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International Business 7e

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1 International Business 7e
by Charles W.L. Hill McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2 Global Production, Outsourcing and Logistics
Chapter 16 Global Production, Outsourcing and Logistics

3 Introduction International firms must answer five interrelated questions: 1. Where should production activities be located? 2. What should be the long-term strategic role of foreign production sites? 3. Should the firm own foreign production activities, or is it better to outsource those activities to independent vendors? 4. How should a globally dispersed supply chain be managed, and what is the role of Internet-based information technology in the management of global logistics? 5. Should the firm manage global logistics itself, or should it outsource the management to enterprises that specialize in this activity?

4 Strategy, Production, And Logistics
Firms need to identify how production and logistics can be conducted internationally to: lower the costs of value creation add value by better serving customer needs Production refers to activities involved in creating a product Logistics refers to the procurement and physical transmission of material through the supply chain, from suppliers to customers Production and logistics are closely linked since a firm’s ability to perform its production activities efficiently depends on a timely supply of high quality material inputs.

5 Strategy, Production, And Logistics
To lower costs, firms can: disperse production to those locations where activities can be performed most efficiently manage the global supply chain efficiently to better match supply and demand To improve quality, firms can: eliminate defective products from the supply chain and the manufacturing process Improved quality will also reduce costs These objectives are interrelated: increasing productivity because time is not wasted producing poor-quality products that cannot be sold, leading to a direct reduction in unit costs lowering rework and scrap costs associated with defective products reducing the warranty costs and time associated with fixing defective products

6 Strategy, Production, And Logistics
To increase product quality, most firms today use the Six Sigma program which aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company Six Sigma, a direct descendant of total quality management (TQM), has a goal of improving product quality In the European Union, firms must meet the standards set forth by ISO 9000 before the firm is allowed access to the European marketplace The total quality management (TQM) philosophy was developed by a number of American consultants such as W. Edwards Deming, Josephy Juran, and A. V. Feigenbaum. Deming identified a number of steps that should be included in any TQM program: Management should embrace the philosophy that mistakes, defects, and poor quality materials are not acceptable Supervisors should work more with employees and provide them with the tools they need to do the job Management should create an environment in which employees will not fear reporting problems Work standards should not only be defined as numbers or quotas, but should include some notion of quality Production process operating at Six Sigma are percent accurate. Only 3.4 defects per million units

7 Strategy, Production, And Logistics
International companies have two other important production and logistics objectives: production and logistics functions must be able to accommodate demands for local responsiveness production and logistics must be able to respond quickly to shifts in customer demand Demands for local responsiveness arise from national differences in consumer tastes and preferences, infrastructure, distribution channels, and host-government demands. Demands for local responsiveness create pressures to decentralize production activities to the major national or regional markets in which the firm does business or to implement flexible manufacturing processes that enable the firm to customize the product coming out of a factory according to the market in which it is to be sold. In recent years, time-based competition has grown more important. When consumer demand is prone to large and unpredictable shifts, the firm that can adapt most quickly to these shifts will gain an advantage.

8 Where To Produce Three factors are important when making location decisions: 1. country factors 2. technological factors 3. product factors

9 Country Factors Firms should locate manufacturing activities in those locations where economic, political, and cultural conditions, including relative factor costs, are most conducive to the performance of that activity Country factors that can affect location decisions include: the availability of skilled labor and supporting industries formal and informal trade barriers expectations about future exchange rate changes transportation costs regulations affecting FDI Management Focus: Philips in China Summary This feature describes Philips NV’s operations in China. Philips, the Dutch consumer electronics, lighting, semiconductor, and medical equipment conglomerate, has been operating factories in China since By 2002, the company had invested $2.5 billion in China and operated 23 factories there. Initially, Philips believed that it would sell a large portion of its output to the local Chinese market. However, the company quickly discovered that the low wages that make China such an attractive production location also meant that the market for its products was smaller than anticipated. Philips’ solution was to export most of its output to the United States and elsewhere. Suggested Discussion Questions 1. What makes China such an attractive production location for Philips? Are there other locations that share the same characteristics? Discussion Points: Several factors make China an attractive production location for Phillips. Perhaps the most important factor is the country’s cheap wages. In addition, the Chinese workforce is well educated, the economy is strong, and many of the company’s suppliers are doing business there. Most students will argue that at least at the moment, China is the only country that offers these particular qualities. While other countries like Mexico and India also have low cost workforces, they do not have the industrial base that is present in China. 2. Philips wants to eventually turn China into a global supply base from which its products will be exported around the world. Consider the advantages and disadvantages of this strategy. Discussion Points: Students should recognize that using China as a global supply base from which to serve the world offers several advantages to Phillips. By having a single production location, the company can capitalize on costs savings that come from economies of scale as well as the low wages in China. However, if economic, political, or other types of problems arise in the country, Phillips could be in serious trouble if it has no alternate locations to fill production gaps. Another Perspective: Students can explore the company in more depth by going to its homepage at {www.Philips.com} and clicking on “Visit Phillips Global”.

10 Technological Factors
The type of technology a firm uses in its manufacturing can affect location decisions Three characteristics of a manufacturing technology are of interest: 1. the level of fixed costs 2. the minimum efficient scale 3. the flexibility of the technology

11 Technological Factors
1. The level of fixed costs: If the fixed costs of setting up a manufacturing plant are high, it might make sense to serve the world market from a single location or from a few locations When fixed costs are relatively low, multiple production plants may be possible Producing in multiple locations allows firms to respond to local markets and reduces dependency on a single location

12 Technological Factors
2. The minimum efficient scale: The larger the minimum efficient scale (the level of output at which most plant-level scale economies are exhausted) of a plant, the more likely centralized production in a single location or a limited number of locations makes sense A low minimum efficient scale allows the firm to respond to local market demands and hedge against currency risk by operating in multiple locations

13 Technological Factors
3. The flexibility of the technology: flexible manufacturing technology or lean production covers a range of manufacturing technologies that are designed to: reduce set up times for complex equipment increase the utilization of individual machines through better scheduling improve quality control at all stages of the manufacturing process

14 Technological Factors
Firms using flexible manufacturing technologies can produce a wide variety of end products at a unit cost that at one time could only be achieved through the mass production of a standardized output Mass customization implies that a firm may be able to customize its product range to meet the demands of local markets yet still control costs Flexible machine cells allow firms to increase efficiency by improving capacity utilization and reducing work-in-progress

15 Classroom Performance System
What allows firms to increase efficiency by improving capacity utilization and reducing work-in-progress? a) mass customization b) Six Sigma technology c) ISO 9000 d) flexible machine cells The answer is d.

16 Technological Factors
Concentrating production at a few choice locations makes sense when: fixed costs are substantial the minimum efficient scale of production is high flexible manufacturing technologies are available Production in multiple locations makes sense when: both fixed costs and the minimum efficient scale of production are relatively low appropriate flexible manufacturing technologies are not available

17 Classroom Performance System
Firms should produce in multiple locations when a) fixed costs are low b) fixed costs are substantial c) the minimum efficient scale of production is high d) flexible manufacturing technologies are available The answer is a.

18 Product Factors Two product factors impact location decisions:
1. the product's value-to-weight ratio: If the value-to-weight ratio is high, it is practical to produce the product in a single location and export it to other parts of the world If the value-to-weight ratio is low, there is greater pressure to manufacture the product in multiple locations across the world 2. whether the product serves universal needs: When products serve universal needs, the need for local responsiveness falls, increasing the attractiveness of concentrating manufacturing in a central location

19 Classroom Performance System
All of the following are key factors that influence the decision of where to produce except a) country factors b) competitors factors c) technological factors d) product factors The answer is b.

20 Locating Production Facilities
There are two basic strategies for locating manufacturing facilities: 1. concentrating them in the optimal location and serving the world market from there 2. decentralizing them in various regional or national locations that are close to major markets

21 Locating Production Facilities
Table 16.1

22 Classroom Performance System
When _______, firms will favor decentralized production. a) there are substantial differences in political economy b) fixed costs are high c) the product’s value-to-weight ratio is high d) exchange rates are volatile The answer is d.

23 Classroom Performance System
Concentrated production makes sense when a) minimum efficient scale is high b) location externalities are not important c) the product does not serve universal needs d) there are few trade barriers The answer is a.

24 The Strategic Role Of Foreign Factories
The strategic role of foreign factories and the strategic advantage of a particular location can change over time Factories initially established to take advantage of low cost labor can evolve into facilities with advanced design capabilities Improvement in a facility comes from two sources: 1. pressure to lower costs or respond to local markets 2. an increase in the availability of advanced factors of production

25 The Strategic Role Of Foreign Factories
Many companies now see foreign factories as globally dispersed centers of excellence This philosophy supports the development of a transnational strategy A major aspect of a transnational strategy is a belief in global learning, or the idea that valuable knowledge does not reside just in a firm’s domestic operations, it may also be found in its foreign subsidiaries This implies that firms are less likely to switch production to new locations simply because some underlying variable like wage rates has changed

26 Outsourcing Production: Make-or-Buy Decisions
Should an international business make or buy the component parts to go into their final product? Make-or-buy decisions are important factors in many firms' manufacturing strategies Today, service firms also face make-or-buy decisions as they choose which activities to outsource and which to keep in-house Make-or-buy decisions involving international markets are more complex than those involving domestic markets Management Focus: Hewlett Packard in Singapore Summary This feature explores the strategic decision making involved in establishing Hewlett Packard’s Singapore plant. The company initially used the plant as a low cost location to manufacture electronic components. Later, entire products were produced in Singapore, Later still, the Singapore plant was involved not only in production but also product design. Today, the plant is an important part of Hewlett Packard’s global network responsible for manufacturing and also product development and design. The following questions can provide the basis for the discussion of this feature. Suggested Discussion Questions 1) What factors were important in Hewlett Packard’s initial decision to open a plant in Singapore? How did these factors contribute to the decision to increase responsibilities at the Singapore plant? Discussion Points: Hewlett-Packard initially selected Singapore as a production location because the country offered a lower cost, well-educated workforce that spoke English. In addition, the country was economically stable, and had a good infrastructure. The lower cost, well-educated workforce enabled Hewlett-Packard to reduce its manufacturing and product development costs when the company decided to assign the responsibility for redesigning its handheld calculator to its Singapore facility. The success of this assignment was such that the company has continued to ask the facility to redesign other products. 2) Today, the Singapore plant is considered to be a “lead plant” for Hewlett Packard. How can the company help the plant continue to be a key component in Hewlett Packard’s global network? Discussion Points: Many students will suggest that communication will be central to ensuring that the Singapore facility remains a lead plant for Hewlett-Packard. Already, the company has made the commitment to ensuring the Singapore facility is on the same page as the headquarters location by transferring engineers from Singapore to the United States, and back. Students will probably suggest that continuing to establish cross-border relationships and teams will be important as the company goes forward. Another Perspective: To further explore Hewlett-Packard’s international operations, go to the company’s web site at {http://www.hp.com/}.

27 The Advantages Of Make Vertical integration (making component parts in-house) can: 1. lower costs - if a firm is more efficient at that production activity than any other enterprise, it may pay the firm to continue manufacturing a product or component part in-house 2. facilitate investments in highly specialized assets - internal production makes sense when substantial investments in specialized assets (assets whose value is contingent upon a particular relationship persisting) are required to manufacture a component

28 The Advantages Of Make 3. protect proprietary technology - a firm might prefer to make component parts that contain proprietary technology in-house in order to maintain control over the technology 4. facilitate the scheduling of adjacent processes - the weakest argument for vertical integration is that the resulting production cost savings make planning, coordination, and scheduling of adjacent processes easier

29 The Advantages Of Buy Buying component parts from independent suppliers: 1. gives the firm greater flexibility By buying component parts from independent suppliers, the firm can maintain its flexibility, switching orders between suppliers as circumstances dictate This is particularly important when changes in exchange rates and trade barriers alter the attractiveness of various supply sources over time Management Focus: Outsourcing at the Boeing Company Summary This feature focuses on the process of generating "make-or-buy" decisions at Boeing. The Boeing Company is the world's largest manufacturer of commercial jet aircraft with a 60 percent share of the global market. Due to decreasing demand for its aircraft and cost constraints on the part of its buyers, Boeing has been forced to find ways to become more price competitive. One strategy that Boeing has utilized is outsourcing. The feature describes Boeing's outsourcing criteria, which involves making a determination whether it is better for Boeing to "make" or "buy" a particular component part. For Boeing this is serious business. On the one hand, Boeing does not want to take unnecessary strategic risks and become too dependent on outside suppliers for critical component parts. On the other hand, Boeing can outsource certain component parts and realize a substantial cost saving. The feature illustrates the nature of this dilemma at Boeing. Discussion of the feature can begin with the following questions. Suggested Discussion Questions 1. Describe Boeing's criteria for determining whether a component part should be "outsourced" or whether it should be manufactured in-house. Are Boeing’s criteria appropriate? Why or why not? Discussion Points: Most students will probably argue that Boeing’s criteria for its make-or-buy decisions are appropriate. The company initially looks at the basic costs involved and whether the component could be made more cheaply in-house or by an outside supplier. Next, Boeing considers the strategic risk associated with outsourcing. Then, the company considers operational risks, and finally, Boeing considers the potential for new orders if it outsources from a company located in a particular country. 2. What could go wrong with Boeing's strategy of outsourcing? Has Boeing taken the necessary precautions? Are there any hazards in the company's strategy? Discussion Points: Boeing should be aware of the risks involved with outsourcing including receiving inferior components, delivery delays, and exposure to exchange rates. In addition, Boeing must ensure that it is properly protected when making outsourcing arrangements that require highly specialized assets. 3. In the future do you believe that Boeing will be doing more or less outsourcing? Justify your answer. Discussion Points: Most students will probably suggest that the trend to outsource will continue. Given the cyclical nature of the business, it probably does not make sense for Boeing to develop in-house production capabilities for components that are readily available on open markets. Another Perspective: Boeing’s home page is available at {http://www.boeing.com}. Students can click on “Select Country” to explore the company’s global initiatives.

30 The Advantages Of Buy 2. helps drive down the firm's cost structure
Firms that buy components from independent suppliers avoid: the challenges involved with coordinating and controlling the additional subunits that are associated with vertical integration the lack of incentive associated with internal suppliers the difficulties with setting appropriate transfer prices 3. helps the firm capture orders from international customers Outsourcing can help firms capture more orders from suppliers’ countries

31 Trade-Offs The benefits of manufacturing components in-house are greatest when: highly specialized assets are involved vertical integration is necessary for protecting proprietary technology the firm is more efficient than external suppliers at performing a particular activity

32 Strategic Alliances With Suppliers
Sometimes, firms can capture the benefits of vertical integration without the associated organizational problems by forming long-term strategic alliances with key suppliers However, these commitments may actually limit strategic flexibility

33 Classroom Performance System
Which of the following is not an advantage of buying from independent suppliers? a) it gives the firm greater flexibility b) it helps drive down the firm's cost structure c) it protects proprietary property d) it helps the firm to capture orders from international customers The answer is c.

34 Managing A Global Supply Chain
Logistics encompasses the activities necessary to get materials to a manufacturing facility, through the manufacturing process, and out through a distribution system to the end user The objectives of logistics are: To manage a global supply chain at the lowest possible cost and in a way that best serves customer needs To help the firm establish a competitive advantage through superior customer service

35 The Role Of Just-in-Time Inventory
The basic philosophy behind just-in-time (JIT) systems is to economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to enter the production process, and not before JIT systems generate major cost savings from reduced warehousing and inventory holding costs JIT systems can help the firm spot defective parts and take them out of the manufacturing process to boost product quality However, a JIT system leaves the firm with no buffer stock of inventory to meet unexpected demand or supply changes

36 The Role Of Information Technology And The Internet
Web-based information systems play a crucial role in materials management They allow firms to optimize production scheduling according to when components are expected to arrive Electronic Data Interchange (EDI): facilitates the tracking of inputs allows the firm to optimize its production schedule lets the firm and its suppliers communicate in real time eliminates the flow of paperwork between the firm and its suppliers


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