Risk And Uncertainty When Entering A New Market Economics Essay

When entering a foreign market for the first time, a firm will be faced with many unknowns. Distinguish between the concepts of “risk” and “uncertainty” when a firm is entering a market of your choice. Give examples of types of risk.

INTRODUCTION

This paper will examine the concept of foreign market incursion by domestic business entities. It will analyse the risks associated with and probe uncertainties inherent in globalizing the local business. The market of choice used in this paper is the entertainment industry in general and the music industry in particular, with a special focus on the music industry in sub-Saharan Africa.

The paper will begin by defining key terms used and then give a broad background of international business and globalisation. The paper will then narrow its focus to the business context within which it will define risks and uncertainties. Each type of risk is expounded upon within the context provided and a conclusion made.

DEFINITION OF KEY TERMS

Credit Risk: (also called default risk) the risk of non-payment or uncertainty associated with payment of financial obligations when they are due.

Foreign Direct Investment (FDI): Any investment abroad in which the company being invested in is controlled by a foreign entity or corporation.

Foreign Exchange Risk: The risk of loss or money depreciation through change in currency exchange rates between the host country and country of origin of foreign investment.

Interest Rate Risk: Uncertainty associated with changes in interest rates.

Location Risk: These are spillover or ‘contamination’ effects created by challenges or problems specific to the region in which a country is in.

Piracy: The act of misuse of other people’s intellectual property.

Pirate: Someone who uses another’s intellectual property as if it were his own.

Political Risk: Actions by groups of people or governments which have the potential to affect the immediate or long term viability of a firm.

Price Risk: Uncertainty associated with potential changes in the price of an asset cause by changes in interest rate levels and rates of return in the economy.

Pure Risk: The type of risk which only offers the potential for loss but never results in gains.

Risk: The likelihood of an occurrence of an outcome which is disadvantageous or harmful.

Sovereign Risk: This is the risk that the government or one of its agencies will refuse to honour agreed terms of a loan agreement whenever the situation makes it arduous or undesirable for it to pay.

Speculative Risk: The type of risk which offers both the potential for gain and the potential for loss.

Systematic Risk: Risk which influences a large number of assets and which are impossible to prevent such as political events or acts of nature. Also called market risk.

Talent: Someone with an exceptional ability.

Uncertainty: The quality of human knowledge or information concerning risk.

Unsystematic Risk: (Specific Risk): Risk which affects a very small number of assets or which is specific to a company such as a lockout at a recording studio.

Visibility: The level of exposure to public scrutiny offered by such factors as a good marketing strategy.

INTERNATIONAL BUSINESS AND GLOBALISATION

The term ‘international business’ is concerned with the exchange of goods and services between individuals, groups and organizations in two or more countries. It includes all cross-border transactions between nations with commercial or political value, both by government and by private entities. Although globalisation is a complex construct to measure, it is widely acknowledged that much of the world’s business is either crossing borders and becoming global, uses imports in its manufacturing and/or supply or competing with foreign products in the same industry. Globalisation is a force that simply cannot be ignored.

For purposes of clarity and due to differences in academic opinion on the subject, a working definition of globalisation for this paper will be derived from Hamilton and Webster (2009):

Globalisation involves the creation of linkages or interconnections between nations. It is usually understood as a process in which barriers (physical, political, economic, cultural) separating different regions of the world as [sic] reduced or removed, thereby stimulating exchanges in goods, services, money, and people (Hamilton & Webster 2009, p.5).

The concept of globalisation acknowledges a world evolution into a global ‘village’ where activities in one part influence and have marked significance over those in other parts in a short space of time (Katsioloudes & Hadjidakis, 2007 p.366). Rapid technological advancement has undoubtedly improved connections between countries by expanding telecommunications, transportation services, government operations and general enterprise. There are, however, both strengths and weaknesses to be derived from the inexorable advancement of globalisation. Supporters of the concept argue that globalisation has brought about amazing dividends including a sharp fall in poverty; improved global health evidenced by an increased global life expectancy and a drop in infant mortality; a rise in global literacy; and an unprecedented wave of democratization (Ã…slund A & Dabrowski M, 2008 p.3).

THE CONTEXT – THE MUSIC INDUSTRY

The music industry is a blend of producers, promoters, talent, the musical art form, the product format and modes of distribution. Unlike in Western nations where big production studios such as SONY BMG, Motown Record Company, and Arista run the industry through music production, record sales, publishing and related merchandise, in many sub-Saharan African countries, the producers are entrepreneurs who more often than not exploit young and inexperienced talent to turn a profit. Returns to the local industry have been handicapped by piracy and the inability or unwillingness of governmental structures to protect intellectual property – in itself a reaction to the growing rates of youth and graduate unemployment. The music industry in the region has therefore experience limited growth until recent years.

Today, advancement in music production technology, the internet, and the influence of multinational enterprises such as telecommunications giants like AIRTEL and MTN are reshaping the musical culture through intense exposure and multi-faceted advertising campaigns promising to deliver new and exotic musical forms to a global market characterised by quick and ready consumption for innovative and new products. Through this economic globalisation, a new musical culture is emerging, and relatively unexposed classical and contemporary musical art forms in sub-Saharan Africa are beginning to enjoy global exposure.

The advantages which the music industry in Africa has to offer are in the uniqueness of the product offering, the vast array of products or individual artistes with individual music and dance styles, and the novelty of the African experience. The Product Life Cycle (PLC) theory explains that the growth stage of international products is characterised by fast growing demand. From an analysis of the music industry in Africa, one could argue that it is rejuvenated into a growth phase in a new product cycle. There is evidence of demand for the new African musical product from such groups as Africans in the diaspora, African Americans, and art lovers from diverse cultural backgrounds. This can be said to be the justification behind the consistent exchange of musical artists between Africa and the West in corporate promotions of international telecommunications giants including Airtel, MTN, Orange and Safaricom in several sub-Saharan African countries.

One could similarly argue that since the election victory of Barack Obama, the first US president of African parentage, African American entertainment moguls wishing to identify with the ‘motherland’ have been creating opportunities for more interaction between Africa and North America in music and film. Film and music festivals such as the Zanzibar International Film Festival (ZIFF), African movie Academy Awards (AMAA), the MTV African Music Awards (the MAMAs), have been consistently attended by American stars of African descent in an effort to increase the involvement and presence of the American entertainment industry (a global leader in the field). Other Awards in the north such as the Music of Black Origin Awards (MOBOs) and the Pan African Film Festival (PAFF) have been striving to acknowledge and recognise African talent in order to spread awareness of the budding industry.

One of the reasons why organizations engage in international business is to minimize risk by securing their product in a market with an expanding economy or to counter the strategies of competitors (Daniels, Radebaugh, & Sullivan, 2009, p.60). When establishing operations abroad, however, a company also exposes itself to certain types of risk. In making an incursion into a foreign market, music businesses are often faced with several unknowns which are highlighted under ‘types of risk’.

RISK AND UNCERTAINTY

Both risk and uncertainty are factors which inherently influence corporate, strategic and tactical decision making in firms. Risks are calculable or known premises of the probability of having an undesirable outcome. They are a combination of the probability of occurrence of hazards and the magnitude or impact of their likely consequences. People who make decisions always have a certain level of knowledge about risks they take. The music producer, for instance, understands the risk of piracy in his immediate environment and the impact it may have on his ability to turn a profit from the music business, or he may understand the risk taken on investing in and promoting hitherto unproven talents in the industry based on mere intuition.

The tolerability of risk is the willingness of a subject to live with a certain level of risk in exchange for some certain benefits. While the risk of competing with ‘pirates’ who have minimal production and set-up costs may be high, the trade-off is often industry visibility for the product which enables the producer or label to get beneficial contracts for live and sometimes international music events. Further risks faced by the music industry in an effort to globalise are outlined below under ‘risks faced by the industry’.

Uncertainty, on the other hand, is the situation in which the decision maker has no precise knowledge of the probability of occurrence of different states of outcome. The decision maker, in essence, has no predictive knowledge of the probability of any form of outcome. The music producer may be largely uncertain whether his or her product or talent is suitable for a market which has a different cultural context which may include a language barrier. He will also probably be uncertain about whether there will be a terrorist attack (a political risk) at any one of the shows organised for the benefit of promoting his talents abroad, even though he may be warned in advance of the risk of a cyclone and other forces of nature.

TYPES OF RISK

Risks may be typified along several different and distinct lines but due to volume restrictions and for the purposes of this paper we shall be examining the typologies listed below:

Country risk

Political risk

Transfer risk

Economic risk

Foreign exchange risk

Location risk

1. Country risk

All businesses which transcend borders become exposed to a certain measure of risk which is not present in their domestic activities and transactions and these are known as country risks. In the narrower view of the concept, country risk is defined as “… risk that a country will not be able to honour its financial commitments” (Katsioloudes & Hadjidakis, 2007 p.185-6). In the broader context, however, country risk analyses are general aggregates of sub-risk factors present within the country. They may be calculated and form the basis on which to determine the desirability of choosing a country upon which to invest. For instance, countries which favour external investments and remove restrictive trade barriers are normally considered to be safe ground for foreign direct investment.

By and large many third world countries like those of sub-Saharan Africa have not got the best end of the globalisation bargain (Waters, 2001 p.45) Due to usual high levels of uncertainty, country risk is not always easily calculated. However, some practitioners calculate country risk by dividing it up into sub-categories of risk which are then aggregated. These usually include: political risk, economic risk; transfer risk; foreign exchange risk; location risk; sovereign risk. According to current country risk ratings, Norway as the country with the least risk for investment (http://en.wikipedia.org/wiki/Country_risk).

2. Political Risk

Political risks include all risks associated with the actions of government especially those to do with the legal dimension, relationships between countries, and security of investments. As with every other facet of business, political risks influence the music industry and the feasibility of globalisation. The African music and entertainment industries desire to move into Asia and North America because of the influence, technology and financial pull of Bollywood in India and Hollywood in the USA. Countries such as Pakistan, Afghanistan, Iraq are not ideal destinations due to political turmoil and the potent risk of loss of life, property or investments there. Other countries with an Eastern or socialist inclination are not attractive to those with capitalist orientations.

In order to avoid fallouts of a political nature in investing in a global music enterprise, those in the African music industry simply need to do some country research to acquire relevant information about political stability and diplomatic relations between the country of potential investment and the country of the investor’s origin. There are a variety of web-based services which offer information on countries via country reports. The probability of travel restrictions barring temporary immigration or work based travel and visa denials due to stringent conditions are also elements of a political nature whose risks need calculation before any major investment can be made.

3. Transfer risk

Sometimes the country of an individual who borrows money in an investment restricts the ability of people in that country to buy foreign exchange. The impact of this is that the borrower may not be able to meet his/her obligations to repay in foreign currency – the currency of the borrowed amount. The risk of this occurring is normally known as transfer risk and because of the role of government in this type of risk; it is also a type of political risk. This risk is mostly present in countries where democracy is not the system of government.

4. Economic Risk

Economic risk in the context of globalisation is the risk that the investment will be economically unsustainable. Variations in different financial inputs and outputs of the enterprise need to add up to ensure that the risk of fallout is checked. In the music industry, when the investment in an artist in terms of publicity and promotion, training and logistical costs are predicted not to be able to be offset by predicted future sales from the work of the artist, then it can be said that the economic risk is too high and it is not a good or advisable investment.

5. Foreign Exchange Risk

This is also known as exchange rate risk or currency risk. It is the risk of change of the value of an investment due to fluctuations between exchange rates of the currency of the investor and the currency of the host country for the investment. The possible adverse effect of foreign exchange risk is that the investment may become more expensive as a result of unprecedented changes in currencies which are outside the control of the investor. A music producer who invests in a product for sale in a foreign market will be happy if the value of the foreign currency appreciates against the value of his local currency as that would mean increased profits for him.

The foreign exchange market is highly volatile and predicting the direction of foreign exchange movement a guessing game. Many foreign buyers prefer to avoid this risk by trading in their local currency.

6. Location Risk

Location risks are risk factors associated with the political neighbours of a country or region. Certain states in North America which border Mexico are affected by illegal immigration and have concerns to do with illegal migrant workers; the political dynamics of such countries as Tunisia affects that of similar or neighbouring countries such as Egypt and Libya as evidenced by the recent revolts (in the first quarter of 2011).

RISK RETURN TRADE-OFF

The risk-return trade-off principle holds that low risk levels are associated with low potential returns while where high risks exist; the possibility of high returns looms large. This is why even when the country risks are great, firms may decide to take on the challenge of investing nevertheless, often prompted by the need to defend against the prospect of the company’s competitors taking the initiative. For example, in the music and entertainment industry, many North American artistes used to shun the Middle East as a suitable showground due to the notion that Middle Eastern ideologies and Islamic values predominant in the culture there were inconsistent with the entertainment requirements of unrestricted freedom of expression. However, in an unprecedented turnaround, Middle Eastern cities such as Dubai are fast becoming a favourite of artistes since big artists like Michael Jackson took the plunge of tapping into the market in the 1990s.

OTHER RISKS FACED BY THE INDUSTRY

Polycentrism may influence the art form of the music talent. Polycentrism works through the belief of foreign business units of trying to act local. Artists and producers are often strongly influenced by the local culture of the foreign environment of investment by sub-elements of personality including the language, dressing, use of available musical instruments and technology, and the musical art itself. Socialization of this nature may cause irreparable modification to the art they offer and the image they normally portray, a product exported for its original nature. This may later influence the potential of the talent to remain intellectually authentic – the musical talent in some instances may be accused of no longer sounding African or of losing authenticity.

SUGGESTED STRATEGY OF INCURSION INTO THE FOREIGN MARKET

Based on the factors examined it is advisable for investors in the music industry to seek partnerships with foreign counterparts in selling the unique products of African traditional and contemporary musical art in a globalised setting. Just as local food is internationalised by countries such as Italy, Japan and the US in entities such as MacDonalds, single entrepreneurs can expand the musical product in clubs which offer African musical content with renewable, trainable talent acting as the products on offer.

The risk from competition, while challenging, helps organizations focus their energies on quality strategies of survival or market expansion. Due to the challenges inherent in integrating into a foreign market, foreign firms must enhance the process of their integration into local markets as a matter of necessity. This can be done by recruiting locals and learning the language and culture (Daniels, Radebaugh, & Sullivan, 2009, p.505) among other integration strategies.

CONCLUSION

The paper has outlined the concepts of risk and uncertainty in the global arena within the context of the incursion of a local business. The sub-Saharan African perspective has been brought to bear on the analysis. The paper highlighted the difference between risk and uncertainty showing their relationship to one another and giving examples on each of the concepts.

The paper has also looked at ways in which a firm in the music and entertainment industry may benefit from globalisation. Comparisons were made between the African music industry and other globalised franchises in the world such as MacDonalds in suggesting a useful model which may be simulated.