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chapter. Global Production, Outsourcing, and Logistics. McGraw-Hill/Irwin Global Business Today, 5e. © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 14. INTRODUCTION Where in the world should productive activities be located?

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chapter

chapter

Global Production, Outsourcing, and Logistics

McGraw-Hill/Irwin

Global Business Today, 5e

© 2008 The McGraw-Hill Companies, Inc., All Rights Reserved.

14

chapter 14 global production outsourcing and logistics
INTRODUCTION

Where in the world should productive activities be located?

What should be the long-term strategic role of foreign production sites?

Should the firm own foreign production activities, or is it better to outsource those activities to independent vendors?

How should a globally dispersed supply chain be managed, and what is the role of Internet-based information technology in the management of global logistics?

Should the firm manage global logistics itself, or should it outsource the management to enterprises that specialize in this activity?

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STRATEGY, PRODUCTION, AND LOGISTICS

How can production and logisticsbe conducted internationally to:

lower the costs of value creation

add value by better serving customer needs

Production refers to activities involved in creating a product. Logistics refers to the procurement and physical transmission of material through the supply chain, from suppliers to customers.

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

These two objectives are interrelated

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There are three ways in which improved quality control reduces costs:

productivity increases because time is not wasted manufacturing poor quality products that cannot be sold

increased product quality means lower re-work and scrap costs

greater product quality means lower warranty and re-work costs

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The main management technique that companies are utilizing to boost their product quality is the Six Sigma program which aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company

Six Sigma, a direct descendant of total quality management (TQM), has a goal of improving product quality

Some countries have also promoted specific quality guidelines

The European Union requires that the quality of a firm’s manufacturing processes and products be certified under a quality standard known as ISO 9000 before the firm is allowed access to the European marketplace

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Two other objectives are important for international companies:

production and logistics functions must be able to accommodate demands for local responsiveness

production and logistics must be able to respond quickly to shifts in customer demand

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WHERE TO PRODUCE

There are three factors that should be when making a location decision:

country factors

technological factors

product factors

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Country Factors

Country factors suggest that a firm should locate it various manufacturing activities in those locations where economic, political, and cultural conditions, including relative factor costs, are most conducive to the performance of that activity

Regulations affecting FDI and trade can significantly affect the appropriateness of specific countries, as can expectations about future exchange rate changes

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Technological Factors

The type of technology a firm uses in its manufacturing can affect location decisions.

Three characteristics of a manufacturing technology are of interest:

the level of fixed costs

its minimum efficient scale

its flexibility

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Fixed Costs

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

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Minimum Efficient Scale

The larger the minimum efficient scale (the level of output at which most plant-level scale economies are exhausted) of a plant, the more likely centralized production in a single location or a limited number of locations makes sense

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Flexible Manufacturing and Mass Customization

The term flexible manufacturing technology or lean production covers a range of manufacturing technologies that are designed to:

reduce set up times for complex equipment

increase the utilization of individual machines through better scheduling

improve quality control at all stages of the manufacturing process

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Flexible manufacturing technologies allow a company to produce a wide variety of end products at a unit cost that at one time could only be achieved through the mass production of a standardized output

Mass customization implies that a firm may be able to customize its product range to suit the needs of different customer groups without bearing a cost penalty

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Flexible machine cells (grouping of various types of machinery, a common materials handler, and a centralized cell controller) are another common flexible manufacturing technology

Adopting flexible manufacturing technologies can help improve the competitive position of firms by allowing the firm to customize products to different national markets in accordance with demands for local responsiveness

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Summary

Concentrating production at a few choice locations makes sense when:

fixed costs are substantial

the minimum efficient scale of production is high

flexible manufacturing technologies are available

Concentrating production at a few choice locations is not as compelling when:

both fixed costs and the minimum efficient scale of production are relatively low

appropriate flexible manufacturing technologies are not available

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Product Factors

Two product factors impact location decisions:

the product's value-to-weight ratio

If the value-to-weight ratio is high, it is practical to produce the product in a single location and export it to other parts of the world.

If the value-to-weight ratio is low, there is greater pressure to manufacture the product in multiple locations across the world.

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whether the product serves universal needs (needs that are the same everywhere)

Since there are few national differences in consumer taste and preference for such products, the need for local responsiveness is reduced, increasing the attractiveness of concentrating manufacturing in a central location.

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Locating Production Facilities

There are two basic strategies for locating manufacturing facilities:

concentrating them in the optimal location and serving the world market from there

decentralizing them in various regional or national locations that are close to major markets

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Classroom Performance System

Decentralized production will be favored when

There are substantial differences in political economy

Fixed costs are high

The product’s value-to-weight ratio is high

Exchange rates are volatile

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Classroom Performance System

Firms will prefer concentrated production when

Minimum efficient scale is high

Location externalities are not important

The product does not serve universal needs

There are few trade barriers

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THE STRATEGIC ROLE OF FOREIGN FACTORIES

The strategic role of foreign factories and the strategic advantage of a particular location can change over time.

A factory initially established to make a standard product to serve a local market, or to take advantage of low cost inputs, can evolve into a facility with advanced design capabilities

As governmental regulations change and/or countries upgrade their factors of production the strategic advantage of a particular location can change

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As the strategic role of a factory is upgraded and a firm develops centers of excellence in different locations worldwide, it supports the development of a transnational strategy

A major aspect of a transnational strategy is a belief in global learning, or the idea that valuable knowledge does not reside just in a firm’s domestic operations, it may also be found in its foreign subsidiaries

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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

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The Advantages of Make

Vertical integration (making component parts in-house):

is associated with lower costs

facilitates investments in highly specialized assets

protects proprietary technology

facilitates the scheduling of adjacent processes

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Lowering Costs

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

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Facilitating Specialized Investments

Internal production makes sense when substantial investments in specialized assets (assets whose value is contingent upon a particular relationship persisting) are required to manufacture a component

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Classroom Performance System

Which of the following is not one of the key factors that influence the decision of where to produce?

Country factors

Competitors factors

Technological factors

Product factors

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Protecting Proprietary Product Technology

A firm might prefer to make component parts that contain proprietary technology in-house in order to maintain control over the technology

Improving Scheduling

The weakest argument for vertical integration is that the resulting production cost savings make planning, coordination, and scheduling of adjacent processes easier

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The Advantages of Buy

Buying component parts from independent suppliers:

gives the firm greater flexibility

helps drive down the firm's cost structure

helps the firm to capture orders from international customers

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Strategic Flexibility

The greatest advantage of buying component parts from independent suppliers is that the firm can maintain its flexibility, switching orders between suppliers as circumstances dictate

This is particularly important when changes in exchange rates and trade barriers might alter the attractiveness of various supply sources over time

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Lower Costs

Firms that buy components from independent suppliers can avoid:

the challenges involved with coordinating and controlling the additional subunits that are associated with vertical integration

the lack of incentive associated with internal suppliers

the difficulties with setting appropriate transfer prices

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Offsets

Outsourcing can help firms capture more orders from suppliers’ countries

Trade-Offs

The benefits of manufacturing components in-house are greatest when:

highly specialized assets are involved

when vertical integration is necessary for protecting proprietary technology

when the firm is more efficient than external suppliers at performing a particular activity.

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Strategic Alliances with Suppliers

Firms have tried to capture some of the benefits of vertical integration, without encountering the associated organizational problems, by entering into long-term strategic alliances with key suppliers

While such alliances can help the firm to capture the benefits associated with vertical integration firms may find their strategic flexibility limited by commitments to alliance partners

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Classroom Performance System

Buying from independent suppliers offers all of the following advantages except

It gives the firm greater flexibility

It helps drive down the firm's cost structure

It protects proprietary property

It helps the firm to capture orders from international customers

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MANAGING A GLOBAL SUPPLY CHAIN

Logistics encompasses the activities necessary to get materials to a manufacturing facility, through the manufacturing process, and out through a distribution system to the end user.

The logistics function is complicated in an international business by factors such as distance, time, exchange rates, and customs barriers

Efficient logistics can have a major impact upon a firm's bottom line

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The Power of Just-in-Time (JIT)

The basic philosophy behind JIT systems is to economize on inventory holding costs by having materials arrive at a manufacturing plant just in time to enter the production process, and not before.

JIT systems generate major cost savings from reduced warehousing and inventory holding costs

JIT systems can help the firm to spot defective parts and take them out of the manufacturing process and boost product quality

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The Role of Information Technology and the Internet

Web-based information systems play a crucial role in materials management.

EDI:

facilitates the tracking of inputs

allows the firm to optimize its production schedule

allows the firm and its suppliers to communicate in real time

eliminates the flow of paperwork between a firm and its suppliers

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CRITICAL THINKING AND DISCUSSION QUESTIONS

1. An electronics firm is considering how best to supply the world market for microprocessors used in consumer and industrial electronic products. A manufacturing plant cost approximately $500 million to construct and requires a highly skilled work force. The total value of the world market for this product over the next 10 years is estimated to be between $10 and $15 billion. The tariffs prevailing in this industry are currently low. What kind of manufacturing strategy do you think the firm should adopt - concentrated or decentralized? What kind of location(s) should the firm favor for its plant(s)?

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CRITICAL THINKING AND DISCUSSION QUESTIONS

2. A chemical firm is considering how best to supply the world market for sulfuric acid. A manufacturing plant costs approximately $20 million to construct and requires a moderately skilled work force. The total value of the world market for this product over the new 10 years is estimated to be between $20 and $30 billion. The tariffs prevailing in this industry are moderate. Should the firm favor concentrated manufacturing or decentralized manufacturing? What kind of location(s) should the firm seek for its plant(s)?

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CRITICAL THINKING AND DISCUSSION QUESTIONS

3. A firm must decide whether to make a component part in-house or to contract it out to an independent supplier. Manufacturing the part requires a nonrecoverable investment in specialized assets. The most efficient suppliers are located in countries with currencies that many foreign exchange analysts expect to appreciate substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house and (b) outsourcing manufacture to an independent supplier? Which option would you recommend? Why?

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CRITICAL THINKING AND DISCUSSION QUESTIONS

4. Explain how an efficient materials management function can help an international business compete more effectively in the global marketplace.

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