Role of Just In Time Inventory

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Global Production and Supply Chain Management

Apple: The Best Supply Chains in the World?

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F or six straight years, Apple has been recognized as having the best worldwide supply chains in the “Gartner Global Supply Chain Top 25” ranking. Numerous accolades have also been made about Apple’s supply chain strategy, operations, and results. For example, Apple’s supply chains “best

demonstrate leadership in applying demand-driven principles to drive business results.” “Apple dominates because it consistently brings both operational and innovation excellence to bear in some of the most competitive markets in the world.” Basically, Apple gets a lot of credit in the supply chain profession for being able to ramp up volumes both in hardware and software while also innovatively helping to redefine the consumer electronics market (e.g., iPhone, iPod, iPad, Mac).

Apple is the world’s second largest information technology company by revenue after Samsung and the third largest mobile phone producer after Samsung and Nokia. In Interbrand’s “Best Global Brands” report, Apple is now also the most valuable brand in the world. It overtook Coca-Cola for the number one position after Coca-Cola’s 13-year run at the top. Apple has an estimated brand value of more than $98 billion. “Few brands have enabled so many people to do so much so easily, which is why Apple has legions of adoring fans.” These “fans” or customers have downloaded apps for Apple’s electronic gadgets more than 50 billion times.

The company’s general supply chain model follows the path of most large multinational corporation’s supply chains. They do research and development to cultivate new technologies and/or to acquire intellectual property needed for future products. They test the product concepts via marketing research, product testing, and total cost analysis. After that, Apple typically does a pre-launch of new products, where global production, sourcing commitments, inventory management, and so on are evaluated. The product launch involves doing demand forecasts, resolving potential backlogs, and ensuring that the products are in the hands of its customers in as fast cycle time as possible. After the launch, monitoring starts with periodic reviews of inventory, demand, life cycle status, and component cost forecasts.

A number of factors make Apple’s global supply chains world leading. First, early on, Apple took steps to manage the total value created in its global supply chains by managing its suppliers and all other providers within the chains. Predetermined expectations of suppliers, exclusivity in supplier arrangements,

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420 Part Six International Business Functions

and volume guarantees ensured a supply chain infrastructure that could support Apple’s aggressive market leadership. Apple’s relationship building with its network partners is also a strength that has helped with increased scaling of production and resulted in improved quality in the manufacturing processes. Plus, and not to be underestimated, Apple has amassed lots of cash! The available cash funds have partially been used to place high volume orders, which strengthen supplier relationships, and in other ways maintain global supply chain leadership.

Using its supply chain infrastructure, Apple has managed to solve most of the challenges it has faced. For example, while the global economic downturn in 2008 presented problems for virtually all companies, Apple came through it in great shape. At the time, Steve Jobs said, “We’re armed with the strongest product line in our history, the most talented employees and the best customers in our industry . . . Apple just reported one of the best quarters in its history.” Other challenges that Apple is facing include obtaining enough quality components for its consumer electronics, potential for supply chain disruptions (natural and people created), dependence on third-party logistics providers, and inventory management issues. In each case, so far, Apple has strategically solved major issues to the satisfaction of the marketplace (the company consistently ranks at the top in “customer satisfaction” in the American Customer Satisfaction Index).

However, everything is not all rosy or positive about Apple. The company’s reputation has taken a few hits recently. For example, Apple was found guilty by a U.S. court of conspiring with publishers to set the price of e-books that were bought using iTunes. The ongoing feud with Samsung regarding various patents keeps lingering year-by- year, and worldwide customers are almost fanatically taking sides for or against Apple. There have also been allegations about the treatment of employees at Foxconn in China (one of the Apple suppliers). Plus, there was a U.S. Senate hearing that investigated Apple’s “highly questionable” tax minimization strategies. Now, on the more positive side, Apple has a portfolio of potential blockbuster products, welcomed upgrades, and innovative services in the making that are sure to remind its fans why they favor Apple products.

The challenges attached to these new offerings are sure to test Apple’s leadership in both brand value and best global supply chains. To some degree, the future challenges are clear. To stay at the top of its industry, Apple has to succeed in slowing Samsung’s momentum and capturing the booming Chinese mobile phone market. As always with Apple, as set in our expectations over the years by Steve Jobs’ “one more thing” announcements, Tim Cook and the new Apple leadership team must keep communicating to the market that their vision, innovations, and leadership can drive the idea that Apple’s best days are ahead. As one way to do this, Apple is on a hiring binge in Asia, adding hundreds of engineers and supply chain managers to its staff in Shangai and Taipei as it seeks to increase the speed at which it introduces new products. Plus, with Tim Cook as the CEO, Apple has a global production and supply chain management expert at the helm who constantly scrutinizes Apple’s supply chains, production operations, and fair labor practices. • Sources: D. Hofman, “The Gartner Supply Chain Top 25,” 2013, www.gartner.com/technology/supply-chain/top25.jsp, accessed April 13, 2014; “Interbrand’s Best Global Brands 2013,” www.interbrand.com/en/best-global-brands/2013/ Best-Global-Brands-2013.aspx, accessed April 13, 2014; “Apple Is the World’s Most Valuable Brand at $98 Billion,” The Huffington Post, September 30, 2013; “Apple Reports Fourth Quarter Results,” Apple Press Info, October 21, 2008; E. Doe, “Apple Goes on Hiring Binge in Asia to Speed Product Releases,” The Wall Street Journal, March 3, 2014; American Customer Satisfaction Index, http://theacsi.org; and “Fixing Apple’s Supply Chains,” The New York Times, April 2, 2012.

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Chapter Fifteen Global Production and Supply Chain Management 421

Introduction As trade barriers fall and global markets develop, many firms increasingly confront a set of interrelated issues. First, where in the world should production activities be located? Should they be concentrated in a single country, or should they be dispersed around the globe, matching the type of activity with country differences in factor costs, tariff barri- ers, political risks, and the like to minimize costs and maxi- mize value added? Second, what should be the long-term strategic role of foreign production sites? Should the firm abandon a foreign site if factor costs change, moving pro- duction to another more favorable location, or is there value to maintaining an operation at a given location even if underlying economic conditions change? Third, should the firm own foreign production activities, or is it better to out- source those activities to independent vendors? Fourth, how should a globally dispersed supply chain be managed, and what is the role of Internet-based information technol- ogy in the management of global logistics and sourcing? Fifth, should the firm manage global supply chains itself, or should it outsource the management to enterprises that specialize in this activity?

The example of Apple’s global supply chains discussed in the opening case touches on some of these issues. Like many modern products, different components for Apple’s consumer electronics are manufactured in different locations to produce a low-cost product. In choosing which company should make which components, Apple was guided by the need to keep the cost of the component parts low so that it could price aggressively and gain market share from its global rivals, Samsung and Nokia. How- ever, as the case demonstrates, Apple may have miscalculated in some areas and the compa- ny’s reputation has taken a few recent hits. As the Apple example illustrates, companies also need to be very careful when deciding to outsource production to foreign suppliers, and they need to think about the total costs of their supply chains, not just basic differentials in production cost.

Strategy, Production, and Supply Chain Management Chapter 12 introduced the concept of the value chain and discussed a number of value creation activities, including production, marketing, logistics, R&D, human resources, and information systems. This chapter focuses on two of these activities—production and supply chain management—and attempts to clarify how they might be performed interna- tionally to (1) lower the costs of value creation and (2) add value by better serving customer needs. We also discuss the contributions of information technology to these activities, which has become particularly important in a globally integrated world. The remaining chapters in this text look at other value creation activities in the international context (marketing, R&D, and human resource management).

In Chapter 12, we defined production as “the activities involved in creating a product.” We used the term production to denote both service and manufacturing activities, because either a service or a physical product can be produced. Although in this chapter we focus more on the production of physical goods, we should not forget that the term can also be applied to services. This has become more evident in recent years, with the continued pattern among U.S. firms to outsource the “production” of certain service activities to developing nations where labor costs are lower (e.g., the trend among many U.S. companies to outsource cus- tomer care services to places such as India, where English is widely spoken and labor costs

LO 15-1 Explain why global production and supply chain management decisions are of central importance to many global companies.

Production Activities involved in creating a product.

Supply Chain Management The integration and coordination of logistics, purchasing, operations, and market channels activities from raw material to the end-customer.

Which Career Would You Choose in Global Supply Chain Management? With increased outsourcing and overseas production sites and customers, supply chain management is a growing field. The Council of Supply Chain Management Professionals (CSCMP), a professional association with more than 8,500 members world- wide, says the industry offers a promising outlook. What’s more, potential employers are everywhere—manufacturers and dis- tributors; government agencies; consulting firms; the transport industry; universities and colleges; service firms such as banks, hospitals, and hotels; and third-party logistics providers. The basic career options in global supply chains include its main functions of logistics, purchasing (sourcing), production and operations management, and marketing channels. Which func- tional area would you choose if you decided to get a job in supply chain management and why? For more information about the organization and careers in this field, visit the CSCMP website at www.cscmp.org and its careers site, www.careers- insupplychain.org.

422 Part Six International Business Functions

are much lower). Supply chain management is the integration and coordination of logistics, purchasing, operations, and market channel activities from raw material to the end- customer. Production and supply chain management are closely linked because a firm’s ability to perform its production activities efficiently depends on a timely supply of high- quality material and information inputs, for which purchasing and logistics are critical functions. Purchasing represents the part of the supply chain that involves worldwide buying of raw material, component parts, and products used in manufacturing of the company’s products and services. Logistics is the part of the supply chain that plans, implements, and controls the effective flows and inventory of raw material, component parts, and products used in manufacturing.

The production and supply chain management functions (purchasing, logistics) of an international firm have a number of important strategic objectives.1 One is to ensure that the total cost of moving from raw materials to finished goods is as low as possible for the value provided to the end-customer. Dispersing production activities to various locations around the globe where each activity can be performed most efficiently can lower the total costs. Costs can also be cut by managing the global supply chain effi- ciently so as to better match supply and demand. This involves both coordination and integration of the supply chain functions inside a global company (e.g., purchasing, logis- tics, production and operations management) and across the independent organizations (e.g., suppliers) involved in the chain. For example, efficient logistics practices reduce the amount of inventory in the system, increases inventory turnover, and facilitates the appropriate transportation modes being used. Maximizing purchasing operations enhance the order fulfillment and delivery, outsourcing initiatives, and supplier selec- tions. Efficient operations ensure that the right location of production is made, establishes which production priorities should be stressed, and facilitates a high-quality outcome of the supply chain.

Another strategic objective shared by production and supply chain management is to increase product (or service) quality by establishing process-based quality standards, and eliminating defective raw material, component parts, and products from the manufactur- ing process and the supply chain.2 In this context, quality means reliability, implying that ultimately the finished product has no defects and performs well. These quality assur- ances should be embedded in both the upstream and downstream portions of the global supply chain. The upstream supply chain includes all of the organizations (e.g., suppliers) and resources that are involved in the portion of the supply chain from raw materials to the production facility (this is sometimes also called the inbound supply chain). The downstream supply chain includes all of the organizations (e.g., wholesaler, retailer) that are involved in the portion of the supply chain from the production facility to the end- customer (this is also sometimes called the outbound supply chain). Through the up- stream and downstream chains, the objectives of reducing costs and increasing quality are not independent of each other. As illustrated in Figure 15.1, the firm that improves

Purchasing The part of the supply chain that includes the worldwide buying of raw material, component parts, and products used in manufacturing of the company’s products and services.

Logistics The part of the supply chain that plans, implements, and controls the effective flows and inventory of raw material, component parts, and products used in manufacturing.

Upstream Supply Chain The portion of the supply chain from raw materials to the production facility.

Downstream Supply Chain The portion of the supply chain from the production facility to the end-customer.

Outsourcing

The Global Production and Supply Chain Management chapter tackles a number of issues related to production, make-or-buy decisions, sourcing, and logistics. Outsourcing is one of the most commonly dis- cussed topics in news media and on the Internet related to production and supply chains. In effect, the word outsourcing sometimes even creates “us against them” mentality (i.e., should the company out- source production or other activities to entities outside its country bor- ders, or should it use only domestic operations?). Often, the answer is

more of a political issue than a strategic resource issue. To stay com- petitive, companies typically opt for the best value to infuse in their supply chains. The “Outsourcing” section on globalEDGE ensures that you have an updated set of data and knowledge on outsourcing (http:// globaledge.msu.edu/global-resources/outsourcing). For example, did you know that there is an International Association of Outsourcing Pro- fessionals? Do you know what it does, its goals, and how many mem- bers it has worldwide?

Chapter Fifteen Global Production and Supply Chain Management 423

its quality control will also reduce its costs of value creation. Improved quality control reduces costs by:

• Increasing productivity because time is not wasted producing poor-quality products that cannot be sold, leading to a direct reduction in unit costs.

• Lowering rework and scrap costs associated with defective products. • Reducing the warranty costs and time associated with fixing defective products.

The effect is to lower the total costs of value creation by reducing both production and after-sales service costs. This creates an increased overall reliability in global production and supply chain management.

The principal tool that most managers now use to increase the reliability of their prod- uct offering is the Six Sigma quality improvement methodology. Six Sigma is a direct descendant of the total quality management (TQM) philosophy that was widely adopted, first by Japanese companies and then American companies, during the 1980s and early 1990s.3 The TQM philosophy was developed by a number of American consultants such as W. Edward Deming, Joseph Juran, and A. V. Feigenbaum.4 Deming identified a number of steps that should be part of any TQM program. He argued that management should embrace the philosophy that mistakes, defects, and poor-quality materials are not acceptable and should be eliminated. He suggested that the quality of supervision should be improved by allowing more time for supervisors to work with employees and by providing them with the tools they need to do the job. Deming recommended that man- agement should create an environment in which employees will not fear reporting prob- lems or recommending improvements. He believed that work standards should not only be defined as numbers or quotas, but also include some notion of quality to promote the production of defect-free output. He argued that management has the responsibility to train employees in new skills to keep pace with changes in the workplace. In addition, he! believed that achieving better quality requires the commitment of everyone in the company.

Six Sigma, the modern successor to TQM, is a statistically based philosophy that aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company. Six Sigma programs have been adopted by several major corporations, such as Motorola, General Electric, and Honeywell. Sigma comes from the Greek letter that statisticians use to represent a standard deviation from a mean; the higher the number of “sigmas,” the smaller the number of errors. At six sigmas, a production process would be 99.99966 per- cent accurate, creating just 3.4 defects per million units. While it is almost impossible for a company to achieve such perfection, Six Sigma quality is a goal to strive toward. Increas- ingly, companies are adopting Six Sigma programs to try to boost their product quality and productivity.5

Total Quality Management (TQM) Management philosophy that takes as its central focus the need to improve the quality of a company’s products and services.

Six Sigma Statistically based methodology for improving product quality.

15.1 FIGURE The Relationship between Quality and Costs Source: From “What Does Product Quality Really Mean?” by David A. Gandin, MIT Sloan Management Review, Fall 1984. Copyright ©1984 by Massachusetts Institute of Technology. All rights reserved. Distributed by Tribune Media Services. Reprinted with permission.

Improves Performance Reliability

Lowers Rework and Scrap Costs

Lowers Manufacturing Costs

Increases Pro!ts

Increases Productivity

Lowers Warranty Costs

Lowers Service Costs

424 Part Six International Business Functions

The growth of international standards has also focused greater attention on the impor- tance of product quality. In Europe, for example, the European Union requires that the quality of a firm’s manufacturing processes and products be certified under a quality stan- dard known as ISO 9000 before the firm is allowed access to the EU marketplace. Although the ISO 9000 certification process has proved to be somewhat bureaucratic and costly for many firms, it does focus management attention on the need to improve the quality of prod- ucts and processes.6

In addition to lowering costs and improving quality, two other objectives have particular importance in international businesses. First, production and supply chain functions must be able to accommodate demands for local responsiveness. As we saw in Chapter 12, de- mands for local responsiveness arise from national differences in consumer tastes and pref- erences, infrastructure, distribution channels, and host-government demands. Demands for local responsiveness create pressures to decentralize production activities to the major na- tional or regional markets in which the firm does business or to implement flexible manu- facturing processes that enable the firm to customize the product coming out of a factory according to the market in which it is to be sold.

Second, production and supply chain management must be able to respond quickly to shifts in customer demand. In recent years, time-based competition has grown more impor- tant.7 When consumer demand is prone to large and unpredictable shifts, the firm that can adapt most quickly to these shifts will gain an advantage.8 As we shall see, both production and supply chain management play critical roles here.

Where to Produce An essential decision facing an international firm is where to locate its production activi- ties to best minimize costs and improve product quality. For the firm contemplating inter- national production, a number of factors must be considered. These factors can be grouped under three broad headings: country factors, technological factors, and produc- tion factors.9

COUNTRY FACTORS We reviewed country-specific factors in some detail earlier in the book. Political and economic systems, culture, and relative factor costs differ from country to country. In Chapter 6, we saw that due to differences in factor costs, some coun- tries have a comparative advantage for producing certain products. In Chapters 2, 3, and 4 we saw how differences in political and economic systems—and national culture—influence the benefits, costs, and risks of doing business in a country. Other things being equal, a firm should locate its various manufacturing activities where the economic, political, and cultural conditions—including relative factor costs—are conducive to the performance of those ac- tivities (for an example, see the accompanying Management Focus, which looks at the Philips investment in China). In Chapter 12, we referred to the benefits derived from such a strat- egy as location economies. We argued that one result of the strategy is the creation of a global web of value creation activities.

Also important in some industries is the presence of global concentrations of activities at certain locations. In Chapter 8, we discussed the role of location externalities in influ- encing foreign direct investment decisions. Externalities include the presence of an appro- priately skilled labor pool and supporting industries.10 Such externalities can play an important role in deciding where to locate production activities. For example, because of a cluster of semiconductor manufacturing plants in Taiwan, a pool of labor with experience in the semiconductor business has developed. In addition, the plants have attracted a num- ber of supporting industries, such as the manufacturers of semiconductor capital equip- ment and silicon, which have established facilities in Taiwan to be near their customers. This implies that there are real benefits to locating in Taiwan, as opposed to another loca- tion that lacks such externalities. Other things being equal, the externalities make Taiwan an attractive location for semiconductor manufacturing facilities. The same process is now under way in two Indian cities, Hyderabad and Bangalore, where both Western and Indian information technology companies have established operations. For example, locals refer

ISO 9000 Certification process that requires certain quality standards must be met.

LO 15-2 Explain how country differences, production technology, and production factors all affect the choice of where to locate production activities.

test PREP Use LearnSmart to help retain what you have learned. Access your instructor’s Connect course to check out LearnSmart or go to learnsmartadvantage.com for help.

Chapter Fifteen Global Production and Supply Chain Management 425

to a section of Hyderabad as “Cyberabad,” where Microsoft, IBM, Infosys, and Qualcomm (among others) have major facilities.

Of course, other things are not equal. Differences in relative factor costs, political econ- omy, culture, and location externalities are important, but other factors also loom large. Formal and informal trade barriers obviously influence location decisions (see Chapter 7), as do transportation costs and rules and regulations regarding foreign direct investment (see Chapter 8). For example, although relative factor costs may make a country look attractive as a location for performing a manufacturing activity, regulations prohibiting foreign direct investment may eliminate this option. Similarly, a consideration of factor costs might sug- gest that a firm should source production of a certain component from a particular country, but trade barriers could make this uneconomical.

Another important country factor is expected future movements in its exchange rate (see Chapters 10 and 11). Adverse changes in exchange rates can quickly alter a country’s attrac- tiveness as a manufacturing base. Currency appreciation can transform a low-cost location into a high-cost location. Many Japanese corporations had to grapple with this problem during the 1990s and early 2000s. The relatively low value of the yen on foreign exchange markets between 1950 and 1980 helped strengthen Japan’s position as a low-cost location for manufacturing. More recently, however, the yen’s steady appreciation against the dollar increased the dollar cost of products exported from Japan, making Japan less attractive as a manufacturing location. In response, many Japanese firms moved their manufacturing off- shore to lower-cost locations in East Asia.

Philips in China

The Dutch consumer electronics, lighting, semiconductor, and medical equipment conglomerate Philips Electronics NV has been operating factories in China since 1985, when the country first opened its mar- kets to foreign investors. When Philips initially entered China, it had dreams of Chinese consumers snapping up its products by the millions. However, the company soon found out that the reason it liked China— low wage rates—also meant that few Chinese workers could afford to buy its products. So Philips hit on a new strategy: Keep the factories in China, but export most of the goods to developed nations.

The initial attractions of China to Philips included low wage rates, an educated workforce, a robust Chinese economy, a stable exchange rate that is linked to the U.S. dollar through a managed float, a rapidly expanding industrial base that includes many other Western and Chinese companies that Philips uses as suppliers, and easier access to world markets given China’s entry into the WTO in 2001. By the early 2000s, Philips employed some 30,000 people in China either directly or indirectly at joint ventures. Philips exported nearly two-thirds of the $7!billion in products that its Chinese factories were producing. At this point, 25 percent of everything that Philips made worldwide came from China.

As time passed, Philips started to give its Chinese factories a greater role in product development. In the TV business, for example, basic de- velopment used to occur in Holland but was moved to Singapore in the early 1990s. In the early 2000s, Philips transferred TV development work to a new R&D center in Suzhou near Shanghai. Similarly, basic product development work on LCD screens for cell phones was shifted to Shanghai. In 2011, in a testament to just how important China had become to Philips, the company moved the global headquarters of its domestic appliances business from Amsterdam to Shanghai. By this

point, China was far more than just an export base. Demand in China had accelerated rapidly, and the country was now the second- largest market for Philips.

Some worry that Philips and companies pursuing a similar strategy might be overdoing it. Too much dependence on China could be dangerous if political, eco- nomic, or other problems disrupt production and the company’s ability to supply global markets. Some observers believe that it might be better if the manufactur- ing facilities of companies were more geographically diverse as a hedge against problems in China. These fears have taken on added importance recently as labor costs have accelerated in China due to labor shortages. According to estimates, labor costs have been growing by 20 percent per year since the 2000s. On the other hand, there is a silver lining to this cloud: Chinese consumption of many of the products that Philips makes there is now rising rapidly.

Sources: B. Einhorn, “Philips’ Expanding Asia Connections,” BusinessWeek Online, November 27, 2003; K. Leggett and P. Wonacott, “The World’s Factory: A Surge in Exports from China Jolts the Global Industry,” The Wall Street Journal, October 10, 2002, p.A1; J.!Blau, “Philips Tears Down Eindhoven R&D Fence,” Research Technology Management 50, no. 6 (2007), pp. 9–11; L.Baijia, “Philips Elevates China’s Market Status,” China Daily, May 26, 2011; and information on Philips NV website, www.philips.com/shared/assets/ Downloadablefile/Investor/2011_05_26_Frans_van_Houten_Morgan_Stanley.pdf.

management FOCUS

Employees work at a Philips stand during a trade show in Shanghai, China.

426 Part Six International Business Functions

TECHNOLOGICAL FACTORS The type of technology a firm uses to perform specific manufacturing activities can be pivotal in location decisions. For example, because of technological constraints, in some cases it is necessary to perform certain manufacturing activities in only one location and serve the world market from there. In other cases, the technology may make it feasible to perform an activity in multiple locations. Three charac- teristics of a manufacturing technology are of interest here: the level of fixed costs, the minimum efficient scale, and the flexibility of the technology.

Fixed Costs As noted in Chapter 12, in some cases the fixed costs of setting up a production plant are so high that a firm must serve the world market from a single loca- tion or from very few locations. For example, it now costs up to $5 billion to set up a state-of-the-art plant to manufacture semiconductor chips. Given this, other things being equal, serving the world market from a single plant sited at a single (optimal) location can make sense.

Conversely, a relatively low level of fixed costs can make it economical to perform a par- ticular activity in several locations at once. This allows the firm to better accommodate de- mands for local responsiveness. Manufacturing in multiple locations may also help the firm avoid becoming too dependent on one location. Being too dependent on one location is particularly risky in a world of floating exchange rates. Many firms disperse their manufac- turing plants to different locations as a “real hedge” against potentially adverse moves in currencies.

Minimum Efficient Scale The concept of economies of scale tells us that as plant output expands, unit costs decrease. The reasons include the greater utilization of capital equipment and the productivity gains that come with specialization of employees within the plant.11 However, beyond a certain level of output, few additional scale economies are available. Thus, the “unit cost curve” declines with output until a certain output level is reached, at which point further increases in output realize little reduction in unit costs. The level of output at which most plant-level scale economies are exhausted is referred to as the minimum efficient scale of output. This is the scale of output a plant must operate to realize all major plant-level scale economies (see Figure 15.2).

The implications of this concept are as follows: The larger the minimum efficient scale of a plant relative to total global demand, the greater the argument for centralizing production in a single location or a limited number of locations. Alternatively, when the minimum effi- cient scale of production is low relative to global demand, it may be economical to manufac- ture a product at several locations. For example, the minimum efficient scale for a plant to manufacture personal computers is about 250,000 units a year, while the total global demand

Minimum Efficient Scale The level of output at which most plant- level scale economies are exhausted.

15.2 FIGURE Typical Unit Cost Curve

Volume

U ni

t C

os ts

Minimum Ef!cient Scale

Chapter Fifteen Global Production and Supply Chain Management 427

exceeds 35 million units a year. The low level of minimum efficient scale in relation to total global demand makes it economically feasible for companies such as Dell and Lenovo to assemble PCs in multiple locations.

As in the case of low fixed costs, the advantages of a low minimum efficient scale include allowing the firm to accommodate demands for local responsiveness or to hedge against currency risk by manufacturing the same product in several locations.

Flexible Manufacturing and Mass Customization Central to the concept of economies of scale is the idea that the best way to achieve high efficiency, and hence low unit costs, is through the mass production of a standardized output. The trade-off implicit in this idea is between unit costs and product variety. Producing greater product variety from a factory implies shorter production runs, which in turn implies an inability to realize economies of scale. That is, wide product variety makes it difficult for a company to increase its production efficiency and thus reduce its unit costs. According to this logic, the way to increase efficiency and drive down unit costs is to limit product variety and produce a stan- dardized product in large volumes.

This view of production efficiency has been challenged by the rise of flexible manufactur- ing technologies. The term flexible manufacturing technology—or lean production, as it is often called—covers a range of manufacturing technologies designed to (1) reduce setup times for complex equipment, (2) increase the utilization of individual machines through better scheduling, and (3) improve quality control at all stages of the manufacturing pro- cess.12 Flexible manufacturing technologies allow the company to produce a wider variety of end products at a unit cost that at one time could be achieved only through the mass pro- duction of a standardized output. Research suggests the adoption of flexible manufacturing technologies may actually increase efficiency and lower unit costs relative to what can be achieved by the mass production of a standardized output while enabling the company to customize its product offering to a much greater extent than was once thought possible. The term mass customization has been coined to describe the ability of companies to use flexible manufacturing technology to reconcile two goals that were once thought to be incompatible—low cost and product customization.13 Flexible manufacturing technologies vary in their sophistication and complexity.

One of the most famous examples of a flexible manufacturing technology, Toyota’s pro- duction system, has been credited with making Toyota the most efficient auto company in the world. (Despite Toyota’s recent problems with sudden uncontrolled acceleration, the company continues to be an efficient producer of high-quality automobiles, according to J.D. Power, which produces an annual quality survey. Toyota’s Lexus models continue to top J.D. Power’s quality rankings.14) Toyota’s flexible manufacturing system was developed by one of the company’s engineers, Taiichi Ohno. After working at Toyota for five years and visiting Ford’s U.S. plants, Ohno became convinced that the mass production philosophy for making cars was flawed. He saw numerous problems with mass production.

First, long production runs created massive inventories that had to be stored in large warehouses. This was expensive, both because of the cost of warehousing and because inven- tories tied up capital in unproductive uses. Second, if the initial machine settings were wrong, long production runs resulted in the production of a large number of defects (i.e., waste). Third, the mass production system was unable to accommodate consumer prefer- ences for product diversity.

In response, Ohno looked for ways to make shorter production runs economical. He developed a number of techniques designed to reduce setup times for production equipment (a major source of fixed costs). By using a system of levers and pulleys, he reduced the time required to change dies on stamping equipment from a full day in 1950 to three minutes by 1971. This made small production runs economical, which allowed Toyota to respond better to consumer demands for product diversity. Small production runs also eliminated the need to hold large inventories, thereby reducing warehousing costs. Plus, small product runs and the lack of inventory meant that defective parts were produced only in small numbers and entered the assembly process immediately. This reduced waste and helped trace defects back to their source to fix the problem. In sum, these innovations enabled Toyota to produce a

Flexible Manufacturing Technology Manufacturing technology designed to improve job scheduling, reduce setup time, and improve quality control.

Lean Production See flexible manufacturing technology.

Mass Customization The production of a variety of end products at a unit cost that could once be achieved only through mass production of a standardized output.

428 Part Six International Business Functions

more diverse product range at a lower unit cost than was possible with conventional mass production.15

Flexible machine cells are another common flexible manufacturing technology. A flexi- ble machine cell is a grouping of various types of machinery, a common materials handler, and a centralized cell controller (computer). Each cell normally contains four to six machines capable of performing a variety of operations. The typical cell is dedicated to the production of a family of parts or products. The settings on machines are computer controlled, which allows each cell to switch quickly between the production of different parts or products.

Improved capacity utilization and reductions in work in progress (i.e., stockpiles of partly finished products) and in waste are major efficiency benefits of flexible machine cells. Improved capacity utilization arises from the reduction in setup times and from the computer- controlled coordination of production flow between machines, which eliminates bottle- necks. The tight coordination between machines also reduces work-in-progress inventory. Reductions in waste are due to the ability of computer-controlled machinery to identify ways to transform inputs into outputs while producing a minimum of unusable waste mate- rial. While freestanding machines might be in use 50 percent of the time, the same machines when grouped into a cell can be used more than 80 percent of the time and produce the same end product with half the waste. This increases efficiency and results in lower costs.

The effects of installing flexible manufacturing technology on a company’s cost structure can be dramatic. The Ford Motor Company has been introducing flexible manufacturing technologies into its automotive plants around the world. These new technologies should allow Ford to produce multiple models from the same line and to switch production from one model to another much more quickly than in the past, allowing Ford to take $2 billion out of its cost structure.16

Besides improving efficiency and lowering costs, flexible manufacturing technologies en- able companies to customize products to the demands of small consumer groups—at a cost that at one time could be achieved only by mass-producing a standardized output. Thus, the technologies help a company achieve mass customization, which increases its customer re- sponsiveness. Most important for international business, flexible manufacturing technologies can help a firm customize products for different national markets. The importance of this ad- vantage cannot be overstated. When flexible manufacturing technologies are available, a firm can manufacture products customized to various national markets at a single factory sited at the optimal location. And it can do this without absorbing a significant cost penalty. Thus,

firms no longer need to establish manufacturing facilities in each major national market to provide products that sat- isfy specific consumer tastes and preferences, part of the rationale for a localization strategy (Chapter 12).

PRODUCTION FACTORS Several production factors feature prominently into the reasons why produc- tion facilities are located and used in a certain way world- wide. They include (1) product features, (2) locating production facilities, and (3) strategic roles for produc- tion facilities.

Product Features Two product features affect location decisions. The first is the product’s value-to- weight ratio because of its influence on transportation costs. Many electronic components and pharmaceuticals have high value-to-weight ratios; they are expensive and they do not weigh very much. Thus, even if they are shipped halfway around the world, their transportation costs account for a very small percentage of total costs. Given this, other things being equal, there is great pres- sure to produce these products in the optimal location and to serve the world market from there. The opposite

Flexible Machine Cells Flexible manufacturing technology in which a grouping of various machine types, a common materials handler, and a centralized cell controller produce a family of products.

Should Nestlé Continue to Invest Heavily in Turkey? According to Nestlé Turkey’s CEO, Hans Ulrich Mayer, Turkey has been a great place to invest. “Turkey has been the recipient of several Nestlé investments many times greater than we invest in other markets,” reported Mayer. Nestlé has invested about 500!million U.S. dollars in Turkey over the last four years, and following its successful breakfast cereal investment in 2011, the company intends to go on investing because of the strong Turkish economy compared to other European economies. Nestlé prod- ucts sold in Turkey, ranging from pet food to chocolates, are manufactured in Turkey and also exported to North Africa and the Middle East. Given the political situation in Turkey, should Nestlé continue to establish increased production (i.e., expand its production facility) in delivering to North Africa and the Middle East, or should it establish production elsewhere?

Source: Invest in Turkey, www.spotblue.co.uk/turkey-property-news/11577/ nestle-goes-on-investing-in-turkey/.

Chapter Fifteen Global Production and Supply Chain Management 429

holds for products with low value-to-weight ratios. Refined sugar, certain bulk chemicals, paint, and petroleum products all have low value-to-weight ratios; they are relatively inex- pensive products that weigh a lot. Accordingly, when they are shipped long distances, trans- portation costs account for a large percentage of total costs. Thus, other things being equal, there is great pressure to make these products in multiple locations close to major markets to reduce transportation costs.

The other product feature that can influence location decisions is whether the product serves universal needs, needs that are the same all over the world. Examples include many industrial products (e.g., industrial electronics, steel, bulk chemicals) and modern con- sumer products (e.g., Apple’s iPhone or iPad, Amazon’s Kindle, Lenovo’s ThinkPad, Sony’s Cyber-shot camera, Microsoft’s Xbox). Because there are few national differences in consumer taste and preference for such products, the need for local responsiveness is reduced. This increases the attractiveness of concentrating production at an optimal location.

Locating Production Facilities There are two basic strategies for locating pro- duction facilities: (1) concentrating them in a centralized location and serving the world market from there or (2) decentralizing them in various regional or national locations that are close to major markets. The appropriate strategic choice is determined by the various country-specific, technological, and product factors discussed in this section and summa- rized in Table 15.1.

As can be seen, concentration of production makes most sense when:

• Differences among countries in factor costs, political economy, and culture have a substantial impact on the costs of manufacturing in various countries.

• Trade barriers are low. • Externalities arising from the concentration of like enterprises favor certain locations. • Important exchange rates are expected to remain relatively stable. • The production technology has high fixed costs and high minimum efficient scale

relative to global demand or flexible manufacturing technology exists. • The product’s value-to-weight ratio is high. • The product serves universal needs.

LO 15-3 Recognize how the role of foreign subsidiaries in production can be enhanced over time as they accumulate knowledge.

15.1 TABLE Location Strategy and Production

Concentrated Production Favored

Decentralized Production Favored

Country Factors

Differences in political economy Substantial Few

Differences in culture Substantial Few

Differences in factor costs Substantial Few

Trade barriers Few Substantial

Location externalities Important in industry Not important in industry

Exchange rates Stable Volatile

Technological Factors

Fixed costs High Low

Minimum efficient scale High Low

Flexible manufacturing technology Available Not available

Product Factors

Value-to-weight ratio High Low

Serves universal needs Yes No

430 Part Six International Business Functions

Alternatively, decentralization of production is appropriate when:

• Differences among countries in factor costs, political economy, and culture do not have a substantial impact on the costs of manufacturing in various countries.

• Trade barriers are high. • Location externalities are not important. • Volatility in important exchange rates is expected. • The production technology has low fixed costs and low minimum efficient scale, and

flexible manufacturing technology is not available. • The product’s value-to-weight ratio is low. • The product does not serve universal needs (i.e., significant differences in consumer

tastes and preferences exist among nations).

In practice, location decisions are seldom clear-cut. For example, it is not unusual for dif- ferences in factor costs, technological factors, and product factors to point toward concen- trated production, while a combination of trade barriers and volatile exchange rates points toward decentralized production. This seems to be the case in the world automobile indus- try. Although the availability of flexible manufacturing and cars’ relatively high value-to- weight ratios suggest concentrated manufacturing, the combination of formal and informal trade barriers and the uncertainties of the world’s current floating exchange rate regime (see Chapter 10) have inhibited firms’ ability to pursue this strategy. For these reasons, several automobile companies have established “top-to-bottom” manufacturing operations in three major regional markets: Asia, North America, and western Europe.

Strategic Roles for Production Facilities The growth of global production among multinational companies has been tremendous over the past two decades, outdoing the growth of home country production by more than tenfold.17 In essence, since the early 1990s, multinationals have opted to set up production facilities outside their home country 10 times for every 1 time they have opted to create such facilities at home. There is a clear strategic rational for this; multinationals are trying to capture the gains associated with a dispersed global production system. This trend is expected to continue going forward. Thus, managers need to be ready to make the decision to open up a new production facility out- side of their home base and decide where to locate the facility.

When making these decisions, managers need to think about the strategic role assigned to a foreign factory. A major consideration here is the importance of global learning—the idea that valuable knowledge does not reside just in a firm’s domestic operations; it may also be found in its foreign subsidiaries. Foreign factories that upgrade their capabilities over time are creating valuable knowledge that might benefit the whole corporation. Foreign factories can have one of a number of strategic roles or designations, including (1) offshore factory, (2) source factory, (3) server factory, (4) contributor factory, (5) outpost factory, and (6) lead factory.18

An offshore factory is one that is developed and set up mainly for producing component parts or finished goods at a lower cost than producing them at home or in any other market. At an offshore factory, investments in technology and managerial resources should ideally be kept to a minimum to achieve greater cost efficiencies. Basically, the best offshore factory should involve minimal everything—from engineering to development to engaging with suppliers to negotiating prices to any form of strategic decisions being made at that facility. In reality, we expect at least some strategic decisions to include input from the offshore fac- tory personnel.

The primary purpose of a source factory is also to drive down costs in the global supply chain. The main difference between a source factory and an offshore factory is the strategic role of the factory, which is more significant for a source factory than for an offshore factory. Managers of a source factory have more of a say in certain decisions, such as purchasing raw materials and component parts used in the production at the source factory. They also have strategic input into production planning, process changes, logistics issues, product custom- ization, and implementation of newer designs when needed. Centrally, a source factory is at the top of the standards in the global supply chain, and these factories are used and treated

Global Learning The flow of skills and product offerings from foreign subsidiary to home country and from foreign subsidiary to foreign subsidiary.

Offshore Factory A factory that is developed and set up mainly for producing component parts or finished goods at a lower cost than producing them at home or in any other market.

Source Factory A factory whose primary purpose is also to drive down costs in the global supply chain.

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just like any factory in the global firm’s home country. This also means that source factories should be located where production costs are low, where infrastructure is well developed, and where it is relatively easy to find a knowledgeable and skilled workforce to make the products.

A server factory is linked into the global supply chain for a global firm to supply specific country or regional markets around the globe. This type of factory—often with the same standards as the top factories in the global firm’s system—is set up to overcome intangible and tangible barriers in the global marketplace. For example, a server factory may be in- tended to overcome tariff barriers, reduce taxes, and reinvest money made in the region. Another obvious reason for a server factory is to reduce or eliminate costly global supply chain operations that would be needed if the factory were located much farther away from the end customers. Managers at a server factory typically have more authority to make mi- nor customizations to please their customers, but they still do not have much more input than managers in an offshore factory relative to the home country factories of the same global firm.

A contributor factory also serves a specific country or world region. The main differ- ence between a contributor factory and a server factory is that a contributor factory has re- sponsibilities for product and process engineering and development. This type of factory also has much more of a choice in terms of which suppliers to use for raw materials and component parts. In fact, a contributor factory often competes with the global firm’s home factories for testing new ideas and products. A contributor factory has its own infrastructure when it comes to development, engineering, and production. This means that a contributor factory is very much stand-alone in terms of what it can do and how it contributes to the global firm’s supply chain efforts.

An outpost factory can be viewed as an intelligence-gathering unit. This means that an outpost factory is often placed near a competitor’s headquarters or main operations, near the most demanding customers, or near key suppliers of unique and critically important parts. An outpost factory also has a function to fill in production; it often operates as a server and/ or offshore factory as well. The outpost factory can be very much connected to the idea of selecting countries for operations based on the countries’ strategic importance rather than on the production logic of a location. Maintaining and potentially even enhancing the posi- tion of the global firm in strategic countries is sometimes viewed as a practical factor. For example, the fact that Nokia has its headquarters in Finland may result in another mobile phone manufacturer locating some operations in Finland, even though the country market is rather small (about 5.5 million people).

A lead factory is intended to create new processes, products, and technologies that can be used throughout the global firm in all parts of the world. This is where cutting- edge production should take place, or at least be tested for implementation in other parts of the firm’s production network. Given the lead factory’s prominent role in setting a high bar for how the global firm wants to provide products to customers, we also expect that it will be located in an area where highly skilled employees can be found (or where they want to locate). A lead factory scenario also implies that managers and employees at the site have a direct connection to and say in which suppliers to use, what designs to implement, and other issues that are of critical importance to the core competencies of the global firm.

THE HIDDEN COSTS OF FOREIGN LOCATIONS There may be some “hidden costs” to basing production in a foreign location. Numerous anecdotes suggest that high employee turnover, shoddy workmanship, poor product quality, and low productivity are significant issues in some outsourcing locations.19

Microsoft, for example, established a major facility in Hyderabad, India, for four very good reasons: (1) The wage rate of software programmers in India is one-third of that in the United States. (2) India has an excellent higher education system that graduates a lot of computer science majors every year. (3) There was already a high concentration of in- formation technology companies and workers in Hyderabad. (4) Many of Microsoft’s highly skilled Indian employees, after spending years in the United States, wanted to

Server Factory A factory linked into the global supply chain for a global firm to supply specific country or regional markets around the globe.

Contributor Factory A factory that serves a specific country or world region.

Outpost Factory A factory that can be viewed as an intelligence-gathering unit.

Lead Factory A factory that is intended to create new processes, products, and technologies that can be used throughout the global firm in all parts of the world.

432 Part Six International Business Functions

return home, and Microsoft saw the Hyderabad facility as a way of holding on to this valuable human capital.

However, the company found that the turnover rate among its Indian employees is higher than in the United States. Demand for software programmers in India is high, and many employees are prone to switch jobs to get better pay. Although Microsoft has tried to limit turnover by offering good benefits and long-term incentive pay, such as stock grants to high performers who stay with the company, many of the Indians who were hired locally appar- ently place little value on long-term incentives and prefer higher current pay. High em- ployee turnover, of course, has a negative impact on productivity. One Microsoft manager in India noted that 40 percent of his core team had left within the past 12 months, making it very difficult to stay on track with development projects.20

Microsoft is not alone in experiencing this problem. The manager of an electronics company that outsourced the manufacture of wireless headsets to China noted that after four years of frustrations with late deliveries and poor quality, his company decided to move production back to the United States. In his words: “On the face of it, labor costs seemed so much lower in China that the decision to move production there was a very easy one. In retrospect, I wish we had looked much closer at productivity and workman- ship. We have actually lost market share because of this decision.”21 Another example of this phenomenon is given in the next Management Focus, which looks at the deci- sion by General Electric to move some production from China back to the United States. The lesson here is that it is important to look beyond pay rates and make judg- ments about employee productivity before deciding whether to outsource activities to foreign locations.

GE Moves Manufacturing from China to the United States

For decades, General Electric has been at the forefront of the move to shift production offshore from high-cost locations inside the United States to cheaper locations, such as China. But there are now some signs that the relentless flow of production offshore may be slowing down and, in some cases, starting to reverse. There are several rea- sons for this. Wage rates in China and some other developing nations have been rising fast, closing the differential between costs in the United States and overseas. In dollar terms, wage rates in China were some five times higher in 2012 than they were in 2000, and they are still rising fast. Labor productivity has also increased sig- nificantly in the United States, further closing the gap in labor costs. Meanwhile, high oil prices have raised the cost of shipping products across oceans, while the abundance of cheap natural gas in the United States is helping to lower production costs. If this were not enough, there are signs that there are benefits to having product design and manufacturing co-located, and in some cases, this is driving a shift in production back to the United States.

A case in point is GE’s GeoSpring water heater. This was originally designed in the United States and manufactured in China. The finished product was then shipped back across the ocean for sale in the United States. In 2010, given the macro trends in labor productivity and en- ergy prices, GE decided to see what would happen if it brought some of its appliance products back to the United States. The GeoSpring was one of its first attempts at this. GE established a team of engineers and

production workers at its appliance plant in Louisville, Kentucky, to see what they could do with the GeoSpring. The team quickly concluded that the GeoSpring was not easy to manufacture due to poor design. They redesigned the product for ease of assembly, eliminating one out of every five parts and cutting material costs by 25 percent. As a result, GE cut the time required to assemble the product from 10 hours in China to 2 hours in Louisville.

The end result: Material costs went down, labor requirement went down, and product quality went up. Indeed, the cost savings were so big that GE was able to reduce the price of the GeoSpring 20 percent below that of the Chinese-manufactured product and still maintain a decent profit margin. Time to market also improved greatly. It used to take five weeks to get a GeoSpring from China into a U.S. retail store— now GE can do that in a matter of days, which improves inventory management.

Having learned from experiences like this, GE is now planning to ramp up production of other appliance products at Louisville. It has recently doubled the workforce there to 3,700, and has also hired 500 new designers and engineers to redesign many of its products for ease of manufacture. A few years ago, less than half of the reve- nues of the appliance business came from products made in the United States. By mid-decade, GE plans to have 75 percent of the revenue of the appliance business to come from American-made products.

Sources: Charles Fishman, “The Insourcing Boom,” The Atlantic, December 2012; and J. R. Immelt, “Sparking an American Manufacturing Renewal,” Harvard Business Review, March!2012.

management FOCUS

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Chapter Fifteen Global Production and Supply Chain Management 433

Make-or-Buy Decisions The make-or-buy decision for a global firm is the strategic decision concerning whether to produce an item in-house (“make”) or purchase it from an outside supplier (“buy”). Make-or-buy decisions are made at both the strategic and operational levels, with the stra- tegic level being focused on the long term and the operational level being more focused on the short term. In some ways, the make-or-buy decision is also the starting point for opera- tions’ influence on global supply chains. That is, someone in the chain—within one firm— has to take the lead in deciding whether the global firm should make the product in-house or buy it from an external supplier. If the decision is to make it in-house, there are certain implications for that firm’s global supply chains (e.g., where to purchase raw materials and component parts). If the decision is to buy the product, that decision also has certain impli- cations (e.g., quality control and competitive priorities management).

A number of things are involved in determining which decision is the correct one for a particular global firm in a particular situation. At a broad level, issues of product success, specialized knowledge, and strategic fit can lead to the make (produce) decision. For exam- ple, if the item or part is critical to the success of the product, including perceptions among primary stakeholders, such a scenario skews the decision in favor of make. Another reason for a make decision is that the item or part requires specialized design or production skills and/or that equipment and reliable alternatives are very scarce. Strategic fit is also impor- tant. If the item or part strategically fits within the firm’s current and/or planned core com- petencies, then it should be a make decision for the global firm.

However, these are strategic decisions at a general level. In reality, the make-or-buy deci- sion is often based largely on two critical factors: cost and production capacity. Cost issues include such things as acquiring raw materials, component parts, and any other inputs into the process, along with the costs of finishing the product. The production capacity is really presented as an opportunity cost. That is, does the firm have the capacity to produce the product at a cost that is at least no higher than the cost of buying it from an external sup- plier? And, if the product is made in-house, what opportu- nity cost would be incurred as a result (e.g., what product or item was the firm unable to produce because of limited pro- duction capacity)? Unfortunately, many, and perhaps most, global companies think that cost and production capacity are the only factors playing into the make-or-buy decision. This is simply not true!

Cost and production capacity are just the two main driv- ers behind make-or-buy choices made by global companies when they engage in global supply chains. The decision of whether to buy or make a product is a much more complex and research-intensive process than the typical global firm may expect, though. For example, how many times have we heard, “Let’s move our production to China because we can get the same quality for a dime-on-the-dollar cost, and that will free up production capacity that we can use to focus on other products”? Of course, dime-on-the-dollar cost is not relevant because we have to take into account the costs of quality control measures that have to be instituted, raw ma- terials that have to be purchased far away from home, for- eign entry requirements, multiple-party contracts, management responsibilities for the outsourced production operations, and so on. Ultimately, we are unlikely to end up with a dime-on-the-dollar cost, but where do we end up and how do we get there? In other words, what are the core ele- ments that we should be evaluating when we are determin- ing whether the correct decision is to make or to buy?

LO 15-4 Identify the factors that influence a firm’s decision of whether to source supplies from within the company or from foreign suppliers.

Make-or-Buy Decision The strategic decision concerning whether to produce an item in-house (“make”) or purchase it from an outside supplier (“buy”).

Do You Expect a Trend in Bringing Jobs Back from Overseas? The United States may be on the verge of bringing back manu- facturing jobs from China. Outsourcing manufacturing to China is not as cheap as it used to be. Many companies, especially in the auto and furniture industries, moved plants overseas once China opened its doors to free trade and foreign investment in the last few decades. Labor was cheaper for American compa- nies—less than $1 per hour by some estimates at the time. Today, labor costs in China have risen dramatically, and shipping and fuel costs have skyrocketed. As China’s economy has expanded and as China has built new factories all across the country, the demand for workers has risen. As a result, wages are up as new companies compete to hire the best workers. Experts note the fears that U.S. manufacturing is in decline are overstated and that the United States is still a manufacturing giant. However, both China and the United States each account for about 20 percent global manufacturing value added. The U.S. share of about 20 percent of global manufacturing value added “has declined only slightly over the past three decades,” accord- ing to the Boston Consulting Group. With these estimates in mind, do you expect more and more outsourced jobs to be “insourced” in the future?

Source: http://rockcenter.msnbc.msn.com/_news/2012.

434 Part Six International Business Functions

To facilitate the make-or-buy decision, we have captured the dynamics of this choice in two figures that center on either operationally favoring a make decision or operationally favoring a buy decision (Figures 15.3 and 15.4). As shown, the core elements in both cases are cost and production capacity. However, the other elements differ for each of the deci- sions and influence the choice differently. This means that we need to evaluate each deci- sion separately, not jointly. In fact, through this process, we may end up thinking that both a make decision and a buy decision would be acceptable and strategically logical for our firm. Keep in mind that this simply means that we have a choice; if both choices seem positive for your firm, choose the one that is the best strategic fit with the least opportunity cost structure.

The elements that favor a make decision—beyond the core elements of cost and produc- tion capacity—include quality control, proprietary technology, having control, excess capac- ity, limited suppliers, assurance of continual supply, and industry drivers (see Figure 15.3). So, the starting point is lower (or at least no greater) cost than what we can expect when we outsource the production to an external party in another country (or another external party in general). The limitation is that we must have excess production capacity or capacity that is best used by our firm for making the product in-house.

After the cost and production capacity decisions have been explored and made (really, after the cost and production hurdles have been overcome), the next set of decisions follows logically from the path in Figure 15.3. For example, if quality control is important to the global firm, cannot be relied on fully if the part is outsourced, and is at the center of the strategic core that customers expect from the firm, then the quality control issue favors a make decision. If there is proprietary technology involved in making the product that can- not or should not be shared with outsourcing parties, then the decision has to be make.

The idea that limited suppliers may influence the make-or-buy choice in the direction of the make selection is important as well. Specifically, it could be that some suppliers do not want to work with certain companies in certain parts of the world. It could also be that a supplier cannot, because of various restrictions on production or location or because of in- ternational barriers, follow the production of your firm’s products to wherever you see fit to locate your production lines.

15.3 FIGURE Operationally Favoring a Make Decision

Cost HavingControl

Quality Control

Proprietary Technology

Excess Capacity

Limited Suppliers

Industry Drivers

Assurance of

Continual Supply

Production Capacity

Chapter Fifteen Global Production and Supply Chain Management 435

Naturally, if the firm has excess capacity that otherwise would not be productively used, the decision should favor a make choice to allow that excess capacity to be used for the ben- efit of the firm in the global marketplace. Some companies also simply want to have control over certain elements of their production processes. This affects the make-or-buy decision in favor of the make choice.

A make decision is also favored if there is any chance that supply cannot be guaranteed if the firm moves its production overseas. And, finally, the industry globalization drivers may dictate that a make decision should be the choice for various trust and commitment reasons involving your industry and the marketplace that you engage with in order to find success.

Now, some of these elements that favor make can probably influence a buy decision as well. Naturally, if one of the make elements is not in favor of the make decision (e.g., if there is no excess capacity), this would suggest that the global firm should think more seriously about a buy decision. However, again, the buy decision also involves a number of other ele- ments that are not necessarily factors in the make decision (see Figure 15.4). As with the make decision, after the cost and production capacity decisions have been considered and made, the next set of decisions for the buy choice follow logically from the path in Figure 15.4. For example, if the global firm has minimal restrictions on which firms or companies it can source raw materials and component parts from, then a buy decision is more likely because outsourcing production also increases the likelihood that other and/or more suppli- ers in those parts of the world will be used.

Another good reason to choose a buy scenario is if the firm lacks the needed expertise to make a product or component part and the supplier or outsourced production choice has that expertise. Supplier competencies can affect the decision in favor of a buy choice as well, especially if those competencies reside closer to the production facility that you buy from than the ones that will be available if you make the product. Small volumes would also be a reason favoring a buy decision; cost efficiencies can seldom be achieved when only small volumes are produced.

Inventory planning is also of critical importance. Even if your firm can make the product equally well in terms of quality and expectations set, perhaps a better choice is to buy simply

15.4 FIGURE Operationally Favoring a Buy Decision

Cost InventoryPlanning

Multisource Policy

Lack of Expertise

Small Volumes

Supplier Compe- tencies

Nonessential Item

Brand Preference

Production Capacity

436 Part Six International Business Functions

in order to strategically manage inventory (which is a cost center in the global supply chain). In certain cases, even brand preference is a reason to go with a buy decision; for example, many computer users favor Intel microchips in their computers, so many of the large com- puter manufacturers opt to buy chips from Intel instead of making them in-house for that reason (this was more true in the 1990s and 2000s than it is now, but it is still a factor). And, of course, if the item to be made is a so-called nonessential item that has little effect on the firm’s core competencies and what the customers expect in terms of uniqueness, this is a fac- tor in favor of a buy decision.

Global Supply Chain Functions To this point in the chapter, we have emphasized global production, a component of the operations management of a supply chain. Issues such as where to produce, the strategic role of a foreign production site, and the make-or-buy decisions are the core aspects of global production. In addition to global production, three additional supply chain func- tions need to be developed in concert with global production. They are logistics, purchas- ing (sourcing), and the company’s distribution strategy (i.e., marketing channels). The latter—distribution strategy—is addressed in Chapter 16, where we discuss marketing and R&D. Here we address logistics and purchasing. From earlier in this chapter, we know that production and supply chain management are closely linked because a firm’s ability to perform its production activities depends on information inputs and a timely supply of high-quality material (raw material, component parts, and even finished products that are used in the manufacturing of new products). Logistics and purchasing are critical func- tions in ensuring that materials are ordered and delivered and that an appropriate level of inventory is managed.

GLOBAL LOGISTICS From earlier in this chapter we know that logistics is the part of the supply chain that plans, implements, and controls the effective flows and inven- tory of raw material, component parts, and products used in manufacturing. The core ac- tivities performed in logistics are (1) global distribution center management, (2) inventory management, (3) packaging and materials handling, (4) transportation, and (5) reverse

logistics. Each of these core logistics is described in the next paragraphs.

A global distribution center (or warehouse) is a facil- ity that positions and allows customization of products for delivery to worldwide wholesalers or retailers or directly to consumers anywhere in the world. Distribution centers (DCs) are used by manufacturers, importers, exporters, wholesalers, retailers, transportation companies, and cus- toms agencies to store products and provide a location where customization can be facilitated. When warehous- ing shifted from passive storage of products to strategic assortments and processing, the term distribution center be- came more widely used to capture this strategic and dy- namic aspect of not only storing, but ofadding value to products that are being warehoused or staged. A DC is at the center of the global supply chain, specifically the order- processing part of the order-fulfillment process. DCs are the foundation of a global supply network because they allow either a single location or satellite warehouses to store quantities and assortments of products and allow for value-added customization. They should be located strate- gically in the global marketplace, considering the aggre- gate total labor and transportation cost of moving products from plants or suppliers through the distribution center and then delivering them to customers.

LO 15-5 Understand the functions of logistics and purchasing (sourcing) within global supply chains.

Global Distribution Center A facility that positions and allows customization of products for delivery to worldwide wholesalers or retailers, or directly to consumers anywhere in the world; also called a global distribution warehouse.

How Much Relationship Building Do You Really Want to Do? Like manufacturers, professional service firms have also been learning how to better manage their delivery on a global basis. For example, some global services firms are dealing with other global firms in a new way, using one supplier for all their ser- vice-related needs around the world. The traditional approach involved the development of market-specific relationships, so the same multinational client would have a number of individual service relationships, one in each major market for each com- pany division. Under a global account management approach, one relationship has a global span—and one contract. Such supply chain practices allow for more effective relationship management, a better sense of what the client needs, more product extension opportunities, and better pricing and econo- mies. But global account management also takes time, energy, and resources. How many “global accounts” do you think would be ideal for a global company? What is the minimum and maxi- mum number of global account relationships a large multina- tional corporation should have (e.g., Microsoft)?

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Chapter Fifteen Global Production and Supply Chain Management 437

Global inventory management can be viewed as the decision-making process regarding the raw materials, work-in-process (component parts), and finished goods inventory for a multinational corporation. The decisions include how much inventory to hold, in what form to hold it, and where to locate it in the supply chain. Examining the largest 20,910 global companies with headquarters in 105 countries, we find that these companies, on average across all industries, carry 14.41 percent of their total assets in some form of inventory.22 These companies have 32.30 percent of their inventory in raw materials, 17.94 percent of their inventory in work-in-process, and 49.76 percent of their inventory in finished goods.23 At the company level, Toyota (www.toyota.com) from Japan, one of the largest automobile firms in the world, has 8.71 percent of its total assets in inventory, with a mix of 25.87, 13.62, and 60.50 percent in raw materials, work-in-process, and finished vehicles, respectively. An- other example is Sinopec (www.sinopec.com), a petroleum firm and the largest firm in China. Sinopec has 21.46 percent of its total assets in inventory, with a mix of 36.58, 42.50, and 20.92 percent in raw materials and component parts, work-in-process, and finished goods, respectively. Note that Sinopec maintains a much higher percentage of its invento- ries in work-in-process and a much lower percentage in finished goods than Toyota does. This suggests that petroleum firms want more flexibility in deciding exactly how to formu- late the finished product. The company’s global inventory strategy must effectively trade off the service and economic benefits of making products in large quantities and positioning them near customers against the risk of having too much stock or the wrong items.

Packaging comes in all shapes, sizes, forms, and uses. It can be divided into three differ- ent types: primary, secondary, and transit. Primary packaging holds the product itself. These are the packages brought home from the store, usually a retailer, by the end-consumer. Sec- ondary packaging (sometimes called case-lot packaging) is designed to contain several pri- mary packages. Bulk buying or warehouse store customers may take secondary packages home (e.g., from Sam’s Club), but this is not the typical mode for retailers. Retailers can also use secondary packaging as an aid when stocking shelves in the store. Transit packaging comes into use when a number of primary and secondary packages are assembled on a pallet or unit load for transportation. Unit-load packaging—through palletizing, shrink-wrapping, or containerization—is the outer packaging envelope that allows for easier handling or product transfer among international suppliers, manufacturers, distribution centers, retail- ers, and any other intermediaries in the global supply chain.

Regardless of where the product is in the global supply chain, packaging is intended to achieve a set of multilayered functions. These can be grouped into (1) perform, (2) protect, and (3) inform.24 Perform refers to (1) the ability of the product in the package to handle be- ing transported between nodes in the global supply chain, (2) the ability of the product to be stored for typical lengths of time for a particular product category, and (3) the package pro- viding the convenience expected by both the supply chain partners and the end-customers. Protect refers to the package’s ability to (1) contain the products properly, (2) preserve the products to maintain their freshness or newness, and (3) provide the necessary security and safety to ensure that the products reach their end destination in their intended shape. Inform refers to the package’s inclusion of (1) logical and sufficient instructions for the use of the products inside the package, including specific requirements to satisfy local regulations, (2)!a statement of a compelling product guarantee, and (3) information about service for the product if and when it is needed.

Transportation refers to the movement of raw material, component parts, and finished goods throughout the global supply chain. It typically represents the largest percentage of any logistics budget and an even greater percentage for global companies because of the distances involved. Global supply chains are directly or indirectly responsible for transport- ing raw materials from their suppliers to the production facilities, work-in-process and fin- ished goods inventories between plants and distribution centers, and finished goods from distribution centers to customers. The primary drivers of transportation rates and the re- sulting aggregate cost are distance, transport mode (ocean, air, or land), size of load, load characteristics, and oil prices. As would be expected, longer distances require more fuel and more time from vehicle operators, so transport rates increase with distance. Transport mode influences rates because of the different technologies involved. Ocean is the least expensive

Global Inventory Management The decision-making process regarding the raw materials, work-in-process (component parts), and finished goods inventory for a multinational corporation.

Packaging The container that holds the product itself. It can be divided into primary, secondary, and transit packaging.

Transportation the movement of inventory through the supply chain.

438 Part Six International Business Functions

because of the size of the vehicles used and the low friction of water. Land is the next least expensive, with rail being less expensive than motor carriers. Air is the most expensive be- cause there is a substantial charge for defying gravity. Transportation rates are heavily in- fluenced by economies of scale, so larger shipments are typically relatively less expensive than smaller shipments. The characteristics of the shipment also influence transportation rates through such factors as product density, value, perishability, potential for damage, and other such factors. Finally, oil prices have a major impact on transportation rates because anywhere from 10 to 40 percent of most carrier costs, depending on the mode, are related to fuel.

Reverse logistics is the process of planning, implementing, and controlling the efficient, cost-effective flow of raw materials, in-process inventory, finished goods, and related infor- mation from the point of consumption to the point of origin for the purpose of recapturing value or proper disposal. The ultimate goal is to optimize the after-market activity or make it more efficient, thus saving money and environmental resources. Reverse logistics is criti- cally important in global supply chains. For example, product returns cost manufacturers and retailers more than $100 billion per year in the United States, or an average of 3.8 per- cent in lost profits.25 Overall, manufacturers spend about 9 to 14 percent of their sales rev- enue on returns. Even more staggering, each year, consumers in America return more than the GDP of two-thirds of the nations in the world. Just these sample numbers suggest that reverse logistics is an incredibly important part of the global supply chain.

GLOBAL PURCHASING As defined in the introduction to this chapter, purchas- ing represents the part of the supply chain that involves worldwide buying of raw material, component parts, and products used in manufacturing of the company’s products and ser- vices. The core activities performed in purchasing include development of an appropriate strategy for global purchasing and selecting the type of purchasing strategy best suited for the company.

There are five strategic levels—from domestic to international to global—that can be undertaken by a global company.26 Level I is simply companies engaging in domestic pur- chasing activities only. Often, these companies stay close to their home base in their do- mestic market when purchasing raw materials, component parts, and the like for their operations (e.g., a Michigan firm purchasing raw materials, such as cherries, from another Michigan firm). Levels II and III are both considered “international purchasing,” but of various degrees and forms. Companies that are at level II engage in international purchas- ing activities only as needed. This means that their approach to international purchasing is often reactive and uncoordinated among the buying locations within the firm and/or across the various units that make up the firm, such as strategic business units and functional units. Companies at level III engage in international purchasing activities as part of the firm’s overall supply chain management strategy. As such, at the level III stage, companies begin to recognize that a well-formulated and well-executed worldwide international pur- chasing strategy can be very effective in elevating the firm’s competitive edge in the mar- ketplace. Levels IV and V both involve “global purchasing” to various degrees. Level IV refers to global purchasing activities that are integrated across worldwide locations. This involves integration and coordination of purchasing strategies across the firm’s buying lo- cations worldwide. With level IV, we are now dealing with a sophisticated form of world- wide purchasing. Level V involves engaging in global purchasing activities that are integrated across worldwide locations and functional groups. Broadly, this means that the firm integrates and coordinates the purchasing of common items, purchasing processes, and supplier selection efforts globally, for example.

Beyond the domestic, international, and global purchasing strategies in levels I through V, purchasing includes a number of basic choices that companies make in deciding how to engage with markets.27 The starting point is a choice of internal purchasing versus external purchasing—in other words, “how to purchase.” We find that roughly 35 percent of the pur- chasing in global companies today is internal (i.e., from sources within their own company), with 65 percent being classified as external (i.e., from sources outside of their company). The next decision, in both internal and external purchasing, is to figure out “where to purchase”

Reverse Logistics The process of moving inventory from the point of consumption to the point of origin in supply chains for the purpose of recapturing value or proper disposal.

Chapter Fifteen Global Production and Supply Chain Management 439

(domestically or globally). This takes us ultimately to the “types of purchasing” (where and how) and the four choices for purchasing strategy: domestic internal purchasing, global in- ternal purchasing, domestic external purchasing, and global external purchasing.

The types of purchasing activities and strategies just discussed come with a set of generic options for the “international arena.” But we all know that outsourcing and offshoring, along with many by-products and other similar yet quite different options, exist in the purchasing world today. At this stage of the text, we feel it is important to go over the outsourcing- related terms and options that companies have, especially the following terms that are often confusing to understand, develop strategy around, and implement: outsourcing, insourcing, offshoring, offshore outsourcing, nearshoring, and co-sourcing (see Table 15.2).

Managing a Global Supply Chain The potential for reducing costs through more efficient supply chain management is enor- mous. For the typical manufacturing enterprise, material costs account for between 50 and 70 percent of revenues, depending on the industry. Even a small reduction in these costs can have a substantial impact on profitability. According to one estimate, for a firm with reve- nues of $1 million, a return on investment rate of 5 percent, and materials costs that are 50!percent of sales revenues, a $15,000 increase in total profits could be achieved either by increasing sales revenues 30 percent or by reducing materials costs by 3 percent.28 In a satu- rated market, it would be much easier to reduce materials costs by 3 percent than to increase sales revenues by 30 percent. As such, managing global supply chains is one of the strategi- cally most important areas for a global company. Four main areas are of concern in manag- ing a global supply chain, including the role of just-in-time inventory, the role of information technology, coordination in global supply chains, and interorganizational relationships in global supply chains.

LO 15-6 Describe what is required to efficiently manage a global supply chain.

15.2 TABLE Outsourcing Terms and Options

Outsourcing A multinational corporation buys products or services from one of its suppliers that produces them somewhere else, whether domestically or globally. In that sense, it also refers to external purchasing in relation to purchasing strategy.

Insourcing A multinational corporation decides to stop outsourcing products or services and instead starts to produce them internally; insourcing is the opposite of outsourcing. Thus it refers to internal purchasing in the context of purchasing strategy.

Offshoring A multinational corporation buys products or services from one of its suppliers that produces them somewhere globally (outside the MNCs home country). Offshoring is thus a form of global external purchasing in terms of purchasing strategy.

Offshore outsourcing A multinational corporation buying products or services from one of its suppliers in a country other than the one in which the product is manufactured or the service is developed. This again is a form of global external purchasing in terms of purchasing strategy.

Nearshoring A multinational corporation transfers business or information technology processes to suppliers in a nearby country, often one that shares a border with the firm’s own country. While nearshoring is not a purchasing activity per se, it involves facilitating global external purchasing.

Co-sourcing A multinational corporation uses both its own employees from inside the firm and an external supplier to perform certain tasks, often in concert with each other. This applies to all four forms of purchasing strategy. It implies that the relationship between the firm and its supplier is rather strategic in nature— often, this involves the top suppliers in a particular product or component category.

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440 Part Six International Business Functions

ROLE OF JUST-IN-TIME INVENTORY Pioneered by Japanese firms dur- ing that country’s remarkable economic transformation during the 1960s and 1970s, just-in- time inventory systems now play a major role in most manufacturing firms. The basic philosophy behind just-in-time (JIT) inventory 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. The major cost savings comes from speeding up inven- tory turnover. This reduces inventory holding costs, such as warehousing and storage costs. It means the company can reduce the amount of working capital it needs to finance inven- tory, freeing capital for other uses and/or lowering the total capital requirements of the en- terprise. Other things being equal, this will boost the company’s profitability as measured by return on capital invested. It also means the company is less likely to have excess unsold in- ventory that it has to write off against earnings or price low to sell.

In addition to the cost benefits, JIT systems can also help firms improve product quality. Under a JIT system, parts enter the manufacturing process immediately; they are not ware- housed. This allows defective inputs to be spotted right away. The problem can then be traced to the supply source and fixed before more defective parts are produced. Under a more traditional system, warehousing parts for weeks before they are used allows many de- fective parts to be produced before a problem is recognized.

The drawback of a JIT system is that it leaves a firm without a buffer stock of inven- tory. Although buffer stocks are expensive to store, they can help a firm respond quickly to increases in demand and tide a firm over shortages brought about by disruption among suppliers. Such a disruption occurred after the September 11, 2001, attacks on the World Trade Center and Pentagon, when the subsequent shutdown of international air travel and shipping left many firms that relied upon globally dispersed suppliers and tightly managed “just-in-time” supply chains without a buffer stock of inventory. A less pro- nounced but similar situation occurred again in April 2003, when the outbreak of the pneumonia-like SARS (severe acute respiratory syndrome) virus in China resulted in the temporary shutdown of several plants operated by foreign companies and disrupted their global supply chains. Similarly, in late 2004, record imports into the United States left several major West Coast shipping ports clogged with too many ships from Asia that could not be unloaded fast enough, which disrupted the finely tuned supply chains of several major U.S. enterprises.29

There are ways of reducing the risks associated with a global supply chain that operates on just-in-time principles. To reduce the risks associated with depending on one supplier for an important input, some firms source these inputs from several suppliers located in differ- ent countries. While this does not help in the case of an event with global ramifications, such as September 11, 2001, it does help manage country-specific supply disruptions, which are more common. Strategically, all global companies need to build in some degree of re- dundancy in supply chains by having multiple options for suppliers.

ROLE OF INFORMATION TECHNOLOGY Web and cloud-based infor- mation systems play a crucial role in modern materials management. By tracking compo- nent parts as they make their way across the globe toward an assembly plant, information systems enable a firm to optimize its production scheduling according to when compo- nents are expected to arrive. By locating component parts in the supply chain precisely, good information systems allow the firm to accelerate production when needed by pulling key components out of the regular supply chain and having them flown to the manufac- turing plant.

Firms now typically use some form of supply chain information system to coordinate the flow of materials into manufacturing, through manufacturing, and out to customers. There are a variety of options for global supply chains. Electronic data interchange (EDI) refers to the electronic interchange of data between two or more companies. Enterprise resource planning (ERP) is a wide-ranging business planning and control system that includes supply chain-related subsystems (e.g., materials requirements planning, or MRP). Collabora- tive planning, forecasting, and replenishment (CPFR) was developed to fill the interorgani- zational connections that ERP cannot fill. Vendor management of inventory (VMI) allows

Just in Time (JIT) Inventory logistics system designed to deliver parts to a production process as they are needed, not before.

Chapter Fifteen Global Production and Supply Chain Management 441

for a holistic overview of the supply chain with a single point of control for all inventory management. A warehouse management system (WMS) often operates in concert with ERP systems; for example, an ERP system defines material requirements, and these are transmit- ted to a distribution center for a WMS.

Before the emergence of the Internet as a major communication medium, firms and their suppliers normally had to purchase expensive proprietary software solutions to implement EDI systems. The ubiquity of the Internet and the availability of web and cloud-based ap- plications have made most of these proprietary solutions obsolete. Less expensive systems that are much easier to install and manage now dominate the market for global supply chain management software. These systems have transformed the management of globally dis- persed supply chains, allowing even small firms to achieve a much better balance between supply and demand, thereby reducing the inventory in their systems and reaping the associ- ated economic benefits. Importantly, with most firms now using these systems, those that do not will find themselves at a competitive disadvantage. This has implications for small and medium-sized companies that may not always have the resources to implement the most sophisticated supply chain information systems.

COORDINATION IN GLOBAL SUPPLY CHAINS Consider how to turn an aircraft, and think in terms of coordination and leverage points. That is, aircraft are typi- cally steered using an integrated system of ailerons on the wings and the rudder at the tail of the aircraft. In comparison to the aircraft, the ailerons and the rudder seem very small. However, leverage allows the coordinated effort of the ailerons and the rudder to turn the aircraft. In other words, putting the right combination of a little leverage on the right places together with a coordinated effort leads to incredible maneuvering ability for the plane. Global supply chains are the same. Integration and coordination are critically important. Global supply chain coordination refers to shared decision-making opportunities and op- erational collaboration of key global supply chain activities.

Shared decision making—such as joint consideration of replenishment, inventory hold- ing costs, collaborative planning, costs of different processes, frequency of orders, batch size, and product development—creates a more integrated, coherent, efficient, and effec- tive global supply chain. This includes shared decision making by supply chain members both inside an organization (e.g., logistics, purchasing, operations, and marketing channels employees) and across organizations (e.g., raw materials producers, transportation compa- nies, manufacturers, wholesalers, retailers). Shared decision making is not joint decision making; it is decision making involving joint considerations. Shared decision making helps in resolving potential conflicts among global supply chain members and fosters a culture of coordination and integration. In most supply chains, certain parties are more influential, and shared decision making, at a minimum, should include the critically important chain members.

To achieve operational integration and collaboration within a global supply chain, six operational objectives should be addressed: responsiveness, variance reduction, inventory reduction, shipment consolidation, quality, and life-cycle support.30 Responsiveness refers to a global firm’s ability to satisfy customers’ requirements across global supply chain functions in a timely manner. Variance reduction refers to integrating a control system across global supply chain functions to eliminate global supply chain disruptions. Inventory reduction refers to integrating an inventory system, controlling asset commitment, and turning velocity across global supply chain functions. Shipment consolidation refers to using various programs to combine small shipments and provide timely, consolidated movement. This includes mul- tiunit coordination across global supply chain functions. Quality refers to integrating a sys- tem so that it achieves zero defects throughout global supply chains. Finally, life-cycle support refers to integrating the activities of reverse logistics, recycling, after-market service, prod- uct recall, and product disposal across global supply chain functions.

INTERORGANIZATIONAL RELATIONSHIPS Interorganizational rela- tionships have been studied and talked about in various contexts for decades. The two keys are trust and commitment. If we always had 100 percent trust within relationships and

Global Supply Chain Coordination The shared decision-making opportunities and operational collaboration of key global supply chain activities.

442 Part Six International Business Functions

100!percent commitment to them, most global supply chains would ultimately be efficient and effective. But we don’t! However, by looking at the building blocks for global supply chains, we would also assume that not all relationships are equally valuable and that they should not be treated as if they were. Two examples centered on upstream/inbound and downstream/outbound supply chain activities can effectively be used to illustrate this point. Figure 15.5 focuses on the upstream (or inbound) supply chain relationships, and Figure 15.6 focuses on the downstream (or outbound) supply chain relationships.

For the upstream/inbound portion of the global supply chain, the three logical scenarios of interacting organizations are labeled as vendors, suppliers, and partners. Each scenario is based on the degree of coordination, integration, and transactional versus relationship em- phasis that the firm should adopt in partnering with other entities in the global supply chain. For instance, a firm uses vendors to obtain raw materials and component parts through a transactional relationship that can change easily. A given firm may use suppliers to obtain raw materials and parts and maintain a relationship with those suppliers based on experience and performance. Another firm may engage with partners to obtain raw materials and parts, maintaining a relationship based on trust and commitment.

For the downstream/outbound portion of the global supply chain, the three logical sce- narios of interacting organizations are labeled as buyers, customers, and clients. As with the upstream/inbound examples, each downstream/outbound scenario is based on the degree of coordination, integration, and transactional versus relationship focus that the firm should adopt in partnering with other entities in the global supply chain. One firm may sell prod- ucts and parts to buyers through a transactional relationship that can change easily. Another firm may sell products and parts to customers and maintain a relationship that is based on experience and performance. Yet another firm may sell products and parts to clients and maintain a relationship that is based on trust and commitment.

Having reviewed the three scenarios for the upstream/inbound and downstream/out- bound portions of the global supply chain, let’s look at the emphasis a global company should place on the relationships with each entity: the benefits to be expected, favorable points of distinction, and resonating focus in the relationship.31 First, however, some basics on value are appropriate. Value between nodes and actors in global supply chains is a function of the cost (money and nonmoney resources) given up in return for the quality

15.5 FIGURE Upstream/Inbound Relationships Vendor

Low Coordination Low Integration Transactional Focus

High Coordination High Integration

Relationship Focus

Supplier Partner

15.6 FIGURE Downstream/Outbound Relationships Buyer

Low Coordination Low Integration Transactional Focus

High Coordination High Integration

Relationship Focus

Customer Client

Chapter Fifteen Global Production and Supply Chain Management 443

(products, services, information, trust, and commitment) received. Basically, greater value is achieved if the quality is greater while the cost remains the same or is reduced, or when the cost is reduced and the quality remains constant.

A global company should allocate 20 percent of its efforts to the vendor category, 30!per- cent to the supplier category, and 50 percent to the partner category in the upstream/ inbound portion of the global supply chain. Likewise, a global company should allocate 20! percent of its efforts to the buyer category, 30 percent to the customer category, and 50!percent to the client category in the downstream/outbound portion of the chain. In the vendor (upstream) and buyer (downstream) portions of the supply chain, the benefits that can be expected include those typical of a transactional exchange (costs equal to quality for the goods bought, but not necessarily the best goods in the marketplace). In the supplier (upstream) and customer (downstream) stages, the expectation is that the firm will receive all the favorable points that the raw materials, component parts, and/or products have rela- tive to the next best alternative in the global marketplace. This takes into account the ideas that the costs are equal to quality for the goods bought and that the goods are among the best goods in the marketplace. Finally, in the partner (upstream) and client (downstream) portions of the supply chain, the benefits that the firm can expect to receive include the one or two points of difference for the raw materials, component parts, and/or products whose improvements will deliver the greatest value to the customer for the foreseeable future (quality greater than cost).

production, p. 421 supply chain management, p. 421 purchasing, p. 422 logistics, p. 422 upstream supply chain, p. 422 downstream supply chain, p. 422 total quality management (TQM), p. 423 Six Sigma, p. 423 ISO 9000, p. 424 minimum efficient scale, p. 426

flexible manufacturing technology, p. 427 lean production, p. 427 mass customization, p. 427 flexible machine cells, p. 428 global learning, p. 430 offshore factory, p. 430 source factory, p. 430 server factory, p. 431 contributor factory, p. 431 outpost factory, p. 431

lead factory, p. 431 make-or-buy decision, p. 433 global distribution center, p. 436 global inventory management, p. 437 packaging, p. 437 transportation, p. 437 reverse logistics, p. 438 just in time (JIT), p. 440 global supply chain coordination, p. 441

Key Terms

Summary

This chapter explained how global production and supply chain management can improve the competitive position of an international business by lowering the total costs of value creation and by performing value creation activities in such ways that customer service is enhanced and value added is maximized. We looked closely at five issues cen- tral to global production and supply chain management: where to produce, the strategic role of foreign production sites, what to make and what to buy, global supply chain functions, and managing a global supply chain. The chap- ter made the following points:

1. The choice of an optimal production location must consider country factors, technological factors, and production factors.

2. Country factors include the influence of factor costs, political economy, and national culture on production costs, along with the presence of location externalities.

3. Technological factors include the fixed costs of setting up production facilities, the minimum efficient scale of production, and the availability of flexible manufacturing technologies that allow for mass customization.

4. Production factors include product features, locating production facilities, and strategic roles for production facilities.

5. Location strategies either concentrate or decentralize manufacturing. The choice should be made in light of

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444 Part Six International Business Functions

country, technological, and production factors. All location decisions involve trade-offs.

6. 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 encourage and foster attempts by local managers to upgrade factory capabilities.

7. 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. Both making and buying component parts are primarily based on cost considerations and production capacity constraints, but each decision (make or buy) is also influenced by several different factors.

8. The core global supply chain functions are logistics, purchasing (sourcing), production (and operations management), and marketing channels.

9. Logistics is the part of the supply chain that plans, implements, and controls the effective flows and inventory of raw material, component parts, and products used in manufacturing. The core activities performed in logistics are to manage global distribution centers, inventory management, packaging and materials handling, transportation, and reverse logistics.

10. Purchasing represents the part of the supply chain that involves worldwide buying of raw material, component parts, and products used in manufacturing of the company’s products and services. The core activities performed in purchasing include

development of an appropriate strategy for global purchasing and selecting the type of purchasing strategy best suited for the company.

11. Managing a supply chain involves orchestrating effective just-in-time inventory systems, using information technology, coordination among functions and entities in the chain, and developing interorganizational relationships.

12. Just-in-time systems generate major cost savings by reducing warehousing and inventory holding costs and by reducing the need to write off excess inventory. In addition, JIT systems help the firm spot defective parts and remove them from the manufacturing process quickly, thereby improving product quality.

13. Information technology, particularly Internet-based electronic data interchange, plays a major role in materials management. EDI facilitates the tracking of inputs, allows the firm to optimize its production schedule, lets the firm and its suppliers communicate in real time, and eliminates the flow of paperwork between a firm and its suppliers.

14. Global supply chain coordination refers to shared decision-making opportunities and operational collaboration of key global supply chain activities.

15. The depth and involvement in interorganizational relationships in global supply chains should be based on the degree of coordination, integration, and transactional versus relationship emphasis that the firm should adopt in partnering with other entities in the global supply chain.

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 costs about $500 million to construct and requires a highly skilled workforce. The total value of the world market for this product over the next 10 years is estimated to be between $10 billion and $15 billion. The tariffs prevailing in this industry are currently low. What kind of location(s) should the firm favor for its plant(s)?

2. A chemical firm is considering how best to supply the world market for sulfuric acid. A manufacturing plant costs about $20 million 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 $20 billion and $30 billion. The tariffs prevailing in this industry are moderate. What kind of location(s) should the firm seek for its plant(s)?

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 manufacturing to an independent supplier? Which option would you recommend? Why?

4. Reread the Management Focus on Philips in China and then answer the following questions: a. What are the 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?

5. Explain how the global supply chain functions of (a)!logistics and (b) purchasing can be used to strategically leverage the global supply chains for a manufacturing company producing mobile phones.

6. What type of interorganizational relationship should a global company consider in the (a) inbound portion of

its supply chains if the goal is to buy commodity- oriented component parts for its own production and (b) outbound portion of its supply chains if the goal is to establish a strong partnership in reaching end-customers?

Use the globalEDGE website (globaledge.msu.edu) to complete the following exercises:

1. The globalization of production makes many people aware of the differences in manufacturing costs worldwide. The U.S. Department of Labor’s Bureau of International Labor Affairs publishes the Chartbook of International Labor Comparisons. Locate the latest edition of this report, and identify the hourly compensation costs for manufacturing workers in China, Brazil, Mexico, Turkey, Germany, and the United States.

2. The World Bank’s Logistics Performance Index (LPI) assesses the trade logistics environment and performance of countries. Locate the most recent LPI ranking. What components for each country are examined to construct the index? Identify the top 10 logistics performers. Prepare an executive summary highlighting the key findings from the LPI. How are these findings helpful for companies trying to build a competitive supply chain network?

Research Task http://globalEDGE.msu.edu

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David Beckham, Freja Beha, Beyoncé, Gisele Bündchen, Georgia May Jag- ger, Miranda Kerr, Madonna, Vanessa Paradis, Katy Perry, Lana Del Rey, Rihanna, Anja Rubik, and so many more. Yes, it sounds like a list of celebri- ties and they are! These celebrities represent just a partial list of really well-known people around the world who have worked with H&M (do you recognize all of them?). But, let’s move on from the “name dropping” to Hennes & Mauritz, or H&M as it is more commonly known. H&M is a Swed- ish multinational retail-clothing giant known for its fashion clothing for women, men, teenagers, and children. H&M has effectively used superstar celebrities like David Beckham, Beyoncé, and Gisele Bündchen for years to carry their advertising message worldwide. Behind the scenes, H&M’s global supply chains are equally well orchestrated and are as high pow- ered as its advertising campaigns.

H&M Hennes & Mauritz AB is now the full name of the company (it started simply as “Hennes” in 1947 in a small Swedish town called Västerås). The idea for the company emerged when, in 1946, Erling Pers- son, the company’s founder, came up with the idea of offering fashionable clothing at relatively low prices while he was on a business trip to the United States. At that time, Erling Persson decided to focus on women’s clothing only, and “Hennes,” which means “her” or “hers” in Swedish, was started. A couple of decades later, in 1968, Hennes acquired the building and inventory of hunting equipment retailer Mauritz Widforss. A supply of men’s clothing was also a part of the inventory. This resulted in menswear being included in the company’s collection—and gave birth to Hennes & Maurits (H&M). H&M now has some 3,200 stores in 54 countries and ap- proximately 116,000 employees. It is the second largest clothing retailer in

the world after Spain-based Inditex (parent company of ZARA) and ahead of U.S.-based GAP Inc.

H&M Hennes & Mauritz AB comprises six different brands, although the H&M brand is the most recognizable worldwide. The other brands are COS, Monki, Weekday, Cheap Monday, and & Other Stories. H&M designs sus- tainable fashion for all people at relatively modest prices and sells its prod- ucts in 54 countries and online in an additional 10 markets. COS explores the concept of style over fashion and sells its products in stores and online in 38 countries. Monki is promoted as a fashion experience and is offered

H&M: The Retail-Clothing Giant

Chapter Fifteen Global Production and Supply Chain Management 445

Pedestrians walk past a H&M store in Singapore.

446 Part Six International Business Functions

in 30 markets in stores and online. Weekday is a jeans-focused fashion destination with sales in 25 markets. Cheap Monday combines “influences from street fashion and subculture with a catwalk vibe” and is offered in some 20 markets. The last brand, called “& Other Stories,” was launched in 2013 and focuses on personal expression and styling, with availability in 17 markets. The collection of these brands, driven by the H&M collection and its footprint in 64 countries, presents a unique global supply chain challenge for the company.

The collections of clothing are created by a team of 160 in-house de- signers and 100 pattern makers. The design and pattern team is large and diverse, representing different age groups and nationalities. H&M Hennes & Mauritz AB’s (H&M from now on) design process is about “striking the right balance between fashion, quality and the best price . . . and it always involves sustainability awareness.” H&M does not own its own factories but instead works with around 900 independent suppliers to implement the team’s designs into reality. These independent suppliers are mostly located in Europe and Asia. They manufacture all of H&M’s products, and they also generally source fabrics and other components needed to create the fashion statements we have come to know from the H&M brands. Some 80 people in the H&M organization are dedicated to constantly audit the working conditions at the factories of suppliers, including safety and quality testing and ensuring that chemicals requirements are met.

Within the global supply chain infrastructure, one key aspect of H&M is the ordering of each product. Specifically, ordering each product at the optimal moment is an important part of H&M achieving the right balance among price, cycle time, and quality. To realize the effectiveness needed to ultimately sell fashion-oriented clothing at affordable prices, H&M works closely with long-term partners and invests significant resources into the sustainability of the work needed in its supply chains. In these areas, H&M strives to promote lasting improvements in working conditions and envi- ronmental impact throughout the footprint that it makes worldwide.

Through its 900 suppliers, the company is connected to some 1,900 facto- ries and about 1.6 million workers.

Sources: H&M website, http://hm.com, accessed April 12, 2014; L. Siegle, “Is H&M The New Home of Ethical Fashion?” The Observer, April 7, 2012; G. Petro, “The Future of Fashion Retailing—The H&M Approach,” Forbes, November 5, 2012; K. Stock, “H&M’s New Store Blitz Moves Faster Than Its Digital Expansion,” Bloomberg Businessweek, March 17, 2014; and M. Kerppola, R. Moody, L. Zheng, and A. Liu, “H&M’s Global Supply Chain Management Sustainability: Factories and Fast Fashion,” GlobaLens, a division of the William Davidson Institute at the University of Michigan, February 8, 2014.

CASE DISCUSSION QUESTIONS 1. Does it surprise you that the second largest clothing retailer is only

selling in stores in 54 countries plus an additional 10 countries online? Why do you think it is not covering more of the world’s countries?

2. H&M does not own any of the factories that produce its clothes. Instead, it relies on some 1,900 factories and 900 suppliers to create what its team designed. These factories and suppliers are mostly in Europe and Asia. How can H&M ensure that its customers receive the quality expected in the clothing?

3. H&M stresses sustainability in its promotional campaigns. How can it ensure that the working conditions are appropriate for the 1.6 million people that serve in its supplier network? Is it even H&M’s role to ensure that the working conditions and environmental impact are great in every market it engages in?

4. If you worked for H&M, what would you suggest that it focus on to become even larger than it is now? Should it have its own factories? Should it expand to more than the 64 countries (54 with stores and 10!online) that it is in now? Should it control more of the global supply chains?

Endnotes

Note: Elements of the sections on Strategic Roles for Production Facili- ties; Make-or-Buy Decisions; Global Supply Chain Functions; Coordi- nation in Global Supply Chains; and Interorganizational Relationships are drawn from Tomas Hult, David Closs, and David Frayer (2014), Global Supply Chain Management, New York: McGraw Hill.

1. T. Hult, D. Closs, and D. Frayer, Global Supply Chain Manage- ment: Leveraging Processes, Measurements, and Tools for Strategic Corporate Advantage (New York: McGraw-Hill Professional, 2014).

2. D. A. Garvin, “What Does Product Quality Really Mean,” Sloan Management Review 26 (Fall 1984), pp. 25–44.

3. See the articles published in the special issue of the Academy of Management Review on Total Quality Management 19, no. 3 (1994). The following article provides a good overview of many of the issues involved from an academic perspective: J.! W. Dean and D. E. Bowen, “Management Theory and Total Quality,” Academy of Management Review 19 (1994), pp.!392–418. Also see T. C. Powell, “Total Quality Manage- ment as Competitive Advantage,” Strategic Management Jour- nal 16 (1995), pp. 15–37; and S. B. Han et al., “The Impact of

ISO 9000 on TQM and Business Performance,” Journal of Business and Economic Studies 13, no. 2 (2007), pp. 1–25.

4. For general background information, see “How to Build Quality,” The Economist, September 23, 1989, pp. 91–92; A. Gabor, The Man Who Discovered Quality (New York: Penguin, 1990); P. B. Crosby, Quality Is Free (New York: Mentor, 1980); and M. Elliot et al., “A Quality World, a Quality Life,” Indus- trial Engineer, January 2003, pp. 26–33.

5. G. T. Lucier and S. Seshadri, “GE Takes Six Sigma beyond the Bottom Line,” Strategic Finance, May 2001, pp. 40–46; and U. D. Kumar et al., “On the Optimal Selection of Process Alternatives in a Six Sigma Implementation,” Inter- national Journal of Production Economics 111, no. 2 (2008), pp. 456–70.

6. M. Saunders, “U.S. Firms Doing Business in Europe Have Options in Registering for ISO 9000 Quality Standards,” Business America, June 14, 1993, p. 7; and Han et al., “The Impact of ISO 9000.”

7. G. Stalk and T. M. Hout, Competing against Time (New York: Free Press, 1990).

Chapter Fifteen Global Production and Supply Chain Management 447

8. N. Tokatli, “Global Sourcing: Insights from the Global Cloth- ing Industry—The Case of Zara, a Fast Fashion Retailer,” Journal of Economic Geography 8, no. 1 (2008), pp. 21–39.

9. Diana Farrell, “Beyond Offshoring,” Harvard Business Review, December 2004, pp. 1–8; and M. A. Cohen and H. L. Lee, “Resource Deployment Analysis of Global Manufacturing and Distribution Networks,” Journal of Manufacturing and Operations Management 2 (1989), pp. 81–104.

10. P. Krugman, “Increasing Returns and Economic Geography,” Journal of Political Economy 99, no. 3 (1991), pp. 483–99; J. M. Shaver and F. Flyer, “Agglomeration Economies, Firm Het- erogeneity, and Foreign Direct Investment in the United States,” Strategic Management Journal 21 (2000), pp. 1175–93; and R. E. Baldwin and T. Okubo, “Heterogeneous Firms, Agglomeration Economies, and Economic Geography,” Jour- nal of Economic Geography 6, no. 3 (2006), pp. 323–50.

11. For a review of the technical arguments, see D. A. Hay and D. J. Morris, Industrial Economics: Theory and Evidence (Oxford, UK: Oxford University Press, 1979). See also C. W. L. Hill and G. R. Jones, Strategic Management: An Integrated Approach (Boston: Houghton Mifflin, 2004).

12. See P. Nemetz and L. Fry, “Flexible Manufacturing Organi- zations: Implications for Strategy Formulation,” Academy of Management Review 13 (1988), pp. 627–38; N. Greenwood, Implementing Flexible Manufacturing Systems (New York: Halstead Press, 1986); J. P. Womack, D. T. Jones, and D. Roos, The Machine That Changed the World (New York: Raw- son Associates, 1990); and R. Parthasarthy and S. P. Seith, “The Impact of Flexible Automation on Business Strategy and Organizational Structure,” Academy of Management Review 17 (1992), pp. 86–111.

13. B. J. Pine, Mass Customization: The New Frontier in Business Competition (Boston: Harvard Business School Press, 1993); S. Kotha, “Mass Customization: Implementing the Emerging Paradigm for Competitive Advantage,” Strategic Management Journal 16 (1995), pp. 21–42; J. H. Gilmore and B. J. Pine II, “The Four Faces of Mass Customization,” Harvard Business Review, January–February 1997, pp. 91–101; and M. Zerenler and D. Ozilhan, “Mass Customization Manufacturing: The Drivers and Concepts,” Journal of American Academy of Busi- ness 12, no. 1 (2007), pp. 230–62.

14. “Toyota Motor Corporation Captures Ten Segment Awards,” J. D. Power press release, March 19, 2009, http://business- center.jdpower.com/news/pressrelease.aspx?ID52009043.

15. M. A. Cusumano, The Japanese Automobile Industry (Cambridge, MA: Harvard University Press, 1989); T. Ohno,

Toyota Production System (Cambridge, MA: Productivity Press, 1990); and Womack, Jones, and Roos, The Machine That Changed the World.

16. P. Waurzyniak, “Ford’s Flexible Push,” Manufacturing Engi- neering, September 2003, pp. 47–50.

17. Hult, Closs, and Frayer, Global Supply Chain Management.

18. F. Kasra, “Making the Most of Foreign Factories,” in World View, ed. J. E. Garten (Boston: Harvard Business School Press, 2000).

19. “The Boomerang Effect,” The Economist, April 21, 2012; and Charles Fishman, “The Insourcing Boom,” The Atlantic, December 2012.

20. This anecdote was told to the author by a Microsoft manager while the author was visiting Microsoft facilities in Hyderabad, India.

21. Interview by author. The manager was a former executive MBA student of the author.

22. Hult, Closs, and Frayer, Global Supply Chain Management.

23. Ibid.

24. D. A. Beeton, Technology Roadmapping in the Packaging Sector (Cambridge, UK: Institute for Manufacturing, University of Cambridge, 2004).

25. J. A. Peterson and V. Kumar, “Can Product Returns Make You Money?” MIT Sloan Management Review 51, no. 3 (2013), pp. 85–89.

26. Hult, Closs, and Frayer, Global Supply Chain Management; R. J. Trent and R. M. Monczka, “Achieving Excellence in Global Sourcing,” MIT Sloan Management Review 47, no. 1 (2005), pp. 24–32.

27. M. Kotabe and K. Helsen, Global Marketing Management (Hoboken, NJ: John Wiley & Sons, 2010).

28. H. F. Busch, “Integrated Materials Management,” IJPD & MM 18 (1990), pp. 28–39.

29. T. Aeppel, “Manufacturers Cope with the Costs of Strained Global Supply Lines,” The Wall Street Journal, December 8, 2004, p. A1.

30. D. J. Bowersox, D. J. Closs, M. B. Cooper, and J. C. Bowersox, Supply Chain Logistics Management (New York: McGraw-Hill Companies, 2012).

31. J. C. Anderson, J. A. Narus, and W. van Rossum (2006), “Cus- tomer Value Propositions in Business Markets,” Harvard Business Review, March, pp. 1–10.