Absolute Advantage – Trade Theories
Absolute advantage is a theory of trade that was first developed by Adam Smith. The theory demonstrates that countries can benefit from specializing in producing and trading goods in which they have an absolute advantage.
Smith identified the sources of absolute advantage as coming from efficiency in production and/or natural advantages, such as climate or geography.
The video below gives a brief overview of the topic, including a simple calculation to demonstrate the concept.
Mercantilism is one of the first, if not the first, trade theories. The idea was popular in the 16th, 17th and 18th centuries. The intellectual argument for mercantilism was lost when Adam Smith introduced the world to the theory of absolute advantage. David Ricardo’s work on comparative advantage further discredited the idea.
Unfortunately, despite centuries of intellectual progress on trade theories, neo-mercantilism still has many supporters. The following video sets out the idea behind mercantilism and the arguments against it.
DISC Personality type test
The DISC personality test is used by organisations to classify personality types. Why do they need to do this?
Sometimes it is used in the selection process. Firms attempt to analyse top performers and then recruit candidates with similar DISC profiles. This is a somewhat controversial use of the tool as it might lead to creating firms full of clones.
A more productive use of the test is to identify DISC types within a team. This can help the team understand each others’ preferred communication and management styles. When done properly this can have powerful consequences for team efficiency and effectiveness.
The presentation slides below summarizes the different aspects of DISC.
IKEA Case Studies
IKEA case studies are very popular in international management classes. Here are a couple of extra resources I came across recently that can help you understand more about this company.
The first is a podcast from the BBC in which reporter Peter Day interviews Anders Dahlvig, the former CEO of the company. In the interview Dahlvig talks about IKEA and about the book The IKEA Edge: Building Global Growth and Social Good at the World’s Most Iconic Home Store he recently wrote.
Click here to download or listen to the interview
The second of our IKEA case studies can be found at Strategy & Business. You will need to register to read the case. But it is free and they have plenty of interesting materials.
You can find the search result for the article here.
Purchasing Power Parity PPP
Purchasing Power Parity – If we lived in a world of truly efficient markets then the price of a basket of goods would be the same in all countries. However, anyone who has taken a trip abroad knows that this is not the case. In fact prices for identical items vary quite widely across nations.
Imagine that a basket of goods cost $50 is the USA. Next, imagine that the same basket of goods costs €40 in France. Let’s assume that the exchange rate is €1 = $1.50. This means that the dollar value of the basket of goods in France is $60. In other words, French consumers must pay 20% more for the same basket of goods.
Now let’s imagine that the typical American worker earns $40,000 per year and the typical French worker earns €30,000 per year. On the face of it the French worker is better off – she earns a dollar equivalent of $45,000 per year. However, as we saw before, she must pay 20% more for the goods she wants to buy. To make the effect clearer, let’s see how many baskets of goods an American worker can buy each year and how many our French worker can buy. Our American worker can buy 800 baskets ($40,000/$50), our French worker can only buy 750 baskets (€30,000/€40). So, she is theoretically $5000 a year richer that her American counterpart, however, she is actually 50 baskets poorer. In order to have the same purchasing power as an American worker, the French worker would need a salary of €32,000 (800 X €40). This implies that the dollar is undervalued against the Euro.
The example above illustrates why comparing figures such as GDP in dollar value can be misleading. Economists acknowledge this by adjusting wages and GDP levels for purchasing power parity PPP. This gives a truer picture of the size of the economy and the spending power of a country’s citizens.
Purchasing Power Parity and Exchange Rates
Theoretically a basket of goods should be the same everywhere. The theory of purchasing power parity when applied to exchange rate prediction states that over time the basket of goods should become equal in price. This means that in order to equalize the exchange rate will change. In our example of the USA and France we started with a rate of €1 = $1.50, this gave a price equivalent of $60 for the $50 basket of goods. For the price of the basket of goods to be equal the Euro exchange rate would have to fall to €1 = $1.25.
In the long run there is some evidence that PPP parity does predict changes in exchange rates. However, is does not appear to have any predictive value over periods of less than five years. In addition there are other reasons why prices may differ between countries. These could be caused by government trade policies, sales taxes and international price discrimination as is practiced by many transnational companies.
Hofstede: 5 Cultural Dimensions
Geert Hofstede is one of the most influential researchers in the field of national culture. His model of culture is comprised of five dimensions:
- Power distance
- Uncertainty avoidance
- Individualism vs.. collectivism
- Masculinity vs.. femininity
- Long- vs.. short-term orientation
All societies have inequalities and hierarchies. These stem from such things as natural abilities, social status, education, wealth and legal status. How do cultures deal with these inequalities in their societies? Hofstede developed an index of what he called power distance. Cultures could tend to either have a narrow power distance or a wide power distance. Cultures with a wide power distance are more accepting of inequalities and may even try to emphasize them. Conversely, cultures with a narrow power distance are less accepting of the inequality and try to reduce the effects of inequality on society.
Implications for management –narrow power distance
- Managers accept the need for support from subordinates if they don’t have the answer to a problem.
- Subordinates expect to be consulted.
- Subordinates don’t like being micromanaged.
- Managers expect to work hard to justify their rewards.
Implications for management –wide power distance
- Managers are expected to be autocratic and paternalistic.
- Managers are seen as the sole decision-makers.
- Workers prefer to cooperate with their manager rather than work together on a problem.
- Referent power and coercion are preferred over reward and expert power
Some cultures are more tolerant of uncertainty and ambiguity than others. The members of cultures that exhibit high uncertainty avoidance try hard to predict the future. They value long-term stability and seem risk averse.
Implications for management –high uncertainty avoidance
- Need to create clear rules.
- Job descriptions must be precise.
- Subordinates given little room to take the initiative.
- Managers are expected to be experts rather than facilitators.
- People are less entrepreneurial.
- Managers and subordinates expect job security and detailed retirement planning.
Implications for management –low uncertainty avoidance
- People are more willing to accept change.
- Managers can be generalists and facilitators.
- Senior positions can be held by managers of a younger age.
- People are more risk taking.
- Managers circumvent formal rules and bypass the hierarchy to get things done.
- Foreigners are more likely to be accepted as managers.
- Competition among co-workers is accepted and may even be seen as desirable.
Individualism vs.. collectivism
In individualistic cultures the needs and feelings of individual members of society are given preference over the group. Individuals are expected to be self-reliant and “live and die” by their own efforts.
In collectivist cultures the interests of the group outweigh the interests of the individual. The individual relies more on the group for resources for survival.
Implications for management –individualistic
- Individual has the right to dissenting views.
- Individualism may be expressed through non-conformity.
- Managers aim to have plenty of variety in work tasks.
- Rewards should be weighed towards individual performance and results.
- Competition within the group is tolerated.
- Loyalty can only be counted on for so long as it suits the individual’s interest.
Implications for management –collectivism
- Individuals derive their identity from belonging to a group.
- Loyalty to members of the group is strong and seen as more important than efficiency.
- Managers reward conformity and loyalty.
- There may be less interaction between the groups than in individualistic cultures.
- There may be a high level of competition between groups inside or outside the organization.
Masculinity vs.. femininity
These dimensions are concerned with a culture’s preference for performance or caring.
Implications for management –masculinity
- Gender roles are more sharply divided, with some jobs being male and other female.
- Men and women find it hard to take jobs /be accepted in roles that are not preferred by their gender.
- Society values performance so competition is seen as good.
- Achievement may be signaled by shows of wealth and power.
- Aggressive tactics are seen as the permissible.
Implications for management –femininity
- Less sharply defined gender roles at work.
- Achievement is measures by levels of human contact rather than ostentatious displays of wealth.
- Relating to others is valued over competing with others.
- Outsiders are regarded sympathetically.
- Individual brilliance is regarded with skepticism (who did you tread on to get where you are?).
Long- vs.. short-term orientation – Confucianism
Hofstede later developed his original work by more in-depth studies of Far-East Asian cultures. The result of these studies was an addition dimension based on Confucian values. Hofstede claims that Confucianism has a long-term orientation to life and values virtue over truth.
Implications for management
- Virtue means not spending more than necessary.
- Virtue means trying to acquire a good education and skills so that you can contribute to society and look after your family.
- The family is the prototype of all organizations.
- The virtuous man should not treat others as he would not like to be treated himself.
1. How close is the stereotype?
Where do you think countries fit on Hofstede’s 5 dimensions? You don’t need to be exact, just indicate a tendency towards one or other end of the dimension, or the middle. Check your answers with Hofstede’s data.
S. Korea, New Zealand, Saudi Arabia, Spain, Holland, Brazil, Kenya, Mexico.
2. Imagine that you are part of a project management team that has been sent to India, China or Brazil to build a new chemical factory. You will be working with locals at all levels of management. What are the major management and communication challenges that you might expect to encounter? How will you cope with them? How much adaptation would you expect from the locals and how much should you adapt to the locals?
Merger and Acquisition Fallacies
I’ve just come across an article in Strategy & Business about merger and acquisition fallacies. This is a topic that always comes up in strategy lessons because it is such a common strategy and yet has such I high failure rate.
I’ll write more about mergers and acquisitions in future posts. In the meantime, this article brings up some interesting points: The Top 10 M & A Fallacies and Self-deceptions.
Porter’s Three Generic Strategies
Three Generic Strategies For Competitive Advantage
Michael Porter came up with the idea that companies could compete using three generic strategies. This idea can be further developed into a five generic strategies framework. These frameworks provide a useful way of thinking about strategy. However they should not be thought of as the only possibilities as several others have suggested that Porter’s ideas are too restrictive especially in a rapidly changing business environment. This means that the definition of mass market and niche market can change dramatically – in some cases such as with the various kinds of mobile phones this change can take place in a matter of months. Another criticism is that it doesn’t take into account markets that don’t exist. Take social networking and other internet based communication for example. These have both created new kinds of businesses and completely upturned older business models. It can be argued that firms that stick to generic strategic thinking models become “married” to these models and become less able to respond to new and emerging market conditions.
On the whole though, the generic strategy models serve as useful frameworks for thinking about strategic problem. This is especially true in cases where the industry or the market is not experiencing dramatic change.
Porter’s Three Generic Strategies: Cost leadership
In order to carry out a cost leadership strategy effectively a firm should be able to create and maintain a lower cost base than its competitors. This might be difficult in the long run in international markets where the firm is engaging in exporting products to markets. For example changes in currency valuations or labor costs can erode a firm’s competitive cost structure. We are beginning to see this happen in China; as Yuan begins to appreciate and labor costs increase many Western buyers are beginning to turn to other countries to buy shoes and clothes. Of course several Chinese manufacturers have responded to these changes in conditions by relocating their factories to countries such as Vietnam and Cambodia.
International firms might however be able to compete in foreign markets based on a cost leadership strategy if import their skills in cost leadership to the foreign market. Take the supermarket sector in China as an example. Both Wal-Mart and Carrefour have been able to establish strong market positions by bringing their expertise in logistics and technology to Chinese supermarket sector. This expertise is not subject to exchange rate movements. Furthermore, as wages rise in China the efficiencies that these firms are able to achieve should allow them to enjoy have an even greater advantage over local competitors.
Porter’s Three Generic Strategies: Focus
The idea behind a focused strategy is that the firm becomes expert in one or a few narrow niches. Firms that follow this kind of strategy can become market leaders either in their own “home” territory or even across the world. Many firms in the German Mittelstand exemplify this strategy. They are often world leaders in a very narrow, highly specialized field of manufacturing. This allows them to compete with foreign firms both in Germany and in the foreigners’ own countries. However, firms should note the key term for being internationally competitive is “highly specialized” – meaning the firm is in a niche that can only effectively be serviced by a handful of expert firms.
The great risk of focus though is that the very specialism that brings success can mean doom if a new technology or changing market needs make the firm’s niche skills redundant. Even if the firm survives such changes in the short term, the focus that they gave to the niche make it very difficult to switch to a new niche both in terms of competences available within the firm and credibility in the market.
Porter’s Three Generic Strategies: Differentiation
Many students and managers get confused about the difference between focus and differentiation. The key difference is that differentiation is the creation of a perception of product difference from the customer’s point of view. The product itself can be a mass-market product. For instance, look at the family car market. Basic mid-sized family cars produced by most of the world’s car companies satisfy the same needs. Car companies compete by creating the impression of difference and persuading a particular segment of customers that their car satisfies their particular need. (Of course there are some genuine points of difference, but these tend to be few and far between – no hate mail from automobile manufacturers please.)
The advantage of a differentiation strategy is that you might be able to compete against a cost leader on some benefits that they are unable to either provide or provide with credibility. The disadvantage is that the firm has to invest significant resources to maintain the real or perceived point of differentiation.
Hall High Context & Low Context Cultures
Hall added several important ideas to cross-cultural analysis. His first contribution was the idea that cultures could be put into broad categories that he called high context and low context cultures.
His is idea was that people show different characteristic styles of communication and relationship building depending on whether they grew up in a high or low context cultures. He defined a high context culture as one in which the cultural environment plays a strong role in creating and interpreting communications. In low context cultures the environment is less important and communications tend to be more explicit. The examples below will help to clarify the differences between high and low context cultures.
Characteristics of High Context Cultures
Relationships tend to be based on a deeper personal involvement between the parties and are on the whole longer lasting.
Communication tends to be indirect with the parties making use of shared cultural code to convey meaning. This can make communication faster and more economical. High context cultures often see a person’s ability to understand meaning without over-explanation as a sign of intelligence. Conversely, over-explanation may be seen as insulting or belittling as it implies that the other party lacks intelligence. This can lead to friction when high context and low context cultures communicate.
Non-verbal communication such as gestures and non-language sounds carry meaning that can help clarify the communicator’s intent. This signals often mean little to those from low context cultures.
There tends to be a high degree of reciprocal loyalty between superior and subordinate. Superiors often feel, and are seen to be, personally responsible for the actions of the subordinate.
High context cultures often prefer spoken agreements over written ones. Written agreements are often seen as a guide or an ideal to which the parties are travelling towards.
There tends to be a strong insider outsider culture. This may be difficult for foreigners, the ultimate outsiders, to break into.
High context cultures are often slow to change with the cultural patterns being deeply embedded into all aspects of life.
Characteristics of Low Context Cultures
Relationships in low context cultures tend not to have such personal involvement as in high context cultures. Relationships are often briefer.
Communication tends to be much more explicit. The communicator tends not to rely on inference to convey meaning. Often people from low context cultures fail to understand or even acknowledge non-verbal communication.
There is a preference for written agreements over spoken ones. These tend to be seen carrying legal weight and are only open for renegotiation in very special circumstances.
There is much less emphasis on insider-outsider groups.
High context cultures are open change and able to change much more rapidly.
Why are Hall’s Ideas on Context Relevant to International Managers?
International managers can benefit from an understanding of the concept of high and low context cultures in three main areas.
Firstly, in the field of managing overseas or foreign staff. An understanding of the concept can help a manager to better understand how to communicate with their staff and how the relationship between her and her subordinates.
Secondly, when negotiating with overseas counterparts she will benefit from understanding their communication style preferences and how they like to frame and implement agreements.
Thirdly, an understanding of Hall’s work will help her realize the importance of tailoring marketing communications to the preferences of the local culture.
Other Important Contributions
Hall made other important contributions to the field of cross-cultural research. He introduced the idea that cultures view time in different ways. This was an important influence on other researchers, most notably Hofstede and Trompenars & Hampden-Turner. He also explored the idea of space in a concept he dubbed proxemics.
Cultural Analysis Kluckhohn & Strodtbeck
Kluckhohn & Strodtbeck were two early pioneers in theories about culture. They identified five, and later a sixth, orientations that they claimed culture groups tended towards.
The importance of their work lies in the influence that it has had on the development of theories by later researchers.
The Kluckhohn & Strodtbeck Model
Orientations Range of variations
What is the nature of people? Good
A mix of good and evil
What is the person’s relationship to
What is the person’s relationship to
other people? Linial (hierarchical)
What is the modality of human activity? Doing
What is the temporal focus of human
What is the conception of space? Private
The Kluckhohn & Strodtbeck model is not often applied to current management theories about intercultural communication and relations. However, an understanding of the concepts of their model can be useful for understanding the concepts of later theories, Hofstede and Trompenaars for instance.
If you would like to go into the Kluckhohn & Strodtbeck model in greater depth try the International Association of Cross-cultural Psychology website.