International Business Strategy, Management & the

Chapter 16

Global Sourcing

International Business

Strategy, Management

& the New Realities by

Cavusgil, Knight & Risenberger

International Business: Strategy, Management, and the New Realities 1

Learning Objectives

1. Trends toward outsourcing, global sourcing, and offshoring

2. Evolution of global sourcing

3. Benefits and challenges of global sourcing for the firm

4. Implementing global sourcing through supplychain management

5. Risks in global sourcing

6. Strategies for minimizing risk in global sourcing

7. Implications of global sourcing for public policy and corporate citizenship


Global Sourcing: Shopping the World

• Along with competitors Reebok and Adidas in the athletic shoes industry, Nike contracts out nearly all of its athletic shoe production to foreign suppliers. These firms are best described as brand owners and marketers, not as manufacturers.

• Apple Computer sources some 70% of its production abroad while focusing its internal resources on improving its operating system and other software platforms. This approach allows Apple to optimally utilize its limited capital resources and focus on its core competences.

• Dell Inc. is another firm that relies extensively on a global manufacturing network, composed largely of independent suppliers.


Global Sourcing

• Global sourcing is the procurement of products or services from suppliers or company-owned subsidiaries located abroad for consumption in the home country or a third country.

• Also called global procurement or global purchasing , global sourcing amounts to importing -- an inbound flow.

• It is an entry strategy that involves a contractual relationship between the buyer (the focal firm) and a foreign supplier. It involves subcontracting the performance of specific manufacturing or services tasks to the firm's own subsidiaries or independent suppliers.

• Global sourcing is classified as a low-control strategy to the extent that the firm is buying from independent suppliers through contractual agreements, as opposed to buying from its own subsidiaries.


Drivers of Global Sourcing

• Technological advances, including instant

Internet connectivity and broadband availability

• Declining communication and transportation costs

• Widespread access to vast information including growing connectivity between suppliers and the customers that they serve; and

• Entrepreneurship and rapid economic transformation in emerging markets.


Decision 1: Outsource or Not?

• Managers must decide between internalization and externalization -- whether each valueadding activity should be conducted in-house or by an independent supplier.

• This is known as the ‘ make or buy’ decision:

“Should we make a product or conduct a particular value-chain activity ourselves, or should we source it from an outside contractor?”

• Firms usually internalize those value-chain activities they consider a part of their core competence , or which involve the use of proprietary knowledge and trade secrets that they want to control.


Outsourcing

• Outsourcing refers to the procurement of selected value-adding activities, including production of intermediate goods or finished products, from independent suppliers.

• This practice of externalizing a particular valueadding activity to outside contractors is known as outsourcing.

• Firms outsource because they generally are not superior at performing all primary and support activities. Most value-adding activities

-- from manufacturing to marketing to aftersales service -- are candidates for outsourcing.


An Example of Outsourcing

• Canon uses its core competencies in precision mechanics, fine optics, and micro electronics to produce some of the world’s best cameras, printers, and copiers.

• Canon usually owns the value-chain activities, such as R&D, that yield improvements in these competences.

• By contrast, companies will usually source from external suppliers when the sourced products or services are peripheral to the firm’s main offerings, can be obtained at lower cost, or can be provided by specialized suppliers.


Business Process Outsourcing (BPO)

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

• BPO includes:

 Back-office activities , which includes internal, upstream business functions such as payroll and billing, and

 Front-office activities , which includes downstream, customer-related services such as marketing or technical support.


Decision 2: Where in the World

Should Value-Adding Activities Be Located?

• Configuration of value-adding activity : The pattern or geographic arrangement of locations where the firm carries out value-chain activities.

• Instead of concentrating value-adding activities in the home country, many firms configure these activities across the world to save money, reduce delivery time, access factors of production, and extract maximal advantages relative to competitors.

• This helps explain the migration of traditional industries from Europe, Japan, and the U.S. to emerging markets in Asia, Latin America, and

Eastern Europe.


An Example of Worldwide Configuration of Value Chain

• The German automaker BMW employs 70,000 factory personnel at 23 sites in 13 countries to manufacture its vehicles.

• Workers at the Munich plant build the BMW 3 Series and supply engines and key body components to other BMW factories abroad.

• In the U.S., BMW has a plant in South Carolina, which makes over 500 vehicles daily for the world market.

• In Northeast China, BMW makes cars in a joint venture with

Brilliance China Automotive Holdings Ltd.

• In India, BMW has a manufacturing presence to serve the needs of the rapidly growing South Asia market.

• BMW must configure sourcing at the best locations worldwide, in order to minimize costs (e.g., by producing in China), access skilled personnel (by producing in Germany), remain close to key markets (by producing in China, India and the U.S.).


A Framework for Global Sourcing and Outsourcing

• The two strategic choices we just discussed lead us to the framework in Exhibit 16.2.

• The focal firm can source from independent suppliers, company-owned subsidiaries and affiliates, or both.

• Cells C and D represent the global sourcing scenarios.

• While global sourcing implies procurement from foreign locations, in some cases the focal firm may purchase from a subsidiary or affiliate located in the foreign country (Cell C).

• This is known as captive sourcing , which refers to sourcing from the firm's own production facilities located abroad. Production is carried out at a foreign facility that results from the focal firm's FDI activities.


Contract Manufacturing:

Global Sourcing from Independent Suppliers

• A more likely scenario is when the focal firm can procure from independent suppliers (Cell D).

• Contract manufacturing : An arrangement in which the focal firm contracts with an independent supplier to manufacture products according to well-defined specifications.

• Global sourcing requires the firm to identify qualified suppliers, develop necessary organizational and technological capabilities to locate and relocate specific tasks, and coordinate a geographically dispersed activities.


Examples of Contract Manufacturing

• Patheon, one of the world's leading contract manufacturers in the pharmaceutical industry, provides drug development and manufacturing services to pharmaceutical and biotechnology firms worldwide.

• Patheon operates 11 factories in N. America and Europe, producing over-the-counter drugs and several of the world's top-selling prescription drugs for most of the world's 20 largest pharmaceutical firms.

• Benetton employs contract manufacturers to produce clothing.

• IKEA uses contract manufacturers to produce furniture.

• Contract manufacturing also offers firms the ability to enter target countries quickly, especially when the market is too small to justify significant local investment.


Offshoring

• Offshoring is a natural extension of global sourcing. It refers to the relocation of a business process or entire manufacturing facility to a foreign country.

• MNEs are particularly active in shifting production facilities or business processes to foreign countries to enhance their competitive advantages.

• Offshoring is especially common in the service sector, including banking, software code writing, legal services, and customer-service activities.

• E.g., large legal hubs have emerged in India that provide services such as drafting contracts and patent applications, conducting research and negotiations, as well as performing paralegal work on behalf of Western clients.

With lawyers in N. America and Europe costing $300 an hour or more, Indian firms can cut legal bills by 75 percent.


Offshoring Destinations

• India receives the bulk of developed nations’ relocated business services. It has a huge pool of qualified labor that work for wages as little as 25 percent of comparable workers in the West.

• India is not the only destination of substantial outsourcing work. Firms in Eastern Europe perform support activities for architectural and engineering firms from the West.

• Accountants in the Philippines perform support work for major accounting firms. Accenture has back-office operations and call centers in Costa Rica. Germany sources IT support services from the Czech Republic and

Romania. Boeing, Motorola, and Nortel do much of their

R&D in Russia. South Africa is the base for technical and user-support services for English, French, and Germanspeaking customers throughout Europe.


Jobs Most Conducive to Offshoring

• Large-scale manufacturing industries whose primary competitive advantage is efficiency and low cost;

• Industries such as automobiles that have uniform customer needs and highly standardized processes in production and other value-chain activities;

• Service industries that are highly labor intensive, e.g., call centers and legal transcription;

• Information-based industries whose functions and activities can be easily transmitted via the Internet, e.g., accounting, billing, and payroll; and

• Industries such as software preparation whose outputs are easy to codify and transmit over the Internet or by telephone, e.g., routine technical support and customer service activities.


Not All Services Can Be Offshored

• Many jobs in the services sector cannot be separated from their place of consumption. This limits the types of services jobs that firms can move abroad.

• Personal contact is vital at the downstream end of virtually all value chains. Other services are consumed locally.

• People normally do not travel abroad to see a doctor, dentist, lawyer, or accountant. Consequently, many service jobs will never be offshored.

• Through 2005, only about 3 percent of jobs in the U.S. that require substantial customer interaction (e.g.,, those in the retailing sector) have been transferred to low-wage economies.

• By 2008, less than 15 percent of all service jobs have moved from advanced economies to emerging markets.


Strategic Implications of Global Sourcing

• Exhibit 16.3 explains the two strategic implications of the two choices MNEs face: whether to perform specific value-adding activities in-house or to outsource them, and whether to concentrate each activity at home or disperse it abroad.

• The 1st row indicates the degree to which management considers each value-adding activity a strategic asset to the firm.

• The 2nd row indicates whether the activity tends to be internalized inside the focal firm or outsourced to a foreign supplier.

• The 3rd row indicates where management typically locates an activity.


Outsourcing Decision is Activity Specific

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

• E.g., firms typically consider R&D and design activities central to their competitive advantage. As a result, they are more likely to internalize these functions, and less likely to outsource them to outside contractors.

• In contrast, manufacturing, logistics, and customer service activities tend to be more readily outsourced and geographically dispersed.

• The decision is also a function of the firm's IB experience and availability of qualified suppliers.


Phases in the Evolution of Global Sourcing

• The first major wave emphasized the manufacturing of input products and began in the 1960s with the shift of

European and U.S. manufacturing to low-cost countries as geographically diverse as Mexico and Spain.

• Early observers pointed to the emergence of the

“modular corporation” and the “virtual corporation.”

• The next wave of global sourcing began in the 1990s with offshoring. In addition to IT services and customersupport activities, other service sectors became part of the offshoring trend.

• Today, business-process outsourcing in product development, human resources, and finance/accounting services has become very common.


Magnitude of Global Sourcing

• The magnitude of global sourcing is considerable.

In 2005, India alone booked $22 billion worth of business in answering customer phone calls, managing far-flung computer networks, processing invoices, and writing custom software for MNEs from all over the world.

• Global sourcing has created more than 1.3 million jobs during the past decade for India.

• Meanwhile, between 2000 and 2004, some 100,000 service jobs were outsourced each year from the

U.S. to other countries.

• In 2006, IT and business-process outsourcing exceeded $150 billion worldwide.


Leading Provider Countries

• China and India are major players in global sourcing.

• Numerous other countries are active players as well.

• Exhibit 16.4 identifies key players by four geographic regions.

• E.g., Cairo-based Exceed Contact Center handles calls in Arabic and European languages for

Microsoft, General Motors, Oracle, and Carrefour.

• Russia is aiming at high-end programming jobs.

With its strong engineering culture, Russia has an abundant pool of underemployed talent available at wages about one-fifth those of the U.S.


The 2005 Offshore Location Attractiveness Index by

A.T. Kearney

• Identifies 9 emerging markets in its list of the 10 most attractive offshoring suppliers: India, China, Malaysia,

Philippines, Singapore, Thailand, Czech Republic, Chile,

Canada, and Brazil.

• In addition to Canada, the other advanced economy in the top

20 destinations is the U.S. (11 th ).

• The index emphasizes various criteria:

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

 Availability and skills of people (cumulative businessprocess experience and skills, labor force availability, education and language, and worker attrition); and

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


Benefits of Global Sourcing

•

Cost efficiency

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

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

• These savings tend to occur particularly in

R&D, product design activities, and backoffice operations such as accounting and data processing.


Strategic Benefits of Global Sourcing

• Faster corporate growth.

• Access to qualified personnel abroad.

• Improved productivity and service.

• Business process redesign.

• Increased speed to market.

• Access to new markets.

• Technological flexibility.

• Improved agility by shedding unnecessary overhead.


Challenges in Global Sourcing

• Vulnerability to exchange rate fluctuations

• Partner selection, qualification, and monitoring costs

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

• Complexity of managing global supply chain

• Limited influence over the manufacturing processes of the supplier

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

• Constrained ability to safeguard intellectual assets


Global Supply Chain Management Capabilities

Greatly Enhance Global Sourcing

• Global supply chain refers to the firm’s integrated network of sourcing, production, and distribution, organized on a world scale, and located in countries where competitive advantage can be maximized.

• Sourcing from numerous suppliers scattered around the world would be neither economical nor feasible without an efficient supply-chain system.

• Boeing’s 787 Dreamliner jet provides a striking example of how global supply-chain management is making global sourcing feasible and, at the same time, contributing to firm competitiveness.


Facilitating Firms are also Responsible for Global Sourcing

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

• Many focal firms delegate supply-chain activities to such independent logistics service providers as DHL, FedEx, TNT, and UPS.

• Consulting firms that manage the logistics of other firms are called third party logistics providers (3PLs) . Using a 3PL is often the best solution for international logistics, especially for firms that produce at low volumes or lack the resources and the expertise to create their own logistics network.


Global Supply-Chain Networks

• A global supply-chain network consolidates a firm’s sourcing, manufacturing, and distribution in a few strategic locations worldwide so the firm can concentrate these activities in countries where it can maximize its competitive advantages.

• Exhibit 16.7 illustrates the stages, functions, and activities in the supply chain.

• It reveals how suppliers interact with the focal firm and how these, in turn, interact with distributors and retailers.

• Each stage in the global supply chain encompasses functions and activities that involve the focal firm in sourcing and distribution.


Supply Chain Management has Become

Sophisticated

• Costs associated with physically delivering a product to an export market may account for as much as 40% of total cost.

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

• Managers use Electronic Data Interchange (EDI) , which passes orders directly from customers to suppliers automatically through a sophisticated ICT platform.

• The UK supermarket chain Tesco greatly reduced inventory costs by using an EDI system to link point-ofsale data to logistics managers. Technology allows Tesco to track product purchases down to the minute.


Logistics and Transportation

• Logistics involves physically moving goods through the supply chain.

• It incorporates information, transportation, inventory, warehousing, materials handling and similar activities associated with the delivery of raw materials, parts, components, and finished products.

• Internationally, logistics is complex due to greater geographical distances; multiple legal and political environments; and the often inadequate and costly nature of distribution infrastructure in individual countries.


Transportation modes

• International logistics typically involves multiple transportation modes .

• Land transportation is conducted via highways and railroads.

• Ocean transportation is handled through large container ships.

• Air transportation involves commercial or cargo aircraft.

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

• Sea transport was revolutionized by the development of 20and 40-foot shipping containers, the big boxes that sit atop ocean-going vessels.

• Sea transportation is very cost-effective because one ship can carry thousands of these containers at a time.


Risks in Global Sourcing

1. Less-than-expected cost savings . Conflicts and misunderstandings arise because of differences in the national and organizational cultures between the focal firm and foreign supplier. Such factors give rise to cost-savings that are less than originally anticipated.

2. Environmental factors . Numerous environmental challenges confront focal firms including: exchange rate fluctuations, labor strikes, adverse macroeconomic events, high tariffs and other trade barriers, and high energy and transportation costs.

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



(cont.)

4. Risk of creating competitors . As the focal firm shares its intellectual property and businessprocess knowledge with foreign suppliers, it also runs the risk of creating future rivals (e.g.,

Schwinn).

5. Inadequate or low-skilled workers . Some foreign suppliers may be staffed by employees who lack appropriate knowledge about the tasks with which they are charged. Other suppliers suffer rapid turnover of skilled employees.



(cont.)

6. Over-reliance on suppliers . Unreliable suppliers may put earlier work aside when they gain a more important client. Suppliers occasionally encounter financial difficulties or are acquired by other firms with different priorities and procedures. Over-reliance can shift control of key activities too much in favor of the supplier.

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

At the extreme, workers find themselves in a psychological limbo, unclear about who their employer really is.


Strategies for Minimizing Risk in Global Sourcing

1.

Firms ought to go offshore for the right reasons.

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

2.

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



(cont.)

3. Choose between a captive operation and a

contract with outside specialists carefully.

They should be vigilant about striking the right balance between the organizational activities that it retains inside the firm, and those that are sourced from outside.

4. Choose countries and suppliers carefully. A common reason for global sourcing failure is that both buyers and suppliers tend not to spend enough time upfront to get to know each other well. They rush into a deal before clarifying partner expectations, which can give rise to misunderstandings and inferior results.



(cont.)

5. The focal firm needs to invest in supplier development and collaboration.

The parties need to exchange information, transfer knowledge, troubleshoot, coordinate, and monitor.

• Management should collaborate closely with suppliers in co-development and co-design activities. This also enables the focal firm to tap into a stream of ideas for new products, processes, technologies, and improvements.

• Efforts to build strong relationships help create a

‘moral contract’ between the focal firm and the supplier, which is often more effective than a formal legal contract.



(cont.)

6. Managers need to proactively safeguard interests:

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

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

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

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

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


Potential Harm to Economies from Global Sourcing

• Critics of global sourcing point to three major problems:

Global sourcing can result in:

 Job losses in the home country,

 Reduced national competitiveness, and

 Declining standards of living.

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

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


Effects on Local Community: A Case Study

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

40 years, providing 2,700 jobs.

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

Foreign Trade Zone.

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

• Assistance from labor unions and the State of Michigan were to no avail. Concessions from the labor union, and over $100 million from

Michigan to Electrolux in tax breaks and grants were insufficient. It did not help that Electrolux -- a Swedish company -- was perceived as having little loyalty to the community.


Can Jobs Offshored be Replaced?

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

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

• According to one estimate, as much as 1/3 of

U.S. workers who have been laid off cannot find suitable employment within a year.

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


Ethical and Social Implications of

Global Sourcing

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

• The bar for global corporate citizenship has been raised.

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

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


The Case for and against Sweatshops

• Those who defend moving production to low-wage facilities abroad point to a lower standard of living as an explanation for the low wages, and argue that their operations benefit the community by providing needed jobs. The choice for local workers is often between low-paid work or no work at all.

• They argue that the alternatives available to such workers are even less desirable, such as poverty, prostitution, and social problems.

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

• Foreign companies that establish factories destroy the preexisting agricultural market that may have provided a better life for laborers.


Potential Benefits to National Economy

• First, by reconfiguring value chains to the most costefficient locations, companies reduce their production costs and enhance their performance.

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

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

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


Public Policy Towards Global Sourcing

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

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

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


Public Policy Towards Global Sourcing

(cont.)

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

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

• Keeping the cost of doing business relatively low.

Through economic and fiscal policies, development of new technologies can be facilitated.

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

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

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


International Business Strategy, Management & the

Chapter 16

Global Sourcing

Cost efficiency

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International Business Strategy, Management & the

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Global Sourcing

Cost efficiency

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