1. International Business An Asian PerspectiveBy
Charles W.L. Hill
Chow-Hou Wee
Krishna Udayasankar
Welcome to International Business, An Asian Perspective, by Charles W.L. Hill, Chow-Hou Wee and Krishna Udayasankar

2. Global Production, Outsourcing, and Logistics
Chapter 16
Global Production, Outsourcing, and Logistics
Chapter 16: Global Production, Outsourcing, and Logistics
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

3. What Are The Main Production Issues For Firms?
International firms must answer five interrelated questions
Where should production activities be located?
What should be the long-term strategic role of foreign production sites?
Should the firm own foreign production activities or 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?
Where should a firm locate its production activities?
In today’s global world, the answer to this question could be anywhere.
Should all production be located in a single market, or is there a reason to locate different activities in different places?
What’s the long term strategic role of foreign production sites?
What factors might cause a firm to make changes in its strategy?
Should the firm outsource, or handle activities in-house?
Firms also need to decide how to manage a globally dispersed supply chain, and what the role of Internet-based information technology should be in the management of global logistics.

4. How Are Strategy, Production, And Logistics Related?
Production - activities involved in creating a product
Logistics - procurement and physical transmission of material through the supply chain, from suppliers to customers
Questions: How can production and logistics
Lower the costs of value creation?
disperse production to the most efficient locations
manage the global supply chain efficiently to better match supply and demand
Add value by better serving customer needs?
eliminate defective products from the supply chain and the manufacturing process
Let’s look at two activities in the value added chain -- production and logistics.
How can these two activities can be conducted internationally to not only lower the costs of value creation, but also to add value by better serving customer needs?
Remember that production refers to activities involved in creating a product, and that logistics refers to the procurement and physical transmission of material through the supply chain from the supplier to the customer.
The production and logistics functions of a firm have two main strategic objectives.
First, to lower costs, and second, to eliminate defective products from the supply chain and the manufacturing process.
Keep in mind that these two objectives are interrelated, so for example, a firm that improves quality control will also reduce the cost of value creation.

5. How Can Quality Be Improved?
Most firms use the Six Sigma program - a direct descendant of total quality management (TQM)
aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout the company
In the European Union, firms must meet ISO 9000 standards before gaining access to the European marketplace
Improved quality reduces costs
How do companies boost product quality?
The main technique that’s used today is the Six Sigma program which focuses on reducing defects, boosting productivity, eliminating waste, and cutting costs throughout the company.
Companies like Motorola and General Electric use this program.
You may already be familiar with the Six Sigma program or its predecessor, total quality management or TQM. TQM was popular in the 1980s and early 1990s.
In addition to Six Sigma and TQM, many countries have set quality guidelines.
The European Union for example, has established a quality standard called ISO 9000, and requires all firms to meet its standards before they’re given access to the European market.

6. How Can Quality Be Improved?
The Relationship Between Quality and Costs
Here you can see the relationship between quality and costs.

7. Where Should Production Be Located?
Firms should locate production so that
production and logistics can be locally responsive
production and logistics can respond quickly to shifts in customer demand
Firms should consider
Country factors
Technological factors
Product factors
Now let’s get back to the question we asked at the start of this discussion-- where should firms produce?
Well, firms want to locate production so that they are to be able to accommodate demands for local responsiveness and to be able to respond quickly to shifts in customer demand.
As you’ll recall from the Opening Case for example, Li & Fung help firms take advantage of the low costs of production across various global locations.
We say there are three factors that might affect the choice of production location, country factors, technological factors, and product factors.
Let’s talk about each one.

8. Why Are Country Factors Important?
Manufacturing should be located where economic, political, and cultural conditions are most conducive to the performance of that activity
Firms should consider
the availability of skilled labor and supporting industries
formal and informal trade barriers
expectations about future exchange rate changes
transportation costs
regulations affecting FDI
You’ll probably recall from our discussions in earlier chapters, that a firm should locate its manufacturing activities where economic and cultural conditions, including relative factor costs, are most conducive to the performance of that activity.
In other words, a firm should produce its product where ever it makes the most sense.
There are several country factors that influence the decision of where to produce.
For example, for a location to even be a possibility, skilled labor and supporting industries must be available.
Regulations on FDI and trade can significantly affect the attractiveness of a country as a production location.
In addition, expectations about the future value of a currency can also influence the decision of where to produce.
Transportation costs are another factor to consider.
China has proved to be a successful production location for the Dutch firm, Phillips NV. In fact, Phillips wants to eventually use China as a global supply base!
You can learn more about Phillips’ plans in the Management Focus in your text.

9. Why Are Technological Factors Important?
Firms should consider
The level of fixed costs
if fixed costs are high, produce in a single location or a few locations
when fixed costs are low, multiple production plants may be possible – allows firms to respond to local demands
The minimum efficient scale
when minimum efficient scale (the level of output at which most plant-level scale economies are exhausted) is high, choose centralized production in a single location or a limited number of locations
when minimum efficient scale is low, respond to local market demands and hedge against currency risk by operating in multiple locations
Technology is another factor to consider when making location decisions.
In particular, we need to look at the level of fixed costs involved, the minimum efficient scale of the technology, and the flexibility of the technology.
Let’s look at each one more closely beginning with the level of fixed costs.
Sometimes, the fixed costs of setting up a manufacturing plant are so high, a firm needs to serve the world market from just a few locations or even from a single location.
It costs more than a billion dollars to set up a semi-conductor plant for example, so a semi-conductor producer is unlikely to establish multiple plants.
Keep in mind of course, that the opposite is also true.
If fixed costs are low, multiple locations might make sense.
How does minimum efficient scale affect the choice of production location?
Well, we say that the larger the minimum efficient scale of a plant, the more likely a firm will centralize production in a single location or produce in just a few locations.

10. Why Are Technological Factors Important?
The flexibility of the technology
flexible manufacturing technology or lean production
reduces set up times for complex equipment
increases the utilization of individual machines
improves quality control
Flexible manufacturing allows firms to produce a wide variety of end products at a relatively low unit cost
Mass customization
Flexible machine cells
How do new technologies influence the decision of where to locate production?
Well, you probably already know that to achieve economies of scale and the costs savings associated with them, firms need to mass produce standardized products.
We typically think that firms that produce a greater variety of products have shorter production runs.
However, these traditional practices are changing. Today, flexible manufacturing, which is also called lean production, is changing the way companies produce, allowing them to challenge the traditional rules of production.
These new technologies are designed to reduce set up times for complex equipment, increase the utilization of individual machines through better scheduling, and improve quality control at all stages of the manufacturing process.
Why is flexible manufacturing so important?
Flexible manufacturing allows companies to produce a wide variety of products at a unit cost that would normally be associated with mass production of a standardized product!
Mass customization implies that a firm can customize its product line to meet the needs of different customers without additional costs.
Another common flexible manufacturing technology involves flexible machine cells. This type of technology groups various types of machinery, a common materials handler, and a centralized cell controller.
Firms that use flexible manufacturing technologies have a competitive advantage over those that don’t because they can customize their products to meet the needs of different national markets.

11. What Should a Firm Do?
Production should be concentrated in a few locations 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
So, should a firm operate multiple production facilities or concentrate production in a few locations?
Firms should concentrate production in a few locations when they have substantial fixed costs, when the minimum efficient scale of production is high, and when flexible manufacturing is an option.
Establishing multiple production locations can make sense when both fixed costs and minimum efficient scale of production are relatively low, and when flexible manufacturing isn’t a good alternative.

12. Why Are Product Factors Important To Location Decisions?
Two product factors impact location decisions
The product's value-to-weight ratio
If the value-to-weight ratio is high, produce the product in a single location and export 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
When products serve universal needs, the need for local responsiveness falls, and concentrating manufacturing in a central location makes sense
How does the product affect the decision of where to locate production?
Well, there are two important factors to consider.
The first is the product’s value-to-weight ratio.
If the value-to-weight ratio is high like it might be with a pharmaceutical product, then it makes sense to produce the product in a single location and export it to other parts of the world.
You know, for example, that it doesn’t cost as much to ship prescription pain killers as it costs to ship a car, so centralized production makes sense.
In contrast, when the value-to-weight ratio is low like it is with paint or a car, there is more pressure to manufacture the product in multiple locations around the world.
The second product factor to consider is whether the product serves universal needs, or needs that are the same everywhere.
When there are few differences in consumer tastes and preferences, the need to be locally responsive is reduced, and centralized manufacturing makes sense.
So, for example, a firm might produce calculators or video game consoles at a single location because they can be produced in bulk.

13. How Are Location, Strategy, And Production Related?
As you can see, the decision of where to locate production is based on the three areas that we’ve discussed, country factors, technological factors, and product factors.

14. What Is 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 established to take advantage of low cost labor can evolve into facilities with advanced design capabilities
Improvement in a facility comes from
Pressure to lower costs or respond to local markets
An increase in the availability of advanced factors of production
Does the attractiveness of a production location change over time?
The answer to this question is yes!
The strategic role of foreign factories, and the strategic advantage of foreign factories can change over time.
A foreign factory that was 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.
Hewlett Packard, for example, initially located it production in Singapore to take advantage of low costs there, but today, the facility is an important center for designing and assembling portable ink jet printers.
You can learn more about Hewlett Packard’s operations in the Management Focus in your text.
Keep in mind that as government regulations change, or as countries upgrade their factors of production, the strategic advantage of a particular location can change.
Just think about some of the changes that have been going on in many developing countries in the last twenty years or so.
Countries that had been economic backwaters just a generation ago are now thriving economies with improved communication and transportation infrastructures.

15. What Is The Strategic Role Of Foreign Factories?
Many companies now see foreign factories as globally dispersed centers of excellence
supports the development of a transnational strategy
global learning - valuable knowledge can be found in foreign subsidiaries
implies that firms are less likely to switch production to new locations simply because some underlying variable like wage rates has changed
Once consequence of these changes is that as the strategic role of a factory is upgraded, and a firm develops centers of excellence around the world, a transnational strategy becomes possible.
So, instead of simply thinking of foreign factories as low cost manufacturing facilities, they become vital components in the firm’s strategy.
Remember also, that an important component of the transnational strategy is the notion of global learning, or the idea that valuable knowledge doesn’t just reside at a firm’s domestic operations, it can also be found in a firm’s foreign subsidiaries.

16. Should A Firm Outsource Production?
Should a firm make or buy the component parts to go into its final product?
Make-or-buy decisions are important to firms' manufacturing strategies
service firms also face make-or-buy decisions
decisions involving international markets are more complex than those involving domestic markets
Now, let’s move on to outsourcing.
Should an international business make or buy the component parts to go into their final product?
The decision of whether to perform an activity in-house or outsource it to another firm, called the make- or- buy decision, is an important factor in many firms’ manufacturing strategies.
Toyota for example, actually produces less than 30 percent of the value of its cars.
The rest is outsourced to other companies.
Nike and Reebok actually outsource all production activities!
Keep in mind that like so many other things, make-or-buy decisions are more complex when they involve international markets than when they involve domestic markets.

17. Why Make? Vertical integration - making component parts in-house
Lowers costs - if a firm is more efficient at that production activity than any other enterprise, manufacturing in-house makes sense
Facilitates investments in highly specialized assets - internal production makes sense when substantial investments in specialized assets are required
Protects proprietary technology – in-house production makes sense when component parts contain proprietary technology
Facilitates the scheduling of adjacent processes - planning, coordination, and scheduling of adjacent processes can be easier with in-house production
What are the advantages of make?
Making components in-house, or vertical integration as it’s also known, has several advantages.
It’s associated with lower costs, it facilitates investments in specialized assets, it protects proprietary technology, and it facilitates the scheduling of adjacent processes.
Let’s look at each of these more closely, beginning with lowering costs.
If a firm is already the most efficient producer of certain products, it doesn’t make sense to outsource to a less efficient producer.
The firm can lower costs by continuing to manufacture the product in-house.
Boeing for example, keeps large systems integration activities in-house because it’s more efficient at this activity than any other firm.
Second, making components in-house also facilitates investments in specialized assets. When a firm has to invest in specialized assets, or assets whose value is contingent upon a particular relationship persisting, internal production makes sense.
So, if Nissan develops a new fuel injection system that it believes will be an important competitive advantage, but that requires specialized assets, Nissan will probably choose to produce the system in-house.
Because the system is unique to Nissan vehicles, it’s not worth it for an outside supplier to make the investments that would be needed.
From Nissan’s, perspective, it wouldn’t be strategically desirable to use an outside supplier because since the supplier would have to make the special investments, Nissan would be more or less tied to that supplier, and couldn’t take advantage of changes in the market.
Third, making a product in-house can help protect proprietary assets.
A firm that outsources something that contains proprietary information runs the risk of losing control over that information.
Boeing for example, manufactures its own cockpits so that it doesn’t give away proprietary information to competitors.
Finally, firms that manufacture in-house also have more control over the planning, coordination, and scheduling or adjacent processes.
For firms with just-in time inventory systems, this can be a real advantage.

18. Why Buy? Buying component parts from independent suppliers
Gives the firm greater flexibility
important when changes in exchange rates and trade barriers alter the attractiveness of various supply sources over time
Helps drive down the firm's cost structure
avoids challenges of coordination and control of additional subunits
avoids the lack of incentive associated with internal suppliers
avoids the difficulties with setting appropriate transfer prices
Helps the firm capture orders from international customers
can help firms gain orders from suppliers’ countries
Why should a firm outsource or buy components?
Buying parts from independent suppliers gives a firm greater flexibility, helps drive down the firm’s cost structure, and helps the firm capture orders from international customers.
Let’s look at each of these beginning with the greater flexibility associated with buying.
Maintaining strategic flexibility is a key advantage of going the buy path.
By buying parts from outside suppliers firms can switch orders between suppliers as circumstances change.
Having strategic flexibility can be especially important when exchange rate movements, political situations, or trade barriers alter the attractiveness of suppliers.
Second, by outsourcing, firms have lower costs because they can avoid the challenges involved in coordinating and controlling the additional activities that would be involved in making the components.
Firms can also lower costs when they avoid the lack of incentive that often comes with internal suppliers.
Because internal suppliers have a captive customer, they often don’t share the same drive to improve quality and lower prices that independent suppliers have.
In addition, it can be difficult to decide how to set transfer prices when products are made in-house.
A number of factors like exchange rates changes, and the ignorance of headquarters about local conditions, affect how prices should be set, and because of the complexity, internal suppliers located in other countries might choose the easy path of simply passing on cost increases rather than trying to find ways to reduce them.
Finally, by outsourcing, firms can capture more orders from a country.
Boeing was able to get a large order from Air India for example, but agreed to shift some subcontracting work to Indian suppliers.

19. Do Strategic Alliances With Suppliers Make Sense?
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
Can firms get the benefits of vertical integration without its disadvantages?
Sometimes!
By forming long-term strategic alliances with key suppliers, firms can mimic vertical integration .
Keep in mind though, that the commitment can actually limit the firm’s flexibility.

20. How Do Firms Manage The 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 goal is to
manage a global supply chain at the lowest possible cost and in a way that best serves customer needs
establish a competitive advantage through superior customer service
Now, let’s move on to discuss how to manage the global supply chain.
Logistics refers to the activities necessary to get materials to a manufacturing facility, through the manufacturing process, and out through the distribution system to the end user.
As you’ve probably guessed, when it comes to international logistics, firms have to deal with complications like distance, time, exchange rates, and customs barriers.
Sometimes, we think of logistics only as an afterthought, but an efficient logistics system can have a significant impact on the firm’s bottom line.
Even a small reduction in materials costs can add up to huge savings!
The goal then, is to manage the global supply chain so that costs are at their minimum, but customer needs are still met.

21. What Is The Role Of Just-In-Time Inventory?
Just-in-time (JIT) systems economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to enter the production process
JIT systems
generate major cost savings from reduced warehousing and inventory holding costs
can help the firm spot defective parts and take them out of the manufacturing process to boost product quality
But, a JIT system leaves the firm with no buffer stock of inventory to meet unexpected demand or supply changes
How can a just-in-time system help a firm as it manage its global supply system?
Many firms have turned to just-in-time or JIT systems as a way to reduce inventory costs.
The basic idea behind a just-in-time system is that inventory holding costs are minimized by having materials arrive just as they’re to enter the production process.
This system was pioneered in Japan during the 1950s and 1960s.
Because inventory turnover is speeded up, firms can reduce warehouse and inventory holding costs.
Another benefit of the just-in-time system is that because parts are used right away, defective parts can be immediately spotted and fixed, before additional defective parts are made.
Remember though, that since a just-in-time system runs without any buffer stock, a firm is vulnerable to disruptions in supply, and also can’t immediately respond to sudden surges in demand.

22. What Is The Role Of Information Technology And The Internet?
Web-based information systems play a crucial role in materials management
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
How can the Internet and other information technology help in the materials management process?
Well, modern materials management depends on web based information to track parts around the world.
Firms can use systems like electronic data interchange, or EDI, to track inputs, optimize productions schedules, communicate with suppliers in real time, and reduce the amount of paperwork with suppliers.
The benefits of these technologies are so important, that firms that don’t take advantage of them often find themselves at a competitive disadvantage.

23. Review Question 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
Now, let’s see how well you understand the material in this chapter. I’ll ask you a few questions. See if you can get them right. Ready?
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.

24. Review Question 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
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.

25. Review Question All of the following are key factors that
influence the decision of where to produce
except
a) country factors
b) competitor factors
c) technological factors
d) product factors
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.

26. Review Question 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
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.

27. Review Question 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
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.

28. Review Question 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
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.