International Business Strategy, Management & the New Realities by Cavusgil, Knight & Risenberger

1. International BusinessStrategy, Management& the New RealitiesbyCavusgil, Knight & Risenberger Chapter 16 Global Sourcing International Business: Strategy, Management, and the New Realities

2. Learning Objectives • Trends toward outsourcing, global sourcing, and offshoring • Evolution of global sourcing • Benefits and challenges of global sourcing for the firm • Implementing global sourcing through supply-chain management • Risks in global sourcing • Strategies for minimizing risk in global sourcing • Implications of global sourcing for public policy and corporate citizenship International Business: Strategy, Management, and the New Realities

3. 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. International Business: Strategy, Management, and the New Realities

5. 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. International Business: Strategy, Management, and the New Realities

6. 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. International Business: Strategy, Management, and the New Realities

7. Decision 1: Outsource or Not? • Managers must decide between internalization and externalization -- whether each value-adding 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. International Business: Strategy, Management, and the New Realities

8. 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 value-adding activity to outside contractors is known asoutsourcing. • Firms outsource because they generally are not superior at performing all primary and support activities. Most value-adding activities -- from manufacturing to marketing to after-sales service -- are candidates for outsourcing. International Business: Strategy, Management, and the New Realities

9. An Example of Outsourcing • Canon uses its corecompetencies 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. International Business: Strategy, Management, and the New Realities

10. 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. International Business: Strategy, Management, and the New Realities

11. 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. International Business: Strategy, Management, and the New Realities

12. 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.). International Business: Strategy, Management, and the New Realities

13. 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. International Business: Strategy, Management, and the New Realities

15. 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. International Business: Strategy, Management, and the New Realities

16. 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. International Business: Strategy, Management, and the New Realities

17. Offshoring • Offshoring is a natural extension of global sourcing. Itrefers 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. International Business: Strategy, Management, and the New Realities

18. 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 German-speaking customers throughout Europe. International Business: Strategy, Management, and the New Realities

19. 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. International Business: Strategy, Management, and the New Realities

20. 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. International Business: Strategy, Management, and the New Realities

21. 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. International Business: Strategy, Management, and the New Realities

23. 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. International Business: Strategy, Management, and the New Realities

24. 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 customer-support 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. International Business: Strategy, Management, and the New Realities

25. 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. International Business: Strategy, Management, and the New Realities

26. 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. International Business: Strategy, Management, and the New Realities

28. 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. (11th). • The index emphasizes various criteria: • Country’s financial structure (compensation costs, infrastructure costs, tax and regulatory costs); • Availability and skills of people (cumulative business-process 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). International Business: Strategy, Management, and the New Realities

30. 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 back-office operations such as accounting and data processing. International Business: Strategy, Management, and the New Realities

32. 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. International Business: Strategy, Management, and the New Realities

33. 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 International Business: Strategy, Management, and the New Realities

34. 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. International Business: Strategy, Management, and the New Realities

37. 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. International Business: Strategy, Management, and the New Realities

38. 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. International Business: Strategy, Management, and the New Realities

40. 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-of-sale data to logistics managers. Technology allows Tesco to track product purchases down to the minute. International Business: Strategy, Management, and the New Realities

41. 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. International Business: Strategy, Management, and the New Realities

42. 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 20- and 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. International Business: Strategy, Management, and the New Realities

43. 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 macro-economic 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. International Business: Strategy, Management, and the New Realities

44. Risks in Global Sourcing (cont.) 4. Risk of creating competitors. As the focal firm shares its intellectual property and business-process 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. International Business: Strategy, Management, and the New Realities

45. Risks in Global Sourcing (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 home-country 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. International Business: Strategy, Management, and the New Realities

46. Strategies for Minimizing Risk in Global Sourcing • 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. • Need to get employees on board. Global sourcingtends 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. International Business: Strategy, Management, and the New Realities

47. Strategies for Minimizing Risk in Global Sourcing (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. International Business: Strategy, Management, and the New Realities

48. Strategies for Minimizing Risk in Global Sourcing (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. International Business: Strategy, Management, and the New Realities

49. Strategies for Minimizing Risk in Global Sourcing (cont.) • 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. International Business: Strategy, Management, and the New Realities

50. 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. International Business: Strategy, Management, and the New Realities