Introduction

In a growing globalized world where cash flows and flows of

funds are getting more complex one would expect

businesses to be completed in seconds through electronic

transactions, which most times is also the case.

Nevertheless, the oldest form of trading and its numerous

variations regain each day their importance in international

trade. Countertrade has become an important element of

the world economy, for all countries whether industrialized,

emerging or developing since World War 2. Despite the

move towards freer trade it may be surprising to find that

barter and Countertrade (CT) are actually growing faster

than world trade. International CT is a global phenomenon

which involves interaction between parties in different

countries and links sales with purchases so that each party

to a transaction is both buyer and seller at some stage. It is

paradoxical that these forms of trade, predating the use of

money and trade finance continue to grow in importance.

Importance of countertrade and its share in the world

market is steadily increasing and it is becoming one of the

important opportunity for doing international trade. As

trade statistics only include monetary transactions an

increasing slice of world trade is being ignored in trade

analysis, economic, trade and policy decisions. Despite the

general perception that CT is more prevalent in centrally

planned economies, their transformation to more market

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based economies has not reduced the incidence of CT as

predicted. Instead more countries have come to embrace

CT. However, it would seem that although the number and

value of transactions is continuing to increase the

modalities and motivations are changing. Limited attention

has been given to the strategic possibilities for the use of

CT in the process of internationalisation.

What Is Countertrade?

Countertrade is a resourceful way to arrange for the sale of

a product from an exporter to a company in a country that

does not have the resources to pay for it in hard currency.

The problem is usually with the importer but may be with

the country's limited reserves as well. An international

credit executive who arms his salespeople with an

innovative countertrade solution gives the sales force a

competitive advantage. In some cases, the company that

cannot come up with a countertrade initiative will not be

able to sell in certain markets.

The most well-known form of countertrade is barter-the

simultaneous exchange of goods. Countertrade experts say

it is also the form least Used.

Definitions

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“International Countertrade”, C. M. Korth defines

countertrade as “a general term covering all forms of trade

whereby a seller or an assignee is required to accept goods

or services from the buyer as either full or partial payment.

The UN defines Countertrade as "commercial transactions

in which provisions are made, in one of a series of related

contracts, for payment by deliveries of goods and/or

services in addition to, or in place of, financial settlement".

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.

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.

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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.

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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,

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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.

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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

Types of counter trade

Countertrade is quite simply the exchange of goods for

goods, but it is also a barrier to free trade. The simplest

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form of countertrade - barter - dates from ancient times, but

more recently various other forms of countertrade have

been used in trade between rich and not so rich countries.

Due to shortages of foreign exchange and a lack of markets

for their products, many nations have engaged in

countertrade. For example, Iraq obtained warships from

Italy in exchange for oil; Spain obtained Colombian coffee in

exchange for Spanish buses.

Countertrade is a barrier to free trade because the sellers

are obliged to take goods they would not otherwise buy, and

in doing so, they close off a market from free and open

competition.

Barter: Is the direct exchange of goods between two

parties. The advantage of

barter is its simplicity.

One disadvantage is that unless goods are swapped

simultaneously, one party is financing the other until

the exchange is complete. A second is that the goods

exchanged may not be goods one or both parties really

want, or may be ones that are difficult to convert into

cash.

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Counter purchase: The assumption by an exporter of

a transferable obligation through a separate but linked

contract to accept as full or partial payment goods and

services from the importer or importing country. The

contract usually stipulates a period during which the

counterpurchase is to be completed, and the goods and

services received in return are pre-specified, subject to

availability and to changes made by the importing

country. In essence, counterpurchase represents an

inter-temporal exchange of goods and services or the

bundling of two transactions, namely current buying

and future selling.Is a reciprocal buying agreement

(not a direct exchange of goods).

The advantage is that both parties get goods they can

use or sell. The disadvantage, however, arises when

one or both parties have to engage in a further

transaction to dispose of the goods to obtain more

useful goods.

Offset trading: Is an obligation imposed on exporters

by governments which requires local industry to be

given the role of producing goods to offset the

purchase price of expensive products.

Offset trading can be done through co-production, sub-

contracting, joint ventures, licensing or turnkey

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arrangements. The offset arrangement is common with

expensive items such as military equipment, aircraft and

ships. The principal reason for this form of countertrade is

to offset the negative effects of such large purchases on the

balance of payments of the importing country.

Offset trading offers the advantage of offsetting the balance

of payment effects for the country importing large outlay

items. The

disadvantage is that it requires the exporter to deal with a

firm in the importing country, which may not be the

exporter's preferred

Switch trading: It involves at least three parties. A

switch trade is used when the products received are of

no use to the exporter or cannot be converted to cash.

The original exporter may then barter the goods

received for other products which may be sold for

cash. This chain of transactions may be repeated a

number of times. As a result, this expands the number

of goods that may be bought and sold. Switch trading

is useful to a country with unique requirements or

goods and can open untapped markets. The

advantages in switch trading are that it enables the

parities to achieve a satisfactory outcome and expands

export markets. It is, however, sometimes difficult to

arrange and may require the services of specialist

brokers course

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Buyback or compensation trading: This is probably

the most common form of countertrade. It usually

consists of the export of a technology package, the

construction of an entire project or the provision of

services by a firm. The buyer in return pays back the

supplier by delivering a share of the output of the

project in the future. For example, in 1980 the

German, French, Italian and British governments

subsidized companies to construct a $US 4 billion

natural gas pipeline in the former Soviet Union . The

former Soviet Union paid for the project with natural

gas.

The advantage of buyback trading is that it acts as a

substitute for FDI in countries which do not welcome FDI.

The disadvantage is that few situations are amenable to this

form of countertrade.

Reasons why counter trade is used :  

Money - some people cannot pay in the currency you

want

"to enable trade to take place in markets which are

unable to pay for imports. This can occur as a result of

a non-convertible currency, a lack of commercial credit

or a shortage of foreign exchange"

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The Political Environment - local jobs and industry

"to protect or stimulate the output of domestic

industries (including agriculture and mineral

extraction) and to help find new export markets"

The Political Environment - rules and regulations to

protect the host country

"as a reflection of political and economic policies which

seek to plan and balance overseas trade"

"To gain a competitive advantage over competing

suppliers."

Documentation

Never assume that the other party will perform in a certain

way when entering a countertrade arrangement. The

documentation, typically prepared by the party arranging

the transaction, should:

connect all parties together;

state the purpose of the trade;

state the responsibilities of the participants; and

summarize how the transaction will run.

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The documentation should include:

the terms of the underlying contract(s);

the requirements of each party;

any local regulations that affect the trade;

timing;

any financing requirements; and

how the arranger will receive its fee.

Adverse effect and managing risk In Countertrade

Transactions

One of the unique risks of countertrade transactions is that

companies often find themselves handling products with

which they are not familiar. This is probably the greatest

risk in a countertrade transaction.

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1. Liability for the Product on Resale

If you acquire title to the product (and even if you do not

acquire title under certain circumstances) and the product

causes damage to third parties, fails to meet the standards

normally expected for the product, or fails to meet the

warranties and/or guarantees for the product being sold,

you can find yourself liable to third parties...including your

customers and independent third parties.

As a manufacturer of a mechanical product or a supplier of

technology, to find yourself the seller of medical equipment,

consumer goods, raw materials, et cetera, for which there is

a legal claim can be a very disturbing and expensive

learning lesson.

Managing risk: The suggestion for managing the risk is do

not take title to the product; this should be obvious advice.

One suggestion is to use a trader or other intermediary who

can be responsible for the potential liability. Either they can

ensure that the product does meet the requirements of the

market or the contract, or they can better deal with the

failure by substituting alternate product, or dealing with the

claim or lawsuit.

2. Currency Risks

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There are really two main currency risks. The first is non-

convertibility, i.e. the currency will not be convertible when

received or required. As many countertrade transactions

are designed to avoid this problem, this is less of a risk than

might be expected. The second risk is that the currency will

have fluctuated in value, and that you will receive fewer

dollars than you expected.

Managing risk: The risk of non-convertibility through

government action can probably be covered by political risk

insurance. Alternatively, you could get a government

guarantee that you will be allowed to convert currency as

required. Of course this may not be much of a guarantee if

the government changes its mind or a new government is in

place, but it also might be insurable.

Currency fluctuations are often capable of being protected

by currency hedging contracts. These are possible on all

hard currencies and on many soft currencies through

specialist traders.

3. Non-Performance

This is obviously the most common risk in any transaction.

This risk may be higher in countertrade transactions, as you

are probably dealing with less developed countries and less

sophisticated sellers.

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Non-performance can take many forms, including complete

failure to deliver, late delivery, partial delivery, or delivery

of damaged, defective, or out-of-specification product.

The effect of non-performance will be different under

different contracts, and depends on the nature of the non-

performance. It can render the sale of your product

impossible, and/or failure could leave your company open to

claims or lawsuits from unhappy buyers.

Managing risk:

1) Make reasonable contracts. The most effective manner is

to ensure that the transaction works. The surest

arrangement is to deal with competent and experienced

partners. But, as we are all aware, this may be extremely

difficult in countertrade transactions, especially in

developing countries and in countries which are changing

from a centrally planned economy to a free market

economy.

A good solution is to make contracts which you are

comfortable that the other party can meet. There is no point

in forcing another party to accept a contract which you are

convinced that they cannot fulfill.

2) Use traders. Another solution is to use other parties that

are experienced in the country and/or product to handle the

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import/export of the products. In other words, use an

experienced trader.

Generally a trader can better assess and manage the risks

than an industrial company attempting to sell its product to

the third-world country. The use of third party experts will

probably assist you to avoid many risks, and will make the

transaction more likely to occur.

3) Use insurance. You may be able to insure the risk under

certain circumstances. Political risk insurance has far

broader coverage application than you might expect.

It is available to cover the failure of the seller for almost any

reason, not just failure to perform because of government

action. The insurance is generally available only for sales by

government-owned enterprises, although other similar

coverages may be available.

4) Get guarantees. If you cannot ensure that performance

will occur, you should protect yourself from the effects of

failure, as much as possible.

In general, some form of guarantee of performance is

usually prudent, these guarantees can include standby

letters of credit, performance bonds, bank guarantees, cash

deposited in an escrow account, product delivered to a

neutral party, or government guarantees, etc.

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4. Payment Risks & Creditworthiness

Payment risk is not a common risk for the countertrade

transaction, as you are purchasing, not selling product.

However, if your barter transaction requires that a short-fall

be paid in cash, there may be a payment risk. There is a

credit worthiness issue if you are required to make a claim

against the seller.

A party failing to pay because it is bankrupt or because it

doesn't want to pay, for whatever reason, is an extremely

difficult problem in an international transaction.

Managing the risk: The traditional method is to use a

letter of credit (L/C) from a reputable bank. If the (L/C) is

not from a reliable bank, it can often be confirmed by a

reliable bank. Or the L/C can be insured or discounted.

Other methods of handling this risk are to insist on security

deposits, or to require guarantees from other parties

working with the seller who are easily sued.

5. Timing Risks

Timing can be a risk in many ways. If your supplier fails to

deliver in time, you may be liable to another party who was

expecting to receive the product.

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Other timing risks impact on currency risks or payment

risks. For example, if your L/C expires before delivery, you

are not guaranteed payment. Or if your hedging expires

before delivery, you may not receive the money you

expected.

Managing the risk: This risk should be generally managed

in the same manner as non-performance. The risk of delay

impacting on your hedging contracts or your L/Cs requires

careful management of your countertrade contract.

6. Risks Arising From Government Regulations

There are several legal risks to international trade

transactions, such as anti-dumping, embargoes, quotas,

licensing, sovereign immunity and foreign corruption

a) Dumping. This occurs when a seller sells a product into

another market at prices less than the home market, or at

prices less than its cost. Often it is more difficult to obtain

the real price for the countertrade product than it is for

traditional sales.

The penalty for dumping is an "anti-dumping duty" which is

chargeable to the importer of the product. Obviously this

could have a detrimental effect on pricing and the

countertrade transaction.

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Managing the risk: The safest method of handling

dumping problems is to use a trader or to act as a broker

and have another party import the product.

If you must be involved, you should provide in your contract

that any anti-dumping duties are for the account of the

seller and should obtain security for this if it is a likely risk.

b) Quotas. These are agreed limits on the volume of

product that can be imported into a country. For example,

there might be an agreement between China and the USA in

which only 20 million items of a textile product can be

imported into the USA in any one year.

If your countertrade transaction involved the import of the

next 2 million items, you would not be allowed to import

them.

The transaction would therefore fail or be delayed until the

quota opened again in the succeeding year. If you have

already delivered your product to the Chinese importer, you

might have to wait for some time. And this could have a

negative impact on your profitability.

One of the problems with the quota system is that the

Customs Service in the importing country will simply refuse

to allow additional product to land.

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It is difficult to obtain accurate information on what

quantity has landed, and the situation can change very

quickly if new product lands between your inquiry and your

product's landing.

Managing the risk. Quotas should also be left to the seller

to obtain, as the responsibility for managing quotas rests

with the exporting country. Alternatively, you could use a

trader to avoid the risk.

c) Embargoes. Certain countries, e.g. Iraq, are subject to

embargo regulations, and any attempt to deal with products

from these countries or to deal with companies/individuals

from these countries may be a criminal offense.

Managing the risk. While you may know that you cannot

deal with Iraq or other countries subject to embargo, you

may not know, say, whether or not the company in Cyprus

(which has offered you steel from Romania) is owned by a

company in an embargoed country.

It is often extremely difficult to ensure that you are not

dealing with a restricted company.

There is no easy solution to the problem, and checking the

regulations to determine whether your partner/seller is

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subject to embargo is time consuming, and probably not

reliable.

d) Licensing. Failure to obtain a required license can mean

that your product is not exportable from a selling country,

or importable in a buying country. And this could obviously

have an extremely negative impact on your countertrade

transaction.

It is standard risk in all international trade transactions, and

there has been much litigation resulting from parties failing

to obtain licenses and determining who had the obligation

to obtain the license.

Managing the risk. In order to avoid problems with

licenses, the obligation of either of the parties to obtain the

necessary licenses must be clearly agreed to in the contract.

e) Sovereign immunity. This is not the result of

government regulation, but is a legal doctrine which

prevents lawsuits against foreign sovereigns.

In other words, you cannot sue foreign governments.

Unfortunately many foreign governments operate business

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or quasi-business operations, and sometimes these

organizations are provided with sovereign immunity.

If you deal with one of these entities and attempt to sue on

a failed transaction, you will be prevented from doing so by

most courts.

Managing the risk. A simple and expedient solution to the

problem is to ensure that the other party waives any

defense of sovereign immunity.

Countertrade Examples

1. Pepsi & Vodka

The countertrade arrangement where the rights to sell

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Russian vodka in the US in exchange for Pepsi (to be

sold in Russia) was a huge story years ago

John G. Swanhaus, Jr., vice president, Pepsi Cola Company

As president of PepsiCo Wines & Spirits International, a

major part of his responsibility was PepsiCo's supply to the

U.S. market of Stolichnaya Russian Vodka as part of a

countertrade agreement to sell Pepsi products in the Soviet

Union.  Pepsi & Vodka -how did it work, 

Pepsi-Cola delivers syrup that is paid for with Stolichnaya

Vodka. Pepsi has the marketing rights of all Stolichnaya

Vodka in the U.S.

Recently Pepsi has made another innovative step by taking

17 submarines, a cruiser, a frigate, and a destroyer in

payment for Pepsi products. In turn, this rag tag fleet of 20

naval vessels will be sold for scrap steel, thereby paying for

Pepsi products being moved to the Soviet Union.

Conclusion

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Countertrade commitments do not come without risk. Risk,

however, can be minimized with proper planning,

appropriate products, internal communication and an

effective protocol contract. When all aspects of a

countertrade agreement are in place, countertrade is a

great tool to create and improve international sales

Choosing a CT strategy has implications for the modalities

selected in particular the key characteristics of temporality,

commitment and company advantage. In turn the CT

strategy pursued will in part determine the contribution to

internationalisation. Such contribution can be measured

along the dimensions identified in the internationalisation

literature. Empirical evidence is supportive of a two-stage

model in which the second stage, the internationalisation

process is moderated by the choice of CT strategy. The

companies described here show wide diversity in CT used

and in their internationalisation processes. It provides a

challenge for further conceptual and empirical development

to refine the model. This paper gives initial thoughts on the

relationship between CT and internationalisation and

suggests an approach to gain further

understanding.

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INDEX

SR. NO. TOPIC

1. Introduction

2. What is counter trade?

3. Four countertrade strategies

4. Types of counter trade

5. Reasons why counter trade is used

6. Documentation

7. Adverse effect managing risk in countertrade

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8. conclusion

Project on: adverse effect of

countertrade

ROLL NO: 21 & 26

SUBJECT: international banking finance

SUBMITTED TO: kanthi MAM

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Four Countertrade Strategies

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."

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."

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."

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 counter purchase as an opportunity to make money through trading, rather than as an inconvenience."

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