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INTRODUCTION

There was a rapid expansion in trade, investment and finance across national
boundaries in the late 19th century, largely due to trade liberalization. A century
down the line, world exports increased from $61bn in 1950 to $6338 billion in 2000.
Globalization was, and probably is, clearly, the word of the day. Deregulation and
liberalization on a global level, was followed by globalization (Nayyar, 2006).
The onset on globalization has given rise to the terms outsourcing and offshoring.
While outsourcing refers to subcontracting a business process to a third party
company, offshoring means the transfer of a business activity to another country.
This report attempts to understand better the underlying reasons and motives for a
company to outsource and offshore its business processes, by analyzing various
economic theories on international operations of a multinational enterprise with
respect to the leading clothing and apparel MNE, Hennes and Mauritz, popularly
known as H&M today.
After a brief introduction to the company and an overview of the fundamental
business processes of the company, a closer look is taken at the outsourcing and
offshoring activities of H&M. These processes are then evaluated with relation to
theories brought forward by economists Coase, Williamson, Hymer and Dunning.
COMPANY OVERVIEW
Hennes & Mauritz (H&M) was founded in 1947 in Sweden by Erling Persson. It was
first established as a store for women named Hennes, meaning hers' in Swedish,
and was later renamed Hennes and Mauritz after Persson acquired the inventory of
Mauritz Widforss, a hunting equipment store. This is known today as H&M (H&M
Annual Report, 2008).
It has set up its business concept as a drive to offer (customers) fashion and
quality at the best price. Ann-Sofie, Head of Design, H&M says At H&M, you should
be able to mix different trends and concepts. There should be something for
everyone (H&M Annual Report, 2008).
Currently H&M has around 1800 stores in 35 countries across North America, Europe
and Asia. It aims to increase its number of stores by 10% - 15% per year,
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simultaneously increasing sales in existing stores. H&M also offers online shopping
in 7 countries (H&M Corporate Website).
In 2008, H&M focussed mainly on its designs; it collaborated with top designers and
introduced a collection concentrated on organic cotton. It also emphasized on
Corporate Social
Responsibility (CSR) by setting in motion a new sustainability strategy. Under this,
close ties are established with its suppliers, setting sustainable social and
environmental standards. Special importance is given to employees' human rights
and simultaneous consideration is given to the effects of its production on the
environment (H&M CSR Report, 2006).
H&M today is a widely accepted brand of top notch fashion clothing and
accessories. Rolf Eriksen, CEO, H&M says H&M for me is a business based on
teamwork, humility and respect for people...[but]...we are cost-conscious and have
a competitive instinct that makes us aim for constant improvements (H&M
Annual Report, 2008). It has seen massive expansion on a global level in the past 7
years and is constantly looking at new avenues to make its mark in.
SUPPLY CHAIN PROCESS & MANAGEMENT
According to Slack (2007), supply chain is series of operations between origins of
products or services and end customers, which transform (assembly, merging, etc.)
an input (usually raw material) into an output (final products); supply chain
management (SCM) aimed to satisfy end customers needs at competitive cost
through managing these operations to achieve improvement in 5 operations
objectives (speed, quality, cost, dependability and flexibility), make sure each
operations can satisfy its own customers and also end-customers regardless of their
position in the supply chain. Companies increasingly competing as a supply chain
rather than independently in order to secure their underpinned competitive
advantage in the industry (Hoppe, 2001; Hill, 2005).

Figure - Supply Chain Process (Palladino, 2010)


SCM involves decisions like what capabilities/operations should be outsource or
develop internally, the location of firms' operations and the management of overall
long-term capacity (Ghezzi, 2006; Hill, 2005; Slack et al., 2007).
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SUPPLY CHAIN MANAGEMENT: FASHION INDUSTRY

Figure - Comparison of Conventional and Fast Fashion industry lead time (Palladino,
2010)
In conventional fashion industry, each supply chain members relationship is loose,
they used to run their business separately without information sharing and schedule
production based on their own forecast (Lee and Kincade, 2003); lack of information
sharing on actual demand and operational differences caused long lead time (6
months) and "bullwhip" effect , restrained the launching of new items to twice a
years (spring/summer and autumn/winter) and causing high level of inventory, and
the risk of each chain members' inventory-on-hand become obsolescence is high.
As a result, conventional-fashion player used to practice a push-strategy (due to
longer lead time needed to introduce a new design) (Palladino, 2010; Lee and
Kincade, 2003; Slack, et al., 2007).
While fast fashion industry practice a totally different approach in managing its
supply chain, the relationship between each chain is close (Barnes and Greenwood,
2006), many players like H&M often act as a supply chain leader to coordinate each
chain, the close relationship among supply chain members not only enhance the
dependability and flexibility of supply chain, it also allow concepts like QR (Quick
Response) and JIT (Just In Time) to be practice throughout the whole supply chain,
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and this effectively shorten the lead time from a normal 6 months to 3-6 weeks
(Palladino, 2010).
Fast-fashion player can introduce new design within short period of time (In H&M
case, 15 days) and the "bullwhip" effect is minimized, consequently, inventory level
is low, so as the obsolescence risk. Short lead time allow practice of pull-strategy
(as shorter time is needed to introduce a new design), which allow better respond to
customers' demand (Palladino, 2010; Ghemawat and Nueno, 2006; Slack, et al.,
2007).
In SCM, the make-or-buy decision is used by firm to achieve desired supply chain
performance objective, for example, outsource production to reduce cost or retain
production in-house to maintain high quality (Slack, et al., 2007; Hill, 2005). In
reality, company don't usually produce every service and products in supply chain
that it needed to satisfy its end-customers, as Slack et al. (2007) explained, firms
can choose to buy products/services directly through outsourcing or produce the
products/services by itself through vertical integration along supply chain, firm
usually choose to outsource activities which it had no competitive advantage in and
retain activities which it believe are critical to firms' success base on the order
winner and qualifier of competing market.

In the make-or-buy decision, conventional fashion industry players prefer


outsourcing to leverage the cheap labour & material cost in developing country to
keep their cost low (Lee and Kincade, 2003), however, outsourcing (especially to
long distance countries) significantly increase lead time, longer lead time means
that retailer must forecast the actual demand few months in advance to place order
earlier so that each collection can be place in store on time.
While fast fashion industry players like H&M had turn the focus from cost to lead
time through vertical integration, short lead time allow retailer to forecast demand
closer to the time it actually occurs (Ghemawat and Nueno, 2006), consequently,
the forecast is more accurate compare with conventional-fashion industry, therefore
the inventory level is significantly lower than conventional-fashion player, the needs
to markdown or write-off item is minimized, conventional-fashion industry player
averagely had to mark down 40% to reduce obsolescence stock (Neuno, 2009;
Gallaugher, 2008) .
H&M BUSINESS MODEL
The H&M head office is located at Stockholm, Sweden. It houses around 100
designers and centrally plans its collections. Continuous inspiration is drawn from
fashion capitals, trade fairs etc. in order to keep in touch with globally dynamic
fashion trends. While overall collection themes are decided upon a year in advance,
latest trends are sensed on short notice (H&M Corporate Website).
The designers at the Head Office work with the procurement department, which in
turn liaises with production offices in various supplier countries. These offices report
back to the procurement department with information on the best suppliers, which
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helps in placing final orders. The finished merchandise is first transported to


distribution centres located in each market. On unpacking, final products are
transported to individual stores (H&M Corporate Website).
OUTSOURCING AND OFFSHORING ACTIVITIES IN H&M

Outsourci
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Offshoring

OUTSOURCING
H&M outsources its production activities, i.e. it does not own any production plants.
Instead, it has around 800 selected suppliers located mainly in Asia and Europe.
These include particularly low-wage countries like Turkey, Bangladesh, Indonesia,
India etc. (H&M Corporate Website).

OFFSHORING
In order to maintain some degree of control over production activities, H&M has set
up about 20 production offices in selected countries. Production Offices help the
company maintain an effective Information and Communication Technology (ICT)
Network. They take care of the key issues of time, quality and quantity; they make
sure that the right quantity of merchandise is manufactured and distributed to
stores at the right time, stressing on superior quality at all times (H&M Corporate
Website).
Employees at local production offices test inspect sample clothing, and thus
bringing down lead time to a competitive level (Databank Consulting, 2004). Apart
from this, auditors regularly inspect work conditions and monitor environmental
effects of manufacturing activities.
This reflects the considerable investment made by H&M on establishing and
maintaining these production offices.
DRIVERS FOR OUTSOURCING AND RELATED THEORIES
The key drivers for H&M to outsource production to global suppliers are as follows:

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Specialization
Cost Reduction
Flexibility

Cost Reduction
By transferring production activities to countries manufacturing good quality
products, with the benefit of low cost labour, low cost of inputs, etc; H&M achieves
high levels of cost effectiveness (McIvor, 2005). Moreover, the company saves on
initial start-up costs of plant, equipment and building.
Flexibility
Since the fashion industry is ever-changing, the ability to modify production
patterns plays a significant role in the company's profit margin. Clothes in greater
demand can be or re-ordered where as those moving slower require lower order
levels (Databank Consulting, 2004).

While H&M can reach finished products to its stores in as low as 20 days, other
competitive players struggle; Zara being the only competitor with a lower lead time
of 15 days. However, lead time may not be the only factor that governs a fashion
merchandiser's success. Rolf Eriksen says, ...In fact, the shortest lead time possible
is not always favorable; only a proper lead allows us to reach the optimum
equilibrium among price, time and quality (China Business Feature, 2007).
Specialization
Through outsourcing, H&M can focus on its core competency, which is designing.
This assists the company to specialize on more value-adding activities and
outsource the more routine activity i.e. production (McIvor, 2005).
DUNNING, 1977
John Dunning, in his paper, explained the factors a company would consider before
moving abroad. Dunning's approach to internationalization includes decisions
regarding Ownership, Location and Internalization advantages - also called the OLI
Framework (Ietto-Gillies, 2005).
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Ownership-specific endowments refer to the internal' advantages that a firm may


possess which affects its efficiency of resource usage. Dunning refers to three
different types of ownership advantages: The first is the advantages a firm may
have over another firm operating in the same location. The second advantage is
one that a firm enjoys over a new firm in the industry. The third variety of ownership
advantages refer to the benefits a company obtains from its multi-nationality
(Dunning, 1993). Location advantages refer to those aspects unique to a particular
country which would draw foreign companies and Internalization advantages are
those which may give a firm an intensive to internalise its operations rather than
lease or rent them to external firms (Ietto-Gillies, 2005).
In the case of H&M, the first and third type of ownership advantage is applicable.
H&M has an ownership advantage through its ability to produce the trendiest
clothing and reach it to individual stores in an extremely competitive lead time of 20
days, owing to the efficiency of its worldwide suppliers. Also, through outsourcing its
production, H&M obtains the skill and know-how wherein its in-house designers
have the ability to create new clothing patterns at rapid paces, thus making design
its core competency. Another asset advantage is its corporate culture, which
promotes flexibility and adaptability (TIME Magazine, 2004). Under the third variety
of ownership advantage, H&M benefits simply from its multi-nationality. H&M has an
advantage from using supplier from varied economic environments, e.g. Turkey in
Europe and Bangladesh in Asia, where it is better positioned to take advantage of
the different market conditions and factor endowments specific to these supplier
countries.
In terms of location advantage, H&M gains from choosing specific suppliers in
emerging economies like China, India, Turkey, Syria etc. The factor endowments of
these countries give H&M a specific advantage in outsourcing its operations to
these locations. These countries benefit from lower input costs, labour costs, energy
costs, relaxed legal and trade barriers etc. which lower production costs for H&M to
a great extent.

The internalization advantage of the eclectic paradigm does not apply to H&M. In
the clothing and apparel industry, adaptability of the firm according to local and
international wants and demands plays a crucial role. For this very reason, H&M
believes in outsourcing and delegating its manufacturing assignments to other
companies and focusing its resources on design.
DRIVERS FOR OFFSHORING AND RELATED THEORIES
H&M offshores its information technology activities. The major drivers for this form
of offshoring are as follows:

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Effective ICT Network

Control
This appears to be the fundamental reason for a firm to internalize its operations.
Production offices makes each supplier sign the H&M Code of Conduct, devised in
the year 1997, to ensure that they comply with environmental and safety
regulations (H&M CSR Report, 2006). This helps H&M keep a watch on the functional
aspects of its suppliers. Moreover, these offices ensure rapid response times for
information sent out from the headquarters to different parts of the world.
Flexibility
H&M ensures better flexibility of data transfer between the head office in Stockholm
and 800 independent suppliers. Production offices are able to collaborate with
suppliers to ensure flexibility in its supply chain, which is needed in the textile
industry owing to its dynamic nature (Oh & Kim, 2007).
Effective ICT Network
H&M production offices help establish an efficient communication network between
the headquarters and suppliers. Timely shared information ensures smooth flow of
merchandise, giving it sufficient time to complete orders (Oh & Kim, 2007). The sale
made of each style of product is monitored through this ICT network.
By keeping this network internal in nature, H&M is able to protect its know-how,
where its skills to achieve superior levels of lead time at lower costs is kept within
the company.

COASE, 1937; WILLIAMSON, 1975


Ronald Coase was the first economist to explore the reasons for the existence of
firms, through the concept of 'transaction costs'. According to Coase, there is a
gap...between the assumption that resources are allocated by means of the price
mechanism and the assumption that this allocation is dependent on the
entrepreneur-coordinator (Coase, 1937). In order to bridge this gap, it is essential
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to compare costs involved in carrying out transactions in the open market to the
costs incurred in organizing resources internally (Ietto-Gillies, 2005). Allocating
resources based on the price mechanism involves transaction costs, which is why a
firm should consider managing its activities within the firm rather than externalizing
them.
Oliver Williamson further expanded on the Transaction Cost Theory by analyzing the
organization of a firm's operations based on its drive to economize transaction
costs. To explain the arguments for a firm to internalize, he introduces three
concepts (Ietto-Gillies, 2005):
I.

II.

III.

Bounded Rationality - due to imperfect information available about the


market. According to Williamson, the problem of bounded rationality of an
entity increases with an increase in the complexity of the environment. For
this reason, Williamson argues that a firm should consider internalizing its
activities.
Opportunistic Behavior - External parties have a tendency to operate solely
with motives of self-interest. This opportunistic behavior is likely to be more
problematic for a firm when its activities involve fewer external forces,
making internal operations a better form of protection from opportunistic
behavior.
Asset Specificity - Assets of a firm turn out to be more productive when they
are used together than when kept separately. According to Williamson, the
assets of a firm will bear higher returns when utilized as a whole.

In the case of H&M, should its ICT network be outsourced, several transaction costs
may have to be incurred due to transactional imperfections in the market. This
refers to the asymmetry of information available to all the buyers and sellers in the
market. The transaction costs H&M may incur are the costs of searching for
appropriate software or partners to perform its information transfer activities, costs
of bargaining and negotiating with global suppliers, legal costs to settle on final
production contracts and costs to enforce its specifications to ensure its external
collaborators perform their duties. For this reason, it can be concluded that H&M
would be better placed setting up a wholly owned production office to internalize its
ICT activities and minimize its transaction costs.
Additionally, by establishing production offices in its major sales markets, the
negative effect of bounded rationality on its profitability is reduced as there is a
higher tendency for perfect knowledge to be available within the different H&M
merchandise suppliers across the world. The local employees at the production
offices ensure timely and uniform distribution of information between the offices at
other locations. Through this, H&M is safeguarded from the aggressive strategies of
its competitors. By internalizing its ICT network, H&M is assured that the important
information transferred between its global suppliers is kept within the company; it is
further assured of better quality of information transfer with minimal distortion.

HYMER, 1960
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Stephen Hymer put forth the first developed theory explaining international
operations of a company. He introduced the fundamental difference between
portfolio investment and direct investment as the desire for control' and the key
reasons for a firm to consider Foreign Direct Investment (FDI). Direct investment
gives a firm control over its business operations abroad, whereas portfolio
investment does not. The primary assumption in Hymer's theory is the existence of
an imperfect market, caused by imperfections in the goods market, factors market,
and additional interference by the government in production activities (Ietto-Gillies,
2005).
Hymer explained two main reasons for a firm to desire control over its international
operations. Type I, called direct investment, refers to a firm's intentions to use its
resources prudently. An investor looks to maintain control of its operations in order
to uphold the safety of his/her investment abroad, especially due to the existence of
an atmosphere of distrust in international transactions. Type II, called international
operations, refers to a situation where firms are motivated to control its foreign
operations with a view to gain market power (Hymer, 1976).
Since all of the manufacturing activities of H&M are outsourced, it would like to gain
a certain degree of control over its international operations in order to secure
returns on its international investments. In other words, H&M looks to control its
international operations under Type I as its main driver to set up production offices
is not to consolidate market power.
In the case of the determinants of its FDI, the first motive is the specific advantage'
H&M gains over its competitors. Every production office has its own quality team to
ensure compliance to its specific Code of Conduct (H&M Annual Report, 2008). Once
H&M exploited all its local opportunities in Sweden, it moved on to other countries.
This advantage of having an owned production office gives H&M a competitive
advantage. Apart from this, H&M enjoys the benefit of 'diversification' of its risks, by
opening its own stores in other countries, thus diversifying its risks of failure in one
particular country.
CONCLUSION
There have been a number of theories regarding the international operations of
multinational enterprises. It is clear that there isn't one particular theory which can
explain the operations of a company in totality as an individual company's
operations are independent of economic theories and reflect the company's
functional and operational strategies. The international operations of H&M can be
described as a blend of theories, each related to the outsourcing and offshoring
activities of the company.
H&M looks to reduce its costs of production, thus outsourcing all its manufacturing
activities to more experienced suppliers located primarily in emerging economies.
At the same time, to establish a middle ground in terms of control over the
manufacturing activities, it has opened production offices to monitor the
manufacturing activities and ensure effective data transfer.

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Due to the dynamic nature of the business environment and the emergence of
organizations such as the WTO, IMF, trade arrangements, and above all, the
establishment of the internet, the corporate world today has become far more open
to the concept of outsourcing than it has ever been. According to Gartner Inc., in
light of the recent economic slump, organizations which do not outsource will
consider outsourcing business processes to focus more on their core functions
(Gartner Inc. Press Release, 2009). Thus, this trend of increased outsourcing and
offshoring activities is certainly on the rise for the years to come.
REFERENCES
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ntest
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4. Dunning, J. (1993). Trade, Location of Economic Activity and the Multinational
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16.Ietto-Gillies, G. (2005). Internalisation and the Transnational Corporation. In


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