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Chapter 16

Global production, Outsourcing, and Logistics

As trade barriers fall and global markets develop, many firms

increasingly confront a set of interrelated issues. Where in this world should production activities be located? What should be the long-term strategic role of foreign production site? Should the firm own foreign production activities, or is it better to outsource those activities to independent vendors? How should a globally dispersed supply chain be managed, and what is the role of internet based information technology in the management of global logistics Should the firm manage global logistics itself, or should it outsource the management to enterprises that specialize in this activity?

Strategy, Production, and Logistics


- the activities involved in creating a product. - can be both service and manufacturing activities, since one can produce a service or a physical product. Logistics - the activity that controls the transmission of physical materials through the value chain, from procurement through production into distribution.

Strategic objectives

a) Lower Costs b) Increase Product Quality Several ways to Improved quality control reduces costs: Increasing productivity because time is not wasted producing poor-quality. Lowering rework and scrap costs associated with defective products. Reducing the warranty costs and time associated with fixing defective products.

Six sigma quality improvement methodology

Six sigma is a statistically based philosophy that

aims to reduce defects, boost productivity, eliminate waste, and cut costs throughout a company. -modern successor of TQM (Total Quality Management) Sigma comes from the Greek letter that the statisticians use to represent a standard deviation fro mean; - the higher the number of sigmas the smaller the number of errors.

Importance of Lowering costs and Improving quality in International Business

First, production and logistics functions must be able

to accommodate demands for local responsiveness.

Demands for local responsiveness arise from national differences in consumer tastes and preferences, infrastructure, distribution channels, and host-government demands.
Second, production and logistics must be able to

respond quickly to shifts in customer demand.

Time-based competition has grown more important. When consumer demand is prone to large and unpredictable shifts, the firm that can adapt most quickly to these shifts will gain in advantage. Production and Logistics play a critical roles here.

An essential decision facing an international firms

is where to locate its production activities to best minimize costs and improve product quality. Factors to considered: 1. Country Factors 2. Technological Factors 3. Product Factors

Firms should locate its various manufacturing

activities where the economic, political, and cultural conditions, including relative factors, are conductive to the performance of those activities. Other things are not equal. Differences in relative factor costs, political economy, culture, and location externalities are important, but other factor also loom large. Formal and Informal trade barriers obviously influence location decisions, as do transportation costs ad rules and regulation regarding foreign direct investment.

Another country factor is expected future

movement in its exchange rate. Adverse changes in exchange rate can quickly alter a countrys attractiveness as a manufacturing base. Currency appreciation can transform a low cost location into a high cost location.

The type of technology a firm uses to perform

specific manufacturing activities can be pivotal in location decisions. Three characteristics of manufacturing technology: Fixed cost Minimum Efficient Scale - level of output at which most plant level scale economics are exhausted.

Flexible manufacturing technology/Lean

production covers a range of manufacturing technologies designed to: - reduce setup times for complex equipment. - increase the utilization of individual machines through better scheduling, and - improve quality control at all stages of the manufacturing process. Mass customization describes 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.

Flexible machine cells

- another common flexible manufacturing technology. - 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 setting on machines are computer controlled, which allows each cell to switch quickly between the production of different parts or products.

Two product features that affect location decisions. Products value to-weight-ratio because of its influence on transportation costs. high value-to-weight rations - expensive and but do not weigh very much. low value-to-weight ratios- relatively inexpensive products that weigh a lot. Whether the product serves universal needs, needs that are the same all over the world.


Two basic strategies for locating production facilities: Concentrating them in a centralized location. Serving the world market from there, or decentralizing them in various regional or national locations that are close to major markets.

Concentrated Production Favored

Country Factors Differences in political economy Differences in culture Differences in factor costs Trade barriers Location externalities Exchange rates Technological Factors Fixed costs Minimum efficient scale Flexible manufacturing technology Product Factors Value-to-weigh ratio Serves universal needs Substantial Substantial Substantial Few Important in industry Stable

Decentralized Production Favored

Few Few Few Substantial Not important in industry Volatile

High High Available

Low Low Not available

High Yes

Low No

The Strategic Role of Foreign Factories

Many foreign factories are established where labor cost

are low. Their strategic role typically is to produce labor intensive products at as low cost as possible. Two sources of improvement: First, pressure from the center to improve a factorys cost structure and/or to customize a product to the demands of customers in a particular nation can start a chain of events that ultimately leads to development of additional capabilities at the factory. Second, the capabilities of a foreign factory can be the increasing abundance of advanced factors of production in the nation in which the factory is located.

Outsourcing Production: Make-or-Buy Decision

Make-or-buy Decision - decisions about whether they should perform a certain value creation activity themselves or outsource it another entity. Outsourcing decision- has gone beyond the manufactured of physical products to embrace the production of service activities. - pose plenty of problems for purely domestic businesses but even more problems for international businesses.

The advantages to make:

Lowering Costs Facilitating Specialized Investments

Specialized asset- is an asset whose value is contingent upon a particular relationship persisting. Protecting Proprietary Product Technology Improving Scheduling

The advantages to buy:

Strategic Flexibility Lower Costs


TRADE-OFFS- there are trade-offs in make-or-buy

decisions. The benefits of making all or part of a product in-house seem to be greatest when highly specialized assets are involved, when vertical integration is necessary for protecting proprietary technology, or when the firm is simply more efficient than external suppliers at performing a particular activity. STRATEGIC ALLIANCES WITH SUPPLIERS several international businesses have tried to reap some benefits of vertical integration without the associated organization problems by entering strategic alliances with essential suppliers.


Logistics- encompasses the activities necessary to get materials from suppliers to a manufacturing facility, through the manufacturing process, and out through a distribution system to the end user. -function manages the global supply chain in the international business. Twin objectives of logistics: To manage a firms global supply chain at the lowest possible cost Serves customers needs

The role of JUST-IN-TIME inventory

Pioneered by Japanese firms during the 1950s and

60s. Economize on inventory holding costs by having materials arrive at manufacturing plant just in time to enter the production process and not before. Reduce inventory holding costs, such as warehousing and storage costs. Helps firms improve product quality.


Electronic Date Interchange (EDI) it is use via Internet to coordinate the flow of materials into manufacturing , and out to customers. Web-based application- have made most of these proprietary solutions obsolete. Less-expensive webbased systems that are much easier to install and manage now dominate the market for global supply chain management software. - transformed the management of globally dispersed supply chains, allowing even small firms to achieve a much better balance between supply and demand and thereby reducing the inventory in their system and reaping the associated economic benefits.

Chapter 15
Exporting, Importing, and Countertrade

Large and small firms export

Exporting is on the rise thanks to the decline in

trade barriers under the WTO and regional economic agreements such as the EU and NAFTA Exporting firms need to Identify market opportunities Deal with foreign exchange risk Navigate import and exporting financing Understand the challenges of doing business in a foreign market

The Promise And Pitfalls Of Exporting

Exporting is a way to increase market size--the

rest of the world is usually much larger market than the domestic market Large firms often proactively seek new export opportunities Many smaller firms are reactive and wait for the world to come to them Many firms fail to realize the potential of the export market Smaller firms are often intimidated by the complexities of exporting and initially run into problems

The Promise And Pitfalls Of Exporting

Common pitfalls include?: poor market analysis poor understanding of competitive conditions a lack of customization for local markets a poor distribution program poorly executed promotional campaigns problems securing financing a general underestimation of the differences and expertise required for foreign market penetration an underestimation of the amount of paperwork and formalities involved

Improving export performance

Assistance available to firms for export process International comparison Information sources Export management companies Exporting Strategy

An International Comparison
A big impediment to exporting is the simple lack

of knowledge of the opportunities available To overcome ignorance firms need to collect information Both Germany and Japan have developed extensive institutional structures for promoting exports Japanese exporters can also take advantage of the knowledge and contacts of sogo shosha, the countrys great trading houses In contrast, American firms have far fewer resources available

Information Sources
The U.S. Department of Commerce is the most

comprehensive source of export information for U.S. firms The International Trade Administration and the United States and Foreign Commercial Service Agency can provide best prospects lists for firms The Department of Commerce also organizes various trade events to help firms make foreign contacts and explore export opportunities The Small Business Administration is also a source of assistance Local and state governments can also provide export support

Utilizing Export Management Companies

Export management companies (EMCs) are

export specialists that act as the export marketing department or international department for client firms EMCs normally accept two types of export assignments: they start exporting operations for a firm with the understanding that the firm will take over operations after they are well established they start services with the understanding that the EMC will have continuing responsibility for selling the

Export Strategy
To reduce the risks of exporting, firms should hire an EMC or export consultant, to help identify opportunities and navigate through the tangled web of paperwork and regulations so often involved in exporting focus on one, or a few, markets at first enter a foreign market on a fairly small scale in order to reduce the costs of any subsequent failures recognize the time and managerial commitment involved develop a good relationship with local distributors and customers hire locals to help establish a presence in the market be proactive

Export and import financing

Lack of trust between international trading

partners due to several factors

Parties have never met Language, cultural and legal system differences Difficulties in tracking down a party in case of

Problem solved by using a third party trusted by

both as an intermediary normally a reputable bank

Lack of Trust
Figure 15.3:

Tools used to aid transactions

Letters of Credit (LOC) Bank guarantee on behalf of importer to exporter assuring payment when exporter presents specified documents Drafts (Bill of Exchange) Written order exporter, telling an importer to pay a specified amount of money at a specified time Bill of Lading Issued to exporter, by carrier. Serves as receipt, contract and document of title

Letter of Credit
Issued by a bank at the request of the importer

Bank pays a specified sum to a beneficiary,

normally the exporter, on presentation of particular, specified documents Fee paid by importer for letter of credit May reduce borrowing ability of importer since the letter is a financial liability

Draft (Bill of exchange)

Written by an exporter instructing an importer

to pay specified amount of money at specified time Required before the buyer can obtain the merchandise
Two types
Sight drafts - payable on presentation to the

drawee Time draft - negotiable instrument allowing for delay in payment

Bill of Lading
Issued to the exporter by the common carrier

transporting the merchandise

Serves three purposes:
Receipt - merchandise described on document has

been received by carrier Contract - carrier is obligated to provide transportation service in return for a certain charge Document of title can be used to obtain payment or a written promise before the merchandise is released to the importer

Export Assistance
There are two forms of government-backed assistance available to exporters: 1. Export-Import Bank
The Export-Import Bank (Eximbank) is an independent agency of the

U.S. government
It provides financing aid to facilitate exports, imports, and the

exchange of commodities between the U.S. and other countries Eximbank achieves its goals though various loan and loan guarantee programs. 2. Export credit insurance Export credit insurance protects exporters against the risk that the importer will default on payment In the U.S., export credit insurance is provided by the Foreign Credit Insurance Association (FICA) FICA provides coverage against commercial risks and political

Trade carried out wholly or partially in goods

rather than money. Denotes a whole range of barter-like agreements Primarily used when a firm exports to a country whose currency is not freely convertible Developing countries e.g. former USSR Importing country may lack the foreign exchange reserves required 8 to 10% of world trade in form of countertrade Example: Venezuelan governments contract with Caterpillar.

Types of Countertrade
Direct exchange of goods and services between two

parties without a cash transaction Two fold problems

If goods are not exchanged simultaneously, one party ends up

financing the other for a period Goods may be unwanted, unusable or have a low re-sale value

Counter purchase
Reciprocal buying agreement

Compensation or buybacks
Occurs when a firm builds a plant in a country or

supplies technology, equipment, training, or other services Agrees to take certain percentage of plants output as partial payment for the contract

Types of Countertrade
Offset One party agrees to purchase goods and services with a specified percentage of the proceeds from the original sale Party can fulfill the obligation with any firm in the country to which the sale is being made Gives exporter greater flexibility to choose goods to be purchased Switch trading Occurs when a third-party trading house buys the firms counter purchase credits and sells them to another firm that can better use them

The Pros And Cons Of Countertrade

Countertrade is attractive because it gives a firm

a way to finance an export deal when other means are not available If a firm is unwilling to enter a countertrade agreement, it may lose an export opportunity to a competitor that is willing to make a countertrade agreement In some cases, a countertrade arrangement may be required by the government of a country to which a firm is exporting goods or services

The Pros And Cons Of Countertrade

Countertrade is unattractive because it may

involve the exchange of unusable or poor-quality goods that the firm cannot dispose of profitably It requires the firm to establish an in-house trading department to handle countertrade deals Countertrade is most attractive to large, diverse multinational enterprises that can use their worldwide network of contacts to dispose of goods acquired in countertrade deals