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International Business: The Challenges of Globalization

Ninth Edition

Chapter 15

Managing International Operations

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This chapter defines the scope of international business and introduces us to some of its most important topics.

Learning Objectives

15.1 Describe the elements to consider when formulating production strategies.

15.2 Outline the issues to consider when acquiring physical resources.

15.3 Identify the key production matters that concern managers.

15.4 Explain the potential ways to finance business operations.

This chapter examines how companies launch and manage their international production efforts. We analyze how companies acquire the materials and products they need and how aspects of the business environment affect production strategies. We also look briefly at how companies finance their activities.

Toyota Races Ahead

Toyota Motor Corporation (www.toyota-global.com)

Controls around 12 percent of the world car market

8th largest company in the world

Annual sales of around $240 billion

Spread its activities across the globe

Toyota’s worldwide production

Most are wholly owned factories

Some are cooperative ventures

Great deal of planning

Toyota Motor Corporation (www.toyota-global.com) controls around 12 percent of the world car market. Toyota is the eighth-largest company in the world, with annual sales of around $240 billion and 349,000 employees.

Toyota has spread its activities across the globe by operating 53 production facilities in 28 countries and selling in more than 170 countries.

Most of Toyota’s worldwide production operations are wholly owned factories, but some are cooperative ventures.

Toyota undertakes a great deal of planning for production capacity, where to locate facilities, the technology used in production, and the layout of facilities.

Production Strategy (1 of 5)

Important Strategic Issues

Capacity Planning

Location of Facilities

Production Processes to Be Used

Layout of Facilities

Production operations are important to achieving a company’s strategy. Careful planning of all aspects of production helps companies cut costs (to become low-cost leaders) or design new products and product features necessary for a differentiation strategy.

Among the important strategic issues that managers must consider are planning for production capacity, the location of facilities, production processes to be used, and the layout of facilities.

Production Strategy (2 of 5)

Capacity Planning

If the capacity being used is greater than the expected market demand

Scale back production

If market demand is growing

Expand capacity

The process of assessing a company’s ability to produce enough output to satisfy market demand is called capacity planning.

Companies must estimate global demand for their products as accurately as possible.

If the capacity being used is greater than the expected market demand, a company may need to scale back production by perhaps reducing the number of employees or work shifts at some facilities.

If market demand is growing, managers must determine in which facilities to expand production or whether additional facilities are needed to expand capacity.

Capacity planning is also extremely important for service companies.

Production Strategy (3 of 5)

Facilities Location Planning

Selecting the location for production facilities

Business environment

Customers’ needs

Supply issues

Taking advantage of location economies

Centralization-versus-decentralization decision

Selecting the location for production facilities is called facilities location planning.

Companies often have many potential locations around the world from which to choose a site for production, R&D, or some other activity.

Aspects of the business environment that are important to facilities location planning include the cost and availability of labor and management, raw materials, component parts, and energy. Other key factors include political stability, the extent of regulation and bureaucracy, economic development, and the local culture, including beliefs about work and important traditions.

Although most service companies must locate near their customers, they must still consider a wide variety of customers’ needs when locating facilities.

Supply issues are also important in location planning.

Selecting highly favorable locations often allows a company to achieve location economies—economic benefits derived from locating production activities in optimal locations.

An important consideration for production managers is whether to centralize or decentralize production facilities. Centralized production refers to the concentration of production facilities in one location. With decentralized production, facilities are spread over several locations and could even mean having one facility for each national business environment in which the company markets its products—a common policy for companies that follow a multinational strategy.

Production Strategy (4 of 5)

Process Planning: Deciding the process that a company will use to create its product

Determinants

Firm’s business-level strategy

Availability and cost of labor in the local market

Standardization versus adaptation

Deciding on the process that a company will use to create its product is called process planning. The particular process to be used is typically determined by a firm’s business-level strategy.

Availability and cost of labor in the local market is crucial to process planning.

Another important issue in production strategy is deciding whether the production process will be standardized for all markets or adapted to manufacture products modified for different markets.

Production Strategy (5 of 5)

Facilities Layout Planning: Deciding the spatial arrangement of production processes within production facilities

Determinants

Availability of space and cost

Company’s business-level strategy

Deciding the spatial arrangement of production processes within production facilities is called facilities layout planning. Where the supply of land is limited, its cost is high. Companies that locate in these markets must use the available space wisely by designing compact facilities. Facility layout depends on the type of production process a company uses, which in turn depends on a company’s business-level strategy.

Quick Study 1

Assessing a firm’s ability to produce enough output to satisfy demand is called what?

Location economies can arise from the optimal execution of what?

What typically determines the process that a firm uses to create its product?

Acquiring Physical Resources

Managers must answer questions that include:

Will the company make or buy the components it needs in the production process?

What will be the sources of any required raw materials?

Will the company acquire facilities and production equipment or build its own?

Before an international company begins operations, it must acquire a number of physical resources. For example, managers must answer questions that include: Will the company make or buy the components it needs in the production process? What will be the sources of any required raw materials? Will the company acquire facilities and production equipment or build its own?

Make-or-Buy Decision (1 of 2)

Reasons to Make

Make-or-Buy Decision: Deciding whether to make a component or to buy it from another company

Vertical Integration: Extension of company activities into stages of production that provide a firm’s inputs (backward integration) or absorb its output (forward integration)

Reasons to Make

Lower Costs

Greater Control

Vertical integration is the process by which a company extends its control over additional stages of production—either inputs or outputs.

Above all, companies make products rather than buy them in order to reduce total costs.

Companies that depend on others for key ingredients or components give up a degree of control. Making rather than buying can give managers greater control over raw materials, product design, and the production process itself—all of which are important factors in product quality. In turn, quality control is especially important when customers are highly sensitive to even slight declines in quality or company reputation.

Make-or-Buy Decision (2 of 2)

Reasons to Buy

Outsourcing: Practice of buying from another company a good or service that is part of a company’s value-added activities

Reasons to Buy

Lower Risk

Greater Flexibility

Market Power

Barriers to Buying

The practice of buying from another company a good or service that is part of a company’s value-added activities is called outsourcing. Outsourcing results from continuous specialization and technological advancement. By outsourcing, a company can reduce the degree to which it is vertically integrated and the overall amount of specialized skills and knowledge that it must possess.

A firm may buy a product to lessen risk exposure. Not having operations abroad eliminates the direct risk to a company’s physical facilities, equipment, and employees.

Also, outsourcing helps a business to retain flexibility. Buying from several suppliers or establishing production facilities in several countries lets a firm source from another location if instability erupts in one location. And if a company’s capital is not invested in plants and equipment, it retains financial flexibility to use excess capital to pursue new opportunities.

A firm also may outsource to increase its market power. Sometimes a supplier even becomes a sort of “hostage” to one customer when that buyer absorbs much of its output. Such a buyer can force quality improvements, cost reductions, and special product modifications.

The government of the buyer’s country may impose import tariffs, which can add from 15 to 50 percent to the cost of a component. Trhe services provided by intermediaries increase the cost of buying aboard.

Acquiring Physical Resources (1 of 2)

Raw Materials

Selection and Acquisition of Raw Materials

Quantity

Quality

Decisions about the selection and acquisition of raw materials are important to many different types of manufacturers. The twin issues of quantity and quality drive many of these decisions.

First, some industries and companies rely almost exclusively on the quantity of locally available raw materials.

Second, the quality of raw material has a huge influence on the quality of a company’s end product.

Acquiring Physical Resources (2 of 2)

Fixed Assets

Options

Acquiring or Modifying Existing Factories

Greenfield Investment

Most companies must acquire fixed (tangible) assets—such as production facilities, inventory warehouses, retail outlets, and production and office equipment—in the host country. Many companies have the option of either (1) acquiring or modifying existing factories or (2) building entirely new facilities—called a greenfield investment.

Quick Study 2

Vertical integration is the process by which a company extends its control over what?

Why might a company make a product in-house rather than buy it?

Why might a firm buy a product rather than make it in-house?

Key Production Concerns (1 of 3)

Quality Improvement Efforts

Total Quality Management (TQM)

Company-wide commitment to meet or exceed customer expectations through continuous quality improvement efforts and processes

ISO 9000

An international certification that companies get when they meet the highest quality standards in their industries

Companies strive toward quality improvement to contain costs and increase value for customers. Quality products help keep production costs low because they reduce waste in valuable inputs, reduce the cost or retrieving defective products from buyers, and reduce the disposal costs that result from the defective products. A company that succeeds in combining a low-cost position with a high-quality product can gain a tremendous competitive advantage.

Total quality management is a company-wide commitment to continuous quality improvement to meet or exceed customer expectations through continuous quality improvement efforts and processes. It places responsibility on each individual for the quality of output. Improving quality helps a firm differentiate itself from rivals and attract loyal customers.

The International Standards Organization (ISO) 9000 is an international certification that a firm receives when it meets the highest quality standards in its industry. A company must demonstrate the reliability and soundness of all of its business processes that affect the quality of its products.

Key Production Concerns (2 of 3)

Shipping and Inventory Costs

Shipping Costs

Storing Inventory

Just-in-Time (JIT) Manufacturing

When the cost of getting inputs into the production process is a large portion of the product’s total cost, producers tend to locate close to the source of those inputs.

Storing great amounts of inventory for production is costly in terms of insuring them against damage or theft and the rent or purchase price of the warehouse needed to store them.

A production technique in which inventory is kept to a minimum and inputs to the production process arrive exactly when they are needed (or just in time) is called just-in-time (JIT) manufacturing.

Key Production Concerns (3 of 3)

Reinvestment versus Divestment

REINVEST

Promising outlook

Growing market

Highest return

DIVEST

Unprofitable outlook

Social unrest

Changing conditions in the competitive global marketplace often force managers to choose between reinvesting in operations and divesting them. The overriding factor is that companies seek the highest returns on investments.

Companies reinvest despite lengthy payback periods if the long-term outlook is good, and reinvest when a market is experiencing rapid growth. Reinvesting in expanding markets is appealing because potential customers may not yet be loyal to any one brand.

Firms may scale back or divest operations abroad when profitability appears farther off than expected. They may also divest when disruptions appear in a host country’s political, social, or economic spheres.

Quick Study 3

Why might a company strive for quality improvement?

The international certification that a company gets when it meets the highest quality standards in its industry is called what?

Under what conditions might a company reinvest earnings in its operations?

Financing Business Operations (1 of 7)

Sources of Financial Resources

Borrowing (Debt)

Issuing Equity (Stock Ownership)

Internal Funding

All companies have a limited supply of resources at their disposal to invest in current operations or new endeavors. So where do companies obtain needed funds? Generally speaking, organizations obtain financial resources through one of three sources:

Borrowing (debt)

Issuing equity (stock ownership)

Internal funding

Financing Business Operations (2 of 7)

Borrowing

Borrowing Difficulties

Exchange Rate Risk

Restrictions on Currency Convertibility

Restrictions on International Capital Flows

Borrowing locally can be advantageous, especially when the value of the local currency has fallen against that of the home country. Still, companies are not always able to borrow funds locally but are forced to seek international sources of capital. Borrowing difficulties include:

Exchange-rate risk

Restrictions on currency convertibility

Restrictions on international capital flows

Financing Business Operations (3 of 7)

Borrowing: Back-to-Back Loan

Back-to-Back Loan: Loan in which a parent company deposits money with a host-country bank, which then lends the money to a subsidiary located in the host country

Figure 15.1 Mexico—United States, Back-to-Back Loan

Companies are not always able to borrow funds locally. Often they are forced to seek international sources of capital. This is sometimes the case when a subsidiary is new to the market and has not yet built a reputation with local lenders. In such cases, a parent firm can help a subsidiary acquire financing through a so-called back-to-back loan—a loan in which a parent company deposits money with a host-country bank, which then lends the money to a subsidiary located in the host country.

For example, suppose that a Mexican company forms a new subsidiary in the United States but that this subsidiary cannot obtain a U.S. bank loan. The Mexican parent company can deposit Mexican pesos in the branch of a U.S. bank in Mexico (see Figure 15.1). The U.S. bank’s home office then lends dollars to the subsidiary in the United States. The amount of money lent in dollars will be equivalent to the amount of pesos on deposit with the U.S. bank’s Mexican branch. When the U.S. subsidiary repays the loan in full, the parent company withdraws its deposit (plus any interest earned) from the U.S. bank’s Mexican branch.

Financing Business Operations (4 of 7)

Issuing Equity

American Depository Receipt (ADR)

Certificate that trades in the United States and that represents a specific number of shares in a non–U.S. company

Venture Capital

Financing obtained from investors who believe that the borrower will experience rapid growth and who receive equity (part ownership) in return

Complying with the rules of listing shares on another country’s stock exchange costs time and money.

To maximize its international exposure, a non-U.S. company can list shares in the United States by issuing American Depository Receipts. These ADRs, as they are called, are certificates that trade in the United States and represent a specific number of shares in a non-U.S. company.

The advantages of ADRs are that buyers pay no currency-conversion fees, there are no minimum purchase requirements, and they carry no limit on the amount of money that a U.S.-based mutual fund can invest in firms not registered on U.S. exchanges.

Another source of equity financing for entrepreneurial start-ups and small businesses is venture capital—financing obtained from investors who believe that the borrower will experience rapid growth and who receive equity (part ownership) in return.

Issuing Equity

Emerging stock markets

Commonly experience extreme volatility

Hot money

Patient money

Poor market regulation

An important contributing factor is that investments into emerging stock markets are often so-called hot money—money that can be quickly withdrawn in times of crisis.

By contrast, patient money—foreign direct investment in factories, equipment, and land—cannot be pulled out as readily.

Poor market regulation can allow large local companies to wield a great deal of influence over their domestic stock markets.

Financing Business Operations (5 of 7)

Internal Funding

Internal equity, debt, and fees

Obtain internal financing from parent companies

Obtain financial capital by issuing equity

Revenue from operations

Lifeblood of international companies and their subsidiaries

Must be sufficient to sustain day-to-day operations

Outside financing only to expand operations or to survive lean periods

Internal equity, debt, and fees:

Spin-off companies and new subsidiaries typically require a period of time before they become financially independent. During this period, they often obtain internal financing from parent companies.

Many international subsidiaries obtain financial capital by issuing equity, which as a rule is not publicly traded.

Parent companies commonly lend money to international subsidiaries during the start-up phase and when subsidiaries undertake large new investments.

Revenue from operations: Money earned from the sale of goods and services is called revenue. This source of capital is the lifeblood of international companies and their subsidiaries. If a company is to succeed in the long term, it must at some point generate sufficient internal revenue to sustain day-to-day operations. At that point, outside financing is required only to expand operations or to survive lean periods—say, during seasonal sales fluctuations.

Financing Business Operations (6 of 7)

Internal Funding

Figure 15.2 Internal Sources of Capital for International Companies

Figure 15.2 summarizes the internal sources of capital for international companies and their subsidiaries.

Financing Business Operations (7 of 7)

Capital Structure

Capital Structure: Mix of equity, debt, and internally generated funds used to finance a company’s activities

Right balance to minimize risk and the cost of capital

Principles do not vary from domestic to international companies

The choice of capital structure is a highly complex decision

The capital structure of a company is the mix of equity, debt, and internally generated funds that it uses to finance its activities. Firms try to strike the right balance among financing methods to minimize risk and the cost of capital. As a rule, companies do not want to carry too much debt in relation to equity that can increase their risk of insolvency. Yet, debt appeals to companies because interest payments on debt are often deductible from taxable earnings.

The basic principles of capital structure do not vary from domestic to international companies. But research indicates that multinational firms have lower ratios of debt to equity than domestic firms.

National restrictions can influence the choice of capital structure. These restrictions include limits on the international flows of capital, the cost of local financing versus the cost of international financing, access to international financial markets, and controls imposed on the exchange of currencies.

The choice of capital structure for each of a company’s international subsidiaries—and, therefore, its own capital structure—is a highly complex decision.

Quick Study 4

In general, through what source do companies obtain financial resources?

A common way for non-U.S. companies to access U.S. capital markets is to issue what?

A firm’s mix of equity, debt, and internally generated funds that it uses to finance its activities is called what?