for the most experienced international business people because of the enormous amount of misleading information which is pumped into the system; a system which is not yet ready to process this amount of information. One is really evaluating the company which posts the trade lead and this is now a very tedious process. Twenty years ago, one could check a telex address and some bank references and know rather quickly how credible a particular company might be in a particular market because there were far fewer companies and individuals doing business. If a company did not own its own telex machine but used a telex service, this was one clearly distinguishing characteristic which was quite helpful in the evaluation process. Since 1987, the year generally accepted as the turning point for the domination of facsimile machines worldwide, it has become much easier for small companies to enter global business as traders and offer specialized international business services. Since 1993, when the browser technology really began to take off and the Internet began to seriously emerge as a marketplace, the changes have been staggering. In the United States, anybody with $18.95 per month can have unlimited access to the Internet, 7 days a week-24 hours per day. With fax machines costing less than $200 and computers as little as $1000 per

system, anybody can get two simple telephone lines and one room in a house, apartment or commercial space and set up their business very easily for a reasonable amount of money.

It is not unusual for people who are just wishfully thinking to write and post trade leads which are designed primarily to elicit responses. These "companies" have limited capability to engage in a business transaction, but their access to the Internet allows them to proliferate what many call "trade leads" but which almost always turn out to be worthless junk. The problem is that these so called trade leads present very appealing business opportunities and are often skillfully written. Such postings can send companies on time consuming and very expensive fishing expeditions which yield no sales and have little potential for future business as well.

A trade lead in 1997 means something quite different than it did in 1977; both here in the United States and around the world as well. Newbies to international business are going to have to face this dilemma head on because it is now an integral part of the international business learning curve. Some trade leads, especially sell offers, are only valid for a very short time. Trade leads for used equipment are somewhat tricky and really require proven expertise. And does anybody really know how to evaluate close-outs?

Following are some guidelines for evaluating trade leads:

1) Look for key words which might indicate a company who is gathering information and not actually going to buy. Always be suspicious of companies who ask for detailed information about manufacturers' prices and do not identify themselves as distributors looking for new lines.

2) Be very wary of companies who post trade leads for large orders and are not easily located in any company or industry directories. These are often small companies who will issue an RFQ (request for quotation) for large quantities in order to get a lower price and then will try to order a very small quantity at that price.

3) Do not be unduly influenced by flowery language. Many small manufacturers get trapped by this when they are looking for a distributor.

4) Be careful of locked market activities. This trade lead will specify a particular product. Your company contacts the manufacturer, hoping to make a commission on the sale, only to find out that the manufacturer already has representation in that country and will not

sell the product to you for resale to that market because they want to protect their distributor relationship.

Locked market activities probably represent a significant amount of the trade leads available. What you have are smaller distributors who are selling just enough to make it profitable for them to try and circumvent the major distributor in their market.

5) Ignore any trade lead which has "letter of intent" or "letter of interest".

6) Ignore companies who claim to deal in any commodity traded on world markets and who are placing trade leads. Traded commodities such as coffee, sugar, urea, oil and gold are handled by well established companies in well established markets. These companies do not place trade leads in order to do business.

7) Be very wary of international business scams designed to separate you from your money. Be suspicious of anybody who prefers phone conversations to written documents. Do not get sucked into fantastic business opportunities which promise to yield you, an inexperienced international trader, huge profits with no risk. Learn which countries and areas have a reputation for spawning international business fraud and avoid them like the plague. Never ever respond to business opportunities which require you to make wire transfers in advance of receiving goods or services.

Following are some guidelines for responding to trade leads:

1) Design your collateral materials to answer the most basic questions and provide enough information for a buying decision to be made.

2) Invest some money in a digital catalog of your products which can be easily transmitted via e-mail or sent by postal mail on a floppy disk. For simplicity's sake, keep the price list and the actual graphics separate, so you can easily edit either one.

3) Do not fall into the sample trap. Unless your samples are extremely inexpensive, charge a minimal fee for them. Do not make a habit of sending samples to anybody who asks for them. Identify the person who is making the request and make sure that this person is the one making the buying decision.

4) Understand that most foreign distributors do not make fast buying decisions. It is not at all unusual for an initial order to require

9-18 months from the time of the initial solicitation depending upon the cost of the item.

5) Understand the difference between selling to an end user on a one time basis and selling to a foreign distributor for future distribution. Obviously, you would want to give the distributor more consideration.

6) Identify your buyer!!! Manufacturers need to be very careful of companies who place an order immediately after your initial response. In some countries, selling to one distributor can by law obligate your company to designate that company as your distributor in that country. Be very careful about designating any company as a distributor without verifying whether or not this will grant exclusivity by law.

It is a good idea to try to identify your buyer. Some companies are so eager to sell in foreign markets that they are unwilling to do this. We do not advise this. If you respond to a trade lead and provide the requested information and samples, you have a right to be in contact with the person making the buying decision. There are several reasons to do this, but wasting your time is the most important.

7) Do not respond to requests for letters inviting a potential buyer to your country for a meeting unless you are already doing business with the company. This is sometimes used as a scam to get a visa for entry on the pretense of doing business. This type of letter is risky unless there is a significant business deal involved. In such a case, you should contact your country's foreign commercial attaché in that country and see if they can make a personal visit on your behalf.

8) Use some common sense. Yes you have to be polite, but that does not mean that you should spend $10,000 and a week to travel overseas to get a $600 order. Everybody would like to meet the people with whom they are doing business overseas, but that is not always practical. Do not hop onto an airplane every time some distributor sends you a very pleasant letter about how much potential business there is in his/her country.

For companies who are new to international trade, huge mailings of collateral materials in response to trade leads represent a significant investment in time and staffing. Try to evaluate the lead as best you can in order to make a judgment about its priority. Yes, you do want to respond to any possible sales lead. However, there

is a difference between a bona fide sales lead and a company which is announcing itself and gathering information for future reference. That company which is gathering information may very well make a purchase but in all likelihood it will be later as opposed to sooner. Only time and experience will allow you to tell the difference.

Your company has spent time, money and other resources to identify potential foreign distributors for your products. Now you have to decide which distributors are correct for you. What do you do? We strongly encourage you to contact an international business consultant or other qualified international business professional. However, before you do contact an international business consultant/professional, there are some basic things that you can do yourself to further evaluate your distributor candidates, thus saving your company some money in making the final decision.

Role of the Foreign Distributor

Your company wants to sell its products in foreign markets. Increased sales mean increased revenues, which should translate into increased profits. In order to accomplish this goal, you must first establish distribution channels in foreign markets. Whether or not you decide to set up your own export department or you work with an established trade intermediary, such as an export management company or global trading company, you will interact in some way with the foreign distributor. Many people believe that the Internet will eventually eliminate the foreign distributor. We are not yet convinced that this is true. For the present time, very few products can be directly sold in foreign markets without a foreign distributor.

For all intents and purposes, the foreign distributor which represents your company in a foreign market (in some countries you will be compelled by law to work with only one primary distributor who will in turn work with smaller wholesale distributors in that market) is YOUR COMPANY. Distribuidoras S.A. in Chile is equal to Widgets Manufacturing Inc. in Philadelphia, Pennsylvania. The Chileans who buy your widgets from Distribuidoras S.A. are in fact dealing with your company, Widgets Manufacturing Inc. Therefore, the decision about which distributor to select is a very important one.

What Does a Foreign Distributor Do?

Some cynics will suggest that foreign distributors are quickly becoming obsolete in international trade as the Internet becomes more important in global commerce. In some instances, this is very true. Small items such as books, jewelry and clothing can be easily shipped to a foreign destination via postal mail or by way of several different express shipping companies such as DHL, Airborne, UPS, Emory and Federal Express. Upon arrival, such small packages can be easily cleared through Customs' and if there is any Customs' duty payable, it can be collected upon delivery. However, most of the products sold in international commerce are neither small nor easily shipped. This is where the role of the foreign distributor working in conjunction with the Customs' House broker/foreign freight forwarder becomes extremely important.

Foreign distributors may be classified in two important ways:

1.stocking

2.non-stocking

A stocking distributor will purchase inventory from the manufacturer or export intermediary. In this way, he/she assumes some risk for selling the product to smaller distributors and/or end users in the foreign market. Generally speaking, a stocking distributor must be a well-established company with a competent sales force that is large enough to cover the country or region in which it is located. Stocking distributors expect manufacturers or export intermediaries to pay some of the costs for local advertising and in some cases, warehousing for the product. Foreign distributors call this "distributor support". Paying support costs is legal and is in the best interests of the distributor and the manufacturer. Occasionally, unscrupulous distributors will abuse this long established international commercial practice to solicit bribes so that the products might be distributed in the foreign country and unscrupulous manufacturers will try to offer bribes to important foreign distributors in order to prevent their competitors from gaining entry to the marketplace.

Non-stocking distributors generally maintain only catalogs and/or samples of a product and take orders from customers in their market. There are many reasons for this practice; among them would be the following: ·

Custom manufactured goods

Seasonal sales

Perishable food products

Limited no. of potential buyers

Both types of distributor are appropriate depending upon the product being sold. You will very rarely have to choose between a stocking and a non-stocking distributor. Foreign distributors are very competitive. Their business is selling your products in their marketplace. If they can not convince your company to choose them as its representative in their country, they might be losing a significant business opportunity. Therefore, foreign distributors have a vested interest in convincing you to do business with them especially if there is a high demand for your product in their country.

Foreign distributors work together with the foreign freight forwarder and Customs' House broker to move your products from the factory to their warehouse or showroom. A foreign freight forwarder is a company that arranges for the transportation of your products from the factory floor to a foreign destination. Foreign freight forwarders work very closely with trucking companies, railroads, airlines and steamship companies. They earn their fees by obtaining the best service at the lowest prices for your company and by properly completing the appropriate forms and executing the correct procedures so that your shipment is secure and will not be held up in Customs' upon its arrival in the foreign country. The foreign freight forwarder is often located nearby your company's factory. Your export intermediary or in-house international trade specialist is probably very familiar with many local foreign freight forwarders and can assist you in choosing the best one for your company. If your shipment is less than a 20' or 40' truck container and will travel overland by rail or truck and then go overseas via air or steamship, you will then need the services of a specialized foreign freight forwarder called a freight consolidator. The freight consolidator buys a large amount of cargo space, typically in 20' or 40' containers for steamships and in some cases in special air cargo containers, and then sells the cargo space to several smaller shippers like yourself, thus consolidating many small shipments into one or two containers and saving your company money on shipping costs. The foreign freight forwarder and freight consolidator will

have Customs' House broker contacts at the foreign destination. The Customs' House broker's job is to clear the shipment through Customs as quickly as possible. It is very possible that the foreign distributor has not participated in choosing any of the other trade intermediaries, which help move your goods overseas. However, the foreign distributor knows his/her market very well and will often collaborate with the export trading company or export department and the other trade intermediaries mentioned above to assure the quick and efficient movement of your goods from the factory floor to their distant foreign destination.

After clearing Customs', your products are shipped to the foreign distributor's place of business. Certain products, such as home appliances, sporting goods equipment, furniture and toys, may require the foreign distributor to maintain a large warehouse. Larger foreign distributors who sell to smaller wholesale distributors might possibly have a showroom or product display area that is located nearby their warehouse but not necessarily in the same facility. Stocking distributors will typically order merchandise based upon their existing inventory and their predicted sales. Experienced stocking distributors know their customers very well and are usually able to anticipate their needs. A non-stocking distributor will notify his/her client of the arrival of their goods and then make arrangements with a local freight forwarder to move the merchandise from the port to its final destination. In some cases, especially in the case of custom-made products, it might be necessary to settle the account that is to complete the financial aspect of the transaction before the goods are moved. Depending upon how the transaction is arranged, the merchandise might be stored in what is called a bonded Customs' warehouse until the buyer makes arrangements to pay the remainder of the cost of the product.

How Do I Get Started?

Before you begin the process of evaluating foreign distributors, you must decide upon your company's international marketing infrastructure. As a manufacturer, you do have several choices of international business professionals who can add value to your business activities. However, you really only have two choices for how your company will set up its international operations in the beginning:

An export marketing intermediary

Or

Setting up an international department

1) Working with an export intermediary, usually an export management company or a global trading company, is probably the fastest and easiest way to get involved in selling to foreign markets. Export management companies will function as your export department. Their name indicates their special orientation but they are merely another form of a global trading company. Global trading companies act as manufacturers' representatives in overseas markets. Often these companies have established networks of distributors in several countries. Their primary role is to assist you in setting up a distributor network in overseas markets. They rely upon their years of experience in global trade and their extensive knowledge of foreign markets to quickly get your products in front of foreign distributors who have the capability of distributing them in their particular market.

Export intermediaries come in several different sizes and have varying levels of expertise. In some cases, especially when the product involves technology, an intermediary's specialized knowledge of the product could be most important. In fact, some global trading companies will specialize in certain product areas. In other instances, product expertise is not very important, but getting into several markets is important. Your choice of an export intermediary will depend upon the following issues:

a) Does my product require a sales force knowledgeable in high tech products or some other kind of very complicated product knowledge?

b) What types of companies has this intermediary represented in the past and what types of companies does it presently represent?

c) Does this company have enough qualified people to assist my company in setting up our foreign distributor network as quickly as possible?

d) How difficult will it be to get somebody on the telephone to deal with any problems which might arise?

e) Does anybody speak any foreign languages?

f) Does the advice that they offer to you seem reasonable and how do your other business advisers perceive this company?

g) Does the company offer you both foreign and domestic references?

h) Is the company willing to allow you to meet the people who will be actually handling your account or are you meeting with only top-level executives?

i) Do people working in their office seem genuinely happy? Do clerks and assistants smile and speak to you? Are they willing and able to answer your questions?

Export intermediaries really do facilitate the transition into selling in foreign markets, but they also have a downside. Global trading companies sometimes seem to be more interested in promoting their own business interests than promoting their clients' products. However, there is a very good explanation for this. From my own experiences I can tell you that many companies say that they want to become involved in exporting to overseas markets. However, very few realize how much work is involved in changing a company so that it has the capability of becoming successful in international trade. Therefore, there is an extremely high failure rate for companies who get started with exporting but do not have the wherewithal to follow through and continue onward with a sound business strategy until they are successful. For very good reasons, global trading companies are reluctant to damage the goodwill that they have built up with foreign distributors and other international business experts who help them to work with their clients. One reason for this can be attributed to manufacturers who do not understand the function of an international business intermediary. Poor communication between manufacturer and export intermediary has killed many successful business opportunities. You have to be completely honest with your export intermediary because failing to do so will often result in bad feelings with a foreign distributor. This is not a good thing.

2) Setting up an international department is your other option. While doing this gives you complete control of your company's international business activities, it is an option that must be very carefully considered. Companies seem to make the same general mistakes when setting up their international department:

a) Choosing the wrong personnel. This is the most common mistake that smaller companies most often make. There is a misconception that anybody can figure out how to do business overseas. It's thought that it is merely a matter of reading a few how-to magazine articles and you're ready to go. This is wrong. Too often, successful small business owners want to adapt their style or formula to international business and it just does not work. The biggest mistake is in thinking that all you have to do is choose an aggressive salesperson and you will be successful. In reality, many business owners are afraid to hire a qualified international business specialist because that means going outside of the company for special expertise. If you plan to set up your own international department/division, you need to have a competent and qualified person to run it. It is just that simple.

b) Not paying a high enough salary. If you are going to set up your own international department, you need to have enough revenues to be able to allocate a special budget for this purpose alone. Skilled international business specialists are paid a little more than other employees are with comparable experience because of their specialized skills. If you try to hire somebody at less than the market price, you will be hiring a person who needs a job immediately. I can guarantee you that this person will leave within a year and will waste your time and resources either developing their own projects or looking for a better job. Do not be cheap. Find a qualified person, pay them a decent salary and allocate a sufficient budget to allow that person to hire experienced and qualified support staff.

c) Insufficient budget. Besides salaries for top rated personnel, you will have to develop collateral marketing materials suitable for your target markets. You will also have to pay travel expenses and several other additional costs. Too many companies do not allocate a sufficient budget for their international division and therefore set it up for eventual failure.

d) No strategic plan. This is a deadly killer. You must have a strategy that takes into account your company's capabilities and the advantages of your product or service. You have to be prepared to knock down some barriers to entry in certain foreign markets and to deal with serious competition in others. The time to figure out what you are going to do is before you actually begin marketing in overseas markets.

e) Failing to do proper research. The Internet has changed the global playing field in a remarkable way. There is now so much

information available about so many products and services worldwide that potential buyers have more and better choices. Because there is so much information available, it is very important to do the appropriate research to identify your competitors and to fully understand what is happening in your particular industry worldwide. Too many businesspeople neglect doing the proper business research, often due to cost considerations. Once again, the cost for good international business research is higher than what one might pay for comparable domestic business research. It is better to pay the proper cost in the beginning because failing to do so will almost always guarantee that you will pay considerably higher costs later on.

f) Being too impatient. I once worked at a global trading company that was acquired by an owner of a small manufacturing business. This man used to pester me for a daily forecast of sales in my division. Finally, I had to leave because he just got too impatient. International business requires a longer transaction time. In my experience, most industrial products require from 9 to 18 months from the first sales letter until the first order. You are not going to set up your international division and then start getting orders three to six months later unless you have developed some exciting new technology that companies want immediately because it will help them make money. This is a fact about international business that many companies just ignore when they make their plans.

Your final decision about how you wish to set up your company's international marketing structure will depend upon your comfort level and also your available budget. If you do not have a sufficient budget to hire skilled and experienced international business people, you should forget setting up your own international department or division and look for an international intermediary to help you set up your distributor network.

We are going to assume here that you have decided to work with an international trade intermediary, which is the most common choice of companies looking to get into global markets. Therefore, it will not be necessary to discuss how to find a distributor because that is exactly what global trading companies do. There are several kinds of working arrangements between a global trading company (Remember that an export management company is a special type of global trading company.) and a manufacturer. The differences will vary only in two ways: will the intermediary actually take title to the goods and then resell them or will the intermediary function more as your export department, not taking title to the goods and receiving a commission? Some manufacturers prefer working with

an intermediary that is actually going to buy the goods outright and then resell them for whatever price they can get. This method involves much less hassle and to some extent, less paperwork to get paid. It is also less risky. Its biggest disadvantage is that the intermediary controls the price of your goods in international markets. Another problem is that your company loses some degree of contact with the foreign distributor. On the other side is the situation where the global trading company acts as your export department, using your letterhead and only changing telephone numbers and addresses, etc. and assumes the same risk as your company. This is more risky for your company, but it allows you to maintain more direct control of your product in global markets. It also allows you more direct contact with the foreign distributor. For companies new to export, this is probably the better choice and the one that we will cover here.

Evaluating a Foreign Distributor

A former colleague of mine, an older lady with many years' experience as an export manager once told me the following:

"Anybody can find a foreign distributor. That's easy. Finding a good foreign distributor, however, is very difficult, but well worth the effort because a good foreign distributor is like a cash cow."

Before making a final decision about a foreign distributor, your company should know more about the following:

a) What is the company's reputation? Ask for trade references, (preferably outside of his/her country) and banking references. If possible, you want to speak with other foreign companies that his/her company represents. Check with your own country's foreign commercial service officer or commercial attaché in that country. Check the company's rating with Dun & Bradstreet. Hire a local independent consultant to prepare a background report on the company. Contact the local chamber of commerce as well as your country or city's chamber of commerce in that market. Contact your state or provincial government's overseas office in that country or region and request a background report. Use the Internet to find out as much as you can about the company via search engines and company directories online as well as a company home page if available.

b) What is the company's competitive profile? How many years in business? How many sales people? What is their marketing technique? How often do they visit customers? Who is their

competition? What is the company's market share as compared to its competitors? What can they tell you about your competitors in their market? You should ask the CEO/owner of the company these questions. If he/she hesitates to answer for more than a second, move on.

c) What does the company expect in terms of manufacturer support? This is a very important question because it will determine whether your potential distributor is trying to extort a bribe from you. More importantly, however, it will tell you how much the company really knows about their market.

d) Discuss your requirements for purchase of minimum inventory. Foreign distributors talk a very good game. Your job is to see if they can deliver on their flowery promises. In some of these areas mentioned above, your global trading company will have some answers. In other cases, commercial attaches and other knowledgeable entities can provide you with good information. Your mission is to ascertain whether or not working with this distributor is going to be in the best interests of your company. If the global trading company can not provide you with specific answers to these questions and tells you not to worry, look very closely at the intermediary. The questions that I have listed here are designed to help you determine the viability and credibility of the distributor. Instead of "we can do this and that, blah, blah, blah", your aim is to make the distributor respond to specific areas of inquiry and to provide you with a clearer picture of exactly how your products will be sold in their market. An added benefit is the fact that these questions will help to evaluate your trade intermediary as well. One trap that you want to definitely avoid is the buddy-buddy relationship between the intermediary and the distributor. We did consulting for one client whose intermediary was being paid bribes or kickbacks by the distributors for choosing them. The kickbacks caused the price of the company's products to be too high in the foreign market and the company started to lose business to a competitor whose product was absolutely inferior.

If your intermediary seems reluctant to allow you access to the foreign distributor, then you must evaluate the intermediary more closely. Really good foreign distributors expect to have to answer these types of questions and look forward to doing so with great enthusiasm. You can avoid problems by asking the questions listed to evaluate the intermediary. One thing that I have found to be true in over 20 years of international business: if a foreign distributor is unable or reluctant to answer questions that will indicate how they sell foreign products in their marketplace and what distinct

advantages they offer over their competitors, look elsewhere for help in going global.

The Globalization of the Small Enterprise by Jeffrey P. Graham

The globalization of the small enterprise will most likely be the most important development in international business as we begin the new millennium. Clearly, the 20th century has witnessed the transformation of global commerce by transnational conglomerates and/or multinational corporations. This transformation is most evident when one considers the impact of the worldwide disaggregation of production and the advent of transfer prices, which tend to distort the real prices of manufactured components transferred across national boundaries but within a multinational corporation. It is certainly the case that large global corporations have created a significant portion of this century's wealth, however, it is the smaller enterprise that has been the engine that has generated most of the world's economic growth over the past 20 years.

The challenge faced by many small enterprises will be how to globalize their operations in order to be able to better source raw materials and components and to take advantage of proximity to global markets in order to compete head to head with much larger companies. In order to do this, smaller companies will be forced to make a choice between two options:

#1 to hire an international business specialist and #2 to retain an international business consulting company.

These choices are not mutually exclusive because it is entirely possible that some companies might choose to do both things. In any case, companies will be forced by rapid changes in the global economy to realign themselves accordingly.

Globalization is a very recent phenomenon for most small and medium sized companies. That is, buying and selling in global markets, up until very recently, was generally speaking an undertaking specifically achieved by the use of an intermediary. In most cases, the intermediary was a global trading company. Global trading companies worldwide shared certain characteristics regardless of national origin. Most were fairly large business organizations with the significant financial resources necessary for international transactions. Contrary to popular myth, much of the business done between a global trading company and a foreign distributor, its overseas counterpart, was conducted on open account. Open account means that the distributor was creditworthy enough to be capable of receiving goods on credit by means of acceptance of a documentary draft. Essentially, a documentary draft is a document that compels the foreign distributor to accept responsibility to pay for a shipment as long as the documents, namely the bill of lading and other shipping and Customs' documents are in order. Still today, the more familiar trade document, the letter of credit, is very often backed up by a documentary draft or bill of exchange. What is most important to note in this context, however, is the fact that until the late 1980's most global trading companies preferred to do business with foreign distributors who were good credit risks and who had both banking and trade references.

In many instances, specialized global trading companies, also known as export management companies, acted as the familiar "middleman". Unfortunately, increased foreign travel and contacts with more foreigners gave very many people the impression that the so-called middleman role was quite easy to perform. It is quite often difficult to dispel such myths.

Nonetheless, being an intermediary is a very complex task that requires significant understanding of differences in business culture and the ways in which an international transaction is concluded. For most manufacturers in the United States, and in other places as well, handing off the task of exporting was a welcome relief. Global trading companies were a group unto themselves, very often shrouded in a veil of secrecy. Most business executives did not want to know the details of how their products got sold overseas just as long as they got sold. As export markets began to grow in earnest in the mid to late 1970's into the early 1980's, global trading companies grew in power. Those business executives who did understand what these intermediaries were doing were quite often deterred from undertaking the role themselves because of its complexity. First there was the issue of finding a good foreign distributor. People who have worked at a global trading company will all tell you the same thing: anybody can find a foreign distributor. The trick is to find a good foreign distributor. Then came the issue of negotiating a good deal for the manufacturer while making sure that the intermediary was properly compensated. Sometimes, it was important to have good banking facilities because both parties wanted to guard against any currency fluctuation swings that might erase profit margins. This, of course, was just the beginning.

For all practical purposes, two significant events changed the nature of global business for small and medium sized companies, especially in North America. It is very important to make this clear distinction from multinational corporations or global conglomerates. The first change was the advent of the facsimile machine. Before the fax machine became prominently used for direct and immediate written communications, most global trading companies relied upon the telex machine for direct and reliable communication. Telex machines were relatively expensive and required trained operators. Thus, any global trading company that was serious about providing services for its clients needed to have trained teletype operators to run the telex machines. These trained operators could wield significant power within a relatively small company that depended upon them for daily communications. The second change was in the educational systems. During the 1980's, local community colleges and many major universities began offering international business specialty courses. Many of the earlier curricula focused primarily on transportation and logistics functions, the types of activities normally performed by a foreign freight forwarder. However, as more people became interested in international business skills, the courses available to the public increased in variety and scope.

These two changes had a swift and far-reaching effect on the business practices of global trade intermediaries. Most notably, the fax machine eliminated the need for teletype operators and this eliminated the jobs of many people who had become very secure in their positions. The easy availability of training for jobs as freight forwarders, Customs' House Brokers, documents examiners and letter of credit specialists meant that a large pool of skilled employees became available for hire by manufacturers. Suddenly, global trading companies who had dominated import-export trade for most of this century found themselves locked into competition with their clients (manufacturers and service providers) for the most highly skilled employees available. Many manufacturers discovered that they could hire in-house international business specialists who could perform most of the actual marketing functions of the intermediary and for significantly less money. As global competition heated up, thinner profit margins meant that any cost savings could mean the difference between making a profit and facing extinction. This basic change in international business practices really intensified in 1987 when the fax machine finally eliminated the use of the telex. What should also be mentioned here is the fact that most of the training of skilled international business specialists had been heretofore limited to the community of global trading companies. Many have referred to this method as the "back room" training method because of the insular nature of global trading companies. That is, one could only learn that which the person offering the training was willing to give. The major flaw in this on-the-job type training was the fact that those doing the training had a vested interest in doing a bad job in order to protect their own position within the company.

The advent of the Internet, especially the use of electronic mail for communications and the increasing popularity of the World Wide Web as a medium for communications, public relations and sales promotion, has hastened the pace of changes now occurring in international commercial practices. E-mail is threatening to eliminate the fax machine as quickly as the fax machine eliminated the telex. The World Wide Web makes it possible for anybody with Internet access to set up a website and offer goods and/or services to the entire world for about U.S. $50 per month.

Compare these costs for entry to those of a global trading company that employed specially trained people such as a telex machine operator, freight forwarder/Customs' House Broker or transportation/logistics coordinator, import-export clerk, documents examiner and import-export marketing people. The elimination of this significant barrier to entry has fostered an environment in which anybody can claim to be an import-export trading company and has given rise to a proliferation of smaller global trading companies offering specialized services. This, in turn, has created a climate of confusion about professional credentials and has also encouraged the proliferation of volumes of useless trade leads (I covered this trade lead topic in some detail in an article titled, "Evaluating Trade Leads", which I wrote in late 1997. This article was summarized in the July 1998 issue of Gateway.) and/or other false or otherwise misleading information in the marketplace.

To make matters worse, you also have the active participation of the international banking community. In this context, one has to remember that the "old" way of doing business, in which the global trading company and the foreign distributor were mutual business partners, effectively limited a bank's ability to earn fees from transactions. The bank was limited to verifying and/or vouching for the credit risk assessment of the foreign distributor and earning fees for discounting commercial paper such as an accepted documentary draft. A bank might also occasionally finance an initial stocking order so that the overseas distributor might have inventory on-hand of the manufacturer's products in order to sell to its clients. Once the reliability of the distributor is established, the bank's participation is very limited. This is a very important point because most people just assume that the letter of credit is the principal way of arranging international transactions. While the letter of credit has been in use in one form or another for several hundred years, it was not the primary document used in international business transactions between a trade intermediary in North America and a foreign distributor until very recently. The changes within global trading companies in North America meant that some institution had to step forward to assume the role previously played by trade intermediaries. Therefore, it was the banks in North America who actually promoted the increased use of the letter of credit as the primary financial instrument of international trade. There was no altruism involved here at all. The banks were hardly interested in making life easier for small and medium sized companies, as some would suggest. No, their motivation upon the disappearance of large trading companies and the appearance of smaller and more specialized intermediaries was merely profit. Not only did banks in North America earn nice profits, but their counterparts overseas made more money as well.

What does all of this mean? For most small and medium sized companies, the aforementioned changes simply mean that their business environment has become more complex. In too many companies, however, it is almost impossible to assess the impact of these changes because too many business executives are still in denial about these changes and have not rethought their business strategy accordingly. It would be very easy to say that this type of in-the-box thinking is to be expected given the circumstances of most small and medium sized companies. In fact, it is probably the case that this is equally true of small and medium sized companies everywhere in the world. To those of us who work with SME's, there is an understanding that these companies almost always focus on their distinctive competency. That is, they tend to really be very good at producing their good or service or developing their new technology and they tend to not be so good at actually selling this good, service or technology to the global marketplace. The most compelling reason for this would be a tendency to think that their product, technology or service

will sell itself because it is so good. While this is quite understandable, it is nevertheless an impediment to success in the global marketplace.

As we move forward into the next millennium, the real challenge for many smaller enterprises will be navigating the complexities of an increasingly globalized marketplace. This will simply mean that companies will have to globalize the operations in one way or another. Some will hire an international business specialist to develop a global strategy. Others will rely upon an international business consultant like myself. Some will hire an in-house specialist as well as retaining an outside consulting company. Almost all companies will be required to develop many different types of business relationships that offer their company a very well defined presence in foreign markets. Companies will also have to find new and more effective ways of assimilating huge amounts of information and analysing it as well. Employees will be required to adapt and learn new skills such as foreign languages and international commercial practices. Top business executives will be required to travel to foreign markets more frequently to visit foreign distributors and to participate in trade missions and trade shows. Industry trade organizations are going to become even more powerful because their membership will represent key business constituencies that will wield significant power. In the very near future, global strategic planning will become an essential factor for the success of the enterprise.

Looking ahead, it is very clear that business executives will have to rethink their global business strategy and to find a more dynamic approach to keep pace with changes in the global marketplace. What is not so clear, however, is how this approach will be developed. It is certain that any new solutions will be technology-based. It is this factor alone that complicates the true nature of the existing challenge for small and medium sized companies. An entirely new profession, international business specialist, has been born within the past 20 years or so and this new highly skilled profession is threatening to upset the delicate balance that exists within the management structure of most small and medium sized companies. When added to the fact that most small and medium sized companies now require a Chief Technology Officer, you now have two powerful business specialists whose input is crucial to the success of the smaller enterprise. Whether or not companies rely upon outside service providers or hire their own staff in-house, the expertise provided by the Chief Technology Officer and the international business specialist will become an essential part of the make-up of any successful company. Given the resistance to change that is an outstanding characteristic of smaller enterprises worldwide, it will be very interesting to see how these new business skills will be incorporated into companies' business culture. When one considers the maverick nature of the people drawn to becoming international business specialists or technology officers, it is quite clear that the early part of the 21st century will be very interesting. In most small and medium sized companies there will be a clash of basic business principles between those who favor a more traditional management approach and those who are preparing for the next generation of global business. How this will play out is anybody's guess, but it should be very interesting to watch it unfold in a global environment that changes daily.

This article was written by Jeffrey P. Graham and it originally appeared on Citibank's

now defunct international business portal.

Now that the U.S. economy is faltering, many business executives are going to give serious consideration to taking their dog and pony shows on the road, so to speak. Trade missions are

frequently mentioned in the how-to-export literature as a sure fire way to quickly develop sales in foreign markets. As with most things written about in the general business press, the reality is quite significantly different than the perception. Unfortunately, this is problematic for many small and medium sized companies.

First of all, there is a persistent notion that merely bringing business people together will result in business deals. Business development specialists frequently make this argument and are often very persuasive. However, anybody who has ever actually sponsored a trade mission or overseas business development conference and then taken the time to do a follow up evaluation will readily tell you that the results are quite often mixed even in the most optimistic scenarios. Why? Well, there exists in the minds of too many people the notion that most business deals are actually done in what are basically social situations; grown men playing golf, women executives getting together for lunch, after hours cocktail parties, and so forth. For this, we have Hollywood writers to blame. While all of these occasions can be a part of the give and take of developing a business relationship, they are not necessarily the focal point upon which closing a deal might rest. There are many complicated factors that go into making a buying decision or closing a business deal across national borders

and therefore it is not very realistic to assume that merely bringing the parties together in the same physical space with free or cheap alcoholic drinks will supercede these other very important issues.

The next problem is the actual nature of the trade mission

itself. Business development specialists will argue that the

trade mission is an integral part of the international

marketing mix. Historically, this has been true to some

extent. What has been likewise true is the fact that industry

organization sponsored trade missions are probably more

successful than those sponsored by government agencies.

But if one examines closely who sponsors the vast majority

of trade missions, you will often find the hand of a

government agency somewhere. Trade missions are

supposed to be about developing trade opportunities.

However, once government agencies become involved, the

mission of the trade mission has been fundamentally

changed. The reason for this is very simple. Trade

missions sponsored by private industry groups tend to pick

venues and choose local partners who have the necessary

expertise to produce successful events. Industry

organizations represent the industry and are not beholden to

other private political interests. When government

agencies become involved, the actual reason for doing the

trade mission may have nothing at all to do with the

particular industry selected or the actual companies

selected to participate. To suggest that this is troublesome

is to egregiously understate the case. Politics, especially

international politics, and business do not mix very well.

The people in government who have power over the budget

and appropriations are quite often dictating policy to career

civil servants. This dichotomy serves to actually undermine

the quality of the intellectual output of those within various

government agencies who have the authority to declare

which trade missions will be supported and which ones will

not. These political appointees who control the purse

strings seldom have the prerequisite international business

experience to understand the folly of their decisions. When

such people oversee the decisions of their more

knowledgeable junior colleagues, anything can and will

happen. Consider the following:

Trade shows are actually joint ventures between two government agencies or two private entities supported or sponsored in part with government funds.

Choosing the target industry and the participants is a crucial aspect in any successful trade mission. When experienced business or economic development professionals have an opportunity to control these decisions, there is usually a consensus about the goals of the mission and the actual particulars of how it will be executed. When this decision is moved “upstairs”, so to speak, back room

political motives enter the fray and such motives do not always play as expected in foreign markets.

The foreign counterparts play an enormous role in the success of a trade mission. If the proper venues are not chosen, there has been insufficient marketing and promotion of the event or there is little interest on the part of the intended target market, attendance can fall off and failure will be a consequence. Such mundane things as failing to set up appointments with the proper officials of government and business and economic development agencies or industry related groups could be disastrous.

Beyond the inherent problems with trade missions, there

are some very simple practical considerations. Whenever a

business executive is approached as part of a recruiting

effort to join a trade mission, there are several factors that

must be considered:

1. What is the cost-benefit analysis? Many business executives approach foreign trade missions from a cost recovery approach. That is, they base their decision upon the likelihood of recovering their cost outlay. While this is a popular notion, we do not heartily endorse it simply because of the lengthy sales cycle in international business. Of course, executives do

have to analyze the costs and the possible future benefits to their companies. With rare exceptions, your company is not likely to get many orders as a result of participating in a trade mission. Executives who do anticipate closing sales and who are unsuccessful often sour on the trade mission process and this is unfortunate. Trade missions are not inexpensive, even when they are partially subsidized by a government agency or private industry trade development group.

2. Seek referrals from other business executives. It is always a good idea to speak with people who have gone on similar trade missions to the same country and/or region in order to get their feedback.

3. Carefully evaluate the agenda. Trade missions that are tightly scheduled and packed with several meetings in different locations present significant logistical difficulties at best. At worse, such agendas do not provide sufficient time for actual partnering to take place.

4. Consider the other trade mission participants very carefully. If your company is a custom machine shop ostensibly going on an industrial trade mission, you should be alarmed if six software companies decide to tag along unless they produce software for industrial controls and processing. If they manufacture computer games, then they might know something that you do not.

Surprises upon arrival at your foreign destination are definitely a bad thing.

5. Do not trust trade mission organizers to tell you the truth. This is very difficult for many business executives because it requires them to approach government officials with a heightened sense of skepticism. However, once recruitment starts for a trade mission, mission organizers become focused on filling slots. If the departure date for a trade mission is quickly looming, expect criteria for admission to slide backwards until all slots are filled.

6. Ask the tough questions. What is the intended target audience? Why are members within the target audience attracted to this mission? Are there any specific incentives for them to attend? Is there a screening process to eliminate employment seekers, sample grabbers and other such distractions? What has been the history of prior missions? Have there been any follow up evaluations done and what do the results indicate? What arrangements have been made for me to have a specific amount of allotted time to privately meet with companies that show an interest in my company’s products and/or services? Are foreign language translators fees included in the mission’s cost structure or are these additional fees? What types of equipment and facilities will be available for presentations and more importantly, are there enough to go around for those companies who might need

them? How extensive is the pre-mission briefing and what areas does it not cover appropriately? What types of collateral marketing materials are required and must they be localized?

Trade missions are designed to transport business

executives into a foreign business environment but within

the protective umbrella of the mission itself. The mission

itself is supposed to compensate for the inherent

weaknesses of many individual executives with little or no

foreign business experience. The purpose of most trade

missions is not the goal clearly stated to the companies

recruited to join the mission. In fact, this goal is almost

never the real purpose of the mission, even though trade

mission organizers will argue thusly to their graves. The

usual purpose of a trade mission is to either satisfy some

industry segment for partisan political purposes or to

demonstrate to the electorate that an administration is hard

at work promoting exports and therefore protecting existing

jobs while going forth to create new jobs. While all of this

is certainly true, it is likewise true that even with such

constraints, trade missions do present companies with an

opportunity to test the waters in selected overseas markets.

In order for your foray into a trade mission to be successful,

you are going to have to be open minded, skeptical, wary

and you’re going to have to be willing to ask lots of very

unpleasant questions. If you can do all of those things, then

you just might be able to actually participate in a trade

mission and accrue some tangible benefit.

This article was written by Jeffrey P. Graham and it originally appeared on Citibank's now defunct international business portal. Copyright © Citibank. All Rights Reserved. This article was written by Jeffrey P. Graham and R. Barry Spaulding and originally appeared on the now defunct Citibank international business portal. Copyright © Citibank. All Rights Reserved.

Understanding Foreign Direct Investment (FDI)

Definition

Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firm’s home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property, In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign

investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privitazation of many industries, has probably been been the most significant catalyst for FDI’s expanded role.

The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970’s to a yearly average of less than $20 billion in the 1980’s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998 (Source: UNCTAD)

Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker economies and can drive out much local competition. The truth lies somewhere in the middle.

For small and medium sized companies, FDI represents an opportunity to become more actively involved in international business activities. In the past 15 years, the classic definition of FDI as noted above has changed considerably. This notion of a change in the classic definition, however, must be kept in the proper context. Very clearly, over 2/3 of direct foreign investment is still made in the form of fixtures, machinery, equipment and buildings. Moreover, larger multinational corporations and conglomerates still make the overwhelming percentage of FDI. But, with the advent of the Internet, the increasing role of technology, loosening of direct investment restrictions in many markets and decreasing communication costs means that newer, non-traditional forms of investment will play an important role in the future. Many governments, especially in industrialized and developed nations, pay very close attention to foreign direct investment because the investment flows into and out of their economies can and does have a significant impact. In the United States, the Bureau of Economic Analysis, a section of the U.S. Department of Commerce, is responsible for collecting economic data about the economy including information about foreign direct investment flows. Monitoring this data is very helpful in trying to determine the impact of such investments on the overall economy, but is especially helpful in evaluating industry segments.

State and local governments watch closely because they want to track their foreign investment attraction programs for successful outcomes.

How Has FDI Changed in the Past Decade?

As mentioned above, the overwhelming majority of foreign direct investment is made in the form of fixtures, machinery, equipment and buildings. This investment is achieved or accomplished mostly via mergers & acquisitions. In the case of traditional manufacturing, this has been the primary mechanism for investment and it has been heretofore very efficient. Within the past decade, however, there has been a dramatic increase in the number of technology startups and this, together with the rise in prominence of Internet usage, has fostered increasing changes in foreign investment patterns. Many of these high tech startups are very small companies that have grown out of research & development projects often affiliated with major universities and with some government sponsorship. Unlike traditional manufacturers, many of these companies do not require huge manufacturing plants and immense warehouses to store inventory. Another factor to consider is the number of companies whose primary product is an intellectual property right such as a software program or a software-based technology or process. Companies such as these can be housed almost anywhere and therefore making a capital investment in them does not require huge outlays for fixtures, machinery and plants.

In many cases, large companies still play a dominant role in investment activities in small, high tech oriented companies. However, unlike in the past, these larger companies are not necessarily acquiring smaller companies outright. There are several reasons for this, but the most important one is most likely the risk associated with such high tech ventures. In the case of mature industries, the products are well defined. The manufacturer usually wants to get closer to its foreign market or wants to circumvent some trade barrier by making a direct foreign investment. The major risk here is that you do not sell enough of the product that you manufactured. However, you have added additional capacity and in the case of multinational corporations this capacity can be used in a variety of ways.

High tech ventures tend to have longer incubation periods. That is, the product tends to require significant development time. In the case of software and other intellectual property type products, the product is constantly changing even before it hits the marketplace. This makes the investment decision more complicated. When you invest in fixtures and machinery, you know what the real and book value of your investment will

be. When you invest in a high tech venture, there is always an element of uncertainty. Unfortunately, the recent spate of dot.com failures is quite illustrative of this point.

Therefore, the expanded role of technology and intellectual property has changed the foreign direct investment playing field. Companies are still motivated to make foreign investments, but because of the vagaries of technology investments, they are now finding new vehicles to accomplish their goals. Consider the following:

Licensing and technology transfer. Licensing and tech transfer have been essential in promoting collaboration between the academic and business communities. Ever since legal hurdles were removed that allowed universities to hold title to research and development done in their labs, licensing agreements have helped turned raw technology into finished products that are viable in competitive marketplaces. With some help from a variety of government agencies in the form of grants for R&D as well as other financial assistance for such things as incubator programs, once timid college researchers are now stepping out and becoming cutting edge entrepreneurs. These strategic alliances have had a serious impact in several high tech industries, including but not limited to: medical and agricultural biotechnology, computer software engineering, telecommunications, advanced materials processing, ceramics, thin materials processing, photonics, digital multimedia production and publishing, optics and imaging and robotics and automation. Industry clusters are now growing uparound the university labs where their derivative technologies were first discovered and nurtured. Licensing agreements allow companies to take full advantage of new and exciting technologies while limiting their overall risk to royalty payments until a particular technology is fully developed and thus ready to put new products into the manufacturing pipelineReciprocal distribution agreements. Actually, this type of strategic alliance is more trade-based, but in a very real sense it does in fact represent a type of direct investment. Basically, two companies, usually within the same or affiliated industries, agree to act as a national distributor for each other’s products. The classical example is to be found in the furniture industry. A U.S.-based manufacturer of tables signs a reciprocal distribution agreement with a Spanish-based manufacturer of chairs. Both companies gain direct access to the other’s distribution network without having to pay distributor support payments and other related expenses found within the distribution channel and neither company can hurt the other’s market for its products. Without such an agreement in place, the Spanish manufacturer might very well have to invest in a national sales office to coordinate its distributor network, manage warehousing, inventory and shipping as well as to handle administrative tasks such as accounting

public relations and advertising Joint venture and other hybrid strategic alliances. The more traditional joint venture is bi-lateral, that is it involves two parties who are within the same industry who are partnering for some strategic advantage. Typical reasons might include a need for access to proprietary technology that might tip the competitive edge in another competitor’s favor, desire to gain access to intellectual capital in the form of ultra-expensive human resources, access to heretofore closed channels of distribution in key regions of the world. One very good reason why many joint ventures only involve two parties is the difficulty in integrating different corporate cultures. With two domestic companies from the same country, it would still be very difficult. However, with two companies from different cultures, it is almost impossible at times. This is probably why pure joint ventures have a fairly high failure rate only five years after inception. Joint ventures involving three or more parties are usually called syndicates and are most often formed for specific projects such as large construction or public works projects that might involve a wide variety of expertise and resources for successful completion. In some cases, syndicates are actually easier to manage because the project itself sets certain limits on each party and close cooperation is not always a prerequisite for ultimate success of the endeavor. Portfolio investment. Yes, we know that you’re paying attention and no we’re not trying to trip you up here. Remember our definition of foreign direct investment as it pertains to controlling interest. For most of the latter part of the 20th century when FDI became an issue, a company’s portfolio investments were not considered a direct investment if the amount of stock and/or capital was not enough to garner a significant voting interest amongst shareholders or owners. However, two or three companies with "soft" investments in another company could find some mutual interests and use their shareholder power effectively for management control. This is another form of strategic alliance, sometimes called "shadow alliances". So, while most company portfolio investments do not strictly qualify as a direct foreign investment, there are instances within a certain context that they are in fact a real direct investment.

Why is FDI important for any consideration of going global?

The simple answer is that making a direct foreign investment allows companies to accomplish several tasks:

Avoiding foreign government pressure for local production Circumventing trade barriers, hidden and otherwise Making the move from domestic export sales to a locally-based national sales office Capability to increase total production capacity Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc;

A more complete response might address the issue of global business partnering in very general terms. While it is nice that many business writers like the expression, “think globally, act locally”, this often used cliché does not really mean very much to the average business executive in a small and medium sized company. The phrase does have significant connotations for multinational corporations. But for executives in SME’s, it is still just another buzzword. The simple explanation for this is the difference in perspective between executives of multinational corporations and small and medium sized companies. Multinational corporations are almost always concerned with worldwide manufacturing capacity and proximity to major markets. Small and medium sized companies tend to be more concerned with selling their products in overseas markets. The advent of the Internet has ushered in a new and very different mindset that tends to focus more on access issues. SME’s in particular are now focusing on access to markets, access to expertise and most of all access to technology.

What would be some of the basic requirements for companies considering a foreign investment?

Depending on the industry sector and type of business, a foreign direct investment may be an attractive and viable option. With rapid globalization of many industries and vertical integration rapidly taking place on a global level, at a minimum a firm needs to keep abreast of global trends in their industry. From a competitive standpoint, it is important to be aware of

whether a company’s competitors are expanding into a foreign market and how they are doing that. At the same time, it also becomes important to monitor how globalization is affecting domestic clients. Often, it becomes imperative to follow the expansion of key clients overseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some stage, export of product or service reaches a critical mass of amount and cost where foreign production or location begins to be more cost effective. Any decision on investing is thus a combination of a number of key factors including:

assessment of internal resources, competitiveness, market analysis market expectations

From an internal resources standpoint, does the firm have senior management support for the investment and the internal management and system capabilities to support the set up time as well as ongoing management of a foreign subsidiary? Has the company conducted extensive market research involving both the industry, product and local regulations governing foreign investment which will set the broad market parameters for any investment decision? Is there a realistic assessment in place of what resource utilization the investment will entail? Has information on local industry and foreign investment regulations, incentives, profit retention, financing, distribution, and other factors been completely analyzed to determine the most viable vehicle for entering the market (greenfield, acquisition, merger, joint venture, etc.)? Has a plan been drawn up with reasonable expectations for expansion into the market through that local vehicle? If the foreign economy, industry or foreign investment climate is characterized by government regulation, have the relevant government agencies been contacted and concurred? Have political risk and foreign exchange risk been factored into the business plan?

This article was written by Jeffrey P. Graham and originally appeared on Citibank's now defunct international business portal. Copyright © Citibank. All Rights Reserved.