Evaluating Performance and Assessing Risk One way to look at Raymond Vernons’ theory of product life cycles’ is to examine the effects of global-free trade within the United States. In today’s economy, US imports are often another country’s exports due to the transfer of manufacturing from industrialized nations towards less-developed nations with emerging economies. According to Marketing News (‘U.S. pays high price for global free trade’, 2004) U.S. manufacturing employment stood at 14.8% at the turn of the millennium- a marked departure from where it originally stood when it began becoming benchmarked in the 1800s. This is congruent with Vernon’s proposed theory of product life cycles as evidenced by the decline in manufacturing jobs within the United States within the past two centuries. Vernon’s theory proposes that several milestones measure a products growth and activity during its lifetime: introduction; growth; maturity; and finally its decline. Vernon’s Theory of Product Life Cycles Before a product’s introduction, marketing segments are established by identifying specific customer needs by analyzing demographics. Based on a market analysis, a product is developed to meet different local or international needs. Products are than exported to different nations and states with similar needs, preferences, and incomes. The downward momentum of the products’ life cycle flows from the most-advanced countries to less developed nations. This is also congruent with demographic theory of transition, which shows how changes in rates of fertility and mortality accompany industrialization in emerging nations which results in phases of rapid population increase, followed by a of population equilibrium achieved through low birth rates and low death rates- which is common in most advanced-nations. The second stage involves growth- where the product is copied and introduced to markets to capture more growth. Production is moved to other countries because the cost is less. One might think of IBM as a good example, as when their computers became duplicated overseas early in the company’s history. Companies gain momentum by riding waves of marketing campaigns aimed at creating new and inventive ways to sell existing products. One would have to journey no farther than the breakfast aisle at the local grocer to see all of the new ways companies like Kellogs’ or Quakers adapt already existing products often to customer’s chagrin, which can only mean profitability and maximizing shareholders’ wealth for businesses. The third stage of Vernon’s theory of product life cycle involves the maturity of the product. This is where an existing industry contracts and eventually concentrates. The low cost leader prevails in this development. The lowest cost manufacturing of copies is almost entirely made up of the lowest cost production locations. One might think of the sneaker company Nike as a good example- as a good part of their manufacturing and production comes from low cost countries. The fourth and final stage of Vernon’s theory of product life cycles involves the decline of the product. Least-developed countries make up a substantial portion of the existing market for these types of products. They have outlived their usefulness in most developed nations and only to stand to make a profit in the least assessable audiences. Textiles are usually the only types of products that make it this part of the product life style, as most high-end products are beyond the cost of audiences in this category. This weak demand results in an eventual withdraw from the country, where the company cannot risk increased operations because of decreased sales. Risk plays an important role to a corporation attempting to maximize its wealth and can be measured, diversified, and analyzed in a variety of ways. Political Risk International business has always been subject to political risk. One popular example in recent history is when Iran experienced a revolution in the nineteen-eighties which exposed international companies to losses in excess of one billion USD. This was a costly lesson for US companies to learn, so studying the effects of political risk relevant to a company’s success in any given country became a much-debated question in academic business circles within recent decades. Companies must define frameworks to protect themselves from political risk if they choose to do business in a country outside its domestic settings. According to the article, a total of 1,535 individual companies from 22 different capital exporting countries have been expropriated from 511 legal actions by 72 separate nations. Fired by increasing nationalism, host countries may create dramatic confrontations with multinational companies which can create instability with foreign direct investors because of political risk. Because of this, different frameworks of assessment are now used by companies to help mitigate the risk associated with political movements, and their sometimes disastrous results. Because these results can be quite unpredictable and their scope quite broad, one of the more popular ways to define political risk is through the capital market theory. The capital market theory suggests that political risk is defined as unsystematic risk, or Alpha risk, which is risk associated with non-business activities like the work of foreign labor or incidence of internal violence. Defining a parameter of risk assessment for political developments in foreign countries means developing a strategic plan that encompasses three important aspects of international business: identifying the elements of political risk relevant to foreign direct investment; developing a monitoring system and evaluating the changing political conditions in the host country, and integrating the political risk assessment into the strategic planning. A corporation can devise and refine their strategic plans based on this information, and to also avoid the risk of expropriation. One of the popular techniques used by corporations is DELPHI, which attempts to draw one to five year plans based on political forecasts in countries (Micallaf,1982). Capital Budgeting Decisions for Risk According to Stapleton (1971), one way for corporations to manage capital budgeting decisions with regards to risky projects is through portfolio analysis. Capital project analysis seeks to maximize shareholder wealth by improving stock value. Assuming the corporation raises equity capital for a new business project, the question becomes whether the corporation should engage in the new project, or decide to use the resources elsewhere. By seeing the opportunity to invest in a certain amount of cash as X at a certain time represented by 0 a corporation can seek to change its future cash flows. Letting P_0j show the stock value to the corporation and its shareholders if it rejects the project, and P_oj^* if the company accepts the project. P_oj^* - P_0j > X_0 would therefore explain the conditions of project acceptance considering the risky project analysis. The corporation would show the net cash flows for negative acceptance as X_1j,X_2j,…,X_nj for positive acceptance as 〖X*〗_1j,〖X*〗_2j,…,〖X*〗_nj.Using the stock value equation when net cash flows are paid as dividends added to this consideration as P_0j = E ( 〖DVX〗_j) - 〖Sσ〗_DVXjfor negative acceptance, and P_0j^* = E ( 〖DVX〗_j^*) - 〖Sσ〗_(DVX*j), for positive acceptance of the project. Replacing these two values would then yield the condition E (D〖VX〗_j^*) – E (〖DVX〗_j) – S (σ_(DVX*j) - σ_(DVX+j)) > X_0. The quantities in the condition for project acceptance can be determined by referencing the incremental cash flows of the risky project by 〖〖E(DVX〗_j^*)-E(DVX〗_j)= E (DVX) where incremental cash flows X_1j,X_2j,…,X_nj and 〖X*〗_1j,〖X*〗_2j,…,〖X*〗_nj show the expected discount value and E(DVX) shows the expected value of the discounted cash flows from the project. If this is the case, σ_DVX=σ_(DVX*^ j)-σ_DVXj explains how 〖DVX〗_j and 〖DVX〗^ are correlated, and σ_DVX can be calculated to find the probability distribution of the expected value of discounted cash flows. By taking the equations and substituting them into the formula a corporation can assert the conditions of project acceptance based on the corporations’ cash flows: E(DVX) - 〖Sσ〗_NDV > X_0. The advantage of using the portfolio theory is that it tells shareholders when might be an important time to diversify their investments. Other ways to measure risk involve determining Rate of Return and Net Discount Value. If we assume X is the initial finance for the project as provided by the preceding conditions, then the expected NDV of the project will be E(NDV) = E (DVX) - X_0. Due to the assertion X_0 the Relevant Risk of the Net Discounted Value would be the same as the Relevant Risk of the discounted value of future cash flow. Substituting these conditions means that project acceptance will be shown as 〖E(NDV)-Sσ〗_NDV>0 and 〖C(NDV)=E(NDV)- Sσ〗_NDV which means finding the certainty equivalent for the NDV of the project. Therefore, the conditions for project acceptance are reduced to C (NDV) > 0. If the market aversion risk factor is shown as S, the probability distribution for the Net Discounted Value becomes 〖-X〗_0+∑_(t=1)^n▒X_t (1 + r)^(-t)=0. This equation does not become reliable when measuring negative cash flows so an alternative to measuring the Rate of Return is the perpetuity equivalent or 〖-X〗_0+(i∑_(t=1)^n▒X_t (1+i)^(-t))/R_p =0. Managing Exchange Rate Risk While it is difficult to forecast currency standard deviations and correlations with pinpoint accuracy over time, the benefits of measuring them on a daily basis can be valuable to a corporation and business activities. A firm will know the specific degree to measure confidence with variability and volatility of different currencies by analyzing these tables. The goal of identifying currency portfolios that have historically showed low exchange rate risks is achieved by measuring its variability. This is first accomplished by collecting the data from exchange rate movements, standard deviations of the exchange rate movements, and the correlations of the exchange rate movements. The benefits of correlating data from currency portfolios are determined by using the variance (〖 VAR〗_i ) coupled with its co-variances, or the statistical measure of the tendency of two variables to change in conjunction with each other. This is either equal, or not equal, to the product of their standard deviations and correlation coefficients. These functions allow individual currencies and their assigned weights to be used as determinants in the following equations, which is explained by Madura and Nosari in the following equation (1984). 〖VAR〗_ρ=∑_(i=1)^n▒W_i^2 〖VAR〗_i+∑_(i=1)^n▒〖i≠j〗 ∑_(k=0)^n▒W_i W_j 〖COV〗_ij …”W_i and W_j are weights assigned to the ith and jth currencies while COV_ij shows the covariance of the ith and jth currencies. Because the covariance of two currencies equal the correlation times the standard deviations, the variance of a currency portfolio can also be shown as a function of the variability of the coupled correlations of individual currencies” (p.99); 〖VAR〗_ρ=∑_(i=1)^n▒W_i^2 〖VAR〗_i+∑_(i=1)^n▒〖i≠j〗 ∑_(k=0)^n▒W_i W_j 〖CORR〗_ij 〖SD〗_i 〖SD〗_j CORR_ij is the correlation coefficient between the ith and jth currencies, while SD_i and SD_j amount to the standard deviations of the ith and jth currencies in the equation expressed above. According to Marquez and Schindler (2007) three different agencies which find the real effective exchange rate in various countries includes the International Monetary Foundation, The Federal Reserve Board, and the Bank for International Settlements. The econometric analyses provided by these different agencies use different methodologies like least squares to form algorithms which help define parameter consistency or model specifications used to establish patterns with regards to exchange rate movements across international borders. Internalization & Integration Internalization and integration involve different developments concerning market structures within organizations. According to Collins Dictionary of Economics (market structure, 2006), it “focuses especially on those aspects of market structure that have an important influence on the behavior of firms and buyers and on market performance”. Some of the different structural features that are part of the architecture of a sound business strategy in relation to meeting performance standards include degrees of seller concentration, buyer concentration, modes of entry, barriers to entry, product homogeneity, product differentiation, diversification, and degrees of integration . Backward integration involves the firm joining together two or more successive stages in a vertically related production process, with the final stages being eventually combined or integrated with earlier stages. This backward flow of capital is used to cut costs and secure supply inputs according to Collins… (backward integration, 2006). Forward integration involves a firm joining together two or more successive stages in a vertically related production/distribution process according to Collins as well, with “the main motive being that the firm will secure a market equaling the firm’s outputs and therefore obtain cost savings” (forward integration, 2006). By combining two, or more, related activities firms can achieve equilibrium compared to separating them as firms can engage in arm’s-length market transactions according to Collins Dictionary of Economics (internalization, 2006). Economic theory postulates that a profit-maximizing firm will seek to internalize sequences of activities if the costs are cheaper than doing the same activities through the market. The most popular form of internalization involves vertical integration. This is where a series of vertically-related activities are synchronized (Vertical integration, 2006). Some of the advantages of vertical integration include reduced costs through manufacturing shortcuts, the avoidance of transaction costs. Internalization is important to horizontal integration as well, where the cost of market imperfections caused by tariffs and quotas unique to individual countries can be exploited by multinational firms seeking the price advantage (Horizontal integrated, 2006).. Another market imperfection closely linked to profit-maximizing strategy involves measuring exchange-rates to help mitigate exchange rate risk.
Posted on: Sat, 16 Nov 2013 18:49:33 +0000
Trending Topics
Recently Viewed Topics
© 2015