Revised 1st Class question

Question – 1 (C is cost, P is price, G is gross, FOB is freight / free on board)

Free on Board – Free is a misnomer. Nothing is free. It simply means that importer is not going to come to exporter’s country to get the goods from factory to be loaded (boarded) on the ship. FOB (Cost) means all the cost of good till it gets boarded on the ship in exporter’s country. FOB (Price) equals FOB (Cost) + Margin added by the exporter. This is called Gross FOB (Price). The agent’s commission is included in it. If the agent’s commission is removed from the Gross FOB (Price), one arrives at Net FOB (Price).

· Gross FOB (Price) = FOB (Cost) + Margin added by exporter

· Net FOB (Price) = Gross FOB (Price) – Agent’s Commission

On what basis, the agent’s commission is calculated –

· Agent’s commission is NOT calculated as a % of Gross FOB (Cost), else agent will calculate the cost incurred to exporter, which no exporter / manufacturer discloses ever. Hence, agent’s commission is calculated as a % of Gross FOB (Price).

· Agent’s commission is NOT calculated as a % of CIF (Price) as exporter is not making money in freight and insurance. So, why pay a % to agent when Insurance and Freight can earn nothing to exporter (they are always at actual).

Scenario – If Gross FOB (Price) is INR 100 and agent’s commission is 5%, then money coming into exporter’s country is 100 - 5%*100 = INR 95 [which is Net FOB (Price)]. The government of Exporter will hence earn Net FOB (Price) as agent will be given commission and after that the money comes to exporter’s country.

Incentive – Incentive is given by the government of Exporter’s country. It is earned on what I have earned for the nation, which is Net FOB (Price), INR 95 (as above example).

CIF – It stands for Carriage, Insurance premium, Freight. C is a misnomer and it actually stands for Gross FOB (Price). Freight and Insurance premium is always calculated on actual as importer can verify the charges for the same by looking at the bills of freight and insurance. So, exporter can’t make money on them (Freight and Insurance are at actual). Hence, exporter makes money on Gross FOB (Price) only by adding his margin in it.

Freight / Cargo – It is the cost of transportation of goods (per tonne of goods transported) generally for commercial gain by ship, truck, vans or train.

Agent’s role – The exporter doesn’t have an office in importer’s country. So, he hires an agent, who represents him there, helps show the importer samples of exporter’s product to win the export order. The agent is signed well before an order is received (or not received).

1. Ex Factory Cost = INR 1,30,000 (Excluding Marketing Cost); Ex Factory cost is the cost up to the gates of the factory

2. Export Marketing Cost (Cost of marketing incurred in international location where product is to be shipped) = INR 30,000 (Here, marketing is done by the exporter to make him known to probable importers in different countries)

3. Transportation cost up to on board the ship = Rs 40,000

4. All costs up to on board the ship is called FOB (C)

5. Assume a profit of 25% of FOB (C)

6. Net FOB (P) = FOB (C) + Profit – Incentives (given by exporter’s government to exporter)

7. Incentives = 10%

8. Incentives are calculated as a % of Net FOB (P)

9. Agents commission = 5% & is calculated as a % of G FOB (P)

10. G FOB (P) – Agent’s Commission = Net FOB (P)

11. Freight = INR 10,000

12. Insurance Premium = 10% of insured value and insured value is 110% of CIF (P)

13. CIF (P) = G FOB (P) + Insurance Premium + Freight

Calculate CIF (P)

Solution –

Let Net FOB (P) be X (Using Equation 6)

Then X + 0.10 X = (1,30,000 + 30,000 + 40,000) + 25% * (1,30,000 + 30,000 + 40,000)

X = 227272

Let Y = G FOB (P) (Using Equation 10)

Y – 0.05 Y = X

Y = 239234

Let Z = CIF (P) (Using Equation 13)

Z = Y + (1%) * (110%) * (Z)

Z = 252006

Revised 1st Class question

Question – 1 (C is cost, P is price, G is gross, FOB is freight / free on board)

Free on Board – Free is a misnomer. Nothing is free. It simply means that importer is not going to come to exporter’s country to get the goods from factory to be loaded (boarded) on the ship. FOB (Cost) means all the cost of good till it gets boarded on the ship in exporter’s country. FOB (Price) equals FOB (Cost) + Margin added by the exporter. This is called Gross FOB (Price). The agent’s commission is included in it. If the agent’s commission is removed from the Gross FOB (Price), one arrives at Net FOB (Price).

· Gross FOB (Price) = FOB (Cost) + Margin added by exporter

· Net FOB (Price) = Gross FOB (Price) – Agent’s Commission

On what basis, the agent’s commission is calculated –

· Agent’s commission is NOT calculated as a % of Gross FOB (Cost), else agent will calculate the cost incurred to exporter, which no exporter / manufacturer discloses ever. Hence, agent’s commission is calculated as a % of Gross FOB (Price).

· Agent’s commission is NOT calculated as a % of CIF (Price) as exporter is not making money in freight and insurance. So, why pay a % to agent when Insurance and Freight can earn nothing to exporter (they are always at actual).

Scenario – If Gross FOB (Price) is INR 100 and agent’s commission is 5%, then money coming into exporter’s country is 100 - 5%*100 = INR 95 [which is Net FOB (Price)]. The government of Exporter will hence earn Net FOB (Price) as agent will be given commission and after that the money comes to exporter’s country.

Incentive – Incentive is given by the government of Exporter’s country. It is earned on what I have earned for the nation, which is Net FOB (Price), INR 95 (as above example).

CIF – It stands for Carriage, Insurance premium, Freight. C is a misnomer and it actually stands for Gross FOB (Price). Freight and Insurance premium is always calculated on actual as importer can verify the charges for the same by looking at the bills of freight and insurance. So, exporter can’t make money on them (Freight and Insurance are at actual). Hence, exporter makes money on Gross FOB (Price) only by adding his margin in it.

Freight / Cargo – It is the cost of transportation of goods (per tonne of goods transported) generally for commercial gain by ship, truck, vans or train.

Agent’s role – The exporter doesn’t have an office in importer’s country. So, he hires an agent, who represents him there, helps show the importer samples of exporter’s product to win the export order. The agent is signed well before an order is received (or not received).

1. Ex Factory Cost = INR 1,30,000 (Excluding Marketing Cost); Ex Factory cost is the cost up to the gates of the factory

2. Export Marketing Cost (Cost of marketing incurred in international location where product is to be shipped) = INR 30,000 (Here, marketing is done by the exporter to make him known to probable importers in different countries)

3. Transportation cost up to on board the ship = Rs 40,000

4. All costs up to on board the ship is called FOB (C)

5. Assume a profit of 25% of FOB (C)

6. Net FOB (P) = FOB (C) + Profit – Incentives (given by exporter’s government to exporter)

7. Incentives = 10%

8. Incentives are calculated as a % of Net FOB (P)

9. Agents commission = 5% & is calculated as a % of G FOB (P)

10. G FOB (P) – Agent’s Commission = Net FOB (P)

11. Freight = INR 10,000

12. Insurance Premium = 10% of insured value and insured value is 110% of CIF (P)

13. CIF (P) = G FOB (P) + Insurance Premium + Freight

Calculate CIF (P)

Solution –

Let Net FOB (P) be X (Using Equation 6)

Then X + 0.10 X = (1,30,000 + 30,000 + 40,000) + 25% * (1,30,000 + 30,000 + 40,000)

X = 227272

Let Y = G FOB (P) (Using Equation 10)

Y – 0.05 Y = X

Y = 239234

Let Z = CIF (P) (Using Equation 13)

Z = Y + (1%) * (110%) * (Z)

Z = 252006

Teaser Question

Question - If I have a technologically superior product, I will go to Germany than to Bangladesh to launch. Please give reason.

Answer - If I will launch in Bangladesh and then go to Germany, it might happen that the technology of mine would have also been discovered there. So, I lose out on German market. But Bangladesh will take its own sweet time to reach that technology. Hence, I am always in command in Bangladesh market

Spanish Company in India - Interesting Analysis

Scenario - There is a 100 year old Spanish company which manufacturers valve in Spain (like a water tap). MD of the company is coming to India for the 1^st time. His agenda is –

· To buy valves as per his company’s logo and design.

· For his company’s stock in Spain – Keep some buffer in stock to fulfill instant demand locally (If someone comes and wants to buy a single valve, he can sell it from this stock). Hence, he will charge a high price compared to contracted supply of goods (Inventory carrying cost, Interest cost). This is 1million dollars (He is going to buy 1 million $ worth valves in 1 shot – Different vendors can make it in small batches but all of them have to supply 1 million $ worth of valves in one go).

· For back to back orders from clients in Germany, UK etc. – 3 million dollars (similar as above).

Hence, his total buying requirement is 4 million dollars. (1$ = INR 50)

He has a sole distributor in India called Venky enterprises for last 2 decades. Venky sells valves from Spain in India to process industries like Chemical plant, fertilizer plant, refineries, petro-chemical plants.

Why anyone will buy valves from outside –

· Made in Spain tag

· Cheaper to import

Hence, Spanish guys wants to buy valves becomes export transaction and Venky selling Spanish valves becomes an import transaction.

MD asks Venky to suggest some local manufacturers in India. (Marketing Intelligence – To sit with competitors to gauge their strategy). Based on trust and long lasting relationship of 2 decades, Venky recommends the name of the manufacturers to MD of Spanish firm.

· EOU (Export oriented unit), Vashi, Navi Mumbai – EOU only exports and doesn’t sell locally at all. This EOU sells valves. Turnover of this company is INR 200 million.

· Company in Ghatkopar, Mumbai Suberb – Domestic turnover of INR 100 million and an export turnover of INR 100 million.

· Federation of SSI (Small Scale Industries) in Vasai, Mumbai. Each SSI has a turnover of INR 10 million. They are strictly small – no financial or marketing muscle. So, they have come together to form a federation. Hence, federation bargains on behalf of SSIs. But contract is then to be given to each SSIs. Federation is just a bargaining body and not a manufacturing body.

· Company in Bhiwandi, outskirts of Mumbai named as Amit trading. Amit trading makes castings and not valves. Turnover is INR 200 million. Casting is used to make valves – In volume, 80% of valve is from casting; in value, only 20% of valve is contributed by casting. Hence, casting companies makes 80% of valves and rest 20% value addition (in terms of volume) is done by valve makers.

· Amit traders has a step brother company (Have same promoters, but 2 different entity - same people have financed both the companies) in Jebel Ali (Free trade zone), Dubai. He makes valves and his turnover is INR 1 billion.

Please do not assume that

ü Casting company makes valves or valve making company makes casting.

ü There are only above players in the market.

ü All the valve company may or may not buy castings from Amit traders.

Spanish MD asks for small manufacturers only (Small and strictly reliable) and not big names. (Bigger companies will try to find out who are Spanish companies end customers are and will try to take it from him – Can cut the Spanish company and go directly to end customer of valves).

Question 1 - What is the one question which comes to your mind after reading the case above?

Answer 1 –

ü What Venky (distributor) is getting out of this deal

ü Whether it is profitable to purchase valves from Dubai or India – Competitiveness / Cost-benefit analysis

ü Why does the Spanish company wants to enter India / is coming to India

ü Is it cost benefit to acquire the company or place the order at SSI

ü Why not buy the company in India manufacturing valves rather than just buy valves

ü From which source, Spanish company should buy the valve

Question 2 – You are EOU & your capacity is full. Spanish company wants to give order worth 1 / 3 / 4 million INR to EOU. Price & delivery date, whatever EOU is comfortable with. How many options does EOU has.

Answer 2 – Options are four – either take 1 million worth of order, take 3 million, take 4 million or take no order.

Why nothing is an option – EOU is already having existing orders to fulfill / his capacity may be full. Rule of business – Do not take new orders / customers at the cost of existing one. Also, the customer is new. After giving the 1^st order, EOU increases its capacity. But then EOU might not receive another order. So, what is the use of investing in machinery to increase capacity (Only for 1 order !!!! … Makes no sense). To avoid this, EOU will try to outsource most of the excess orders.

Question 3 – Spanish company wants to give entire 4 million INR order to EOU, but on a condition that logo and design of valve should be as per their company. What is the fear in the mind of EOU after executing the order?

Answer 3 – The EOU would have spent years to build his brand under which his quality product gets delivered. Spanish company is asking to part away with that. That’s the fear. (Indirect promotion of Spanish company’s brand).

The result will be Spanish company will go to EOU’s customers in EOU’s market and will deliver EOU’s product under his name / brand and will build his market share (Brand erosion of EOU).

May be my customer wanted to give extra order, but now rather giving it to me, they will give that extra order to Spanish company and I will be continuing with old set of orders only.

Question 4 – You are Amit Traders. Spanish company wants to give order worth 4 million INR. Price & delivery date, whatever Amit trader is comfortable with. Amit trader accepts the order. How will they execute the order.

Answer 4 – Amit traders gives the castings to SSI. SSI makes the valves (It is called Job work / sub-contracting / business process outsourcing). Amit traders then exports to Spanish company.

Why not send the castings to Dubai & ask the Dubai form to make castings – Problem is customs in India is going to murder Amit traders as their order sheet will show export of valves outside India (to Spanish company) though they are only exporting castings to Dubai under that order sheet. Hence, order sheet needs to be changed by Spanish company stating that Amit traders will only export castings out of India.

Why Spanish company is not doing business directly with SSI – Total order is worth 4 million USD or 4*50 = 200 million INR. Each member of SSI has power to cater to 10 million INR. Amit traders will take the headache of bargaining with federation of SSI and will see that order is completed on time without any glitches.

Question 5 – The Spanish company pays the Amit traders (casting guy) after order is delivered. Now, what is the fear Amit trader will have in their mind?

Answer 5 – Amit trader is supplier to company in Ghatkopar, EOU and SSI. All 3 of them (the Ghatkopar company, EOU and SSI) were trying to get this valve order from Spanish company, but finally Amit traders gets it, who is a casting maker and not a valve maker. Amit trader will approach all 3 of them. But now, all 3 of them will start looking Amit traders as competitor, though Amit trader still manufactures castings and not valves. This might result in them not taking the orders and Amit traders manufacturing valves themselves. If it happens, then it will now become a competitor to its Dubai partner as well who is into business of making castings.

Question 6 – Reliance is setting up a refinery in Jamnagar, Gujrat. Venky contacts Reliance to supply valves. Reliance asks whether Venky is a registered supplier. Venky then registers as a vendor of valves. Reliance then asks Venky that who is the manufacturer, please register them. Venky registers Spanish company (Here, Spanish company is exporting to India). There are 2 ways it can be done –

1. Reliance gives order to Venky and he passes on it to Spanish company and they in turn gives the cost in $ which Venky converts in INR and quotes to Reliance.

2. Reliance directly deals with Spanish company and gives commission to Venky.

In both the above cases, Venky benefits as Spanish company can’t cut Venky off. Which route will Reliance will take and why?

Answer 6 – Take the 1^st route - With Venky involved as mediator. Reason -

1. In case, Valves leaks or has problem, Reliance can catch Venky’s neck very easily – Venky has to be technically strong.

2. Spanish company might not give high credit period (period for payment of valves) to Reliance, but Venky can as he is a local player – Venky has to be financially strong.

3. When valves comes to India, Venky goes to the port, clears it from customs by paying import duty, loads it on a truck and send it to Jamnagar. Reliance does not have to do anything. And on top of it, Reliance pays Venky after 5 months (though Venky will add all the above costs as well as his margin).

Question 7 – Reliance is now in a desperate need of valves. Venky and Spanish company has valves in stock. Reliance asks to lower the price, which Venky put downs. The company from Ghatkopar can also supply, at reduced new prices, but not before 3 months. Reliance agrees to buy from Venky. After the above, the Spanish company and Venky had a hearty laugh though they supplied the best valves to Reliance at Reliance’s desired credit period of 5 months (though market practice is 3 months), though Venky paid Spanish company immediately. Why Venky & Spanish company are laughing (that finally they gave back Reliance what it deserved)?

Answer 7 - Spanish company bought valves from the Ghatkopar company sometime ago. But because of bad forecasting, they bought excess and it was now in their stock lying idle. They now sold it to Reliance, who could have easily bought it from Ghatkopar at a cheaper price, but now had to buy the same stuff via Spanish company at a much higher price (price of logo and design of Spanish company) because of urgency. Moreover, Reliance still believed that it had bought valves made from Spain. Hence, Spanish company and Venky were laughing (This is a rare scenario).

Question 8 – Spanish company comes and asks to supply valves to him. Price and delivery date, whatever you are comfortable with. But remember packaging. Make good sea-worthy packaging. Use good marine plywood. Water should not enter the wood and the valve should not be rusted. (The packaging of the valve has to be good, protection against rusting). Put each valve in a plastic bag, vacumize and seal the bag. Put not more than 4 valves in 1 box. Close the box, put nails on top and steel straps around the box (as it will lifted in Spain using fork lifts, hence, can’t use threads / ropes, otherwise box will whop), put name of company on top. Put non-soluble ink stencil marking, if not put, it may disappear and customs from Spain will ask to open all boxes – packaging / re-packaging cost will increase.

Spanish company tells that they will pay for all this. Venky has to ship it’s client in UK and Germany. What is odd about this story.

Answer 8 – Spanish company can’t take the risk of revealing the client’s name or next time, Venky will supply directly to them. The above is applicable only if Spanish company supplies to its own companies / subsidiaries in UK and Germany.

Why this story / message behind this story – International business is all about least cost production location.

What is the story afterwards – No one accepted order of Venky as the price coated by Spanish company was very low. So, Spanish company invited all 4 of them on a day at a gap of 1 hour each. On the d-day, Spanish guy was sitting with Venky. EOU comes 1^st, meets them, Spanish guy quotes the same price, EOU rejects it as earlier, Spanish guy says – Thank you and EOU representative leaves the meeting room. Outside he sees, the SSI representative sitting. So, now EOU thinks, that SSI might get the order if he quotes a slightly lower price and mentality says – If I do not get the order, others should also not get the order. EOU again enters and quotes a lower price. Similarly, all the other 3 goes through the same situation and quotes lower price.

What could have avoided this price war – If instead of thinking that no one should get the order, he would have thought that let someone get the order and all others will share the order by forming a CARTEL, then they could have not brought down their prices & Spanish guy would not have known it and would have accepted the original price.

Honda in USA

Honda in USA

Why set up a plant in US by a Japanese firm (like Honda did) – As import barriers by US for Japanese goods went up (Voluntary restraint agreement) because Japanese cars were fuel efficient as big 3 local manufacturers like Ford, GM were concerned. As the oil prices went up (after middle-east conflict and fight in early 70s), the customer in US now wanted fuel efficient cars. Honda was taking away the market from them as their engine was best in the world and vehicles had high fuel efficiency.

Hence, as per voluntary restriction, only 1.6 billion cars could be exported to US by Japan in a year in proportion of local car market share in Japan by exporting companies. In that, Honda was 5^th and had a low share in local market. Hence, its export to US was hit by this policy. (1-Toyota, 2-Nissan, 3-Mazda, 4-Dietsu, 5- Honda).

Main reason for FDI –

· When import barriers go up – FDI happens for incentives

· Political reasons – FDI happens for political reasons (US making FDI of 10 billion USD as against 2 billion USD in Philippines after the dictator ship was abolished and new government which came was against them. US used Philippines to fuel their jets to keep a check on China taking over Taiwan)

· FDI happens to take control of local company and runs management of that company (Michelin buying local plant in US called Firestone as exporting tires to US was getting costly and Toyota, their biggest client was hence, moving away from them. But Michelin didn’t introduce its manufacturing technology even after getting the management control, till they raised their stake from 10% to 23% to be assured that no one else can take over the company and hence, their newly introduced manufacturing technology – When the largest customer of yours goes to a foreign nation, follow them).

Analysis – Sumantra Ghosal (Crossing International Frontiers)

X – Axis = Level of Strategic importance of local environment	BLACK HOLE (Suck technology of Dell, IBM, Compaq, HP – Acer in US in early 80s at the height of silicon valley boom and just opens a miniature replica rather than a big plant which could cater to high demand in US. Acer went there to steal technology – Industrial Espionage)
	Y-Axis = Level of usage of local resources

Why Honda took Ohio, USA as manufacturing place – Ohio in mid-west bordering Canada and there is a lake in Ohio. Why not go to Michigan, where there is a big car ancillary. Even cost is not a factor because going south, Miami till Mexico, labor cost is lowest. Export to Canada was also not the reason as US usage of cars is 4-5 times than Canada (Every US family owns 3-4 cars average), so US itself is a big market to be captured.

Real Story – Governor of Ohio heard some big car company from Japan was coming to US. He flew down to Japan to find out which company by talking to all the Japanese car manufacturers there. Honda replied as they were coming. He invited them to choose any piece of land in Ohio by travelling in his private jet. The governor was actually wooing the Honda company to do FDI in Ohio to make it a successful car manufacturing hub of US (Increase Sales tax for Government and employment for people of Ohio).

Initial investment of Honda was 1.1 billion USD. The governor gave them 600 million USD as soft loan. Also, he gave Honda tax holidays. He drenched the LAKE in Ohio to facilitate bringing in spare parts from Ontario. There is a highway (Callaway no -13) which he made 8 laner. Governor did all this at the expense of state of Ohio.

Even to cut costs further for Honda via JIT, the governor bought all the Japanese suppliers of Honda to Ohio and gave them soft loans and tax holidays.

USP of Honda –

1. Best engines in the world (V-Tek engine)

2. Switch assembly line – where diff model cars can be prepared on one assembly line(less downtime to switch the product on same assembly line – produce Civic – switch – produce CRV – switch – Go to Accord). Economies of scale of different types of vehicles is achieved.

3. Honda was the 1^st of the few foreign car companies who complied with the CLEAN AIR ACT in US.

EPCG

Treaties –

India does not have a regional block with Brazil (Brazil has its own regional block called Merkoza), but has a preferential trade agreement – Duty is reduced for Brazilian products in India & vice versa. Hence, one country gets into preferential trade agreement with another when there is high degree of trade among them.

MFN (Most favored nation) – Every country has an MFN, but WTO said, under preferential trade agreement, MFN is not possible as MFN is a form of preferential trade agreement. WTO facilitates the meeting where all such treaties are kept and discussed.

In ASEAN, because of entry of India (full access after 10 years of struggle), which members would be most affected –

1) Korea – India has become largest supplier of automobile spare parts, greater than China

2) Malaysia

India is largest exporter of Prawns today. Thailand might affect it (Tiger prawns).

Companies like Phizer has its largest selling Vitamin tablet – Bechosils, manufacturing outsourced to small units (subcontracting).

Direct Selling - Project Shakti– Unilever – In Indian rural markets, the widows in village are asked to become a distributor of Unilever (as shelf space in shops / retail chains is too costly). These women take the material from Depots and pay them later. The material to be sold is Sashes (In villages, big bottle of shampoos / detergent can’t be sold).

Export promotion capital goods scheme (EPCG) – Used by Brazil, India has copied this concept from Brazil.

I, as a manufacturer, imports a machine valued 10 million. Government waives the duty on it (may be worth 2 million), but asks the manufacturer to give a legal undertaking that he should export goods worth 8 times the duty (16 million) in the coming 8 years using that machine.

In this process, the manufacturer is upgrading himself.

Who does all this–

1) Person who is into exports in a big way

2) Person who is 100% sure that he has got a buy-back agreement (Parent company abroad promises to buyback all the material I have produced).

Drawback – If promise not fulfilled, the person has to pay original duty + 100% penalty on a depreciated machine 8 years later. He would have been better off paying 2 million on a new machine than 4 million on a depreciated machine.

All licenses are issued by DGFT in India (Directorate General of Foreign Trade) like AL, EPCG.

Corollary 1 – If find an equally capable manufacturer in India, who can manufacture the same machine. But since, I am buying from India and not importing the machine, whether I can get EPCG – Government says – YES, they will waive all the local taxes imposed to manufacture the machine in India. Why- Because there is no outflow of foreign exchange (because of buying the machine locally), so saving of foreign exchange by nation. Also, the local manufacturing will enhance (Incentive for local) the machine manufacturer to climb up the value chain and sell the same machine in international market.

3 books in India –

1) Export Import policy – Foreign trade policy

a. Chief controller of imports and exports – now DGFT

2) Standard input output norms (SION)

3) Value addition norms

The last 2 books covers all the products India can, has, will export and has described the parameters for those products. Example – A shirt if exported, then one can take DD, AL, only for 8 buttons per shirt (how much kilos of buttons / fabric/ yarn one can import for 1 kilo of shirt exported).

Process of Value Addition - AL, DD, DEPB

Value Addition

World over it is defined as

(The FOB value of exports – The CIF value of imports) / (CIF Value of Imports)

The theory is called (A-B)*100%/(B) = 33%. Here, A = 133 (value of goods exported after value addition), B=100 (value of goods imported)

This theory exists in developing countries like India, Brazil, Russia, China (BRIC countries) and not in trading countries like Dubai, Singapore. Hence, in a trading nation, the % value addition can be just 4% - 5% as against 33% (Exception – Only goods with very high value like Gold, Diamond; hence, value addition can’t be very high).

If value addition is = or more than 33%, the import of raw material is DUTY FREE. Hence, cost of raw material is cheap, so, cost of finished goods is cheap; hence, selling price of finished good is cheap and more buyers from world over will buy the goods.

Theory says, I will allow one to import provided the raw material imported is used in the exportable product. Government says – it will give incentives only on FOB value of exports and not on CIF (which includes insurance and freight, calculated at actual); if Government gives on CIF, it will give more incentive (as CIF > FOB). Also, govt gives incentives on value addition. Since, there is no value addition by the exporter on insurance and freight, why Govt should give incentive on it (i.e. CIF price).

But when something is imported, the incentives are calculated on CIF price and not FOB price.

Advance License - One gets this license from a government body. In India, one gets it from DGFT (Director General of Foreign Trade). This license allow one to import raw material duty free in India provided the material is used to add value (33% or more) in the exportable product (It is a pre-shipment incentive – Exporter already has the export order with him, hence, he is importing). In case, the raw material is received duty free and then the order gets cancelled, then one has to pay duty to Government.

Corollary 1 – People import the raw material, sells into local market, buys a substandard replacement raw material and use it in exportable goods and can easily get away.

Corollary 2 - If someone buys raw material from India, all the local taxes like excise (Central Tax), Vat (State Tax), Octroi (Municipal / City tax) on raw material will be refunded if the finished good made out of this raw material is exported.

Corollary3 – In case, I am a trader (buy goods and export) and exports goods outside the country, will my support manufacturer who imports raw materials for making that good can get AL - Here, the trader can apply for advance license. But here, trader has not paid duty. The manufacturer can only apply for AL, if the name of manufacturer appears in a document called shipping bill. (The shipping bill is filed with every export and similarly, bill of entry is filed with every import). For that, the manufacturer’s name is mentioned as support manufacturer (gets recognition by the government), else he won’t get the AL. Hence, trader has to import the goods on his name to get AL so that overall cost of export is under control. Hence, AL can’t be sold or transferred to anyone else (unlike DEPB).

Duty Drawback –

Scenario – Assume, I receive a local order from A for 5 shirts (every shirt uses 5 buttons). But A wants buttons from Bangkok. So, I import 100 buttons and pay the duty. I can’t claim advance license as the processed / final product – shirt is to be sold locally. I use 5*5 = 25 button for 5 shirts and is left with 75 buttons. I receive a similar order from a foreign client B for 15 shirts. I use the remaining 75 buttons and export. But I have already paid the duty on buttons, but now I am earning foreign exchange for the nation for those 75 buttons. How can I claim it? (The foreign client will not want to pay a higher price for the shirt because of the duty I paid on raw material).

Here, Government says we will give you the duty back called as duty drawback. It is given by the drawback section of Ministry of commerce via cheque after the exporter shows proof of exports (invoice with custom’s stamping, bill of lading, calculation of refund of duty amount showing how much buttons I imported and how much shirts I exported with those buttons). Government will not pay interest on the credited duty (via cheque) though it might take 3-4 months after duty is paid. Also, the amount will come to another account (and not current / working capital account of company) called drawback account. Instead of above process, Govt says they will come with a drawback booklet published by ministry of commerce.

Corollary 1 – Government of India says - duty drawback amount for an exported pure cotton shirt will be 10% of FOB price of shirt. In case my value addition to shirt is high because I sell it as branded product at a much higher price, hence, my FOB price for the shirts will also be high. Hence, the duty drawback on exported shirt >>> Import duty I paid on buttons (raw material). The government incentives the local exporter (kickback to exporter) because he is earning far more foreign exchange for the country for the same set of goods, which was sold cheaper earlier to branded companies like GAP who would in turn sell it at 20 times the price of it. In China, it is as high as 60%. Hence, the exporter is in huge profit and can reduce the prices of its product sold in foreign market at lowest possible prices.

Duty drawback is paid in local currency. DD is given by many countries and not specific to India.

Hence, I am dumping / flooding the world market with my cheap exported goods – DUMPING. Hence, there is an anti-dumping clause attached to it. WTO wants to curb dumping because of Duty Drawback advantage because of local government. But for that, WTO needs to prove it, which they can’t, as the governments of nations never publish this.

Corollary 2 - But, China and Bangladesh finished goods cost are India’s raw material cost. Hence, I can’t compete on those simple products. I need to climb up the value chain and sell designer shirts which are branded as against simple shirts. For that, I may have to show my collection in Paris (branding and marketing). Hence, Government of India now subsidizes the marketing cost also by having a Marketing fund (ITPO – Indian trade promotion organization @ Pragati Maidan, New Delhi).

Corollary 3 – Even if I am buying buttons locally and paying local taxes and will export the shirts to foreign nation, Government will still incentivize the duty drawback as 10% of FOB price of shirt >>> price of buttons + local taxes. Here, even I am not importing the good, I get incentivized under duty drawback because I am earning foreign exchange for nation. But one can’t claim both, the import duty as well as local taxes.

DEPB (Duty entitlement passbook scheme)

Like DD, DEPB has rates fixed (like 10% of FOB of cotton shirts) and it has a handbook which describes the details. Example – 8% of gross FOB price of shirt; if agent’s commission is there, it will be 8% of net FOB.

I will get the credit in the form of a hand written book, but I can’t en-cash it. But one can use this credit for the following purpose –

I can offset the credit amount with the duty I / anyone else pays on import of goods. Here, I can import anything under the sun and can get the offset and the imported material where I get DEPB need not to be exported after value addition (except negative list of imports like weapons, drugs, animal skin, ivory tusk, peacock feathers, tiger skin, crocodile leather, fur).

In case the product is not listed in the DEPB booklet, one can write the self made DEPB rates to Government via the export council. Hence, many times, industry decides the rates of DEPB.

It has validity of 12 months. Also, 6 months extension is also possible.

Corollary 1 –

· Can one sell a DEPB credit (I have exported and have DEPB credit, and I do not have money to import, so the credit has not off-set) – YES, but too many DEPB credit floating, hence, the importer might give me INR 2 as against DEPB credit claim of INR 8.

· Can I sell AL credit – NO. Only Exporter of the support manufacturer can get it (if his name is mentioned in shipping bill.

Government gives either DEPB or AL or DD or refund of local taxes, and not all for the same set of goods. Also, the offsetting is done in INR (local currency) and not in $.

DEPB is pre-shipment incentive (as I will claim and nullify the import duty upfront rather than waiting for exports to happen made of imported goods). DD / AL are post-shipment incentives (I need to export 1^st, then claim the refund).

DEPB rate is less than AL / DD as in AL, one has the restriction of export the finished goods made out of imports with a certain % of value addition.

Process of Arbitration - Interesting explanation by Venky Pony

Arbitration Process

The clause is decided / added when the contract is signed. For arbitration, let’s assume exporter goes to Indo-Singapore chamber of Commerce in Singapore. Exporter informs registrar that he wants to do arbitration against Importer (not paid for goods). Registrar will check whether there is an arbitration clause in the contract. Registrar will write a letter to importer to participate in arbitration and will give 15 days for replying to it. If importer replies then importer becomes “respondent” and exporter becomes “claimant”. The registrar will now give them a panel which has a “list of arbitrators” – people having high reputation, who do arbitration not for money, but for status. Arbitrator needs to be invited by chamber of commerce. An “arbitrator” is by virtue of his / her expertise in a particular trade / field and not because of qualification (expertise in making diamonds, antiques etc.). Both importer and exporter will choose 1 person as arbitrator. Then a 3^rd umpire is chosen from 2^nd panel – in case the 2 selected arbitrators do not come to any consensus.

Now the claimant / exporter submit the document to registrar to support his claim (gives 5 copies – 3 to arbitrators, 1 to respondent and 1 to registrar). Similarly, the respondent will make a counter claim and will make 5 copies. The claims will continue till all the documents are finished from both sides (documents includes contract, email, fax copies etc.).

For arbitration, the parties can settle it via video conferencing / tele conferencing (physical presence is not required).

Who pays for this entire process – Both parties pays an equal amount, which is kept in a kitty. The arbitrators are paid something like $1000 per hour of sitting and reading the documents from the kitty. Hence, it is a very expensive process in the initial stages (Litigation is expensive over a period of time). Most arbitration has to be completed within 12 months. Hence, it is a faster process. Here, argument is not done; everything is based on documentation filed. The person who wins has his documentation perfectly in order.

After the arbitration is over, “Arbitration Award” is given. All the 3 arbitrators are called “Arbitration Tribunal”.

Arbitration is legally binding; How – WTO says if anyone is going for an arbitration, do his and his respondent’s country has an act for arbitration passed by its Parliament (Indian Act – Arbitration and Reconciliation Act, 1996). Now, every participating member of WTO has an arbitration act. The penalty is decided by the panel based on the value of the contract, interest due, opportunity lost due to arbitration by the correct party.

Now, the award has been passed in favor of exporter, but importer is not paying. What next – The exporter files a writ petition (which comes up faster) in his country in court of law. The court will ask 2 questions –

· Who did the arbitration – Indo Singapore chamber of Commerce.

· Was it followed properly – The exporter submits the letter received from registrar.

The exporter is given a decree from the court and then exporter goes to importer’s country and files the decree in importer’s country’s court. The court in importer’s country will also ask the same 2 questions and will ask for the letter (decree). On receipt of the same, the court of importer’s country will issue a contempt notice against the importer. Now, the importer will have to pay, else he will be imprisoned. Here, the exporter will demand money for his legal expenses also. Hence, payment after arbitration decision is cheaper than after arbitration & litigation.

Only bad part for exporter could be that importer has become insolvent and can’t pay.

Types of Risk in doing International Business

Types of Insurance –

1) Cargo Insurance – This risk comes into picture if say goods catch fire or the ship sinks [1% of insured value and insured value is 110% of CIF (P)].

2) Risk Insurance – The risk of non-payment of foreign exchange. All these risks are covered by agencies like TATA AIG, Lombard. This risk comes into picture when the importer–

a. Becomes insolvent (Solvency risk)

b. Not come to collect the documents (DP Risk)

c. Collects the document, promises to pay but does not pay (DA Risk)

3) Fluctuation Risk Insurance – Covers the risk of currency fluctuation between giving quotation and payment against delivery of goods. Use of Option / Forward (Derivative products) to cover the risk.

Modes of Payment in International Business

Modes of payment in International Business

1) Documents against payment (DP) / Cash against document (CAD) –

After the goods are shipped to the importer, the documents are sent to the importer’s bank via exporter’s bank. The importer’s bank then calls the importer and asks for payment against collection of document, sent by exporter for collection of goods from the port in importer’s country (document reaches in 3 days well before goods reach on port of importer).

Risk – Importer doesn’t go to collect the document only. Importer’s bank can’t debit any money from importer’s account in DP – no liability for importer’s bank to pay the exporter’s bank.

Still, the control of the goods has not passed over to the importer – in favor of exporter. But now the goods are at importer’s port.

Scenario - Another buyer comes and proposes to buy the goods arrived at 50% discount. The exporter will see whether selling the goods at 50% is profitable or taking back the goods via ship (return freight) and selling it in own market is profitable. Also, exporter has to see whether goods are standardized or made specific for importer’s market (customized goods) like apparels.

Corollary 1- But the buyer is actually a friend of importer and importer only asked him to go and strike a deal @ 50% discount, with exporter having nowhere to go (the warehouse at importer’s country will cost a lot to keep the goods till a buyer comes – In case, the goods are perishable like Banana, then it needs to be sold immediately or its prices because of warehouse cost, is going to hit the roof).

Corollary 2 – All – Importer, exporter and new buyer, are hand in glove. Exporter only told importer not to collect document so that exporter can show he has sold his goods at a huge discount and has thus, incurred a loss. In this way, he will get rebate from Government on his exports. Also, for the balance 50%, he will keep that money outside his country as black money. Only thing is exporter can’t do this mischief every time with Govt. or FEMA can get hold of him and he won’t be in a position to do any financial transaction (like paying vendors, office staff etc) for sustaining his business.

Where DP is done – Between subsidiaries, where promoters are same. Like between Unilever & Hindustan Lever.

2) Documents against acceptance (DA) –

It is riskier than DP.

Similar to above, the importer’s bank will give all the documents to the importer without payment. Also, they will give one more document called as bill of exchange (BOE). Importer will sign BOE promising to pay the exporter the agreed contracted sum of money 1 month from the date of shipment. The document will be handed over to importer’s bank who in turn will keep a copy for records and send it to exporter’s bank who in turn will give it to the exporter. As mentioned above, based on BOE signed copy, importer’s bank will handover the documents to importer. Importer then goes to the port, clear goods and now will pay exporter after 1 month.

(Credit is always calculated from date of shipment or date of bill of lading – lading means to carry. Bill of lading is given by the shipping company. If importer has bill of lading, it means he owns the goods. Bill of lading is title of ownership).

Risk – Goods are gone – taken by importer and importer is not obliged to pay. But in DP, at least goods were in possession of exporter.

In both DP and DA, banks are spectators. The liability of payment does not lie with exporter’s or importer’s bank. They only charge a small amount for handling the documents (fees of DA can be as low as 0.01% - 0.05% of the contractual value in India – fees is paid by both importer and exporter to their respective banks).

3) Open Account – Bank doesn’t come in between. The truck driver carries the document along with goods from one country to another (say within Europe or between US & Canada). Bank is always a far better institution than a truck driver to call and reply upon in case of an arbitration / litigation / dispute. It is the RISKIEST. Only done between subsidiaries.

4) Letter of Credit (LC) –

Less risky, but not totally riskless.

Process of LC - Importer will go to his bank to open a LC. Bank will check the credibility of the importer (repayment capacity). Importer also has to give letter of intent obtained from his distributors / sellers whom he will sell the imported goods – just to show that importer is a genuine buyer. Bank will ask for Collateral (gold, house, mutual funds etc. – Collateral value should be double than the value of LC). But in case importer already has an account (both personal and business) with the bank, which has a good repayment record, then bank may not ask for all of the above.

Bank will ask one question – Which is the bank of exporter. (Importer’s bank can directly pass on LC to exporter’s bank or it can pass it through its local partner bank in that country)

There are 3 banks involved in this transaction –

1) Importer’s bank in importer’s country – Opening Bank (Opens the LC); Issuing Bank (Issues the LC)

2) Importer’s bank branch in exporter’s country –Corresponding Bank

3) Exporter’s bank - Receiving Bank (Receives the LC); Beneficiary bank; Negotiating Bank (Negotiates documents which needs to be sent for custom’s clearance by exporter on behalf of exporter)

What is LC – It is nothing but a letter (guarantee / promissory note) issued by an opening bank (Importer’s bank) to the negotiating bank (exporter’s bank) telling the negotiating bank to pay the beneficiary (exporter) a sum of $XXX as mentioned in the contract provided beneficiary fulfills the terms and conditions fulfilled by the letter.

DA and DP is an understanding between importer and exporter and banks were just doing job of Courier Company. LC on the other hand is an undertaking given by importer’s bank to exporter’s bank asking exporter’s bank to pay the beneficiary a sum of $XXX as mentioned in the contract provided beneficiary / exporter fulfills the terms and conditions of letter of credit.

What are the terms & conditions – Documents, as mentioned above (like Bill of Lading, invoice etc.). Everything should be as per description / text in LC and may or may not be as per contract (Last date of shipment etc.).

If all the documents as per LC are in order and is received by the importer’s bank, they will immediately debit importer’s bank account and will send the money to exporter’s bank to be credited into beneficiary’s account.

Even if the importer becomes insolvent, the importer’s bank has collateral and will recover after paying the exporter’s bank.

What happens if validity of the LC expires and document has still not been submitted by exporter to his / her bank – The importer has to make amendments in LC. But importer may or may not agree to it. Importer can ask now that he wants to do a DA (as material would have left the port in exporter’s country but by the time document were submitted, LC expired).

Clauses in an International Business Contract

LD Vs Penalty Clause

Question 1 – In the event, the exporter is unable to supply the goods on or before 24^th June, 2010, the exporter is liable to pay liquidated damages of 1% per week to a maximum of 5% of the undelivered portion of goods with a grace period of 2 weeks. Note –

· The contract is $ 100

· $ 50 worth of goods has already been supplied on or before 24^th June, 2010.

Calculate the liquidated damages (LD).

Answer 1 -

Dates	LD / Week
15th July, 2010	1% of 50 = 0.5
22nd July, 2010	1
29th July, 2010	1.5
5th Aug, 2010	2
12th Aug, 2010	2.5 (5% of 50)
19th Aug, 2010	2.5

Analysis – This is a bad clause from importer’s point of view, as exporter can supply anytime after 12^th Aug, 2010 with a penalty of $ 2.5 only.

Why exporter is doing that – Exporter has got another buyer who is willing to pay higher price for the same material. Hence, exporter will divert the goods to this new buyer instead of me.

Possible impact on importer - The importer will be in trouble, as he might have to supply the balance $ 50 worth of goods to retailers in his country, which in above scenario, he can’t do.

What can be done – Importer will put a clause in the agreement that the payment of 1^st $50 worth of goods will be released only after exporter releases the balance $50 of goods.

Question 2 - What is the difference between a LD clause and a penalty clause?

Answer 2 –

Penalty Clause – Exporter will be charged a % (2%-3%) on the entire lot of goods (here it is $ 100), if he supplies the balance outstanding goods late ($ 50).

LD (Liquidated damage)– It is in favor of exporter as it takes into account only undelivered portion for calculating the penalty.

Question 3 – What is the biggest risk to the exporter in question 1?

Answer 3 – It may happen, that exporter may not receive the money from the importer.

Question 4– What document(s) is signed before order is taken and executed?

Answer 4 –

· Order sheet (Singapore) – The order sheet is between 2 companies and is signed by the importer and is sent to exporter for his signing / stamping to be finally sent back to importer. Order sheet is also accepted in court of law. Problem with order sheet is its genuineness (letter head of a company can be easily prepared).

· Stamp Paper – More sound as it is signed by witnesses and acceptable in a court of law. It can’t be duplicated – Since, Telgi scam did duplicate stamp paper in India, prefer Singaporian stamp paper.

When is a contract written – After importer has sent an enquiry, exporter has sent the quotation and then both of them have finalized the terms and conditions, after the protracted discussions were over, then the contract would have been signed. Hence, contract is culmination (conclusion / result) of discussion between 2 parties.

List of documents exporter needs to give to importer of goods for collection of goods at port -

· Invoice

· Packing list

· 3^rd party inspection (requested by the importer of goods – like SGS, Llyods, TUV)

· Certificate of origin (Issued by chamber of commerce – who decides the list of importable / exportable goods)

· Bill of Lading

Class Quiz 4

Question - The importer tells the exporter to ship the goods in a ship or a vessel not older than 15 years. Draw an inference.

Answer – Older the vessel, the insurance premium will go up. Hence, CIF price goes up [CIF (P) = G FOB (P) + Insurance Premium + Freight]

Question - Why Mahindra and Mahindra (making SUV – Sports utility vehicles) target smaller markets like Ukraine / Kazakistan / Uzbekistan?

Answer – Environmental norms (emission norms) are not present, else car prices will go up dramatically (unlike in Europe, which has Euro-4 or Euro-5 norms). Also, source the components locally (80%-90% of car is bought out items – buy and assemble)

Rather than trying to reduce the price of the finished product, reduce the price of components.

Strategies in International Business

Venky Pony Class - Strategy in International Business

Rationalized manufacturing – It is based on rational thinking that to maintain profit, either increase selling price (not possible in today’s scenario) or reduce cost. To reduce cost, reduce process / manufacturing cost. Instead, one can go to a cheaper manufacturer also and buy raw material from him / her. Go back in the value chain, control all components manufacturing. Hence, high capital requirement is there. Also, subsidiaries should talk to each other on regular basis (bottleneck theory). It can’t become strategically independent as still I am not manufacturing all the components (but instead buying it from cheapest market). (High FDI with extensive coordination among subsidiaries – look at the strategy from the unit who is investing)

Marketing Satellite – Kellogs from US comes to Singapore and proposes to set up a packaging unit for corn flakes. No manufacturing takes place, only packaging, distribution and marketing happens (Hardly any value addition is done to the product. Value addition happens when manufacturing is done in host country which is Singapore here). Hence, there is FDI and Kellogs will control the management of packaging units in Singapore (no local partner, all are subsidiaries). Subsidiary handles the marketing in Singapore on its own. Marketing satellite can’t become strategically independent as the main product still comes from the parent company (US). (Export based strategy with decentralized marketing)

Miniature replica – Kellogs says it will set up a plant in Singapore. May buy corn from local market or foreign market. But will open a small unit for meeting domestic demand in Singapore. This is miniature replica. When the demand will increase in near future or when this setup starts exporting to nearby countries, the head office instructs the Singapore office to manage its own finances, HR, R&D. Then, the miniature replica becomes strategically independent. (Pure Local Strategy – because of demand in local market, miniature replica is set up)

Product specialist – Perrier is a brand of bottled mineral (water is taken from a spring in South France). It was bought out by Nestle in 1992. Uniqueness of this water – It is a carbonated spring water (water brushes the lime stone and hence, has natural bubbles). It is bottled at the source. Sell it as Bubbly spring water. Ordinary water is called packaged drinking water, whereas in mineral water, one plays around with the salts in water (to reduce high degree of Sodium, Potassium, Magnesium and make the water more healthy). Hence, mineral water is more expensive then packaged drinking water. Here, Perrier is product specialist for Nestle as no one can duplicate this kind of water. Perrier always looks at global market because only they have that sort of water. Product specialist can hence become strategically independent as it only owns the product. (Purest Global Strategy)

Strategically independent – Pure local – Miniature replica / Pure Global – Product specialist

Class Quiz 3

Question 3 – There is a company A in country A (developed country), which manufactures product A which comprises of components a, b, c, d only. Component a is cheapest in India, b in Pakistan, c in Sri Lanka and d in Bangladesh (all these are developing countries). There is demand of A in all 4 developing countries (different demand due to different count of population). All these 4 developing countries has shortage of foreign exchange. For India, it earns ‘a’ and spends ‘A’. Cost of A > Cost of a. Hence, for India, there is net outflow of foreign exchange. Hence, to curb this outflow, Government puts import duty on import of ‘A’ in India. Hence, landed cost of ‘A’ increases after import. Company A loses market share as its product is now costly compared to earlier. But consumers are also used to product A. So, they search for a substitute.

If you are company A, what will you do next.

How demand is gauged –
• Factor proportion theory – Where one looks at factor of production (like raw materials, capital, labor, technology). Go to that place where FOP is cheaply available.
• Theory of country size – Bigger the country and bigger the population, more is demand / consumption (more imports and exports). In case of Australia, country is big but population is scarce.

Answer – India, Pakistan, Sri Lanka and Bangladesh come under trade agreement of SAARC.
India will manufacture A and will import components of A duty free from – b,c,d and will export duty free A to all SAARC neighbors. No logic in setting up manufacturing plant for A in all countries. It is also not advisable to set up plant in the cheapest country like Bangladesh, even if it is cheaper than India because logistics / transportation cost is going to be high when sent to India. In India also, there will 2-3 plants for manufacturing A. Hence, India becomes net exporter of A and net importer of A too (in case demand is not met by local manufacturing).
Here, India is hence called Host country and Country A is called Parent country.
Outsourcing Demerit – b,c or d can stop supplying me stating that some other company is giving them better rates. Hence, a (India) should go backward integration and manufacture b,c,d.
FDI (Foreign direct investment) – Parent company comes to host country and invests (in enterprise in foreign country which is called host country) to take control of management. Important here is control of management via capital investment. FDI stays in the foreign country.

Foreign portfolio investment – A hedge fund house invests in foreign markets which is giving high returns in order to give good returns to its investors. Hence, at the end they take the money back to parent country. Hence, capital does not stay in foreign country.

Bottleneck theory – If a,b,c,d are owned by A (via FDI), then it requires excellent communication among all 4 subsidiaries else there will be delays / bottlenecks in the supply of raw materials from any one of them, which will delay the final product A.