(Reprinted from BarterNews issue #17, 1988.)

The American Way To Countertrade

By: C.G. Alex and Barbara Bowers

Countertrade is controversial because it is a trade management practice. However, trade management is widespread; the United Nations estimates that fully 50% of present world trade is managed trade, with countertrade accounting for half of that, or 25% of total world trade.

The slow response of government and academia to the institutionalization of countertrade has left U.S. international business students and managers to learn the hard way how to use a trade management mechanism to their own advantage.

American managers, most of whom finished school some years ago, had never heard of countertrade explosion in reciprocal trade. They either lost lucrative sales through refusal to engage in the mysterious practice of countertrade, or signed a countertrade contract first and then discovered that they needed some sort of strategy.

Managers who would never hear of putting the company into a new market without extensive research and strategy formulation innocently put the company unprepared into a whole new trading environment. They had to stumble through their early countertrade transactions--learning on the job by trial and error.

It is not surprising then, that many U.S. companies have no specific policy or strategy concerning countertrade. Some deliberately downplay countertrade, feeling that it is only a small part of their international operations and thus is not worth the trouble of special policy and strategy formulation.

Others are interested in countertrade, perhaps even enthusiastic about its possibilities as a marketing tool, but have not been able to develop an effective strategy due to inexperience, confusion, intercompany conflict, or lack of intercompany coordination.

The basic policies and strategies outlined here represent and attempt to classify and compare the countertrade practices of selected American companies, and might be used by other companies to evaluate their own countertrade practices.

Frameworks for strategy formulation and the strategic process in countertrade are also provided. The terms "policy" and "strategy" are often used interchangeably, although distinctions can be made between the two terms.

Countertrade policy is defined here as the company's attitude toward countertrade. While countertrade strategy is defined as the approach the company takes to countertrade planning and transactions. There are two basic types of countertrade policies: company advantage and mutual advantage.

Under a company advantage policy, countertrade/offset is used primarily for the company's benefit (to make a sale, to maintain market share, etc.), with the needs of the buyer country being met at the minimum possible levels. Most companies follow this policy.

The effectiveness of the company advantage policy varies. At best, it results in a satisfactory arrangement for both seller and buyer. At worst, it can be a disaster; companies may try to get out of their obligations once the sales contract is signed--on the theory that it will be easier to pay the penalty than carry out the offset--and then get into a lot of trouble with the buyer country.

In contrast, companies with a mutual advantage policy give the needs of the buyer country equal weight with their own. Under this policy, the company is concerned with the goals of the buyer country (i.e., modernization, industrialization, balancing trade, increasing living standards, etc.), and how the countertrade transaction will help achieve these goals. These companies are willing to meet the challenge of achieving mutual benefit through countertrade, and in most cases their efforts are successful.

The choice of a countertrade policy may be an early and deliberate decision on the part of the company president. More often, however, the policy evolves slowly, growing out of the company's experiences in trading with different companies. If the company trades with "good" countries--those in which the state trading officials are well-intentioned, straight forward, and efficient in carrying out their side of the deal--it will probably develop a mutual advantage policy.

There are also some cases in which the company begins to follow a mutual advantage policy in a particular country because of a foreign-born executive's loyalty to that country, and then expands the policy to include trade with other counties.

Companies which have countertraded with "problem" countries usually hate countertrade; depending on how difficult their experiences are, they will either approach countertrade with extreme caution or wish it would disappear.

If the company has encountered corrupt foreign officials, slow delivery or non-delivery of counterpurchase products, poor quality products, sudden changes in product availability, demands for the moon (secret product formulas, proprietary technology, etc.) or other aggravations, it can hardly be blamed for following a company advantage policy.

On the other hand, some companies whose countertrade transactions run relatively smoothly still resent having to countertrade. This resentment may be due to something concrete, such as lowered profits, or to something intangible, such as a belief in the pure forms of free trade and fair competition. Sometimes the company is simply new to countertrade, and wants to move cautiously until it builds up expertise.

Countertrade policies may change over time, due to many factors. These include changes in corporate leadership, the weight of accumulated countertrade experiences, profit levels, and the overall international trade and financial environment.

Generally the policy moves from the lower form of company advantage to the higher form of mutual advantage, although sometimes a singularly bad countertrade experience can push the policy backward to the lower form.

Dual policies may exist within the same company, with some divisions believing in company advantage and others in mutual advantages. This situation reflects ambivalent leadership. Some companies are in a state of flux concerning countertrade policy.

For these reasons, the policies of individual companies are somewhat difficult to identify, but they can be roughly classified. The following examples of the two policies given reflect the author's observations of companies' countertrade activities rather than policy statements of the companies themselves.

Cyrus Eaton Co. and Armand Hammer's Occidental Petroleum Corp. are classic examples of companies with mutual advantage policies. Both companies have been trading and countertrading with socialist countries since the 1950s. Each company has exceeded $50bn in trade and investment. They are heavily involved in infrastructure projects for economic development and modernization.

These projects include agriculture and dairy technology, mining and chemicals, energy and transport, and high technology. Cyrus Eaton and Armand Hammer have been powerful positive forces in the promotion of East-West trade.

Coca-Cola Co. operates under a mutual advantage policy through Coca-Cola Trading Co. In most countries, Coca-Cola goes much further than simply selling syrup and taking back local products; the company transfers food and beverage technology and assists in developing foreign marketing programs.

Most of these programs are designed to help the countries penetrate the American market. For example Coca-Cola assisted Yugoslavia and Romania in the production of wine for the American market, advising them on American taste in wines and appropriate package designs, as well as making agreements with American wine distributors.

In Turkey, Coca-Cola set up a joint venture to produce tomato paste for the American market and other markets, providing management and technology for the plant. Coca-Cola generally tries to set up a partnership with customer countries.

Avon, Colt Industries, and Grumman International are examples of companies following a company advantage policy. Avon uses countertrade to release blocked funds; they build plants in various countries and export part of the production in order to generate hard currency.

Avon products made in developing countries are exported to other developing countries, rather than to industrial countries. (Unlike most products, 80% of the cost of cosmetics is promotion; thus there is no cost advantage in making cosmetics in low-wage countries for export to industrial markets. Avon does not accept counterpurchase products.

Colt's defence divisions do a small amount of countertrade in order to compete with foreign defence firms. They usually limit their countertrade obligations to sourcing or counterpurchase; they do not buy back or export products related to the original sale. Counterpurchases are liquidated through trading companies.

The defense divisions of Grumman handle substantial amounts of countertrade. Their countertrade methods include sourcing, counterpurchase, and subcontracting. Grumman uses trading companies to liquidate indirect offset obligations.

Boeing and McDonnell Douglas are examples of companies with dual countertrade policies; their military and commercial divisions each follow different policies. Boeing Commercial Aircraft Co. follows the company advantage policy. In the sale of the 747 and other civilian transport aircraft, they will accept only minimal countertrade obligations, and will then liquidate these obligations through outside trading companies.

In some cases, they will handle direct offset such as aircraft maintenance facilities. Boeing's defense divisions operate under the mutual advantage policy, however; as illustrated by programs like the Peace Shield offset with Saudi Arabia in which Boeing is helping the Saudis develop a number of high-technology projects.

In contrast to Boeing, the commercial company of McDonnell Douglas follows the mutual advantage policy, while the military follows the company advantage policy. Douglas Co. was one of the first companies to market civilian aircraft through countertrade. They emphasize export development in buyer countries, helping the countries market nontraditional as well as traditional exports.

A recent large project is the offset with China for the sale of MD-82 jetliners. The offset includes subcontracting of components to the Shanghai Aviation International Corp., manufacture of landing gear doors in China, technical training, and participation of Chinese engineers in the design of new generation McDonnell Douglas aircraft.

The military aircraft company, McDonnell Co., has a small countertrade staff to fulfill direct offset obligations, and liquidates other obligations though a New York trading company which it helped to establish.

Four Countertrade Strategies

The countertrade strategies of American companies may be divided into four general types, defensive, passive, reactive, and proactive. Defensive, passive, and reactive strategies correspond to the company advantage policy, while proactive strategy is derived from the mutual advantage policy. Again, the following identification of strategies for individual companies is based on the author's observations.

Defensive. Companies with a defensive countertrade strategy ostensibly do not countertrade at all; however, they make many countertrade-type arrangements with buyer countries. These companies will avoid any contractual countertrade obligations, but they make it clear to the country that they will reciprocate in some way for the sale. Some companies will sell their products at rock-bottom prices and promise to help the country with export development.

Others participate in barter deals by having an intermediary like an independent trader take title to the goods on each side, therefore making the transaction appear to be conventional import and export rather than a swap. No matter what kind of deal is made, however, these companies will insist that they do not countertrade. They seldom have in-house trade units.

A variation of the defensive strategy is that of companies that say they do not countertrade, although they do it openly and regularly with Eastern European countries and China. They seem to think that this trade does not count, offering the excuse that "it's the only way to do business in socialist countries." They may also be defining countertrade as practice restricted to developing countries.

Incidentally, most industrial country governments that practice military offset among themselves follow a defensive countertrade strategy. The beneficiary countries call their requirements "industrial benefits" and swear that they are against countertrade; the partner countries go along with this by refusing to include military offset in the definition of countertrade.

Examples of companies following a defensive countertrade strategy are Bell Helicopter, Textron, EBASCO, Gould, and Borden.

Passive. Companies with passive countertrade strategies regard countertrade as a necessary evil. They participate in countertrade at minimal level, on an ad hoc basis. Some companies operate this way because they have product leverage (i.e., little or no competition), while others follow the passive strategy because of disinterest in countertrade.

These companies will accept contractual offset and countertrade obligations, but only on their own terms. They will rarely obligate themselves to export development or indirect offsets such as counterpurchases. However, they will use countertrade for sourcing, which is a form of export development.

Passive strategy companies regard countertrade primarily as a form of export financing. They will not initiate countertrade or offer it as a sales incentive; rather, they will wait until the buyer country requests countertrade. Some of these companies have small in-house countertrade units.

Most chemical companies and manufacturers of chemical products have passive countertrade strategies. These include DuPont, Dow Chemical, Cyanamid, Smith-Kline, and the chemical divisions of Amaco and the Ethyl Corp.

Some of the defense companies with product leverage also have passive strategies, including Lockheed-Georgia, Martin Marietta Aerospace, Texas Instruments, Sperry Corp., and Singer Co. Other companies using passive countertrade strategies are Alcoa, Polaroid, S.C. Johnson & Sons, and Nabisco.

Reactive. This is the most common strategy among American companies. Companies with reacting strategies will cooperate with the buyer country in offset/countertrade requirements, they use countertrade strictly as a competitive tool, on the theory that they cannot make the sale unless they agree to countertrade.

Although they may consider countertrade as a permanent feature of their international operations, they do not see it as a marketing tool for expansion. Reactive companies often have large in-house countertrade units, and use outside trading companies when necessary. They rarely have in-house world trading companies.

Most defense companies have reactive strategies. Among these are the defense divisions of Litton, Grumman International, Garrett, BMY, TRW, Perkin-Elmer, Emerson Electric, General Dynamics, Northrop, Allied Signal, McDonnell, Motorola, ITT, Raytheon, and LTV Aerospace and Defense Co. Non-defence companies with reactive countertrade strategies include Kodak, Xerox, Dresser Industries, Chrysler, Burroughs, and IBM.

Proactive. Companies with proactive strategies have made a commitment to countertrade. They use countertrade aggressively as a marketing tool, and are interested in making trading an active and profitable part of their business. They regard offset and counterpurchase as an opportunity to make money through trading, rather than as an inconvenience.

Proactive companies participate in all kinds of countertrade, including global sourcing, releasing of blocked funds, trade development, and trade financing. They often have in-house world trading companies, and will sometimes liquidate countertrade obligations for other companies.

Examples of companies with proactive countertrade strategies include Cyrus Eaton, Occidental Petroleum, Continental Grain, Caterpillar, Monsanto, General Foods, Goodyear, Rockwell, General Electric, FMC, Westinghouse, Tenneco, 3M, General Motors, Ford, Coca-Cola, United Technologies, Pepsi-Cola, and the civilian product divisions of McDonnell and Lockheed.

Developing A Strategy

A company's strategy should be guided by the policy it has formulated to achieve its goals. Unfortunately, the guidelines derived from company policy are not always specific. This can result in either the wrong strategy, or multiple and conflicting strategies within one company.

When a company has an ambiguous countertrade policy, the divisions are left to interpret the policy as they see fit, and they will develop strategies on a trial and error basis. Sometimes one division will take the initiative in countertrade/offset; the manager of that division becomes the company countertrade expert by default, and other divisions will follow his strategy.

This at least results in a consistent strategy, even if it happens to be the wrong one. In other cases, the divisions handle countertrade independently, with each division following its own strategies or adopting various contingency strategies. The entire company's countertrade related sales performance suffers because of a lack of coordination and teamwork.

The first step the company must take in developing a countertrade strategy is to define its policy clearly to its divisions. It should then make periodic reviews and evaluations to ensure that the strategy being used is consistent with the policy.

However, the divisions should have the flexibility to use contingency strategies, as long as these strategies are within the framework of company policy. Finally, it is important that the divisions coordinate their countertrade operations, in order to minimize conflict and improve cost effectiveness.

The countertrade policies discussed here are mutual advantage and company advantage and, as noted earlier, proactive strategy is usually associated with the mutual advantage policy, while the defensive, passive, and reactive strategies fit the company advantage policy. In rare cases, however, proactive strategy may be used by a company following the company advantage policy.

The mutual advantage countertrade policy is the appropriate policy for socially responsible multinational corporations. Multinationals are expected to contribute to the economic development of developing countries through the transfer of management, marketing, finance, and technology. Countertrade is part of this effort, and is treated as a developmental activity. In industrial countries, multinational corporations are expected to provide technology and employment.

Many U.S. corporations agree with this policy in theory, but cannot afford to follow it. American business is geared to short-term profit because of the st ructure of financial markets. Only the largest corporations can afford to undertake socially responsible projects; such projects are usually oriented to long-term profit. Large-scale countertrade operations involving economic and trade development usually fall into this category.

Under the proactive strategy of a company following a mutual advantage policy the major task is to design a countertrade/offset project that will be profitable for both parties. The objective is to get continued and expanded business in the country (market growth) through the establishment of a long-term relationship, even if it means losing money for the first few years.

Companies following a company advantage policy are more entrepreneurial and opportunistic than socially responsible. They are usually profit maximizers. The most effective strategy under a company advantage policy is the reactive strategy. The major objective of the reactive strategy is to make the sale through cooperation with the buyer country.

The goal is not so much long-term business as it is satisfaction of the buyer country in a particular countertrade/offset deal. The objective of the passive strategy is either sourcing or export financing; cooperative arrangements with the buyer country are not very important.

The least effective strategy is the defensive strategy. Companies using this strategy are the "sneaky countertraders," they want the benefits of countertrade (making the sale, export financing, etc.) without the responsibility of contractual, countertrade operations. This is a short-term strategy.

Synergy And Strategy

In the context of countertrade, synergy means the benefits accruing to the company from the cooperative activities of the countertrade unit and the divisions. The choice of strategy directly effects the level of synergy, as well as the financial position of the countertrade unit.

Figure 1 shows a matrix in which countertrade strategies are classified by levels of synergy and cost-benefits of the countertrade unit to the company. The nine cells position three of the four basic strategies-- proactive, reactive, and passive--according to their relative proportions of costs and benefits.

The defensive strategy is not included in the matrix because companies using that strategy usually do not have a countertrade unit. The optimum position in the matrix is cell 1.1., which represents the maximum in synergy and benefits. The lowest position is cell 3.3., where synergy is low and costs are high. The median position is 2.2., where synergy is median and costs are at break-even.

Some companies may find that their strategy does not correspond with one particular cell because of the varying practices of the divisions, each of which may have its own countertrade offices and strategies.

The Strategic Process

Many companies do not have a clear strategic process for countertrade/offset bids and transactions, although they may have a well-defined overall strategy such as reactive or proactive. The strategic process in countertrade is not directly related to the type of strategy used; rather, it is a series of steps that companies should follow in countertrade operations, as illustrated in Figure 2.

The first step is to analyze the countertrade/offset needs of both the company and the buyer country. The company's needs may include entering a new market, maintaining market share, or releasing blocked funds. Some typical needs of buyer countries are industrial development, export development, import substitution employment, and the generation of foreign exchange. In analyzing these factors, the company must decide how it can match its needs with those of the buyer country.

The second step is the cost-benefit feasibility analysis. The company should estimate the cost of: (1) human resources, which is the cost of doing the entire transaction in-house versus giving it to a trading company or other service provider, or a combination approach, and (2) other costs such as legal, insurance, shipping, and financing. These costs must then be weighted against the anticipated benefits in terms of profit, market share, and future sales to the country (market growth)

When the countertrade needs and cost-benefits have been analyzed, the company is ready to prepare its sales bid and accompanying countertrade proposal. (Some portions of the countertrade cost is usually factored into the sales bid; although this practice is routinely prohibited by buyer country governments, it is necessary.) After the proposals are submitted, the company enters into negotiations with the buyer country.

Areas covered in the countertrade/offset proposal negotiations may include the offset percentage, amount and type of technology to be transferred, amount of investment in joint ventures, degree of technical and management training to be provided, duration of the obligation, level of nonperformance penalty, method of enforcement of the obligation (best efforts, liquidated damages, etc.), and details about the counterpurchases (products available, quantities available, delivery dates, etc.)

In some countries, the countertrade regulations may specify such things as additionality (exports above the usual level), specific markets for exports, or prohibition of the use of third-party traders. These points must also be negotiated, if the company feels unable to carry out the proposed obligations under specific restrictions.

The contracts are signed when the negotiations are completed: one for the sale and one for the countertrade. In sales implementation, the company should adhere to the promised delivery schedules. In the implementation of the countertrade/offset obligation -- which may include counterpurchase, buyback, technology transfer, joint ventures or sourcing--the company should make periodic progress reports to the buyer country. Throughout the countertrade implementation period, the company should make periodic cost-benefits evaluations.

An authorized agency of the buyer country will issue a certification when the countertrade obligations have been fulfilled. At this point, the company should do a cost-benefit analysis. The analysis should be used as guide for improving future countertrade transactions.