Introduction
In a growing globalized world where cash flows and flows of
funds are getting more complex one would expect
businesses to be completed in seconds through electronic
transactions, which most times is also the case.
Nevertheless, the oldest form of trading and its numerous
variations regain each day their importance in international
trade. Countertrade has become an important element of
the world economy, for all countries whether industrialized,
emerging or developing since World War 2. Despite the
move towards freer trade it may be surprising to find that
barter and Countertrade (CT) are actually growing faster
than world trade. International CT is a global phenomenon
which involves interaction between parties in different
countries and links sales with purchases so that each party
to a transaction is both buyer and seller at some stage. It is
paradoxical that these forms of trade, predating the use of
money and trade finance continue to grow in importance.
Importance of countertrade and its share in the world
market is steadily increasing and it is becoming one of the
important opportunity for doing international trade. As
trade statistics only include monetary transactions an
increasing slice of world trade is being ignored in trade
analysis, economic, trade and policy decisions. Despite the
general perception that CT is more prevalent in centrally
planned economies, their transformation to more market
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based economies has not reduced the incidence of CT as
predicted. Instead more countries have come to embrace
CT. However, it would seem that although the number and
value of transactions is continuing to increase the
modalities and motivations are changing. Limited attention
has been given to the strategic possibilities for the use of
CT in the process of internationalisation.
What Is Countertrade?
Countertrade is a resourceful way to arrange for the sale of
a product from an exporter to a company in a country that
does not have the resources to pay for it in hard currency.
The problem is usually with the importer but may be with
the country's limited reserves as well. An international
credit executive who arms his salespeople with an
innovative countertrade solution gives the sales force a
competitive advantage. In some cases, the company that
cannot come up with a countertrade initiative will not be
able to sell in certain markets.
The most well-known form of countertrade is barter-the
simultaneous exchange of goods. Countertrade experts say
it is also the form least Used.
Definitions
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“International Countertrade”, C. M. Korth defines
countertrade as “a general term covering all forms of trade
whereby a seller or an assignee is required to accept goods
or services from the buyer as either full or partial payment.
The UN defines Countertrade as "commercial transactions
in which provisions are made, in one of a series of related
contracts, for payment by deliveries of goods and/or
services in addition to, or in place of, financial settlement".
Four Countertrade Strategies
The countertrade strategies of American companies may be
divided into four general types, defensive, passive, reactive,
and proactive. Defensive, passive, and reactive strategies
correspond to the company advantage policy, while
proactive strategy is derived from the mutual advantage
policy.
Defensive: Companies with a defensive countertrade
strategy ostensibly do not countertrade at all; however,
they make many countertrade-type arrangements with
buyer countries. These companies will avoid any
contractual countertrade obligations, but they make it
clear to the country that they will reciprocate in some
way for the sale. Some companies will sell their
products at rock-bottom prices and promise to help the
country with export development.
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Others participate in barter deals by having an intermediary
like an independent trader take title to the goods on each
side, therefore making the transaction appear to be
conventional import and export rather than a swap. No
matter what kind of deal is made, however, these companies
will insist that they do not countertrade. They seldom have
in-house trade units.
A variation of the defensive strategy is that of companies
that say they do not countertrade, although they do it
openly and regularly with Eastern European countries and
China. They seem to think that this trade does not count,
offering the excuse that "it's the only way to do business in
socialist countries." They may also be defining countertrade
as practice restricted to developing countries.
Incidentally, most industrial country governments that
practice military offset among themselves follow a defensive
countertrade strategy. The beneficiary countries call their
requirements "industrial benefits" and swear that they are
against countertrade; the partner countries go along with
this by refusing to include military offset in the definition of
countertrade.
Examples of companies following a defensive countertrade
strategy are Bell Helicopter, Textron, EBASCO, Gould,
and Borden.
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Passive: Companies with passive countertrade
strategies regard countertrade as a necessary evil.
They participate in countertrade at minimal level, on
an ad hoc basis. Some companies operate this way
because they have product leverage (i.e., little or no
competition), while others follow the passive strategy
because of disinterest in countertrade.
These companies will accept contractual offset and
countertrade obligations, but only on their own terms. They
will rarely obligate themselves to export development or
indirect offsets such as counterpurchases. However, they
will use countertrade for sourcing, which is a form of export
development.
Passive strategy companies regard countertrade primarily
as a form of export financing. They will not initiate
countertrade or offer it as a sales incentive; rather, they will
wait until the buyer country requests countertrade. Some of
these companies have small in-house countertrade units.
Most chemical companies and manufacturers of chemical
products have passive countertrade strategies. These
include DuPont, Dow Chemical, Cyanamid, Smith-Kline, and
the chemical divisions of Amaco and the Ethyl Corp.
Some of the defense companies with product leverage also
have passive strategies, including Lockheed-Georgia,
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Martin Marietta Aerospace, Texas Instruments, Sperry
Corp., and Singer Co. Other companies using passive
countertrade strategies are Alcoa, Polaroid, S.C. Johnson
& Sons, and Nabisco.
Reactive: This is the most common strategy among
American companies. Companies with reacting
strategies will cooperate with the buyer country in
offset/countertrade requirements, they use
countertrade strictly as a competitive tool, on the
theory that they cannot make the sale unless they
agree to countertrade.
Although they may consider countertrade as a permanent
feature of their international operations, they do not see it
as a marketing tool for expansion. Reactive companies often
have large in-house countertrade units, and use outside
trading companies when necessary. They rarely have in-
house world trading companies.
Most defense companies have reactive strategies. Among
these are the defense divisions of Litton, Grumman
International, Garrett, BMY, TRW, Perkin-Elmer,
Emerson Electric, General Dynamics, Northrop, Allied
Signal, McDonnell, Motorola, ITT, Raytheon, and LTV
Aerospace and Defense Co. Non-defence companies with
reactive countertrade strategies include Kodak, Xerox,
Dresser Industries, Chrysler, Burroughs, and IBM.
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Proactive: Companies with proactive strategies have
made a commitment to countertrade. They use
countertrade aggressively as a marketing tool, and are
interested in making trading an active and profitable
part of their business. They regard offset and
counterpurchase as an opportunity to make money
through trading, rather than as an inconvenience.
Proactive companies participate in all kinds of countertrade,
including global sourcing, releasing of blocked funds, trade
development, and trade financing. They often have in-house
world trading companies, and will sometimes liquidate
countertrade obligations for other companies.
Examples of companies with proactive countertrade
strategies include Cyrus Eaton, Occidental Petroleum,
Continental Grain, Caterpillar, Monsanto, General
Foods, Goodyear, Rockwell, General Electric, FMC,
Westinghouse, Tenneco, 3M, General Motors, Ford,
Coca-Cola, United Technologies, Pepsi-Cola, and the
civilian product divisions of McDonnell and Lockheed
Types of counter trade
Countertrade is quite simply the exchange of goods for
goods, but it is also a barrier to free trade. The simplest
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form of countertrade - barter - dates from ancient times, but
more recently various other forms of countertrade have
been used in trade between rich and not so rich countries.
Due to shortages of foreign exchange and a lack of markets
for their products, many nations have engaged in
countertrade. For example, Iraq obtained warships from
Italy in exchange for oil; Spain obtained Colombian coffee in
exchange for Spanish buses.
Countertrade is a barrier to free trade because the sellers
are obliged to take goods they would not otherwise buy, and
in doing so, they close off a market from free and open
competition.
Barter: Is the direct exchange of goods between two
parties. The advantage of
barter is its simplicity.
One disadvantage is that unless goods are swapped
simultaneously, one party is financing the other until
the exchange is complete. A second is that the goods
exchanged may not be goods one or both parties really
want, or may be ones that are difficult to convert into
cash.
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Counter purchase: The assumption by an exporter of
a transferable obligation through a separate but linked
contract to accept as full or partial payment goods and
services from the importer or importing country. The
contract usually stipulates a period during which the
counterpurchase is to be completed, and the goods and
services received in return are pre-specified, subject to
availability and to changes made by the importing
country. In essence, counterpurchase represents an
inter-temporal exchange of goods and services or the
bundling of two transactions, namely current buying
and future selling.Is a reciprocal buying agreement
(not a direct exchange of goods).
The advantage is that both parties get goods they can
use or sell. The disadvantage, however, arises when
one or both parties have to engage in a further
transaction to dispose of the goods to obtain more
useful goods.
Offset trading: Is an obligation imposed on exporters
by governments which requires local industry to be
given the role of producing goods to offset the
purchase price of expensive products.
Offset trading can be done through co-production, sub-
contracting, joint ventures, licensing or turnkey
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arrangements. The offset arrangement is common with
expensive items such as military equipment, aircraft and
ships. The principal reason for this form of countertrade is
to offset the negative effects of such large purchases on the
balance of payments of the importing country.
Offset trading offers the advantage of offsetting the balance
of payment effects for the country importing large outlay
items. The
disadvantage is that it requires the exporter to deal with a
firm in the importing country, which may not be the
exporter's preferred
Switch trading: It involves at least three parties. A
switch trade is used when the products received are of
no use to the exporter or cannot be converted to cash.
The original exporter may then barter the goods
received for other products which may be sold for
cash. This chain of transactions may be repeated a
number of times. As a result, this expands the number
of goods that may be bought and sold. Switch trading
is useful to a country with unique requirements or
goods and can open untapped markets. The
advantages in switch trading are that it enables the
parities to achieve a satisfactory outcome and expands
export markets. It is, however, sometimes difficult to
arrange and may require the services of specialist
brokers course
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Buyback or compensation trading: This is probably
the most common form of countertrade. It usually
consists of the export of a technology package, the
construction of an entire project or the provision of
services by a firm. The buyer in return pays back the
supplier by delivering a share of the output of the
project in the future. For example, in 1980 the
German, French, Italian and British governments
subsidized companies to construct a $US 4 billion
natural gas pipeline in the former Soviet Union . The
former Soviet Union paid for the project with natural
gas.
The advantage of buyback trading is that it acts as a
substitute for FDI in countries which do not welcome FDI.
The disadvantage is that few situations are amenable to this
form of countertrade.
Reasons why counter trade is used :
Money - some people cannot pay in the currency you
want
"to enable trade to take place in markets which are
unable to pay for imports. This can occur as a result of
a non-convertible currency, a lack of commercial credit
or a shortage of foreign exchange"
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The Political Environment - local jobs and industry
"to protect or stimulate the output of domestic
industries (including agriculture and mineral
extraction) and to help find new export markets"
The Political Environment - rules and regulations to
protect the host country
"as a reflection of political and economic policies which
seek to plan and balance overseas trade"
"To gain a competitive advantage over competing
suppliers."
Documentation
Never assume that the other party will perform in a certain
way when entering a countertrade arrangement. The
documentation, typically prepared by the party arranging
the transaction, should:
connect all parties together;
state the purpose of the trade;
state the responsibilities of the participants; and
summarize how the transaction will run.
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The documentation should include:
the terms of the underlying contract(s);
the requirements of each party;
any local regulations that affect the trade;
timing;
any financing requirements; and
how the arranger will receive its fee.
Adverse effect and managing risk In Countertrade
Transactions
One of the unique risks of countertrade transactions is that
companies often find themselves handling products with
which they are not familiar. This is probably the greatest
risk in a countertrade transaction.
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1. Liability for the Product on Resale
If you acquire title to the product (and even if you do not
acquire title under certain circumstances) and the product
causes damage to third parties, fails to meet the standards
normally expected for the product, or fails to meet the
warranties and/or guarantees for the product being sold,
you can find yourself liable to third parties...including your
customers and independent third parties.
As a manufacturer of a mechanical product or a supplier of
technology, to find yourself the seller of medical equipment,
consumer goods, raw materials, et cetera, for which there is
a legal claim can be a very disturbing and expensive
learning lesson.
Managing risk: The suggestion for managing the risk is do
not take title to the product; this should be obvious advice.
One suggestion is to use a trader or other intermediary who
can be responsible for the potential liability. Either they can
ensure that the product does meet the requirements of the
market or the contract, or they can better deal with the
failure by substituting alternate product, or dealing with the
claim or lawsuit.
2. Currency Risks
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There are really two main currency risks. The first is non-
convertibility, i.e. the currency will not be convertible when
received or required. As many countertrade transactions
are designed to avoid this problem, this is less of a risk than
might be expected. The second risk is that the currency will
have fluctuated in value, and that you will receive fewer
dollars than you expected.
Managing risk: The risk of non-convertibility through
government action can probably be covered by political risk
insurance. Alternatively, you could get a government
guarantee that you will be allowed to convert currency as
required. Of course this may not be much of a guarantee if
the government changes its mind or a new government is in
place, but it also might be insurable.
Currency fluctuations are often capable of being protected
by currency hedging contracts. These are possible on all
hard currencies and on many soft currencies through
specialist traders.
3. Non-Performance
This is obviously the most common risk in any transaction.
This risk may be higher in countertrade transactions, as you
are probably dealing with less developed countries and less
sophisticated sellers.
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Non-performance can take many forms, including complete
failure to deliver, late delivery, partial delivery, or delivery
of damaged, defective, or out-of-specification product.
The effect of non-performance will be different under
different contracts, and depends on the nature of the non-
performance. It can render the sale of your product
impossible, and/or failure could leave your company open to
claims or lawsuits from unhappy buyers.
Managing risk:
1) Make reasonable contracts. The most effective manner is
to ensure that the transaction works. The surest
arrangement is to deal with competent and experienced
partners. But, as we are all aware, this may be extremely
difficult in countertrade transactions, especially in
developing countries and in countries which are changing
from a centrally planned economy to a free market
economy.
A good solution is to make contracts which you are
comfortable that the other party can meet. There is no point
in forcing another party to accept a contract which you are
convinced that they cannot fulfill.
2) Use traders. Another solution is to use other parties that
are experienced in the country and/or product to handle the
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import/export of the products. In other words, use an
experienced trader.
Generally a trader can better assess and manage the risks
than an industrial company attempting to sell its product to
the third-world country. The use of third party experts will
probably assist you to avoid many risks, and will make the
transaction more likely to occur.
3) Use insurance. You may be able to insure the risk under
certain circumstances. Political risk insurance has far
broader coverage application than you might expect.
It is available to cover the failure of the seller for almost any
reason, not just failure to perform because of government
action. The insurance is generally available only for sales by
government-owned enterprises, although other similar
coverages may be available.
4) Get guarantees. If you cannot ensure that performance
will occur, you should protect yourself from the effects of
failure, as much as possible.
In general, some form of guarantee of performance is
usually prudent, these guarantees can include standby
letters of credit, performance bonds, bank guarantees, cash
deposited in an escrow account, product delivered to a
neutral party, or government guarantees, etc.
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4. Payment Risks & Creditworthiness
Payment risk is not a common risk for the countertrade
transaction, as you are purchasing, not selling product.
However, if your barter transaction requires that a short-fall
be paid in cash, there may be a payment risk. There is a
credit worthiness issue if you are required to make a claim
against the seller.
A party failing to pay because it is bankrupt or because it
doesn't want to pay, for whatever reason, is an extremely
difficult problem in an international transaction.
Managing the risk: The traditional method is to use a
letter of credit (L/C) from a reputable bank. If the (L/C) is
not from a reliable bank, it can often be confirmed by a
reliable bank. Or the L/C can be insured or discounted.
Other methods of handling this risk are to insist on security
deposits, or to require guarantees from other parties
working with the seller who are easily sued.
5. Timing Risks
Timing can be a risk in many ways. If your supplier fails to
deliver in time, you may be liable to another party who was
expecting to receive the product.
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Other timing risks impact on currency risks or payment
risks. For example, if your L/C expires before delivery, you
are not guaranteed payment. Or if your hedging expires
before delivery, you may not receive the money you
expected.
Managing the risk: This risk should be generally managed
in the same manner as non-performance. The risk of delay
impacting on your hedging contracts or your L/Cs requires
careful management of your countertrade contract.
6. Risks Arising From Government Regulations
There are several legal risks to international trade
transactions, such as anti-dumping, embargoes, quotas,
licensing, sovereign immunity and foreign corruption
a) Dumping. This occurs when a seller sells a product into
another market at prices less than the home market, or at
prices less than its cost. Often it is more difficult to obtain
the real price for the countertrade product than it is for
traditional sales.
The penalty for dumping is an "anti-dumping duty" which is
chargeable to the importer of the product. Obviously this
could have a detrimental effect on pricing and the
countertrade transaction.
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Managing the risk: The safest method of handling
dumping problems is to use a trader or to act as a broker
and have another party import the product.
If you must be involved, you should provide in your contract
that any anti-dumping duties are for the account of the
seller and should obtain security for this if it is a likely risk.
b) Quotas. These are agreed limits on the volume of
product that can be imported into a country. For example,
there might be an agreement between China and the USA in
which only 20 million items of a textile product can be
imported into the USA in any one year.
If your countertrade transaction involved the import of the
next 2 million items, you would not be allowed to import
them.
The transaction would therefore fail or be delayed until the
quota opened again in the succeeding year. If you have
already delivered your product to the Chinese importer, you
might have to wait for some time. And this could have a
negative impact on your profitability.
One of the problems with the quota system is that the
Customs Service in the importing country will simply refuse
to allow additional product to land.
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It is difficult to obtain accurate information on what
quantity has landed, and the situation can change very
quickly if new product lands between your inquiry and your
product's landing.
Managing the risk. Quotas should also be left to the seller
to obtain, as the responsibility for managing quotas rests
with the exporting country. Alternatively, you could use a
trader to avoid the risk.
c) Embargoes. Certain countries, e.g. Iraq, are subject to
embargo regulations, and any attempt to deal with products
from these countries or to deal with companies/individuals
from these countries may be a criminal offense.
Managing the risk. While you may know that you cannot
deal with Iraq or other countries subject to embargo, you
may not know, say, whether or not the company in Cyprus
(which has offered you steel from Romania) is owned by a
company in an embargoed country.
It is often extremely difficult to ensure that you are not
dealing with a restricted company.
There is no easy solution to the problem, and checking the
regulations to determine whether your partner/seller is
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subject to embargo is time consuming, and probably not
reliable.
d) Licensing. Failure to obtain a required license can mean
that your product is not exportable from a selling country,
or importable in a buying country. And this could obviously
have an extremely negative impact on your countertrade
transaction.
It is standard risk in all international trade transactions, and
there has been much litigation resulting from parties failing
to obtain licenses and determining who had the obligation
to obtain the license.
Managing the risk. In order to avoid problems with
licenses, the obligation of either of the parties to obtain the
necessary licenses must be clearly agreed to in the contract.
e) Sovereign immunity. This is not the result of
government regulation, but is a legal doctrine which
prevents lawsuits against foreign sovereigns.
In other words, you cannot sue foreign governments.
Unfortunately many foreign governments operate business
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or quasi-business operations, and sometimes these
organizations are provided with sovereign immunity.
If you deal with one of these entities and attempt to sue on
a failed transaction, you will be prevented from doing so by
most courts.
Managing the risk. A simple and expedient solution to the
problem is to ensure that the other party waives any
defense of sovereign immunity.
Countertrade Examples
1. Pepsi & Vodka
The countertrade arrangement where the rights to sell
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Russian vodka in the US in exchange for Pepsi (to be
sold in Russia) was a huge story years ago
John G. Swanhaus, Jr., vice president, Pepsi Cola Company
As president of PepsiCo Wines & Spirits International, a
major part of his responsibility was PepsiCo's supply to the
U.S. market of Stolichnaya Russian Vodka as part of a
countertrade agreement to sell Pepsi products in the Soviet
Union. Pepsi & Vodka -how did it work,
Pepsi-Cola delivers syrup that is paid for with Stolichnaya
Vodka. Pepsi has the marketing rights of all Stolichnaya
Vodka in the U.S.
Recently Pepsi has made another innovative step by taking
17 submarines, a cruiser, a frigate, and a destroyer in
payment for Pepsi products. In turn, this rag tag fleet of 20
naval vessels will be sold for scrap steel, thereby paying for
Pepsi products being moved to the Soviet Union.
Conclusion
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Countertrade commitments do not come without risk. Risk,
however, can be minimized with proper planning,
appropriate products, internal communication and an
effective protocol contract. When all aspects of a
countertrade agreement are in place, countertrade is a
great tool to create and improve international sales
Choosing a CT strategy has implications for the modalities
selected in particular the key characteristics of temporality,
commitment and company advantage. In turn the CT
strategy pursued will in part determine the contribution to
internationalisation. Such contribution can be measured
along the dimensions identified in the internationalisation
literature. Empirical evidence is supportive of a two-stage
model in which the second stage, the internationalisation
process is moderated by the choice of CT strategy. The
companies described here show wide diversity in CT used
and in their internationalisation processes. It provides a
challenge for further conceptual and empirical development
to refine the model. This paper gives initial thoughts on the
relationship between CT and internationalisation and
suggests an approach to gain further
understanding.
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INDEX
SR. NO. TOPIC
1. Introduction
2. What is counter trade?
3. Four countertrade strategies
4. Types of counter trade
5. Reasons why counter trade is used
6. Documentation
7. Adverse effect managing risk in countertrade
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8. conclusion
Project on: adverse effect of
countertrade
ROLL NO: 21 & 26
SUBJECT: international banking finance
SUBMITTED TO: kanthi MAM
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Four Countertrade Strategies
Defensive. "Companies with a defensive countertrade strategy ostensibly do not countertrade at all; however, they make many countertrade-type arrangements with buyer countries. These companies will avoid any contractual countertrade obligations, but they make it clear to the country that they will reciprocate in some way for the sale. Some companies will sell their products at rock-bottom prices and promise to help the country with export development."
Passive. "Companies with passive countertrade strategies regard countertrade as a necessary evil. They participate in countertrade at minimal level, on an ad hoc basis. Some companies operate this way because they have product leverage (i.e., little or no competition), while others follow the passive strategy because of disinterest in countertrade."
Reactive. "This is the most common strategy among American companies. Companies with reacting strategies will cooperate with the buyer country in offset/countertrade requirements, they use countertrade strictly as a competitive tool, on the theory that they cannot make the sale unless they agree to countertrade."
Proactive. "Companies with proactive strategies have made a commitment to countertrade. They use countertrade aggressively as a marketing tool, and are interested in making trading an active and profitable part of their business. They regard offset and counter purchase as an opportunity to make money through trading, rather than as an inconvenience."
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