WHY COMPANIES TRADE
WHY COMPANIES TRADE
Most trade theories approach the issue from a national perspective; that is,
they begin with a question such as, "Why should Sri Lanka trade?" Regard-
less of the advantages that countries may gain by trading, trade ordinarily will
not begin unless businesses within the country perceive that there are opportunities for exporting and importing. Since companies have a limited number
of resources, they must decide whether to exploit those resources domesti-
cally or internationally. Only if they see that the international opportunities
might be greater than the domestic ones will they divert their resources to the
foreign sector. To understand why trade takes place, it is therefore useful to
understand the trade advantages accruing to individual businesses.
Export Opportunities
Excess Capacity
Use Companies frequently have immediate or long-term output capabilities for which there is inadequate domestic demand. This may be in the form of known reserves of natural resources or product-specific capabilities that cannot be easily diverted to the production of other goods for which there might be an adequate domestic demand.
As shown earlier in this chapter, small countries tend to trade more than large countries. One reason is that process technology may allow a firm to produce efficiently only on a large scale, larger than the demand in the domestic market. Take automobile production, for example. Volvo has a much greater need to export from the small Swedish market than General Motors does from the large U.S. market.
Cost Reduction
Studies have shown that a company can generally reduce its costs by 20-30 percent each time its output is doubled, a phenomenon known as the experience curve.27 For instance, if we assume a 20 percent cost reduction and an initial cost of $100 per unit, the second unit produced will cost $80, the fourth $64, and so on. The reduction may come about because of several factors: covering fixed costs over a larger output, increasing efficiency because of the experience gained producing large quantities of units, and making quantity purchases of materials and transportation. Therefore, it is obvious that the market leader may garner cost advantages over competitors. One way a company can increase output is by defining its market in global rather than domestic terms.
More Profitability
A producer might be able to sell the same product at a greater profit abroad than at home. This may happen because the competitive environment in the foreign market is different, possibly because the product is in a different stage of its life cycle abroad. Thus a mature stage at home may force domestic price cutting, whereas a growth stage abroad may make price reductions unnecessary there. Greater profitability also may come about
because of different government actions at home or abroad that affect profitability—for example, differences in the taxation of earnings or differences in regulations on prices.
Risk Spreading By spreading sales over more than one country market, a producer might be able to minimize fluctuations in demand. This may come about because business cycles vary from country to country and because products might be in different stages of their life cycles in different countries. Another factor in spreading risk through exportation is that a producer might be able to develop more customers, thereby reducing its vulnerability to the loss of any single or few customers.
Most trade theories approach the issue from a national perspective; that is,
they begin with a question such as, "Why should Sri Lanka trade?" Regard-
less of the advantages that countries may gain by trading, trade ordinarily will
not begin unless businesses within the country perceive that there are opportunities for exporting and importing. Since companies have a limited number
of resources, they must decide whether to exploit those resources domesti-
cally or internationally. Only if they see that the international opportunities
might be greater than the domestic ones will they divert their resources to the
foreign sector. To understand why trade takes place, it is therefore useful to
understand the trade advantages accruing to individual businesses.
Export Opportunities
Excess Capacity
Use Companies frequently have immediate or long-term output capabilities for which there is inadequate domestic demand. This may be in the form of known reserves of natural resources or product-specific capabilities that cannot be easily diverted to the production of other goods for which there might be an adequate domestic demand.
As shown earlier in this chapter, small countries tend to trade more than large countries. One reason is that process technology may allow a firm to produce efficiently only on a large scale, larger than the demand in the domestic market. Take automobile production, for example. Volvo has a much greater need to export from the small Swedish market than General Motors does from the large U.S. market.
Cost Reduction
Studies have shown that a company can generally reduce its costs by 20-30 percent each time its output is doubled, a phenomenon known as the experience curve.27 For instance, if we assume a 20 percent cost reduction and an initial cost of $100 per unit, the second unit produced will cost $80, the fourth $64, and so on. The reduction may come about because of several factors: covering fixed costs over a larger output, increasing efficiency because of the experience gained producing large quantities of units, and making quantity purchases of materials and transportation. Therefore, it is obvious that the market leader may garner cost advantages over competitors. One way a company can increase output is by defining its market in global rather than domestic terms.
More Profitability
A producer might be able to sell the same product at a greater profit abroad than at home. This may happen because the competitive environment in the foreign market is different, possibly because the product is in a different stage of its life cycle abroad. Thus a mature stage at home may force domestic price cutting, whereas a growth stage abroad may make price reductions unnecessary there. Greater profitability also may come about
because of different government actions at home or abroad that affect profitability—for example, differences in the taxation of earnings or differences in regulations on prices.
Risk Spreading By spreading sales over more than one country market, a producer might be able to minimize fluctuations in demand. This may come about because business cycles vary from country to country and because products might be in different stages of their life cycles in different countries. Another factor in spreading risk through exportation is that a producer might be able to develop more customers, thereby reducing its vulnerability to the loss of any single or few customers.
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