Exporting and setting up an international business can be interesting and exciting and in some cases challenging too. Setting up a business in a new foreign location is difficult and is often guided with various challenges and risks. There are new skills to be learned and new knowledge to be acquired. It becomes important to know about new markets, different laws and regulations, different buying habits, etc. It is important to remember that by expanding in an international market, the business is going to run differently in the home country and the operation will largely be determined by economic political and cultural differences. It is important to understand the difference between domestic and international business and risks involved thereof.
Risks in International Business are the major barriers for any growth. The increase in an export market is highly beneficial to an economy. International business is characteristically expensive in terms of domestic business. There are number of reasons such as tariffs, cost of delay, time, cost related to different legal systems, etc., that can act as risks when a business decides to expand internationally. The factors of production like labor and capital are more mobile within the territories of the country than across other countries. Broadly risks in international trade can be divided under several types.
- Political Risks include Political instability
- Economic Risks
- Currency Risks
- Legal Risks
- Various forms of protectionist trade legislations
- Financial risks: expenses associated with customizing products.
- Multiple, conflicting and changing governmental laws and regulations
- Potentially adverse tax situations and consequences
- Local accounting principles, practices and procedures.
- Foreign currency exchange rate fluctuations
- Communication barriers arising from language, culture & customs
- Supervisory challenges arising from distance & physical absence
The above-mentioned risks are broadly defined. However, the most important risks that an international business faces are:
Political Risks:Political risk can be defined as the risk of losing money due to changes that occur in a country’s government or regulatory environment. While most of the countries where the business is likely to be expanding have stable governments, there are many concerns that it may have to confront. All member nations of the world trade organization are committed to free trade but protectionism still exits. Tariffs and quotas may place restrictions on the businesses’ ability to trade. Import and Exports licenses, custom duties and laws regulating currency control are requirements that must be explored. Each country has a different political and legal system. Thefts of intellectual property and illegal knock offs are facts of life, so the business needs to be prepared. Acts of war, terrorism, trade barriers and military cops are all extreme examples of political risks. Every country is characterized by diverse political and legal systems that pose significant challenges for company strategy and performance, as managers must adhere to business laws and regulations. Preferential subsidies, government incentives and protection from competition reduce business costs and influence strategic decision-making.
Financial Risks: One important risk of engaging in IB lies with exchange rates. This is not a factor when the business is all-domestic, but when the buyer has another currency; then the business must protect itself against losses due to exchange rate changes. Foreign exchange markets are fairly stable and barring an international crisis, the risk is not great. Managing international transactions requires extra precautions about payments. If the buyer is abroad then the business must take steps to assure that it will be paid. Foreign credit insurance and letters of credit can alleviate much of the risk of selling the products in overseas markets, since they will provide the business with the knowledge of the buyer’s ability to pay. Financial risk is also posed by an exposure to unanticipated changes in the exchange rate between two currencies. The exchange rate between currencies fluctuates over time and can lead to unexpected gains or losses. Currency exchange rate risk includes transactional exposure, economic exposure, and translation exposure.
Economic Risks: There are several economic issues that the business must deal with when engaging in international operations. If the business is importing materials or products, it must take extra precautions to ensure timely delivery. Geography and economic conditions in the country the business is dealing with are important factors. Mountains and oceans create international barriers that must be worked into the business plan. Economic stability may be an issue if the transactions involve third world nations. Even if they are politically stable, they may lack the infrastructure to provide a sound economic environment. Economic risk is also the risk associated with a country’s financial condition and ability to repay its debts. Economic indicator movements in the foreign country such as GDP, unemployment, purchasing power, inflation, etc., are important measurement for economic risk.
Cross Cultural Risk: Difference in languages, lifestyles, attitudes, work ethics, customs and religion, where a cultural miscommunication can jeopardize everything. Cultural blunders can hinder the effectiveness of foreign manager. Language – critical dimension of culture, Language differences impede effective communication, - cultural differences may lead to suboptimal business strategies.
Poor Quality Risk:Exported goods can be rejected on the basis of poor quality. Therefore it is always recommended that products be checked before being exported. It is better to allow for an expansion procedure that protects the exporter, the distributor and the final consumer.
Legal Risks: International laws and regulations change frequently and therefore it is very important for an international business or an exporter to draft a contract in conjunction with a lawyer or legal firm of that country, thereby ensuring that the exporter’s interests are taken care of.
Unforeseen Risks: Unforeseen risks in the event of natural disasters floods, earthquake or an act of terrorism may cause damage to exported products. It is therefore important that an exporter ensures a force majeure clause in the export contract.
Once the business is aware of all the risk that it could face in an international market, it needs to have risk management plans that will help the business to broaden its risk profile in the foreign market. The risk management plan should be simple and clear for a small business. The four basic elements of the risk management process are:
- Identifying the risks and establishing context
- Assessing the probability and consequences of risks
- Developing strategies to mitigate these risks
- Monitoring and reviewing outcomes
Thus, before investing in a foreign country, investors should assess the possibility of the investing country’s political risk (the stability of politics and attitude towards foreign investment) or estimate the foreign country’s current economic condition and future development via foreign country’s GDP, unemployment rate, purchasing power, and inflation. In International markets there are more risks to carry; however at the same time, there are more potential gains the business can receive. Before setting up an international business perform due diligence on the country’s economic, political and cultural condition.