# Competing in the Global Marketplace

## Barriers to Trade

1. What are the barriers to international trade?
International trade is carried out by both businesses and governments—as long as no one puts up trade barriers. In general, trade barriers keep firms from selling to one another in foreign markets. The major obstacles to international trade are natural barriers, tariff barriers, and nontariff barriers.

### Natural Barriers

Natural barriers to trade can be either physical or cultural. For instance, even though raising beef in the relative warmth of Argentina may cost less than raising beef in the bitter cold of Siberia, the cost of shipping the beef from South America to Siberia might drive the price too high. Distance is thus one of the natural barriers to international trade.
Language is another natural trade barrier. People who can’t communicate effectively may not be able to negotiate trade agreements or may ship the wrong goods.

### Tariff Barriers

A tariff is a tax imposed by a nation on imported goods. It may be a charge per unit, such as per barrel of oil or per new car; it may be a percentage of the value of the goods, such as 5 percent of a $500,000 shipment of shoes; or it may be a combination. No matter how it is assessed, any tariff makes imported goods more costly, so they are less able to compete with domestic products.
Protective tariffs make imported products less attractive to buyers than domestic products. The United States, for instance, has protective tariffs on imported poultry, textiles, sugar, and some types of steel and clothing, and in March of 2018 the Trump administration added tariffs on steel and aluminum from most countries. On the other side of the world, Japan imposes a tariff on U.S. cigarettes that makes them cost 60 percent more than Japanese brands. U.S. tobacco firms believe they could get as much as a third of the Japanese market if there were no tariffs on cigarettes. With tariffs, they have under 2 percent of the market.

### Arguments for and against Tariffs

Congress has debated the issue of tariffs since 1789. The main arguments for tariffs include the following:
1. Tariffs protect infant industries. A tariff can give a struggling new domestic industry time to become an effective global competitor.
2. Tariffs protect U.S. jobs. Unions and others say tariffs keep foreign labor from taking away U.S. jobs.
3. Tariffs aid in military preparedness. Tariffs should protect industries and technology during peacetime that are vital to the military in the event of war.
The main arguments against tariffs include the following:
1. Tariffs discourage free trade, and free trade lets the principle of competitive advantage work most efficiently.
2. Tariffs raise prices, thereby decreasing consumers’ purchasing power. In 2017, the United States imposed tariffs of 63.86 percent to 190.71 percent on a wide variety of Chinese steel products. The idea was to give U.S. steel manufacturers a fair market after the Department of Commerce concluded their antidumping and anti-subsidy probes. It is still too early to determine what the effects of these tariffs will be, but higher steel prices are likely. Heavy users of steel, such as construction and automobile industries, will see big increases in their production costs. It is also likely that China may impose tariffs on certain U.S. products and services and that any negotiations on intellectual property and piracy will bog down.

### Nontariff Barriers

Governments also use other tools besides tariffs to restrict trade. One type of nontariff barrier is the import quota, or limits on the quantity of a certain good that can be imported. The goal of setting quotas is to limit imports to the specific amount of a given product. The United States protects its shrinking textile industry with quotas. A complete list of the commodities and products subject to import quotas is available on line at the U.S. Customs and Border Protection Agency website.
A complete ban against importing or exporting a product is an embargo. Often embargoes are set up for defense purposes. For instance, the United States does not allow various high-tech products, such as supercomputers and lasers, to be exported to countries that are not allies. Although this embargo costs U.S. firms billions of dollars each year in lost sales, it keeps enemies from using the latest technology in their military hardware.
Government rules that give special privileges to domestic manufacturers and retailers are called buy-national regulations. One such regulation in the United States bans the use of foreign steel in constructing U.S. highways. Many state governments have buy-national rules for supplies and services. In a more subtle move, a country may make it hard for foreign products to enter its markets by establishing customs regulations that are different from generally accepted international standards, such as requiring bottles to be quart size rather than liter size.
Exchange controls are laws that require a company earning foreign exchange (foreign currency) from its exports to sell the foreign exchange to a control agency, usually a central bank. For example, assume that Rolex, a Swiss company, sells 300 watches to Zales Jewelers, a U.S. chain, for US$600,000. If Switzerland had exchange controls, Rolex would have to sell its U.S. dollars to the Swiss central bank and would receive Swiss francs. If Rolex wants to buy goods (supplies to make watches) from abroad, it must go to the central bank and buy foreign exchange (currency). By controlling the amount of foreign exchange sold to companies, the government controls the amount of products that can be imported. Limiting imports and encouraging exports helps a government to create a favorable balance of trade.

### Summary of Learning Outcomes

1. What are the barriers to international trade?
The three major barriers to international trade are natural barriers, such as distance and language; tariff barriers, or taxes on imported goods; and nontariff barriers. The nontariff barriers to trade include import quotas, embargoes, buy-national regulations, and exchange controls. The main argument against tariffs is that they discourage free trade and keep the principle of comparative advantage from working efficiently. The main argument for using tariffs is that they help protect domestic companies, industries, and workers.


# Competing in the Global Marketplace

## Fostering Global Trade

1. How do governments and institutions foster world trade?

### Antidumping Laws

U.S. firms don’t always get to compete on an equal basis with foreign firms in international trade. To level the playing field, Congress has passed antidumping laws. Dumping is the practice of charging a lower price for a product (perhaps below cost) in foreign markets than in the firm’s home market. The company might be trying to win foreign customers, or it might be seeking to get rid of surplus goods.
When the variation in price can’t be explained by differences in the cost of serving the two markets, dumping is suspected. Most industrialized countries have antidumping regulations. They are especially concerned about predatory dumping, the attempt to gain control of a foreign market by destroying competitors with impossibly low prices.
The United States recently imposed tariffs on softwood lumber from Canada. Canada was found guilty of pricing softwood lumber at between 7.72 and 4.49 percent below their costs. U.S. customs officers will now levy tariffs on Canadian timber exports with tax rates from 17.41 percent to 30.88 percent, depending on the business.
From our discussion so far, it might seem that governments act only to restrain global trade. On the contrary, governments and international financial organizations work hard to increase it, as this section explains.

### Trade Negotiations and the World Trade Organization

The Uruguay Round of trade negotiations is an agreement that dramatically lowers trade barriers worldwide. Adopted in 1994, the agreement has been now signed by 148 nations. The most ambitious global trade agreement ever negotiated, the Uruguay Round reduced tariffs by one-third worldwide, a move that is expected to increase global income by $235 billion annually. Perhaps the most notable aspect of the agreement is its recognition of new global realities. For the first time, an agreement covers services, intellectual property rights, and trade-related investment measures such as exchange controls.
As a follow-up to the Uruguay Round, a negotiating round started in the capital of Qatar in 2001 is called the Doha Round. To date, the round has shown little progress in advancing free trade. Developing nations are pushing for the reduction of farm subsidies in the United States, Europe, and Japan. Poor countries say that the subsidies stimulate overproduction, which drives down global agricultural prices. Because developing nations’ primary exports are agricultural commodities, low prices mean that they cannot compete in the global marketplace. On the other hand, the United States and Europe are interested in bringing down trade barriers in services and manufacturing. The continuing talks have served as a lightning rod for protesters, who claim that the World Trade Organization (WTO) serves the interests of multinational corporations, promotes trade over preserving the environment, and treats poor nations unfairly.
The World Trade Organization replaces the old General Agreement on Tariffs and Trade (GATT), which was created in 1948. The GATT contained extensive loopholes that enabled countries to evade agreements to reduce trade barriers. Today, all WTO members must fully comply with all agreements under the Uruguay Round. The WTO also has an effective dispute settlement procedure with strict time limits to resolve disputes.
The WTO has emerged as the world’s most powerful institution for reducing trade barriers and opening markets. The advantage of WTO membership is that member countries lower trade barriers among themselves. Countries that don’t belong must negotiate trade agreements individually with all their trading partners. Only a few countries, such as North Korea, Turkmenistan, and Eritrea, are not members of the WTO.
The United States has had mixed results in bringing disputes before the WTO. To date, it has won slightly fewer than half of the cases it has presented to the WTO. America has also won about one-third of the cases brought against it by other countries. One of America’s recent losses came in a ruling where the U.S. claimed that tuna imported from Mexico was not meeting the “dolphin safe” criteria, meaning that dolphins were not being killed during the process to catching tuna. The WTO ruled in favor of Mexico. Recently, the United States targeted Europe, India, South Korea, Canada, and Argentina to file cases against. The disputes ranged from European aviation practices to Indian trade barriers affecting U.S. automakers.
One of the biggest disputes before the WTO involved the United States and the European Union. The United States claims that Europe has given Airbus $15 billion in aid to develop airplanes. The European Union claims that the U.S. government has provided $23 billion in military research that has benefited Boeing’s commercial aircraft business. It also claimed that Washington State (the home of Boeing manufacturing) has given the company $3.2 billion in unfair tax breaks.

### The World Bank and International Monetary Fund

Two international financial organizations are instrumental in fostering global trade. The World Bank offers low-interest loans to developing nations. Originally, the purpose of the loans was to help these nations build infrastructure such as roads, power plants, schools, drainage projects, and hospitals. Now the World Bank offers loans to help developing nations relieve their debt burdens. To receive the loans, countries must pledge to lower trade barriers and aid private enterprise. In addition to making loans, the World Bank is a major source of advice and information for developing nations. The United States has granted the organization millions to create knowledge databases on nutrition, birth control, software engineering, creating quality products, and basic accounting systems.
The International Monetary Fund (IMF) was founded in 1945, one year after the creation of the World Bank, to promote trade through financial cooperation and eliminate trade barriers in the process. The IMF makes short-term loans to member nations that are unable to meet their budgetary expenses. It operates as a lender of last resort for troubled nations. In exchange for these emergency loans, IMF lenders frequently extract significant commitments from the borrowing nations to address the problems that led to the crises. These steps may include curtailing imports or even devaluing the currency.
Some global financial problems do not have a simple solution. One option would be to pump a lot more funds into the IMF, giving it enough resources to bail out troubled countries and put them back on their feet. In effect, the IMF would be turned into a real lender of last resort for the world economy.
The danger of counting on the IMF, though, is the “moral hazard” problem. Investors would assume that the IMF would bail them out and would therefore be encouraged to take bigger and bigger risks in emerging markets, leading to the possibility of even deeper financial crises in the future.

### Summary of Learning Outcomes

1. How do governments and institutions foster world trade?
The World Trade Organization, established by the Uruguay Round of trade negotiations, has dramatically lowered trade barriers worldwide. For the first time, a trade agreement covers services, intellectual property rights, and exchange controls. The World Bank makes loans to developing nations to help build infrastructures. The International Monetary Fund makes loans to member nations that cannot meet their budgetary expenses. Despite efforts to expand trade, terrorism can have a negative impact on trade growth.


# Competing in the Global Marketplace

## International Economic Communities

1. What are international economic communities?
Nations that frequently trade with each other may decide to formalize their relationship. The governments meet and work out agreements for a common economic policy. The result is an economic community or, in other cases, a bilateral trade agreement (an agreement between two countries to lower trade barriers). For example, two nations may agree upon a preferential tariff, which gives advantages to one nation (or several nations) over others. When members of the British Commonwealth (countries that are former British territories) trade with Great Britain, they pay lower tariffs than do other nations. For example, Canada and Australia are former British territories but still members of the British Commonwealth. You will note that Queen Elizabeth still appears on Canadian currency and the Union Jack is still incorporated into the Australian flag. In other cases, nations may form free-trade associations. In a free-trade zone, few duties or rules restrict trade among the partners, but nations outside the zone must pay the tariffs set by the individual members.

### North American Free Trade Agreement (NAFTA)

The North American Free Trade Agreement (NAFTA) created the world’s largest free-trade zone. The agreement was ratified by the U.S. Congress in 1993. It includes Canada, the United States, and Mexico, with a combined population of 450 million and an economy of over $20.8 trillion.
NAFTA has since been modified by the U.S.-Mexico-Canada Agreement (USMCA). The USMCA was largely accepted and entered into force on July 1, 2020.
Canada, one of the largest U.S. trading partners, entered a free-trade agreement with the United States in 1988. Thus, most of the new long-run opportunities opened for U.S. business under NAFTA are in Mexico, America’s third-largest trading partner. Before NAFTA, tariffs on Mexican exports to the United States averaged just 4 percent, and most goods entered the United States duty-free, so NAFTA’s primary impact was to open the Mexican market to U.S. companies. When the treaty went into effect, tariffs on about half the items traded across the Rio Grande disappeared. Since NAFTA came into effect, U.S.-Mexican trade has increased from $80 billion to $515 billion annually. The pact removed a web of Mexican licensing requirements, quotas, and tariffs that limited transactions in U.S. goods and services. For instance, the pact allows U.S. and Canadian financial-services companies to own subsidiaries in Mexico for the first time in 50 years.
The real test of NAFTA and now USMCA will be whether it can deliver rising prosperity on both sides of the Rio Grande. For Mexicans, NAFTA must provide rising wages, better benefits, and an expanding middle class with enough purchasing power to keep buying goods from the United States and Canada. That scenario seems to be working. At the Delphi Corp. auto parts plant in Ciudad Juárez, just across the border from El Paso, Texas, the assembly line is a cross section of working-class Mexico. In the years since NAFTA lowered trade and investment barriers, Delphi has significantly expanded its presence in the country. Today it employs 70,000 Mexicans, who every day receive up to 70 million U.S.-made components to assemble into parts. The wages are modest by U.S. standards—an assembly-line worker with two years’ experience earns about $2.30 an hour. But that’s triple Mexico’s minimum wage, and Delphi jobs are among the most coveted in Juárez. The United States recently notified the Canadian and Mexican governments that it intends to renegotiate aspects of the NAFTA agreement.
One of the largest new trade agreement is Mercosur, which includes Peru, Brazil, Argentina, Uruguay, and Paraguay. The elimination of most tariffs among the trading partners has resulted in trade revenues that currently exceed $16 billion annually. Recent recessions in Mercosur countries have limited economic growth, even though trade among Mercosur countries has continued to grow. Most recently, the largest new trade agreement is the Regional Comprehensive Economic Partnership (RCEP). This trade agreement includes fifteen (15) Asian States and signals to investors that the region is still committed to multilateral trade integration. One item that is most notable about this trade agreement is that the U.S. is not a member.

### Central America Free Trade Agreement

The newest free trade agreement is the Central America Free Trade Agreement (CAFTA) passed in 2005. Besides the United States, the agreement includes Costa Rica, the Dominican Republic, El Salvador, Guatemala, Honduras, and Nicaragua. The United States is already the principal exporter to these nations, so economists don’t think that it will result in a major increase in U.S. exports. It will, however, reduce tariffs on exports to CAFTA countries. Already, some 80 percent of the goods imported into the United States from CAFTA nations are tariff-free. CAFTA countries may benefit from the new permanent trade deal if U.S. multinational firms deepen their investment in the region.

### The European Union

In 1993, the member countries of the European Community (EC) ratified the Maastricht Treaty, which proposed to take the EC further toward economic, monetary, and political union. Although the heart of the treaty deals with developing a unified European Market, Maastricht was also intended to increase integration among European Union (EU) members.
The EU has helped increase this integration by creating a borderless economy for the 28 European nations, shown on the map in .
European Union member states have set up common institutions to which they delegate some of their sovereignty so that decisions on specific matters of joint interest can be made democratically at the European level. This pooling of sovereignty is also called European integration. In 2016, citizens of the United Kingdom voted to leave the European Union, a plan known as Brexit, which could take several years to occur.
One of the principal objectives of the European Union is to promote economic progress of all member countries. The EU has stimulated economic progress by eliminating trade barriers, differences in tax laws, and differences in product standards, and by establishing a common currency. A new European Community Bank was created, along with a common currency called the euro. The European Union’s single market has created 2.5 million new jobs since it was founded and generated more than $1 trillion in new wealth. The opening of national EU markets has brought down the price of national telephone calls by 50 percent since 1998. Under pressure of competition, the prices of airfares in Europe have fallen significantly. The removal of national restrictions has enabled more than 15 million Europeans to go to another EU country to work or spend their retirement.
The EU is a very tough antitrust enforcer; some would say it is tougher than the United States. The EU, for example, fined Google $2.7 billion for favoring some of its own services in its search results. Unlike in the United States, the EU can seal off corporate offices for unspecified periods to prevent destruction of evidence and enter the homes, cars, yachts, and other personal property of executives suspected of abusing their companies’ market power or conspiring to fix prices.
Microsoft has been fighting the European Court since 2002, with no quick end in sight. The Court fined Microsoft for monopolizing internet access by offering Internet Explorer with its Windows software. The company is also appealing a Court decision requiring it to share code with “open source” companies. Another big U.S. company, Coca-Cola, settled a six-year antitrust dispute with the European Court by agreeing to strict limits on its sales tactics. Coke can’t sign exclusive agreements with retailers that would ban competing soft drinks or give retailers rebates based on sales volume. Furthermore, it must give rivals, like Pepsi, 20 percent of the space in Coke coolers so Pepsi can stock its own brands. If Coke violates the terms of the agreement, it will be fined 10 percent of its worldwide revenue (over $2 billion).
An entirely different type of problem facing global businesses is the possibility of a protectionist movement by the EU against outsiders. For example, European automakers have proposed holding Japanese imports at roughly their current 10 percent market share. The Irish, Danes, and Dutch don’t make cars and have unrestricted home markets; they are unhappy at the prospect of limited imports of Toyotas and Hondas. Meanwhile, France has a strict quota on Japanese cars to protect its own Renault and Peugeot. These local automakers could be hurt if the quota is raised at all.
Interestingly, a number of big U.S. companies are already considered more “European” than many European companies. Coke and Kellogg’s are considered classic European brand names. Ford and General Motors compete for the largest share of auto sales on the continent. Apple, IBM, and Dell dominate their markets. General Electric, AT&T, and Westinghouse are already strong all over Europe and have invested heavily in new manufacturing facilities there.
The European Union proposed a constitution that would centralize powers at the Union level and decrease the powers of individual member countries. It also would create a single voice in world affairs by creating a post of foreign minister. The constitution also gave the EU control over political asylum, immigration, guaranteed freedom of speech, and collective labor bargaining. In order to become law, each EU country had to ratify the constitution. The two most powerful countries in the EU, France and Germany, voted “no” in the summer of 2005. Citizens of both countries were afraid that the constitution would draw jobs away from Western Europe and to the Eastern European EU countries. These new members of the EU have lower wage rates and fewer regulations. Voters were also worried that the constitution would result in free-market reforms along American or British lines over France and Germany’s traditional social protections. Concerns over immigration also sparked the referendum vote that is leading to the United Kingdom leaving the European Union.

### Summary of Learning Outcomes

1. What are international economic communities?
International economic communities reduce trade barriers among themselves while often establishing common tariffs and other trade barriers toward nonmember countries. The best-known economic communities are the European Union, NAFTA, CAFTA, and Mercosur.


# Competing in the Global Marketplace

## Participating in the Global Marketplace

1. How do companies enter the global marketplace?
Companies decide to “go global” for a number of reasons. Perhaps the most urgent reason is to earn additional profits. If a firm has a unique product or technological advantage not available to other international competitors, this advantage should result in major business successes abroad. In other situations, management may have exclusive market information about foreign customers, marketplaces, or market situations. In this case, although exclusivity can provide an initial motivation for going global, managers must realize that competitors will eventually catch up. Finally, saturated domestic markets, excess capacity, and potential for cost savings can also be motivators to expand into international markets. A company can enter global trade in several ways, as this section describes.

### Exporting

When a company decides to enter the global market, usually the least complicated and least risky alternative is exporting, or selling domestically produced products to buyers in another country. A company, for example, can sell directly to foreign importers or buyers. Exporting is not limited to huge corporations such as General Motors or Apple. Indeed, small companies typically enter the global marketplace by exporting. China is the world’s largest exporter, followed by the United States. Many small businesses claim that they lack the money, time, or knowledge of foreign markets that exporting requires. The U.S. Small Business Administration (SBA) now offers the Export Working Capital Program, which helps small and medium-size firms obtain working capital (money) to complete export sales. The SBA also provides counseling and legal assistance for small businesses that wish to enter the global marketplace. Companies such as American Building Restoration Products of Franklin, Wisconsin, have benefited tremendously from becoming exporters. American Building is now selling its chemical products to building restoration companies in Mexico, Israel, Japan, and Korea. Exports account for more than 5 percent of the firm’s total sales.
Plenty of governmental help is available when a company decides to begin exporting. Export Assistance Centers (EAC) provide a one-stop resource for help in exporting. Over 700 EACs are placed strategically around the country. Often the SBA is located in the same building as the EAC. The SBA can guarantee loans of $50,000 to $100,000 to help an exporter grow its business. Online help is also available at http://www.ustr.gov. The site lists international trade events, offers international marketing research, and has practical tools to help with every step of the exporting process. Companies considering exporting for the first time can go to http://www.export.gov and get answers to questions such as: What’s in it for me? Am I ready for this? What do I have to do? The site also provides a huge list of resources for the first-time exporter.

### Licensing and Franchising

Another effective way for a firm to move into the global arena with relatively little risk is to sell a license to manufacture its product to a firm in a foreign country. Licensing is the legal process whereby a firm (the licensor) agrees to let another firm (the licensee) use a manufacturing process, trademark, patent, trade secret, or other proprietary knowledge. The licensee, in turn, agrees to pay the licensor a royalty or fee agreed on by both parties.
International licensing is a multibillion-dollar-a-year industry. Entertainment and character licensing, such as DVD movies and characters such as Batman, is the largest single category. Trademarks are the second-largest source of licensing revenue. Caterpillar licenses its brand for both shoes and clothing, which is very popular in Europe.
U.S. companies have eagerly embraced the licensing concept. For instance, Labatt Brewing Company has a license to produce Miller High Life in Canada. The Spalding Company receives more than $2 million annually from license agreements on its sporting goods. Fruit of the Loom lends its name through licensing to 45 consumer items in Japan alone, for at least 1 percent of the licensee’s gross sales.
The licensor must make sure it can exercise sufficient control over the licensee’s activities to ensure proper quality, pricing, distribution, and so on. Licensing may also create a new competitor in the long run if the licensee decides to void the license agreement. International law is often ineffective in stopping such actions. Two common ways that a licensor can maintain effective control over its licensees are by shipping one or more critical components from the United States and by locally registering patents and trademarks in its own name.
Franchising is a form of licensing that has grown rapidly in recent years. Many U.S. franchisors operate thousands of outlets in foreign countries. More than half of the international franchises are for fast-food restaurants and business services. McDonald’s, however, decided to sell its Chinese stores to a group of outside investors for $1.8 billion, but retained 20 percent of the equity.
Having a big-name franchise doesn’t always guarantee success or mean that the job will be easy. In China, Home Depot closed its stores after opening 12 to serve the large Chinese population. Had they done market research, they would have known that the majority of urban dwellers live in recently built apartments and that DIY (Do It Yourself) is viewed with disdain in Chinese society, where it is seen as a sign of poverty. When Subway opened its first sandwich shop in China, locals stood outside and watched for a few days. Patrons were so confused that the franchisee had to print signs explaining how to order. Customers didn’t believe the tuna salad was made from a fish because they couldn’t see the head or tail. And they didn’t like the idea of touching their food, so they would hold the sandwich vertically, peel off the paper wrap, and eat it like a banana. Most of all, the Chinese customers didn’t want sandwiches.
It’s not unusual for Western food chains to adapt their strategies when selling in China. McDonald’s, aware that the Chinese consume more chicken than beef, offered a spicy chicken burger. KFC got rid of coleslaw in favor of seasonal dishes such as shredded carrots or bamboo shoots.

### Contract Manufacturing

In contract manufacturing, a foreign firm manufactures private-label goods under a domestic firm’s brand. Marketing may be handled by either the domestic company or the foreign manufacturer. Levi Strauss, for instance, entered into an agreement with the French fashion house of Cacharel to produce a new Levi’s line, Something New, for distribution in Germany.
The advantage of contract manufacturing is that it lets a company test the water in a foreign country. By allowing the foreign firm to produce a certain volume of products to specification and put the domestic firm’s brand name on the goods, the domestic firm can broaden its global marketing base without investing in overseas plants and equipment. After establishing a solid base, the domestic firm may switch to a joint venture or direct investment, explained below.

### Joint Ventures

Joint ventures are somewhat similar to licensing agreements. In a joint venture, the domestic firm buys part of a foreign company or joins with a foreign company to create a new entity. A joint venture is a quick and relatively inexpensive way to enter the global market. It can also be very risky. Many joint ventures fail. Others fall victim to a takeover, in which one partner buys out the other.
Sometimes countries have required local partners in order to establish a business in their country. China, for example, had this requirement in a number of industries until recently. Thus, a joint venture was the only way to enter the market. Joint ventures help reduce risks by sharing costs and technology. Often joint ventures will bring together different strengths from each member. In the General Motors-Suzuki joint venture in Canada, for example, both parties have contributed and gained. The alliance, CAMI Automotive, was formed to manufacture low-end cars for the U.S. market. The plant, which was run by Suzuki management, produces the Chevrolet Equinox and the Pontiac Torrent, as well as the new Suzuki SUV. Through CAMI, Suzuki has gained access to GM’s dealer network and an expanded market for parts and components. GM avoided the cost of developing low-end cars and obtained models it needed to revitalize the lower end of its product line and its average fuel economy rating. After the successful joint venture, General Motors gained full control of the operation in 2011. The CAMI factory may be one of the most productive plants in North America. There GM has learned how Japanese automakers use work teams, run flexible assembly lines, and manage quality control.

### Direct Foreign Investment

Active ownership of a foreign company or of overseas manufacturing or marketing facilities is direct foreign investment. Direct investors have either a controlling interest or a large minority interest in the firm. Thus, they stand to receive the greatest potential reward but also face the greatest potential risk. A firm may make a direct foreign investment by acquiring an interest in an existing company or by building new facilities. It might do so because it has trouble transferring some resources to a foreign operation or obtaining that resource locally. One important resource is personnel, especially managers. If the local labor market is tight, the firm may buy an entire foreign firm and retain all its employees instead of paying higher salaries than competitors.
Sometimes firms make direct investments because they can find no suitable local partners. Also, direct investments avoid the communication problems and conflicts of interest that can arise with joint ventures. IBM, in the past, insisted on total ownership of its foreign investments because it did not want to share control with local partners.
General Motors has done very well by building a $4,400 (RMB 29,800) minivan in China that gets 43 miles per gallon in city driving. The Wuling Sunshine has a quarter the horsepower of U.S. minivans, weak acceleration, and a top speed of 81 miles per hour. The seats are only a third of the thickness of seats in Western models, but look plush compared to similar Chinese cars. The minivans have made GM the largest automotive seller in China, and have made China a large profit center for GM.
Walmart now has over 6,000 stores located outside the United States. In 2016, international sales were over $116 billion. About one-third of all new Walmart stores are opened in global markets.
Not all of Walmart’s global investments have been successful. In Germany, Walmart bought the 21-store Wertkauf hypermarket chain and then 74 unprofitable and often decrepit Interspar stores. Problems in integrating and upgrading the stores resulted in at least $200 million in losses. Like all other German stores, Walmart stores were required by law to close at 8 p.m. on weekdays and 4 p.m. on Saturdays, and they could not open at all on Sundays. Costs were astronomical. As a result, Walmart left the German retail market.
Walmart has turned the corner on its international operations. It is pushing operational authority down to country managers in order to respond better to local cultures. Walmart enforces certain core principles such as everyday low prices, but country managers handle their own buying, logistics, building design, and other operational decisions.
Global firms change their strategies as local market conditions evolve. For example, major oil companies like Shell Oil and ExxonMobil had to react to dramatic changes in the price of oil due to technological advances such as more efficient automobiles, fracking, and horizontal drilling.

### Countertrade

International trade does not always involve cash. Today, countertrade is a fast-growing way to conduct international business. In countertrade, part or all of the payment for goods or services is in the form of other goods or services. Countertrade is a form of barter (swapping goods for goods), an age-old practice whose origins have been traced back to cave dwellers. The U.S. Commerce Department says that roughly 30 percent of all international trade involves countertrade. Each year, about 300,000 U.S. firms engage in some form of countertrade. U.S. companies, including General Electric, Pepsi, General Motors, and Boeing, barter billions of goods and services every year. Recently, the Malaysian government bought 20 diesel-powered locomotives from China and paid for them with palm oil.

### Summary of Learning Outcomes

1. How do companies enter the global marketplace?
There are a number of ways to enter the global market. The major ones are exporting, licensing, contract manufacturing, joint ventures, and direct investment.


# Competing in the Global Marketplace

## Threats and Opportunities in the Global Marketplace

1. What threats and opportunities exist in the global marketplace?
To be successful in a foreign market, companies must fully understand the foreign environment in which they plan to operate. Politics, cultural differences, and the economic environment can represent both opportunities and pitfalls in the global marketplace.

### Political Considerations

We have already discussed how tariffs, exchange controls, and other governmental actions threaten foreign producers. The political structure of a country may also jeopardize a foreign producer’s success in international trade.
Intense nationalism, for example, can lead to difficulties. Nationalism is the sense of national consciousness that boosts the culture and interests of one country over those of all other countries. Strongly nationalistic countries, such as Iran and New Guinea, often discourage investment by foreign companies. In other, less radical forms of nationalism, the government may take actions to hinder foreign operations. France, for example, requires pop music stations to play at least 40 percent of their songs in French. This law was enacted because the French love American rock and roll. Without airtime, American music sales suffer. In another example of nationalism, U.S.-based PPG made an unsolicited bid to acquire Netherlands-based AzkoNobel NV. There was a chorus of opposition from Dutch politicians to the idea of a foreign takeover of AzkoNobel, the Dutch paint manufacturer. The government warned that it would move to defend AzkoNobel from a hostile takeover attempt. AzkoNobel played up the sentiment, tweeting about its rejection of the hostile takeover with the hashtag #DutchPride.
In a hostile climate, a government may expropriate a foreign company’s assets, taking ownership and compensating the former owners. Even worse is confiscation, when the owner receives no compensation. This happened during rebellions in several African nations during the 1990s and 2000s.

### Cultural Differences

Central to any society is the common set of values shared by its citizens that determine what is socially acceptable. Culture underlies the family, educational system, religion, and social class system. The network of social organizations generates overlapping roles and status positions. These values and roles have a tremendous effect on people’s preferences and thus on marketers’ options. For example, in China Walmart holds live fishing contests on the premises, and in South Korea the company hosts a food competition with variations on a popular Korean dish, kimchee.
Language is another important aspect of culture. Marketers must take care in selecting product names and translating slogans and promotional messages so as not to convey the wrong meaning. For example, Mitsubishi Motors had to rename its Pajero model in Spanish-speaking countries because the term refers to a sexual activity. Toyota Motor’s MR2 model dropped the 2 in France because the combination sounds like a French swear word. The literal translation of Coca-Cola in Chinese characters means “bite the wax tadpole.”
Each country has its own customs and traditions that determine business practices and influence negotiations with foreign customers. For example, attempting to do business in Western Europe during the first two weeks in August is virtually impossible. Businesses close, and everyone goes on vacation at the same time. In many countries, personal relationships are more important than financial considerations. For instance, skipping social engagements in Mexico may lead to lost sales. Negotiations in Japan often include long evenings of dining, drinking, and entertaining; only after a close personal relationship has been formed do business negotiations begin.  presents some cultural dos and don’ts.

### Economic Environment

The level of economic development varies considerably, ranging from countries where everyday survival is a struggle, such as Sudan and Eritrea, to countries that are highly developed, such as Switzerland and Japan. In general, complex, sophisticated industries are found in developed countries, and more basic industries are found in less developed nations. Average family incomes are higher in the more developed countries than in the least-developed markets. Larger incomes mean greater purchasing power and demand, not only for consumer goods and services but also for the machinery and workers required to produce consumer goods.  provides a glimpse of global wealth.
Business opportunities are usually better in countries that have an economic infrastructure in place. Infrastructure is the basic institutions and public facilities upon which an economy’s development depends. When we think about how our own economy works, we tend to take our infrastructure for granted. It includes the money and banking system that provide the major investment loans to our nation’s businesses; the educational system that turns out the incredible varieties of skills and basic research that actually run our nation’s production lines; the extensive transportation and communications systems—interstate highways, railroads, airports, canals, telephones, internet sites, postal systems, and television stations—that link almost every piece of our geography into one market; the energy system that powers our factories; and, of course, the market system itself, which brings our nation’s goods and services into our homes and businesses.

### Summary of Learning Outcomes

1. What threats and opportunities exist in the global marketplace?
Domestic firms entering the international arena need to consider the politics, economies, and culture of the countries where they plan to do business. For example, government trade policies can be loose or restrictive, countries can be nationalistic, and governments can change. In the area of culture, many products fail because companies don’t understand the culture of the country where they are trying to sell their products. Some developing countries also lack an economic infrastructure, which often makes it very difficult to conduct business.


# Competing in the Global Marketplace

## The Impact of Multinational Corporations

1. What are the advantages of multinational corporations?
Corporations that move resources, goods, services, and skills across national boundaries without regard to the country in which their headquarters are located are multinational corporations. Some are so rich and have so many employees that they resemble small countries. For example, the sales of both Exxon and Walmart are larger than the GDP of all but a few nations in the world. Multinational companies are heavily engaged in international trade. The successful ones take political and cultural differences into account.
Many global brands sell much more outside the United States than at home. Coca-Cola, Philip Morris’s Marlboro brand, Pepsi, Kellogg, Pampers, Nescafe, and Gillette, are examples.
The Fortune 500 made over $1.5 trillion in profit in 2016. In slow-growing, developed economies like Europe and Japan, a weaker dollar helps, because it means cheaper products to sell into those markets, and profits earned in those markets translate into more dollars back home. Meanwhile, emerging markets in Asia, Latin America, and Eastern Europe are growing steadily. General Electric expects 60 percent of its revenue growth to come from emerging markets over the next decade. For Brown-Forman, the spirits company, a fifth of its sales growth of Jack Daniels, the Tennessee whiskey, is coming from developing markets like Mexico and Poland. IBM had rapid sales growth in emerging markets such as Russia, India, and Brazil.
The largest multinational corporations in the world are shown in .
Despite the success of American multinationals abroad, there is some indication that preference for U.S. brands may be slipping.

### The Multinational Advantage

Large multinationals have several advantages over other companies. For instance, multinationals can often overcome trade problems. Taiwan and South Korea have long had an embargo against Japanese cars for political reasons and to help domestic automakers. Yet Honda USA, a Japanese-owned company based in the United States, sends Accords to Taiwan and Korea. In another example, when the environmentally conscious Green movement challenged the biotechnology research conducted by BASF, a major German chemical and drug manufacturer, BASF moved its cancer and immune-system research to Cambridge, Massachusetts.
Another advantage for multinationals is their ability to sidestep regulatory problems. U.S. drugmaker SmithKline and Britain’s Beecham decided to merge in part so that they could avoid licensing and regulatory hassles in their largest markets. The merged company can say it’s an insider in both Europe and the United States. “When we go to Brussels, we’re a member state [of the European Union],” one executive explains. “And when we go to Washington, we’re an American company.”
Multinationals can also shift production from one plant to another as market conditions change. When European demand for a certain solvent declined, Dow Chemical instructed its German plant to switch to manufacturing a chemical that had been imported from Louisiana and Texas. Computer models help Dow make decisions like these so it can run its plants more efficiently and keep costs down.
Multinationals can also tap new technology from around the world. In the United States, Xerox has introduced some 80 different office copiers that were designed and built by Fuji Xerox, its joint venture with a Japanese company. Versions of the super-concentrated detergent that Procter & Gamble first formulated in Japan in response to a rival’s product are now being sold under the Ariel brand name in Europe and under the Cheer and Tide labels in the United States. Also, consider Otis Elevator’s development of the Elevonic 411, an elevator that is programmed to send more cars to floors where demand is high. It was developed by six research centers in five countries. Otis’s group in Farmington, Connecticut, handled the systems integration, a Japanese group designed the special motor drives that make the elevators ride smoothly, a French group perfected the door systems, a German group handled the electronics, and a Spanish group took care of the small-geared components. Otis says the international effort saved more than $10 million in design costs and cut the process from four years to two.
Finally, multinationals can often save a lot in labor costs, even in highly unionized countries. For example, when Xerox started moving copier-rebuilding work to Mexico to take advantage of the lower wages, its union in Rochester, New York, objected because it saw that members’ jobs were at risk. Eventually, the union agreed to change work styles and to improve productivity to keep the jobs at home.

### Summary of Learning Outcomes

1. What are the advantages of multinational corporations?
Multinational corporations have several advantages. First, they can sidestep restrictive trade and licensing restrictions because they frequently have headquarters in more than one country. Multinationals can also move their operations from one country to the next depending on which location offers more favorable economic conditions. In addition, multinationals can tap into a vast source of technological expertise by drawing upon the knowledge of a global workforce.


# Competing in the Global Marketplace

## Trends in Global Competition

1. What are the trends in the global marketplace?
In this section, we will examine several underlying trends that will continue to propel the dramatic growth in world trade. These trends are market expansion, resource acquisition, and the emergence of China and India.

### Market Expansion

The need for businesses to expand their markets is perhaps the most fundamental reason for the growth in world trade. The limited size of domestic markets often motivates managers to seek markets beyond their national frontiers. The economies of large-scale manufacturing demand big markets. Domestic markets, particularly in smaller countries like Denmark and the Netherlands, simply can’t generate enough demand. Nestlé was one of the first businesses to “go global” because its home country, Switzerland, is so small. Nestlé was shipping milk to 16 different countries as early as 1875. Today, hundreds of thousands of businesses are recognizing the potential rich rewards to be found in international markets.

### Resource Acquisition

More and more companies are going to the global marketplace to acquire the resources they need to operate efficiently. These resources may be cheap or skilled labor, scarce raw materials, technology, or capital. Nike, for example, has manufacturing facilities in many Asian countries in order to use cheaper labor. Honda opened a design studio in southern California to put that “California flair” into the design of some of its vehicles. Large multinational banks such as Bank of New York and Citigroup have offices in Geneva, Switzerland. Geneva is the private banking center of Europe and attracts capital from around the globe.

### The Emergence of China and India

China and India—two of the world’s economic powerhouses—are impacting businesses around the globe, in very different ways. The boom in China’s worldwide exports has left few sectors unscathed, be they garlic growers in California, jeans makers in Mexico, or plastic-mold manufacturers in South Korea. India’s impact has altered how hundreds of service companies from Texas to Ireland compete for billions of dollars in contracts.
The causes and consequences of each nation’s growth are somewhat different. China’s exports have boomed largely thanks to foreign investment: lured by low labor costs, big manufacturers have surged into China to expand their production base and push down prices globally. Now manufacturers of all sizes, making everything from windshield wipers to washing machines to clothing, are scrambling either to reduce costs at home or to outsource more of what they make in cheaper locales such as China and India.
Indians are playing invaluable roles in the global innovation chain. Hewlett-Packard, Cisco Systems, and other tech giants now rely on their Indian teams to devise software platforms and multimedia features for next-generation devices. Google principal scientist Krishna Bharat set up the Google Bangalore lab complete with colorful furniture, exercise balls, and a Yamaha organ—like Google’s Mountain View, California, headquarters—to work on core search-engine technology. Indian engineering houses use 3-D computer simulations to tweak designs of everything from car engines and forklifts to aircraft wings for such clients as General Motors Corp. and Boeing Co. Barring unforeseen circumstances, within five years India should vault over Germany as the world’s fourth-biggest economy. By mid-century, China should overtake the United States as number one. By then, China and India could account for half of global output.
An accelerating trend is that technical and managerial skills in both China and India are becoming more important than cheap assembly labor. China will stay dominant in mass manufacturing and is one of the few nations building multibillion-dollar electronics and heavy industrial plants. India is a rising power in software, design, services, and precision industry.

### Summary of Learning Outcomes

1. What are the trends in the global marketplace?
Global business activity will continue to escalate due to several factors. Firms that desire a larger customer base or need additional resources will continue to seek opportunities outside their country’s borders. China and India are emerging as global economic powerhouses.

### Preparing for Tomorrow’s Workplace Skills

1. How can a country’s customs create barriers to trade? Ask foreign students to describe such barriers in their country. American students should give examples of problems that foreign businesspeople might experience with American customs. (Information)
2. Should the United Kingdom exit the European Union? Why might Britain not wish to exit? (Systems)
3. Do you think that CAFTA will have a major impact on the U.S. economy? Why? (Systems)
4. What do you think is the best way for a small company to enter international trade? Why? (Information)
5. How can the United States compete against China and India in the long run? (Information)
6. Identify some U.S. multinational companies that have been successful in world markets. How do you think they have achieved their success? (Information)
7. Team Activity Divide the class into teams. Each team should choose a country and research its infrastructure to determine how it will help or hinder trade. Include a variety of countries, ranging from the most highly developed to the least developed. (Resources, Interpersonal, Information, Technology)

### Ethics Activity

The executives of a clothing manufacturer want to outsource some of their manufacturing to more cost-efficient locations in Indonesia. After visiting several possible sites, they choose one and begin to negotiate with local officials. They discover that it will take about six months to get the necessary permits. One of the local politicians approaches the executives over dinner and hints that he can speed up the process for an advisory fee of $5,000.
Using a web search tool, locate articles about this topic, and then write responses to the following questions. Be sure to support your arguments and cite your sources.
Ethical Dilemma: Is paying the advisory fee a bribe or an acceptable cost of doing business in that area of the world? What should the executives do before agreeing to pay the fee?
Sources: Eric Markowitz, “The Truth about Bribery and Doing Foreign Business,” Inc., https://www.inc.com, accessed March 19, 2018; Roberto A. Ferdman, “How the World’s Biggest Companies Bribe Foreign Governments,” The Washington Post, https://www.washingtonpost.com, accessed March 19, 2018; David Rising, “The 10 Countries Most Likely to Use Bribery in Business,” Huffington Post, https://www.huffingtonpost.com, accessed March 19, 2018.

### Working the Net

1. Go to the Trade Compliance Center site at http://tcc.export.gov. Click on Foreign Trade Barrier Examples, and then search the reports. Pick a country that interests you from the index, and read the most current available reports for that country. Would this country be a good market for a small U.S. motor scooter manufacturer interested in expanding internationally? Why or why not? What are the main barriers to trade the company might face?
2. While still at the Trade Compliance Center site, http://tcc.export.gov, click on Trade Agreements and then List All Agreements. Select one that interests you, and summarize what you learn about it.
3. Review the historical data about exchange rates between the U.S. dollar and the Japanese yen available at http://www.x-rates.com. Pull up charts comparing the yen to the dollar for several years. List any trends you spot. What years would have been best for a U.S. company to enter the Japanese marketplace? Given current exchange rate conditions, do you think Japanese companies are increasing or decreasing their exporting efforts in the United States?
4. Visit Foreign Trade Online, http://www.foreign-trade.com, and browse through the resources of this international business-to-business trade portal. What types of information does the site provide? Which would be most useful to a company looking to begin exporting? To a company who already exports and wants to find new markets? Rate the usefulness of the site and the information it offers.
5. Go to http://www.fita.org, which is the Federation of International Trade Associations. Click on Really Useful Links for International Trade. Follow five of those links, and explain how they would help a U.S. manufacturer that wanted to go global.
6. Go to the World Trade Organization site at http://www.wto.org. Next, click on WTO News. Inform the class about current activities and actions at the WTO.
7. Go to http://www.worldbank.org and then to http://www.imf.org. Compare the types of information available on each website. Pick one example from each site, and report your findings to the class.

### Creative Thinking Case

### We Want Our MTV (International)

MTV, a division of Viacom International Media Networks and a mainstay of American pop culture, is just as popular in Shanghai as it is in Seattle and Sydney, or in Lagos (Nigeria) as it is in Los Angeles. MTV is a division of Viacom, and their international divisions are called the Viacom International Media Networks. London-based MTV Networks International, the world’s largest global network, has taken its winning formula to 167 foreign markets on six continents, including urban and rural areas. It reaches 4 billion homes in 40 languages through locally programmed and locally operated TV channels and websites. While the United States currently generates about 70 percent of MTV’s profits, 85 percent of the company’s subscriber base lives outside the United States.
The MTV brand has evolved beyond its music television roots into a multimedia lifestyle, entertainment, and culture brand for all ages. In addition to MTV and MTV2, its channel lineup includes Nickelodeon, VH1, Comedy Central, LOGO, TMF (The Music Factory), Game One, and several European music, comedy, and lifestyle channels, as well as Paramount Channel, Spike, and a growing number of flagship local networks such as Channel 5 in the UK, Telefe in Argentina, and COLORS in India. Adding to the complexity is MTV’s multimedia and interactive nature, with gaming, texting, and websites, as well as television. Another challenge is integrating acquisitions of local companies such as South American Telefe, which it purchased in 2016.
The company also has an international insights team that gathers the latest consumer insights from around the world. You can get some insight into this initiative at https://insights.viacom.com. The local perspective is invaluable in helping the network understand its markets, whether in terms of musical tastes or what entertainment children like. For example, Alex Okosi, a Nigerian who went to college in the United States, is chief executive for MTV Base, which launched in sub-Saharan Africa in 2005. Okosi recommended that MTV consider each country as an individual market, rather than blending them all together.
One reason for MTVNI’s success is “glocalization”—its ability to adapt programs to fit local cultures while still maintaining a consistent, special style. “When we set a channel up, we always provide a set of parameters in terms of standards of things we require,” an MTV executive explains. “Obviously an MTV channel that doesn’t look good enough is not going to do the business for us, let alone for the audience. There’s a higher expectation.” Then the local unit can tailor content to its market. MTV India conveys a “sense of the colorful street culture,” explains Bill Roedy, former MTV Networks International president, while MTV Japan has “a sense of technology edginess; MTV Italy, style and elegance.” In Africa, MTV Base features videos from top African artists as well as from emerging African music talent. According to company executives, the goal is to “provide a unique cultural meeting point for young people in Africa, using the common language of music to connect music fans from different backgrounds and cultures.”
2. Do you think that MTV’s future lies mostly in its international operations? Explain your reasoning.
3. What types of political, economic, and competitive challenges does MTV Networks International face by operating worldwide?
4. How has MTV Networks International overcome cultural differences to create a world brand?
Sources: MTV Viacom Blog, http://blog.viacom.com, accessed June 30, 2017; MTV International website, http://www.mtv.com/, accessed June 30, 2017; MTV Consumer Insights website, https://insights.viacom.com, accessed June 30, 2017.

### Hot Links Address Book

1. A good starting place for help in doing business in foreign markets is the U.S. government’s export portal. Here you will find links to export basics, regulations, exchange rates, country and industry research, and much more. http://www.export.gov
2. For links to a wealth of statistics on world trade, go to the U.S. International Trade Administration’s (ITA) Office of Trade and Economic Analysis website, http://www.ita.doc.gov.
3. Check out the current U.S. balance of trade with various countries at http://www.bea.gov.
4. Get up-to-the-minute exchange rates at http://www.xe.com.
5. The World Trade Organization tracks the latest trade developments between countries and regions around the world. For the most recent global trading news, visit the WTO’s website at http://www.wto.org.
6. Gain additional insight into the workings of the International Monetary Fund at http://www.imf.org.
7. For the latest information about NAFTA, visit http://www.naftanow.org.
8. Think you’d like to work overseas? For information about jobs in foreign countries, visit http://www.internationaljobs.com.


# Forms of Business Ownership

## Introduction

### Learning Outcomes

After reading this chapter, you should be able to answer these questions:
1. What are the advantages and disadvantages of the sole proprietorship form of business organization?
2. What are the advantages of operating as a partnership, and what downside risks should partners consider?
3. How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations?
4. What other options for business organization does a company have in addition to sole proprietorships, partnerships, and corporations?
5. What makes franchising an appropriate form of organization for some types of business, and why does it continue to grow in importance?
6. Why are mergers and acquisitions important to a company’s overall growth?
7. What current trends will affect the business organizations of the future?
This chapter discusses sole proprietorships, as well as several other forms of business ownership, including partnerships and corporations, and compares the advantages and disadvantages of each.
With a good idea and some cash in hand, you decide to start a business. But before you get going, you need to ask yourself some questions that will help you decide what form of business organization will best suit your needs.
Would you prefer to go it alone as a sole proprietorship, or do you want others to share your burdens and challenges in a partnership? Or would the limited liability protection of a corporation, or perhaps the flexibility of a limited liability company (LLC), make more sense?
There are other questions you need to consider too: Will you need financing? How easy will it be to obtain? Will you attract employees? How will the business be taxed, and who will be liable for the company’s debts? If you choose to share ownership with others, how much operating control would they want, and what costs would be associated with that?
As  illustrates, sole proprietorships are the most popular form of business ownership, accounting for 72 percent of all businesses, compared with 10 percent for partnerships and 18 percent for corporations. Because most sole proprietorships and partnerships remain small, corporations generate approximately 81 percent of total business revenues and 58 percent of total profits.
Most start-up businesses select one of these major ownership forms. In the following pages, we will discover the advantages and disadvantages of each form of business ownership and the factors that may make it necessary to change from one form of organization to another as the needs of the business change. As a company expands from small to midsize or larger, the form of business structure selected in the beginning may no longer be appropriate.


# Forms of Business Ownership

## Going It Alone: Sole Proprietorships

1. What are the advantages and disadvantages of the sole proprietorship form of business organization?
Jeremy Shepherd was working full-time for an airline when, at the age of 22, he wandered into an exotic pearl market in China, searching for a gift for his girlfriend. The strand of pearls he handpicked by instinct was later valued by a jeweler back in the States at 20 times what he paid for it. Jeremy cashed his next paycheck and hurried back to Asia, buying every pearl he could afford. Founded in 1996, his company Pearl Paradise was brought online in 2000. Shepherd chose the sole proprietorship form of business organization—a business that is established, owned, operated, and often financed by one person—because it was the easiest to set up. He did not want partners, and low liability exposure made incorporating unnecessary.
Fluent in Mandarin Chinese, Japanese, and Spanish and immersed in Asian culture, Shepherd believed the internet was the way to market his pearls (http://www.pearlparadise.com). Offering a wide range of pearl jewelry through 14 websites worldwide, his company sells as many as 1,000 items per day. The recent addition of an exclusive Los Angeles showroom allows celebrity customers to shop by appointment. With $20 million in sales annually, PearlParadise.com is the industry leader in terms of sales and volume.

### Advantages of Sole Proprietorships

Sole proprietorships have several advantages that make them popular:
1. Easy and inexpensive to form. As Jeremy Shepherd discovered, sole proprietorships have few legal requirements (local licenses and permits) and are not expensive to form, making them the business organization of choice for many small companies and start-ups.
2. Profits all go to the owner. The owner of a sole proprietorship obtains the start-up funds and gets all the profits earned by the business. The more efficiently the firm operates, the higher the company’s profitability.
3. Direct control of the business. All business decisions are made by the sole proprietorship owner without having to consult anyone else.
4. Freedom from government regulation. Sole proprietorships have more freedom than other forms of business with respect to government controls.
5. No special taxation. Sole proprietorships do not pay special franchise or corporate taxes. Profits are taxed as personal income as reported on the owner’s individual tax return.
6. Ease of dissolution. With no co-owners or partners, the sole proprietor can sell the business or close the doors at any time, making this form of business organization an ideal way to test a new business idea.

### Disadvantages of Sole Proprietorships

Along with the freedom to operate the business as they wish, sole proprietors face several disadvantages:
1. Unlimited liability. From a legal standpoint, the sole proprietor and the company are one and the same, making the business owner personally responsible for all debts the company incurs, even if they exceed the company’s value. The owner may need to sell other personal property—their car, home, or other investments—to satisfy claims against the business.
2. Difficulty raising capital. Business assets are unprotected against claims of personal creditors, so business lenders view sole proprietorships as high risk due to the owner’s unlimited liability. Owners must often use personal funds—borrowing on credit cards, second-mortgaging their homes, or selling investments—to finance their business. Expansion plans can also be affected by an inability to raise additional funding.
3. Limited managerial expertise. The success of a sole proprietorship rests solely with the skills and talents of the owner, who must wear many different hats and make all decisions. Owners are often not equally skilled in all areas of running a business. A graphic designer may be a wonderful artist but not know bookkeeping, how to manage production, or how to market their work.
4. Trouble finding qualified employees. Sole proprietors often cannot offer the same pay, fringe benefits, and advancement as larger companies, making them less attractive to employees seeking the most favorable employment opportunities.
5. Personal time commitment. Running a sole proprietorship business requires personal sacrifices and a huge time commitment, often dominating the owner’s life with 12-hour workdays and 7-day workweeks.
6. Unstable business life. The life span of a sole proprietorship can be uncertain. The owner may lose interest, experience ill health, retire, or die. The business will cease to exist unless the owner makes provisions for it to continue operating or puts it up for sale.
7. Losses are the owner’s responsibility. The sole proprietor is responsible for all losses, although tax laws allow these to be deducted from other personal income.
The sole proprietorship may be a suitable choice for a one-person start-up operation with no employees and little risk of liability exposure. For many sole proprietors, however, this is a temporary choice, and as the business grows, the owner may be unable to operate with limited financial and managerial resources. At this point, the owner may decide to take in one or more partners to ensure that the business continues to flourish.

### Summary of Learning Outcomes

1. What are the advantages and disadvantages of the sole proprietorship form of business organization?
The advantages of sole proprietorships include ease and low cost of formation, the owner’s rights to all profits, the owner’s control of the business, relative freedom from government regulation, absence of special taxes, and ease of dissolution. Disadvantages include owner’s unlimited liability for debts and personal absorption of all losses, difficulty in raising capital, limited managerial expertise, difficulty in finding qualified employees, large personal time commitment, and unstable business life.


# Forms of Business Ownership

## Partnerships: Sharing the Load

1. What are the advantages of operating as a partnership, and what downside risks should partners consider?
Can partnerships, an association of two or more individuals who agree to operate a business together for profit, be hazardous to a business’s health? Let’s assume partners Ron and Liz own a stylish and successful beauty salon. After a few years of operating the business, they find they have contrasting visions for their company. Liz is happy with the status quo, while Ron wants to expand the business by bringing in investors and opening salons in other locations.
How do they resolve this impasse? By asking themselves some tough questions. Whose view of the future is more realistic? Does the business actually have the expansion potential Ron believes it does? Where will he find investors to make his dream of multiple locations a reality? Is he willing to dissolve the partnership and start over again on his own? And who would have the right to their clients?
Ron realizes that expanding the business in line with his vision would require a large financial risk and that his partnership with Liz offers many advantages he would miss in a sole proprietorship form of business organization. After much consideration, he decides to leave things as they are.
For those individuals who do not like to “go it alone,” a partnership is relatively simple to set up. Offering a shared form of business ownership, it is a popular choice for professional-service firms such as lawyers, accountants, architects, stockbrokers, and real estate companies.
The parties agree, either orally or in writing, to share in the profits and losses of a joint enterprise. A written partnership agreement, spelling out the terms and conditions of the partnership, is recommended to prevent later conflicts between the partners. Such agreements typically include the name of the partnership, its purpose, and the contributions of each partner (financial, asset, skill/talent). It also outlines the responsibilities and duties of each partner and their compensation structure (salary, profit sharing, etc.). It should contain provisions for the addition of new partners, the sale of partnership interests, and procedures for resolving conflicts, dissolving the business, and distributing the assets.
There are two basic types of partnerships: general and limited. In a general partnership, all partners share in the management and profits. They co-own the assets, and each can act on behalf of the firm. Each partner also has unlimited liability for all the business obligations of the firm. A limited partnership has two types of partners: one or more general partners, who have unlimited liability, and one or more limited partners, whose liability is limited to the amount of their investment. In return for limited liability, limited partners agree not to take part in the day-to-day management of the firm. They help to finance the business, but the general partners maintain operational control.
There are also limited liability partnerships (LLP), which are similar to a general partnership except that partners are not held responsible for the business debt and liabilities. Another type is a limited liability limited partnership (LLLP), which is basically a limited partnership with addition of limited liability, hence protecting the general partner from the debt and liabilities of the partnership.

### Advantages of Partnerships

Some advantages of partnerships come quickly to mind:
1. Ease of formation. Like sole proprietorships, partnerships are easy to form. The partners agree to do business together and draw up a partnership agreement. For most partnerships, applicable state laws are not complex.
2. Availability of capital. Because two or more people contribute financial resources, partnerships can raise funds more easily for operating expenses and business expansion. The partners’ combined financial strength also increases the firm’s ability to raise funds from outside sources.
3. Diversity of skills and expertise. Partners share the responsibilities of managing and operating the business. Combining partner skills to set goals, manage the overall direction of the firm, and solve problems increases the chances for the partnership’s success. To find the right partner, you must examine your own strengths and weaknesses and know what you need from a partner. Ideal partnerships bring together people with complementary backgrounds rather than those with similar experience, skills, and talents. In  you’ll find some advice on choosing a partner.
4. Flexibility. General partners are actively involved in managing their firm and can respond quickly to changes in the business environment.
5. No special taxes. Partnerships pay no income taxes. A partnership must file a partnership return with the Internal Revenue Service, reporting how profits or losses were divided among the partners. Each partner’s profit or loss is then reported on the partner’s personal income tax return, with any profits taxed at personal income tax rates.
6. Relative freedom from government control. Except for state rules for licensing and permits, the government has little control over partnership activities.

### Disadvantages of Partnerships

Business owners must consider the following disadvantages of setting up their company as a partnership:
1. Unlimited liability. All general partners have unlimited liability for the debts of the business. In fact, any one partner can be held personally liable for all partnership debts and legal judgments (such as malpractice)—regardless of who caused them. As with sole proprietorships, business failure can lead to a loss of the general partners’ personal assets. To overcome this problem, many states now allow the formation of limited liability partnerships (LLPs), which protect each individual partner from responsibility for the acts of other partners and limit their liability to harm resulting from their own actions.
2. Potential for conflicts between partners. Partners may have different ideas about how to run their business, which employees to hire, how to allocate responsibilities, and when to expand. Differences in personalities and work styles can cause clashes or breakdowns in communication, sometimes requiring outside intervention to save the business.
3. Complexity of profit sharing. Dividing the profits is relatively easy if all partners contribute equal amounts of time, expertise, and capital. But if one partner puts in more money and others more time, it might be more difficult to arrive at a fair profit-sharing formula.
4. Difficulty exiting or dissolving a partnership. As a rule, partnerships are easier to form than to leave. When one partner wants to leave, the value of their share must be calculated. To whom will that share be sold, and will that person be acceptable to the other partners? If a partner who owns more than 50 percent of the entity withdraws, dies, or becomes disabled, the partnership must reorganize or end. To avoid these problems, most partnership agreements include specific guidelines for transferring partnership interests and buy–sell agreements that make provision for surviving partners to buy a deceased partner’s interest. Partners can also purchase special life insurance policies designed to fund such a purchase.
Business partnerships are often compared to marriages. As with a marriage, choosing the right partner is critical. So if you are considering forming a partnership, allow plenty of time to evaluate your and your potential partner’s goals, personality, expertise, and working style before joining forces.

### Summary of Learning Outcomes

1. What are the advantages of operating as a partnership, and what downside risks should partners consider?
The advantages of partnerships include ease of formation, availability of capital, diversity of managerial skills and expertise, flexibility to respond to changing business conditions, no special taxes, and relative freedom from government control. Disadvantages include unlimited liability for general partners, potential for conflict between partners, sharing of profits, and difficulty exiting or dissolving the partnership. Partnerships can be formed as either general or limited partnerships. In a general partnership, the operations of the business are controlled by one or more general partners with unlimited liability. The partners co-own the assets and share the profits. Each partner is individually liable for all debts and contracts of the partnership. In a limited partnership, the limited partners are financial partners whose liability is limited to their investment; they do not participate in the firm’s operations.


# Forms of Business Ownership

## Corporations: Limiting Your Liability

1. How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations?
When people think of corporations, they typically think of major, well-known companies, such as Apple, Alphabet (parent company of Google), Netflix, IBM, Microsoft, Boeing, and General Electric. But corporations range in size from large multinationals with thousands of employees and billions of dollars in sales to midsize or even smaller firms with few employees and revenues under $25,000.
A corporation is a legal entity subject to the laws of the state in which it is formed, where the right to operate as a business is issued by state charter. A corporation can own property, enter into contracts, sue and be sued, and engage in business operations under the terms of its charter. Unlike sole proprietorships and partnerships, corporations are taxable entities with a life separate from their owners, who are not personally liable for its debts.
When launching her company, Executive Property Management Services, Inc., 32-year-old Linda Ravden realized she needed the liability protection of the corporate form of business organization. Her company specialized in providing customized property management services to mid- and upper-level corporate executives on extended work assignments abroad, often for three to five years or longer. Taking care of substantial properties in the million-dollar range and above was no small responsibility for Ravden’s company. Therefore, the protection of a corporate business structure, along with carefully detailed contracts outlining the company’s obligations, were crucial in providing Ravden with the liability protection she needed—and the peace of mind to focus on running her business without constant worry. Note that an LLC does not provide unlimited protection; you can still get in trouble for such things as mingling personal and business funds.
Corporations play an important role in the U.S. economy. As  demonstrated, corporations account for only 18 percent of all businesses but generate 81 percent of all revenues and 58 percent of all profits. Company type and size vary; however, when you look at the top companies by revenue in the United States or globally, they include many familiar names that affect our daily lives.
In the United States, according to  magazine, the top three corporations in the 2017 were (1) Walmart Stores (revenue: $485.9 B), (2) Berkshire Hathaway (revenue: $223.6 B), and (3) Apple (revenue: $215.6 B), whereas  magazine found that the top three corporations were (1) Berkshire Hathaway (revenue: $222.9B), (2) Apple (revenue: $217.5B), and (3) JPMorgan Chase (revenue: $102.5B). By comparison, the top three companies in 2017 according to the  were (1) Apple, (2) Alphabet, and (3) Microsoft. These corporations rise and fall on the various lists based on their revenue in a given year and how the organizations measure revenue and the time frames that they use.

### The Incorporation Process

Setting up a corporation is more complex than starting a sole proprietorship or partnership. Most states base their laws for chartering corporations on the Model Business Corporation Act of the American Bar Association, although registration procedures, fees, taxes, and laws that regulate corporations vary from state to state.
A firm does not have to incorporate in the state where it is based and may benefit by comparing the rules of several states before choosing a state of incorporation. Although Delaware is a small state with few corporations actually based there, its procorporate policies make it the state of incorporation for many companies, including about half the Fortune 500. Incorporating a company involves five main steps:
1. Selecting the company’s name
2. Writing the articles of incorporation (see ) and filing them with the appropriate state office, usually the secretary of state
3. Paying required fees and taxes
4. Holding an organizational meeting
5. Adopting bylaws, electing directors, and passing the first operating resolutions
The state issues a corporate charter based on information in the articles of incorporation. Once the corporation has its charter, it holds an organizational meeting to adopt bylaws, elect directors, and pass initial operating resolutions. Bylaws provide legal and managerial guidelines for operating the firm.

### The Corporate Structure

As  shows, corporations have their own organizational structure with three important components: stockholders, directors, and officers.
Stockholders (or shareholders) are the owners of a corporation, holding shares of stock that provide them with certain rights. They may receive a portion of the corporation’s profits in the form of dividends, and they can sell or transfer their ownership in the corporation (represented by their shares of stock) at any time. Stockholders can attend annual meetings, elect the board of directors, and vote on matters that affect the corporation in accordance with its charter and bylaws. Each share of stock generally carries one vote.
The stockholders elect a board of directors to govern and handle the overall management of the corporation. The directors set major corporate goals and policies, hire corporate officers, and oversee the firm’s operations and finances. Small firms may have as few as 3 directors, whereas large corporations usually have 10 to 15.
The boards of large corporations typically include both corporate executives and outside directors (not employed by the organization) chosen for their professional and personal expertise. Outside directors often bring a fresh view to the corporation’s activities because they are independent of the firm.
Hired by the board, the officers of a corporation are its top management and include the president and chief executive officer (CEO), vice presidents, treasurer, and secretary, who are responsible for achieving corporate goals and policies. Officers may also be board members and stockholders.

### Advantages of Corporations

The corporate structure allows companies to merge financial and human resources into enterprises with great potential for growth and profits:
1. Limited liability. A key advantage of corporations is that they are separate legal entities that exist apart from their owners. Owners’ (stockholders’) liability for the obligations of the firm is limited to the amount of the stock they own. If the corporation goes bankrupt, creditors can look only to the assets of the corporation for payment.
2. Ease of transferring ownership. Stockholders of public corporations can sell their shares at any time without affecting the status of the corporation.
3. Unlimited life. The life of a corporation is unlimited. Although corporate charters specify a life term, they also include rules for renewal. Because the corporation is an entity separate from its owners, the death or withdrawal of an owner does not affect its existence, unlike a sole proprietorship or partnership.
4. Tax deductions. Corporations are allowed certain tax deductions, such as operating expenses, which reduces their taxable income.
5. Ability to attract financing. Corporations can raise money by selling new shares of stock. Dividing ownership into smaller units makes it affordable to more investors, who can purchase one or several thousand shares. The large size and stability of corporations also helps them get bank financing. All these financial resources allow corporations to invest in facilities and human resources and expand beyond the scope of sole proprietorships or partnerships. It would be impossible for a sole proprietorship or partnership to make automobiles, provide nationwide telecommunications, or build oil or chemical refineries.

### Disadvantages of Corporations

Although corporations offer companies many benefits, they have some disadvantages:
1. Double taxation of profits. Corporations must pay federal and state income taxes on their profits. In addition, any profits (dividends) paid to stockholders are taxed as personal income, although at a somewhat reduced rate.
2. Cost and complexity of formation. As outlined earlier, forming a corporation involves several steps, and costs can run into thousands of dollars, including state filing, registration, and license fees, as well as the cost of attorneys and accountants.
3. More government restrictions. Unlike sole proprietorships and partnerships, corporations are subject to many regulations and reporting requirements. For example, corporations must register in each state where they do business and must also register with the Securities and Exchange Commission (SEC) before selling stock to the public. Unless it is closely held (owned by a small group of stockholders), a firm must publish financial reports on a regular basis and file other special reports with the SEC and state and federal agencies. These reporting requirements can impose substantial costs, and published information on corporate operations may also give competitors an advantage.

### Types of Corporations

Three types of corporate business organization provide limited liability.
The C corporation is the conventional or basic form of corporate organization. Small businesses may achieve liability protection through S corporations or limited liability companies (LLCs).
An S corporation is a hybrid entity, allowing smaller corporations to avoid double taxation of corporate profits as long as they meet certain size and ownership requirements. Organized like a corporation with stockholders, directors, and officers, an S corporation is taxed like a partnership. Income and losses flow through to the stockholders and are taxed as personal income. S corporations are allowed a maximum of 100 qualifying shareholders and one class of stock. The owners of an S corporation are not personally liable for the debts of the corporation.
A newer type of business entity, the limited liability company (LLC), is also a hybrid organization. Like S corporations, they appeal to small businesses because they are easy to set up and not subject to many restrictions. LLCs offer the same liability protection as corporations as well as the option of being taxed as a partnership or a corporation. First authorized in Wyoming in 1977, LLCs became popular after a 1988 tax ruling that treats them like partnerships for tax purposes. Today all states allow the formation of LLCs.
 summarizes the advantages and disadvantages of each form of business ownership.

### Summary of Learning Outcomes

1. How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations?
A corporation is a legal entity chartered by a state. Its organizational structure includes stockholders who own the corporation, a board of directors elected by the stockholders to govern the firm, and officers who carry out the goals and policies set by the board. Stockholders can sell or transfer their shares at any time and are entitled to receive profits in the form of dividends. Advantages of corporations include limited liability, ease of transferring ownership, unlimited life tax deductions, and the ability to attract financing. Disadvantages include double taxation of profits, the cost and complexity of formation, and government restrictions.


# Forms of Business Ownership

## Specialized Forms of Business Organization

1. What other options for business organization does a company have in addition to sole proprietorships, partnerships, and corporations?
In addition to the three main forms, several specialized types of business organization also play an important role in our economy. We will look at cooperatives and joint ventures in this section and take a detailed look at franchising in the following section.

### Cooperatives

When you eat a Sunkist orange or spread Land O’Lakes butter on your toast, you are consuming foods produced by cooperatives. A cooperative is a legal entity with several corporate features, such as limited liability, an unlimited life span, an elected board of directors, and an administrative staff. Member-owners pay annual fees to the cooperative and share in the profits, which are distributed to members in proportion to their contributions. Because they do not retain any profits, cooperatives are not subject to taxes.
There are currently 2.6 million cooperatives with one billion members employing more than 12.5 million employees in more than 145 countries worldwide. Cooperatives operate in every industry, including agriculture, childcare, energy, financial services, food retailing and distribution, health care, insurance, housing, purchasing and shared services, and telecommunications, among others. They range in size from large enterprises such as Fortune 500 companies to small local storefronts and fall into four distinct categories: consumer, producer, worker, and purchasing/shared services.
Cooperatives are autonomous businesses owned and democratically controlled by their members—the people who buy their goods or use their services—not by investors. Unlike investor-owned businesses, cooperatives are organized solely to meet the needs of the member-owners, not to accumulate capital for investors. As democratically controlled businesses, many cooperatives practice the principle of “one member, one vote,” providing members with equal control over the cooperative.
There are two types of cooperatives. Buyer cooperatives combine members’ purchasing power. Pooling buying power and buying in volume increases purchasing power and efficiency, resulting in lower prices. At the end of the year, members get shares of the profits based on how much they bought. Obtaining discounts to lower costs gives the corner Ace Hardware store the chance to survive against retailing giants such as Home Depot Inc. and Lowe’s.
Founded in 1924, Ace Hardware is one of the nation’s largest cooperatives and is wholly owned by its independent hardware retailer members in stores spanning all 50 states and 70 countries. In August 2017, Ace opened its 5,000th store. In 2017, the company reported its revenues in the second quarter were $1.5 billion, which was an increase of 4.6 percent from 2016’s second quarter. The net income for the second quarter of 2017 was $51.1 million.
Seller cooperatives are popular in agriculture, wherein individual producers join to compete more effectively with large producers. Member dues support market development, national advertising, and other business activities. In addition to Sunkist and Land O’Lakes, other familiar cooperatives are Calavo (avocados), Ocean Spray (cranberries and juices), and Blue Diamond (nuts). CHS Inc., the largest cooperative in the United States, sells energy, supply, food, and grain.
Cooperatives empower people to improve their quality of life and enhance their economic opportunities through self-help. Throughout the world, cooperatives are providing members with credit and financial services, energy, consumer goods, affordable housing, telecommunications, and other services that would not otherwise be available to them. There are several principles that cooperatives must follow, according to San Luis Valley REC, International Co-operative Alliance, and Daman Prakash, author of The Principles of Cooperation. They include (1) open membership, which means that cooperatives are open to all people to use its services; (2) democratic member control, which means that organizations are controlled by their members; (3) members’ economic participation, which means that members contribute equally to the capital of the cooperative; (4) autonomy, which means cooperatives are self-help organizations controlled by their members; and (5) education and training, which means that cooperatives provide education and training for their members while also electing representatives, managers, and employees.

### Joint Ventures

In a joint venture, two or more companies form an alliance to pursue a specific project, usually for a specified time period. There are many reasons for joint ventures. The project may be too large for one company to handle on its own, and joint ventures also afford companies access to new markets, products, or technology. Both large and small companies can benefit from joint ventures.
In 2005, South Korea’s Hyundai Motor Company announced it signed a $1.24 billion deal to form a joint venture with China’s Guangzhou Automobile Group. The arrangement gave the South Korean automaker access to the commercial vehicle market in China, where its passenger cars are already the top selling foreign brand. Each side will hold equal stakes in the new entity, named Guangzhou Hyundai Motor Company. The new plant began production in 2007 with an annual capacity of 200,000 units producing small to large trucks and buses as well as commercial vehicles. According to Reuters, Hyundai made plans to build a fifth factory in China. With five factories in operation, Hyundai’s annual Chinese production capacity will be 1.65 million vehicles.

### Summary of Learning Outcomes

1. What other options for business organization does a company have in addition to sole proprietorships, partnerships, and corporations?
Businesses can also organize as limited liability companies, cooperatives, joint ventures, and franchises. A limited liability company (LLC) provides limited liability for its owners but is taxed like a partnership. These two features make it an attractive form of business organization for many small firms. Cooperatives are collectively owned by individuals or businesses with similar interests that combine to achieve more economic power. Cooperatives distribute all profits to their members. Two types of cooperatives are buyer and seller cooperatives. A joint venture is an alliance of two or more companies formed to undertake a special project. Joint ventures can be set up in various ways, through partnerships or special-purpose corporations. By sharing management expertise, technology, products, and financial and operational resources, companies can reduce the risk of new enterprises.