Chapter 16 - Global Production, Outsourcing and Logistics
Global Production, Outsourcing and Logistics
Learning objectives


Explain why production and
logistics decisions are of central
importance to many
multinational businesses.
Explain how country
differences, production
technology, and product
features all affect the choice of
where to locate production
activities.

Discuss how the role of foreign
subsidiaries in production can
be enhanced over time as they
accumulate knowledge.

Identify the factors that
influence a firm’s decision of
whether to source supplies from
within the company or from
foreign suppliers.

Articulate what is required to
efficiently coordinate a globally
dispersed production system.
16
This chapter focuses on two of major activities—
production and materials management, and attempts to
clarify how when they are performed internationally, the
cost of value creation can be lowered, and how value can
be added by better serving customer needs.
The choice of an optimal manufacturing location must
consider country factors, technological factors, and
product factors.
Foreign factories can improve their capabilities over time,
and this can be of immense strategic benefit to the firm.
Managers need to view foreign factories as potential
centers of excellence and to encourage and foster attempts
by local managers to upgrade factory capabilities.
An essential issue in many international businesses is
determining which component parts should be
manufactured in-house and which should be outsourced to
independent suppliers.
The chapter also discusses the contributions of
information technology to these activities. This is
especially important in the era of the Internet.
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Chapter 16 - Global Production, Outsourcing and Logistics
OUTLINE OF CHAPTER 16: GLOBAL PRODUCTION, OUTSOURCING, AND
LOGISTICS
Opening Case: Li & Fung
Introduction
Strategy, Production, and Logistics
Where to Produce
Country Factors
Technological Factors
Product Factors
Locating Production Facilities
Management Focus: Phillips in China
The Strategic Role of Foreign Factories
Management Focus: Hewlett-Packard in Singapore
Outsourcing Production: Make-or-Buy Decisions
The Advantages of Make
The Advantages of Buy
Trade-offs
Strategic Alliances with Suppliers
Management Focus: Outsourcing at the Boeing Company
Managing a Global Supply Chain
The Role of Just-in-Time Inventory
The Role of Information Technology and the Internet
Chapter Summary
Critical Discussion Questions
Closing Case: Microsoft—Outsourcing Xbox Production
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Chapter 16 - Global Production, Outsourcing and Logistics
CLASSROOM DISCUSSION POINT
Using the auto industry, ask students to reflect on the production decisions of several
companies. Why does BMW produce cars in Alabama? Why does General Motors have
a plant in China? Why does Nissan have design studios in Southern California? Try to
get students to address all of the basic production issues outlined below.
The five basic questions that deal with production are:
1. Where should production be located and should it be concentrated or dispersed?
2. What should be the long-term strategic role of foreign production sites? Should the
firm abandon a foreign site if factor costs change, or is there value to maintaining an
operation at a given location even if economic conditions change?
3. Should the firm own foreign production or should production be outsourced?
4. How should a globally-dispersed supply chain be managed?
5. Should the firm manage the logistics or outsource their management?
OPENING CASE: Li & Fung
Summary
The opening case explores the operations of Li & Fung, one of the largest multinational
trading companies in the developing world. Serving customers like The Limited retail
clothing chain, Li & Fung uses its network of independent suppliers to find the best
manufacturing enterprises to produce products. The company uses information systems
to manage and coordinate its web of globally dispersed activities. Discussion of the case
can revolve around the following questions:
1. What services does Li & Fung sell to its customers? What makes the service
beneficial to its buyers?
2. What is Li & Fung’s competitive advantage? How does this help the company serve
its customers?
3. Why is it important for Li & Fung to have multiple suppliers?
Another Perspective: Students can explore Li & Fung’s operations more extensively by
going to the company’s web site at {http://www.lifung.com/eng/global/home.php}. Click
on “Global Network” to see the extent of the company’s global operations.
LECTURE OUTLINE FOR CHAPTER
This lecture outline follows the Power Point Presentation (PPT) provided along with this
instructor’s manual. The PPT slides include additional notes that can be viewed by
clicking on “view”, then on “notes”. The following provides a brief overview of each
Power Point slide along with teaching tips, and additional perspectives.
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Chapter 16 - Global Production, Outsourcing and Logistics
Slide 16-3 Introduction
Where should foreign production be located? How should a globally dispersed supply
chain be managed?
Slides 16-4-16-7 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
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.
Another Perspective: To extend the discussion on TQM and Six Sigma go to
{http://www.isixsigma.com/sixsigma/six_sigma.asp}and
{http://home.att.net/~iso9k1/tqm/tqm.html}.
Slide 16-8 Where to Produce?
Three factors are important when making location decisions:
1. country factors
2. technological factors
3. product factors
When fixed costs are substantial, the minimum efficient scale of production is high,
and/or flexible manufacturing technologies are available, the arguments for concentrating
production at a few choice locations are strong.
Slide 16-9 Country Factors
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
Another Perspective: The United States Central Intelligence Agency maintains a “country
profile” on each country in the world. The country profiles provide useful information to
a companies contemplating doing business in a particular country. The country profiles,
{https://www.cia.gov/cia/publications/factbook/index.html}, are available to the public.
Students can use the reports as a basis for comparing different production locations.
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Chapter 16 - Global Production, Outsourcing and Logistics
Another Perspective: For additional information about a particular country, Yahoo
provides an easy-to-search bank of linked sources that provide information about almost
every country in the world. The site, {http://www.yahoo.com/Government/Countries/},
is useful to make quick comparisons between countries to gauge their relative
attractiveness as production locations.
Slides 16-10-16-16 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
Slide 16-18 Product Factors
Two product factors impact location decisions:
1. the product's value-to-weight ratio:
2. whether the product serves universal needs:
Slides 16-20-16-21 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
Slides 16-24-16-25 The Strategic Role of Foreign Factories
The strategic role of foreign factories and the strategic advantage of a particular location
can change over time.
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
Slide 16-26 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.
Slides 16-27-16-28 The Advantages of Make
1. lower costs
2. facilitates investments in highly specialized assets
3. protects proprietary technology
4. facilitate the scheduling of adjacent processes
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Slides 16-29-16-30 The Advantages of Buy
Buying component parts from independent suppliers:
1. gives the firm greater flexibility
2. helps drive down the firm's cost structure
3. helps the firm capture orders from international customers
Slide 16-31 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
Slide 16-32 Strategic Alliances with Suppliers
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.
Slide 16-34 Managing 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
Another Perspective: Stanford University maintains a web site that is a forum for the
dissemination of research and practical advice in the area of global supply chain management.
The site supplies current information that can help embellish a lecture on global materials
management. The site is available at {http://www-leland.standford.edu/group/scformu/}.
Slide 16-35 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
Slide 16-36 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.
CRITICAL THINKING AND DISCUSSION QUESTIONS
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QUESTION 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 costs approximately $500 million to construct and requires a highly
skilled work force. The total value of the world market over the next ten years for this
product is estimated to be between $10 billion and $15 billion. The tariffs prevailing in
this industry are currently low. Should the firm favor concentrated manufacturing or
decentralized manufacturing? What kind of location(s) should the firm favor for its
plant(s)?
ANSWER 1: The firm should pursue a concentrated manufacturing strategy 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 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.
QUESTION 2: A chemical firm is considering how best to supply the world market for
sulfuric acid. A manufacturing plant costs approximately $20million to construct and
requires a moderately skilled workforce. The total value of the world market for this
product over the next 10 years is estimated to be between $20billion and $30 billion
range. 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 2: 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 high fixed costs, 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.
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Chapter 16 - Global Production, Outsourcing and Logistics
QUESTION 3: Reread the Management Focus on Philips in China then answer the
following questions:
a) What are the major benefits to Philips of shifting so much of its global production to
China?
b) What are the risks associated with a heavy concentration of manufacturing assets in
China?
c) What strategies might Philips adopt to maximize the benefits and mitigate the risks
associated with moving so much product development and production activity to
developing nations like China?
ANSWER 3:
a) China an attractive production location for Phillips for several reasons. 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. 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.
b) Most students will recognize that Philips is taking a risk by concentrating its
manufacturing in China. If economic, political, or other types of problems arise in the
country, Phillips could be in serious trouble since it will not have alternate locations to
fill production gaps.
c) Some students might recommend that Philips consider forming joint venture with local
firms to gain some protection against the threat of nationalization or other adverse moves
from a foreign government. Other students may suggest that Philips maintain production
facilities in more than one country to offset potential problems in another.
QUESTION 4: 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 4: 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.
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QUESTION 5: Explain how an efficient materials management function can help an
international business to compete more effectively in the global market place?
ANSWER 5: 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.
CLOSING CASE: Microsoft—Outsourcing Xbox Production
Summary
The closing case focuses on Microsoft and the outsourcing of its Xbox production. Xbox
was Microsoft’s first entry into the video game market, and unlike its other products that
included computer peripherals such as mice, keyboards, and joysticks, Xbox represented
a specialized functional computer in its own right. Microsoft ultimately decided to
outsource production of the Xbox believing that it did not have the manufacturing and
logistics capabilities to make Xbox itself. Discussion of the case can revolve around the
following questions.
QUESTION 1: What was the strategic advantage to Microsoft of outsourcing Xbox
production to Flextronics?
ANSWER 1: Microsoft’s primary business is to develop software. While the company
also sells computer hardware such as mice and keyboards, these products represent a
much smaller part of the company’s overall revenues. Consequently, when considering
whether to produce the Xbox in house or to outsource, the company chose the latter
strategy. In doing so, Microsoft was able to continue to focus on its core business while
allowing another company, Flextronics, which has expertise in managing a global supply
chain, to handle production.
QUESTION 2: What were the risks associated with outsourcing to Flextronics? Did
Microsoft mitigate these risks? Do you think Microsoft would have been better off
making the Xbox itself?
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ANSWER 2: When a company makes the decision to outsource, it gives up control over
the production process. Issues such a timeliness, quality, and so on become the
responsibility of another company. When Microsoft decided to outsource Xbox
production, the company chose to work with a company, Flextronics, with which it had a
long history. The two companies had collaborated in the past, and strong personal
relationships existed between them. These factors combined with Flextronics advantages
in the global supply chain management area created a strong case for Microsoft’s
outsourcing decision.
QUESTION 3: How did Flextronics’ industrial park strategy enable the company to
respond to national changes in relative factor costs?
ANSWER 3: Under Flextronics’ industrial park strategy, key suppliers were required to
establish their operations near a Flextronics assembly plant in low-cost locations near the
customer’s end market. This strategy facilitated just-in-time inventory systems and
reduced transportation costs, and also avoided the break-downs that could occur in a
globally dispersed supply chain. The strategy also enabled Flextronics to shift production
to new locations as cost and demand conditions warranted.
QUESTION 4: How important are web based information systems to the relationship
between Microsoft and Flextronics? What are the economic advantages of real time
information flows between Microsoft, Flextronics, and Flextronics’ own subcontractors?
ANSWER 4: The real-time, web-based relationships between Microsoft and Flextronics
are a critical component in the relationship between the two companies. Microsoft can
provide demand information to Flextronics which can then adjust its production
schedules so that inventory and costs are minimized, yet demand is still satisfied.
Without the real time information systems in place, surplus inventory could drive up
costs. A similar argument can be made for the real time information flows that exist
between Flextronics and its suppliers.
Another Perspective: Students may want to compare Microsoft’s Xbox
{http://www.microsoft.com/xbox/}strategy with that of competitors such as Nintendo’s
Wii {http://wii.nintendo.com/}or Sony’s Playstation2 {http://www.playstation.com/}.
Students can identify whether competitor products are produced in-house or whether they
are outsourced.
INTEGRATING iGLOBES
There are several iGLOBE video clips that can be integrated with the material presented
in this chapter. In particular, you might consider the following:
Title: New Tainted Chinese Products Add to Safety Worries
Run Time: 8:53
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Chapter 16 - Global Production, Outsourcing and Logistics
Abstract: This video explores the safety of consumer imports from China.
Key Concepts: product safety and liability, international trade, globalization, law
enforcement
Notes: The safety of consumer imports from China has been called into question recently
after a series of dubious products entered the United States market. The problem began
with imports of tainted pet food, but has since spread to tires, toys, toothpaste, and
seafood. At this point though, it is not clear whether the problem is a series of isolated
incidents that have become high-profile cases, or a systemic issue that will be more
difficult to resolve. American consumers are growing increasingly wary of products
imported from China, a situation that could spell disaster for China.
Donald Straszheim, an expert on China from Roth Capital Partners, points out that the
issue is especially challenging because no one really knows how widespread it is. He
notes that China not only lacks a strong regulatory regime, it also has no history of being
open about issues like this. While there are probably some unscrupulous business people
substituting improper products, a bigger challenge associated with the problem is that the
Chinese economy is very fragmented. The United States imports about 50 percent of its
apple juice from China for example, juice that comes from some three million producers!
Inspecting and monitoring that many producers would be virtually impossible.
Straszheim also says that while some regulations may exist in China, enforcement is lax.
In the United States, questions are being raised about who is responsible for ensuring
food safety. The Food and Drug Administration claims it does not have the resources
necessary to manage this type of problem. Thanks to the tremendous increase in imports
that has occurred in recent years, its border inspectors are already stretched too thin.
Caroline Smith Dewaal, director of food safety for the Center for Science in the Public
Interest, has called for better labeling of products imported from China. Dewaal notes
that it is no longer enough to simply identify where a product is made because many
ingredients come from China. The United States for example, imports wheat gluten and
apple juice from China, which are then incorporated into other products. She has
suggested that labels read Made in America with Chinese ingredients for example.
Dewaal has also raised the issue of whether American producers and retailers are liable
for tainted products. She is encouraging American consumers to demand accountability
for the products they purchase, and push Congress to take a more active role in resolving
the problem.
Discussion Questions:
1. After the scandals involving the safety of products imported from China, many
American consumers are already wary of purchasing products from the nation. As a
consumer, how can you protect yourself from tainted products? Can safeguards be
implemented on a national basis?
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2. So far, the Chinese government has remained relatively quiet on the issue of its exports
of tainted products to the United States. How should China respond to the situation?
Should the United States become involved? Should the two governments work together?
How might China’s highly fragmented market affect the situation?
3. Questions have been raised as to whether producers and retailers in the United States
should be held accountable for the safety of the products they sell. In your opinion, are
they responsible for the safety of their products? Why or why not?
4. What does the situation involving tainted exports from China mean for producers in
other nations? Does it affect other consumers?
INTEGRATING VIDEOS
There are also several longer video clips that can be integrated with the material
presented in this chapter. In particular, you might consider the following:
Title 14: DHL Global Delivery Service
Notes: DHL, which started in 1969 in San Francisco with a $3,000 investment, delivers
packages to 120,000 destinations in 200 countries, bringing in over $50 billion in
revenues. DHL is a market leader in international express delivery. In fact, the
company considers itself to be the inventor of international express shipping. DHL built
its global operations by slowly expanding its services over the years. The company
followed a backward path around the world from its San Francisco offices into Asia,
moving on to Europe and Africa, and finally into North America. Its American
operations have been strengthened with its recent acquisition of Airborne.
DHL’s focus on improving its service in the U.S. prompted the company to acquire
Airborne rather than take the time to build its own operations. The acquisition gave DHL
the infrastructure necessary to become a serious competitor in the market. Now the
acquisition is part of the company’s overall operation providing U.S.-based gateways for
packages traveling to other parts of the world. All packages traveling outside the U.S.
must pass through the U.S. Customs office located within the gateway sites.
Discussion Guide:
1. DHL has relied on its own agents when shipping internationally. Discuss the service.
What are the advantages of having in-house handling of packages when shipping
internationally rather than using agents who work for several different companies?
2. Rather building its own operations from scratch when it moved into the U.S. market,
DHL chose to acquire Airborne. Discuss the advantages and disadvantages of this
strategy.
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Chapter 16 - Global Production, Outsourcing and Logistics
3. Reflect on DHL’s U.S. gateway system that provides on-site customs clearance
services. Does this give DHL a competitive advantage? Why or why not?
4. DHL believes customers using international express delivery services are looking for
speed and reliability. Using the pressure for costs reduction/pressure for local
responsiveness grid, consider the international shipping business. Where do the major
players stand relative to one another? Is any one player better positioned to succeed?
globalEDGE™ Exercise Questions
Use the globalEDGE™ site {http://globalEDGE.msu.edu/} to complete the following
exercises:
Exercise 1
The globalization of production makes many people more aware of the differences in
manufacturing costs worldwide. The U.S. Department of Labor’s Bureau of International
Labor Affairs publishes a Chartbook of International Labor Comparisons. Locate the
latest edition of this report and identify the hourly compensation costs for manufacturing
workers in the U.S., Japan, Korea, Taiwan, Germany and the U.K.
Exercise 2
The internationalization of manufacturing has become much more predominant in recent
years. In fact, the Industry Week magazine ranks the world’s largest manufacturing
companies by sales revenue. Identify the largest Chinese manufacturing companies as
provided in the most recent ranking by paying special attention to the industries these
companies operate in.
Answers to the Exercises
Exercise 1
The Chartbook of International Labor Comparisons can be located by searching for the
term “Chartbook of International Labor Comparisons” at
{http://globaledge.msu.edu/ResourceDesk/}. The resource is titled “A Chartbook of
International Labor Comparisons: United States, Europe and Asia” and is located under
the globalEDGE™ Category “Research: Statistical Data Sources”. Hourly compensation
costs are listed under the “Competitiveness Indicators for Manufacturing” section of this
report. Be sure to check the “Resource Desk only” checkbox of the search function on the
globalEDGE website.
Search Phrase: “Chartbook of International Labor Comparisons”
Resource Name: A Chartbook of International Labor Comparisons: United States,
Europe, and Asia
Website: {http://www.dol.gov/asp/media/reports/chartbook/index.htm}
globalEDGE™ Category: “Research: Statistical Data Sources”
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Exercise 2
The Industry Week magazine ranking can be located by searching for the term “Industry
Week” at {http://globaledge.msu.edu/ResourceDesk/}. The resource is titled
“IndustryWeek: IW 1000 - World's Largest Manufacturing Companies” and is located
under the globalEDGE™ Category “Research: Rankings”. For 2007, there were 28
Chinese manufacturers in the ranking. These companies were from a variety of industries.
Be sure to check the “Resource Desk only” checkbox of the search function on the
globalEDGE website.
Search Phrase: “Industry Week”
Resource Name: IndustryWeek: IW 1000 - World's Largest Manufacturing Companies
Website: {http://www.industryweek.com/iwinprint/iw1000/}
globalEDGE™ Category: “Research: Rankings”
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