International Business Strategy, Management & the New Realities by Cavusgil, Knight & Risenberger Chapter 16 Global Sourcing

Global Sourcing—Drug Trials 40% of drug trials done in emerging markets (Russia, India & China) Lower costs to recruit doctors and patients Large potential & diverse populations Less likelihood patients are taking other meds $900M to bring a drug to mkt; ½ for testing 40% of trial budget for patient recruitment Drug trial costs $30,000/patient in U.S. vs. $3,000 in Romania Ethical Questions (Oversight issues)

40% of drug trials done in emerging markets (Russia, India & China)

Lower costs to recruit doctors and patients

Large potential & diverse populations

Less likelihood patients are taking other meds

$900M to bring a drug to mkt; ½ for testing

40% of trial budget for patient recruitment

Drug trial costs $30,000/patient in U.S. vs. $3,000 in Romania

Ethical Questions (Oversight issues)

Global Sourcing: Shopping the World Athletic shoe firms are best described as brand owners and marketers, not as manufacturers. Apple Computer sources 70% of its production abroad and focuses on its internal core competencies Dell relies on a global manufacturing network, composed largely of independent suppliers.

Athletic shoe firms are best described as brand owners and marketers, not as manufacturers.

Apple Computer sources 70% of its production abroad and focuses on its internal core competencies

Dell relies on a global manufacturing network, composed largely of independent suppliers.

Drivers of Global Sourcing Technological advances Widespread access to vast information including growing connectivity between suppliers and the customers Declining communication and transportation costs Entrepreneurship and rapid economic transformation in emerging markets.

Technological advances

Widespread access to vast information including growing connectivity between suppliers and the customers

Declining communication and transportation costs

Entrepreneurship and rapid economic transformation in emerging markets.

Decision 1: Outsource or Not? Managers must decide whether each value-adding activity should be conducted in-house or by an independent supplier. Known as the ‘ make or buy’ decision Internalize core competence or activities you want to control

Managers must decide whether each value-adding activity should be conducted in-house or by an independent supplier.

Known as the ‘ make or buy’ decision

Internalize core competence or activities you want to control

Business Process Outsourcing (BPO) Business Process Outsourcing (BPO) . The outsourcing of business functions to independent suppliers such as accounting, payroll, and human resource functions, IT services, customer service, and technical support. Back-office activities Front-office activities

Business Process Outsourcing (BPO) . The outsourcing of business functions to independent suppliers such as accounting, payroll, and human resource functions, IT services, customer service, and technical support.

Back-office activities

Front-office activities

Captive Sourcing Captive sourcing refers to sourcing from the firm's own production facilities located abroad. Production is carried out at a foreign facility that results from the focal firm's FDI activities.

Captive sourcing refers to sourcing from the firm's own production facilities located abroad. Production is carried out at a foreign facility that results from the focal firm's FDI activities.

Most Popular

These decisions depend largely on the strategic importance of the particular activity to the firm

Who’s the more popular global source? INDIA or CHINA China—Manufacturing Large amount of skilled, low cost labor 350,000 engineers graduate each year Huge domestic market with rapid, sustainable growth Government attitude changing toward probiz Weak on IP Language and culture are challenging Lacks quality infrastructure Government bureaucracy India—Services (e.g., backshop)

China—Manufacturing

Large amount of skilled, low cost labor

350,000 engineers graduate each year

Huge domestic market with rapid, sustainable growth

Government attitude changing toward probiz

Weak on IP

Language and culture are challenging

Lacks quality infrastructure

Government bureaucracy

India—Services (e.g., backshop)

The 2005 Offshore Location Attractiveness Index by A.T. Kearney Identifies 9 emerging markets in its list of the 10 most attractive offshoring suppliers: India, China, Malaysia, Philippines, Singapore, Thailand, Czech Republic, Chile, Canada, and Brazil. In addition to Canada, the other advanced economy in the top 20 destinations is the U.S. (11 th ). The index emphasizes various criteria: Country’s financial structure (compensation costs, infrastructure costs, tax and regulatory costs); Availability and skills of people (cumulative business-process experience and skills, labor force availability, education and language, and worker attrition); and Nature of the business environment (the country’s political and economic environment, physical infrastructure, cultural adaptability, and security of intellectual property).

Identifies 9 emerging markets in its list of the 10 most attractive offshoring suppliers: India, China, Malaysia, Philippines, Singapore, Thailand, Czech Republic, Chile, Canada, and Brazil.

In addition to Canada, the other advanced economy in the top 20 destinations is the U.S. (11 th ).

The index emphasizes various criteria:

Country’s financial structure (compensation costs, infrastructure costs, tax and regulatory costs);

Availability and skills of people (cumulative business-process experience and skills, labor force availability, education and language, and worker attrition); and

Nature of the business environment (the country’s political and economic environment, physical infrastructure, cultural adaptability, and security of intellectual property).

Benefits of Global Sourcing Cost efficiency is the traditional rationale for sourcing abroad. The firm takes advantage of ‘ labor arbitrage ’ ─ the large wage gap between advanced economies and emerging markets. One study found that firms expect to save an average of more than 40% off baseline costs as a result of offshoring. These savings tend to occur particularly in R&D, product design activities, and back-office operations such as accounting and data processing.

Cost efficiency is the traditional rationale for sourcing abroad. The firm takes advantage of ‘ labor arbitrage ’ ─ the large wage gap between advanced economies and emerging markets.

One study found that firms expect to save an average of more than 40% off baseline costs as a result of offshoring.

These savings tend to occur particularly in R&D, product design activities, and back-office operations such as accounting and data processing.

Strategic Benefits of Global Sourcing Faster corporate growth. Access to qualified personnel abroad. Improved productivity and service. Business process redesign. Increased speed to market. Access to new markets. Technological flexibility. Improved agility by shedding unnecessary overhead.

Faster corporate growth.

Access to qualified personnel abroad.

Improved productivity and service.

Business process redesign.

Increased speed to market.

Access to new markets.

Technological flexibility.

Improved agility by shedding unnecessary overhead.

Challenges in Global Sourcing Vulnerability to exchange rate fluctuations Partner selection, qualification, and monitoring costs Increased complexity of managing a worldwide network of production locations and partners Complexity of managing global supply chain Limited influence over the manufacturing processes of the supplier Potential vulnerability to opportunistic behavior or actions in bad faith by suppliers Constrained ability to safeguard intellectual assets

Vulnerability to exchange rate fluctuations

Partner selection, qualification, and monitoring costs

Increased complexity of managing a worldwide network of production locations and partners

Complexity of managing global supply chain

Limited influence over the manufacturing processes of the supplier

Potential vulnerability to opportunistic behavior or actions in bad faith by suppliers

Constrained ability to safeguard intellectual assets

Facilitating Firms are also Responsible for Global Sourcing Networks of supply-chain hubs and providers of global delivery service are an integral part of global supply chains. Many focal firms delegate supply-chain activities to DHL, FedEx, TNT, and UPS. Consulting firms that manage the logistics of other firms are called third party logistics providers (3PLs) . Using a 3PL is best when: firms that produce at low volumes lack the resources and the expertise to create their own logistics network.

Networks of supply-chain hubs and providers of global delivery service are an integral part of global supply chains.

Many focal firms delegate supply-chain activities to DHL, FedEx, TNT, and UPS.

Consulting firms that manage the logistics of other firms are called third party logistics providers (3PLs) . Using a 3PL is best when:

firms that produce at low volumes

lack the resources and the expertise to create their own logistics network.

Supply Chain Management has Become Sophisticated Physically delivering a product to an export market may account for as much as 40% of total cost. Experienced firms make optimal use of information and communications technology (ICT), which streamlines supply chains, reducing costs and increasing distribution efficiency. Electronic Data Interchange (EDI) pass orders directly from customers to suppliers automatically through a sophisticated ICT platform. Tesco greatly reduced inventory costs by using an EDI system to link point-of-sale data to logistics managers.

Physically delivering a product to an export market may account for as much as 40% of total cost.

Experienced firms make optimal use of information and communications technology (ICT), which streamlines supply chains, reducing costs and increasing distribution efficiency.

Electronic Data Interchange (EDI) pass orders directly from customers to suppliers automatically through a sophisticated ICT platform.

Tesco greatly reduced inventory costs by using an EDI system to link point-of-sale data to logistics managers.

Transportation modes International logistics typically involves multiple transportation modes . Land transportation is conducted via highways and railroads. Ocean transportation is handled through large container ships. Air transportation involves commercial or cargo aircraft. Ocean and air transport are common in IB because of long shipping distances. Ships are the most common transportation mode. Sea transport was revolutionized by the development of 20- and 40-foot shipping containers Cost-effective because one ship can carry thousands of these containers at a time.

International logistics typically involves multiple transportation modes .

Land transportation is conducted via highways and railroads.

Ocean transportation is handled through large container ships.

Air transportation involves commercial or cargo aircraft.

Ocean and air transport are common in IB because of long shipping distances. Ships are the most common transportation mode.

Sea transport was revolutionized by the development of 20- and 40-foot shipping containers

Cost-effective because one ship can carry thousands of these containers at a time.

Risks in Global Sourcing 1. Less-than-expected cost savings . Conflicts and misunderstandings arise because of differences 2. Environmental factors . Environmental challenges e.g., exchange rate fluctuations, labor strikes, adverse macro-economic events, high tariffs and other trade barriers, and high energy and transportation costs. 3. Weak legal environment . Many popular locations have weak laws and enforcement regarding intellectual property, which can lead to erosion of key strategic assets.

1. Less-than-expected cost savings . Conflicts and misunderstandings arise because of differences

2. Environmental factors . Environmental challenges e.g., exchange rate fluctuations, labor strikes, adverse macro-economic events, high tariffs and other trade barriers, and high energy and transportation costs.

3. Weak legal environment . Many popular locations have weak laws and enforcement regarding intellectual property, which can lead to erosion of key strategic assets.

Risks in Global Sourcing (cont.) 4. Risk of creating competitors . As firms share its intellectual property and business-process knowledge with foreign suppliers 5. Inadequate or low-skilled workers . Employees may lack KSAs or high rapid turnover of skilled employees.

4. Risk of creating competitors . As firms share its intellectual property and business-process knowledge with foreign suppliers

5. Inadequate or low-skilled workers . Employees may lack KSAs or high rapid turnover of skilled employees.

Risks in Global Sourcing (cont.) 6. Over-reliance on suppliers . Unreliable suppliers may put earlier work aside when they gain a more important client. 7. Erosion of morale and commitment among home-country employees . Global sourcing can create a situation in which employees are caught in the middle between their employer and their employer’s clients.

6. Over-reliance on suppliers . Unreliable suppliers may put earlier work aside when they gain a more important client.

7. Erosion of morale and commitment among home-country employees . Global sourcing can create a situation in which employees are caught in the middle between their employer and their employer’s clients.

Strategies for Minimizing Risk in Global Sourcing Firms ought to go offshore for the right reasons . The best rationale is strategic. Cost-cutting is often a distraction from more beneficial, long-term goals such as enhancing the quality of offerings, improving overall productivity, and freeing up knowledge workers and other core resources that can be redeployed to improve long-term performance. Need to get employees on board . Global sourcing tends to invite opposition from employees and other organizational stakeholders. Disaffected middle managers can undermine projects. Poorly planned sourcing projects can create unnecessary tension and harm employee morale.

Firms ought to go offshore for the right reasons . The best rationale is strategic. Cost-cutting is often a distraction from more beneficial, long-term goals such as enhancing the quality of offerings, improving overall productivity, and freeing up knowledge workers and other core resources that can be redeployed to improve long-term performance.

Need to get employees on board . Global sourcing tends to invite opposition from employees and other organizational stakeholders. Disaffected middle managers can undermine projects. Poorly planned sourcing projects can create unnecessary tension and harm employee morale.

Strategies for Minimizing Risk in Global Sourcing (cont.) 3. Choose between a captive operation and a contract with outside specialists carefully . Strike the right balance between the organizational activities that it retains inside the firm, and those that are sourced from outside. 4. Choose countries and suppliers carefully . A common reason for global sourcing failure is that both buyers and suppliers tend not to spend enough time upfront to get to know each other well.

3. Choose between a captive operation and a contract with outside specialists carefully . Strike the right balance between the organizational activities that it retains inside the firm, and those that are sourced from outside.

4. Choose countries and suppliers carefully . A common reason for global sourcing failure is that both buyers and suppliers tend not to spend enough time upfront to get to know each other well.

Strategies for Minimizing Risk in Global Sourcing (cont.) 5. The focal firm needs to invest in supplier development and collaboration . The parties need to exchange information, transfer knowledge, troubleshoot, coordinate, and monitor.

5. The focal firm needs to invest in supplier development and collaboration . The parties need to exchange information, transfer knowledge, troubleshoot, coordinate, and monitor.

Strategies for Minimizing Risk in Global Sourcing (cont.) Managers need to proactively safeguard interests: Encourage the supplier to refrain from engaging in potentially destructive acts that jeopardize the firm’s reputation. Escalate commitments by making partner-specific investments (such as sharing knowledge with the supplier), allowing for ongoing review, learning, and adjustment. Share costs and revenues by building a stake for the supplier so that, in case of failure to conform to expectations, the supplier also suffers costs or foregoes revenues. Maintain flexibility in selecting partners by keeping options open to find alternative partners. Hold the partner at bay by withholding access to IP and key assets, in order to safeguard the firm’s interests for the long term. If conflicts with the supplier become an ongoing problem, one option for the firm is to acquire full or partial ownership of the supplier.

Managers need to proactively safeguard interests:

Encourage the supplier to refrain from engaging in potentially destructive acts that jeopardize the firm’s reputation.

Escalate commitments by making partner-specific investments (such as sharing knowledge with the supplier), allowing for ongoing review, learning, and adjustment.

Share costs and revenues by building a stake for the supplier so that, in case of failure to conform to expectations, the supplier also suffers costs or foregoes revenues.

Maintain flexibility in selecting partners by keeping options open to find alternative partners.

Hold the partner at bay by withholding access to IP and key assets, in order to safeguard the firm’s interests for the long term. If conflicts with the supplier become an ongoing problem, one option for the firm is to acquire full or partial ownership of the supplier.

Potential Harm to Economies from Global Sourcing Critics of global sourcing point to three major problems: Global sourcing can result in: Job losses in the home country, Reduced national competitiveness, and Declining standards of living. As more tasks are performed at lower cost with comparable quality in other countries, high-wage countries will eventually lose their national competitiveness. Critics fear that long-held knowledge and skills will eventually drain away to other countries, and the lower wages paid abroad to perform jobs that were previously done in high-wage countries will eventually pull down wages in the latter countries, leading to lower living standards.

Critics of global sourcing point to three major problems: Global sourcing can result in:

Job losses in the home country,

Reduced national competitiveness, and

Declining standards of living.

As more tasks are performed at lower cost with comparable quality in other countries, high-wage countries will eventually lose their national competitiveness.

Critics fear that long-held knowledge and skills will eventually drain away to other countries, and the lower wages paid abroad to perform jobs that were previously done in high-wage countries will eventually pull down wages in the latter countries, leading to lower living standards.

Effects on Local Community: A Case Study Electrolux, one of the world’s largest appliance makers, closed its factory in Michigan and moved production to Mexico. The company had been producing refrigerators in Greenville, Michigan, for nearly 40 years, providing 2,700 jobs. From the company's viewpoint, closing the plant made economic sense. It had weak financial performance and costly labor. By establishing a Maquiladora plant in Juarez, Mexico, Electrolux sought to profit from low wages and take advantage of the El Paso Foreign Trade Zone. From the local community's standpoint, however, the decision was devastating. How could so many jobs be replaced in such a small community? What would happen to the town’s social and economic landscape? Assistance from labor unions and the State of Michigan were to no avail. Concessions from the labor union, and over $100 million from Michigan to Electrolux in tax breaks and grants were insufficient. It did not help that Electrolux -- a Swedish company -- was perceived as having little loyalty to the community.

Electrolux, one of the world’s largest appliance makers, closed its factory in Michigan and moved production to Mexico. The company had been producing refrigerators in Greenville, Michigan, for nearly 40 years, providing 2,700 jobs.

From the company's viewpoint, closing the plant made economic sense. It had weak financial performance and costly labor. By establishing a Maquiladora plant in Juarez, Mexico, Electrolux sought to profit from low wages and take advantage of the El Paso Foreign Trade Zone.

From the local community's standpoint, however, the decision was devastating. How could so many jobs be replaced in such a small community? What would happen to the town’s social and economic landscape?

Assistance from labor unions and the State of Michigan were to no avail. Concessions from the labor union, and over $100 million from Michigan to Electrolux in tax breaks and grants were insufficient. It did not help that Electrolux -- a Swedish company -- was perceived as having little loyalty to the community.

Can Jobs Offshored be Replaced? Proponents of global sourcing argue that workers who lose their jobs due to offshoring can find new work. Redeployment assumption may be overly optimistic. It takes considerable time for laid-off workers to find new jobs. According to one estimate, as much as 1/3 of U.S. workers who have been laid off cannot find suitable employment within a year. Even workers who do find new jobs may be unable to achieve wages and work levels that equal those of their former positions.

Proponents of global sourcing argue that workers who lose their jobs due to offshoring can find new work.

Redeployment assumption may be overly optimistic. It takes considerable time for laid-off workers to find new jobs.

According to one estimate, as much as 1/3 of U.S. workers who have been laid off cannot find suitable employment within a year.

Even workers who do find new jobs may be unable to achieve wages and work levels that equal those of their former positions.

Ethical and Social Implications of Global Sourcing The prevalence of global sourcing has also raised public debate about the role of MNEs in protecting the environment, promoting human rights, and improving labor practices and working conditions. The bar for global corporate citizenship has been raised. Consider the case of foreign suppliers that operate sweatshops -- factories in which people may work long hours for very low wages, often in harsh conditions. Sweatshops may employ child labor, a practice that has been outlawed in much of the world.

The prevalence of global sourcing has also raised public debate about the role of MNEs in protecting the environment, promoting human rights, and improving labor practices and working conditions.

The bar for global corporate citizenship has been raised.

Consider the case of foreign suppliers that operate sweatshops -- factories in which people may work long hours for very low wages, often in harsh conditions.

Sweatshops may employ child labor, a practice that has been outlawed in much of the world.

The Case for and against Sweatshops Those who defend moving production to low-wage facilities abroad point to: lower standard of living as an explanation for the low wages, and argue that their operations benefit the community by providing needed jobs. The choice for local workers is often between low-paid work or no work at all. Alternatives are even less desirable, such as poverty, prostitution, and social problems. Opponents also argue that corporations that sell their products in wealthy countries have a responsibility to pay their workers according to basic Western standards, especially when their products command high prices in advanced-economy markets. Foreign companies that establish factories destroy the pre-existing agricultural market that may have provided a better life for laborers. (Family structure)

Those who defend moving production to low-wage facilities abroad point to:

lower standard of living as an explanation for the low wages, and argue that their operations benefit the community by providing needed jobs. The choice for local workers is often between low-paid work or no work at all.

Alternatives are even less desirable, such as poverty, prostitution, and social problems.

Opponents also argue that corporations that sell their products in wealthy countries have a responsibility to pay their workers according to basic Western standards, especially when their products command high prices in advanced-economy markets.

Foreign companies that establish factories destroy the pre-existing agricultural market that may have provided a better life for laborers. (Family structure)

Potential Benefits to National Economy First , by reconfiguring value chains to the most cost-efficient locations, companies reduce their production costs and enhance their performance. Second , cost reductions and enhanced competitiveness allow firms to reduce the prices that they charge their customers. Third , by leveraging a flexible labor market and strong economic growth, countries that outsource may be able to shift their labor force to higher-value activities. This transformation has the effect of boosting the nation’s productivity and industrial efficiency. Finally , declining wages may be offset by lower prices secured for outsourced products or services. Hence global sourcing tends to indirectly increase consumers’ purchasing power and lift their living standards. (Wal-Mart)

First , by reconfiguring value chains to the most cost-efficient locations, companies reduce their production costs and enhance their performance.

Second , cost reductions and enhanced competitiveness allow firms to reduce the prices that they charge their customers.

Third , by leveraging a flexible labor market and strong economic growth, countries that outsource may be able to shift their labor force to higher-value activities. This transformation has the effect of boosting the nation’s productivity and industrial efficiency.

Finally , declining wages may be offset by lower prices secured for outsourced products or services. Hence global sourcing tends to indirectly increase consumers’ purchasing power and lift their living standards. (Wal-Mart)

Public Policy Towards Global Sourcing From a public-policy standpoint, it is impractical for a nation to adopt a unilateral policy against global sourcing. Instead of seeking to restrict global sourcing, a more appropriate role for public policy may be to mitigate the harm that it can cause. Offshoring is a process of creative destruction. It creates new advantages and opportunities, while eliminating certain types of jobs and adversely impacting particular economic sectors and segments of the population.

From a public-policy standpoint, it is impractical for a nation to adopt a unilateral policy against global sourcing.

Instead of seeking to restrict global sourcing, a more appropriate role for public policy may be to mitigate the harm that it can cause.

Offshoring is a process of creative destruction. It creates new advantages and opportunities, while eliminating certain types of jobs and adversely impacting particular economic sectors and segments of the population.

Public Policy Towards Global Sourcing (cont.) If the loss of certain jobs is inevitable as a result of offshoring, public-policy makers are better off taken some proactive actions. Examples: Guiding employment towards higher value-added jobs by stimulating innovation, for example. Keeping the cost of doing business relatively low. Through economic and fiscal policies, development of new technologies can be facilitated. (Seek FDI from foreign sources) Keeping the cost of capital needed to finance R&D relatively low. Ensuring that the nation has a strong educational system, including technical schools and well-funded universities that supply engineers, scientists, and knowledge workers. Increasing worker flexibility so that those who lose jobs can be redeployed in other positions.

If the loss of certain jobs is inevitable as a result of offshoring, public-policy makers are better off taken some proactive actions. Examples:

Guiding employment towards higher value-added jobs by stimulating innovation, for example.

Keeping the cost of doing business relatively low. Through economic and fiscal policies, development of new technologies can be facilitated. (Seek FDI from foreign sources)

Keeping the cost of capital needed to finance R&D relatively low.

Ensuring that the nation has a strong educational system, including technical schools and well-funded universities that supply engineers, scientists, and knowledge workers.

Increasing worker flexibility so that those who lose jobs can be redeployed in other positions.