The exporter sells the draft to the Bank of New York at a discount from its face value and receives the discounted cash value of the draft in return.
The Bank of Paris notifies the French importer of the arrival of the documents. She agrees to pay the Bank of Paris in 90 days. The Bank of Paris releases the documents so the importer can take possession of the shipment.
In 90 days, the Bank of Paris receives the importer's payment, so it has funds to pay the maturing draft.
In 90 days, the holder of the matured acceptance (in this case, the Bank of New York) presents it to the Bank of Paris for payment. The Bank of Paris pays.
Export Assistance
Prospective U.S. exporters can draw on two forms of governmentbacked assistance to help finance their export programs. They can get financing aid from the Export - Import Bank and export credit insurance from the Foreign Credit Insurance Association.
Export-Import Bank
The Export - Import Bank, often referred to as Eximbank, is an independent agency of the US government. Its mission is to provide financing aid that will facilitate exports, imports, and the exchange of commodities between the United States and other countries. Eximbank pursues this mission with various loan and loanguarantee programs.
Eximbank guarantees repayment of medium and longterm loans US commercial banks make to foreign borrowers for purchasing US exports. The Eximbank guarantee makes the commercial banks more willing to lend cash to foreign enterprises.
Eximbank also has a direct lending operation under which it lends dollars to foreign borrowers for use in purchasing US exports. In some cases, it grants loans that commercial banks would not if it sees a potential benefit to the United States in doing so. The foreign borrowers use the loans to pay US suppliers and repay the loan to Eximbank with interest.
Export Credit Insurance
For reasons outlined earlier, exporters clearly prefer to get letters of credit from importers. However, at times an exporter who insists on a letter of credit is likely to lose an order to one who does not require a letter of credit. Thus, particularly when the importer is in a strong bargaining position and able to play competing suppliers off against each other, an exporter may have to forgo a letter of credit.13 The lack of a letter of credit exposes the exporter to the risk that the foreign importer will default on payment. The exporter can insure against this possibility by buying export credit insurance. If the customer defaults, the insurance firm will cover a major portion of the loss.
In the United States, export credit insurance is provided by the Foreign Credit Insurance Association (FCIA), an association of private commercial institutions operating under the guidance of the Export - Import Bank. The FCIA provides coverage against commercial risks and political risks. Losses due to commercial risk result from the buyer's insolvency or payment default. Political losses arise from actions of governments that are beyond the control of either buyer or seller.
Countertrade
Countertrade is an alternative means of structuring an international sale when conventional means of payment are difficult, costly, or nonexistent. We first encountered countertrade in Chapter 9 in our discussion of currency convertibility. There we noted that many currencies are not freely convertible into other currencies. A government may restrict the convertibility of its currency to preserve its foreign exchange reserves so they can service international debt commitments and purchase crucial imports.14 This is problematic for exporters. Nonconvertibility implies that the exporter may not be able to be paid in his or her home currency; and few exporters would desire payment in a currency that is not convertible. Countertrade is often the solution. Countertrade denotes a whole range of barterlike agreements; its principle is to trade goods and services for other goods and services when they cannot be traded for money. Some examples of countertrade are:
An Italian company that manufactures power generating equipment, ABB SAE Sadelmi SpA, was awarded a 720 million baht ($17.7 million) contract by the Electricity Generating Authority of Thailand. The contract specified that the company had to accept 218 million baht ($5.4 million) of Thai farm products as part of the payment.
Saudi Arabia agreed to buy 10 747 jets from Boeing with payment in crude oil, discounted at 10 percent below posted world oil prices.
General Electric won a contract for a $150 million electric generator project in Romania by agreeing to market $150 million of Romanian products in markets to which Romania did not have access.
The Venezuelan government negotiated a contract with Caterpillar under which Venezuela would trade 350,000 tons of iron ore for Caterpillar earthmoving equipment.
Albania offered such items as spring water, tomato juice, and chrome ore in exchange for a $60 million fertilizer and methanol complex.
Philip Morris ships cigarettes to Russia, for which it receives chemicals that can be used to make fertilizer. Philip Morris ships the chemicals to China, and in return, China ships glassware to North America for retail sale by Philip Morris.15
The Growth of Countertrade
In the modern era, countertrade arose in the 1960s as a way for the Soviet Union and the communist states of Eastern Europe, whose currencies were generally nonconvertible, to purchase imports. During the 1980s, the technique grew in popularity among many developing nations that lacked the foreign exchange reserves required to purchase necessary imports. Today, reflecting their own shortages of foreign exchange reserves, many of the successor states to the former Soviet Union and the Eastern European Communist nations are engaging in countertrade to purchase their imports. Consequently, according to some estimates, more than 20 percent of world trade by value in 1998 was in the form of countertrade, up from only 2 percent in 1975.16 There was a notable increase in the volume of countertrade after the Asian financial crisis of 1997. That crisis left many Asian nations with little hard currency with which they could finance international trade. In the tight monetary regime that followed the crisis in 1997, many Asian firms found it very difficult to get access to export credits to finance their own international trade. Consequently, they turned to the only option available to them--countertrade.
Given the importance of countertrade as a means of financing world trade, prospective exporters will have to engage in this technique from time to time to gain access to international markets. The governments of developing nations sometimes insist on a certain amount of countertrade.17 For example, all foreign companies contracted by Thai state agencies for work costing more than 500 million baht ($12.3 million) are required to accept at least 30 percent of their payment in Thai agricultural products. Between 1994 and mid-1998 foreign firms purchased 21 billion baht ($517 million) in Thai goods under countertrade deals.18
Types of Countertrade
With its roots in the simple trading of goods and services for other goods and services, countertrade has evolved into a diverse set of activities that can be categorized as five distinct types of trading arrangements: barter, counterpurchase, offset, switch trading, and compensation or buyback.19 Figure 15.5 summarizes the popularity of each of these arrangements as indicated in a survey of multinational corporations. Many countertrade deals involve not just one arrangement, but elements of two or more.
Barter
Barter is the direct exchange of goods and/or services between two parties without a cash transaction. Although barter is the simplest arrangement, it is not common. Its problems are twofold. First, if goods are not exchanged simultaneously, one party ends up financing the other for a period. Second, firms engaged in barter run the risk of having to accept goods they do not want, cannot use, or have difficulty reselling at a reasonable price. For these reasons, barter is viewed as the most restrictive countertrade arrangement. It is primarily used for onetimeonly deals in transactions with trading partners who are not creditworthy or trustworthy.
Counterpurchase
Counterpurchase is a reciprocal buying agreement. It occurs when a firm agrees to purchase a certain amount of materials back from a country to which a sale is made. Suppose a US firm sells some products to China. China pays the US firm in dollars, but in exchange, the US firm agrees to spend some of its proceeds from the sale on textiles produced by China.
Figure 15.5
Countertrade Practice
Source: Reprinted from "The Do's and Don'ts of International Countertrade," by J. R. Carter and J. Gagne, Sloan Management Review, Spring 1988, pp. 31 - 37, Table 2, by permission of the publisher. Copyright 1998 by Sloan Management Association. All rights reserved.
Thus, although China must draw on its foreign exchange reserves to pay the US firm, it knows it will receive some of those dollars back because of the counterpurchase agreement. In one counterpurchase agreement, Rolls-Royce sold jet parts to Finland. As part of the deal, Rolls-Royce agreed to use some of the proceeds from the sale to purchase Finnish-manufactured TV sets that it would then sell in Great Britain.
Offset
Offset is similar to counterpurchase insofar as one party agrees to purchase goods and services with a specified percentage of the proceeds from the original sale. The difference is that this party can fulfill the obligation with any firm in the country to which the sale is being made. From an exporter's perspective, this is more attractive than a straight counterpurchase agreement because it gives the exporter greater flexibility to choose the goods that it wishes to purchase.
Switch Trading
Switch trading refers to the use of a specialized thirdparty trading house in a countertrade arrangement. When a firm enters a counterpurchase or offset agreement with a country, it often ends up with what are called counterpurchase credits, which can be used to purchase goods from that country. Switch trading occurs when a third-party trading house buys the firm's counterpurchase credits and sells them to another firm that can better use them. For example, a US firm concludes a counterpurchase agreement with Poland for which it receives some number of counterpurchase credits for purchasing Polish goods. The US firm cannot use and does not want any Polish goods, however, so it sells the credits to a thirdparty trading house at a discount. The trading house finds a firm that can use the credits and sells them at a profit.
In one example of switch trading, Poland and Greece had a counterpurchase agreement that called for Poland to buy the same USdollar value of goods from Greece that it sold to Greece. However, Poland could not find enough Greek goods that it required, so it ended up with a dollardenominated counterpurchase balance in Greece that it was unwilling to use. A switch trader bought the right to 250,000 counterpurchase dollars from Poland for $225,000 and sold them to a European sultana (grape) merchant for $235,000, who used them to purchase sultanas from Greece.
Compensation or Buybacks
A buyback occurs when a firm builds a plant in a country--or supplies technology, equipment, training, or other services to the country--and agrees to take a certain percentage of the plant's output as partial payment for the contract. For example, Occidental Petroleum negotiated a deal with the former Soviet Union under which Occidental would build several ammonia plants in the Soviet Union and as partial payment receive ammonia over a 20 - year period.
The Pros and Cons of Countertrade
The main attraction of countertrade is that it can give a firm a way to finance an export deal when other means are not available. Given the problems that many developing nations have in raising the foreign exchange necessary to pay for imports, countertrade may be the only option available when doing business in these countries. Even when countertrade is not the only option for structuring an export transaction, many countries prefer countertrade to cash deals. Thus, if a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement.
But the drawbacks of countertrade agreements are substantial. Other things being equal, all firms would prefer to be paid in hard currency. Countertrade contracts may involve the exchange of unusable or poor - quality goods that the firm cannot dispose of profitably. For example, a few years ago, one US firm got burned when 50 percent of the television sets it received in a countertrade agreement with Hungary were defective and could not be sold. In addition, even if the goods it receives are of high quality, the firm still needs to dispose of them profitably. To do this, countertrade requires the firm to invest in an in - house trading department dedicated to arranging and managing countertrade deals. This can be expensive and time consuming.
Given these drawbacks, countertrade is most attractive to large, diverse multinational enterprises that can use their worldwide network of contacts to dispose of goods acquired in countertrading. The masters of countertrade are Japan's giant trading firms, the sogo shosha, who use their vast networks of affiliated companies to profitably dispose of goods acquired through countertrade agreements. The trading firm of Mitsui & Company, for example, has about 120 affiliated companies in almost every sector of the manufacturing and service industries. If one of Mitsui's affiliates receives goods in a countertrade agreement that it cannot consume, Mitsui & Company will normally be able to find another affiliate that can profitably use them. Firms affiliated with one of Japan's sogo shosha often have a competitive advantage in countries where countertrade agreements are preferred.
Western firms that are large, diverse, and have a global reach (e.g., General Electric, Philip Morris, and 3M) have similar profit advantages from countertrade agreements. Indeed, 3M has established its own trading company--3M Global Trading, Inc.--to develop and manage the company's international countertrade programs. Unless there is no alternative, small and mediumsized exporters should probably try to avoid countertrade deals because they lack the worldwide network of operations that may be required to profitably utilize or dispose of goods acquired through them.20
Chapter Summary
In this chapter, we examined the steps that firms must take to establish themselves as exporters. This chapter made the following points:
One big impediment to exporting is ignorance of foreign market opportunities.
Neophyte exporters often become discouraged or frustrated with the exporting process because they encounter many problems, delays, and pitfalls.
The way to overcome ignorance is to gather information. In the United States, a number of institutions, most important of which is the US Department of Commerce, can help firms gather information and in the matchmaking process. Export management companies can also help an exporter to identify export opportunities.
Many of the pitfalls associated with exporting can be avoided if a company hires an experienced export management company, or export consultant and if it adopts the appropriate export strategy.
Firms engaged in international trade must do business with people they cannot trust and people who may be difficult to track down if they default on an obligation. Due to the lack of trust, each party to an international transaction has a different set of preferences regarding the configuration of the transaction.
The problems arising from lack of trust between exporters and importers can be solved by using a third party that is trusted by both, normally a reputable bank.
A letter of credit is issued by a bank at the request of an importer. It states that the bank promises to pay a beneficiary, normally the exporter, on presentation of documents specified in the letter.
A draft is the instrument normally used in international commerce to effect payment. It is an order written by an exporter instructing an importer, or an importer's agent, to pay a specified amount of money at a specified time.
Drafts are either sight drafts or time drafts. Time drafts are negotiable instruments.
A bill of lading is issued to the exporter by the common carrier transporting the merchandise. It serves as a receipt, a contract, and a document of title.
US exporters can draw on two types of government - backed assistance to help finance their exports: loans from the Export - Import Bank and export credit insurance from the FCIA.
Countertrade includes a whole range of barterlike agreements. It is primarily used when a firm exports to a country whose currency is not freely convertible and who may lack the foreign exchange reserves required to purchase the imports.
The main attraction of countertrade is that it gives a firm a way to finance an export deal when other means are not available. A firm that insists on being paid in hard currency may be at a competitive disadvantage vis-à-vis one that is willing to engage in countertrade.
The main disadvantage of countertrade is that the firm may receive unusable or poor-quality goods that cannot be disposed of profitably.
Critical Discussion Questions
A firm based in Washington state wants to export a shipload of finished lumber to the Philippines. The would-be importer cannot get sufficient credit from domestic sources to pay for the shipment but insists that the finished lumber can quickly be resold in the Philippines for a profit. Outline the steps the exporter should take to effect this export to the Philippines.
You are the assistant to the CEO of a small textile firm that manufactures high-quality, premium-priced, stylish clothing. The CEO has decided to see what the opportunities are for exporting and has asked you for advice as to the steps the company should take. What advice would you give to the CEO?
An alternative to using a letter of credit is export credit insurance. What are the advantages and disadvantages of using export credit insurance rather than a letter of credit for exporting (a) A luxury yacht from California to Canada, and (b) machine tools from New York to the Ukrainian Republic?
How do you explain the popularity of countertrade? Under what scenarios might its popularity increase still further by the year 2005? Under what scenarios might its popularity decline by the year 2005?
Closing Case Downey's Soup
Downey's is an Irish tavern in Philadelphia created over 20 years ago by Jack Downey. Over the years, the fortunes of the restaurant have wavered, but the strength of some favorite menu items has helped it survive economic downturns. In particular, the lobster bisque soup was met with increasing popularity, but Downey's efforts to market it have been sporadic. Never did Downey imagine that his lobster bisque would someday be the cause of an international trade dispute.
Unbeknown to Downey, the Japanese have a strong penchant for lobster. When the Philadelphia office of the Japanese External Trade Organization (Jetro) asked Downey to serve his lobster bisque at a mini trade show in 1991, he began to think about mass production of his soups. The Japanese loved the lobster bisque. They gave Downey a strong impression that the soup would sell very well in Japan. At the time, Downey did not have a formal product line but that seemed to be only a minor obstacle.
After the trade show, Michael Fisher, executive vice president for the newly formed Downey Foods Inc., was sent on an all-expenses-paid 10-day marketing trip to Japan by Jetro. (Jetro sponsors approximately 60 Americans for similar trips each year.) Although interest expressed by the food brokers and buyers he met seemed to be more polite than enthusiastic, he did get an initial order for 1,000 cases of the lobster bisque. The only condition placed by the buyer was to have the salt content reduced to comply with local Japanese tastes. Both Jetro and Fisher considered this initial order the beginning of rich export relationship with Japan.
Fisher contracted a food processor in Virginia, adapted the recipe for the new salt content, and shipped the soup to Japan in short order. Visions of expanded sales in Japan were quickly dashed as the cases of soup were detained at customs. Samples were sent to a government laboratory and eventually denied entry for containing polysorbate, an emulsifying and anti-foaming agent used by food processors. Though it is considered harmless in the United States, polysorbate is not on Jetro's list of 347 approved food additives.
Fisher and Downey did not give up. They reformulated the soup to improve the taste and comply with Jetro's additive regulations. They had the soup tested and certified by a Japanese-approved lab, the Oregon Department of Agriculture's Export Service Center, to meet all Japanese standards. Then, in the fall of 1993, they sent another 1,000 cases to Japan.
The soup was denied entry again. Japanese officials said the expiration date on the Oregon tests had passed, so they retested the cans. Traces of polysorbate were found. A sample from that shipment was sent back to Oregon, and it passed. Two identical cans of soup were sent back to Japan and tested. They failed. Back in Oregon, a sample of the same shipment was tested again and no traces of polysorbate were found.
Japanese officials refused to allow the soup into Japan anyway. By this time, Downey's had been paid $20,000 that it could not afford to give back. "It stunned the customer," says Fisher. "But it stunned me a lot more. I was counting on dozens of reorders."
Fisher filed appeals with the US Embassy in Tokyo to no avail. "It became a bureaucratic/political issue," says
Fisher. "There was a face-saving problem. The Japanese had rejected the soup twice. There was no way they could reverse the decision."
The final irony came when a New York-based Japanese trader sent a few cases of Downey's regular (no reduced salt content) lobster bisque to Japan. This shipment sailed through customs without a problem.
Where was Jetro when Downey's soups were stalled in customs? Fisher thought he had everything covered. He followed the advice of Jetro, adjusted the soups to meet Japanese palates, and had them tested to meet Japanese food standards. Apparently, Jetro failed to inform Fisher of the apparent need for a local partner to sell and distribute in Japan. Most food companies have trouble getting into Japan, whether large or small. Agricultural products are one of the most difficult things to get into the Japanese market.
Jetro's agricultural specialist, Tatsuya Kajishima, contradicts the claim that Japan is hostile to food imports by stating the following statistic: 30 percent of Japan's food imports come from the United States. Further, Japan is the fourth largest importer of America's soups to the tune of $6.5 million worth of soup purchased in 1993. Most of these sales came from Campbell's Soup Co.
Although this venture was not particularly profitable for Downey Foods Inc., the company has been able to redirect its research and development efforts to build its domestic product line. Through its local broker, Santucci Associates, Downey Foods attracted the attention of Liberty Richter Inc., a national distributor of gourmet and imported food items.
http://www.downeysrestaurant.com
Source: Case written by Mureen Kibelsted and Charles Hill from original research by Mureen Kibelsted.
Case Discussion Questions
Did Downey Foods' export opportunity occur as a result of proactive action by Downey or was its strategy reactive?
Why did Downey experience frustrations when trying to export to Japan? What actions might Downey take to improve its prospects of succeeding in the Japanese market?
You have been hired by Downey Foods to develop an exporting strategy for the firm. What steps do you think Downey should take to increase the volume of its exports?