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Systematic Differences Between International & Domestic Business Transactions

May 24, 2014 0 Comment

For Queensland or Northern Territory based cattle producers, selling into the local Australian market on the simplest ‘cash on delivery’ (COD) basis possible to domestic abattoirs as well as into Indonesia via the live cattle export trade, the recent significant disruption of that export trade – and its susceptibility to Australian domestic political risk – would doubtless lead them to conclude that employing Schaffer et al. (2012, p.31) terminology, export sales were systematically riskier than domestic sales so that, ‘the management of international business is the management of risk’. But would this conclusion be entirely correct, especially when taking into account, the comparative risk-based returns? The following discussion, based on module 1 of the study guide and 2010 1st assignment marking guide question 1 answer, takes a succinct theoretical approach based on Knight, Williamson, North and Heiner.

First, the Schaffer et al. (2012) (“Schaffer”) approach and hypothesis is that IBTs comprising trade (sales transactions), technology and intellectual property licensing, plus foreign direct investment (FDI), are inherently riskier than their domestic equivalent DBTs, comprising transaction risk, political risk and foreign law risk. The precise nature of risk isn’t exactly defined but is used in its non-technical ordinary usage of the (greater) likelihood of some adverse event occurring in an IBT than its equivalent DBT. That single term covering what economists have identified as: risk, uncertainty and ambiguity.

  • Risk concerns a fixed probability distribution of outcomes as originally described by Knight in 1921.
  • Uncertainty concerns a situation where the range of possible outcomes is known but their probability is unknown.
  • Ambiguity describes a scenario where the decision-making agent can’t identify (all) possible outcomes because they either lack relevant knowledge or can’t assess its reliability (North 2005, p.13).

This means on Schaffer’s approach that firms undertaking IBTs, unavoidably encounter more uncertain, ambiguous or difficult environments than if they undertook entirely domestic transactions; the regulatory field is more extensive and complicated, plus there are more transactions and parties involved. According to Heiner (1983, p.585), ‘uncertainty exists because agents can’t decipher all of the complexity of the decision problems they face, which literally prevents them from selecting the most preferred alternatives.’ Nonetheless the agent/firm must address that uncertainty and ambiguity, hat is to minimise the “C-D gap” which lies between, ‘an agent’s decision-making competence and the difficulty of a decision’ (Heiner 1985, p.391). To be sure, the decisional process of firms undertaking DBTs and IBTs employs the same three part transaction cost economics (TCE) scheme: comparative contractual analysis; assessing alternative governance forms; and examining the time aspects of process differences and with transactions undertaken in markets i.e. short-term contracting unless it generates adverse costs i.e. market failure occurs in which case such transactions are undertaken within the firm – referred to as the markets versus hierarchies choice (Williamson 1981). IBTs may or may not be systematically more uncertain and ambiguous that their equivalent DBTs; but there may not be an equivalent domestic market. For example, whilst DBTs comprise most of the GDP of the US, in Singapore’s entrepot economy the import-export trade comprises over 400% of GDP. So whatever extra time, trouble, expense and risk that trade or IBTs exact at Singapore’s expense, it’s definitely worth the effort and is evidently readily manageable risk-wise. To be sure, with a small population and domestic demand, Singapore’s economy can only grow via net export growth. In other words, there may be no actual DBT ‘risk’ comparator. In this way, a Singaporean manufacturer of electronic componentry must master the relevant C-D gap to set up the business in the first instance and remain profitable. And conversely, domestic demand may be supplied almost entirely by imports: e.g. the laptop, desktop computer and motorcycle markets in Australia. Successful exporting firms are evidently able to develop goods and services attracting demand worldwide in conjunction with excellent market intelligence and efficient business systems including contractual risk management. The availability of standardised legal contracts and international banking services also significantly boost firm level competence and functionality. And so even if the Schaffer hypothesis is on balance correct, the difficulty of the task – the potential C-D gap – shouldn’t be overstated because, unless it’s capable of closure then the export-import trade is unsustainable. So applying Heiner (1983, 1985) boosting decision making competence and functionality at the individual firm level, is the solution; though admittedly, external or exogenous sourced events sometimes overwhelm even the most competent export-oriented firms. No one expects the unexpected export trade equivalent of the Spanish Inquisition!

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