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Barters and buy-backs: Let Western firms beware!
BARTERS A N D BUY-BACKS: LET WESTERN FIRMS BEWARE! Non-monetary trade between Eastern-bloc firms and Western ones is not without certain drawbacks: repatriation of "profits" is often difficult; quality of goods, poor; and variety, limited.
R O B E R T E. WEIGAND 54
International trade without m o n e y is flourishing today. Indeed, it is nearly the only way for some Western companies to do business with Eastern Europe, the developing countries, and, more recently, with the People's Republic of China. Recent deals include: Armand Hammer negotiated an agreement to trade phosphate rock from Occidental Petroleum Corporation's mines in Florida for molten sulphur from Poland. The agreement would last twenty years and would involve a b o u t a million tons of phosphate rock a year and about 500,000 tons of sulphur. At the time the agreement was discussed, the market price for phosphate rock was about $33 a ton and molten sulphur was about $67 a ton. No m o n e y was expected to change hands unless market prices for the two products changed. Control Data Corporation hoped to sell a
ROBERT E. WEIGAND is a professor of marketing at the University of Illinois at Chicago Circle.
BUSINESS HORIZONS
new computer to the Soviet Union's Ministry of Culture, b u t the Ministry did not want to give up hard currency. So Control D a t a proposed that the Ministry lend some of Leningrad's Hermitage art collection to Western museums. Part of the proceeds would go to Control Data to pay for the computer. The Soviets would get their computer, Westerners would get to see a priceless art collection, and Control Data would get its money. In the Soviet-American confrontation following the invasion of Afghanistan, this deal was canceled. Monarch Wine Company, a subsidiary of Manischewitz, is sending a team of American technicians to the People's Republic of China to teach the Chinese more about brewing, bottling, and packaging beer and vodka. Monarch will also furnish the Chinese with equipment to modernize the Chinese brewery and distillery. It will take back beer and vodka for its pay, acting as the exclusive distributor in the United States for the Tsingtao brand.
Barters and Buy-Backs: Let Western Firms Beware]
These non-money arrangements are increasingly c o m m o n and often involve huge amounts of capital.
BARTER DEALS Barter-also known as counterpurchasing-is nothing more than trading some goods or services for other goods or services. ABBA is Europe's largest selling recording group, partly because it has agreed to take goods instead of hard currency from government trading organizations in eastern Europe. Sometimes it takes chemicals, sometimes fresh fruit, sometimes machine tools, all of which are sold for hard currency in the West by a trading c o m p a n y subsidiary of Beijerinvest (Sweden). Or, for another example, PepsiCo, a company that is intimately involved in international business, has been bottling Pepsi Cola in Hungary since 1974, but has been unable to repatriate its profits. So it used some of its accumulated revenue to produce the movie The Ninth Configuration. The movie was shot in Hungary (where most of the expenses were incurred), and PepsiCo used all those unconvertible forints it had accumulated over the years to pay for it. The movie is being distributed in the West where PepsiCo can collect its revenue in hard currency. Triangular or quadrangular barter arrangements are more difficult to arrange, but certainly not unknown. One of the most celebrated barter deals is PepsiCo's swap with the Soviet Union. The arrangement involves Pepsi syrup being sent from its British plant to bottling plants in Novorossisk, Evpatoriya, and Tallinn. The Soviets exchange Stolichnaya vodka for the syrup and technical assistance. And Monsieur Henri, PepsiCo's own liquor distributor, markets the vodka. The barter arrangement is convenient to PepsiCo because the vodka acquired from the Soviet Union complements the other products sold by Monsieur Henri. Each party in a barter arrangement negotiates and signs the contracts. Thus if an
American company hopes to swap superphosphoric acid to the People's Republic of China for the right to Pohai Gulf oil leases off the China coast (presently being discussed by an American-based multinational firm) two contracts probably will be signed. One will oblige the Chinese to purchase a specific a m o u n t of chemicals at the world price during a specified time. The other contract will allow the American company to explore for oil and presumably extract and market their discoveries for a specified future period. Each party is expected to fulfill its part of each contract and to pay the other party in the event it should fail to perform. The non-performance penalties, of course, are written into the two contracts.
BUY-BACK DEALS Buy-backs, also known as compensation trading, occur when one partner sells equipment, expertise, or technology to another party and takes its pay in the output of the facilities that the equipment, expertise, or technology has helped to build. For example Technip (France) is building a chemical plant in the People's Republic of China that will produce integrated olefins, aromatics, and fibres. The French have agreed to take back part of their pay in the plant's output, marketing them for hard currency in Western markets. More recently, Pierre Cardin has agreed to serve as a consultant to China, taking his pay in silks and cashmeres that will be marketed in the West under the Cardin label. On the one hand, barter or compensation arrangements with other nations are attractive to Western businesses, a Such deals, many of which involve hundreds of millions of dollars, offer the opportunity to enter new markets not yet served by Western suppliers. Furthermore, the Western company that is prone to enter barter or compensation arrangements is 1. Robert E. Weigand, "International Trade Without Money," Harvard Business Review, November-December, 1977: 38.
JUNE 1980
55
ROBERT
E. W E I G A N D
"International trade nearly the only way Eastern Europe, the People's Republic of
without money is flourishing today. Indeed, it is for some Western companies to do business with developing countries, and, more recently, with the China."
competitively ahead of those companies that refuse to enter such transactions: not to engage in such deals is nearly tantamount to excluding business with a large number of controlled economies. 2 On the other hand, there are five major problems associated with non-monetary trade, most of which have not been adequately explored.
government bureau that is supposed to reconcile the disparate interests of its trading organizations. If the effort is successful a Western partner may be able to market its produce to one trading organization b u t be free to receive products from a different trading organization. Nonetheless, this new bureau does not resolve the fact that the Socialist-bloc states usually offer only those products for which there is not a ready cash market in other countries.
THE "SKINNY LIST"
56
Western traders who agree to non-money trade with controlled states cannot expect a rich assortment of products for their payment. Unhappily, the offered pay-back is likely to be goods that are in ample supply in Western markets. Just because Soviet nations produce a wide range of either consumer or industrial goods does not mean they are willing to trade all of those goods. It is far more likely that a trading organization will limit barter choices considerably. For example, Promsyrioimport, a trading organization in the Soviet Union, is interested in importing steel welding electrodes. But it insists that its supplier take cast iron tubes or steel pipes to complete the transaction. The Westerner would prefer to take back bicycles or farm machinery, b u t those products are the export responsibility of Raznoimport, a different trading organization. The Soviet Union recently established the Main Administration For Compensation Arrangements With The West (MACAW), a 2. Pomiliu Verzariu, Scott Bozek, and JeNelle Matheson, East-West Countertrade Practices (Washington: U.S. Depart-
ment of Commerce, 1978): 24-35.
BUSINESS HORIZONS
PERSISTENTLY POOR QUALITY The most c o m m o n problem cited b y those who receive products in p a y m e n t from the Eastern-bloc countries is that often such goods are not suitable for sophisticated Western markets. Perhaps the best quick-and-dirty test of product quality is a visit to a department store in Prague, Warsaw, or Moscow. Western tourists are unlikely to find anything that they want to buy. Consumer goods are in short supply, and those that are available do not generally match the quality available in the West. Such problems can be resolved b u t not easily. One c o m m o n solution is to find buyers in markets that are not as discriminating as are Western customers. Specialized marketing institutions, mostly in Western Europe, have grown up in response to the need to switch products from one country to another. Barter houses usually charge substantial fees, b u t much of the commission (or margin, if y o u prefer) is passed along to the customer. The barter house, for example, agrees to take products from a Western customer that origi-
Barters and Buy-Backs: Let Western Firms Beware!
r ~ , ~-
.:~ ..t
i,:
57
hated in the Soviet bloc b u t pays the Western owner only 65 percent of the goods' nominal value. Then the barter house finds a customer in Thailand, Syria, Ghana, or Peru who is willing to pay 70 percent of nominal value. The barter house receives a 5 percent commission, the Western partner receives its cash, and the final customer gets something he or she can use. Since products received in either barter or compensation trade must sometimes be heavily discounted (the 35 per cent in the example just cited is not unusual) the Western partner must generally build a comfortable premium into the price of the product he is sending to his trading partner. Astute international traders will effectively m u d d y the waters so that it is not evident that higher than usual prices are being charged. There is no advan-
tage in affronting Socialist bloc trading organizations with the blunt assertion that much of their o u t p u t must be dumped at distress prices. The Easterners may be asked for "special" prices because the Westerner wants to "open new markets" or because "unusually large quantities" are involved. Or the Easterner may be asked to pay "special charges" for technical assistance, charges that are free to cash customers. The difficulty of selling Eastern-bloc products obliges Westerners to anticipate the likely price at which the products can be sold. Most traders follow this rule: D o n ' t go into a deal unless y o u can see a way out of it. A second solution to the quality problem, particularly applicable to buy-back arrangements, is to establish quality criteria that must be met b y the compensation partner.
JUNE 1980
ROBERT E. WEIGAND
58
This approach is possible wherever objective measures of product quality are available and c a n be understood by both parties. For example, International Harvester furnished its compensation partner in Poland with exact specifications for tractor engine parts. It insists that the parts shipped to the West meet these standards, and it refuses to accept substandard parts. Such an approach requires that the Western partner have the confidence that its partner can attain a level of production that meets acceptable quality levels. In the absence of this certainty, the Western company may discover that none of the output is ever acceptable. A third solution to the quality problem is to station technical personnel on site to assist the compensation partner in achieving and maintaining product quality. The success of this approach varies among countries. Some of the Socialist states are unwilling to allow temporary residency to foreigners, regardless of how desirable their technical role in the country may be. However, other countries welcome foreigners and are eager to bring low Eastern production standards up to acceptable Western levels.
GOODS DON'T FIT "IN HOUSE" The goods that Western companies must take back-either through barter or compensation arrangements-rarely fit neatly into their factories, offices, or marketing channels. As I already suggested, barter houses prosper because they help solve this problem for their clients by finding customers for all kinds of unwanted products, at least if the price is right. However, many imaginative businesses have managed to find ways to use the products they receive either in their own production or to sell it through their own marketing channels. For example, CadburySchweppes, Ltd. (U.K.) is licensed to bottle and market soft drinks in Bulgaria. Since profit repatriation is difficult, it takes back a substantial volume of fruits that it uses as raw
BUSINESS HORIZONS
materials for its English production operations. It also sells Bulgarian canned fruits and vegetables through its own marketing channels which reach British grocers. And the PepsiCo-Soviet barter arrangement that I described earlier is nearly an ideal example: the Stolichnaya vodka that Pepsi takes in barter fits neatly into the American company's marketing channel. Monsieur Henri, PepsiCo's distributor, did not sell vodka before the arrangement was completed, so no existing product in the line was displaced; furthermore, no additional fixed costs were involved except the initial promotional campaign. However there is a risk that marketing people-those responsible for international sales-will go beyond the bounds of good judgment in deciding whether or not products they receive from non-money trade can be used in-house or fitted into existing marketing channels. There are ample international stories about companies that receive products that are less than ideal and then improvidently try to fit them into the firm's production plans. This is dangerous because goods received in non-money trade may rupture the routine purchasing patterns that the company's purchasing agents and buyers have worked long and hard to build up. This may not be serious if the new supplier can furnish the same products on a dependable time schedule in the future. But if the barter arrangement is a one-time event, the advantages of making the sale may be neutralized by the cost of a break in normal buying practices.
CLONING A NEW R I V A L Another important disadvantage of engaging in non-money trade is that foreign goods may compete with the Western company's own products. Obviously, this does not occur when a Westerner ships machine tool counting units to an Eastern-bloc country and receives dried peaches in return. However, many industries-chemicals, for example--are con-
Barters and Buy-Backs: L e t Western Firms Beware t
"Barter also known as counterpurchasing--is nothing more than trading some goods or services for other goods or services . . . . Buy-backs, also known as compensation trading, occur when one partner sells equipment, expertise, or technology to another party and takes its pay in the output of the facilities that the equipment, expertise, or technology has helped to build."
cerned that they have traded away technology that their new Eastern trade partners can use to compete in Western markets. Suppose a Western firm agrees to furnish technology to help build plants and to take a substantial portion of their payment in chemicals as soon as the new plants begin to function. There is no assurance that the Eastern country will limit its shipments to the amount necessary to pay for the technology. Indeed, the opportunity to earn foreign exchange is one of the major reasons East European countries have selected chemicals suited to Western markets as an area for economic growth. To compound the problem even further, some of the Soviet-bloc countries not only enjoy most-favored-nation status but they actually qualify for economic assistance as well--usually meaning low interest loans funded by various Western European governments! And the final irony, at least to those whose home markets are being invaded, is that the imported products may receive favored tariff treatment. In the early 1970s the developed countries abandoned non-discrimination when they elected to reduce or eliminate tariffs on products coming from the developing countries. Under United Nations auspices, the Generalized System of Preferences allowed each country (or grouping of countries) to list the countries and products which would be favored. For example, the initial American list, announced in late 1975, consisted of 2,724 products coming from 98 countries and 34 territories. Most of America's preference list consisted of raw materials
and agricultural products. This was eminently sensible as long as the developing countries' products did not compete directly with those of the developed countries. But the developing countries today are shipping their products to the United States, Western Europe, and Japan and these products compete with and sometimes challenge the secure position of the high cost domestic ones. The developing countries' products are sometimes assembled in Western government-subsidized plants and pay zero tariffs. Many Western European businesses believe this is unfair. There is little hope a barter house will keep home markets pure. In an era of instant communications and low cost shipping rates it doesn't take long for goods that are destined for Angola to show up in New Orleans. And ironically, the more the Western partner has insisted that only high quality products will be taken in trade, the greater is the likelihood that the goods will end up in Western markets. Controlled economies use barter and compensation arrangements because such deals permit hitch-hiking on the Western partner's already developed marketing channels. Under different circumstances, a business complement would be highly desirable. For the Socialist states to provide the production facilities and the Western partner to provide the marketing capacity would be perfectly acceptable. But when Eastern-bloc products move through already established marketing channels in Western markets, they may do so at the expense of other products that are
jUNE 1980
59
ROBERT E. WEIGAND
" T h e r e are five major problems associated with non-monetary trade, most of which have not been adequately explored . . . . T h e most common problem cited by those who receive products in payment from the Eastern-bloc countries is that often such goods are not suitable for sophisticated Western markets."
60
already in the company line. For example, the Japan-Soviet Business Cooperation Committee has been slow to arrive at decisions concerning a copper mine, an asbestos mine, and a steel mill. The Soviets have long hoped to develop Siberia (where these projects would be located) and have expressed an interest in using Japanese capital and technical expertise. And the Japanese have long viewed Siberia as a source for much needed raw materials. However, the talks have stalled-particularly with respect to the steel mill-because Japan has enough steel from its own mills and, unfortunately, the Soviets want to pay them with more steel. There is no assurance, furthermore, that the Soviet states will not ultimately market their products through independently established marketing channels in the West. Although not the result of a barter or compensation arrangement, the Soviet-Fiat arrangement illustrates h o w new rivals can be unintentionally cloned. After protracted negotiations, Fiat agreed to help the Soviet Union build an automobile plant to serve the enormous local demand for cars. The size of the market and the pent-up demand for private transportation in the U.S.S.R. is well known. However, soon after the first cars rolled off the assembly line, Russian-built automobilies known in the West as "Ladas" began appearing, first in Belgium and shortly after in the rest of Western Europe, Africa, and more recently, the United States and Canada. It is unfortunate, at least from the Italian company's point of view, that the Lada looks and operates much like the Fiat.
BUSINESS HORIZONS
HOW MUCH TO TAKE BACK?
Finally, the Eastern states and developing countries appear to be applying more pressure for barter and compensation arrangements t o d a y than just a few years ago. As little as five years ago, compensation arrangements in which the Western partner received about 80 percent of its pay in cash and the remaining 20 percent in goods were the rule. Receiving small amounts of Eastern products was little more than a token of the Western partner's good will. These small amounts of goods did not create the major problems that larger-scale barter and compensation arrangements have created. Among the compensation contracts now being negotiated, the ratio of cash to goods is generally the inverse of what it was five years ago. Instead of receiving 80 percent cash and 20 percent goods, compensation arrangements increasingly call for the buy-back to hover around 80 percent or even higher. In many recent compensation arrangements, the compensation consists entirely of end products. And although still uncommon, there is trade talk that some Western partners are contracted to take back more goods than the value of a plant they build would warrant, sell those goods in Western markets, and return the hard currency balance to the East. All this means that, as the phenomenon of doing business via barter and compensation arrangements expands, more markets will have to be found for poor products, new rivals will be unwittingly encouraged, labor
Barters and Buy-Backs: Let Western Firms Beware!
unions will be antagonized as jobs are "exp o r t e d , " and business people at all levels will have to learn to accommodate an unusual assortment of goods taken in trade. To some economists, the practices described in this article no d o u b t unleash quite different thoughts. On the one hand, nonm o n e y trading is simply one more manifestation of mercantilism. The methods may be different, b u t insistence on bilateral trading is no different in its intent from export subsidies, tax allowances for expatriate business people, or cheap transportation rates on the national shipping line. Its purpose is to assure that international trading accounts are balanced every year, not just country-by-country b u t even on a c o m p a n y - b y - c o m p a n y basis. For example, the German " N e w Plan" of 1934 very carefully spelled out what goods could be imported, h o w much they would cost, and who Germany's trading partners would be. Under such restricted circumstances it is no surprise that Germany's international trade was so divorced from market preferences. The New Plan was intended, of course, to build an industrial base and ultimately a war machine. 3 On the other hand, other economists may look on non-money trade as nothing more than a legitimate attempt by the less developed countries to gain access to markets in the developed countries. One theory, known as the "Vernon hypothesis," tells us that although industries originate in the wealthy industrialized countries, the locus of produc-
3. Howard S. Ellis, Exchange Control in Central Europe (Cambridge, Mass.: Harvard University Press, 1941).
tion may shift to developing countries later in the product's life cycle. 4 For example America was once a powerful leader in the production of textiles, shoes, steel, and automobiles. However, the technology of such industries is widely known, raw materials are almost universally available, and there are no serious patent or trade secret monopolies that prevent developing countries from being major producers of such goods. However, Vernon points out that industrialized countries may protect their markets through tariffs, quotas, stringent health and safety rules, " b u y local" laws, and an assortment of other protectionist devices. Economists can further argue that industrialized countries have not made enough trading concessions to accommodate the products of the Eastern bloc. Although the data vary, there are estimates that the Eastern bloc's debt to the West is about $56 billion. The Soviet Union is the leader, owing about $16.8 billion, and Poland runs a close second, owing about $13.5 billion. Perhaps the Eastern-bloc and developing countries have found a means of access to Western markets, a tying agreement that commands Western companies or countries to b u y back products that they would prefer to produce at home or b u y elsewhere. IS] 4. Raymond Vernon, "The Trade Expansion Act In Perspective," Emerging Concepts In Marketing (Chicago: American Marketing Association, 1962), pp. 384-389. See also Raymond Vernon, "International Investment and International Trade In The Life Cycle," Quarterly Journal of Economics, May, 1966: 190-207. 5. Ministry for Inter-German Relations, Federal Republic of Germany, as reported in The New York Times, February 24, 1979: 35.
JUNE 1980
61
R O B E R T E. WEIGAND 54
International trade without m o n e y is flourishing today. Indeed, it is nearly the only way for some Western companies to do business with Eastern Europe, the developing countries, and, more recently, with the People's Republic of China. Recent deals include: Armand Hammer negotiated an agreement to trade phosphate rock from Occidental Petroleum Corporation's mines in Florida for molten sulphur from Poland. The agreement would last twenty years and would involve a b o u t a million tons of phosphate rock a year and about 500,000 tons of sulphur. At the time the agreement was discussed, the market price for phosphate rock was about $33 a ton and molten sulphur was about $67 a ton. No m o n e y was expected to change hands unless market prices for the two products changed. Control Data Corporation hoped to sell a
ROBERT E. WEIGAND is a professor of marketing at the University of Illinois at Chicago Circle.
BUSINESS HORIZONS
new computer to the Soviet Union's Ministry of Culture, b u t the Ministry did not want to give up hard currency. So Control D a t a proposed that the Ministry lend some of Leningrad's Hermitage art collection to Western museums. Part of the proceeds would go to Control Data to pay for the computer. The Soviets would get their computer, Westerners would get to see a priceless art collection, and Control Data would get its money. In the Soviet-American confrontation following the invasion of Afghanistan, this deal was canceled. Monarch Wine Company, a subsidiary of Manischewitz, is sending a team of American technicians to the People's Republic of China to teach the Chinese more about brewing, bottling, and packaging beer and vodka. Monarch will also furnish the Chinese with equipment to modernize the Chinese brewery and distillery. It will take back beer and vodka for its pay, acting as the exclusive distributor in the United States for the Tsingtao brand.
Barters and Buy-Backs: Let Western Firms Beware]
These non-money arrangements are increasingly c o m m o n and often involve huge amounts of capital.
BARTER DEALS Barter-also known as counterpurchasing-is nothing more than trading some goods or services for other goods or services. ABBA is Europe's largest selling recording group, partly because it has agreed to take goods instead of hard currency from government trading organizations in eastern Europe. Sometimes it takes chemicals, sometimes fresh fruit, sometimes machine tools, all of which are sold for hard currency in the West by a trading c o m p a n y subsidiary of Beijerinvest (Sweden). Or, for another example, PepsiCo, a company that is intimately involved in international business, has been bottling Pepsi Cola in Hungary since 1974, but has been unable to repatriate its profits. So it used some of its accumulated revenue to produce the movie The Ninth Configuration. The movie was shot in Hungary (where most of the expenses were incurred), and PepsiCo used all those unconvertible forints it had accumulated over the years to pay for it. The movie is being distributed in the West where PepsiCo can collect its revenue in hard currency. Triangular or quadrangular barter arrangements are more difficult to arrange, but certainly not unknown. One of the most celebrated barter deals is PepsiCo's swap with the Soviet Union. The arrangement involves Pepsi syrup being sent from its British plant to bottling plants in Novorossisk, Evpatoriya, and Tallinn. The Soviets exchange Stolichnaya vodka for the syrup and technical assistance. And Monsieur Henri, PepsiCo's own liquor distributor, markets the vodka. The barter arrangement is convenient to PepsiCo because the vodka acquired from the Soviet Union complements the other products sold by Monsieur Henri. Each party in a barter arrangement negotiates and signs the contracts. Thus if an
American company hopes to swap superphosphoric acid to the People's Republic of China for the right to Pohai Gulf oil leases off the China coast (presently being discussed by an American-based multinational firm) two contracts probably will be signed. One will oblige the Chinese to purchase a specific a m o u n t of chemicals at the world price during a specified time. The other contract will allow the American company to explore for oil and presumably extract and market their discoveries for a specified future period. Each party is expected to fulfill its part of each contract and to pay the other party in the event it should fail to perform. The non-performance penalties, of course, are written into the two contracts.
BUY-BACK DEALS Buy-backs, also known as compensation trading, occur when one partner sells equipment, expertise, or technology to another party and takes its pay in the output of the facilities that the equipment, expertise, or technology has helped to build. For example Technip (France) is building a chemical plant in the People's Republic of China that will produce integrated olefins, aromatics, and fibres. The French have agreed to take back part of their pay in the plant's output, marketing them for hard currency in Western markets. More recently, Pierre Cardin has agreed to serve as a consultant to China, taking his pay in silks and cashmeres that will be marketed in the West under the Cardin label. On the one hand, barter or compensation arrangements with other nations are attractive to Western businesses, a Such deals, many of which involve hundreds of millions of dollars, offer the opportunity to enter new markets not yet served by Western suppliers. Furthermore, the Western company that is prone to enter barter or compensation arrangements is 1. Robert E. Weigand, "International Trade Without Money," Harvard Business Review, November-December, 1977: 38.
JUNE 1980
55
ROBERT
E. W E I G A N D
"International trade nearly the only way Eastern Europe, the People's Republic of
without money is flourishing today. Indeed, it is for some Western companies to do business with developing countries, and, more recently, with the China."
competitively ahead of those companies that refuse to enter such transactions: not to engage in such deals is nearly tantamount to excluding business with a large number of controlled economies. 2 On the other hand, there are five major problems associated with non-monetary trade, most of which have not been adequately explored.
government bureau that is supposed to reconcile the disparate interests of its trading organizations. If the effort is successful a Western partner may be able to market its produce to one trading organization b u t be free to receive products from a different trading organization. Nonetheless, this new bureau does not resolve the fact that the Socialist-bloc states usually offer only those products for which there is not a ready cash market in other countries.
THE "SKINNY LIST"
56
Western traders who agree to non-money trade with controlled states cannot expect a rich assortment of products for their payment. Unhappily, the offered pay-back is likely to be goods that are in ample supply in Western markets. Just because Soviet nations produce a wide range of either consumer or industrial goods does not mean they are willing to trade all of those goods. It is far more likely that a trading organization will limit barter choices considerably. For example, Promsyrioimport, a trading organization in the Soviet Union, is interested in importing steel welding electrodes. But it insists that its supplier take cast iron tubes or steel pipes to complete the transaction. The Westerner would prefer to take back bicycles or farm machinery, b u t those products are the export responsibility of Raznoimport, a different trading organization. The Soviet Union recently established the Main Administration For Compensation Arrangements With The West (MACAW), a 2. Pomiliu Verzariu, Scott Bozek, and JeNelle Matheson, East-West Countertrade Practices (Washington: U.S. Depart-
ment of Commerce, 1978): 24-35.
BUSINESS HORIZONS
PERSISTENTLY POOR QUALITY The most c o m m o n problem cited b y those who receive products in p a y m e n t from the Eastern-bloc countries is that often such goods are not suitable for sophisticated Western markets. Perhaps the best quick-and-dirty test of product quality is a visit to a department store in Prague, Warsaw, or Moscow. Western tourists are unlikely to find anything that they want to buy. Consumer goods are in short supply, and those that are available do not generally match the quality available in the West. Such problems can be resolved b u t not easily. One c o m m o n solution is to find buyers in markets that are not as discriminating as are Western customers. Specialized marketing institutions, mostly in Western Europe, have grown up in response to the need to switch products from one country to another. Barter houses usually charge substantial fees, b u t much of the commission (or margin, if y o u prefer) is passed along to the customer. The barter house, for example, agrees to take products from a Western customer that origi-
Barters and Buy-Backs: Let Western Firms Beware!
r ~ , ~-
.:~ ..t
i,:
57
hated in the Soviet bloc b u t pays the Western owner only 65 percent of the goods' nominal value. Then the barter house finds a customer in Thailand, Syria, Ghana, or Peru who is willing to pay 70 percent of nominal value. The barter house receives a 5 percent commission, the Western partner receives its cash, and the final customer gets something he or she can use. Since products received in either barter or compensation trade must sometimes be heavily discounted (the 35 per cent in the example just cited is not unusual) the Western partner must generally build a comfortable premium into the price of the product he is sending to his trading partner. Astute international traders will effectively m u d d y the waters so that it is not evident that higher than usual prices are being charged. There is no advan-
tage in affronting Socialist bloc trading organizations with the blunt assertion that much of their o u t p u t must be dumped at distress prices. The Easterners may be asked for "special" prices because the Westerner wants to "open new markets" or because "unusually large quantities" are involved. Or the Easterner may be asked to pay "special charges" for technical assistance, charges that are free to cash customers. The difficulty of selling Eastern-bloc products obliges Westerners to anticipate the likely price at which the products can be sold. Most traders follow this rule: D o n ' t go into a deal unless y o u can see a way out of it. A second solution to the quality problem, particularly applicable to buy-back arrangements, is to establish quality criteria that must be met b y the compensation partner.
JUNE 1980
ROBERT E. WEIGAND
58
This approach is possible wherever objective measures of product quality are available and c a n be understood by both parties. For example, International Harvester furnished its compensation partner in Poland with exact specifications for tractor engine parts. It insists that the parts shipped to the West meet these standards, and it refuses to accept substandard parts. Such an approach requires that the Western partner have the confidence that its partner can attain a level of production that meets acceptable quality levels. In the absence of this certainty, the Western company may discover that none of the output is ever acceptable. A third solution to the quality problem is to station technical personnel on site to assist the compensation partner in achieving and maintaining product quality. The success of this approach varies among countries. Some of the Socialist states are unwilling to allow temporary residency to foreigners, regardless of how desirable their technical role in the country may be. However, other countries welcome foreigners and are eager to bring low Eastern production standards up to acceptable Western levels.
GOODS DON'T FIT "IN HOUSE" The goods that Western companies must take back-either through barter or compensation arrangements-rarely fit neatly into their factories, offices, or marketing channels. As I already suggested, barter houses prosper because they help solve this problem for their clients by finding customers for all kinds of unwanted products, at least if the price is right. However, many imaginative businesses have managed to find ways to use the products they receive either in their own production or to sell it through their own marketing channels. For example, CadburySchweppes, Ltd. (U.K.) is licensed to bottle and market soft drinks in Bulgaria. Since profit repatriation is difficult, it takes back a substantial volume of fruits that it uses as raw
BUSINESS HORIZONS
materials for its English production operations. It also sells Bulgarian canned fruits and vegetables through its own marketing channels which reach British grocers. And the PepsiCo-Soviet barter arrangement that I described earlier is nearly an ideal example: the Stolichnaya vodka that Pepsi takes in barter fits neatly into the American company's marketing channel. Monsieur Henri, PepsiCo's distributor, did not sell vodka before the arrangement was completed, so no existing product in the line was displaced; furthermore, no additional fixed costs were involved except the initial promotional campaign. However there is a risk that marketing people-those responsible for international sales-will go beyond the bounds of good judgment in deciding whether or not products they receive from non-money trade can be used in-house or fitted into existing marketing channels. There are ample international stories about companies that receive products that are less than ideal and then improvidently try to fit them into the firm's production plans. This is dangerous because goods received in non-money trade may rupture the routine purchasing patterns that the company's purchasing agents and buyers have worked long and hard to build up. This may not be serious if the new supplier can furnish the same products on a dependable time schedule in the future. But if the barter arrangement is a one-time event, the advantages of making the sale may be neutralized by the cost of a break in normal buying practices.
CLONING A NEW R I V A L Another important disadvantage of engaging in non-money trade is that foreign goods may compete with the Western company's own products. Obviously, this does not occur when a Westerner ships machine tool counting units to an Eastern-bloc country and receives dried peaches in return. However, many industries-chemicals, for example--are con-
Barters and Buy-Backs: L e t Western Firms Beware t
"Barter also known as counterpurchasing--is nothing more than trading some goods or services for other goods or services . . . . Buy-backs, also known as compensation trading, occur when one partner sells equipment, expertise, or technology to another party and takes its pay in the output of the facilities that the equipment, expertise, or technology has helped to build."
cerned that they have traded away technology that their new Eastern trade partners can use to compete in Western markets. Suppose a Western firm agrees to furnish technology to help build plants and to take a substantial portion of their payment in chemicals as soon as the new plants begin to function. There is no assurance that the Eastern country will limit its shipments to the amount necessary to pay for the technology. Indeed, the opportunity to earn foreign exchange is one of the major reasons East European countries have selected chemicals suited to Western markets as an area for economic growth. To compound the problem even further, some of the Soviet-bloc countries not only enjoy most-favored-nation status but they actually qualify for economic assistance as well--usually meaning low interest loans funded by various Western European governments! And the final irony, at least to those whose home markets are being invaded, is that the imported products may receive favored tariff treatment. In the early 1970s the developed countries abandoned non-discrimination when they elected to reduce or eliminate tariffs on products coming from the developing countries. Under United Nations auspices, the Generalized System of Preferences allowed each country (or grouping of countries) to list the countries and products which would be favored. For example, the initial American list, announced in late 1975, consisted of 2,724 products coming from 98 countries and 34 territories. Most of America's preference list consisted of raw materials
and agricultural products. This was eminently sensible as long as the developing countries' products did not compete directly with those of the developed countries. But the developing countries today are shipping their products to the United States, Western Europe, and Japan and these products compete with and sometimes challenge the secure position of the high cost domestic ones. The developing countries' products are sometimes assembled in Western government-subsidized plants and pay zero tariffs. Many Western European businesses believe this is unfair. There is little hope a barter house will keep home markets pure. In an era of instant communications and low cost shipping rates it doesn't take long for goods that are destined for Angola to show up in New Orleans. And ironically, the more the Western partner has insisted that only high quality products will be taken in trade, the greater is the likelihood that the goods will end up in Western markets. Controlled economies use barter and compensation arrangements because such deals permit hitch-hiking on the Western partner's already developed marketing channels. Under different circumstances, a business complement would be highly desirable. For the Socialist states to provide the production facilities and the Western partner to provide the marketing capacity would be perfectly acceptable. But when Eastern-bloc products move through already established marketing channels in Western markets, they may do so at the expense of other products that are
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ROBERT E. WEIGAND
" T h e r e are five major problems associated with non-monetary trade, most of which have not been adequately explored . . . . T h e most common problem cited by those who receive products in payment from the Eastern-bloc countries is that often such goods are not suitable for sophisticated Western markets."
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already in the company line. For example, the Japan-Soviet Business Cooperation Committee has been slow to arrive at decisions concerning a copper mine, an asbestos mine, and a steel mill. The Soviets have long hoped to develop Siberia (where these projects would be located) and have expressed an interest in using Japanese capital and technical expertise. And the Japanese have long viewed Siberia as a source for much needed raw materials. However, the talks have stalled-particularly with respect to the steel mill-because Japan has enough steel from its own mills and, unfortunately, the Soviets want to pay them with more steel. There is no assurance, furthermore, that the Soviet states will not ultimately market their products through independently established marketing channels in the West. Although not the result of a barter or compensation arrangement, the Soviet-Fiat arrangement illustrates h o w new rivals can be unintentionally cloned. After protracted negotiations, Fiat agreed to help the Soviet Union build an automobile plant to serve the enormous local demand for cars. The size of the market and the pent-up demand for private transportation in the U.S.S.R. is well known. However, soon after the first cars rolled off the assembly line, Russian-built automobilies known in the West as "Ladas" began appearing, first in Belgium and shortly after in the rest of Western Europe, Africa, and more recently, the United States and Canada. It is unfortunate, at least from the Italian company's point of view, that the Lada looks and operates much like the Fiat.
BUSINESS HORIZONS
HOW MUCH TO TAKE BACK?
Finally, the Eastern states and developing countries appear to be applying more pressure for barter and compensation arrangements t o d a y than just a few years ago. As little as five years ago, compensation arrangements in which the Western partner received about 80 percent of its pay in cash and the remaining 20 percent in goods were the rule. Receiving small amounts of Eastern products was little more than a token of the Western partner's good will. These small amounts of goods did not create the major problems that larger-scale barter and compensation arrangements have created. Among the compensation contracts now being negotiated, the ratio of cash to goods is generally the inverse of what it was five years ago. Instead of receiving 80 percent cash and 20 percent goods, compensation arrangements increasingly call for the buy-back to hover around 80 percent or even higher. In many recent compensation arrangements, the compensation consists entirely of end products. And although still uncommon, there is trade talk that some Western partners are contracted to take back more goods than the value of a plant they build would warrant, sell those goods in Western markets, and return the hard currency balance to the East. All this means that, as the phenomenon of doing business via barter and compensation arrangements expands, more markets will have to be found for poor products, new rivals will be unwittingly encouraged, labor
Barters and Buy-Backs: Let Western Firms Beware!
unions will be antagonized as jobs are "exp o r t e d , " and business people at all levels will have to learn to accommodate an unusual assortment of goods taken in trade. To some economists, the practices described in this article no d o u b t unleash quite different thoughts. On the one hand, nonm o n e y trading is simply one more manifestation of mercantilism. The methods may be different, b u t insistence on bilateral trading is no different in its intent from export subsidies, tax allowances for expatriate business people, or cheap transportation rates on the national shipping line. Its purpose is to assure that international trading accounts are balanced every year, not just country-by-country b u t even on a c o m p a n y - b y - c o m p a n y basis. For example, the German " N e w Plan" of 1934 very carefully spelled out what goods could be imported, h o w much they would cost, and who Germany's trading partners would be. Under such restricted circumstances it is no surprise that Germany's international trade was so divorced from market preferences. The New Plan was intended, of course, to build an industrial base and ultimately a war machine. 3 On the other hand, other economists may look on non-money trade as nothing more than a legitimate attempt by the less developed countries to gain access to markets in the developed countries. One theory, known as the "Vernon hypothesis," tells us that although industries originate in the wealthy industrialized countries, the locus of produc-
3. Howard S. Ellis, Exchange Control in Central Europe (Cambridge, Mass.: Harvard University Press, 1941).
tion may shift to developing countries later in the product's life cycle. 4 For example America was once a powerful leader in the production of textiles, shoes, steel, and automobiles. However, the technology of such industries is widely known, raw materials are almost universally available, and there are no serious patent or trade secret monopolies that prevent developing countries from being major producers of such goods. However, Vernon points out that industrialized countries may protect their markets through tariffs, quotas, stringent health and safety rules, " b u y local" laws, and an assortment of other protectionist devices. Economists can further argue that industrialized countries have not made enough trading concessions to accommodate the products of the Eastern bloc. Although the data vary, there are estimates that the Eastern bloc's debt to the West is about $56 billion. The Soviet Union is the leader, owing about $16.8 billion, and Poland runs a close second, owing about $13.5 billion. Perhaps the Eastern-bloc and developing countries have found a means of access to Western markets, a tying agreement that commands Western companies or countries to b u y back products that they would prefer to produce at home or b u y elsewhere. IS] 4. Raymond Vernon, "The Trade Expansion Act In Perspective," Emerging Concepts In Marketing (Chicago: American Marketing Association, 1962), pp. 384-389. See also Raymond Vernon, "International Investment and International Trade In The Life Cycle," Quarterly Journal of Economics, May, 1966: 190-207. 5. Ministry for Inter-German Relations, Federal Republic of Germany, as reported in The New York Times, February 24, 1979: 35.
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