What You Need to Know to Go Global

CHAPTER 1:
WHY IS INTERNATIONAL TRADE IMPORTANT TO THE FUTURE OF YOUR BUSINESS?

“Every man lives by exchanging.” – Adam Smith

Many of you already know why international trade is important to the future of your business. The short answer is that international markets potentially provide many new customers for your products or services, allowing you to increase sales and profitability. At the same time you may have to compete with international competitors in your existing domestic markets.

If you limit your horizons to your domestic markets at best you likely will be ignoring potential customers and at worse you may be put out of business by foreign competition. This sad story has played out many times in recent years. The previously successful small local retailer cannot compete with multinational retailers such as Wal-Mart that source many goods from overseas suppliers. A small manufacturer of automotive aftermarket accessories cannot compete with imports from China. A small local accounting firm cannot compete with an accounting firm that uses backroom services from India to reduce costs. Communities that have invested in infrastructure to attract call centers lose their call center business to India and the Philippines.

Opportunities for small businesses

On the bright side, many small businesses based in the United States have participated in the international market with great success. The following examples are drawn from my personal experience. Crowe & Co., a South Carolina based firm that manufactures and sells explosive detection kits (“EDKs”). Crowe sells its product and services all over the world. Weld-Aid, a Michigan based firm that manufactures and sells products to increase welding efficiency. Weld-Aid sells its products in many countries around the world. Bergandi Machinery, based in California, produces and sells machines for the fencing industry in more than 50 countries. Small consulting firms, such as Nathan Associates, based in Virginia, sell their services to clients in many foreign markets.

Are you already convinced?

If you are already convinced that international trade is important to the future of your business, after you read about Cheung’s proposed business in the next section you may want to skip the remainder of this Chapter and read Chapters 2 through 7, the “how to” Chapters. But for those of you who are not yet convinced that international trade is important to the future of your business, or (like me) enjoy history, this Chapter provides the long answer to the question.

Cheung was convinced but didn’t know about trade transaction costs

When I was writing this book a young Chinese man, Cheung, a recent “green card” arrival in the United States, asked my advice concerning shipping consumer goods from the United States to China. He had noticed that many consumer products are less expensive in America than in China and hoped to make some money, first by selling goods purchased here to his friends and acquaintances in China and, if successful, expanding his business to commercial distributors in China. I said this might be a good idea. Significant price differences between national markets for goods or services are the basis for most international trade transactions and he already had friends in China who would be his initial customers. But first he had to do some checking. Compared to a domestic sale of goods or services there are many additional transaction costs involved in international trade transactions; therefore the price differences between the US market and China that he was noticing might be illusory.

For example, unlike China and most other foreign economies, the U.S has no national sales tax or “VAT”. In many economies the VAT can be quite high; for example, Mexico has a 16% VAT, China has a 17% VAT, and Denmark a 25% VAT. This alone frequently makes goods sold at retail in the United States less expensive than the same goods sold in many foreign markets. And if he shipped consumer goods to China they would also likely be subject to significant import duties and fees that might eliminate much of any perceived price difference.

Other transaction costs for international sales normally include compliance with various national health, safety and product standards, product marking requirements, packing for international shipping, the cost of international shipping by air, surface or sea freight, insurance against damage or loss during shipment, freight forwarding and customs clearance fees, and demurrage and warehousing (resulting from port/airport delays, delays in customs clearance and delays in delivery to customers). And if he started with small sales for relatively heavy products shipped by airmail, the transport costs could be particularly high.

The currency used for the sales transaction also involves significant risks. Although the U.S. dollar is widely used throughout the world the foreign buyer or seller may stipulate that the transaction be in their nation’s currency. This could result in a substantial loss to the buyer if that currency significantly appreciates between the time of the contract and the time of payment. As an example, China’s currency, the yuan or renminbi (RMB) has been appreciating since 2006 when the rate was fixed at around 8.2 RMB to one dollar, but was then devalued in August 2015. If a contract is entered into in RMB when the exchange rate is 6.27 RMB to 1 U.S. dollar (the exchange rate when this book was written) and the exchange rate has changed to 5.5 RMB to 1 dollar at the time payment pursuant to the contract is due, a party that must exchange dollars for RMB will bear the loss and a party that must exchange RMB for dollars will have a windfall gain.

Even when the U.S. dollar is used as the currency for the transaction, as is frequently the case, currency fluctuations may change the economic bargain resulting in one of the parties being disadvantaged. For example, when I worked as a consultant in Astana, Kazakhstan in 2014 the local currency (tenge) was devalued about 15% without warning; this made my contract more expensive for my client because my payments were by contract stipulated to be made in U.S. dollars. On the other hand, since I was living in Astana my local living costs were suddenly reduced by 15%.

Small value international sales of consumer products can be handled by credit card with additional international transaction fees assessed by the credit card company. However, assuring prompt payment for higher value goods or services delivered may involve significant additional transaction costs for international sales. The safest option of course is for a seller to require payment in full prior to delivering the goods or services but this is frequently not acceptable to international buyers. International customers understandably want to be assured of the quality and quantity of goods or services and that goods will be delivered on time before paying for them. These concerns are usually resolved by using trade finance and by inspections of the quality and quantity of goods by a certified third party expert. Banks and other financial institutions offer trade finance to qualified traders. These are letters of credit and other documentary instruments that are used to assure payment when the seller of goods or services has complied with the terms of the contract. Other third parties, international inspection companies may also be used to assure that the goods or services meet contract specifications. Needless to say these trade services are not inexpensive and they can add significant additional costs to international trade transactions.