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V. Summary of Interviews with U.S. Firms on the Oneration of the Licensing System Extensive interviews on the competitive effects of the licensing system were held with over 20 firms. Based on these interviews we discerned a basic framework to characterize how a firm's interaction with the license system influences their competitive position. Before describing the framework, we first discuss some overall generalizations developed from the interview process. One conclusion that emerged from the interviews is that some of the aggregate statistics on the operation of the licensing system can be misleading about its competitive effects. For example, the reported rate for denial of licenses tends to obscure the reality of the way the system influences business behavior. The denial rate reported by DOC is less than one percent, and the rate reported by the Questionnaire respondents is just above one percent. What is not evident in these statistics, but became clear from the interviews, was that the denial rate 62Extensive interviews were conducted with over 20 U.S.-based companies randomly selected from the questionnaire respondents who indicated they were willing to be interviewed about the control system in detail. The firms selected varied with respect to size of the parent, size of foreign sales, experience with the U.S. control system and type of exported products. -57-

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is in some sense artificially low. For example, a number of companies reported they do not submit certain types of license applications because they assume the license will not be approved. In addition, some of the larger companies that are well versed in dealing with the system stated that if their application runs into difficulties, they will often ask for their applications to be RWAd rather than denied,63 or the firm will modify the scope of the application to take into account various objections raised by the licensing officials. Another reason why the denial rate does not indicate the true restrictiveness of the system is what can be called a de facto denial when applications are approved too late--the sale is lost or the trade show is over. Firms also reported they had either given up trying to sell to the U.S.S.R. and Bloc countries or had substantially reduced their level of effort.64 For all of these reasons, the reported denial rate is not a very good indicator to gauge effectiveness or effects of the license system. 63This lowers the denial rate by 25 percent. See Chapter IV. 64This result was also evident in the NAS Questionnaire response to the question "Did your firm, by choice, not sell to Warsaw Pact countries?" with 45 percent reporting yes. Overall, only 30 percent of the firms had sales to Bloc countries, but 70 percent of the large firms reported trade with Bloc countries. -58-

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Another often-cited indicator of competitive effects is lost sales, where the principal cause of the lost sale was some aspect of the U.S. export controls. The firms which were interviewed indicated several problems associated with trying to develop a real measure of lost sales. First, it was difficult to identify what sales were lost solely or principally due to the license system. Even the lost sales figures that are reported due to the U.S. export control system are suspect because most of the large companies interviewed indicated they do not keep track of such information and said that often the foreign customer will not cite the U.S. control system as a contributing factor to the lost sale. Therefore, systematically tracking the extent of lost sales from company data is difficult.65 Reports of lost sales also understate any long-run effects of the system on U.S. firms' competitiveness by focusing on only the short-run cost of the loss of a particular transaction. A significant number of companies stated that when a sale was lost due to a delayed license or some other aspect of the licensing process interfering with a transaction, the customer was 65The NAS Questionnaire was designed with this problem in mind. Appendix B presents an analysis of analytic instruments trade which directly links changes in trade to changes in the license rules. This approach bypasses the problems associated with measuring lost sales. _59_

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very often permanently lost. And, as indicated above, some companies stated they chose not to export to certain markets due to the control system and therefore lose potential sales. The discussion on the denial rate and lost sales demonstrate both the complex nature of the effects of the U.S. export control system and the difficulty in measuring its competitive effects. The remainder of this chapter pulls together the interview results in a framework designed to focus on the way the licensing system influences f i ~-m behavior. What appears to be happening regarding the competitive effects of the system is that the U.S. export control system acts as a barrier to entry for U.S. companies that want to enter international markets. Simply stated, the system increases the cost of doing business abroad. A portion of the barrier to entry cost relates to economies of scale created by the way the licensing process operates. Interviewed firms indicate economies of scale also play an important role in determining to what extent a firm can operate in different foreign markets. Different foreign markets in the context of the licensing system means COCOM, -60-

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non-COCOM West, Bloc, and PRC. Scale effects, therefore, partly explain the firm-size effects discussed in earlier chapters. There also is a different perspective between larger firms and smaller firms about how they began to comply with the export license regulations. A number of small firms interviewed stated they had for many years been exporting unaware they may have needed to receive a validated license for their type of export. A surprising number indicated their first awareness came only after their goods were seized as part of the Custom Agency's Operation Exodus. These firms then had to make the choice of investing in basic compliance procedures or foregoing foreign sales. Larger firms, while in some instances also incurring penalties due to being stopped by Operation Exodus indicated no such discrete decision to comply or withdraw. Returning to the issue of how the export license system creates entry costs, the up-front cost of compliance for a firm comes in the form of training employees, learning the regulations, developing channels of communication with the DOC, changing marketing procedures, collecting proper documentation and even educating -61-

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customers. All companies must make these basic investments if they are to comply with the export control system. Some companies/ typically smaller firms, buy the necessary knowledge and experience by hiring an outside contractor. Still, this front-end cost can be fairly high and can deter firms from even beginning the process at all. The more resources a company can afford to spend on learning the system, the better their understanding of how the process works and the more facile they become in dealing with it. An illustration of this point drawn from the interviews is that those companies that can afford to have direct, constant contact with a DOC licensing officer tended to have an advantage in terms of gaining a better understanding of license criteria or the status of pending applications over those companies whose only contact is by mail or phone. The reasons are straightforward--firms report that the phone lines at the Export Administration are often clogged and the use of the mail slows communication. The advantage of the larger firms that can afford the investment needed to closely monitor their license applications manifests itself most obviously in shorter processing times for license applications. (See the data on average processing time in the NAS -62-

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Questionnaire results and also Chapter III.) Interviewed firms consistently supported the view that the large firm advantage relative to smaller firms is a direct result of being able to commit more resources to working the licensing system. At some point, company management must decide what level of long-term resource commitment they are willing to make towards the export control system beyond the installation of a basic compliance system. There are four general levels of commitment to exports that can be identified for a firm. Companies typically trade at one of these levels based on the compliance cost they are able to accept.66 In turn, the level Dictates which markets are available, marketing procedures, delivery schedules and so forth. The resultant company approach toward exporting influences the different potential competitive effects created by the export control system. At the lowest level are firms that export low-level technology goods only to COCOM-member countries. Typically, these firms are small and relatively new to 66Compliance cost here means not only direct administrative costs but also the overall ability of the firm to operate the licensing system. -63-

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exporting or are trying for the first time to establish a foreign sales base. By limiting its trade to this category, a company will incur a relatively low cost of compliance but, in turn , its markets and products are restricted. The maj or front-end investment these companies must make is that of learning the regulations and learning how to fill out the application form properly--including proper class) f ication 0 f the product and accompanying documentation. The interviewed firms that were new to the system indicated even these basic tasks were difficult because the regulations are extraordinarily difficult to understand without outside assistance. The on-going resource commitment at this basic level is relatively low because processing time for licenses is fairly predictable and therefore does not require extensive follow up once the firm successfully understands the basic way the system operates. If a firm wants to trade at a higher level of technology and/or with non-COCOM free-worId destinations, then the interviewed fibrous indicated that a significantly greater resource commitment to compliance is required. In other words, the initial entry cost and on-going resource commitments are higher and economies of scale become more -64-

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important. The companies explained that economies of scale become a factor because firms need to support the cost associated with learning more about the system with more trade and the more the company knows, the easier it is to work an increased trade volume through the license system. One of the most often identified costs of engaging in non- COCOM free-world trade is the unpredictability associated with license applications that require interagency review. According to the interviewed firms, the higher costs result from the difficulty in getting reliable information on the status of their license applications and inability to accurately predict how long processing will take. Most of the companies interviewed stated they received very little information on the status of a license once it entered the interagency review stage. One exporter described the interagency review process as a "black hole." Companies said that information on the status of a license was important since they needed to coordinate a complex set of activities related to production, shipment, and distribution as well as maintain communication with their customers if a license application is delayed. Beyond wanting to know what stage of processing an application is in as part of their efforts to schedule around the -65-

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approval, they also said that ~ owing the status is necessary in order to respond to application problems and avert potential delay or rejection. The difficulty of obtaining information results in an increase in the administrative cost of tracking a license application through the processing system. It is here that a Washington presence or direct channels of communication with licensing officials become important. The firms told us that status inquiries by phone are rarely successful in obtaining the information needed to adequately track and monitor the status of a license. Not only are status checks difficult to get, but processing time can vary significantly for different applications with nearly identical characteristics. As the processing time increases beyond standard times, all companies increase their resource commitment towards a given application. This form of the cost associated with non-COCOM trade is closely related to the information cost discussed above. Companies begin to send their representatives to visit agencies or start making almost daily inquiries to learn of the application status. If the processing continues to be delayed, frequently senior -66-

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company executives may become involved, or a Congressman, or, in the case of foreign firms, their embassy officials. The unpredictability of processing time is an inherent element in the U.S. export licensing system in this category of trade. The result is that the U.S. licensing system may not be the deciding factor in a transaction decision, but it can be the pacing factor. Companies reported that the U.S. reputation as reliable suppliers is damaged by long processing times. The firms explained that a reliable supplier is a company that will deliver on time, without unexpected delays. Foreign customers want supply schedules they can plan around and to that end some interviewed companies report their customers are beginning to put contingency statements for license approvals into contracts. The benefits associated with engaging in trade at this level depend to a significant degree on a firms' potential volume of foreign business. Economies of scale allowed the larger firms interviewed to participate at this level to a greater extent than smaller firms. The larger firms can afford the resource commitment required because of their volume of export. -67-

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The largest exporters interviewed indicated a third level of resource commitment. At this level, companies cover the policy side of the system in addition to the administrative side. The educational emphasis switches from the company learning the system to the company educating the Export Administration or other agencies about particular products and problems. The companies are willing to incur the costs of trying to modify the system. They have representatives on the Commerce Department Technical Advisory Committees, or work for special legislation or participate in other policy level activities. The final level is for those firms that engage in Bloc trade. As noted in Chapter IV, many U.S. companies have essentially written off trade with the Bloc because the cost of working with the licensing system is too high. Companies consistently report that East-West trade is very different from West-West trade. When asked about processing times, experiences with the license system or customer relations, they specify that their response depends on whether the question applies to East-West or West-West trade. According to the NAS Survey, processing time for Bloc applications is three times longer than for -68-

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free-worId applications and only a third of the respondents export to the Bloc. These responses confirm information obtained from the interviews that the potential volume of trade to the East Bloc is too small for many firms to support the cost of engaging the control system at this level. -69- .