Global Production, Outsourcing, and Logistics

Global Production, Outsourcing, and Logistics
14 chapter Global Production, Outsourcing, and Logistics McGraw-Hill/Irwin Global Business Today, 5e © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

Chapter 14: Global Production, Outsourcing, and Logistics
INTRODUCTION Where in the world should productive activities be located? What should be the long-term strategic role of foreign production sites? Should the firm own foreign production activities, or is it better to outsource those activities to independent vendors? 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? Should the firm manage global logistics itself, or should it outsource the management to enterprises that specialize in this activity?

STRATEGY, PRODUCTION, AND LOGISTICS How can production and logistics 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.

The objectives of the production and logistics function are to lower costs and increase product quality by eliminating defective products from both the supply chain and the manufacturing process These two objectives are interrelated

There are three ways in which improved quality control reduces costs: productivity increases because time is not wasted manufacturing poor quality products that cannot be sold increased product quality means lower re-work and scrap costs greater product quality means lower warranty and re-work costs

The main management technique that companies are utilizing to boost their product quality is 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 Some countries have also promoted specific quality guidelines The European Union requires that the quality of a firm’s manufacturing processes and products be certified under a quality standard known as ISO 9000 before the firm is allowed access to the European marketplace

Two other objectives are important for international companies: 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

WHERE TO PRODUCE There are three factors that should be when making a location decision: country factors technological factors product factors Internet Extra: The World Factbook offers very detailed guides on countries and is a great starting place to explore the relative merits of different countries as investment destinations. Create a fictitious product and market. Then go to the site { Click on the countries you are interested in exploring. Then identify various relevant factors such as government or transportation. Develop a ranking system to help you identify the best location to produce your product.

Country Factors Country factors suggest that a firm should locate it various manufacturing activities in those locations where economic, political, and cultural conditions, including relative factor costs, are most conducive to the performance of that activity Regulations affecting FDI and trade can significantly affect the appropriateness of specific countries, as can expectations about future exchange rate changes 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? 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.

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: the level of fixed costs its minimum efficient scale its flexibility

Fixed Costs In some cases the fixed costs of setting up a manufacturing plant are so high that a firm must serve the world market from a single location or from a very few locations

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

Flexible Manufacturing and Mass Customization The term 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

Flexible manufacturing technologies allow a company to 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 suit the needs of different customer groups without bearing a cost penalty

Flexible machine cells (grouping of various types of machinery, a common materials handler, and a centralized cell controller) are another common flexible manufacturing technology Adopting flexible manufacturing technologies can help improve the competitive position of firms by allowing the firm to customize products to different national markets in accordance with demands for local responsiveness

Summary 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 Concentrating production at a few choice locations is not as compelling when: both fixed costs and the minimum efficient scale of production are relatively low appropriate flexible manufacturing technologies are not available

Product Factors Two product factors impact location decisions: 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.

whether the product serves universal needs (needs that are the same everywhere) Since there are few national differences in consumer taste and preference for such products, the need for local responsiveness is reduced, increasing the attractiveness of concentrating manufacturing in a central location.

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

The appropriate strategic choice is determined by various country, technological, and product factors.

Classroom Performance System Decentralized production will be favored when There are substantial differences in political economy Fixed costs are high The product’s value-to-weight ratio is high Exchange rates are volatile Classroom Performance System Answer: d

Classroom Performance System Firms will prefer concentrated production when Minimum efficient scale is high Location externalities are not important The product does not serve universal needs There are few trade barriers Classroom Performance System Answer: a

THE STRATEGIC ROLE OF FOREIGN FACTORIES The strategic role of foreign factories and the strategic advantage of a particular location can change over time. A factory initially established to make a standard product to serve a local market, or to take advantage of low cost inputs, can evolve into a facility with advanced design capabilities As governmental regulations change and/or countries upgrade their factors of production the strategic advantage of a particular location can change

As the strategic role of a factory is upgraded and a firm develops centers of excellence in different locations worldwide, it 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 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 plans 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? 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?

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

The Advantages of Make Vertical integration (making component parts in-house): is associated with lower costs facilitates investments in highly specialized assets protects proprietary technology facilitates the scheduling of adjacent processes

Lowering Costs If the firm is more efficient at that a production activity than any other enterprise, it may pay a firm to continue manufacturing a product or component part in-house

Facilitating Specialized Investments 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

Classroom Performance System Which of the following is not one of the key factors that influence the decision of where to produce? Country factors Competitors factors Technological factors Product factors Classroom Performance System Answer: b

Protecting Proprietary Product Technology A firm might prefer to make component parts that contain proprietary technology in-house in order to maintain control over the technology Improving Scheduling The weakest argument for vertical integration is that the resulting production cost savings make planning, coordination, and scheduling of adjacent processes easier 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? 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? 3. In the future do you believe that Boeing will be doing more or less outsourcing? Justify your answer.

The Advantages of Buy Buying component parts from independent suppliers: gives the firm greater flexibility helps drive down the firm's cost structure helps the firm to capture orders from international customers

Strategic Flexibility The greatest advantage of buying component parts from independent suppliers is that 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 might alter the attractiveness of various supply sources over time

Lower Costs Firms that buy components from independent suppliers can 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

Offsets Outsourcing can help firms capture more orders from suppliers’ countries Trade-Offs The benefits of manufacturing components in-house are greatest when: highly specialized assets are involved when vertical integration is necessary for protecting proprietary technology when the firm is more efficient than external suppliers at performing a particular activity.

Strategic Alliances with Suppliers Firms have tried to capture some of the benefits of vertical integration, without encountering the associated organizational problems, by entering into long-term strategic alliances with key suppliers While such alliances can help the firm to capture the benefits associated with vertical integration firms may find their strategic flexibility limited by commitments to alliance partners

Classroom Performance System Buying from independent suppliers offers all of the following advantages except It gives the firm greater flexibility It helps drive down the firm's cost structure It protects proprietary property It helps the firm to capture orders from international customers Classroom Performance System Answer: c

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 logistics function is complicated in an international business by factors such as distance, time, exchange rates, and customs barriers Efficient logistics can have a major impact upon a firm's bottom line

The Power of Just-in-Time (JIT) The basic philosophy behind 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 to spot defective parts and take them out of the manufacturing process and boost product quality

The Role of Information Technology and the Internet Web-based information systems play a crucial role in materials management. EDI: facilitates the tracking of inputs allows the firm to optimize its production schedule allows the firm and its suppliers to communicate in real time eliminates the flow of paperwork between a firm and its suppliers

CRITICAL THINKING AND DISCUSSION QUESTIONS 1. An electronics firm is considering how best to supply the world market for microprocessors used in consumer and industrial electronic products. A manufacturing plant cost approximately $500 million to construct and requires a highly skilled work force. The total value of the world market for this product over the next 10 years is estimated to be between $10 and $15 billion. The tariffs prevailing in this industry are currently low. What kind of manufacturing strategy do you think the firm should adopt - concentrated or decentralized? What kind of location(s) should the firm favor for its plant(s)? Answer: The firm should pursue a concentrated manufacturing because (1) the tariffs prevailing in the industry are low, (2) the cost of building a plant to produce the microprocessors is high, and (3) the product's value-to-weight ratio is high. All of these factors favor a concentrated vs. a decentralized manufacturing strategy. In terms of location, the company should consider three factors: country factors, technology factors, and product factors. First, in terms of country factors, the firm should locate its plant in a country that has a highly skilled pool of workers available. That criterion probably limits the firm to developed nations. Second, in terms of technology factors, the firm is compelled to limit the number of its manufacturing facilities because of the high cost of constructing a plant. Third, in terms of product factors, the firm can manufacturer its product in a central location due to the relatively high value-weight ratio and the universal appeal of the product.

CRITICAL THINKING AND DISCUSSION QUESTIONS 2. A chemical firm is considering how best to supply the world market for sulfuric acid. A manufacturing plant costs approximately $20 million to construct and requires a moderately skilled work force. The total value of the world market for this product over the new 10 years is estimated to be between $20 and $30 billion. The tariffs prevailing in this industry are moderate. Should the firm favor concentrated manufacturing or decentralized manufacturing? What kind of location(s) should the firm seek for its plant(s)? Answer: This question is a tougher call than the scenario depicted in Question #1. The firm should probably pursue a limited decentralized manufacturing strategy (meaning that the firm should not set up a plant in every country that it sells to, but should set up plants in several "regions" of the world). This strategy makes sense because (1) The tariffs prevailing in the industry are moderate (rather than low), (2) the cost of constructing a facility is relatively modest ($20 million), and (3) only a moderately skilled work force is needed (which is probably available in many low-cost regions of the world). The firm should select its location based on country factors, technology factors and product factors. In terms of country factors, the firm should find locations where semi-skilled labor is inexpensive. In terms of technology factors, the firm is not constrained by a high fixed costs associated with its product, so technology is not a pervasive issue. Finally, product factors favor the firm locating in several locations throughout the world. The company's product has a low value-weight ratio, making it unattractive to produce the product in a central location and export it across the world.

CRITICAL THINKING AND DISCUSSION QUESTIONS 3. A firm must decide whether to make a component part in-house or to contract it out to an independent supplier. Manufacturing the part requires a nonrecoverable investment in specialized assets. The most efficient suppliers are located in countries with currencies that many foreign exchange analysts expect to appreciate substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house and (b) outsourcing manufacture to an independent supplier? Which option would you recommend? Why? Answer: Manufacturing in-house would reduce the risk of currency appreciation and rising costs from independent suppliers. Specialized asset investment would make firm dependent on specific suppliers, however, technological know-how would be protected, and improved scheduling would be available. Out-sourcing would be beneficial if the product using the component fails in the market because the supplier will bear the cost of the non-recoverable investment, and flexibility in case a better component can be designed or bought would be preserved. Outsourcing would also lower organizational and coordination costs. Based on what we know, manufacturing in house may be slightly preferred, but other information could tip the decision the other way.

CRITICAL THINKING AND DISCUSSION QUESTIONS 4. Explain how an efficient materials management function can help an international business compete more effectively in the global marketplace. Answer: Given the complexity involved in coordination of material and product flows in a multinational enterprise (purchases, currency exchange, inbound and outbound transportation, production, inventory, communication, expediting, tariffs and duties), a materials management function can help to assure that these flows take place in the most efficient manner possible. A related advantage is that by having a materials management function, a firm may obtain improved information about the costs of different transport alternatives, and choose to reconfigure some of its flows to better take advantage of these costs. By being better able to utilize just in time techniques, the cost of production can be lowered while the quality is increased. The materials management function can also help an international business to develop information technology systems that allow it to better track the flow of goods throughout the firm.

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