Module IV

External Environment

PESTLE Analysis

A PESTEL Analysis is an analytical tool for strategic business planning, incorporating strategies and
programs to reach the business goals. A PESTEL analysis is used to identify and analyse the key drivers
of change the external business environment, as well as when plans to launch a new product, project or
service into the market is considered. This can be used for business planning, strategic planning,
marketing planning, product development, organisational planning, and research reports. The idea of this
tool is to analyse the external environment from many different angles, and to provide a complete
evaluation when considering a certain idea or plan, providing insight to whether a project is better placed
than its competitors, and if its able to respond to change more effectively. Understanding these
environments helps to minimize threats, while maximizing opportunities. Environmental scanning can
help business identify opportunities in the market while avoiding costly mistakes or risks. These
environments include:

 Political
 Economic
 Social
 Technological
 Environmental
 Legal
All aspects (or environments) are important in delivering a multi visioned analysis of the organisations
external environment. Although different industries will hold higher value to one environment over
another, it is imperative to apply all aspects to any business strategy who wants to develop, grow or even
sustain their involvement in the market. A PESTEL analysis forms a much more comprehensive result
over a SWOT analysis.
When the factors for each environment are assessed, this information can then be analysed further using
a SWOT analysis to identify the threats and weakness associated with each of the factors.

Environmental Factors Explained

Political Factors

These factors involve governmental influences effecting the economy and how a business can be
operated. These include, but not limited to:

 Government policy
 Political stability or instability overseas
 Foreign trade policy
 Tax policy
 Labor laws
 Terrorism and military considerations
 Environmental laws
 Funding grants and initiatives
 Trade restrictions
 Fiscal policy
Organisations need to adapt to political changes both current and future in order to remain compliant
while trading. An example of this is if a government introduces a new tax, the organisation may need to
reassess their revenue generating structure if said taxes deem this nonviable.

Economic Factors

These factors determine an economy’s performance resulting in impacting the organisations operational
capabilities as well as their profitability and sustainability. These include, but are not limited to:

 Economic Growth
 Interest Rates
 Exchange rates
  Inflation
 Disposable income of consumers
 Disposable income of businesses
 Taxation
 Interstate taxes
 Wages rates
 Financing capabilities
Breaking this factor down further, we can class the Economics into Macro and Micro-economic factors.
The Macro includes the management of demand in any given economy, tax rate control, taxation policy
and governmental expenditure. Micro refers to the way people spend their disposable income, an area of
interest for business to consumer organisations. An example of how economics effect an organisations
performance is if there was a rise in inflation, the company would need to increase their supply price,
causing a potential loss of sales to their clients.
Social Factors

Also known as socio-cultural factors, these factors consider the beliefs, attitudes and trends of the
population that affect the market and community socially. This requires the advantages and disadvantages
the product holds to the community to be considered. These factors include but are not limited to:

 Population growth
 Age distribution
 Health consciousness
 Career attitudes
 Customer buying trends
 Cultural trends
 Demographics
 Industrial reviews and consumer confidence
 Organisational image
These factors show high consideration for businesses and marketers as this has direct relation to
customers spending habits and their motivation. An example of this would be in high tourism locations,
requiring the business strategy to be sustainable during the low seasons, yet capable of accommodating
the demand during the busy seasons.
Technological Factors

In a world of technological innovation and increased demand on technology, these factors impact the way
organisations market their products, as well as platforms for marketing itself, while also realizing
technology often becomes outdated within a short period of time after its released. These factors include
but are not limited to:

 Producing goods and services

 Emerging technologies
 Maturity of technologies
 Distributing goods and services
 Communicating with target markets
 Potential Copyright infringements
 Increased training to use innovation
 Potential Return on Investment (ROI)

These factors affect the operations of the organisation and can pose opportunities as well as risks. An
automated system needing continual servicing due to malfunctions, can pose supply issues and drop the
reliability of the company causing a loss in clients.

Environmental Factors

These factors consider ecological and environmental aspects including those which influence or are
determined by the the surrounding environment. Environmental factors have increased in their importance
for analysis over the last 15 years or so due to the changes in material supply and pollution controls.
These factors include but are not limited to:

 The decline of raw materials

 Pollution and green house gas emissions
 Promoting positive business ethics and sustainability
 Reduction of their carbon foot print.
 Climate and weather
 Environmental Legislation
 Geographical location (and accessibility)
Industries including tourism, farming and agriculture see this aspect of a PESTEL to be crucial in their
industries operations. Consumers are also showing a higher regard for ‘going green’ and supporting
organisations that show their efforts in following this trend. An example of this is from the oil companies
using sugar cane (a renewable source) to make ethanol fuel for automotive transportation.
Legal Factors

The legal considerations can be a make or break for an organisation. Although PESTEL analysis is
typically and external evaluation, Legal factors considered need both internal and external consideration.
With governmental laws laws effecting how an organisation acts, internal policies are also taken into
account when developing strategies for the company. If these factors are not continually reviewed, large
fines, imprisonment and business closure can become reality. These factors include but are not limited to:

 Health & Safety

 Equal Opportunities

 Advertising Standards

 Consumer Rights and laws

 Product Labeling

 Product Safety

 Safety Standards

 Labor Laws

 Future Legislation

 Competitive Legislation

Although challenging at base level, when an organisation become national and more so inter national,
different legislation’s are in place depending on your area of trade which must also be considered.

Advantages of a PESTEL Analysis

 Helps to understand and provide insight into the business environment

 Encourages strategic thinking and promotes innovation
 Reduces risk when introducing new strategies
 Reduces the effects of future threats to the organisation
 Opens new opportunities
 Model is simple to use
 Promotes team collaboration

Disadvantages of a PESTEL Analysis

 Continual analysis and updates given the changing market

 Requires diversity in perspectives to achieve deeper analysis
  Mainly based on assumptions given its future vision
 Collaboration of data can be time consuming and expensive
 Missing data or unexpected changes in the market can lead to financial losses

Implications of environmental differences due to Economic, Social, Political, legal, cultural

variations

Cultural factors affecting International Business Operations

Culture ‘Culture refers to learned norms based on the values, attitudes, and beliefs of a group of people’.

 Cultural factors have an important impact on the flow of business. Each society has its own
elements of culture. These elements of culture are manifested through:
o Language
o Verbal & nonverbal
o Religion
o Values and attitudes
o Manners and customs
o Material elements
o Aesthetics
o Education
o Social institutions
Adaptation of these elements for an international company depends on its level in the market
participation –for example, licensing versus direct investment and the product or service marketed
The most important issue for a foreign company is cultural analysis, which includes information that
helps the company´ staff to take planning decisions. This information from the cultural analysis must be
more than collecting the facts; these must also be interpreted in the proper way.Another significant issue
about culture is the levels manifested through artefacts, values and underlying assumptions

Culture in each country is meditated through three factors: cultural forces, cultural messages and
consumer decision process. Family, education and national identity manifest cultural forces. Ethics and
morality, behaviour and roles and design influence cultural messages. Culture is also influenced from
universal needs and wants in the society and consumer trends. These cultural differences are different in
country A and country B. The foreign company must analyze and cope with these cultural differences and
harness the tension to bring about reconciliation between these countries. With combining and
synthesizing cultural differences the foreign company can integrate different cultural perspectives and
seek a dynamic solution to problems that may arise.

Hofstede (2001) states that masculinity versus femininity describes the degree to which societies display
the stereotype male female or related to division of emotional roles between men and women. Confucian
dynamism is the new dimension added of the cross-cultural framework. It relates to whether a culture is
universalistic or particularistic. Culture that is universalistic believe what is true and good can be applied
everywhere, whereas particular culture believe circumstances and relationships are more important in
determining what is good and right.

Cultural advantages can arise from different values and ways of seeing the world. To realize competitive
advantage from them, it is first necessary to try to understand them. For cultural differences to be lower
these should be managed. According to Hoecklin (1994) there are four strategies for managing cultural
differences:

1) Building a strong corporate culture internationally

2) Developing a common technical or professional culture worldwide
3) Relying on strong financial or planning systems.
4) Leaving each culture alone
Gaining benefits from cultural differences
Accepting cultural differences provides business organisation with a wide range of business expertise and
gives you novel business insights to overcome business-related problems. It's helps to cope with potential
barriers regarding international business and culture.

It is vital for a global company to understand that there is a difference in the definition of culture per se
and culture in relation to the context of international business. Culture is typically defined as a group of
common and accepted standards shared by a specific society. When you put it in international business
context, what one society considers as professional may be different for another foreign society.

It must be understood that cultural differences affect global business in three primary areas –
organizational hierarchy, etiquette, and communication. Understanding them and recognizing their effects
on the business will prevent from creating misunderstandings with foreign clients and colleagues.

1. Communication

Effective communication is vital to business success, whether it is a start-up or a big corporation. When
the business ventures into the international business arena, one way of bridging the cultural differences is
through language. Understand the language your target market speaks and know how you use it to convey
your message. In India for example, business professionals typically communicate in nuanced and
indirect ways. This is opposite to the Finns who tend to be direct and brief in their communication.

Aside from the verbal communication, it is essential to learn that non-verbal communication is also
extremely important when dealing with international businesses.

2. Interactions

Gestures that are common in one country, like making eye to eye contact and shaking hands firmly, may
be taken as offensive or unusual by foreign clients or business partners.. Doing research on accepted and
proper business etiquette is important.

3. Etiquette in the workplace

Put high importance on the formality of address when dealing with foreign business partners and
colleagues. In some cultures, it is all right to address a person you've recently met by their first name,
while in other countries, they would rather that you address them by their surname or their title.
Canadians and Americans often use first names, even when dealing with new acquaintances. But in many
Asian countries, such as Singapore, China and South Korea, people should always address a person
formally by adding Mr. or Ms. before their surname.

Punctuality is something that is relative. When companies deal with business partners, clients or
colleagues from the United States, South Korea, Japan and Russia, it is expected to be on time. In
Germany, it is expected to be at least 10 minutes early prior to appointment. In Greece, they expect
foreigners to arrive on time but just like in Russia, it is expected that the counterpart arrives slightly late.
Brazil is ambivalent. They could either be late by a few or several minutes unless it’s indicated that they
follow the English time, meaning they should arrive at the agreed time.

In Malaysia, expect to wait up to an hour if the counterpart will be about five minutes late. They are not
required to give an explanation, either. In China, it is acceptable to be at least 10 minutes late while in
Mexico, it is quite normal for people to be late by 30 minutes for a business meeting. When doing
business in Nigeria or Ghana, the appointed hour for the meeting may be one hour late or within the day.
In Morocco, personal meetings could be delayed by an hour and in some cases, a day. When scheduling
meetings in India, understand that being punctual is not one of their ways.

4. Hierarchy in the organization

Cultural norms dictate how attitudes towards management and organizational hierarchy are perceived. In
some cultures, junior staff and people in middle management may or may not be allowed to speak up
during meetings. In some countries, it is difficult to question decisions by senior officers or express
opinions that are different from the rest.

Attitudes are dependent on social equality or the societal values of a country. In some countries such as
Japan and South Korea where respect for elders and people in positions of authority is deeply ingrained in
the members of society, the concept is applied to the workplace as well. It helps in defining
responsibilities and roles in the company and those holding positions in senior management expect
deference from junior staff and a higher level of formality and respect.

However, the situation is different in Scandinavian countries. In Norway for example, societal equality is
emphasized so the organizational hierarchy tends to be flat. The workplace environment calls for
cooperation across all departments and informal communication is prevalent.

Differences in negotiating styles

Negotiation is a principal component of international business. Culture influences the way people behave,
communicate and think. These characteristics are reflected in the way they negotiate. It is crucial for
businesses to understand cultural differences during business transactions and find ways to hurdle the
barriers these differences present.

Spanish speakers view negotiation as the means to have a contract, while in some Asian countries,
negotiations are taken as the way to build stronger and firmer business relationships. The Japanese regard
negotiation as a win-win process while the Spanish look at it as a win-lose process.

The way one communicates during negotiations should be carefully considered. Israelis and Americas are
very direct, so you immediately know if the transaction is approved or not. The Japanese, however, tend
to be indirect. You have to read and carefully interpret vague signs to know if they rejected or accepted
your proposal.

Some cultures are very emotional like the Latin Americans. Most Asians, on the other hand, have a
tendency to suppress their emotions and keep things formal.

Even the way different cultures handle contracts vary. Americans like to have every detail included in the
contract because they want to anticipate possible eventualities and circumstances. The deal equates to a
contract, therefore everything that was discussed and accepted during the negotiation should be specified
in the contract. The Chinese, on the other hand, prefer a contract to have the general principles only,
because for them, sealing a deal means forming a relationship with the business partner.

Remain competitive and successful in the global market

Cultural differences are sensitive issues and those who take the time to address these differences will have
a better chance of remaining competitive and successful in the international business environment.

Businesses preparing to enter the global market have to diligently learn how cultural differences can
affect their conduct of business in different markets. Their performance depends on understanding
cultural diversity and that different markets have their own set of priorities, preferences and expectations.

Economic Environment

Elements of the economic environment

Managers use different economic measures to assess a country’s level of performance and potential.
Some may be informal or idiosyncratic indicators in a country-for example, the number of wireless
phones or circulation patterns of newspapers. In practice, managers usually begin their analyses by
looking at the monetary value of the total flow of goods and services in the economy of a nation. They
refine this analysis by considering issues like growth rates, income distribution, inflation, unemployment,
wages, productivity, debt, and the balance of payments. Let’s examine those factors

Gross National Income (GNI) measures the income generated both by total domestic production as well
as the international production activities of national companies. GNI is the value of all production in the
domestic economy plus the net flows of factor income from abroad during a one-period. Technically, GNI
is the market value of final goods and services newly produced by domestically owned factors of
production.

Gross Domestic Product (GDP) GNI is the broadest measure of economic activity for a country. An
essential part of GNI is Gross domestic product (GDP) – the total value of all goods and services
produced within a nation’s borders over one year, no matter whether domestic or foreign-owned
companies make the product.

Improving the power of GNI GNI is a robust estimator of an economy’s absolute performance. However,
GNI can mislead managers when they compare countries. For example, economic powers, like the United
States, Japan and Germany, consistently claim the top spots on rankings of countries by GNI. As such, a
quick look at these rankings might give the impression that these top-ranked countries are far richer than
countries like Ireland or Luxembourg. Therefore, managers improve the usefulness of GNI by adjusting it
from the number of people in a country, growth rate, the local cost of living and economic sustainability.

Per capital conversion: Managers transform GNI, as well as many other economic indicators, by the
people who live in a country. This conversion leads to a per capita estimator that measures a country’s
relative performance. For example, GNI may be low in the absolute terms, such as is the case for
Luxembourg, which ranks among the smaller economies of the world. But Luxembourg ranks first in the
world by GNI per capita.

Purchasing power parity: Managers, when comparing markets, often convert the GNI figure in one nation
in terms of the currency of their home market. This simple conversion greatly refines economic analysis.
This simple conversion can create a systematic distortion. Exchange rates tell us how many units of
currency it takes to buy one unit of another – for example, how many Indian rupees one needs to buy one
US dollar. However, exchange rates do not tell us what that unit of local currency can buy in its home
country. Managers adjust GNI per capita for a particular country in terms of its local purchasing power
parity (PPP). The most common PPP exchange rate comes from comparing a basket of goods and
services in a country with an equivalent basket in the United States. GNI per capita in terms of relative
PPP is higher in India because of the lower cost of living. This means that it costs far less to buy the same
basket of goods in India than it does in the United States.

Degree of Human Development: Monetary indicators, misrepresent the scale and scope of a country’s
level of development. Managers can deal with these concerns by looking at a country’s degree of human
development- in terms of both economic and social factors- to estimate present and future economic
activity. Jointly considering economic and social indicators enables managers to more fully measure
development in terms of the capabilities and opportunities that people enjoy.

Features of the economy

GNI and its variations estimate the absolute and relative income of a country. As such, these data create
powerful, first-order indicators of a country’s performance and potential. Managers also study other
features or an economy. Let’s look at various features of the economy

Inflation: A general, sustained rise in process measured against a standard level of purchasing power is
called inflation. In mainstream economics, inflation results when aggregate demand grows faster than
aggregates supply. Operationally, we measure inflation by comparing two sets of goods at two points in
time and computing the increase in cost that is not reflected by an increase in the quality of the good.
Inflation and the cost of living: Consider the impact of inflation on the cost of living. Rising prices make
it more difficult for consumers to buy products unless their incomes rise at the same or faster pace.

Unemployment: The unemployment rate is the number of unemployed workers who are seeking
employment for pay dividend by the total civilian labor force. Countries that are unable to create jobs for
their citizens create a risky business environment. Generally, people out of work and unable to find jobs
depress economic growth, create social pressures, and provoke political uncertainty. As such, the
proportion of unemployed workers in a country shows how well country productivity uses it human
resources.

The working – Age population Presently, the wealthier countries of the world are watching their working-
age population shrink from approximately 740 million to 690 million people between 2000 to 2025.
However at the same time, the working age population will increase across poorer countries from 3
billion to 4 billion people.

Labor Regulation Emerging economies also face challenges from excessive labor regulation that
aggravates unemployment. For example, India’s labor laws, little changed since they were enacted after
the country’s independence 1947, make it difficult to lay off employees even if company’s fortunes are
hit hard or economy slows.

Poverty: The distribution of income is important to understand a market’s performance and potential.
Still, its reliance on central tendencies in income distributions presumes there actually is a reasonable
income within a country. Poverty has many dimensions. In general terms, it is condition in which a
person or community is deprived of, or lacks the essentials for, a minimum standard of well-being and
life.

Poverty and the Economic Environment: Poverty impacts economic environments. For example, 100
percent of Canadians have access to clean water, whereas 13 percent of people in Afghanistan do. The
growth of worldwide business activity and economic progress ultimately depend on alleviating poverty.

Labor Costs and Total costs: For many goods and services, the cost of labour is a key element of total
costs. Consequently, companies scan the world, looking for the best deal with the difference between low-
cost and high cost countries. The labor cost savings a company realizes by outsourcing a service job to
India can be as much as 60 percent.
Productivity: Companies refine their interpretation of labor costs by considering productivity specifically,
the amount of output created per unit input used. In terms of labor, productivity is the quantity is the
quantity produced per person per labor hour.

The balance of Payments: A country’s balance of payments (BOP), officially known as the Statement of
International, is the statement of the balance of a country’s trade and financial transactions as conducted
by individuals, businesses, and government agencies located in that nation with the rest of the world over
a specific period.

BOP and Economic Stability: Managers use the BOP to assess a country economic stability. By
measuring a country’s transaction with the rest of the world, the BOP estimates a country’s financial
stability in the world market.

The scope of international business depends, to a large extent, on the economic system. At one end, there
are the free market economies or capitalist economies, and at the other end are the centrally planned
economies or communist countries. In between these two are the mixed economies. Within the mixed
economic system itself, there are wide variations. The freedom of private enterprise is the greatest in the
free market economy, which is characterized by the following assumptions: (i) The factors of production
(labor, land, capital) are privately owned, and production occurs at the initiative of the private enterprise.
(ii) Income is received in monetary form by the sale of services of the factors of production and from the
profits of the private enterprise. (iii) Members of the free market economy have freedom of choice in so
far as consumption, occupation, savings and investment are concerned. (iv) The free market economy is
not planned controlled or regulated by the government. The government satisfies community or collective
wants, but does not compete with private firms, nor does it tell the people where to work or what to
produce. The completely free market economy, however, is an abstract system rather than a real one.
Today, even the so-called market economies are subject to a number of government regulations.
Countries like the United States, Japan, Australia, Canada and member countries of the EEC are regarded
as market economies. The communist countries have, by and large, a centrally planned economic system.
Under the rule of a communist or authoritarian socialist government, the state owns all the means of
production, determines the goals of production and controls the economy according to a central master
plan. There is hardly any consumer sovereignty in a centrally planned economy, unlike in the free market
economy. The consumption pattern in a centrally planned economy is dictated by the state. China, East
Germany Soviet Union, Czechoslovakia, Hungary, Poland etc., had centrally planned economies.
However, recently several of these countries have discarded communist system and have moved towards
the market economy. In between the capitalist system and the centrally planned system falls the system of
the mixed economy, under which both the public and private sectors co-exist, as in India. The extent of
state participation varies widely between the mixed economies. However, in many mixed economies, the
strategic and other nationally very important industries are fully owned or dominated by the state. The
economic system, thus, is a very important determinant of the scope of private business. The economic
system and policy are, therefore, very important external constraints on business.

POLITICAL AND LEGAL ENVIRONMENT Political and government environment has close
relationship with the economic system and economic policy. For example, the communist countries had a
centrally planned economic system. In most countries, apart from those laws that control investment and
related matters, there are a number of laws that regulate the conduct of the business. These laws cover
such matters as standards of products, packaging, promotion etc. In many countries, with a view to
protecting consumer interests, regulations have become stronger. Regulations to protect the purity of the
environment and preserve the ecological balance have assumed great importance in many countries. Some
governments specify certain standards for the products (including packaging) to be marketed in the
country; some even prohibit the marketing of certain products. In most nations, promotional activities are
subject to various types of controls. Media advertising is not permitted in Libya. Several European
countries restrain the use of children in commercial advertisements. In a number of countries, including
India, the advertisement of alcoholic liquor is prohibited. Advertisements, including packaging, of
cigarettes must carry the statutory warning that ―cigarette smoking is injurious to health‖. Similarly,
advertisements of baby food must necessarily inform the potential buyer that breast-feeding in the best. In
countries like Germany, product comparison advertisements and the use of superlatives like ‗best‘ or
‗excellent‘ in advertisements is not allowed In the United States, the Federal Trade Commission is
empowered to require a company to provide the quality, performance or comparative prices of its
products.

PHYSICAL AND TECHNOLOGICAL ENVIRONMENT Physical Factors, such as geographical

factors, weather and climatic conditions may call for modifications in the product, etc., to suit the
environment because these environmental factors are uncontrollable. For example, Esso adapted its
gasoline formulations to suit the weather conditions prevailing in different markets. Business prospects
depend also on the availability of certain physical facilities. Some products, like many consumer durables,
have certain use facility characteristics. The sale of television sets, for example, is limited by the extent of
the coverage of the telecasting. Similarly, the demand for refrigerators and other electrical appliances is
affected by the extent of electrification and the reliability of power supply. The demand for LPG gas
stoves is affected by the rate of growth of gas connections.
Technological factors sometimes pose problems. A firm, which is unable to cope with the technological
changes, may not survive. Further, the differing technological environment of different markets or
countires may call for product modifications. For example, many appliances and instruments in the
U.S.A. are designed for 110 volts but this needs to be converted into 240 volts in countries which have
that power system. Technological developments may increase the demand for some existing products. For
example, voltage stabilisers help increase the sale of electrical appliances in markets characterised by
frequent voltage fluctuations I power supply. However, the introduction of TV‘s, Fridges etc, with in built
voltage stabilizer adversely affects the demand for voltage stabilizers.

INTERNATIONAL ENVIRONMENT The international environment is very important from the point
of view of certain categories of business. It is particularly important for industries directly depending on
imports or exports and import-competing industries. For example, a recession in foreign markets, or the
adoption of protectionist policies by foreign nations, may create difficulties for industries depending on
exports. On the other hand, a boom in the export market or a relaxation of the protectionist policies may
help the export-oriented industries. A liberalization of imports may help some industries which use
imported items, but may adversely affect import-competing industries. It has been observed that major
international developments have their spread effects on domestic business. The Great Depression in the
United States sent its shock waves to a number of other countries. Oil price hikes have seriously affected
a number of economies. These hikes have increased the cost of production and the prices of certain
products, such as fertilizers, synthetic fibres, etc. The high oil price has led to an increase in the demand
for automobile models that economise energy consumption. The demand for natural fibres increased
because of the oil crisis. The oil crisis also prompted some companies to resort to demarketing.
―Demarketing refers to the process of cutting consumer demand for a product back to level that can be
supplied by the firm‖. Some oil companies-the Indian Oil Corporation, for example-have publicized tips o
how to cut oil consumption.

When the fertilizer price shot up following the oil crisis, some fertilizer companies appealed to the
farmers to use fertilizers only for important and remunerative crops. The importance of natural manure
like compost as a substitute for chemical fertilizers was also emphasized. The oil crisis led to a
reorientation of the Government of India‘s energy policy. Such developments affect the demand,
consumption and investment pattern. A good export market enables a firm to develop a more profitable
product mix and to consolidate its position in the domestic market. Many companies now plan production
capacities and investment taking into account also the foreign markets. Export marketing facilitates the
attainment of optimum capacity utilization; a company may be able to mitigate the effects of domestic
recession by exporting. However, a company which depends on the export market to a considerable
extent has also to face the impact of adverse developments in foreign markets.

International business is a necessity in today‘s world. The gains for greater awareness and
knowledge of international business fare immense for nations, multi-national enterprises, trading
companies, exporters and even individuals. To go global, the first step would be to understand the
international business environment. International business in nothing but extending the areas of activities
of business across the boundaries. We have discussed about the importance of understanding international
business environment in detail. The concepts of microenvironment and macro environment with reference
to the political, legal, economical and cultural background are also discussed. Understanding international
business environment requires greater research and information. The fulfillment of this research could
happen with greater understanding of the framework for analyzing the international business
environment.
 Module V

Modes of Payment in Trade:

Cash-in-Advance

With cash-in-advance payment terms, an exporter can avoid credit risk because payment is received
before the ownership of the goods is transferred. For international sales, wire transfers and credit cards are
the most commonly used cash-in-advance options available to exporters.

However, requiring payment in advance is the least attractive option for the buyer, because it creates
unfavorable cash flow. Foreign buyers are also concerned that the goods may not be sent if payment is
made in advance. Thus, exporters who insist on this payment method as their sole manner of doing
business may lose to competitors who offer more attractive payment terms.

Letters of Credit

Letters of credit (LCs) are one of the most secure instruments available to international traders. An LC is
a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that
the terms and conditions stated in the LC have been met, as verified through the presentation of all
required documents. The buyer establishes credit and pays his or her bank to render this service. An LC is
useful when reliable credit information about a foreign buyer is difficult to obtain, but the exporter is
satisfied with the creditworthiness of the buyer’s foreign bank. An LC also protects the buyer since no
payment obligation arises until the goods have been shipped as promised.

Standby letter of credit

A standby letter of credit (SLOC) is a legal document that guarantees a bank's commitment of payment to
a seller in the event that the buyer–or the bank's client–defaults on the agreement. A standby letter of
credit helps facilitate international trade between companies that don't know each other and have different
laws and regulations. Although the buyer is certain to receive the goods and the seller certain to receive
payment, a SLOC doesn't guarantee the buyer will be happy with the goods.

Documentary Collections

A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of the
payment for a sale to its bank (remitting bank), which sends the documents that its buyer needs to the
importer’s bank (collecting bank), with instructions to release the documents to the buyer for payment.
Funds are received from the importer and remitted to the exporter through the banks involved in the
collection in exchange for those documents. D/Cs involve using a draft that requires the importer to pay
the face amount either at sight (document against payment) or on a specified date (document against
acceptance). The collection letter gives instructions that specify the documents required for the transfer of
title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process
and limited recourse in the event of non-payment. D/Cs are generally less expensive than LCs.

Open Account

An open account transaction is a sale where the goods are shipped and delivered before payment is due,
which in international sales is typically in 30, 60 or 90 days. Obviously, this is one of the most
advantageous options to the importer in terms of cash flow and cost, but it is consequently one of the
highest risk options for an exporter. Because of intense competition in export markets, foreign buyers
often press exporters for open account terms since the extension of credit by the seller to the buyer is
more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their
competitors. Exporters can offer competitive open account terms while substantially mitigating the risk of
non-payment by using one or more of the appropriate trade finance techniques.When offering open
account terms, the exporter can seek extra protection using export credit insurance.

Consignment

Consignment in international trade is a variation of open account in which payment is sent to the exporter
only after the goods have been sold by the foreign distributor to the end customer. An international
consignment transaction is based on a contractual arrangement in which the foreign distributor receives,
manages, and sells the goods for the exporter who retains title to the goods until they are sold. Clearly,
exporting on consignment is very risky as the exporter is not guaranteed any payment and its goods are in
a foreign country in the hands of an independent distributor or agent. Consignment helps exporters
become more competitive on the basis of better availability and faster delivery of goods. Selling on
consignment can also help exporters reduce the direct costs of storing and managing inventory. The key
to success in exporting on consignment is to partner with a reputable and trustworthy foreign distributor
or a third-party logistics provider. Appropriate insurance should be in place to cover consigned goods in
transit or in possession of a foreign distributor as well as to mitigate the risk of non-payment.

Bills of Exchange:

A bill of exchange is a written order once used primarily in international trade that binds one party to pay
a fixed sum of money to another party on demand or at a predetermined date. Bills of exchange are
similar to checks and promissory notes—they can be drawn by individuals or banks and are generally
transferable by endorsements.

A standby letter of credit (SLOC) is a legal document that guarantees a bank's commitment of payment to
a seller in the event that the buyer–or the bank's client–defaults on the agreement. A standby letter of
credit helps facilitate international trade between companies that don't know each other and have different
laws and regulations. Although the buyer is certain to receive the goods and the seller certain to receive
payment, a SLOC doesn't guarantee the buyer will be happy with the goods.