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lodelcar · 5 years

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BUILDING UP A FOREIGN TRADE ACTIVITY IS PRECEDED BY BUILDING UP A BUSINESS

picture: modern lace worker, Brussels

Introduction

I have written this text to share it with my postgraduate students from the VUB. They start a year of International Trade and Investment full of courage from various nationalities and from various study backgrounds. They do this with a great deal of diligence and dedication but often find that they do not master the premises: the fact that the course deals with doing business, producing, trading, buying and selling. For many of them, who are at the start of a professional life, even the theoretical knowledge about this is lacking.

That is why I have decided, during an hour and a half, with many examples, to try and guide them in doing business.

1. Doing business

Doing business takes only three forms: it is either about producing something or about purchasing items and then reselling them, or about selling one’s own knowledge and skills to third parties. People sometimes need material for the latter, but they don't sell it. People only sell their workforce and intelligence. The latter are called services. Although they account for between 75% and 80% of the economic activities in most countries, in this article I will deliberately limit myself to agriculture and the manufacturing industry. Because in this presentation we want to end up at trading with foreign partners, and this is primarily about tangible products.

Two stories can support this:

The company F.E. T* 2011, 100 km from the Ukrainian capital Kiev has 2000 ha of land, which it owns partially and leases mostly (long lease 50 y). 80% of the farm’s turnover comes from traditional crops, such as wheat and corn. In order to make future oriented products, the farmer started to develop an entire line (30 items) of dairy products from goat milk, to yoghurt and kephir and even ice cream since 2016. Today the income of this activity line is good for 20% of the turnover. The farmer aims at reaching 50% over 5 years. The goats have been purchased in France and a breeding process started. They now have 1500 goats and intent to increase the amount to up to 3000 goats. They have a milk production capacity for up to 7000 l/day. They are at 2000 l/day. The equipment for milk treatment is Israeli, as well as the milk production supervisor. Cheese production equipment comes from France and Italy as well as their cheese making consultant. The ice cream consultant comes from Italy. The farmer goes yearly to a large goat fair Caprina in France where he learns about gear and equipment and meets potential consultants. This dairy line is a typical example of vertical integration. The production is entirely mastered by the farm from the breeding of goats, the collection and distillation of the milk, the production of the dairy products, the production of the bottles out of small plastic objects purchased in China, the bottling, the development of logo and packaging design, the packaging and the transportation to the retailers. Important is that the farm does and finances market research, developed its own brand Z*, as well as its own design with colour codes. They even intend to create in the future a second high-end brand. These steps enables them to grow organically and in a sustainable way. They declined until now to produce for private labels of retailers. Even with Auchan, with whom they negotiate now, they declined the private label production.

The company W* close to Chisinau in Moldova sells tractors and agricultural equipment from the brand C*, of which they have a dealership agreement during 3 years in Moldova. Before they had a dealership with the Italian M* G*. They also sell equipment from the Swedish brand V*. The company recently built new premises as rep office for C*. They built a state of the art show room and offices with workshop for repairing. The company also sells fertilisers and pesticides as well as seeds for crops. They don’t sell liquids but solid boxes. Their suppliers are BASF, Bayer, Pioneer for the seeds. They produce also seeds themselves (sunflowers).

Services companies are often related to ICT development. Until five years ago, ICT focused primarily on processes and their management. Because of our increasingly complex society, which demands more transparency, which requires faster and more thorough reporting, and which is monitored more and more, large companies have to manage such large volumes of data that they can use help for this. Data is becoming very important, now even more for large, say, listed companies. But medium-sized companies will suffer the same fate in the future. The engineers at the -nowadays “unicorn”- company C* in Brussels are active in data governance and in data stewardship. In this way they do not address the IT departments within a company, but rather the business people themselves.. There are 20 potential customers in Belgium. That is why they had resolutely gone international from the start. They are mainly talking to banks, insurance companies, pharmaceutical companies, etc. But also large governments, large public companies, universities.

2. Import and export

Import and export are often activities that go together in the same company. A company often needs products that are not present in its own country or that are present at too high a price or of poor quality. The company needs these products both to make its own products and to sell them to other customers. He will therefore have to import them. A company is sometimes approached at a trade fair or thanks to its website via e-mail by foreign companies who are convinced that they can use the semi-finished products or raw materials that our company produces in their own production process. In other circumstances our company finds a foreign-interested company at a trade fair that is convinced that there is a market for our company's products in its country and that it wants to sell it there.

3. Producing and selling products.

A company from the manufacturing industry needs raw materials or semi-finished products to make its own products. Depending on the type of quality that they wish to deliver, they must determine where they will purchase their raw materials. Are these present in the country itself or do they have to import them? They also need machines to manufacture their products. Depending on the quality that they are trying to deliver, on their financing options and on the number of staff they have at their disposal, they will purchase their machines, either abroad or domestically but often from abroad.

The company O* in Obuchov,Ukraine has machinery for 2 types of products: polyamide and cotton for women and children socks. They are the second producer in Ukraine. The cotton comes from Turkey, the polyamide from Italy, the elastane from Korea through Poland, the yarn from Italy.

The company D* in Chisinau, Moldova produces fiberglass mesh for construction, especially walls and insolation. It produces 1,2 M m²/month. Thanks to a new machine of the K* from Chemnitz they will be able to double their production to 2.5 M m²/month. They export 90% of his product to Romania, Bulgaria, Germany, Spain and Italy. The company has 100 staff members and is looking this to extend by recruiting 40 new staff members. They have difficulties to find qualified staff. The raw material comes by 80 % from Bielarus, by 20% % from Germany, Switzerland, Latvia and Poland.

4. Buying and selling products

This activity is often performed by a permanent sales representative in a region or a country. This person or company can be established as self-employed in the country (agent, shop / webshop), or can be established as a subsidiary of the foreign company (sales office, shop / webshop) with its own legal status. A representative on the payroll of the foreign company may also be located in the country: he may sell the products but the deal is concluded by the main house abroad and the invoice also comes from the main house. The company W* described above, also houses the rep office of the company for whom they do the sales in the Chisinau region.

Why are companies entering and selling products from abroad? There can be several reasons for this. It is possible that a specific type of machine or product is not produced on the local market because the size of the country is too small for it. It may also be that the importer can deliver in a cheaper way than the products already on the market. It may also be that the new products are much more sophisticated and can therefore make them work much more productively. It may also be that products have built up such a reputation or became a brand that is in demand throughout the world. This last one is the case for many fancy clothing brands like Gucci, Dolce & Gabbana, Dior etc.

Which products do companies offer abroad? That can be anything: from raw materials such as seeds for agriculture, yarns for textiles or fiberglass for construction, to semi-finished products such as fabrics for clothing, goats for milk and cheese production to finished products such as luxury clothing, refrigerators but also cooling installations for cold storage.

The company V* – Groups Ltd in Kiev, Ukraine is a trader. He buys cereals and looks for opportunities. He does business with Sri Lanka, Myanmar, India and many other countries. His warehouse capacity was insufficient and obsolete. He stocked on the ground floor. With a bank loan he has been able to construct 2 grain silos of 3,018 tons capacity each. The silos are erected close to a railway platform, thus avoiding logistical problems and damage to the goods. He found a new business opportunity with Sri Lanka for sale of split yellow peas and next requires an optical sorting machine.

5. The production or purchasing process and its financial aspects

A production company might purchase raw materials or semi-finished products from elsewhere. Before the production of their new product is finished, several weeks or months sometimes pass. And then the new product must still be put on the market, sold and the invoice must be paid. A company therefore needs a financial buffer: that is called working capital. Chocolate producers in Belgium and Switzerland who supply products for the Chinese New Year, which often takes place in February, start their production in September of the year before! Companies often purchase large quantities of raw materials at times when they are offered cheaply and stock them for later production. The same applies to a store: it purchases finished products to resell in the store. There is also a lead time of several days, weeks or months. Here, too, the store needs a buffer called working capital.

The company O* in Ukraine makes pavement tiles out of concrete with artistic top layers. They produce 300 different types of pavement in 60 different shapes. They also produce stone levelling machines of the brand W*. They have offices in Lviv, Ukraine but have their production is set-up 80 km further, where they have 4 separate plants. During winter season, because of the cold, the production is stopped. They received a loan from the bank over 3 year for working capital, since January 2017. The additionality of this loan type for O* is the tenor: 3 years’ working capital enables a company to plan strategically: buy raw material when prices are low and stock it in order to produce through a longer period. And also have a 5-month buffer stock in times of scarcity through political crisis. They have large storage capacities (70.000 tons) for as well raw as finished material.

But those companies also need machines for their production, storage areas, large stores for their sales, trucks for their transport, tractors to work their land. They purchase them or build them with a bank loan. The cost of that loan must be passed on in the selling price. These loans, which are usually of a longer duration, are called investment capital. A company can also invest with its own resources.

The company K* , a wine production company in Georgia specialises in making wines for the lower and medium segment, priced at USD 5 to 8 /bottle. 75% of its production goes to the former CIS countries, of which 50% to Russia, where they have a distributor with the necessary connections, the remainder goes to Ukraine, Belarus, Kazakhstan, Armenia. The final 25% goes to China, US and recently, the UK. In 2016 the company invested in new reservoir tanks, fermentation facilities, refrigerators, a steam generator and a filling & labelling line. The client received in total a loan from BoG. In 2017, the company reapplied for a second loan for land, construction, production facilities over 36 months. Additionally, they invested in health and safety procedures for the workers, environmental protection (by reducing ozone depleting substances), low voltage machinery, electromagnetic compatibility and in measures for materials that come in contact with food. Thanks to the investments the company increased its production volume from 4,6 m litres in 2016 to 6 m litres in 2017, an impressive 35% increase. In labelling and bottling they were able to increase production by 50%.

6. Access to finance

All research reports around the world reveal that access to finance is the aspect that most often blocks the growth of SMEs. Working capital is usually requested for relatively short periods, such as three, six or twelve months. However, the amounts required are often important. The duration of the loan for capital goods is longer: this depends on the price and durability of the good: a computer is outdated after 4 years, a car or light truck starts to show signs of wear after 5 years, machines will certainly be operational during 10 to 20 years, industrial buildings as well. But do the banks have any loans with this duration for all those terms?

A bank's assignment is simple and difficult at the same time. A bank collects money from people who can spare the cash for a certain period of time and gives a fee for this. In Western Europe and North America, this allowance has been peanuts for several years. In Eastern Europe, Africa, large parts of Asia and Latin America, this allowance is quite substantial. Yet most of these “savers” are wary of leaving their money with the banks for too long: they want to buy things with it, or they do not trust the monetary policy of their country and are always afraid of a devaluation of their currency. With the money that banks collect from citizens and companies, they finance loans. They earn their profit through the spread between the interest rate they give for the savings and the interest rate they charge for the credits. But it is difficult for them to grant 10-year loans if they can only collect one-year savings. Moreover, there are few citizens who put away savings for 20 years. The only ones that do that are the pension funds. But what if there aren't any in a country? Which is the case in many countries. The international financial institutions such as African Development Bank, Asian Development Bank, European Investment Bank and European Bank for Reconstruction and Development offer longer-term loans to local banks, that can then transfer them to their customers. Only: most of those loans are in dollars or euros. Again a problem. Because the citizens and companies of the country usually do not have repayment capacity in dollars or euros but in the local currency. And if that local currency is not stable and has a tendency to devalue frequently, local banks are not keen to withdraw long-term dollars or euro loans. Hedging is the only option that remains. Hedging is a type of contract that a bank concludes with a specialized institution to mitigate the risk of devaluation: the contract foresees the exchange rate of euro / dollar to the local currency at the time of repayment, even if the local currency has meanwhile been devalued. Hedging in this case can be considered as a type of insurance. And there are now some companies that also dare to hedge "exotic" currencies. The price ,for this insurance is important though: up to 7 % of the amount.

Banks also do not like to take risks. It is often the central bank of the country that obliges them to be very restrictive in giving loans. Because they have been confronted in the past with bad loans to large outdated government companies that were poorly managed and therefore worked with losses. Governments that have to bear such a burden then hit back with the blunt ax and prevent any loan that is not covered by collateral. Where all statistics indicate that lending to SMEs is much less risky!

Therefore: collateral. In many countries, the way collaterals can be offered to guarantee credit is limited to tangible assets: buildings, land, machines. Intangible assets like the company’s goodwill are not accepted. The valuation of the tangible assets is by law done by the Association of property evaluators. These experts apply the principle of “market value coverage”. Based upon their valuation the size of collateral is put by the bank. It mostly comes to 140% of the loan. Once a credit is taken, the bank declares it to the central credit reporting system. Based upon the regularity of the reimbursement a company is classified class 1, 2, 3 or 4. Class 1 is all payments are done on a regular basis. Class 2 is a company of which arrears were limited from 30 to 60 days. Companies with arrears of between 60 and 90 days are class 3. Companies with arrears of more than 90 days are sent to recovery as class 4. Recovery is compulsory and taken from the profit automatically and can therefore jeopardise the existence of the company. In certain cases the collateral will be sold without warning.

7. Difficulties to tackle

Managing a company goes further than ensuring that people and machines work, that stocks are replenished, that bills are paid and that sales run smoothly. There are constant obstacles that need to be overcome: the financial aspect, the transport aspect, the legal aspect and - once a company starts exporting - the political aspect.

7.1. The banking aspect

A company is practically obliged to work with a bank: it has to make payments and it often needs funds for working capital and for investments.

Payments go faster and smoother nowadays thanks to automation and now also thanks to fintech applications. There are payment cards and credit cards that allow customers to pay without cash and give the collecting company the assurance that the money will be in the account. There are international transaction systems such as SWIFT or the European IBAN that create uniformity between banks and countries and thereby make payment transactions run faster and more efficiently. The currency aspect remains a stumbling block. Although more and more currencies are freely exchangeable, there are still a lot of them that are not convertible. Contracts with companies from such countries are therefore often in USD, EUR or CNY. Banks that operate in those countries are not always considered reliable by the others and must therefore be patterned by an internationally respected confirming bank. There are even countries with which the US in particular are in conflict. They then oblige all banks in the world not to do transactions with banks from that country. Iran, Cuba and North Korea have been assigned such a fate. There are always solutions, but they are complicated and time-consuming.

We have already explained the credit aspect: the fact that in many countries long-term loans are far more the exception than the rule. The extravagant guarantees that are requested. The non-customer-oriented thinking of banks that only wait until a loan is repaid and have no eye for the growth of companies and the usefulness that these can have for the further development of a country. But also the positive role for SMEs that IFIs play such as African Development Bank, Asian Development Bank, European Investment Bank.

Last but not least is the interest charged on loans. In many countries, the interest rate is a double digit, and companies think this is freakish. Where do those freak interest rates come from? The Central Bank of a country offers its banks short-term loans to banks that need them to clear a deficit for one or a few days ("overnight" or tomorrow-next day = “tom-next”). The Central Bank itself is able to provide with these loans because it borrows money on the international money market and pays interest for that. The interest rate the central has to pay for that depends on the country's rating, which is the appreciation of the economy and the way a country makes economic progress. That appreciation is indicated depending on the rating agency with numbers and letters and reflects on the local currency. The lower those ratings are, the more risk premium a central bank has to pay on the international money market. She therefore passes on the risk premium to the local banks, which naturally also pass it on to their customers. Hence countries where the banks demand a double digit interest, when they provide with loans in local currency.

7.2. The transport system

Goods must reach the customer from the workplace. That requires transport. Road transport and train transport are usually the first choice for domestic transport. River transport is still very limited in Europe, is much more present in Asia. When it comes to transport to foreign destinations for import or export, the nature of the product - its weight, its durability, the urgency of the customer - determines the choice between truck, train, ship or plane. All these means of transport have their own international documents, luckily. International rules have also been worked out that determine who becomes the owner of the goods and when. These rules are called the Incoterms, and there are so 11 containing 3 letters each. There are RULES FOR EVERY TYPE OF TRANSPORTATION and there are RULES FOR OVERSEAS AND INLAND TRANSPORTATION BY VESSEL.

Import and export is also about customs and import duties to be paid. It is important to realize the value of customs zones such as the EU and free trade zones such as NAFTA, Mercosur, ECOWAS or ASEAN. The service provider that is most approached by companies to steer this aspect of transport in the right direction is the freight forwarder.

Transporting also entails risks: goods can be damaged or stolen, incidents such as harbor strikes can occur, so that perishable goods do not reach the customer in time. There are insurance policies for these types of problems, but they obviously cost and there is not always room to pass them on to the end customer.

7.3. The legal aspect

Trading within the same country offers few surprises once one knows the legal framework in which one operates. Foreign managers are often surprised that things are not treated in the same way everywhere. Anglo-Saxon legislation is based on a completely different approach than the European continental one. A contract based upon Anglo-Saxon law contains minimum 30 pages, a continental European one can be limited to three-four pages because everything is in the law. In the other continents, the laws were partly inspired by Americans and partly by Europeans. A treacherous aspect in the U.S. is, for example, the principle of litigation: one is going to provoke newcomers and then be able to sue them for not respecting the legislation.

A second aspect is the lack of certain pieces of legislation such as the law on bankruptcy, the law on pledging commercial goods, the law on claiming goods and objects, the mortgage legislation.

A third aspect is the independence of the courts. This is essential if the rule of law is to work objectively. But in many countries, judges are nationalistic, so a case brought to court by a foreign company, or where the foreign company needs to defend itself, is lost in advance.

7.4. The tax aspect

Taxes are the deepest expression of the deepest emotion of a country: there are hundreds and they take different aspects everywhere, even within a country. Brazil, the US and India are federal countries in which the states can collect taxes. And do so with pleasure. Informing yourself in advance is of the utmost importance because it can drastically influence the price worked out by consultants to the end consumer. And one must also know that the principle of VAT is not used all over the world, especially not in the US. Tax declarations are another aspect that one needs to check beforehand. In the US, certain spontaneous declarations are assumed, the consequences of a non-spontaneous declaration can be horrendous.

The last aspect that should be taken into account are the double taxation treaties. Thanks to this, a company only has to pay tax once, either in its home country or in the trading country. That is, for example, the reason why Belgian companies trade with China via Hong Kong.

7.5. The business development aspect

The Access to finance aspect has many consequences. Opportunities can pass because companies in a country have insufficient production capacity. This requires heavier and more efficient machines that cannot be purchased due to the lack of collateral.

The pharmaceutical production company I* in Cape Verde, Africa exported since 1995 to Angola and Mozambique. Those markets became too large and the company’s production capacity was unable to produce the required quantities based upon the governmental tenders they won. The quality is good, but the production capacity is not adapted to large markets.

The same goes for the printing sector in Rwanda, Africa who cannot fulfill orders to print packaging material on time because the local industry is unable to produce cardboard of the correct quality. All packaging cardboard has to be imported. And transportation over road in Africa is perilous and time consuming.

Another aspect that triggers problems is the cultural one. Our company I* in Cape Verde limits its export to Portuguese speaking countries, because otherwise they have to print several packaging types and product information, and they can’t stock it. Coca Cola has been active in China since 1995. That does not mean that the first years of the sales effort were a success. The Chinese were not used to drinking ice-cold drinks: their preference was for hot drinks. So it took Coca-Cola a lot of marketing effort to convince them that ice-cold drinks could quench their thirst. Eastern European wine producers from Romania, Bulgaria and Moldova have had to put a lot of effort into adapting their wines to Western European tastes. Eastern Europeans simply like semi-sweet wines and do not touch dry wines. In Western Europe, semi-sweet wines can only be sold to a very limited segment. It has therefore required a great deal of investment in new storage and maturing capacity (wooden or metal barrels) to produce specifically for Western Europe at a competitive price.

8. Geography and geopolitics

An International Trade and Investment student can be expected to find countries on a map. He can also be expected to realize that there are numerous free trade agreements between countries and groups of countries such as EU, NAFTA, Mercosur, ECOWAS, East-African Community, Association of Southeast Asian Nations (ASEAN countries).

While a customs union and a free trade area are similar in some ways, they are also different. A customs union represents a higher level of economic integration than a free trade area does. The key distinction between customs unions and free trade areas, however, involves their approach to non-treaty nations. While a customs union, by definition, requires all parties to the agreement to establish identical external tariffs with regard to trade with non-treaty nations (those nations that are not signatories to the agreement), members of a free trade area are free to establish whatever tariff rates with respect to foreign imports from non-signatory nations that they deem necessary or desirable. An example of a customs union is the Southern African Customs Union (SACU). An example of free trade area is the ASEAN Free Trade Area (AFTA). Members of the EU, the largest and most productive customs union in existence,, have agreed to, among other criteria for membership, maintain a common external tariff system with respect to outside nations. Free trade areas, like the North American Free Trade Agreement (NAFTA), are less cohesive to the extent that each of the three member nations, the United States, Canada and Mexico, are free to establish tariff policies distinct from each other.

But it is also important for him to grasp that some organizations and initiatives are not only created or organized inspired by goodwill. Certain organizations have been established for power reasons. Some have old-colonial some have also neo-colonial intentions. They exist, one has to work with them and sometimes for them, one can do business with them. One should not necessarily respond enthusiastically to them.

Students are invited to study the background, objectives and history of the following organizations: the Road and Belt initiative, Eurasian economic union, USAid, Eastern Partnership Agreement + DCFTA, Union for the Mediterranean (UfM), West African Economic and Monetary Union (UEMOA) , Organization international de la Francophonie (OIF), the Commonwealth of Nations.

ATTACHMENT

Do you want to import products from non EU countries into the European Union?

https://www.brusselsnetwork.be/do-you-want-to-import-products-from-non-eu-countries-into-the-european-union/

If you want to import a product from a non European country into the European Union, you need to comply with import rules and taxes.

The Trade Helpdesk is specially designed for businesses based outside the EU or importing into the EU.

You’ll find all you need to know about exporting to the EU, including:

health, safety and technical standards you’ll need to meet

customs duties you’ll need to pay at the border

internal taxes in each of the 28 countries

the rules of origin that define where a product is from and whether it profits from preferential duty rates

forms to send with your shipments

Find your way on the Trade Helpdesk through the 6 easy steps for importing into Europe:

Open the search box.

Browse the classification tree or type a keyword.

Define your product, the exporting country and the importing country.

Check ‘Requirements’: the health, safety or technical standards your product needs to meet

Check the ‘Internal taxes’: the VAT or excise duties for your product in the importing country.

the standard rate of EU import duty for your product

a possibly reduced rate if the exporting country has a trade agreement with the EU or benefits from a preferential scheme

any quota or antidumping duties

they indicate the minimum processing your product must undergo in your contry to be considered as ‘originating’ there

the origin depends also on where the inputs you use for your final product are from

the customs offices at EU borders will verify your origin certificate

find out how much other countries are already exporting to the EU of your kind of product