MGM5966 - Analyzing Challenges in Cross-Border Business Activities

This essay examines the multifaceted challenges encountered by foreign firms in cross-border business activities, categorizing them into formal and informal systems. The formal systems analysis includes political risks such as government interference, political instability, and conflicts between countries, alongside the impact of different economic systems like command, traditional, market, and mixed economies. It also addresses legal system challenges, including intellectual property rights and labor laws. The informal systems section delves into cultural differences, social norms, and language barriers that affect international business operations. The essay highlights how these factors create risks, costs, and uncertainties that multinational companies must navigate to succeed in the global market, referencing specific examples and academic research to support its arguments. Desklib offers similar solved assignments and resources for students.

Running head: DOINNG BUSINESS ACROSS BORDERS
Challenges Faced by Foreign Firms doing Business Cross-borders
Name
Institution

DOINNG BUSINESS ACROSS BORDERS 2
Table of Contents
1.0 Introduction..........................................................................................................................3
2.0 Formal Systems...............................................................................................................3
2.1. Political Systems.............................................................................................................3
2.1.1. Government political systems..............................................................................3
2.1.2. Political Instability...............................................................................................4
2.1.3. Conflicts between host countries and other countries..........................................5
2.2. Economic Systems.......................................................................................................5
2.2.1. Category of the Economic Systems.....................................................................5
2.3. Legal Systems..............................................................................................................9
3.0. Informal Systems..........................................................................................................10
3.1. Cultural Differences..................................................................................................10
3.2. Social Norms.............................................................................................................12
3.3. Language Barrier.......................................................................................................12
4.0. Conclusion.....................................................................................................................13
5.0. References.....................................................................................................................14

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1.0 Introduction
Due to increasing rate of globalization and technological advancements, commercial
activities like foreign direct investments (FDI), emergence of multinational companies
(MNC), and joint international ventures (JIV) as well as strategic alliances have been moving
on upward trajectory. Globalization has improved interaction and foreign trade across many
countries. However, a number of factors have slowed down foreign business activities. These
factors are broadly compartmentalized into two: formal and informal systems. Formal
systems include factors like political systems, economic systems, and legal systems and
informal system, while informal system encompass cultural, social, and linguistic aspects.
This paper analyses the risks, costs, and uncertainties that these factors impose towards
undertaking foreign business activities.
2.0 Formal Systems
2.1. Political Systems
2.1.1. Government political systems
There has been increasing academic concern on the relationship between international
business and political environment. One of the most fundamental issues in this context is the
type of the political risks that may hamper foreign investment. In most instances, when
political risk depicts government interference with market operations. According to Ghosh
(2015), political risk emanates from the government’s action to prevent or interfere with the
business transactions by either changing the terms of agreement or confiscating partially of or
the foreign owned business assets. Farnell and Crookes (2016) define political risk as
“government or sovereign interference with the business operations.” Some scholars equate
political backlash with the environmental aspects like direct violence, instability, and
competition (Cavusgil et al., 2017). Ghosh (2015) identifies the dynamic feature of political

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environment but contends that progressive and gradual changes that are unexpected do not
define the political risk. However, political uncertainties affect the business in terms of
transfer— technology, people, payments, and capital uncertainties; operational— business
regulation uncertainties; and control— uncertainties concerning policies that relates to the
management control (Kaur and Sandhu, 2013). Operational and transfer uncertainties flow
from the political-economic events to ownership-control events.
2.1.2. Political Instability
According to Ma et al (2013), political activities have great influence on the economic
activities of a country, and as such, a shift in regime may dramatically transform the economy
socialism to capitalism. Similarly, power concerns affect the economic policies that a country
adopts. For a regime that has been installed through coup may adopt radical socialism that
strip all foreign-owned companies their assets. Political expropriations may also be in form of
inclusion of forceful renegotiation of contracts with public enterprises, violating the
agreement on tax benefits, revisiting business regulatory rules to the detriment of the private
investors, and nationalization of private assets without redress (Immarino and McCain, 2013).
Uncertainty about the regime change may affect the value of the business expected returns
and influence their variations. Political systems have great influence the investment strategy.
Countries that experience consistent political instabilities are prone to political
violence and have quintessentially weak institutions. In such scenarios, the investment
decisions are underpinned on the risk of asset destruction, sporadic changes in the domestic
demand, and the poor infrastructure. In addition, countries that undergo political conflicts
tend to have slow economic growth and low income per capita. Political instability may also
result to destruction of properties and looting. In most times, political unrest culminates to the
state of anarchy, which is another factor inhibits foreign investment. Political instability is the

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reason why most developed and emerging economies do not want to invest in countries like
Somalia, Syria, and Pakistan. This is because there is more risk involved in such countries
compared to the politically stable countries like China (Wild and Wild, 2018).
2.1.3. Conflicts between host countries and other countries
Like the internal conflicts, border disputes can result to a reduction in capital inflow
and capital outflow, thereby blighting FDI. Conducting a business along tumultuous zones
may expose the firm to high risks of asset destruction and staff insecurity. Conflict among the
countries materially reduces the demand for business products (Wild and Wild, 2018). For
instance, the border conflict between Russia and Ukraine over Crimea has plummeted FDI in
Ukraine “from $4.5 billion in 2013 to $410 million in 2014” (Vox Ukraine, 2017)
2.2. Economic Systems
2.2.1. Category of the Economic Systems
There are four distinct types of the economic systems: traditional economy, market
economy, command economy, and the mixed economy (Immarino and McCann, 2013). A
command economy is an economic system where coordination of economic activities
operates under direct control, directive, and regulations of the administrative systems. The
economic activities are considered significant to the complex social systems that they cannot
be left to operate under the context of the free market. Under this economic system, the
economic agents, especially in the production organizations, take orders from high ranks
within the authority in the political hierarchy. Therefore, the authorities directly undertake the
firm activities, resource employment, production output, management of disturbances, and
their coordination.
Essentially, the central government sets the firm production targets. Some of the
activities that government regulation encompasses include price levels, budgetary control and

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allocation, material balance, and technical coefficients. According to White and White
(2016), this kind of command authority may collide with market forces in crucial sectors of
the economy hence manipulating the political direction. Some of the countries whose
economies are inherently command system include Russia, China, and North Korea.
On the other hand, traditional economy is the type of economy in which “customs,
traditions and believes prescribe the principles of economic organization for production of
goods and services is built up around traditions, according to which a particular society lives”
(Ghosh, 2015). Technology and other innovations are discouraged to enable the traditional
systems that have been embedded on the economic systems over the years to remain. Most
countries that adopt this system of the economy are usually agricultural-dependent and rural-
based. The economy is quintessentially subsistence characterized by barter trade. Economic
activities are rarely commercial, and is dominated by activities like hunting and gathering,
cultivations, small-scale fishing, without any modern form of technology.
Verbeke (2013) attests the amount surplus produced under the traditional economy is
very little. The traditional system of economy is popular in the developing countries and the
emerging markets, particularly among the aboriginal population. Another feature of such
economy is that the families train their children concerning the traditional customs about
resource allocation in the community. Underdeveloped parts of Africa, Asia, and South
America still apply this system of the economy. One of the merit of this kind of economy is
that it encourages inclusivity. Every person has a specified role to undertake in the growth of
the economy, hence strengthening social bonds. Another benefit is that the n basic needs are
met. The kind of life in this system appreciates basic items instead of the luxury lifestyle.
However, this type of the economy is rigid to change and inhibits high standards of living.

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Market economy refers to the type of economic system where forces of market
demand and supply inherently controls the economic activities (Verbeke, 2013). This means
that there is no government intervention or regulation. The state only offers security to buyers
and sellers by protecting their individual lives and property against criminals. An absolute
free market economy involves full ownership of the resources by individuals. Similarly,
individuals without government involvement undertake the decisions of the market. Ideally,
producer produces the amount the like and sets prices for their products. Owners of factors of
production also have the discretion on what to pay the employees. However, such decisions
are implicitly under the market demand and supply forces, which is inbuilt. The market forces
determine how much the producer will produce and for how much the producer will sell. The
economic decisions in the market economy vest on the buyers and the sellers. The market
economy promotes competition, which enhances efficient use of the economic resources
(Beugelsdijk and Mudambi, 2013).
In the mixed economic system, the government undertakes part of planning and
production activities while private enterprises control some of the production activities
(Beugelsdijk and Mudambi, 2013). Most importantly, the public systems operate in a
coordinated fashion to ensure that there is partly free and partly centralized. Usually, the
government undertakes the investment activities that involves huge capital outlay and are
unattractive to the private investors due to the low profit margin and high degree of the risks
are involved. Examples of such investments include electricity, provision of water and health
services. Mixed economy has both characteristics of command and market economy.
The economy is compartmentalized into four sectors: private sector, which owns and
controls resources; the public sector, which engages in production of essential goods and
services. Joint sector is where the private sectors collaborate with the public sector to

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undertake economic activities and in the cooperative sector, small-scale producers collaborate
in production activities to achieve the economies of scale (Beugelsdijk and Mudambi, 2013).
Another fundamental feature of the mixed economy is the maximum social wellbeing. The
mixed economy system has regulations to ensure that the private sectors engage in the
production activities in a sustainable manner. Therefore, the government can impose quotas,
tariffs, and labour laws to promote sustainability and social welfare. The government also
ensure that there is equal distribution of wealth through taxation and investment models.
Similarly, while the market forces of demand and supply determines the prices, they are also
under government control. The government may establish price ceiling, fix price, or impose
value added tax to control the consumption of certain products.
The economic system that mostly favours doing business is the mixed economy (Wild
and Wild, 2018). The traditional system may be detrimental to foreign investment since the
inhabitants are rigid to change. On the other hand, the command system encourages state
regulation, which may stifle completion and eventually affect the growth and the profitability
of the business. The free market economy encourages competition, specialization, but it is
prone to civil unrest and market failure, which may hamper business operations. Due
uncertainties that characterize command economy, countries like Russia have experienced
decline in inward FDI (Wild and Wild, 2018). However, socialist economies are marked
political instability due to one-party state factor. For instance, the FDI in Vietnam registered a
96% increase in the number of FDI projects, from $5075 billion in 2015 to $18103 billion in
2016 (Hanh et al., 2017). The economic system has been favourable hence attracting MNC
like Toyota, Unilever, and Canon.

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2.3. Legal Systems
Legal systems can affect the foreign investment by influencing the investors’
perception on the returns and the risks involved in an investment. Laws that are designed to
raise investment cost my may discourage the foreign investors and make the remaining part
to raise their demands on the return investment. The main transaction cost to foreign
investment, according to Cantwell (2014), is the uncertainty risk about the commercial and
legal structures, as well as the risks of breaching intellectual property laws. However, Yu et al
(2013) argue that there is no need of stronger intellectual property laws when the business is
operating in countries that do have the capacity to invest in technology and contravene the
intangible asset laws. Other legal risks include labour laws and taxation policies. Peng and
Meyer (2016) observe that absence of international legislative framework that can address
such policy issues may impose a huge risk to the foreign business. Without adequate
intergovernmental operations to establish mechanisms and principles that guide business
operations between the two countries, investors may be exposed to legal risks and
uncertainties. To reduce such risks, it is imperative that the countries implant international
legal systems to promote familiarity with the foreign country’s legal system.
Another legal risk that international businesses may face is difficulty in optimum
connections to address unique challenges that the international business operation presents.
Farnell and Crookes (2016) observe that foreign investors may be exposed to demarcation
problems when in matters of defining obligations and rights. One of the main difference
between the international and domestic transactions is the existence of broader range of
parties in legal relationships. Demarcation problems may spawn overlapping problems and
other disputing issues. More often, contractual relationships applies to international
transactions, for instance buyer and seller contract, carriage contract, insurance contract,

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buyer and bank contract, as well as bank and the buyer contract. Such system of transaction
explicitly discourages international business firms.
In addition, money transfer across different countries usually involves legal process
that blends local laws with the international arrangements. Specialized contract policies
define the obligations and rights of the payee, payer, and banks facilitating the transactions.
Some of the regulatory concerns that emerge are general fraud, fund misappropriation,
security systems, and confidentiality issues (Cantwell, 2014). The nature of the transaction
also demands that the legal systems ride in the same pace with finance and trade institutions.
Some of the aforementioned issues replicate in foreign direct investment system.
Some of the legal systems give the state full control over the production firms hence making
foreign investment difficult, particularly in countries that embrace “customary international
laws.” in similar vein, countries that operates under command economy stipulates that the
government will control the foreign businesses, which may clash with the local host laws
(Ghosh, 2015). Some countries may also impose restriction requirements to protect the local
enterprises. Some of such restrictions include like performance requirements, which
stipulates the specifications that a company must meet to join a particular sector of
production; licencing requirements, majorly administrative verification; operational
requirements, and joint venture requirements, which insists on inclusion of local capital in the
foreign production process (.Ghosh, 2015)
3.0. Informal Systems
3.1. Cultural Differences
Culture refers to “a set of shared values, assumptions and beliefs that are learnt
through membership in a group, and that influence the attitudes and behaviours of
group members” (Vadi, 2011) Multinational companies or businesses that engage in the

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direct foreign investment must observe foreign differences to succeed in a foreign
environment. Failure to observe cultural differences can be detrimental to business in terms
of strained relationships, poor performance, and reputation vitiation. According to White
(2016), it is imperative for businesses that want to invest in foreign countries to understand
how culture materializes as well as how cultural differences influence commercial activities
globally. Ideally, culture is multifaceted phenomenon and exits at different categories like
occupational groups, business units, organizations, industries, and geographical units.
Therefore, a firm must consider all these factors before it embarks on the foreign investment.
Beugelsdijk and Mudambi (2013) observe that national cultural diversity has remain
consistent over time. In another nuanced study, Ghosh (2015) asserts that there is existential
resilience of cultural standards even after occurrences like immigration, globalization,
technological advancements, formal education, and cross-cultural activities like games. Most
Cultures like United States, Canada, and Australia vests on universal commitments, for
example upholding integrity, while most cultures in the Russia, China, and North Korea
emphasizes on loyalty to relationships and people. The resilience of culture values across
different countries is significant to MNC that face numerous national cultures in their
operations. This means that operation across the borders presents substantial complexities
since it compels the multinational companies to redesign their ethics and standards in
accordance with the cultural milieu that they operate. To be effective in its operation, the
business must incur knowledge cost on the locals’ behaviour and understand their cultural
mechanisms. To mitigate cultural uncertainties, MNC like KFC, Coca-Cola, and Unilever
have been employing employees from the host countries (Ghosh, 2015)

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3.2. Social Norms
In social norms, the individualism and collectivism is the main hurdle for the MNC.
Individualism social system puts more weight on the personal preference rather than the
whole community or a group. Most countries that embrace individualism like the one the
United States and United Kingdom have quintessentially lose structures that emphasize on
the individual rights, independence, and personal achievements and initiatives. On the other
hand, collectivism social systems, like in China and North Korea, distinctions are based on
the community or group fashion, and community interest comes first at the expense of
individual’s interest (Beugelsdijk and Mudambi, 2013). Like in the case of cultural
differences, the MNC must incur knowledge cost and uncertainty risk to operate in in a
socially different setup. Asian countries like China, Singapore, Korea, and Taiwan accounts
for 70% of FDI in Taiwan because their social systems are almost similar (Hanh et al., 2017)
3.3. Language Barrier
Linguistic distance is also one of the major uncertainty risk that MNC are likely to
face. For instance, when investing in Venezuela, business executives must ensure that the
staffs are multicultural competent (Yu et al., 2013). This may require additional training,
which is costly. In addition, due to language barriers, the business must incur knowledge cost,
information asymmetry, and moral hazard cost. For business to be effectual in its operation, it
must liaise with national commercial and international agencies within that country. The
business must also work closely with the local inhabitants since they understand the
environment better. To invest in East Africa, MNC like Unilever and Coca-Cola have to
ensure that their employees are well conversant with English and Swahili languages (Ghosh,
2015)