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International Business Environment Essay

| October 20, 2011 | 0 Comments

EXECUTIVE SUMMARY

Careful consideration must be given to key factors before a company makes the decision to expand into foreign markets. PharmaMed, a U.S. based multinational manufacturer and distributor of medicines and consumer healthcare company, has identified Mexico as an extremely promising country for expansion. It is true that U.S. commercial expansion in Mexico has grown considerably over the past years, especially since the 1994 North American Free Trade Agreement (NAFTA) began promoting industrial development. Nonetheless, PharmaMed is aware that Mexico is not a straightforward country to operate in and economic, cultural and political forces can dent commercial objectives. This paper seeks to examine the suitability of the target country for further pharmaceutical expansion. We will conduct an analysis of cultural, political, economic, legal and protectionist issues in order to devise an international expansion strategy. The findings will determine recommendations on whether PharmaMed should adopt a trade only policy or venture into Foreign Direct Investment (FDI).

1          Introduction

Globalisation progressed significantly in the past decade facilitated by modern communication, transportation and improved infrastructure as well as political choice to consciously open markets to international trade and finance (WTO, GATT, as well as regional trade blocs: EU, NAFTA, ASEAN, etc). Besides the possibility of increased sales and revenues, there are several reasons why companies should consider targeting the global marketplace. Toftoy (1999) identifies the drive to offset sales decline in the domestic market. Even if the sales are not declining in the domestic market, being present in other markets can act as a safeguard for the future. A further international trade theory is put forward by Vernon (1966, 1971) and Wells (1968, 1969) arguing that a country will begin by exporting its product and later undertaking foreign direct investment as the product moves through its life cycle. Levitt’s 1965 Product Life cycle model illustrates this pattern (see figure 1)

 

Essentially, macroeconomics risks and operational risks are diversified by engaging in business in more than one country. If operations are underperforming in one country, hopefully, the performance will be offset by profitable performance in another country. Another argument for overseas trade is the idea of improving competitive position. This, ties in with the opportunity to lower manufacturing and labour costs. Additionally, possible funding benefits from the trade block to which the host country belongs may also influence a company to expand overseas.

 

However, cultural and language barriers, political issues and variations in religious beliefs, societal norms and business negotiation styles impact how business should be conducted with international counterparts.

The aim of this report is to provide guidance to PharmaMed’s proposals to expand overseas into Mexico. Key analysis on the host country will help the company decide whether to engage upon an export only policy or to undertake investment in the country.

 

1.1 The Pharmaceutical industry: PharmaMed

 

Consistent with most industries “the economic, social, cultural and political changes that come with globalization create both opportunities and challenges for pharmaceutical industry” (Mansell, 2010). The Wall Street Journal (July 2009, cited in Medical News) pinpoints and an important development in the U.S. pharmaceutical industry in its observation that for the first time in half a century, sales of prescription drugs declined in 2009, historically the industry’s biggest and most profitable market. Consequently, the industry reaction is a more favourable perception of expansion into developing countries. Indeed, Pfizer has set up operations in China, India, Brazil, Russia and Turkey. With sales totalling $1.4 billon from emerging markets in the first quarter of 2009, the company is “benefiting from the belief… in the developing world that branded medicines are worth paying a premium for because they are safer and more effective than generics”(Wall Street Journal, July 2010). A look at such positive success stories both encourages and forces PharmaMed to follow suit in order to maximize revenue growth. Like its competitors PharmaMed has witnessed declining sales in its primary medication distribution offering. As a result senior management has set in place investigative plans to expand into the developing country markets. As such, the focus is on the E7 Countries (China, India, Brazil, Russia, Indonesia, Mexico, and Turkey) in particular Mexico. This interest is based on the literature that ‘the E7 countries represent increasing opportunities for pharmaceutical companies constrained by maturing markets in the West’ (Espicom Business Intelligence, 2010).

 

1.2 Mexico

 

Emerging Pharmaceuticals Markets Globally (2008) reports that the E7 pharmaceutical markets are expected to grow at a CAGR 11% between 2007 and 2012, reaching revenues worth nearly $116 billion. In contrast the G7 pharmaceutical markets are projected to grow at CAGR 4.95% between the same periods. The question is what makes Mexico a favourable environment for expansion? Significantly, Espicom Business Intelligence (2010) in its pharmaceutical market analysis report observes that 2010 saw the announcement of regulatory measures to simplify regulatory procedures. Which include the transmission of drug registration or increasing OTC (over the counter) medicines already registered in the USA and Canada. These measures should prove to be attractive to a manufacturer and distribution of Medication Company, such as PharmaMed.

 

2         The business system and the national culture

 

The concept of National Business System as launched by Whitley (1999) centres around the belief that companies do not operate in a vacuum, but are economic actors affected by numerous influences from the environment. Companies operate in markets, business sectors and have to comply with law and regulations. The majority of these influences are linked to the nation in which the company is operating. The U.S. and Mexico share many common interests related to trade, investment, and regulatory cooperation are closely tied in other areas as well. Indeed, the economic relationship with Mexico has strengthened considerably under the 1994 NAFTA alliance in the form of the 1993 and 1998 Foreign Investment Law (FIL). Which, provided a broad scope for foreign investment and simplified the process of registering foreign companies. Figure 2 shows that as a result trade between the two countries have more than tripled since the agreement was implemented (Villarreal, 2010).

 

Figure 2: Trade effectives of NAFTA implementation. Total U.S. Mexico trade in goods in billions of US dollars

 

Importantly, lower NAFTA tariffs on pharmaceuticals have fostered greater choice for imports needed (US Department of Commerce, 1994). A world class patent regime in Mexico, bolstered by NAFTA’ patent provision, gives innovators a favourable environment to launch new components. Indeed, the Mexican pharmaceutical market is the leading and most developed in Latin America and the ninth largest worldwide, with sales valued at US$13.5 billion in 2006 (Massachusetts Office of International Trade and Investment (MOITI, 1996). It is important to take the state as the basic geopolitical unit for studying the operation of companies. States remain the primary unit of political competition and mobilization. Thus, individuals and collective actors usually organize themselves at the national level to compete for state resources and legitimacy. As such an organization wishing to enter trading activities within a given country will be subject to regulations, and the pharmaceutical industry is no exception. Thus, MOITI (1996) cites that according to current regulations, in order to export pharmaceutical products to Mexico, the exporting country must register and import those pharmaceutical products through a host pharmaceutical manufacturer, a local manufacturer holding a sanitary licence for such products. This firm acts a “guarantor” with local authorities vis a vis the foreign company, in particular with regards to manufacturing practices, registration and quality control.

 

Connected with the national business system are cultural issues that will inevitably come into play in the international trading process. How is this reflective in the pharmaceutical industry? Analytical insight into Mexican culture reveals the importance of the family; the deeply held rooted Roman Catholic religion, the nationalist pride, the high degree of personal sensitivity of Mexicans and the importance given to time. All of which have implications in communication styles, decision-making, negotiating, contracting and planning and business etiquette. Cultural sensitivity must be the foundation of business activities. The literature defines cultural sensitivity in rather general terms, such as “understanding the cultural context of each market and the degree which (markets) are culturally similar” (Toyne and Walters, 1993). There is, however, agreement that cultural sensitivity requires cultural awareness, avoidance of culture-bound thinking and reduction of cultural biases (Douglas and Craig, 1983, Toyne and Walters, 1993). There is also consensus that culture is multidimensional. For example, Hofstede (1991) identifies five dimensions along which culture differs: power distance, individualism, uncertainty avoidance, masculinity and long term orientation. Figure 3 illustrates the results of these dimensions when applied to Mexico.

 

In carrying out our analysis on Hofstede’s cultural dimensional scores we will draw on information from the itim International website. As can be seen Mexico’s highest Hofstede dimension is Uncertainty Avoidance (82), indicating that society’s low level of tolerance for uncertainty, does not readily accept change and is risk adverse. Mexico’s low Individualism (30) ranking indicates that an inclination to collectivism rather than to individualism. This is manifest in close long term commitment to the ‘member group’, be it family, extended family, or extended relationships. A high Masculinity ranking (69) indicates a high degree of gender differentiation roles. The male dominates a significant portion of society and power structures. Finally, the high ranking Power Distance Index (81) is indicative of a high level of inequality of power and wealth within Mexican society. To achieve an appreciation of Mexico’s and the USA’s cultural makeup it is vital to provide a comparative study of Hofstede’s analysis of cultural dimensions applied to the USA (see figure 4).

 

 

Figure 4: Geert Holstede Cultural Dimensional scores for USA

 

Importantly, the USA’s Individualism score is the highest in the world, demonstrating the high extent to which people look after themselves and their immediate family only. The Power Distance score of 40 indicates that U.S. society is decentralized with a flatter organizational structure, a smaller portion of supervisors and employees empowered to make their own decisions. A high masculine score places greater value on success, money and material possessions. Americans score 62 on the masculinity, 24% higher than the world average. The USA’s UAI score of 46 is 38% lower than the world average. This suggests that Americans tolerate much more risk and are more comfortable with ambiguities and rapid change. Finally, the USA’s low LTO score of 29 indicates that the importance of the beliefs of meeting obligations and also reflect a tendency for an appreciation for cultural traditions.

 

In order to achieve successful international trading results in Mexico PharmaMed must respect Mexican cultural strong uncertainty avoidance, low individualism, centralized power structures and higher masculinity scores. The purpose of employing Hofstede’s dimensions is to show that U.S. culture and Mexican cultural differences do not doom overseas expansion to failure. Instead, they suggest that cultural sensitivity and cultural adaptation on the part of both countries is especially important to the success of the venture. This chapter focused on how understanding of the local culture and business environment can give managers an advantage in the pharmaceutical industry. Such differences in culture and the way of life in Mexico necessitate that managers develop international expertise to manage on a contingency basis according to the host-country environment. International managers can benefit greatly from understanding the nature, dimensions, and variables of a specific culture and how these affect work and organisational processes. This cultural awareness enables them to develop appropriate policies and determine how to plan, organize, lead, and control in a specific international setting. Such a process of adaptation to the environment is necessary to implement strategy successfully. It also leads to effective interaction in a workforce of increasing cultural diversity, both in the United States and Mexico

 

 

3         US-Mexico trading patterns in the Pharmaceutical INDUSTRY

Importantly, lower NAFTA tariffs on pharmaceuticals have fostered greater choice for imports needed (US Department of Commerce, 1994). A world class patent regime inMexico, bolstered by NAFTA’ patent provision, gives innovators a favourable environment to launch new components. Indeed, the Mexican pharmaceutical market is the leading and most developed in Latin America and the ninth largest worldwide. According to Business Monitor International‘s (BMI) Mexico Pharmaceuticals & Healthcare Report (2010) the total drug market in Mexico will increase from US$9.79bn in 2009 to US$18.96bn by 2014 at a compound annual growth rate (CAGR) of 14.1%. Thereafter the CAGR will slow to 7.6% to 2019, giving a final market value of US$27.48bn. Per-capita spending on medicines will be US$170 in 2014; up from US$91 in 2009, while the proportion of GDP dedicated to drug spending was 1.13% in 2009 and will reach 1.25% by 2014.

The presence of the US Food and Drug Administration FDA) in Mexico should strengthen existing regulatory ties between the two countries.
BMI (2010) expects the FDA to be in close contact with Mexican authorities regarding food and medicine production in order to boost the safety of all products destined for the US, while also encouraging regulatory harmonisation and knowledge transfer.

 

How can PharmaMed compete in this market? Clearly to survive in such a competitive market PharmaMed will have to be relevant and current in the Mexican pharmaceutical industry, whilst being legally protected. This means being fully up-to-date on all regulations regarding exporting and importing, licence requirements, approval of brand names, labelling requirements, certificates of quality and marketing practices.

 

We suggest that entry into the Mexican market should initially be aimed at Seguro Popular, the Mexican state-run health insurance scheme for those on low incomes or without other healthcare options. This is because according to BMI (2010) Seguro Popular intends to enrol an additional 12mn people in 2010. In 2011, another 6mn people will be added to the scheme, giving a total of 18mn new additions and comprising the last remaining segment of the Mexican population eligible to be included in the programme. This coincides with changing health patterns in the Mexican population – pointing at an increase in diabetes, cardiovascular diseases, stroke and cancer (Roberts and Stott, 2010). Since we specialise in medications for these diseases, taking advantage of such changes should give us a competitive edge.

 

 

4         The Exchange Rate Regime

 

The literature agrees that the Mexican currency crisis of 1994 induced important changes in view of policy makers and economists concerning choice of exchange rate regimes (Villerreal, 2010). A number of authors began to argue that a world of high capital mobility, intermediate regimes are highly prone to currency crisis. The notion gradually started to emerge suggesting that developing countries should either have a pure floating exchange or a hard ‘peg’ regime. As a result after the crisis Mexico let the peso float while using a monetary policy of monetary aggregates to control inflation. In 1999 the country switched to an inflation targeting monetary regime, with monetary instruments to determine interest rates. Forex Realm (2011) report that one US Dollar equates to 13.2085 Mexican pesos. The observation is also made that like the U.S. the Mexican peso is considered to be one of the important national currencies, which is used in millions of currency trading and conversion. However, Pharmaletter (Jan. 2011) states that the current Mexican peso against the U.S. dollar is causing uncertainty, with increasing pharmaceutical costs. This is expected to affect previously registered import levels. The overall pharmacy sector is facing stagnation, into negative growth. On a positive note, the downturn and evolving regulatory environment are fuelling generics consumption. This market doubled in 2010.

 

In this chapter we also need to concentrate on the falling value of U.S dollar against major currencies (see figure 5).

 

Figure 5: Deliotte Research Study (2006)

 

As identified in a Deloitte Research Study (2006) Steep and long term shifts in the foreign exchange rates create discrepancies in cost and revenue models resulting in operational and strategic risk. To formulate effective risk management strategies, PharmaMed needs to assess the risk exposures rising from sensitivities in cost and revenues under various exchange rate scenarios.

 

Exchange rate shifts can create shifts across the supply chain. If the dollar slides, pharmaceutical companies with offshore sourcing and operations may face soaring input material and shipping costs and supplier risks. PharmaMed would see a hike in labour costs in dollar terms. On the demand side if the company decides to pass on the increased costs to customers it may result in reduced demands or loss of sales. Moreover, the exchange rate risks faced by customers can impact PharmaMed directly, significantly rising strategic and operation risks.

 

4.1 Political Risks

 

Risk in international trade is unavoidable, especially when it involves countries in the developing world (Busse, 2005).  Among many of the risks involved in it, the political ones are the most difficult to measure, while having the potential of greatest damage as well. The political risks themselves can be classified according to their different origins and etiologies. That is, change of government, violent conflicts, sanctions and political trade risks

 

4.1.1       Change of Government

The political risks that can confront an international trader can arise in several ways. The most common of these is the ‘change of government’ (Fitzpatrick, 1931).

 

4.1.2       Violent conflicts

Developing countries face a higher risk of violent conflicts (Oetzel et al. 2007). Violent conflicts, whether internal or external are invariably damaging to trade

 

4.1.3       Sanctions

Another political risk to international trade exists in the form of conflicts without violence. International sanctions are the main form of these, which may be precipitated by an action of the host country.

 

4.1.4       Political trade risks

A peculiar form of political risks is changes in trading pattern imposed by politics. An example is a sudden ban on all imports or exports of a particular commodity, due to the sudden popular mood against those trades (Orden, 2004).

 

How do the above apply to Mexico? Bremer (2010) argues that raging drug gang violence, a tepid economic recovery, flagging momentum on economic reforms and declining oil output are risks to watch for in Mexico. All of these ties in with the above citations. In relation to the pharmaceutical industry the publication, Pharmaceutical Technology (Jan 2009) identifies that a significant hurdle still to contend with is protection of intellectual property, while the large-scale prevalence of counterfeit drugs remains a major challenge.

 

How can PharmaMed manage the political risk? Unfortunately, there isn’t a perfect solution. Investing always has risks — and political risk is one of them. Yet without risk there would be no reward. To plan for managing a risk, the first step is to compute the probability of its occurrence. Once that is done, a decision needs to be taken as to whether in the light of that risk and the probable loss arising from it; it makes any sense to continue with the business. A difficult and tricky question is to quantify this risk in monetary terms, which alone is a sensible indicator for the need to spend on planning for it. Once it is decided to continue with business in spite of these risks, then necessary provisions need to be made for the losses likely to arise from them, while also attempting to hedge against each of those risks to the best extent possible.

 

5         FDI or Export

In light of our research should PharmaMed choose an exporting strategy or a FDI (Foreign Direct Investments) in expanding into Mexico? When an organisation has made a decision to enter an overseas market, there are a variety of options open to it. These options vary with cost, risk and the degree of control that can be exercised over them. The simplest form of entry strategy is exporting using either a direct or indirect method such as an agent, in the case of the former, or countertrade, in the case of the latter. More complex forms include truly global operations, which may involve joint ventures, or export processing zones (all of which are forms of Foreign Direct investment). Having decided on the form of export strategy, decisions have to be made on the specific channels. On the other hand, FDI offers more far reaching influences for the investing country because it involves ownership, whole or partial control of a company in a foreign country. Drawing on the research presented in this paper, especially those that relate to uncertain pharmaceutical future growth in Mexico, we propose a mixed foreign market entry strategy.

 

That is, combining FDI with exporting rather than choosing one single foreign market entry.  The research by Johanson and Vahlne (1977) shows that many firms minimize the uncertainty risks in internationalization by adopting an incremental approach. Specifically, they expand their foreign operations gradually, beginning with entry into foreign markets with similar cultures before moving on to the dissimilar ones. And, for each foreign market entry, the process starts with exporting, followed by setting up local sales subsidiaries, and then the establishment of production facilities. We believe that this incremental process will allow us to learn from the experience we acquire in the initial operations, and use this knowledge to reduce the uncertainty we face in subsequent expansion efforts. Additionally, we believe that this will protects PharmaMed from the downside risks of failure by increasing overseas resource commitment over a certain time period, contingent on the performance of prior foreign operations.

 

 

6         CONCLUSION

 

This report has assessed PharmaMed’s intended expansion into Mexico, in light of cultural, industrial and macroeconomic factors. The results garnered from this analysis highlight that for PharmaMed to achieve successful operations in Mexico, it must understand its culture and develop the necessary expertise required to manage the host environment business.

 

Exchange and Political risks are also factors that have been identified as critical to the success of PharmaMed’s expansion into Mexico, and this must be addressed appropriately. The incremental process of foreign expansion has also been found to be an ideal option for expansion into Mexico, which could start with exporting, then setting up local sales subsidiaries, and finally the establishment of production facilities. Therefore, based on these analyses, it is recommended that PharmaMed does expand into Mexico, with particular emphasis on managing political, exchange rate and cultural issues that may arise.

 

 

7         Recommendations

Before acting we have to plan our approach. Here are helpful recommendations for PharmaMed:

 

1.  Research local product requirements

Find out about customer preferences, local standards and product regulations. We may need to change the product’s appearance, or to fundamentally redesign it.

 

We may need to translate labelling and instructions redesign packaging to suit the local market. We may even need to change your product’s name or logo if they have unfortunate connotations locally.

 

2. Find out how local commercial practice differs from the U.S.

 

Find out about local business behaviour.

 

Investigate how products are marketed and sold, including any legal restrictions.

 

3. Identify the key contacts we need to build relationships with.

Key contacts may include customers or suppliers, agents, trade organisations and government departments.

 

4. Decide what use we will make of agents

.

The way the market operates may mean that it is easier to sell through a local agent (or distributor), rather than directly. In the Mexican Pharmaceutical industry this is a legal requirement.

 

A local agent can be a valuable source of market information, and can help us find customers and build relationships with them.

 

Take legal advice before entering into a contractual relationship with an agent or distributor. It can be difficult and expensive to terminate the relationship later on.

 

The above recommendations are essential for determining success in PharmaMed’s overseas efforts. Researching products and commercial requirements, while aligning with overseas contacts will give PharmaMed a competitive Edge. To the achieve this, the company will have to embark a series of managerial and staff training programmes. Projects should then be delegated to relevant departments to see the operation through.

 

8         REFERENCES

Boone, L., and Kurtz, D.L. (2009) Contemporary Business, Wiley and Sons Inc, 800pp

Bremer, C. (2010) FACTBOX: Key Political Risks to Watch in Mexico [online], available: www.reuters.com [22 January 2011]

Busse, M. (2005) Measuring Political Risks to Foreign Investment, Ashgate Publishing, London, 200pp

Business Monitor International (2010) Mexico Pharmaceutical and Healthcare Report Q2, www.businessmonitor.com [22 January 2011]

Calenti, L. (2010) The Drug Industry and the NAFTA Experience [online], available: http://www.thepharmaletter.com/ [22 January 2011]

Deloitte (2006) Global Economic Outlook 2006: Global Risks, Regional Opportunities, www.deloitte.com [22 January 2011]

Douglas, S. P. and Craig, C. S. (1983) International Marketing Research. Prentice Hall, New York, 456pp

Episcom Business International (2010) The Outlook for Pharmaceuticals

Forex Realm (2010) Exchange rates between Mexican Peso and US Dollar [online], Available: http://www.forexrealm.com/forex-rates/  [22 January 2011]

Hofstede, G. (1991) Cultures and organizations — software of the mind, McGraw Hill, New York, 191pp

Itim International (2009) Geert Hofstede Cultural Dimensions [online], Available:

http://www.geert-hofstede.com/hofstede_mexico.shtml  [22 January 2011]

Johanson, J. and Vahlne, J. E. (1977) The Internationalization of the Firm: A model of knowledge development and increasing foreign market commitments, Journal of International Business Studies, Vol. 8, p23

 

Levitt, T. (1965) Exploit the Product Life Cycle. Harvard Business Review, November/December, pp.81-84

 

Massachusetts Office of International Trade and Investment (2006) Life Science Companies Doing Business in Massachusetts: An Introduction U.S. and Massachusetts Laws for Foreign Life Science Companies

The Pharmaletter (2011) Outlook For Pharmaceutical Markets In Latin America, Now Worth a Total of $50 Billion [online], available: http://www.thepharmaletter.com/ [22 January 2011]

Roberts, I. and Stott, R. (2010) Doctors and Climate Change, The Lancet, Vol. 376 (9755), pp1801 – 1802

RNCOS (2009) Emerging Pharmaceutical Markets Globally [online], available: http://www.rncos.com/Report/IM081.htm [22 January 2011]

Toftoy, C. (1999) Management Training to Gain For Small And Medium Sized Enterprises: Focus On Latin. Center For Advancement Of Small Business. George Washington University.

Toyne, B. and Walters, P.G. (1993) Global Marketing Management: A Strategic Prespective, Allyn and Bacon, Boston, 394pp

US Department of Commerce (1994) International Trade Administration [online], available: www.commerce.gov [21 January 2011]

Vernon, R. (1966) International Investment and international Trade in the product cycle, Quarterly Journal of Economics 80, p190-207

Villarreal, M.A. (2010) U.S.- Mexico Economic Relations: Trends, Issues And Implications. Congressional Research Service.

Wells, L. T. (1968) A product life cycle for international trade? Journal of Marketing, Vol. 33, July pp. 1-6.

Wells, L.T. (1969) Test of a product cycle model of international trade Quarterly Journal of Economics, February, pp. 152-62.

Whitley, R. (2007) Business Systems and Organisational Capablities: The Institutional Structuring of Competitive Competences.OxfordUniversityPress. 487pp

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