January 1999 Issue

ISSUES IN MANAGING THE MULTINATIONAL CORPORATION

By Ellwood F. Oakley, III, Ernest R. Larkins, and Gary M. Winkle

Companies entering the international business arena often face two sets of operational and strategic issues. The first set includes issues that are familiar to them in a domestic setting but that take on new dimensions in the global realm. The second set involves entirely new issues with which domestic companies have little knowledge or experience to guide them.

A business's plan for conducting commerce abroad must begin with an assessment of its goals. The attractiveness of a proposal for international expansion or investment can vary greatly depending on company objectives. As shown in the accompanying Exhibit, the amount of risk, control, and profit potential increases with each level of commitment to conducting a global enterprise. If the initial goal is merely to increase sales, the adoption of an export model is probably the appropriate strategy. If, on the other hand, the business objective is to penetrate a local market in a developing region of the world, the global strategy would almost certainly require investment at the licensing or joint venture level.

Exporting

To illustrate strategic planning when engaging in business abroad, consider a U.S.-based poultry processing company that wishes to expand internationally at minimal risk. Initially, the company might decide on direct exporting. To sell its product abroad, the company targets a country or region of the world with a market ripe for its poultry products. State and local chambers of commerce, state offices of international trade, and consultants with international experience often can assist in analyzing foreign markets. Another valuable source of market information is the Export Hotline, a free fax-retrieval system sponsored by the U.S. Department of Commerce and several multinational companies. To obtain access to the Export Hotline system, companies can call (800) 872-9767.

A careful analysis of foreign markets does not guarantee success in the international arena. Direct sales abroad often entail other special challenges that do not confront the purely domestic company. The most critical issues involve the selection of foreign agents, careful wording of international sales contracts and agency agreements, collections from foreign buyers, and compliance with export regulations. These issues are discussed below.

To save time and costs, a firm might retain a local representative to oversee the foreign sale of its product. The selection of a competent, honest, and helpful agent is often the most important choice a company makes in the initial stages of its international venture. The business should make this decision in the same careful, deliberate fashion that it would in expanding its sales into another U.S. region. Yet many companies doing business abroad for the first time are careless about this critical decision. The excitement of international travel, coupled with jet lag and culture shock, can lead to a hasty choice of agent. Just because Hans drives a shiny new Mercedes and is a great dinner host does not guarantee that he will be a solid and reliable agent for the company's poultry sales effort in Germany.

To avoid costly mistakes, the company should ask prospective sales representatives the same questions regarding sales experience and product knowledge that it would ask of a new sales representative in the United States. The company should seek and verify references and, perhaps most importantly, slow the selection process down to a comfortable pace. It should interview at least three prospective agents before choosing one and insist that its first choice fly to the United States for a final interview so that initial impressions can be confirmed without the aura of the Moselle (river and wine) clouding the decision-making process.

Even with a good sales representative, failure to properly structure the agency agreement may result in a "dependent agent," which constitutes an office or permanent establishment in many countries. As a result, the company may unwittingly subject all of its international sales operations to the host country's legal system. To avoid this and other legal entanglements, the poultry exporter should retain expert legal and accounting services prior to entering the international marketplace. References for firms with such expertise in the host country can be obtained from the same sources noted above for market analysis. In addition, recent business articles often provide background information that is helpful in communicating with foreign legal counsel, accountants, and other professionals in meaningful ways. Homework conducted at this stage of the venture can save the multinational enterprise from a series of unnecessary, unpleasant, and unprofitable gaffes as it enters international markets.

After the exporter chooses an agent and begins selling abroad, the most significant practical problem is getting paid. In the United States, the seller undertakes collection efforts and, as a last resort, begins litigation when an invoice does not produce voluntary payment. While U.S. litigation can be frustrating, time consuming, and expensive, it typically produces at least partial payment. In contrast, the legal system in many developing countries is so fragile that the seller's day in court may never come and, even if it does, payment is not assured.

The international business relies heavily on the use of letters of credit (LC) to provide credit protection. In simple terms, the LC process works as follows: The buyer enters a credit agreement with an issuing bank, which is typically the buyer's primary banker, and the issuing bank writes an LC in favor of the seller (the beneficiary). The LC provides that the issuing bank will pay the seller when the latter presents a clean bill of lading. The seller typically uses a bank in its own country to confirm and guarantee the terms of the issuing bank's LC. The confirming bank has an ongoing relationship with the issuing bank and bears the risk that the LC is valid. The carrier of the goods (either ship or plane) gives the bill of lading to the seller at the time of shipment. The bill of lading describes the shipped goods, specifies the loading location and destination, and contains a statement that the goods contain no known defects or damage at time of acceptance ("clean"). When the seller presents the bill of lading, the issuing bank makes the agreed payment and gives the bill of lading to the buyer. The buyer uses that document to claim the goods when they arrive.

In addition to the bill of lading, the buyer requires an invoice, a certificate of origin for custom purposes, a certificate of insurance insuring the goods against damage during shipment, and a certificate of inspection from a designated organization indicating the quality and condition of the goods at the time of shipping. Payment is made based on an inspection of the various shipping documents and certificates. Accordingly, it is imperative that the exporter complete the documentation accurately and on a timely basis. Professionals in the export division of national banks and freight forwarders (companies with specialized knowledge of international sales transactions) can handle the highly technical documentation process and procure the necessary certificates. In addition, freight forwarders can book space on carriers, review LCs, and procure export licenses for the seller. Unless the multinational has a large, experienced staff, the use of a freight forwarder saves time and expense and greatly enhances the probability that payment will be received.

Even with sophisticated intermediaries to facilitate collection, the U.S. exporter or the foreign buyer might dispute other terms or conditions of the sales contract. Language and cultural differences can cause good faith misunderstandings. To create a long-term relationship, the parties might attempt to work through their differences, but a set of governing dispute resolution principles should be incorporated into the sales agreement in the event negotiations fail.

The sales contract should clearly state which country's legal system will be used to resolve disputes. Contracts without a choice of U.S. law clause can prove disastrous when an exporter sells to certain developing countries where even the most basic premises of contract law might not hold. Inserting a choice of law provision binds both parties to the designated country's internal law, and courts around the globe routinely enforce such a clause. However, the multinational must be sensitive to the trading partner's concerns. Just as the U.S. exporter may be wary of binding itself to the unfamiliar laws of another culture, so the importer may feel uncomfortable submitting disputes to the U.S. legal system. Horror stories of the U.S. civil jury system make headlines not only at home, but also abroad. Fortunately, a workable compromise is available when both parties feel uneasy about the legal system in their partner's country.

Governments have negotiated common understandings of substantive law and procedure. Most developed countries, as well as many developing nations, are signatories to the United Nations Convention on Contracts for the International Sale of Goods (CISG). Absent an express choice of law clause in the sales contract, the treaty's provisions bind parties that reside in CISG countries. Though CISG does not cover services and some goods, the treaty brings a much needed level of stability to most international business transactions.

Contracting parties often insert arbitration clauses that subject disputes to international arbitral tribunals such as the International Chamber of Commerce (ICC) or the United Nations Commission on International Trade Law (UNCITRAL). The UNCITRAL rules, in particular, are widely recognized. Such international arbitration regimes bypass court systems entirely and establish speedy and efficient procedures. Likewise, more than 100 nations have signed the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards. Known as the New York Convention, this international agreement provides a procedural mechanism to enforce international contracts containing arbitration clauses. It permits parties holding arbitral awards to seek enforcement in the signatories' national courts. Since the award is enforceable in most nations, each party has a vested interest in respecting the arbitral process.

Licensing

Steep legal barriers to trade, such as quotas and tariffs, as well as cultural differences can impede or preclude exports to some countries. Similarly, the high cost of transporting certain goods can cause them to be uncompetitive in distant markets. In these situations, a manufacturer might attempt to penetrate foreign markets through licensing arrangements with companies based in the host country. Licenses are contractual agreements in which a licensor makes its intellectual property available to an oversees licensee in return for compensation based on the licensee's production or sales volume. Types of intellectual property commonly licensed include manufacturing know-how, patents, trade secrets, trademarks, and copyrights.

The scope and duration of protection under trademark and patent laws vary from one nation to another. Many countries enforce their existing laws less vigorously than does the United States. For example, the production of counterfeit computer software, film, and clothing that infringe on U.S. intellectual property rights is rampant in some areas of the world.

In many countries, protection is granted to the patent or trademark filer who files first. Many U.S. companies have been surprised to find that unscrupulous parties with no colorable claim have pirated their intellectual property interests simply by filing first. The International Convention for the Protection of Industrial Property Rights (the Paris Convention), which 99 countries including the United States have signed, addresses the cross-border problem of piracy. Each participant in the Paris Convention agrees to grant businesses in other signatory nations a grace period to make corresponding filings in host countries. For patents and trademarks, the grace periods are one year and six months from the initial home country filings, respectively. Filings within the grace period are granted appropriate protection. In addition, the Madrid Agreement Concerning the International Registration of Trademarks allows a trademark holder in one country to register it at the World Intellectual Property Organization. Proper registration automatically extends trademark protection in the other signatory nations.

To benefit from the international agreements on intellectual property rights, a U.S. business must develop a strategic plan based on international expansion. The business must undertake protective filings promptly in all nations where it anticipates doing business in the future. Patent attorneys who register domestic intellectual property rights typically have correspondent firms in other nations that perform such filings at a modest cost.

Another form of trademark licensing is franchising, a concept familiar to U.S. businesses. A typical agreement conveys to the franchisee a package of licensed rights to use the franchisor's trademarks, service marks, patents, and trade secrets. International franchising offers solutions to impediments that U.S. firms often encounter when seeking direct investment abroad. By working with local franchisees, host country regulations and restrictions on foreign investments can be satisfied more easily. In addition, the local presence often can anticipate and remedy the sometimes subtle cultural nuances. For example, PepsiCo experienced how not to introduce a product line through the release of its 7-Up brand of soft drink in Shanghai. While exploring why 7-Up was not selling, PepsiCo discovered that the phrase "7-Up" meant "death by drinking" in the local dialect. A local franchisee would have anticipated and avoided the problem. By way of contrast, the Kentucky Fried Chicken (KFC) franchises in Japan modified the original U.S. recipes to reflect the taste expectations of the Japanese customer. As a result, KFC's franchise sales in Japan have shown phenomenal growth.

Despite the attractiveness of franchising, one word of caution is in order. Many countries consider franchise agreements to be invalid unless the parties agree to the local courts' jurisdiction. By submitting to local jurisdiction, the collection of disputed franchise fees can become problematic. Furthermore, host countries' laws on patents, trademarks, and antitrust violations often are held applicable even when negotiated terms in the franchise agreement state they are not. Thus, the franchisor that does not properly register its patents and trademarks in the host country can effectively lose control of its most valuable assets.

Joint Ventures

In a joint venture (JV), two or more firms join forces to carry out a common business enterprise. For the nonresident participant, a JV effectively spreads risks (both political and economic) and facilitates entry into the foreign market. When the host partner has an established distribution system, the investor participant obtains an immediate local market share. In addition, the JV can expect greater sales to public buyers in countries where strong nationalist feelings inhibit foreign company contracts.

A successful JV requires patience; a willingness to develop an understanding of different cultures, values, and decision-making processes; and a commitment to stay the course through the inevitable rough spots. Without that long-term commitment, the JV can become a financial and managerial nightmare.

Joint venturers can structure their efforts as a partnership, corporation, or limited liability company. However, some developing countries require that residents or nationals own at least 51% of any business enterprise. In effect, foreign interests are not allowed to control legal entities. Multinationals often resist sharing or losing control of their operations and forgo such ventures. As a result, developing countries with such restrictions have lost opportunities for foreign investment. These lost opportunities, in turn, have encouraged these nations to relax their foreign ownership laws. Indeed, one of the key provisions of the 1993 North American Free Trade Agreement (NAFTA), the high-profile, trilateral trade agreement among Canada, Mexico, and the United States, was Mexico's commitment to phase out its foreign investment restrictions. Sometimes the relaxation of foreign investment laws is done less formally through quid pro quo exceptions to investment statutes. For example, a country might permit majority ownership in return for the transfer of modern technology to the host nation or the location of a manufacturing plant in a high unemployment area. IBM generally has avoided JVs as a matter of business strategy. Yet it has expanded production considerably in Mexico by agreeing to produce current models and export a high percentage of the production.

In developing countries that still preclude foreign control of legal entities, alternative arrangements are sometimes used. For example, the joint venturers might work together through a mere contractual relationship. The contract generally specifies the duration of the business relationship and each participant's rights and obligations.

Direct Investments

Direct investments carry the greatest profit potential for a multinational business enterprise but also involve the greatest risks. All of the previously discussed risks exist for a stand-alone direct investment. In addition, the multinational business operating alone in a host country must bear the entire spectrum of political, currency, cultural, legal, and business risks by itself. For this reason, only the most sophisticated multinational enterprise with deep financial resources generally undertakes this form of business abroad. When the multinational does commit the time, capital, and personnel to a direct foreign investment, it has the option of operating as a branch office or wholly-owned subsidiary. While the parent company has more direct control over a branch, the major disadvantage is that the parent must assume all risks of the branch operations, including legal liability.

A foreign subsidiary is formed pursuant to and governed by company or corporate laws in the host country. In contrast to a branch, a subsidiary is a separate legal entity and, thus, insulates the parent from unlimited liability. Recall the 1984 Union Carbide chemical plant disaster in Bhopal, India, in which the use of a foreign subsidiary insulated the $5 billion of the parent corporation's equity from the 300,000 Indian claimants. Had this incident occurred in the United States, home to the parent corporation, the liabilities associated with the mass disaster likely would have bankrupted Union Carbide.

In summary, the business objectives of the multinational determine, to a large extent, the form of its foreign investments. Both the risk and reward ratios increase as the business increases its commitment from exporting to licensing, to joint ventures, and finally to direct investments. *

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