International trade requires macroeconomic stability in the host country. Ideally, the economy of the host country should embark upon a sustainable growth path to foster foreign investment and international trade opportunities, while supported by a strong banking system. However, there are several business risks that a firm launching onto a foreign country should assess.
The first risk assessment should be associated to the bargaining power of the firm expanding to a foreign market. Factors such as product/ service uniqueness, technological advancement, the firm’s size and operational growth facilitate the effective management of distribution channels, while maintaining product or service quality.
At the same time, the bargaining power of the host country is equally substantial to profitable international operations in terms of the size of the market, its wealth, the abundance in its raw materials and the level of governmental intervention.
Other risks associated to international trade are:
Customer Risk
Customer risk investigates the identity of customers in the host country. By assessing customer risk, the firm inspects if customers are legally established businesses in the host country or importers, if the firms’ exports are compatible with the customers’ business profile, what are the customers’ credit limits and period, their trading history, their paying credibility and solvency.
Credit Risk
Credit risk is associated with the customers’ solvency but also the firm’s business cycle. To assess this type of risk, the firm needs to take into consideration the amount of credit outstanding – both overseas and domestic – in the trading accounts, the impact of a customer’s financial pitfall of the firm, the maximum amount of credit which should not be exceeded, and most importantly how to finance the offered credit period. Having sufficient cash to allow offering credit terms in export sales is a substantial part of the firm’s business circle.
Foreign exchange risk is associated with dealing in the host country in more than one currency. This type of international trade risk typically affects export and import businesses as they are exposed to fluctuations in the foreign exchange markets. If money
is converted to another currency in order to make a payment to the host country, then any changes in the currency exchange rate will cause that money’s value to either decrease or increase when the payment is being made and currency is converted back into the original currency.
Political Risk
Political risk measures the variability in the value of the firm, caused by uncertainty about political changes. In the era of globalization, host countries may be facing rigid legislative, judiciary and governmental institutions, unfavourable to international operations from foreign firms. Moreover, dictatorships, bribery, corruption and unstable governments are, in many cases, substantial reasons for assessing the political risk involved in a firm’s launching onto a foreign country.
Moreover, political risk in the host country is often not correlated with global economic conditions thus eliminating the possibility of global intervention. Ideally, the firm’s cash flows should be invested in different host countries. Yet, in the absence of global intervention, the firm’s cash flows do not allow risk diversification.
Country Risk
Closely related to the political risk factor, country risk is affected by the legislative, judiciary and governmental institutions, the current account deficit, the level of national debt, the foreign exchange reserves, the internal or external threats to the host country and the imposition of tariff or other quotas, and import or export restrictions. It may also include the risk of physical climactic catastrophes such as flood, drought, and earthquake.
Beyond doubt, doing business in a foreign country entails major business risks. The key is to assess these risks properly in order to eliminate the failure factor in the firm’s global operations, but also to be prepared to anticipate the cost of such a failure.
