Conditions That Prompt Trade

Why Firms Look Abroad

Most firms start by selling in their home country. The reasons a firm starts to sell abroad fall into two groups.

Push factor: a problem in the home market that drives a firm to look for sales abroad.

Pull factor: a benefit of selling abroad that attracts a firm to expand there.

Push Factors

Saturated Markets

Saturated market: a market where most people who want the product already have it, so sales grow slowly and come mainly from replacements.

Almost every adult in the UK owns a smartphone, so a phone maker can only grow at home by taking customers from rivals. In a country where ownership is still rising, every new buyer is extra demand.

Saturated home market → few new customers → sales and revenue stop growing → the firm sells in countries where demand is still rising → higher sales and profit.

Competition

More rivals at home → price cuts to keep customers → lower margins and profit → the firm sells where it faces less competition and can charge more.

Pull Factors

Economies of Scale

Selling in more countries lets a firm produce more, and a larger scale of output brings lower average costs (unit 2.1.1).

New export markets → higher output → bulk buying, and design and advertising costs spread over more units → lower average cost → lower prices or higher profit per unit.

Risk Spreading

A firm that sells in one country depends on that one economy. Selling in several means a fall in demand in one market can be made up by sales elsewhere.

A recession hits the UK → UK sales fall, but sales in other countries hold up → revenue and cash flow stay steadier → less risk of losses and job cuts.

This works best when the markets don't move together. Economies are more interdependent than they used to be (unit 3.1.3), so a global recession can hit every market at once.

Offshoring and Outsourcing

Firms also trade by buying from abroad: they move parts of their production to countries where it is cheaper.

Offshoring: moving part of a firm's production or services to another country.

Outsourcing: paying another firm to carry out work the business used to do itself.

The two can go together. A UK clothing brand that pays a factory in Vietnam to make its shirts is both offshoring and outsourcing. A UK bank that moves its call centre to its own office in India is offshoring but not outsourcing.

When a firm offshores or outsources:

• Costs: wages and rents are lower abroad → lower unit costs → the firm can cut prices or earn a higher margin.
• Focus: a specialist supplier does the routine work → the firm puts its staff and money into what it does best, such as design → a stronger product.
• UK workers: jobs move abroad → staff are made redundant → lower incomes in the areas the work left.

Whether it pays depends on:

• Control over quality: it is harder to check work done by another firm thousands of miles away. Faults or poor working conditions at a supplier can damage the brand.
• The length of the supply chain: goods take weeks to ship, so the firm reacts more slowly to changes in demand, and a blocked port can halt supplies.
• Whether the cost gap lasts: as wages rise in emerging economies (unit 3.1.1), the saving shrinks, and some firms bring work back home.

Extending the Product Life Cycle

A product can be in maturity or decline in one country and only just launching in another (unit 2.1.3). Selling in a new market is an extension strategy: it starts the life cycle again.

UK sales start to fall → the firm launches the product in a country where it is new → sales grow again → more revenue from a product whose development is already paid for → cash to fund new products.

This works when the product is new to customers abroad. A product in decline because better technology has replaced it is likely to decline everywhere.

Raising Capacity Utilisation

A firm with spare capacity has premises and machinery standing idle (unit 2.3.2). Orders from abroad can fill it.

Export orders → higher output from the same factory → fixed costs spread over more units → lower average cost and higher profit.

Exports can also smooth out a seasonal business. A UK maker of garden furniture is quiet in the British winter, which is summer in Australia.

How much selling abroad helps depends on:

• The cost of entering the market: marketing, shipping and adapting the product for a new country can cost more than the extra sales bring in.
• Exchange rates: a stronger pound makes UK exports dearer abroad and cuts the value of foreign sales in pounds (unit 2.4.4).
• How much spare capacity there is: a firm already near full capacity would need a new factory to meet foreign orders, which removes the cost advantage.