Intercultural Communication in the Global Workplace

Fifth Edition

Iris Varner Professor Emerita, Illinois State University

Linda Beamer Emerita Professor, California State University, Los Angeles

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INTERCULTURAL COMMUNICATION IN THE GLOBAL WORKPLACE, FIFTH EDITON

Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY 10020. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Previous editions © 2008, 2005, and 2001. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

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communication—Social aspects. 3. International business enterprises—Social aspects. 4. Intercultural communication. I. Beamer, Linda. II. Beamer, Linda. Intercultural communication in the global workplace. III. Title. HD30.3.B4 2010 658.4’5—dc22 2009054446

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For Carson and David

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iv

Preface to the Fifth Edition

Welcome to the fifth edition of Intercultural Communication in the Global Work- place. The fourth edition has been used around the globe. We are grateful for the reception of the earlier editions, particularly the many comments and suggestions users have given us. We have incorporated those comments into the fifth edition and are confident that this book presents a valuable tool in your understanding of the impact of culture on international business communication.

The effects of culture on human behavior in general and on global business activities in particular make headline news almost every day. More than ever businesspeople cite cultural understanding as the single most important factor in international success. Prof. Dr. Marion Debruyne is quoted as saying “Culture is the real power of globalization.”1 Dramatic changes in communication technology—the growth around the planet of satellite and cellular telephony— since our first edition have made international communication commonplace.

When we wrote the first edition, e-mail was just starting to be used widely, but it was almost impossible to attach files to an e-mail. We used FedEx to send book chapters to each other for comments and suggestions. Today, files can be sent eas- ily all over the world; we can talk to each other and even see each other on our com- puter screens. Blogs, Facebook, and Twitter have revolutionized communication. Technology allows us to use rich channels that do not just transmit text but also our gestures, facial expressions, and pauses. We can communicate over vast dis- tances as if we sat in the same room. Companies have embraced this new technol- ogy to facilitate communication among their employees from around the world. A survey of new media published in The Economist magazine in April 2006 reported that thanks to broadband technology, mass media are being replaced by personal media created by the users of the Internet.1 Since 2006, personal media devices have developed further, and offer, in addition to a chance to speak and listen, the capability to receive and transmit data to and from mobile devices. “Nowadays, YouTube streams more data in three months than all the world’s radio stations plus cable and broadcast television channels stream in a year.”2 It’s a long way from the development over 40 years ago of technology to allow internetworking—the ori- gin of the “Internet”—to exist.

The technological revolution means that organizations need intercultural com- munication skills even more today than they did when this book was first written. The fifth edition of Intercultural Communication in the Global Workplace has updated discussions of globalization and new technology in business communica- tion. The discussion of multicultural teams in the workplace has been expanded.

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What else is new? The fifth edition has a new discussion about the study of communication in different cultures, and the study of communication between cultures. It also shows how intercultural communication research fits within the dominant research paradigms, and includes an analysis of their strengths and weaknesses. The descriptions of religions and their influence on intercultural business communication has been expanded. The concept of Cultural Intelli- gence (CQ) is now discussed in greater detail throughout the book. Chapter 3 has a new section on culture’s influence on how people reason, and Chapter 4 has a new section on self-identity and self-construal in relation to culture. Chapter 8 includes an expanded discussion about culture’s effect on conflict management.

Chapter 12 ties together the concepts discussed in all the other chapters. It applies updated intercultural knowledge to the case of DaimlerChrysler and ex- amines the cultural reasons for the failure of the merger within just seven years of its beginning. This chapter also introduces the role diverse teams play in the success of international business. Two in-depth cases in the Appendix to Chapter 12 provide an opportunity to apply intercultural knowledge to specific problems.

Throughout the book we have added more short cases, and kept the introduc- tory vignettes to each chapter to illustrate the issues covered in that chapter. New illustrations and examples have been added, often drawn from cultures not men- tioned in the earlier editions.

Users of earlier editions will notice that the appearance of the fifth edition is more user-friendly, as we continue to improve the book’s layout and add new exhibits.

These changes reflect our continued commitment to provide a source for read- ers that addresses culture and cultural variations, communication across cultures for business purposes, and the way culture affects organizations.

Many new books have arrived in the marketplace since we finished our fourth edition, but we are convinced this one is unique: It addresses the issues of culture and communication within the context of international business.

The fifth edition of Intercultural Communication in the Global Workplace, like the first four editions, provides examples of how cultural values and practices im- pact business communication. We explore the relationships among the cultural en- vironments of the firm and the structure of the firm. We look at how companies and individuals communicate. Throughout the discussions about specific commu- nication tasks, we concentrate on the underlying cultural reasons for behavior. This approach, as we asserted from the very first edition, we confidently believe will help the reader develop an ability to work successfully within an environment of cultural diversity both at home and abroad.

We have continued to strive to avoid specific cultural viewpoints in this book but have come to realize since the first edition that total cultural neutrality is not possible. Nor is it desirable in a sense; every human has some cultural filters through which she or he views the world. And comments from users have confirmed this. Nevertheless, the framework we develop here applies to all

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readers regardless of their native cultures. This book is for anyone from anywhere around the globe who wants to develop and improve intercultural business com- munication skills. Intercultural business communication is an exciting field, and we are proud to be able to contribute to a broader understanding of it.

Notes 1. The Economist, April 2006. 2. “The Internet at 40,” The Economist, September 4, 2009, http://www.economist

.com/sciencetechnology/displaystory.cfm?story_id=14391822.

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About the Authors

Iris I. Varner is the Director for the International Business Institute and a Professor Emerita in international business at the College of Business, at Illinois State University, where she taught the cultural environment of international business and international management. Her PhD, MBA, and MA are from the University of Oklahoma. She has the Staatsexamen and Assessorenexamen from the Albert-Ludwigs-Universität, Freiburg, Germany.

Varner has extensive international experience. She grew up in the former East Germany and studied in Germany, France, Great Britain, the United States, and Taiwan. She has given seminars and lectures around the globe, including New Zealand, Russia, France, Belgium, Japan, Germany, and China and has spent time in many other countries. She is an ad hoc professor at the University of Lugano, Switzerland, where she teaches in the Executive Masters Program for Corporate Communication Management and at Shanghai University, China.

Varner is the author of over 80 articles in the area of intercultural managerial communication. Her research, which she has presented at regional, national, and in- ternational conventions, has focused on the connections between culture, commu- nication, and business practices. She has been honored with the Outstanding Membership Award and the Meada Gibbs Outstanding Teaching Award of the As- sociation for Business Communication. She was named a Fellow of the Association for Business Communication and a Caterpillar Scholar and State Farm Fellow by Illinois State University.

As a president of the Association for Business Communication in 2000 to 2001, she contributed greatly to the internationalization of the organization. She was chair of the Ethics Committee and is an active member of the International Committee. Varner is a member of the Academy of Management and the Academy for Human Resource Development. She also serves as a reviewer for a number of scholarly publications and consults for a variety of national and international firms.

Linda Beamer is an Emerita Professor of California State University, Los Angeles, where she taught undergraduate business communication, intercultural communication, and diversity in the workplace, and courses in high-performance management and international business in the MBA. She received the honors stu- dents’ Professor of the Year award in 2001, and in 2002 she received the Out- standing Professor award from her campus, followed by a Distinguished Woman award in 2005. She subsequently taught intercultural communication to

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undergraduate and postgraduate students at Unitec New Zealand, where she and her husband make their home.

She has taught and consulted in the United States, Great Britain, Canada, the Middle East, China, Argentina, Mexico, Hong Kong, Japan, and New Zealand. Her BA is from the College of Wooster in Ohio (with one year in Scotland at Ed- inburgh University), and her MA and PhD are from the University of Toronto. The latter led to dual U.S.–Canadian citizenship.

Her research, resulting in about two dozen publications and 70 presentations, has focused primarily on the effects of culture on business communication, with a special interest in Chinese communication issues. She has served on the Editorial Board of Business Communication Quarterly and was Associate Editor of the Journal of Business Communication; she frequently reviews for other publications as well. She served as President of the Association for Business Communication in 2004, as Chair of the Intercultural Committee of the Association for Business Communication, and as a member of the Board of Directors. In 2005, she was hon- ored with the Fellow award. She was also voted a Fellow of the International Acad- emy of Intercultural Research at its inception in 1997.

Beamer has been the recipient of several research grants and received the Out- standing Publication award from the Association for Business Communication. She held a six-year Visiting Professor appointment at Unitec New Zealand before moving to Auckland, and held a three-year Visiting Professor appointment at Shanghai University until 2009. She taught at Chuo University in Tokyo in 2004 and 2010, and has been a guest lecturer at many campuses around the world.

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Intercultural Communication in the Global Workplace is the result of many years of work. Although this book is based to a great extent on our professional research and personal experiences, we also want to acknowledge the suggestions and ad- vice we have received from our families, friends, clients, colleagues, and students. We are particularly indebted to the users of previous editions for giving us valu- able feedback. Many people have been generous in sharing information with us, and we are grateful for their support.

We give special thanks to the reviewers who carefully read the fourth edition and offered their insights and suggestions.

Last, but not least, we thank the people at McGraw-Hill/Irwin, and particularly Jolynn Kilburg, the developmental editor. Their work and support made this edition possible.

Acknowledgments

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Introduction

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The Need for Intercultural Business Communication Competence What does culture have to do with business? In the past, many business majors and practitioners immersed in questions of financial forecasting, market studies, and management models did not examine culture and the way it affects business. Un- like the hard data from measurable issues, culture is soft and, at times, slippery. Al- though it can be elusive, culture is still undeniably important. It’s often easiest to spot culture at work when something goes wrong, when a key element of culture is overlooked. Here is an example:

Mickey Mouse took up residence in Hong Kong in 2005, but Mainland Chinese visitors to the new theme park seemed unsure about the meaning of the Happiest Place on Earth. Disney film characters like Cinderella, Snow White and the Seven Dwarfs, and Tinkerbell are based on fairy tales and stories from Europe that are unfamiliar to children in China. Disney television shows with cartoon characters for children haven’t been aired in China for decades, as they have in the United States. Meanwhile, visitors who were puzzled by the theme park wandered aimlessly up Main Street and had their pictures taken with Marie the Cat—a character from the 1970s movie The Aristocats, whose appeal is in her appearance: It is remarkably similar to the hugely popular Japanese figure, Hello Kitty.

However, in early 2006 sparse crowds were replaced by hordes, and visitors’ mild bafflement turned to outrage. Hong Kong Disneyland was deluged by crowds. Three times during the “Golden Week” of the Chinese New Year the gates to the park were closed after the first 30,000 visitors came through, and thousands more visitors with paid tickets in their hands were turned away. Many parents who had spent large sums of money on travel to the promised holiday treat were photographed attempting to climb the fence or toss their child over it. Disappointed patrons threatened to sue Disney.

Disney made a public apology. The problem of too many visitors had come about because Hong Kong Disneyland, worried about lack of sales, had sold tickets that were good for up to six months. Many bought their tickets and then held on to them until the New Year holidays, something the Disneyland managers hadn’t anticipated. The chairman of the rival Ocean Park was quoted as saying it was a mess: “Many of the problems ‘were things that somebody who did their homework should have realized and understood.’”1

Nor was the Golden Week debacle the first cultural bump in the road for Hong Kong Disneyland. Initially, a park restaurant planned to serve shark fin’s soup, a Chinese delicacy that was later withdrawn from the menu because of animal rights protests. Local celebrities were invited for public relations appearances, but they subsequently complained they weren’t treated well by Disney executives from the United States. Disney also had learned that Chinese visitors to parks preferred places for taking photographs over roller coaster rides, so they put fewer rides into this park, which is the smallest of the six worldwide. As a result, shortly after it opened the park was criticized for being too small.

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Other culture-related issues that plagued the opening of Hong Kong Disneyland were the danger to children’s health from people smoking in nonsmoking areas, and the threat to sanitation from some visitors’ practice of urinating on the flowerbeds near food areas.

Hong Kong Disneyland isn’t an isolated instance of cultural misunderstandings. The history of the Disney theme park in France is notorious. Euro Disney had similar problems with unplanned crowds when it first opened. Locals who had postponed their visits during the summer tourist season surged to visit in September 1992. French critics called Euro Disney an example of U.S. cultural imperialism, and hundreds of employees left their jobs after a few days. The Disney prohibition on the sale of alcohol in its theme parks did not fit with the French custom of drinking wine with meals. But by 2006 it had become France’s number-one tourist destination with 50 million visitors a year.2

Similarly, the future of tourism in Hong Kong is bright, and Disney has adapted to take advantage of it. The people of Hong Kong may have had more patience with the U.S. company than the French did. Chief Executive Donald Tsang said when the theme park opened: “We have to remember that Disneyland is a new organization [in Hong Kong] . . . It may need time to understand the situation of Hong Kong and especially the culture of Hong Kongers and figure out how to make all its employees happy.”3

More and more organizations with strong success records at home, like Disney, are finding themselves involved in communication between cultures, either because they are doing business in unfamiliar foreign countries, or because they are sourcing from another country and seeking financing and a workforce from another country.

Companies around the world have increasingly multicultural workforces. In the United States, for example, Latinos (from Mexico and Central and South America) have become the biggest minority group. In Europe, the composition of the population is changing as more and more people emigrate from Africa, Asia, and the Middle East. In the Middle East, many workers come from India, the Philippines, and Southeast Asia. Countries like Holland and Australia are considering an examination system to see if immigrant applicants are culturally suited to living in those countries. As a result of these migrations, people with diverse cultural backgrounds and different languages are working side by side in many countries, creating a workplace that is multicultural.

Business communication today is intercultural communication. To communi- cate with people from another culture, one needs to understand the culture. To do that, one needs a method. This book offers an approach to unfamiliar cultures that makes understanding easier and consequently makes business communication with those cultures more effective. We believe intercultural business communica- tion skills can be learned.

At its lowest level, business communication with unfamiliar cultures means sim- ply finding a translator for conducting discussions in a foreign language. However, as more and more corporations are finding out, communication must take into ac- count unarticulated meanings and the thinking behind the words—not just the words alone. To be effective, communication must be culturally correct, not merely gram- matically correct.

To understand the significance of a message from someone, you need to un- derstand the way that person looks at the world and the values that weigh heavily

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in that person’s view of the world. That view includes meanings that are assumed to be universal (even when they are not), the importance of the words that are used, and the way the message is organized and transmitted. You also need to know what to expect when someone engages in a particular communication behavior such as making a decision known, negotiating a sales agreement, or writing a legal con- tract. And you’d be wise to know something about the organization that person works in and the way its structure—a result of culture—affects communication.

In applying intercultural communication skills to practical business concerns, this book makes an important contribution. Most books about doing business with peo- ple from other cultures come from one of two areas, either intercultural and cross- cultural communication scholarship and its near relative, intercultural training, or international business. Intercultural and cross-cultural communication scholarship is grounded in a body of theory but has little direct application to business communi- cation. Intercultural training draws from psychology and related fields and special- izes in preparing people for sojourns in foreign countries for development work, such as for the Peace Corps, for studying abroad, or for working in an expatriate posting, but this training typically has little application to business communication.

Books on international business, in contrast, concentrate on business functions such as finance, management, marketing, shipping and insurance, and accounting. They tend to ignore the importance of the all-encompassing communication tasks and the skills necessary to complete them successfully. They also tend to ignore the different priorities in other cultures that affect the act of communication and its outcomes.

This book connects business communication and understanding of cultural priorities with actual business practices. Of course, business practices themselves, as the book points out, are culturally based.

By combining intercultural communication skills with business, this book helps you become a successful communicator in culturally diverse workplace environ- ments both at home and abroad. As more and more firms are finding out, effective intercultural communication is crucial for success domestically and internationally.

Intercultural Business Communication Competence and Growing Domestic Diversity

All over the world, nations are trying to come to terms with the growing diversity of their populations. Reactions range from a warm welcome, to conditional acceptance, to mere tolerance, to rejection. As migrations of workers and refugees have increased globally, some countries are trying to control diversity by estab- lishing strict guidelines for emigration from other countries. Other countries are attempting to develop government policies concerning the rights of immigrants to preserve their own cultures in their adopted homelands. Canada is an example of a bicultural (English and French) country where federal and provincial govern- ments have ministers of multiculturalism to protect the cultural “mosaic” pattern that immigrants bring to Canada. New Zealand is an example of a country that has

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issues of biculturalism (Māori and non-Māori) to work through and that needs additional energy and resources to attend to the increasing cultural diversity of immigrants.

The United States historically afforded a home to people of diverse cultures. But even in the United States, with its ideals of equality and tolerance, the advan- tages and disadvantages of acknowledging diversity are debated hotly. Social crit- ics in the United States have voiced opposition to measures that preserve immigrants’ cultural differences. They say the insistence on diversity separates Americans from one another by forcing them to focus on what differentiates them. This view holds that the “melting pot” that has been alleged to describe American culture depends on the fusing of all cultural identities into one, in keeping with the American ideal of offering equal American-ness to everybody. Furthermore, they warn that multiculturalism may threaten the very characteristic that is so American: the union of one from many.

We don’t subscribe to this view. We do acknowledge that uniformity is easier to deal with than diversity. Diversity is difficult, although it also can be very rewarding. Often the impulse to deny cultural differences comes from embarrass- ment at focusing on difference, since frequently to be different is to be excluded. It isn’t polite to point out that someone looks different, talks differently, wears different clothes, or eats different food. Thus, many times, out of a concern to avoid making someone feel uncomfortable, difference is played down.

This attitude may be motivated in the United States by a sincere desire for equal behavior toward people regardless of their ethnic or cultural background under the all-encompassing umbrella of the ideal of equality. After all, most people who call themselves “American” have ancestors who were immigrants. Today, many still have a strong desire to include newcomers in a friendly and tolerant national em- brace and to affirm the high priority of equality in American culture. This is also true of some people in other countries with recent immigrant populations, such as New Zealand, Canada, Argentina, and Australia, as communities struggle to reconcile national identity with newer cultures.

People from different cultures really are different (as well as similar) in how they see the world. That’s a great thing about being human, and a potential source of delight and wonderment as much as a source of fear and suspicion—the choice is ours. As people of different cultures we begin with different databases, use dif- ferent operating environments, run different software and process information dif- ferently to get to what are often different goals. To pretend we’re all alike underneath is wrong and can lead to ineffectual communication or worse. The way to deal with diversity is not to deny it or ignore it but to learn about differences so they don’t impair communication and successful business transactions.

We also need new models to describe diverse populations. The description of the United States, for example, as a “melting pot” is neither an accurate descrip- tion of the reality nor an ideal that many of the more recent immigrants embrace. Even the immigrants from Europe of a previous century did not “melt”; they created a new culture with distinct differences based on cultural heritage. Some have described this integration as a salad or a pizza or a stew, in which each

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element retains a recognizable identity but contributes to the flavor of all. The combination gains something from each ingredient. The United States’ value of tolerance has in some cases given immigrants to that country the freedom to keep their own identities while becoming part of a new culture. In other countries, sim- ilar cases exist, and they represent a goal to which all can aspire.

Cultural differences don’t prevent us from working with each other or commu- nicating with each other or transacting productive business with each other. Indeed, we must learn to work with each other. The future of any organization depends on it. When connections are formed with people from other cultures, similarities appear. We weave fabrics of cooperation in which we see recurring common threads. It’s a source of delight to realize someone from a culture very different from one’s own has the same attitude or value or behavior. Furthermore, to see and accept different priorities and views can provide strength and create new synergies.

The essential ingredient for a successful cultural mix is skill in putting into operation the knowledge you acquire about another culture; this is intercultural communication competence. Many companies around the globe, such as Hewlett- Packard in the United States, have discovered the value of intercultural communi- cation skills and the increased productivity they bring. These organizations have instituted diversity programs to train employees.

Changes in Communication Technology and Political Structures

The 20th century nurtured unprecedented change in communication technology. The first decade of the 21st century brought even faster change. International com- munication that only a few decades ago took days, if not weeks, now takes nanoseconds. With e-mail, faxes, the Internet, satellites, cellular telephones, and conferencing software we contact our international partners at a moment’s notice. If we want a more personal exchange, audio and video desktop technology, video teleconferencing, and Skype bring the other person right into our office.

Today’s techno-developments are in the realm of participatory communication. In the first decade of the 21st century, words like “blog,” “wiki,” and “podcasting” appeared in our dictionaries. Podcasting (“pod” coming from the Apple product the iPod, for downloading music and audio as well as video from the Internet, and “casting” from broadcasting) allows podcasters to record anything and then up- load it to the Internet where it can be downloaded by other users. Every garage band can play to unknown listeners. Every orator can declaim to the globe. At sites like Second Life, people create virtual identities for themselves, called avatars, and engage in creative ventures such as making films. How this kind of participative communication will impact the entertainment industry, such as Disney with whom we began this introduction, remains to be seen.

The variety of channels of business communication has also increased. Instant Messaging, wikis in the workplace, blogs and texting by mobile phone, Black- Berry, iPhone, or other smartphone devices carry written messages. They also can

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transmit still and moving visual images. Voicemail, podcaster feeds, and Skype systems carry audio and video messages. The choice of which channel to use in a particular situation is influenced by cultural priorities and values, and those choices are multiplying.

The changes in technology have facilitated the exchange of ideas, but they also have magnified the possibilities for cultural blunders. It is so easy to assume that the person on the other end of the connection communicates just as we do. After all, he or she uses the same technology and maybe even the same business terminology.

In addition to changes in technology, political and economic changes affect business communication internationally. China, the world’s largest market for mo- bile telephony, is adopting more and more Western practices and a market econ- omy. India is a technological powerhouse. Small industrialized countries jostle with big ones. Non-Western countries are becoming more assertive and protective of their cultural values and behaviors and do not accept Western dominance in business practices any longer. These new voices are increasingly powerful. Not long ago an elite group of industrialized countries could more or less dictate economic practices. This is changing. Today, the first-world “overconsumers” are being forced to take into consideration the cultural values and practices of “sustainable consumers.”

As a result, understanding other cultures is more important than ever. If we con- sider that people with the same economic, political, and cultural background have problems communicating effectively, we can appreciate the difficulties and chal- lenges that people from diverse cultures face when trying to communicate. Misunderstandings will always be a part of intercultural communication. One of the goals of this book is to minimize misunderstandings through an awareness of the priorities and expectations of business partners.

International Business and Corporate Responses Managers in the past talked about the need for faster and more efficient communi- cation, as if speed guaranteed effective communication. They paid lip service to the need for good intercultural communication, but staffing decisions typically were based on technical knowledge rather than good intercultural communication skills.

Now with growing competition and increasing globalization, that attitude is beginning to change. International experience in more countries is becoming more important for making it to the top of the corporate ladder. The car industry is a good example for worldwide alliances, mergers, and joint ventures that have required an increasing understanding of international business practices and intercultural communication dynamics.

The trend toward a global business environment is not restricted to car manufacturers or big industrialized countries such as the United States, Germany, Japan, France, Canada, and Great Britain. Nor is it restricted to large cities or trade centers on the coasts. Global business involves geographic locations that just a few years ago were considered to be wholly engaged in domestic business. Many small towns in the landlocked states of Mexico, for example, are involved in

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xvi Introduction

international business today. Chinese investments in Africa show that international business has new players today who are not only based in the Western world.

Local firms may export or import; they may be owned by foreign firms, or foreign firms may establish subsidiaries. People who never dreamed of going into international business may work side by side with recent immigrants from differ- ent cultures. The salesperson in a small business in a small town in any one of a hundred countries may have to answer inquiries from around the world. The sales- person doesn’t have time to think about how to deal with a foreigner. She or he must be ready to communicate on the spot.

The Foundation for Intercultural Business Communication The first step in effective intercultural communication involves self-analysis, self-awareness, and understanding. You can’t understand the other party unless you understand yourself.

The next step is the understanding and acceptance of differences. That does not mean we have to agree with another culture’s viewpoint or adopt another culture’s values. It does mean we (and they) must examine our (and their) priorities and de- termine how we all can best work together, being different. In the process, we will realize that a person entering another culture will always have to adapt to a num- ber of cultural conditions. That doesn’t mean turning one’s back on one’s own culture or denying its priorities. Rather, it means learning what motivates others and how other cultural priorities inform the behavior, attitudes, and values of busi- ness colleagues. This approach means adding to one’s own culture, not subtracting from it. For example, a businessperson from New Zealand going to Japan must adapt to many Japanese practices, just as a Japanese businessperson going to New Zealand must adapt to a variety of New Zealand practices.

In attempting to understand another culture’s perspective, we will gain greater ground if we take off our cultural blinders and develop sensitivity in the way we speak and behave. That is not always easy. We are all culturally based and cultur- ally biased.

For example, people in the United States refer to themselves as “Americans.” They often say that they live in “America.” Most Europeans use the same termi- nology. Germans, for example, refer to the country of the United States as die Staaten (the States) or as USA, but they always refer to the people as Amerikaner (Americans). The French call the people of the United States les americains (Americans); they refer to the country as les Etats Unis (the United States) or l’Amerique (America). The Japanese refer to people from the United States as america-jin. But these are not precisely accurate terms; they constitute an example of cultural bias. People from Central America and South America call themselves “American,” too, and call people from the United States yanquis (Yan- kees). “North Americans” are people from Canada, Mexico, and the United States.

As residents of the United States, accustomed to using the word American to refer to people of the United States, we have struggled with the terminology in the writing of this book. We have attempted to distinguish between other Americans

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Introduction xvii

and those in the United States. But no exclusive term exists for the people of the United States—such as Statesians or USians—comparable to Mexicans or Cana- dians. We use the United States when referring to the country and often use the phrase people of the United States and United States businesspeople to refer to the people. But occasionally, when we feel the context is clearly the United States, we also use the term Americans to denote the people.

The third step in intercultural competence is to challenge the knowledge we have gained about other cultures and to see our understanding as flexible and in- complete. In any intercultural encounter, variations will occur. What we expect won’t be exactly what we get. Openness and willingness to learn characterize the skilled person in intercultural communication.

The fourth step is analysis of communication behavior to reach conclusions about what has been successful and what has not. This book offers many examples of both success and failure. Specific communication tasks presented in the fol- lowing chapters help with learning beyond stereotypes. Business correspondence, greeting behavior, conflict management, face-to-face and technology-mediated communications, and negotiations appear in the book, and they offer us an oppor- tunity to model the analyses a good intercultural communicator must make.

The final step in intercultural communication competence is enacting what one has learned. You know as a newcomer to a culture when you have done something that is culturally incorrect; you also know when you can behave in accord with the other culture. At that point, you are walking in the shoes of the other culture. That is the ultimate goal of learning about a culture and learning the skills to communicate with that culture: to behave as if you are of that culture. In addition to this individ- ual-level goal, you can also apply these principles to business organizations, as illustrated in the cases at the end of the book.

The Organization of This Book This book has three major parts:

1. An understanding of culture and how to get to know unfamiliar cultures for business, and how to understand culture’s impact on communication.
2. The application of intercultural communication skills to specific business com- munication tasks.
3. The implications of intercultural business communication for the domestic multicultural/international/global firm.

Part One

This section begins with an introduction to culture followed by the first steps in developing intercultural communication skills and a look at the way culture affects communication. A discussion follows about the study of communication across cultures. Chapter 2 examines the issue of language in communication with an unfamiliar culture and discusses the important role of the interpreter. Chapters 3 and 4 present a structure for understanding the dimensions of an unfamiliar

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xviii Introduction

culture by posing specific questions. The questions are in five different categories, and they cover the priorities or values of any culture that are important for busi- ness. Examples show how these priorities affect business transactions.

Part Two

Chapter 5 discusses the influences of cultural values and language patterns on the organization of business messages. Chapter 6 looks at the role of nonverbal com- munication across cultures. Chapter 7 discusses what happens when people from different cultures encounter one another in specific social contexts that have dif- ferent meanings for each party, and also touches on ethics across cultures. Chap- ter 8 examines the impact of cultural priorities on information gathering, decision making, problem solving, and conflict managing—all activities that involve cer- tain communication tasks. Chapter 9 concludes this section on the application of intercultural communication skills to business negotiations across cultures and to multicultural teams.

Part Three

Chapter 10 explores the legal environment and the communication implications for the international/global manager. Chapter 11 ties intercultural business com- munication practices to the organization and structure of the international/global firm. A broad variety of examples illustrates the impact of structure on communi- cation. The last chapter applies the concepts from all the previous chapters to the case of DaimlerChrysler. Through this case analysis, you can see how culture af- fects real business decisions in the real world. This chapter also discusses how companies can use the work of intercultural teams to take advantage of the poten- tial synergies of diverse groups in achieving corporate goals.

In connecting intercultural communication theory and international business concerns, this book presents a unique approach. It probes the reasons for cultural priorities and behavior and identifies the major applications in intercultural busi- ness communication tasks. In this process, it establishes a framework that will help readers ask the right questions and identify cultural issues so they can communi- cate effectively in new cultural settings.

This book is based on many years of research and experience living and work- ing in a variety of cultures. The many examples make the book particularly valu- able for anyone who wants to be an effective player in international business.

Notes 1. Bruce Einhorn, “Disney’s Mobbed Kingdom,” BusinessWeek Online,

February 6, 2006, Academic Search Premier database (retrieved April 25, 2006).

1. “Introduction to Disneyland Paris,” Frommer’s. www.frommers.com/ destinations/disneylandparis/0796010001.html (retrieved August 15, 2006).
2. Paul Wiseman, “Miscues Mar Opening of Hong Kong Disney,” USA Today, Section: Money, November 10, 2005, p. 5b, Academic Search Premier database (retrieved April 25, 2006).

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Contents in Brief 1. Culture and Communication 1

1. The Role of Language in Intercultural Business Communication 43
2. Getting to Know Another Culture 93
3. The Self and Groups 139
4. Organizing Messages to Other Cultures 173
5. Nonverbal Language in Intercultural Communication 217
6. Cultural Rules for Establishing Relationships 251
7. Information, Decisions, and Solutions 289
8. Intercultural Negotiation Teams 329
9. Legal and Governmental Considerations in Intercultural Business Communication 365
10. The Influence of Business Structures and Corporate Culture on Intercultural Business Communication 403
11. Intercultural Dynamics in the International Company 447

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Contents Preface to the Fifth Edition iv

About the Authors vii

Acknowledgments ix

Introduction x

Chapter 1 Culture and Communication 1

The Importance of Learning about Cultures 2

Making Sense of Our World 3 The World Is Becoming Increasingly Diverse 4 People around the World ARE Different 4 Preventing Mistakes 4 Responding to Different Cultures 6 Hostility to Difference 6 Curiosity about Difference 7 Denying Difference 7 Cooperating with Difference 8

Understanding Culture 9 Culture Is Coherent 10 Culture Is Learned 11 Culture Is the View of a Group of People 11 Culture Ranks What Is Important 12 Culture Furnishes Attitudes 13 Culture Dictates How to Behave 13 Onstage and Backstage Elements of Culture 14 Transactional Cultures 15 Adopting Another Culture’s Behavior 16 Self-Knowledge and Understanding One’s Own Culture 19 Cultural Intelligence 23

The Question of Change in Cultures 24 Are Cultures Merging into One Global Culture? 24 Ever-Changing Popular Taste 25 The Study of Communication across Cultures 26

Three Characteristics of the Discipline of Cross-cultural Communication 27 Study of the Communication of Groups versus the Study of Individuals’ Communication 27 Intercultural and Cross-cultural Communication Study 27 Two Broad Approaches to Communication Research in the Social Sciences 29 Study of Culture and Communication: Individuals or Cultures 34 Intercultural Business Communication 35 Perception and Communication 35 A Schemata Model for Intercultural Communication 36

Chapter 2 The Role of Language in Intercultural Business Communication 43

The Relationship between Language and Culture 44

Language as a Reflection of the Environment 46 Language as a Reflection of Values 46 The Meaning of Words 47 Changes in Language 48 Acronyms 51 Implications of the Language Barrier 51

Selection of the Right Language 52 Linguistic Considerations 52 Business Considerations 54 Political Considerations 56 The Appropriate Level of Fluency 56

The Company Language 58 Choosing a Company Language 58 Using Additional Foreign Language Expertise 63

The Role of the Interpreter 64 The Importance of Choosing a Good Interpreter 66 The Effective Use of an Interpreter—Some Guidelines 67

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Contents xxi

Communication with Nonnative Speakers 70 Effective Face-to-Face Communication 70 Effective Written Communication 73

The Impact of Technology on Oral and Written Communication 80

Some Guidelines for Communicating with Businesspeople from Different Cultures 86 Communication with a Multicultural Workforce 88

Chapter 3 Getting to Know Another Culture 93

Ways to Study Culture 94 Research Approaches to Studying Cultures 94 Studying Whole Cultures 94 Cultural Generalizations 95 Hofstede’s Research and Other Studies 96 The GLOBE Study 97 Studying Individuals 98 Culture as a Theoretical Construct 98 Generalizations and Stereotypes 99 High-context Communication and Low-context Communication 100 The Cultural Dimensions Approach in This Book 103 Where Can Information about Cultures Be Found? 104

Category 1: Thinking and Knowing 106 Does Knowing Come from Concepts or Experience? 106 Does Learning Come from Asking Questions or Mastering Received Wisdom? 107 Does Knowledge Have Limits? 108 How Do People Reason? 109

Category 2: Doing and Achieving 112 Is Doing Important or Is Being Important? 112 Are Tasks Done Sequentially or Simultaneously? 112 Do Results or Relationships Take Priority? 113 Is Uncertainty Avoided or Tolerated? 115 Is Luck an Essential Factor or an Irrelevance? 115 Are Rules to Be Followed or Bent? 118

Category 3: The Big Picture 118 Do Humans Dominate Nature or Does Nature Dominate Humans? 119

Are Divine Powers or Humans at the Center of Events? 120 How Is Time Understood, Measured, and Kept? 130 Is Change Positive or Negative? 132 Is Death the End of Life or Part of Life? 133

Chapter 4 The Self and Groups 139

Category 4: The Self and Self-identity 140 Self-identity—A Social Psychology Approach 141 Self-identity—A Communication Approach 141 Self-identity—A Critical Approach 141 Self-identity and Cultural Value Dimensions 142 Self-construal: Independent and Interdependent 142 The Basic Unit of Society: The Individual or the Collective? 143 Obligation and Indebtedness: Burdens or Benefits? 147 Age: Is Seniority Valued or Discounted? 150 Gender: Are Women Equals or Subordinates? 151

Category 5: Social Organization 156 Group Membership: Temporary or Permanent? 156 Form: Important or Untrustworthy? 161 Personal Matters: Private or Public? 163 Social Organizational Patterns: Horizontal or Hierarchical? 165 Approach to Authority: Direct or Mediated? 167

Conclusion 169

Chapter 5 Organizing Messages to Other Cultures 173

Review of the Communication Model 174 Meaning and the Communication Model 174 Why: The Purpose and Factors of Communication 176 Who in Business Communication 179 Where: Channels of Communication 179 When: Time and Timing of Communication 181

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Organizing Routine Messages 181 The Direct Plan 181 The Indirect Plan 182

Organizing Persuasive Messages and Argumentation 186

Argumentation and Logic 187 Persuasion Tactics 191

Organizing Unwelcome Messages 192 Communicating about Problems 192 Saying No 194

Organizing Problem-Solving Messages 195 Storytelling 195 Analogy 197 Syllogistic and Inductive Reasoning 198 Bargaining Discourse 199

The Role and Force of Words 199 The Relative Importance of Encoding Messages in Words 199 The Role of Words in Arabic Cultures 200 The Role of Words in Japanese Culture 202 The Role of Words in English-Speaking Cultures 203 The Effect of Language’s Structure 203

Channels of Business Messages 206 Internal Channels for Written Messages 206 External Channels for Written Messages 208 Structured Behavior Channels 209 Oral Channels 209

Communication Style 210 Formal or Informal: Hierarchical or Horizontal 210 Framed Messages 211

Chapter 6 Nonverbal Language in Intercultural Communication 217

Paralanguage 220 Vocal Qualifiers 220 Vocalization 220

Nonverbal Business Conventions in Face-to-Face Encounters 221

Eye Contact 221 Facial Expressions 223 Gestures 226 Timing in Spoken Exchanges 228

Touching 230 The Language of Space 234 Appearance 244 Silence 247

Chapter 7 Cultural Rules for Establishing Relationships 251

Respect for Authority and the Structuring of Messages 252

Signals of Respect 252 Positions of Authority 254 Dress as a Symbol of Authority 256

Power Distance and Symbols of Power and Authority 258

Tone and Behavior of Power and Authority 259 Language as an Indicator of Power and Authority 264 Family and Societal Structures as Indicators of Power 267

Assertiveness vs. Harmony 268 Standing Up for One’s Rights 268 Preserving Harmony 270

Recognition of Performance as a Signal of Authority 271

Monetary Recognition 271 Nonmonetary Rewards 272

The Role of Social Contacts in Intercultural Business 274

Conventions for Extending Invitations 274 Mixing Social Engagements and Business 276 Appropriate Behavior for Hosts and Guests 276 Gift Giving 278 Dealing with Controversy in Social Settings 280 Holiday Greetings 281

Ethical Considerations in Intercultural Engagements 282

Chapter 8 Information, Decisions, and Solutions 289

The Nature of Business Information 291 The Impact of Culture on What Constitutes Information 291 The Assessment of Information 291

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The Possession of Information 292 Formal and Informal Information 295 Soft vs. Hard Data 297 Criteria for Business Information 298

Sources of Business Information 299 Formal Sources 299 Informal Sources 300

Information and Knowledge Management 301 Decision Making 303

Making Decisions Based on Ends 304 Making Decisions Based on Means 305

Problem Solving and Conflict Resolution 308 Defining Problems and Dealing with Them 309 Managing Conflicts 310 Conflict Management Modes 312 Conflict Communication Modes 316 Communicating about Conflicts between Members of Different Cultures 320

Chapter 9 Intercultural Negotiation Teams 329

Intercultural Negotiation 331 What Really Happened with Canwall in China? 332 How Knowledge of Culture Can Help 334

Factors in the Negotiation Task 342 Expectations for Outcomes 343 Orientation of the Negotiating Team 345 The Physical Context of the Negotiation 349 Communication and Style of Negotiating 352

The Phases of Negotiation 356 The Development of a Relationship 356 Information Exchange about the Topic under Negotiation 357 Persuasion 358 Concession and Agreement 361

Chapter 10 Legal and Governmental Considerations in Intercultural Business Communication 365

Communication and Legal Messages 367 Specific Legal Systems 371

Code Law 371 Anglo-American Common Law 372 Islamic Law 373 Socialist Law 374

Dispute Settlement 375 Direct Confrontation and Arbitration 375 Communication with Agents 377 Trademarks and Intellectual Property 379

International Enterprise and the National Interests 381

Legal Issues in Labor and Management Communication 385

Labor Regulations 386 Employment Communication 386 Laws for Safety on the Job 388 Equal Opportunity 390

Legal Considerations in Marketing Communication 391

Investment Attitudes and the Communication of Financial Information 394

Chapter 11 The Influence of Business Structures and Corporate Culture on Intercultural Business Communication 403

Corporate Culture and Intercultural Communication 405

Stages in Internationalization 409 The Import–Export Stage 410

Reasons for Exporting 410 Communication in the Import–Export Environment 412

The Multinational Corporation 415 The National Subsidiary 415 The International Division 417

The Global Firm 426 The Structure of a Global Firm 426 Communication in a Global Organization 427

Implications of Cultural Aspects of Business Structures for Communication in an International Firm 433

Communication in an Organization Based on Credentials 433 Communication in an Organization Based on Context 435

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Communication in an Organization Based on Family Orientation 438 Communication in an Organization Based on Political Principles 440

Chapter 12 Intercultural Dynamics in the International Company 447

Cultural Issues in the DaimlerChrysler Merger 450

Preparation and Training 451 Attitudes toward Management 452 Attitudes toward Compensation 453 Regulatory Issues 454 Reports on the Merger 455

Intercultural Business Communication as a Strategic Tool for Success 458

The Process of Intercultural Business Communication 458 Dynamics of Culturally Diverse Teams 463

Culture in the Context of Corporate Strategy 471 When Teams Are Not Effective 476

Try to Adapt to Each Other’s Expectations 476 Specific Abilities that Make up Teamwork CQ 476 Subdivide the Team and Tasks 480 Have a Manager Intervene 480 Remove Member(s) or Disband the Team 481

Applying Your Cultural Knowledge to Business Situations 481

Appendix Case 1: What Else Can Go Wrong? 485 Questions for Discussion 488 Case 2: Hana, a Joint Venture Between Health Snacks and Toka Foods 488 Questions for Discussion 494

Index 494

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1

C H A P T E R O N E

Culture and Communication Martin Walpert is the president of a family-owned business called Walpert Industries Ltd. in Montreal, Canada, that produces Christmas crackers. The company, located in French Canada, is one of the world’s top five suppliers of the product (mainly to consumers in English-speaking countries), and exports two-thirds of its output to the United States. Walpert estimates that the international market for crackers is about $150 million, with the majority sold in Great Britain.

Crackers are paper tubes with small trinkets inside. When the twisted ends of the cracker are pulled, it pops or “cracks,” causing the contents to spill out. Crackers are a tra- dition dating from Victorian England, and they are still very popular in England and in the countries Britain dominated in the 19th century.

The story of British crackers begins with an English confectioner in France, who saw Parisians selling paper twists of candy and brought the idea back to England. Instead of us- ing candy, he filled his twists with little novelties and romantic verses. The result was a 19th-century success story of intercultural adaptation, because crackers became a tradition among British Christmas revelers. Today, crackers often have jokes instead of poems, a funny paper hat to wear at dinner, and prizes ranging from gimmicks and noisemakers to small watches. (In J. K. Rowling’s book, Harry Potter and the Sorcerer’s Stone, for instance, Harry Potter pulled crackers that emitted a loud explosion and produced mice and admirals’ hats.) Crackers are colorful—usually red, green, and gold—and are typically laid alongside place settings at Christmas dinners or hung on Christmas trees.

Like many companies today, product manufacture at Walpert Industries Ltd. spans sev- eral countries. While its home office is in Canada, its crackers are manufactured in China, where in 1997 the company invested in a plant outside Beijing. Locating in China has given Walpert a competitive edge because labor costs are lower there than in Canada. However, due to the transnational nature of his company’s production, Martin Walpert was soon to learn a valuable lesson regarding the role of culture in business.1

In December 2002, when some Canadian families opened their Christmas crackers made by Walpert, they had an unpleasant surprise. They discovered tiny plastic panda bears wearing military-style caps with a swastika on them. Some were saluting.

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Martin Walpert is well aware that the swastika is the symbol used by the German Nazi party in the mid 20th century, and represents the horrors the Nazis perpetrated against Jews and other groups in World War II. A swastika was the last thing he wanted in his Christmas crackers. He wondered if he was the victim of a deliberate attempt to sabotage the company’s business.

After receiving complaints and seeing newspaper articles about the swastika-wearing pandas, Martin Walpert launched an investigation. He already knew that in China panda bears are a cute, positive symbol appropriate for a holiday, especially a holiday for children. Furthermore, he knew that when Walpert Industries in Montreal approved the design of the red, green, and gold crackers, the panda bears did not wear swastikas. The swastikas, Walpert concluded, had been added by someone in China. But why?

Through his investigation, Walpert learned that the swastika, so negative in European cultures today, is a very old and positive Buddhist symbol of prosperity in Eastern cultures. In fact, the swastika has been used by many ancient cultures all over the world. In Greece, it is known as the G cross (crux gammata), because the Greek letter gamma, which looks like an upside-down L, appears as the four arms of the symbol. In Hindu culture, the swastika is associated with the god Ganesh.

Celts, Romans, and ancient Germanic peoples also used the swastika. In the early 20th century, English-speaking people believed it to be a good luck symbol, and the four L arms stood for luck, light, love, and life. The swastika also has been found in central Asia, as well as in Mayan and southwestern U.S. native cultures. The unauthorized ad- dition of the swastika to the panda bears in the Christmas crackers was well-intentioned, not sabotage.

However, Martin Walpert’s customers primarily saw the meaning of the swastika as negative, and his company has made sure that no more swastikas appear on its products.

The Importance of Learning about Cultures Why learn about foreign cultures when you are doing business internationally? Because understanding others’ cultures is important to success.

Understanding foreign cultures is not only important for companies that oper- ate in more than one global area and market internationally. It is just as important for organizations at home that employ workers from more than one culture. Work- places are increasingly multicultural around the world as employees are recruited globally. In the workplace, companies need to understand the cultural basis of behavior for everyone, and culture’s role in the way people make meaning.

Understanding culture is also important for individuals who work in the global workplace. Often culture comes to our attention when something goes wrong at work. Something we feel is important seems to be overlooked or set aside. Or perhaps we know a little bit about another culture, but what we know makes us puzzled. We may hear people speak or see their actions and not comprehend it.

The two important reasons for understanding culture are to learn how others make sense of their environment, and to prevent mistakes and miscommunication.

2 Chapter 1

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Making Sense of Our World An example of the challenge of making sense of our world occurred when Disney opened a theme park in Hong Kong that many visitors from China went to experience. In Hong Kong, children watch TV programs made by Disney, the American entertainment giant. For many years, Hong Kong children have grown up with these cartoon characters in their stories. Many characters are animals who act like humans—Donald Duck, Bugs Bunny, Mickey Mouse—and other charac- ters come from children’s stories and folklore, like Aladdin. But the people in mainland China were not familiar with the characters. The cartoon characters had not been on their TVs. They wandered around Hong Kong Disneyland unable to make sense of it. When they encountered people in the costumes of Disney characters, they were baffled.

A similar experience awaits visitors from Europe or North America who go to Dubai and visit the Ibn Battuta shopping mall. The largest themed mall in the world, it has six sectors, each representing a region Ibn Battuta visited in his unparalleled world travels: Andalusia, Tunisia, Egypt, Persia, India, and China. If you don’t know who Ibn Battuta is, however, the costumed host who greets you will baffle you, or have no meaning. To make sense of the theme of the Dubai shopping mall, you need to know something about the culture.

Culture and Communication 3

Ibn Battuta, a young Islamic law scholar, was curious to travel and learn about the world. Shortly after his 21st birth- day in 1325, he set out on a journey to Mecca, on the Muslim pilgrimage called the hajj. He returned to his home in Tangiers, Morocco, 24 years later, after traveling through almost the whole of the Islamic world. He still wasn’t finished, though. He made further journeys, only coming back to Morocco for good in 1354. He has been called “the world’s greatest pre-modern traveler.”2

Like many young adults, Ibn Battuta wanted to experience the world. However, unlike most students today, he traveled more than 75,000 miles, acquired a number of wives on the way, had narrow escapes from death and impris- onment, and served many of the 14th century’s most important rulers.

Fortunately, he dictated his travels to a scholar named Ibn Juzayy, at the court of the Sultan of Morocco. The resulting book, Rihla (the Journey), tells how Ibn Battuta first went to Mecca through North Africa and Egypt, then to Syria and Palestine. His next journey was to Iraq and Mesopotamia, then back to Mecca again. Then he traveled to Yemen, Aden, Mombasa (in east Africa), Kulwa, Oman, Hormuz, Bahrain, and back to Mecca for his third hajj. His fourth itinerary was to have been to India, but instead he revisited Egypt and the Middle East, then modern Turkey, the Black Sea, and the southern Ukraine to Constantinople. Then he turned east and eventually crossed the Hindu Kush mountains into Afghanistan, Pakistan, and India. He next made a roundabout journey from Delhi to China, passing twice through the Maldives Islands in the Indian Ocean, and finally reaching Canton (southern China) via Sumatra (Indonesia), Malaya, and Cambodia. His long journey back from China took him to India, and then to Muscat (Oman), then through Iran, Iraq, Syria, Palestine, and Egypt, to Mecca again for his seventh and final hajj.

I n F o c u s

(continued)

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Even if you haven’t traveled to other countries, you may have met or observed people from other cultures and felt baffled. You may have been unable to figure out what their behavior meant or what meaning lay behind their symbols. If you haven’t yet met people from other cultures in your work, you will. When you do, you will want to understand them. This is why we study culture. Culture explains how people make sense of their world.

The World Is Becoming Increasingly Diverse All over the world, nations are experiencing more and more people from other cul- tures coming into their countries. Some people give newcomers a warm welcome. Some are less warm, but allow foreigners to thrive. Some reject those who come from a different culture. Tourism is expanding, migration is increasing, and people are mov- ing in large numbers. Some governments (for example, Australia and the Netherlands) are proposing to manage immigration by having newcomers take tests to see how likely they are to fit into those nations. Other countries (Canada, for example) are trying to develop government policies to help immigrants keep their own cultures.

The United States has a long history of offering a home to people from many other countries. But in spite of its ideals of equality and tolerance, some people in the United States argue against allowing immigrants to keep their own language— in school, for instance. They say recognizing difference actually separates people, rather than enables people to tolerate others who are unlike them.

Because people from different cultures get jobs all over the world, you will experience cultural difference when you go to another country. At the same time, if you stay home, you will likely be working with people from other places and cul- tures. In order to do your job, you will need to make sense of other people’s cultures.

People around the World ARE Different People from different cultures really are different (as well as similar) in how they see the world. Cultures are the amazing products of human imagination, and that is a reason to celebrate differences. We people of this earth have created many interesting cultures throughout human history. They are a source of delight and wonder. The variety of cultures expresses what it means to be a human being.

Preventing Mistakes The Walpert case that opened this chapter is one example of how a lack of cultural understanding can create problems for businesses. It also shows that cultural mis- takes can be unconscious or unintentional, but damaging nevertheless.

4 Chapter 1

When he arrived back in Tangier, he learned his mother had passed away in the Black Death pandemic. His father had died earlier. He decided to travel again, this time to Andalusia, the part of southern Spain under Muslim rule, and his final journey was by camel train across the Sahara to Niger and Timbuktu in central Africa.

Ibn Battuta described for Ibn Juzayy his culture shock, his impressions of the local scene, the people he met, and the ways of life he experienced. You can read more about him3 and also watch trailers for the BBC television series about Ibn Battuta on YouTube.

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Documented cultural mistakes in international business are easy to find on the Internet. The blunders-and-bloops literature is full of instances in which the error was fatal and the deal came apart, as well as instances in which the error was laughable. Many cases have led to a loss of business. The failures usually result because someone didn’t understand the reasons why people think as they do and value what they do.

Today, businesses are looking for markets, suppliers, associates, partners, sub- sidiaries, joint-venture partners, customers, employees, and a favorable image in more than one country. Successful businesspeople must be able to communicate interculturally both at home and abroad.

Donald Hastings, chairman emeritus of Lincoln Electric, attributed many of his company’s mistakes abroad to the attitude that since the company’s practices were successful in the United States, they certainly would succeed in other countries.

Culture and Communication 5

Donald Hastings had been chairman of Lincoln Electric, a leading manufacturer of arc-welding products, for only 24 minutes on the July day when he first learned the company was suffering huge losses in Europe. The losses meant the company might not be able to pay U.S. employees their expected annual bonuses. Since the bonus system was a key component of the manufacturer’s success, with bonuses making up about half the U.S. employees’ annual salary, this was a much more significant threat than simply a disappointing performance by the company. For the first time in its 75-year history, it looked like Lincoln would have to report a consolidated loss.

Lincoln Electric, based in Cleveland, Ohio, had expanded hugely, spending about $325 million to acquire foreign companies. But according to Hastings, lack of knowledge about the cultures of the acquired companies, and the cul- tures of the countries where they operated, was a critical factor in the company’s financial nosedive.

First, the company didn’t realize that a bonus system was not an incentive to European workers, who were hostile to the idea of competing with co-workers for their annual pay. Their pay scales were negotiated by labor leaders. The idea that some workers, based on individual performance, might earn more or less than the agreed income was un- acceptable to European workers.

Second, Lincoln Electric learned that products not made in a European country would not be able to penetrate a European market that easily because of a cultural loyalty to domestically produced goods.

A third problem was that executives of the recently acquired European companies wanted to deal only with Lincoln’s top executives, not with lower-level people sent over from Ohio. This status issue arose primarily in Germany, from the cultural characteristic of hierarchy in German culture.

A fourth cultural issue was that workers in Germany, France, and other European countries typically have a month of vacation in the summer, and so production gears down during that slow time. Lincoln wasn’t used to that in its U.S. operation.

A fifth and fundamental problem was that nobody in the executive ranks at Lincoln had had international experi- ence or had lived abroad. The Chief Executive Officer didn’t even have a passport, and a last-minute panic occurred when the company scrambled to get one for him for an urgent trip to Europe. Finally, Hastings realized that he could not hope to bring Lincoln back to profitability without moving to Europe, where he could be at hand to deal with prob- lems immediately, while learning what he and the other executives needed to know about that culture.

I n F o c u s

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The U.S. workers of Lincoln Electric, who had been fully informed of the com- pany’s negative financial situation in Europe, rallied to help the company. Their enormous efforts paid off. At the same time, the chairman and executives painfully learned the lessons of culture they needed to know to operate overseas.4

Most businesspeople want to act appropriately and avoid offending their counterparts in foreign countries. They want to know what people in other cultures value, if only for the sake of making a sale. One researcher suggests that McDonald’s is successful in 118 countries because it practices a localized approach. McDonald’s succeeds because it offers what local people want.5 That means being sensitive to the cultural needs of the immediate market.

Responding to Different Cultures When members of different cultures find themselves face to face, a number of responses are possible. History shows that one response is to clash and struggle for dominance of one set of values over another. History also shows conflict is not the only result.

Contact and communication between people from different cultures is as old as human existence on earth. Consider, for example, the life of Moses (Musa in Arabic). Moses was born about 1228 B.C.E. when his mother, an Israelite, was a slave in a foreign country, Egypt. Her son was adopted into the family of the ruler, the Pharaoh. Thus, Moses was raised in two cultures. He married a woman from yet another culture, the culture of Midian, where he lived for eight to ten years. (Midian today is variously identified as southern Jordan or Ethiopia or northwest Saudi Arabia. In any case, the Midian culture was a different culture from either the culture of the Israelites or the culture of the Egyptians.)

According to some accounts, when Moses led the Jews out of Egypt, he and the children of Israel encountered Amalekites, Canaanites, Edomites, Ammonites, Moabites, and Midianites. Reports tell how Moses’people interacted with the people of these different cultures. Some encounters were in battle (Amalekites, Canaanites), some were in making efforts to avoid hostility (Edomites, Ammonites, Moabites at first), and some encounters involved sexual seduction by women (Midianites, whom the Israelites later slaughtered). The responses ranged from hostility to cooperation to close personal relationships.

Thus, the life of one person who lived long ago shows us that encounters with people from different cultures are not new, and neither are the various responses to difference. They have been going on even longer than records tell.

Hostility to Difference Hostile responses to immigrants show up in the histories of many countries. Immigrants speak languages that may be unrelated to the host culture’s languages; they may write in systems the hosts cannot decipher; they often have worldviews that have been developed without reference to the host culture. It is sometimes a shock to realize that far from wanting to become part of the dominant culture, some immigrants reject it out of fear they will lose their own culture. Immigration stories from every continent include experiences of hostility.

6 Chapter 1

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In the past few years, hostility toward immigrant groups has made the news in France, Belgium, Germany, Spain, and Italy, along with countries in the Middle East, Asia, and all the nations of the “new world.”

In companies, too, people of one culture may experience hostility from people of another culture. But hostility is by no means the only inevitable response to members of other cultures.

Curiosity about Difference Ibn Battuta was curious to experience other cultures. Seven hundred years later, people all over the world are still curious about people from other cultures. The Internet and sites like Facebook and YouTube bring us more closely together than ever before on a larger-than-ever stage. An open, respectful interest in learning about another culture motivates many people to connect around the globe and at work with members of other cultures.

In addition to satisfying one’s curiosity, another reason to learn about a culture is to establish connections with people who think differently. Close personal relationships can endure between people from different cultures, to the mutual enrichment of both. Along with the connection may be a wish to compute the meanings of things by using a different mental operating environment and running different mental software. To connect with someone who is different is to affirm something that is importantly human.

Denying Difference In some cultures, showing curiosity about difference is not good manners. Furthermore, some argue that emphasizing difference separates people, and does not help us get along with each other. They support a denial of difference, whether out of a misguided but well-meaning wish to avoid conflict, or out of fear and lack of skills for finding out about difference. Denial of difference is the opposite of curiosity.

The productive way to respond to cultural difference is not to deny it exists, but to learn about difference and how to communicate about it.

Assumptions of Superiority

A common human response to differences in cultures is “Of course they’re differ- ent, but we’re better. If they really knew our culture, they’d prefer to be one of us.”

English-speaking cultures encode this assumption of superiority by using words such as backward and primitive to criticize those whose cultures are differ- ent. Other languages have their own terms for the same thing. Of course, such eval- uations are one cultural view, not an absolute assessment. They really say more about the person holding the opinion than about the persons being criticized.

For instance, the Japanese think of outsiders as barbarians; the Chinese call their country the Middle Kingdom and for centuries considered only Chinese to be “cooked” and all outsiders to be “raw” (uncivilized, because not familiar with the Chinese culture). Your culture has its terms for outsiders, and its attitudes—not

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always acknowledged—about the superiority of your culture. All groups tend to look at their own culture as superior, and others as inferior.

Ethnocentrism

“The Germans live in Germany, the Romans live in Rome, the Turks live in Turkey, but the English live at home.”6

You generally can depend on this: Members of other cultures, deep down in their heart of hearts, are convinced their own culture is the normal one. People everywhere tend to assume their own culture has got things right, and they tend to assess all other cultures by how closely they resemble their own.

The self-reference criterion is an important concept that explains this behavior. Through the self-reference criterion, people tend to evaluate everything they see and experience on the basis of their own background and then act on their evalu- ations accordingly.7 People in all cultures use this self-reference criterion in con- sidering other cultures. It’s a kind of mental comparison that goes on consciously and unconsciously.

Those with little experience of other cultures are especially inclined to be- lieve that their own culture (ethnicity) is normative and at the center of human experience—hence ethnocentrism. The further from our own another culture is, the more it seems to belong on the fringe, to be peripheral and not normal. Con- versely, the closer to our own culture another culture is, the truer it seems to be. Along with a preference for cultures that are similar to our own is the view that difference is dangerous. It threatens the norm. It’s only a small step from there to viewing difference as dismissible, or even wrong.

For this reason, ethnocentrism can lead to a complacency about one’s own culture, a lack of interest in understanding another culture, and actual discrimina- tion against people of other cultures.

Assumptions of Universality

One of the comments people often hear from travelers to foreign countries is, “They may talk (dress, eat) differently, but underneath they’re just like us.” This notion is profoundly incorrect. People underneath are not alike. Culture is the whole view of the universe from which people assess the meaning of life and their appropriate response to it, and those views are not the same. Let’s put this another way: People begin with different operating environments and run different soft- ware. They have different databases and process information differently, with different goals for their information processing. They arrive at different results.

To pretend we are all alike, or should be, can lead to miscommunication or failed communication. The future of businesses and indeed of the world may well depend upon people who think differently acting together.

Cooperating with Difference Cultural differences don’t prevent us from working together. We can communicate and have productive business relationships even though we are different. Indeed, we must work together.

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Geert Hofstede, the Dutch researcher who laid the foundation for cross-cultural studies, advises: “The principle of surviving in a multicultural world is that one does not need to think, feel, and act in the same way in order to agree on practical issues and to cooperate.”8

We can agree to be different and to celebrate diversity. The more we know about other cultures, the more we will know about our own. Then we can begin to explain why people from different cultures behave the way they do in business situations. Their behavior will differ even if their workplace is in the same culture.

When connections form between people from different cultures, similarities appear. Together we weave a fabric of cooperation, in which we see common threads. It is a source of delight to realize someone from a different culture has the same idea as you. It is very satisfying to connect in friendship and cooperation with someone who has a different culture but similar goals.

We don’t have to become like people from other cultures. We don’t have to adopt their customs. We don’t even have to like them. But we do have to learn about what makes sense in their culture, and how to communicate effectively with them.

Three things are necessary in order to minimize and prevent mistakes across cultures. Knowledge about one’s own culture is the first step. With this, knowledge about another culture is easier to learn. The second requirement is motivation— the drive to know and to use the knowledge. The third step is implementing knowl- edge, and behaving in a way that makes sense in the other culture, the one in which you want to do business.

Understanding Culture Culture is difficult to define because it is a large and inclusive concept. Over 500 definitions of culture exist. Some are not helpful, because they are too general, such as “everything you need to know in life to get along in a society.” Culture involves learned and shared behaviors, values, and material objects. It also encompasses what people create to express values, attitudes, and norms of behavior.

Culture is largely undiscussed by the members who share it. E. T. Hall wrote:

Culture [is] those deep, common, unstated experiences which members of a given culture share, which they communicate without knowing, and which form the backdrop against which all other events are judged.9

Culture is like the water that fish swim in—a reality that is taken for granted and rarely examined. It is in the air we breathe and is as necessary to our under- standing of who we are as air is to our physical life. Culture is the property of a community of people, not simply a set of characteristics of individuals. Societies are shaped by culture, and that shaping comes from similar life experiences and similar interpretations of what those experiences mean.

If culture is mental software, it is also a mental map of reality. It tells us from early childhood what matters, what to prefer, what to avoid, and what to do. Culture

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also tells us what ought to be.10 It gives us assumptions about the ideal beyond what individuals may experience. It helps us in setting priorities. It establishes codes for behavior and provides justification and legitimization for that behavior.

In order to understand another culture, you need to understand your own. Cul- ture determines business practices, for instance. Business practices are not neutral or value-free. Neither are communication practices. You need to understand the cultural values you transmit when you interact with someone from another culture, as well as understand the other person’s cultural values. You also need to recognize the likelihood that there will be gaps in your comprehension, and holes instead of connections, in your interaction.

From among the many definitions of culture, here is the definition this book will use.

Culture is the coherent, learned, shared view of a group of people about life’s concerns, expressed in symbols and activities, that ranks what is important, furnishes attitudes about what things are appropriate, and dictates behavior.

This definition merits a closer examination. First, it contains three characteris- tics of culture—coherent, learned, and shared—and then it outlines three things that culture does.

Culture Is Coherent Each culture, past or present, is coherent and complete within itself—an entire view of the universe. A pioneer researcher into the study of cultures, Edward Tylor, said in 1871 that culture is:

. . . the outward expression of a unifying and consistent vision brought by a partic- ular community to its confrontation with such core issues as the origins of the cosmos, the harsh unpredictability of the natural environment, the nature of society and humankind’s place in the order of things.11

The fact that different groups of human beings at different times in history could develop different visions is a cause for wonder. Often, as we shall see, dif- ferent cultures develop different behaviors but have similar visions. The incredi- ble variety of cultures fascinates historians, anthropologists, travelers, and nearly everybody else. It makes all our lives richer when we glimpse, and even claim, a bit of this treasure of human achievement.

Regardless of how peculiar a fragment or single thread of a culture seems, when it is placed within the whole tapestry of the culture, it makes sense.

The completeness of cultures also means that members looking out from their own seamless view of the universe probably do not see anything lacking in their unifying and consistent vision. This is the source of ethnocentrism.

Here is a hypothetical case to illustrate the coherence of culture. Let’s imagine that a boat full of south-coast Chinese sets sail for San Francisco, which has been known as “Old Gold Mountain” in China from the 19th century, a place where im- migrants can acquire gold. But a storm blows the boat off course and wrecks the navigation instruments. Eventually the Chinese make landfall off the coast of

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Mexico, although they don’t know where they are. It is the last week of October, much later than their intended arrival in San Francisco. They wearily go ashore to the nearest town. To their horror and dismay, in every store window and every home’s doorway are images of skeletons, skulls, and graves. In China, death is not mentioned, let alone broadcast by images everywhere. “What sort of people live here?” they ask each other.

The Chinese voyagers have arrived in Mexico at the time of el Dia de los Muer- tos, the Day of the Dead. It is a fiesta with deep meaning for Mexican families. It emphasizes family ties that reach beyond the grave, as departed family members are remembered and brought to join the living family through a celebration. The skulls and skeletons in the windows are made of candy and bread, and are meant to be eaten, to show how unimportant death is, and how the people are not afraid of death as the end of family relationships.

In fact, the Chinese traditionally hold a celebration with a similar objective, called Qing Ming, on the fifth day of the fourth month, or April 5. They too visit the graves of departed family members to reaffirm their family union in spite of death. If the Chinese were able to learn why Mexicans display skulls and skeletons everywhere, they would understand the Mexicans’attitudes toward death symbols. But if they were to see only the cultural fragment—a bit of behavior—they would regard it as bizarre, unnatural, and odious.

Culture Is Learned Culture is not something we are born with; rather, it is learned. Much of what is learned about one’s own culture is stored in mental categories that are recalled only when they are challenged by something different. We all have to be taught our culture. The process begins immediately after birth—and perhaps even earlier, according to some.

If culture is learned, it is also learnable. That means nobody has to remain for a lifetime locked inside only one culture. If you want to understand other cultures, you can learn them—not just learn about them but actually get inside them and act according to what is expected. Many people have learned more than one culture and can move comfortably within and among them. When circumstances dictate, they make the transition from one culture to another easily. Businesses don’t have to ac- cept failure in another culture simply because they do not have an employee who grew up in that culture.

This book is about how to learn other cultures. We believe it is not only possi- ble to do so but also interesting, rewarding, and necessary.

Culture Is the View of a Group of People A culture is shared by a society. Members of the society agree about the meanings of things and about the why. Along with everyone from whom they have learned their culture—family, teachers, spiritual leaders, peers, and legal, political, and educational institutions—they have interpreted life experiences in ways that validate their own culture’s views. They agree about what the important things are—the things that truly merit respect. They agree without having to talk about it.

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Societies are motivated by common views, which are a dynamic force enabling them to achieve goals such as protecting economic resources and developing alliances.

People in a culture share symbols of that culture. The most obvious set of symbols is language. Much more will be said about the role of language (in Chapter 2) and communication (later in this chapter). Visual symbols such as company logos, icons, religious images, and national flags form the visual vocabulary of a culture.

Thus, the three characteristics of culture are that it is coherent, learned, and shared. Now we’ll look at three things culture does.

Culture Ranks What Is Important Cultures rank what is important. In other words, cultures teach values or priorities.

What is of paramount importance to one group may be virtually meaningless to another. For instance, consider the amassing of wealth. In one Pacific Island culture, the Guru rumba of Papua New Guinea, a rich man is required to expend all the fortune he has spent long years accumulating—in this case, pigs—in the lavish entertainment of the members of his society. Being able to entertain this way is the real meaning of wealth, because it means that the giver is owed and there- fore has great prestige. Try to explain that to a businessperson in the United States or Hong Kong or Italy who has spent his or her life amassing monetary wealth! Usually in these cultures, resources are saved and increased, not depleted in one big blowout. To be sure, businesspeople in these cultures often make generous charitable and philanthropic donations, but their cultures teach them to value per- sonal wealth as something to cultivate, like a garden, and make it grow.

The term values crops up frequently in books about intercultural business, as does the term attitude. What is the difference? Values are standards we use to judge what is important. Values are mental constructs that underlie specific attitudes and that determine attitudes as well as behavior. They enable us to evaluate what mat- ters to us or apply standards to our attitudes and behaviors. People go to war over values and conduct business by values.

Because values tell us how to weigh the worth of something, they indicate a relative hierarchy. We can talk about values as cultural priorities. Within a cul- ture, values may be of greater or lesser importance. For example, a culture may

12 Chapter 1

A story is told of the Sultan of Brunei, one of the world’s wealthiest men, who was shopping in a department store in Manhattan. When he made a purchase, he was asked for identification. However, he carried no identification. “I’m the Sultan of Brunei,” he stated. The salesperson insisted that he had to show identification. A quick-thinking aide to the sultan darted forward, put his hand in his pocket, and pulled out a bill in the currency of Brunei. All the money in Brunei has the Sultan’s picture on it. What values in the Brunei culture does this story suggest?

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put a high value on honesty and a low value on making only a minimal effort. Values or priorities vary from culture to culture: Progress reports about the de- livery of a component may be of great value to a Dutch firm associated with a business in Japan but of little value to a Japanese firm awaiting the delivery of a component from Holland.

Culture Furnishes Attitudes Attitudes are learned tendencies to respond to phenomena (events, people, expe- riences) in a consistent way. Attitudes are feelings, positive or negative, about something, based on values. Attitudes can change, although changing some atti- tudes can be difficult. You can have an attitude toward eating raw fish, for exam- ple, that is positive and is based on the belief that expert preparation of sushi and sashimi by Japanese chefs results in culinary delicacies. Or you may have an atti- tude that is negative, based on the belief that raw fish can contain parasites that cause unpleasant consequences in the human digestive system. You can even hold both attitudes at the same time. If you do, you probably value both fine eating ex- periences and physical health.

Attitudes are based on beliefs as well as on values. Beliefs are convictions or certainties that come from subjective and often personal ideas rather than on proof or fact. Belief systems, or religions, are powerful sources of values and attitudes in cultures. We will look at religions in more detail in Chapter 3.

Attitudes vary according to how important something is (its value). In Mexican culture, when an aunt dies, the family expects that business associates understand the family has suffered a significant event. A boss is expected to have an under- standing attitude toward an employee who is unable to get a report done by the dead- line because of the funeral and family needs. In Britain, the attitude toward a business associate’s loss of an aunt is that this is a private affair, regrettable and per- haps very sad, but something that may not affect the relative’s ability to get a report done by the deadline. In fact, for a businessperson in the UK, handling the situation well means keeping it from having an impact on work.

Culture Dictates How to Behave Behavior refers to actions. To continue the example in the previous discussion, a brief expression of sympathy by a businessperson to a bereaved work associate is appropri- ate British behavior. Co-workers may send a card, if they have worked together for a time. In Mexico, in contrast, much more than an expression of sympathy is appropriate behavior. Business associates may attend the funeral, send flowers, offer services such as transporting family members, and visit the family’s home to show respect.

Behavior comes directly from attitudes about how significant something is—how it is valued. Values drive actions. We’re back at the point made earlier: Cultural priorities motivate business behavior.

In intercultural interactions, cultural differences usually make themselves known first by behavior, which is related to attitudes and which springs from values in the culture.

Table 1.1 illustrates briefly how values, attitudes, and behaviors are related.

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The Japanese employee with a hangover illustrates the value of group member- ship: The employee goes out drinking with co-workers and expects his boss to be sympathetic to his family problems. Another value is hierarchy: The boss is in the position of parent or counselor, one who has the ability to forgive a missed deadline. An attitude is the way the employee views his own situation regarding the missed deadline and his hangover: It couldn’t be helped because he is struggling with prob- lems at home, and his excessive drinking is excusable (another attitude) because he has these problems. A behavior is drinking until late at night with co-workers.

Onstage and Backstage Elements of Culture Onstage culture is the behavior we display. It is what people who are in contact with one another find easiest to observe and discuss. Onstage culture involves actions such as shaking hands, bowing, or kissing upon meeting. It includes

14 Chapter 1

A Japanese employee in Tokyo has not written a report that’s due to his boss. The deadline has arrived. The situation is that problems at home with his wife have encouraged him to spend his evenings drinking with fellow employees and going home very late. The result is a raging hangover that makes him unable to concentrate on writing the report. He goes to his boss and explains all this. For the Japanese worker, neither the excessive drinking nor the domestic prob- lem is a source of shame, and his expectation is that the superior’s attitude will be acceptance and a paternalistic concern for the employee’s plight. The superior’s behavior is probably to counsel the employee and inquire into the domestic situation in subsequent weeks.12

When this scenario is presented to businesspeople in the United States, however, their reaction is that an employee who explained that he had failed to complete a report because of a hangover from excessive drinking (whether or not it was to escape domestic problems) probably would be in double trouble with his superior. He would be criticized for drinking too much, and for not completing the report on time.

In the United States, the superior’s behavior would probably be to tell the employee to get a grip on himself and seek some help, or else expect unpleasant consequences. The employee in the United States may be just as debili- tated by a hangover as his Japanese counterpart, but he will offer some other reason for not being able to get the report done. He may stay home, telling the boss he’s ill.

I n F o c u s

Value Attitude Behavior

Honesty Telling lies is wrong. Lying Family Family events come first. Choosing to attend a family

party rather than go out with friends

TABLE 1.1 Relationship of Values, Attitudes, and Behavior

Status High status means one has better control over events and people.

Dressing expensively to show high status

Achievement Achievement deserves praise. Giving recognition for an accomplishment

Harmony Dissent causes disruption in groups.

Refraining from disagreeing

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traditional ways of celebrating with food and dances, costumes and music. When people are asked to describe another culture, they often refer to onstage behavior.

By contrast, backstage culture is not so visible. Backstage culture is values. Backstage culture underlies what others see onstage. The actors themselves are not always aware that their onstage behavior is culturally driven; they think their back- stage culture is simply normal. Backstage cultural aspects include the ways peo- ple make decisions, respond to deadlines, accomplish tasks, rank events by importance, and conceptualize knowledge. If you can explain backstage behavior, you understand the why of culture.

In Japan, a foreign observer can see young people who dress like young people in the United States or Western Europe, listen to the same music, and go to the same new cinema releases. Onstage images are virtually interchangeable. The backstage cultures of Japan, the United States, and Western Europe, however, are very different. A foreign observer can misattribute reasons for onstage behavior, thinking the reasons are the same in different cultures because the observable be- haviors look the same.

The why is the essence of a people’s culture. If you understand why people value some things, you can make good guesses about why they value other things. If you understand why they behave a certain way, you can interpret other behavior with some degree of accuracy. Once you have insight into what people think is impor- tant and how they behave, you can do business with them. You know what makes them the way they are.

Transactional Cultures What happens onstage when members of different cultures interact? What do we see? Does each person act out a script for behavior that is from his or her culture?

Sometimes this is exactly what happens. A person initiates an exchange that is based on expectations that come from his or her backstage culture. The following provides an example.

A businessperson from Saudi Arabia, who wants to show willingness to get to know a businessperson from England, stands close during a conversation. The English person politely maintains a distance to show respect for the Saudi. A kind of dance results in which the conversing pair move across a room. The English per- son backs up and the Saudi moves forward.

In another example, at an initial meeting a Mexican businessman holds out his hand to shake a Japanese businessman’s hand, while the Japanese simultaneously attempts to bow toward the Mexican. We can see that each is following a script from his own culture.

But keep watching the stage. What we are likely to see next is that the Japanese quickly holds out his hand, while the Mexican attempts a bow. What happens on- stage when members of different cultures interact may be different from their usual behavior in their own cultures. The new behavior may be temporary, compared with their enduring backstage cultures.

Consider, for example, the experience of several Western businesspeople who had taken seminars to prepare them for negotiating business deals in Saudi Ara- bia. As they sat down at the negotiating table, they heard the Saudi executive say,

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“We can do business either the Western way or the Arab way. What’s your choice?”13 The Saudi was talking about onstage cultural adaptation, or in other words, creating a transactional culture.

A transactional culture exists when interactants respond to cultural cues and modify their own behavior, creating—or co-creating—a new, temporary cul- ture. In this transactional culture, the participants can perform behaviors and act upon attitudes that are shaped primarily by the interaction. The context of the interaction becomes more important for molding actions than the individu- als’ cultural backgrounds. Transactional culture exists when interactants are sensitive to, and knowledgeable about, another culture, and adjust their behav- ior. The amount of adjusted behavior depends on several factors, including their level of knowledge about the other culture, their willingness to experiment with new behaviors and attitudes, and their previous experience with successful intercultural interactions.

For instance, a Canadian businessman may put his hands together at the palms, fingers up, to give a wai greeting to a Thai businessman, although the Canadian would not wai to a fellow Canadian. A Taiwanese businesswoman with experience of Brazilian culture may kiss the cheek of a Brazilian businessman at their first meeting but would not kiss the cheek of a Taiwanese man or woman. They have learned to act as if they were members of the other culture when interacting with the other party. Transactional cultural behaviors are transitory and last only as long as the interactants are involved in communication together.

Adopting Another Culture’s Behavior When members of a culture adapt permanently to another culture, they function as members of that culture. They may retain their old culture, but it is not activated either backstage or onstage, until they are again with members of their original culture. Adopting a new culture has historical precedents, as Kongo shows.

16 Chapter 1

In the year 578, a carpenter named Kongo, with special skills in constructing temples made of wood traveled, from Korea to Japan. He and his sons began constructing the Shitennoji temple in Osaka for the emperor. Over succeeding generations, sons worked with fathers from the Kongo family in the business of building Buddhist temples and Shinto shrines in Japan for successive emperors.

Today, the company, Kongo Gumi, is still going strong following the calling of miyadaiku (temple builders). They continue to be the carpenters who maintain the Shitennoji temple. The current chief executive, Masakazu Kongo, says that as the only son he wasn’t allowed to go skydiving or do anything that might endanger his ability to carry on the family business, which is thought to be the oldest continuous family business in the world.

The company is strong, and in a modern twist, the CEO looks forward to having the more than 1,400-year-old family business carried on—by his oldest daughter!14

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Some sources for intercultural communication offer lists of behavioral dos and taboos as guides for success in other cultures. These lists are popular and offer some pragmatic help, such as this one governing nonverbal communication:

• Never refuse an offer of coffee from a businessman in Kuwait.

• Be very careful not to point the sole of your foot at someone in Thailand.

• Remove your jacket and work in shirtsleeves in Japan only after your Japanese colleagues do so first.

• Never help yourself to food when you are the guest of honor at a banquet in China.

• Do not become irritated if you find yourself waiting half an hour or more for an appointment with a businessperson from Venezuela.

• Use business courtesies in Dubai, such as shaking hands when introduced, except when females are involved.

• Do not offer your host gifts for his wife or children when doing business in Saudi Arabia.

• Plan to spend about two hours on lunch in France.

Dos and taboos lists are usually accurate, but their helpfulness is limited because they focus only on onstage behavior. One-sentence advice on behavior is like seeing a snapshot from a movie. It is accurate, but without the context of the whole movie, the snapshot’s significance may not be understandable. Lists of dos and taboos don’t explain why you should or should not behave in a particular way in a particular place. They don’t tell you anything about backstage behavior. Even if a business traveler has a very long list, who can consult a list for every situation in every different country?

Once you begin to build a picture of a culture’s priorities, you can draw fairly accurate deductions about what kind of behavior will be offensive and what kind will be pleasing. Chapters 3 and 4 discuss what questions to ask to gain an under- standing of a culture that will enable you to do business effectively.

Culture Shock

Culture shock is an inevitable result of immersion in a new and unfamiliar culture. It happens to everybody. It’s important to know that culture shock and its symp- toms are normal and to be expected.

Culture shock is the sense of dislocation and the problems—psychological and even physical—that result from the stress of trying to make the hundreds of adjustments necessary for living in a foreign culture. Actually, the term culture shock is not accurate, because it refers to a range of responses that take place over time. However, it isn’t a single jolt. Culture shock is experienced in four stages.

The first stage of experiencing a new culture is usually euphoria. Everything about the exciting new adventure is wonderful. This stage generally lasts no longer than two weeks, and some people skip it altogether. Some short-visit travelers go home before they have progressed to the next stage. All who stay for more than a short visit go on to the second stage.

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The second stage is a downturn as disillusionment and frustration arise. This is usually the stage people refer to when they use the term culture shock. It is a feeling of not being in step with the members of the culture. It results from find- ing out that there are inadequacies in your understanding, your mental road map for navigating this new culture. You don’t know what you don’t know. Finding out what you don’t know is exhausting, even when it is also exciting. Inevitably, there are disappointments in yourself and in others; inevitably, you make mistakes. When the adjustment to a new culture means an upward change in status, people feel good about the new culture. When the adjustment means a downward change in status, people quickly feel unhappy.

Most sojourners—travelers who stay for a longer time than a few days— experience psychological symptoms of culture shock. Some people find them- selves becoming depressed. They may experience long periods of homesickness. Some are very lonely and may get involved in relationships that they wouldn’t form if they were in their own culture. Nearly all sojourners and temporary resi- dents in a new culture experience dissatisfaction with the way things are. Things that seemed acceptable when they first arrived become irritations. Sojourners can become aggressive and exhibit unpleasant behavior that they would not use at home. They may get angry easily and express hostility and suspicion toward mem- bers of the host culture. Frequently, culture shock shows itself when sojourners believe that native members of the culture are trying to take advantage of them— to overcharge them, for example—because they are foreign.

Physical symptoms also can result from this stage of culture shock. They in- clude aches and pains in limbs, headaches, chronic fatigue and lack of energy, loss of appetite, inability to get a good night’s sleep, stomach upsets, and frequent colds or flu. This stage can last longer than the first euphoric stage—perhaps months.

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Rs514: Rose 6080 Case 3

4 pages

choose two countries from very different cultural contexts other than your own native country.

For example: I’m choosing to analyze China and France, since I’m America and can’t choose my home culture/country. A helpful tool can be found at https://www.hofstede-insights.com/product/compare-countries/

In your primary discussion post please describe 5 key challenges that could be expected in a business or government negotiation between these two countries/cultures. Keep you posts informative yet concise.Keep in mind your comments should focus specifically on the negotiations skills and strategies necessary between these two cultures as if you were assigned by your government or business to lead a negotiations team.

Please draw from your textbook and lecture materials as well as any outside sources you may decide to include. Don’t over-rely on Hofstede….add additional color from other theories of perspectives.

Your 3 follow-up posts should include additional challenges that you perceive in looking at the negotiating cultures your classmate has chosen. You can feel free to comment on your own culture/country as a follow-up to another student’s post.

Initial posts by midnight Wednesday and minimum two follow-ups by Sunday midnight. This discussion board post will count as both participation and Case Study #3 and as 10 points toward your final grade. So please regard this as a bit more than just the typical discussion posting !

DO NOT CHOOSE CHINA THIS COUNTRY TO COMPARE

Varner Chapters 9 & 10

materials to watch: https://www.youtube.com/watch?v=-4GjC0ipJIA

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Calculate the present value of each cash flow and then determine how long it takes to pay back on a discounted basis

CHAPTER 9

NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.

KEY CONCEPTS AND SKILLS

Be able to compute payback and discounted payback and understand their shortcomings
Understand accounting rates of return and their shortcomings
Be able to compute internal rates of return (standard and modified) and understand their strengths and weaknesses
Be able to compute the net present value and understand why it is the best decision criterion
Be able to compute the profitability index and understand its relation to net present value
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CHAPTER OUTLINE

Net Present Value
The Payback Rule
The Discounted Payback
The Average Accounting Return
The Internal Rate of Return
The Profitability Index
The Practice of Capital Budgeting
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Lecture Tip: A logical prerequisite to the analysis of investment opportunities is the creation of investment opportunities. Unlike the field of investments, where the analyst more or less takes the investment opportunity set as a given, the field of capital budgeting relies on the work of people in the areas of engineering, research and development, information technology and others for the creation of investment opportunities. As such, it is important to remind students of the importance of creativity in this area, as well as the importance of analytical techniques.

GOOD DECISION CRITERIA

We need to ask ourselves the following questions when evaluating capital budgeting decision rules:
Does the decision rule adjust for the time value of money?

Does the decision rule adjust for risk?

Does the decision rule provide information on whether we are creating value for the firm?

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Economics students will recognize that the practice of capital budgeting defines the firm’s investment opportunity schedule.

NET PRESENT VALUE

The difference between the market value of a project and its cost
How much value is created from undertaking an investment?
The first step is to estimate the expected future cash flows.

The second step is to estimate the required return for projects of this risk level.

The third step is to find the present value of the cash flows and subtract the initial investment.

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We learn how to estimate the cash flows and the required return in subsequent chapters.

The NPV measures the increase in firm value, which is also the increase in the value of what the shareholders own. Thus, making decisions with the NPV rule facilitates the achievement of our goal in Chapter 1 – making decisions that will maximize shareholder wealth.

Lecture Tip: Although this point may seem obvious, it is often helpful to stress the word “net” in net present value. It is not uncommon for some students to carelessly calculate the PV of a project’s future cash flows and fail to subtract out its cost (after all this is what the programmers of Lotus and Excel did when they programmed the NPV function). The PV of future cash flows is not NPV; rather, NPV is the amount remaining after offsetting the PV of future cash flows with the initial cost. Thus, the NPV amount determines the incremental value created by undertaking the investment.

PROJECT EXAMPLE INFORMATION

You are reviewing a new project and have estimated the following cash flows:
Year 0: CF = -165,000

Year 1: CF = 63,120; NI = 13,620

Year 2: CF = 70,800; NI = 3,300

Year 3: CF = 91,080; NI = 29,100

Average Book Value = 72,000

Your required return for assets of this risk level is 12%.
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This example will be used for each of the decision rules so that the students can compare the different rules and see that conflicts can arise. This illustrates the importance of recognizing which decision rules provide the best information for making decisions that will increase owner wealth.

NPV – DECISION RULE

If the NPV is positive, accept the project
A positive NPV means that the project is expected to add value to the firm and will therefore increase the wealth of the owners.
Since our goal is to increase owner wealth, NPV is a direct measure of how well this project will meet our goal.
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Lecture Tip: Here’s another perspective on the meaning of NPV. If we accept a project with a negative NPV of -$2,422, this is financially equivalent to investing $2,422 today and receiving nothing in return. Therefore, the total value of the firm would decrease by $2,422. This assumes that the various components (cash flow estimates, discount rate, etc.) used in the computation are correct.

Lecture Tip: In practice, financial managers are rarely presented with zero NPV projects for at least two reasons. First, in an abstract sense, zero is just another of the infinite number of values the NPV can take; as such, the likelihood of obtaining any particular number is small. Second, and more pragmatically, in most large firms, capital investment proposals are submitted to the finance group from other areas for analysis. Those submitting proposals recognize the ambivalence associated with zero NPVs and are less likely to send them to the finance group in the first place.

COMPUTING NPV FOR THE PROJECT

Using the formulas:
NPV = -165,000 + 63,120/(1.12) + 70,800/(1.12)2 + 91,080/(1.12)3 = 12,627.41

Using the calculator:
CF0 = -165,000; C01 = 63,120; F01 = 1; C02 = 70,800; F02 = 1; C03 = 91,080; F03 = 1; NPV; I = 12; CPT NPV = 12,627.41

Do we accept or reject the project?
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Again, the calculator used for the illustration is the TI BA-II plus. The basic procedure is the same; you start with the year 0 cash flow and then enter the cash flows in order. F01, F02, etc. are used to set the frequency of a cash flow occurrence. Many calculators only require you to use this function if the frequency is something other than 1.

Since we have a positive NPV, we should accept the project.

DECISION CRITERIA TEST – NPV

Does the NPV rule account for the time value of money?
Does the NPV rule account for the risk of the cash flows?
Does the NPV rule provide an indication about the increase in value?
Should we consider the NPV rule for our primary decision rule?
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The answer to all of these questions is yes

The risk of the cash flows is accounted for through the choice of the discount rate.

CALCULATING NPVS WITH A SPREADSHEET

Spreadsheets are an excellent way to compute NPVs, especially when you have to compute the cash flows as well.
Using the NPV function
The first component is the required return entered as a decimal

The second component is the range of cash flows beginning with year 1

Subtract the initial investment after computing the NPV

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Sheet1
Year 0 1 2 3
Cash Flows -165000 63120 70800 91080
Required Return 0.12
NPV – WRONG $11,274.48
NPV – RIGHT $12,627.41
Sheet2
Sheet3
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Click on the Excel icon to go to an embedded Excel worksheet that has the cash flows along with the right and wrong way to compute NPV. Click on the cell with the solution to show the students the difference in the formulas.

PAYBACK PERIOD

How long does it take to get the initial cost back in a nominal sense?
Computation
Estimate the cash flows

Subtract the future cash flows from the initial cost until the initial investment has been recovered

Decision Rule – Accept if the payback period is less than some preset limit
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COMPUTING PAYBACK

Assume we will accept the project if it pays back within two years.
Year 1: 165,000 – 63,120 = 101,880 still to recover

Year 2: 101,880 – 70,800 = 31,080 still to recover

Year 3: 31,080 – 91,080 = -60,000 project pays back in year 3

Do we accept or reject the project?
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The payback period is year 3 if you assume that the cash flows occur at the end of the year, as we do with all of the other decision rules.

If we assume that the cash flows occur evenly throughout the year, then the project pays back in 2.34 years.

Either way, the payback rule would say to reject the project.

DECISION CRITERIA TEST – PAYBACK

Does the payback rule account for the time value of money?
Does the payback rule account for the risk of the cash flows?
Does the payback rule provide an indication about the increase in value?
Should we consider the payback rule for our primary decision rule?
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The answer to all of these questions is no.

Lecture Tip: The payback period can be interpreted as a naïve form of discounting if we consider the class of investments with level cash flows over arbitrarily long lives. Since the present value of a perpetuity is the payment divided by the discount rate, a payback period cutoff can be seen to imply a certain discount rate. That is:
cost/annual cash flow = payback period cutoff
cost = annual cash flow times payback period cutoff

The PV of a perpetuity is: PV = annual cash flow / R. This illustrates the inverse relationship between the payback period cutoff and the discount rate.

ADVANTAGES AND DISADVANTAGES OF PAYBACK

Advantages
Easy to understand

Adjusts for uncertainty of later cash flows

Biased toward liquidity

Disadvantages
Ignores the time value of money

Requires an arbitrary cutoff point

Ignores cash flows beyond the cutoff date

Biased against long-term projects, such as research and development, and new projects

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Teaching the payback rule seems to put one in a delicate situation – as the text indicates, the rule is flawed as an indicator of project desirability. Yet, past surveys suggest that practitioners often use it as a secondary decision measure. How can we explain this apparent discrepancy between theory and practice? While the payback period is widely used in practice, it is rarely the primary decision criterion. As William Baumol pointed out in the early 1960s, the payback rule serves as a crude “risk screening” device – the longer cash is tied up, the greater the likelihood that it will not be returned. The payback period may be helpful when mutually exclusive projects are compared. Given two similar projects with different paybacks, the project with the shorter payback is often, but not always, the better project. Similarly, the bias toward liquidity may be justifiable in such industries as healthcare, where technology changes rapidly, requiring quick payback to make machines justifiable, or in international investments where the possibility of government seizure of assets exists.

DISCOUNTED PAYBACK PERIOD

Compute the present value of each cash flow and then determine how long it takes to pay back on a discounted basis
Compare to a specified required period
Decision Rule: Accept the project if it pays back on a discounted basis within the specified time
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COMPUTING DISCOUNTED PAYBACK

Assume we will accept the project if it pays back on a discounted basis in 2 years.
Compute the PV for each cash flow and determine the payback period using discounted cash flows
Year 1: 165,000 – 63,120/1.121 = 108,643

Year 2: 108,643 – 70,800/1.122 = 52,202

Year 3: 52,202 – 91,080/1.123 = -12,627 project pays back in year 3

Do we accept or reject the project?
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No – it doesn’t pay back on a discounted basis within the required 2-year period

DECISION CRITERIA TEST – DISCOUNTED PAYBACK

Does the discounted payback rule account for the time value of money?
Does the discounted payback rule account for the risk of the cash flows?
Does the discounted payback rule provide an indication about the increase in value?
Should we consider the discounted payback rule for our primary decision rule?
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The answer to the first two questions is yes.

The answer to the third question is no because of the arbitrary cut-off date.

Since the rule does not indicate whether or not we are creating value for the firm, it should not be the primary decision rule.

ADVANTAGES AND DISADVANTAGES OF DISCOUNTED PAYBACK

Advantages
Includes time value of money

Easy to understand

Does not accept negative estimated NPV investments when all future cash flows are positive

Biased towards liquidity

Disadvantages
May reject positive NPV investments

Requires an arbitrary cutoff point

Ignores cash flows beyond the cutoff point

Biased against long-term projects, such as R&D and new products

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AVERAGE ACCOUNTING RETURN

There are many different definitions for average accounting return
The one used in the book is:
Average net income / average book value

Note that the average book value depends on how the asset is depreciated.

Need to have a target cutoff rate
Decision Rule: Accept the project if the AAR is greater than a preset rate
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The example in the book uses straight line depreciation to a zero salvage; that is why you can take the initial investment and divide by 2. If you use MACRS, you need to compute the BV in each period and take the average in the standard way.

COMPUTING AAR

Assume we require an average accounting return of 25%
Average Net Income:
(13,620 + 3,300 + 29,100) / 3 = 15,340

AAR = 15,340 / 72,000 = .213 = 21.3%
Do we accept or reject the project?
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Students may ask where you came up with the 25%. Point out that this is one of the drawbacks of this rule. There is no good theory for determining what the return should be. We generally just use some rule of thumb.

This rule would indicate that we reject the project.

DECISION CRITERIA TEST – AAR

Does the AAR rule account for the time value of money?
Does the AAR rule account for the risk of the cash flows?
Does the AAR rule provide an indication about the increase in value?
Should we consider the AAR rule for our primary decision rule?
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The answer to all of these questions is no. In fact, this rule is even worse than the payback rule in that it doesn’t even use cash flows for the analysis. It uses net income and book value. Thus, it is not surprising that most surveys indicate that few large firms employ the payback and/or AAR methods exclusively.

ADVANTAGES AND DISADVANTAGES OF AAR

Advantages
Easy to calculate

Needed information will usually be available

Disadvantages
Not a true rate of return; time value of money is ignored

Uses an arbitrary benchmark cutoff rate

Based on accounting net income and book values, not cash flows and market values

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Lecture Tip: An alternative view of the AAR is that it is the micro-level analogue to the ROA discussed in a previous chapter. As you remember, firm ROA is normally computed as Firm Net Income / Firm Total Assets. And, it is not uncommon to employ values averaged over several quarters or years in order to smooth out this measure. Some analysts ask, “If the ROA is appropriate for the firm, why is it less appropriate for a project?” Perhaps the best answer is that whether you compute the measure for the firm or for a project, you need to recognize the limitations – it doesn’t account for risk or the time value of money and it is based on accounting, rather than market, data.

INTERNAL RATE OF RETURN

This is the most important alternative to NPV
It is often used in practice and is intuitively appealing
It is based entirely on the estimated cash flows and is independent of interest rates found elsewhere
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The IRR rule is very important. Management, and individuals in general, often have a much better feel for percentage returns, and the value that is created, than they do for dollar increases. A dollar increase doesn’t appear to provide as much information if we don’t know what the initial expenditure was. Whether or not the additional information is relevant is another issue.

IRR – DEFINITION AND DECISION RULE

Definition: IRR is the return that makes the NPV = 0
Decision Rule: Accept the project if the IRR is greater than the required return.
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COMPUTING IRR

If you do not have a financial calculator, then this becomes a trial and error process
Calculator
Enter the cash flows as you did with NPV

Press IRR and then CPT

IRR = 16.13% > 12% required return

Do we accept or reject the project?
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Many of the financial calculators will compute the IRR as soon as it is pressed; others require that you press compute.

NPV PROFILE FOR THE PROJECT

IRR = 16.13%

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Note that the NPV profile is also a form of sensitivity analysis.

DECISION CRITERIA TEST – IRR

Does the IRR rule account for the time value of money?
Does the IRR rule account for the risk of the cash flows?
Does the IRR rule provide an indication about the increase in value?
Should we consider the IRR rule for our primary decision criteria?
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The answer to all of these questions is yes, although it is not always as obvious.

The IRR rule accounts for time value because it is finding the rate of return that equates all of the cash flows on a time value basis.

The IRR rule accounts for the risk of the cash flows because you compare it to the required return, which is determined by the risk of the project.

The IRR rule provides an indication of value because we will always increase value if we can earn a return greater than our required return.

We could consider the IRR rule as our primary decision criteria, but as we will see, it has some problems that the NPV does not have. That is why we end up choosing the NPV as our ultimate decision rule.

ADVANTAGES OF IRR

Knowing a return is intuitively appealing
It is a simple way to communicate the value of a project to someone who doesn’t know all the estimation details
If the IRR is high enough, you may not need to estimate a required return, which is often a difficult task
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You should point out, however, that if you get a very large IRR then you should go back and look at your cash flow estimates again. In competitive markets, extremely high IRRs should be rare. Also, since the IRR calculation assumes that you can reinvest future cash flows at the IRR, a high IRR may be unrealistic.

CALCULATING IRRS WITH A SPREADSHEET

You start with the cash flows the same as you did for the NPV
You use the IRR function
You first enter your range of cash flows, beginning with the initial cash flow

You can enter a guess, but it is not necessary

The default format is a whole percent – you will normally want to increase the decimal places to at least two

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Sheet1
Year 0 1 2 3
Cash Flows -165000 63120 70800 91080
Required Return 0.12
NPV – WRONG $11,274.48
NPV – RIGHT $12,627.41
IRR 16% 16.13%
Default Format
Sheet2
Sheet3
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Click on the Excel icon to go to an embedded spreadsheet so that you can illustrate how to compute IRR on the spreadsheet.

SUMMARY OF DECISIONS FOR THE PROJECT

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Summary
Net Present Value Accept
Payback Period Reject
Discounted Payback Period Reject
Average Accounting Return Reject
Internal Rate of Return Accept
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So what should we do?

We have two rules that indicate to accept and three that indicate to reject.

NPV VS. IRR

NPV and IRR will generally give us the same decision
Exceptions:
Nonconventional cash flows – cash flow signs change more than once

Mutually exclusive projects

Initial investments are substantially different (issue of scale)
Timing of cash flows is substantially different
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IRR AND NONCONVENTIONAL
CASH FLOWS

When the cash flows change sign more than once, there is more than one IRR
When you solve for IRR you are solving for the root of an equation, and when you cross the x-axis more than once, there will be more than one return that solves the equation
If you have more than one IRR, which one do you use to make your decision?
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Lecture Tip: A good introduction to mutually exclusive projects and non-conventional cash flows is to provide examples that students can relate to. An excellent example of mutually exclusive projects is the choice of which college or university to attend. Many students apply and are accepted to more than one college, yet they cannot attend more than one at a time. Consequently, they have to decide between mutually exclusive projects.

Nonconventional cash flows and multiple IRRs occur when there is a net cost to shutting down a project. The most common examples deal with collecting natural resources. After the resource has been harvested, there is generally a cost associated with restoring the environment.

ANOTHER EXAMPLE: NONCONVENTIONAL CASH FLOWS

Suppose an investment will cost $90,000 initially and will generate the following cash flows:
Year 1: 132,000

Year 2: 100,000

Year 3: -150,000

The required return is 15%.
Should we accept or reject the project?
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NPV = – 90,000 + 132,000 / 1.15 + 100,000 / (1.15)2 – 150,000 / (1.15)3 = 1,769.54

Calculator: CF0 = -90,000; C01 = 132,000; F01 = 1; C02 = 100,000; F02 = 1; C03 = -150,000; F03 = 1; I = 15; CPT NPV = 1769.54

If you compute the IRR on the calculator, you get 10.11% because it is the first one that you come to. So, if you just blindly use the calculator without recognizing the uneven cash flows, NPV would say to accept and IRR would say to reject.

Another type of nonconventional cash flow involves a “financing” project, where there is a positive cash flow followed by a series of negative cash flows. This is the opposite of an “investing” project. In this case, our decision rule reverses, and we accept a project if the IRR is less than the cost of capital, since we are borrowing at a lower rate.

NPV PROFILE

IRR = 10.11% and 42.66%

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You should accept the project if the required return is between 10.11% and 42.66%

SUMMARY OF DECISION RULES

The NPV is positive at a required return of 15%, so you should Accept
If you use the financial calculator, you would get an IRR of 10.11% which would tell you to Reject
You need to recognize that there are non-conventional cash flows and look at the NPV profile
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IRR AND MUTUALLY EXCLUSIVE PROJECTS

Mutually exclusive projects
If you choose one, you can’t choose the other

Example: You can choose to attend graduate school at either Harvard or Stanford, but not both

Intuitively, you would use the following decision rules:
NPV – choose the project with the higher NPV

IRR – choose the project with the higher IRR

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EXAMPLE WITH MUTUALLY
EXCLUSIVE PROJECTS

The required return for both projects is 10%.

Which project should you accept and why?

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Period Project A Project B
0 -500 -400
1 325 325
2 325 200
IRR 19.43% 22.17%
NPV 64.05 60.74
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As long as we do not have limited capital, we should choose project A. Students will often argue that you should choose B because then you can invest the additional $100 in another good project, say C. The point is that if we do not have limited capital, we can invest in A and C and still be better off.

If we have limited capital, then we will need to examine what combinations of projects with A provide the highest NPV and what combinations of projects with B provide the highest NPV. You then go with the set that will create the most value. If you have limited capital and a large number of mutually exclusive projects, then you will want to set up a computer program to determine the best combination of projects within the budget constraints. The important point is that we DO NOT use IRR to choose between projects regardless of whether or not we have limited capital.

Embedded in the analysis, we may want to calculate the NPV of the incremental project, i.e., the additional CF represented by project A above project B. The IRR of this CF stream is the crossover point and provides the return on the incremental investment.

NPV PROFILES

IRR for A = 19.43%

IRR for B = 22.17%

Crossover Point = 11.8%

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If the required return is less than the crossover point of 11.8%, then you should choose A

If the required return is greater than the crossover point of 11.8%, then you should choose B

CONFLICTS BETWEEN
NPV AND IRR

NPV directly measures the increase in value to the firm
Whenever there is a conflict between NPV and another decision rule, you should always use NPV
IRR is unreliable in the following situations
Nonconventional cash flows

Mutually exclusive projects

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MODIFIED IRR

Calculate the net present value of all cash outflows using the borrowing rate.
Calculate the net future value of all cash inflows using the investing rate.
Find the rate of return that equates these values.
Benefits: single answer and specific rates for borrowing and reinvestment
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PROFITABILITY INDEX

Measures the benefit per unit cost, based on the time value of money
A profitability index of 1.1 implies that for every $1 of investment, we create an additional $0.10 in value
This measure can be very useful in situations in which we have limited capital
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ADVANTAGES AND DISADVANTAGES OF PROFITABILITY INDEX

Advantages
Closely related to NPV, generally leading to identical decisions

Easy to understand and communicate

May be useful when available investment funds are limited

Disadvantages
May lead to incorrect decisions in comparisons of mutually exclusive investments

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CAPITAL BUDGETING
IN PRACTICE

We should consider several investment criteria when making decisions
NPV and IRR are the most commonly used primary investment criteria
Payback is a commonly used secondary investment criteria
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Even though payback and AAR should not be used to make the final decision, we should consider the project very carefully if they suggest rejection. There may be more risk than we have considered or we may want to pay additional attention to our cash flow estimations. Sensitivity and scenario analysis can be used to help us evaluate our cash flows.

The fact that payback is commonly used as a secondary criterion may be because short paybacks allow firms to have funds sooner to invest in other projects without going to the capital markets.

Why are smaller firms more likely to use payback as a primary decision criterion?

small firms don’t have direct access to the capital markets and therefore find it more difficult to estimate discount rates based on funds cost;
the AAR is the project-level equivalent to the ROA measure used for analyzing firm profitability; and
(3) some small firm decision-makers may be less aware of DCF approaches than their large firm counterparts.

When managers are judged and rewarded primarily on the basis of periodic accounting figures, there is an incentive to evaluate projects with methods such as payback or average accounting return. On the other hand, when compensation is tied to firm value, it makes more sense to use NPV as the primary decision tool.

SUMMARY – DCF CRITERIA

Net present value
Difference between market value and cost

Take the project if the NPV is positive

Has no serious problems

Preferred decision criterion

Internal rate of return
Discount rate that makes NPV = 0

Take the project if the IRR is greater than the required return

Same decision as NPV with conventional cash flows

IRR is unreliable with nonconventional cash flows or mutually exclusive projects

Profitability Index
Benefit-cost ratio

Take investment if PI > 1

Cannot be used to rank mutually exclusive projects

May be used to rank projects in the presence of capital rationing

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For IRR, we assume a conventional investment project. For a financing project, we accept if the IRR is less than the “required” rate.

SUMMARY – PAYBACK CRITERIA

Payback period
Length of time until initial investment is recovered

Take the project if it pays back within some specified period

Doesn’t account for time value of money, and there is an arbitrary cutoff period

Discounted payback period
Length of time until initial investment is recovered on a discounted basis

Take the project if it pays back in some specified period

There is an arbitrary cutoff period

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SUMMARY – ACCOUNTING CRITERION

Average Accounting Return
Measure of accounting profit relative to book value

Similar to return on assets measure

Take the investment if the AAR exceeds some specified return level

Serious problems and should not be used

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QUICK QUIZ

Consider an investment that costs $100,000 and has a cash inflow of $25,000 every year for 5 years. The required return is 9%, and required payback is 4 years.
What is the payback period?

What is the discounted payback period?

What is the NPV?

What is the IRR?

Should we accept the project?

What decision rule should be the primary decision method?
When is the IRR rule unreliable?
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Payback period = 4 years

The project does not pay back on a discounted basis.

NPV = -2,758.72

IRR = 7.93%

ETHICS ISSUES

An ABC poll in the spring of 2004 found that one-third of students age 12 – 17 admitted to cheating and the percentage increased as the students got older and felt more grade pressure. If a book entitled “How to Cheat: A User’s Guide” would generate a positive NPV, would it be proper for a publishing company to offer the new book?
Should a firm exceed the minimum legal limits of government imposed environmental regulations and be responsible for the environment, even if this responsibility leads to a wealth reduction for the firm? Is environmental damage merely a cost of doing business?
Should municipalities offer monetary incentives to induce firms to relocate to their areas?
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Case 1:

Assume the publishing company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The book would sell for $7.50 per copy and net the company a profit of $6 per copy after royalties, marketing costs and taxes. Year one net would be $60,000. From a capital budgeting standpoint, is it financially wise to buy the publication rights? What is the NPV of this investment? The year 0 cash flow is -20,000, year 1 is 60,000, and years 2 and 3 are 30,000 each. Given a cost of capital of 8%, the NPV is just over $85,000. It looks good, right? Now ask the class if the publishing of this book would encourage cheating and if the publishing company would want to be associated with this text and its message. Some students may feel that one should accept these profitable investment opportunities, while others might prefer that the publication of this profitable text be rejected due to the behavior it could encourage. Although the example is simplistic, this type of issue is not uncommon and serves as a starting point for a discussion of the value of “reputational capital.”

Case 2:

Assume that to comply with the Air Quality Control Act of 1989, a company must install three smoke stack scrubber units to its ventilation stacks at an installed cost of $355,000 per unit. An estimated $100,000 per unit in fines could be saved each year over the five-year life of the ventilation stacks. The cost of capital is 14% for the firm. The analysis of the investment results in a NPV of -$35,076. Could investment in a healthier working environment result in lower long-term costs in the form of lower future health costs? If so, might this decision result in an increase in shareholder wealth? Notice that if the answer to this second question is yes, it suggests that our original analysis omitted some side benefits to the project.

COMPREHENSIVE PROBLEM

An investment project has the following cash flows: CF0 = -1,000,000; C01 – C08 = 200,000 each
If the required rate of return is 12%, what decision should be made using NPV?
How would the IRR decision rule be used for this project, and what decision would be reached?
How are the above two decisions related?
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Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.

8.*

NPV = -$6,472; reject the project since it would lower the value of the firm.

IRR = 11.81%, so reject the project since it would tie up investable funds in a project that will provide insufficient return.

The NPV and IRR decision rules will provide the same decision for all independent projects with conventional/normal cash flow patterns. If a project adds value to the firm (i.e., has a positive NPV), then it must be expected to provide a return above that which is required. Both of those justifications are good for shareholders.

CHAPTER 9

END OF CHAPTER

9-*

Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.

8.*

Lecture Tip: A logical prerequisite to the analysis of investment opportunities is the creation of investment opportunities. Unlike the field of investments, where the analyst more or less takes the investment opportunity set as a given, the field of capital budgeting relies on the work of people in the areas of engineering, research and development, information technology and others for the creation of investment opportunities. As such, it is important to remind students of the importance of creativity in this area, as well as the importance of analytical techniques.

8.*

Economics students will recognize that the practice of capital budgeting defines the firm’s investment opportunity schedule.

8.*

We learn how to estimate the cash flows and the required return in subsequent chapters.

The NPV measures the increase in firm value, which is also the increase in the value of what the shareholders own. Thus, making decisions with the NPV rule facilitates the achievement of our goal in Chapter 1 – making decisions that will maximize shareholder wealth.

Lecture Tip: Although this point may seem obvious, it is often helpful to stress the word “net” in net present value. It is not uncommon for some students to carelessly calculate the PV of a project’s future cash flows and fail to subtract out its cost (after all this is what the programmers of Lotus and Excel did when they programmed the NPV function). The PV of future cash flows is not NPV; rather, NPV is the amount remaining after offsetting the PV of future cash flows with the initial cost. Thus, the NPV amount determines the incremental value created by undertaking the investment.

8.*

This example will be used for each of the decision rules so that the students can compare the different rules and see that conflicts can arise. This illustrates the importance of recognizing which decision rules provide the best information for making decisions that will increase owner wealth.

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Lecture Tip: Here’s another perspective on the meaning of NPV. If we accept a project with a negative NPV of -$2,422, this is financially equivalent to investing $2,422 today and receiving nothing in return. Therefore, the total value of the firm would decrease by $2,422. This assumes that the various components (cash flow estimates, discount rate, etc.) used in the computation are correct.

Lecture Tip: In practice, financial managers are rarely presented with zero NPV projects for at least two reasons. First, in an abstract sense, zero is just another of the infinite number of values the NPV can take; as such, the likelihood of obtaining any particular number is small. Second, and more pragmatically, in most large firms, capital investment proposals are submitted to the finance group from other areas for analysis. Those submitting proposals recognize the ambivalence associated with zero NPVs and are less likely to send them to the finance group in the first place.

8.*

Again, the calculator used for the illustration is the TI BA-II plus. The basic procedure is the same; you start with the year 0 cash flow and then enter the cash flows in order. F01, F02, etc. are used to set the frequency of a cash flow occurrence. Many calculators only require you to use this function if the frequency is something other than 1.

Since we have a positive NPV, we should accept the project.

8.*

The answer to all of these questions is yes

The risk of the cash flows is accounted for through the choice of the discount rate.

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Click on the Excel icon to go to an embedded Excel worksheet that has the cash flows along with the right and wrong way to compute NPV. Click on the cell with the solution to show the students the difference in the formulas.

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The payback period is year 3 if you assume that the cash flows occur at the end of the year, as we do with all of the other decision rules.

If we assume that the cash flows occur evenly throughout the year, then the project pays back in 2.34 years.

Either way, the payback rule would say to reject the project.

8.*

The answer to all of these questions is no.

Lecture Tip: The payback period can be interpreted as a naïve form of discounting if we consider the class of investments with level cash flows over arbitrarily long lives. Since the present value of a perpetuity is the payment divided by the discount rate, a payback period cutoff can be seen to imply a certain discount rate. That is:
cost/annual cash flow = payback period cutoff
cost = annual cash flow times payback period cutoff

The PV of a perpetuity is: PV = annual cash flow / R. This illustrates the inverse relationship between the payback period cutoff and the discount rate.

8.*

Teaching the payback rule seems to put one in a delicate situation – as the text indicates, the rule is flawed as an indicator of project desirability. Yet, past surveys suggest that practitioners often use it as a secondary decision measure. How can we explain this apparent discrepancy between theory and practice? While the payback period is widely used in practice, it is rarely the primary decision criterion. As William Baumol pointed out in the early 1960s, the payback rule serves as a crude “risk screening” device – the longer cash is tied up, the greater the likelihood that it will not be returned. The payback period may be helpful when mutually exclusive projects are compared. Given two similar projects with different paybacks, the project with the shorter payback is often, but not always, the better project. Similarly, the bias toward liquidity may be justifiable in such industries as healthcare, where technology changes rapidly, requiring quick payback to make machines justifiable, or in international investments where the possibility of government seizure of assets exists.

8.*

No – it doesn’t pay back on a discounted basis within the required 2-year period

8.*

The answer to the first two questions is yes.

The answer to the third question is no because of the arbitrary cut-off date.

Since the rule does not indicate whether or not we are creating value for the firm, it should not be the primary decision rule.

8.*

The example in the book uses straight line depreciation to a zero salvage; that is why you can take the initial investment and divide by 2. If you use MACRS, you need to compute the BV in each period and take the average in the standard way.

8.*

Students may ask where you came up with the 25%. Point out that this is one of the drawbacks of this rule. There is no good theory for determining what the return should be. We generally just use some rule of thumb.

This rule would indicate that we reject the project.

8.*

The answer to all of these questions is no. In fact, this rule is even worse than the payback rule in that it doesn’t even use cash flows for the analysis. It uses net income and book value. Thus, it is not surprising that most surveys indicate that few large firms employ the payback and/or AAR methods exclusively.

8.*

Lecture Tip: An alternative view of the AAR is that it is the micro-level analogue to the ROA discussed in a previous chapter. As you remember, firm ROA is normally computed as Firm Net Income / Firm Total Assets. And, it is not uncommon to employ values averaged over several quarters or years in order to smooth out this measure. Some analysts ask, “If the ROA is appropriate for the firm, why is it less appropriate for a project?” Perhaps the best answer is that whether you compute the measure for the firm or for a project, you need to recognize the limitations – it doesn’t account for risk or the time value of money and it is based on accounting, rather than market, data.

8.*

The IRR rule is very important. Management, and individuals in general, often have a much better feel for percentage returns, and the value that is created, than they do for dollar increases. A dollar increase doesn’t appear to provide as much information if we don’t know what the initial expenditure was. Whether or not the additional information is relevant is another issue.

8.*

Many of the financial calculators will compute the IRR as soon as it is pressed; others require that you press compute.

8.*

Note that the NPV profile is also a form of sensitivity analysis.

8.*

The answer to all of these questions is yes, although it is not always as obvious.

The IRR rule accounts for time value because it is finding the rate of return that equates all of the cash flows on a time value basis.

The IRR rule accounts for the risk of the cash flows because you compare it to the required return, which is determined by the risk of the project.

The IRR rule provides an indication of value because we will always increase value if we can earn a return greater than our required return.

We could consider the IRR rule as our primary decision criteria, but as we will see, it has some problems that the NPV does not have. That is why we end up choosing the NPV as our ultimate decision rule.

8.*

You should point out, however, that if you get a very large IRR then you should go back and look at your cash flow estimates again. In competitive markets, extremely high IRRs should be rare. Also, since the IRR calculation assumes that you can reinvest future cash flows at the IRR, a high IRR may be unrealistic.

8.*

Click on the Excel icon to go to an embedded spreadsheet so that you can illustrate how to compute IRR on the spreadsheet.

8.*

So what should we do?

We have two rules that indicate to accept and three that indicate to reject.

8.*

Lecture Tip: A good introduction to mutually exclusive projects and non-conventional cash flows is to provide examples that students can relate to. An excellent example of mutually exclusive projects is the choice of which college or university to attend. Many students apply and are accepted to more than one college, yet they cannot attend more than one at a time. Consequently, they have to decide between mutually exclusive projects.

Nonconventional cash flows and multiple IRRs occur when there is a net cost to shutting down a project. The most common examples deal with collecting natural resources. After the resource has been harvested, there is generally a cost associated with restoring the environment.

8.*

NPV = – 90,000 + 132,000 / 1.15 + 100,000 / (1.15)2 – 150,000 / (1.15)3 = 1,769.54

Calculator: CF0 = -90,000; C01 = 132,000; F01 = 1; C02 = 100,000; F02 = 1; C03 = -150,000; F03 = 1; I = 15; CPT NPV = 1769.54

If you compute the IRR on the calculator, you get 10.11% because it is the first one that you come to. So, if you just blindly use the calculator without recognizing the uneven cash flows, NPV would say to accept and IRR would say to reject.

Another type of nonconventional cash flow involves a “financing” project, where there is a positive cash flow followed by a series of negative cash flows. This is the opposite of an “investing” project. In this case, our decision rule reverses, and we accept a project if the IRR is less than the cost of capital, since we are borrowing at a lower rate.

8.*

You should accept the project if the required return is between 10.11% and 42.66%

8.*

As long as we do not have limited capital, we should choose project A. Students will often argue that you should choose B because then you can invest the additional $100 in another good project, say C. The point is that if we do not have limited capital, we can invest in A and C and still be better off.

If we have limited capital, then we will need to examine what combinations of projects with A provide the highest NPV and what combinations of projects with B provide the highest NPV. You then go with the set that will create the most value. If you have limited capital and a large number of mutually exclusive projects, then you will want to set up a computer program to determine the best combination of projects within the budget constraints. The important point is that we DO NOT use IRR to choose between projects regardless of whether or not we have limited capital.

Embedded in the analysis, we may want to calculate the NPV of the incremental project, i.e., the additional CF represented by project A above project B. The IRR of this CF stream is the crossover point and provides the return on the incremental investment.

8.*

If the required return is less than the crossover point of 11.8%, then you should choose A

If the required return is greater than the crossover point of 11.8%, then you should choose B

8.*

8.*

Even though payback and AAR should not be used to make the final decision, we should consider the project very carefully if they suggest rejection. There may be more risk than we have considered or we may want to pay additional attention to our cash flow estimations. Sensitivity and scenario analysis can be used to help us evaluate our cash flows.

The fact that payback is commonly used as a secondary criterion may be because short paybacks allow firms to have funds sooner to invest in other projects without going to the capital markets.

Why are smaller firms more likely to use payback as a primary decision criterion?

small firms don’t have direct access to the capital markets and therefore find it more difficult to estimate discount rates based on funds cost;
the AAR is the project-level equivalent to the ROA measure used for analyzing firm profitability; and
(3) some small firm decision-makers may be less aware of DCF approaches than their large firm counterparts.

When managers are judged and rewarded primarily on the basis of periodic accounting figures, there is an incentive to evaluate projects with methods such as payback or average accounting return. On the other hand, when compensation is tied to firm value, it makes more sense to use NPV as the primary decision tool.

8.*

For IRR, we assume a conventional investment project. For a financing project, we accept if the IRR is less than the “required” rate.

8.*

Payback period = 4 years

The project does not pay back on a discounted basis.

NPV = -2,758.72

IRR = 7.93%

8.*

Case 1:

Assume the publishing company has a cost of capital of 8% and estimates it could sell 10,000 volumes by the end of year one and 5,000 volumes in each of the following two years. The immediate printing costs for the 20,000 volumes would be $20,000. The book would sell for $7.50 per copy and net the company a profit of $6 per copy after royalties, marketing costs and taxes. Year one net would be $60,000. From a capital budgeting standpoint, is it financially wise to buy the publication rights? What is the NPV of this investment? The year 0 cash flow is -20,000, year 1 is 60,000, and years 2 and 3 are 30,000 each. Given a cost of capital of 8%, the NPV is just over $85,000. It looks good, right? Now ask the class if the publishing of this book would encourage cheating and if the publishing company would want to be associated with this text and its message. Some students may feel that one should accept these profitable investment opportunities, while others might prefer that the publication of this profitable text be rejected due to the behavior it could encourage. Although the example is simplistic, this type of issue is not uncommon and serves as a starting point for a discussion of the value of “reputational capital.”

Case 2:

Assume that to comply with the Air Quality Control Act of 1989, a company must install three smoke stack scrubber units to its ventilation stacks at an installed cost of $355,000 per unit. An estimated $100,000 per unit in fines could be saved each year over the five-year life of the ventilation stacks. The cost of capital is 14% for the firm. The analysis of the investment results in a NPV of -$35,076. Could investment in a healthier working environment result in lower long-term costs in the form of lower future health costs? If so, might this decision result in an increase in shareholder wealth? Notice that if the answer to this second question is yes, it suggests that our original analysis omitted some side benefits to the project.

8.*

NPV = -$6,472; reject the project since it would lower the value of the firm.

IRR = 11.81%, so reject the project since it would tie up investable funds in a project that will provide insufficient return.

The NPV and IRR decision rules will provide the same decision for all independent projects with conventional/normal cash flow patterns. If a project adds value to the firm (i.e., has a positive NPV), then it must be expected to provide a return above that which is required. Both of those justifications are good for shareholders.

-20,000

-10,000

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

00.020.040.060.080.10.120.140.160.180.20.22

Discount Rate

NPV

($10,000.00)

($8,000.00)

($6,000.00)

($4,000.00)

($2,000.00)

$0.00

$2,000.00

$4,000.00

00.050.10.150.20.250.30.350.40.450.50.55

Discount Rate

NPV

($40.00)

($20.00)

$0.00

$20.00

$40.00

$60.00

$80.00

$100.00

$120.00

$140.00

$160.00

00.050.10.150.20.250.3

Discount Rate

NPV

A

B

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module 3 Discussion

Complete Textbook (Problems & Applications) & post online.

Chapter 7- Answer Question #1 p.244

Reread the ‘Operations in practice’ case at the start of the chapter that describes the Volkswagen and Google operations. What do you think the main objectives of each layout were?

Chapter 8 – Answer Question #1 p.274

In the early part of this chapter, three technologies are described: 3D printing, the Internet of Things, and Telemedicine. Try to describe the technologies by answering the ‘four key ques- tions’ that are also described.

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