International Business: The New Realities by This chapter discusses global sourcing. International Business: The New Realities by Cavusgil, Knight and Riesenberger Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Learning Objectives 1. Outsourcing, global sourcing, and offshoring 2. Benefits of global sourcing 3. Risks of global sourcing 4. Strategies for minimizing the risks of global sourcing 5. Implementing global sourcing through supply- chain management 6. Global sourcing and corporate social responsibility Learning objectives include the risks and benefits of global sourcing, as well as strategies and corporate social responsibility considerations when sourcing globally. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Global Sourcing Procurement of products or services from suppliers located abroad for consumption in the home country or a third country Also called global outsourcing, global procurement, or global purchasing; a type of importing Involves a contractual relationship between the buyer and the foreign supplier, in which the performance of a specific value-chain activity is subcontracted to the firm's own subsidiary or to an independent supplier Global sourcing is a low-control strategy in which the focal firm sources from independent suppliers through contractual agreements, as opposed to the high-control strategy of buying from company-owned subsidiaries. Global sourcing frequently represents the firm’s initial involvement in international business. For many firms, it increases management’s awareness about other international opportunities. Global sourcing has been an established international business activity since the 1980s, and has gained momentum in the current phase of globalization. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Sourcing for Dell Inspiron Notebook Computer Dell Notebook Computers are an excellent example of a product that has sources for its parts from countries around the globe. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Drivers of Global Sourcing Technological advances in communications, especially the Internet and international telephony Falling costs of international business Entrepreneurship and rapid economic transformation in emerging market countries Three key drivers are especially responsible for the growth of global sourcing in recent years: ■ Technological advances in communications, especially the Internet and international telephony. Access to vast online information means focal firms can quickly find suppliers to anywhere in the world that meet specific needs. ■ Falling costs of international business. Tariffs and other trade barriers have declined substantially. Efficient communication and transportation systems have made international procurement cost effective and accessible to any firm. ■ Entrepreneurship and rapid economic transformation in emerging markets. China, India, and other emerging markets have quickly developed as important suppliers of various products and services. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Two Key Decisions Regarding Global Sourcing Decision 1: Outsource or not Decide whether each value-adding activity should be conducted in-house or by an independent supplier. Known as the ‘make or buy’ decision. Firms usually internalize activities that are part of their core competence or that involve the use of valuable intellectual property. Decision 2: Where in the world should value-adding activities be located? Firms configure their value-chain activities in specific countries to cut costs, reduce transit time, access favorable factors of production, and access competitive advantages. Decision 1: Outsource or not? Managers must decide between internalization and externalization—whether each value-adding activity should be conducted in-house or by an external, independent supplier. In business, this is traditionally known as the make or buy decision. Firms usually internalize those value-chain activities they consider part of their core competencies, those that require the use of proprietary knowledge and trade secrets they want to control. Decision 2: Where in the world should value-adding activities be located? Instead of concentrating value-adding activities in their home country, many firms configure them across the world to save money, reduce delivery time, access factors of production, or extract maximum advantages relative to competitors. External suppliers are typically located in countries characterized by low-cost labor, competent production processes, and specific knowledge about relevant engineering and development activities. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Example of Worldwide Value Chain Configuration Automaker BMW employs 70,000 factory personnel at 23 sites in 13 countries to manufacture its vehicles. The Munich plant builds the BMW 3 Series and supplies engines to other BMW factories abroad. The South Carolina plant makes 500 vehicles daily. A plant in NE China makes cars in a local joint venture. A plant in India makes BMWs for the Asian market. BMW configures sourcing to minimize costs (by producing in China), access skilled personnel (by producing in Germany), and remain close to key markets (by producing in China, India, and the United States). BMW has operations that make automobile parts in 13 countries. These locations are on three continents and employ over 70,000 employees. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Global Sourcing of Manufacturing Toy companies like Lego and Mattel outsource much of their production to manufacturers in China. Global sourcing helps reduce costs, improves productivity, and facilitates the redesign of critical value-chain activities. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Business Process Outsourcing (BPO) Outsourcing of business functions, such as accounting, human resource functions, IT services, and customer service, to independent suppliers BPO includes: Back-office activities, including internal, upstream business functions such as payroll and billing Front-office activities, including down-stream, customer-related services such as marketing or technical support Business Process Outsourcing (BPO) is when a company contracts with an independent company to supply activities for the company, such as payroll or technical support. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Business Process Outsourcing Minimizing the risks of global sourcing or BPO entails several, critical strategies. Following a careful selection process, the focal firm should invest in collaborating and communicating with suppliers. Pictured is a call center in New Delhi, India. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Global Sourcing from Subsidiaries Versus Independent Suppliers In global sourcing, the focal firm has two major choices. It can source from: (1) Independent suppliers, or (2) Company-owned subsidiaries and affiliates. Global sourcing from independent suppliers involves outsourcing production to a third-party provider abroad. Captive sourcing is sourcing from the firm’s own production facilities located abroad. Production is carried out at a foreign facility that the focal firm fully or partly owns through direct investment. Many companies have the option of using either company-owned suppliers or independent suppliers when considering sourcing options. If the company chooses to use its own subsidiaries, this is called “captive sourcing.” Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Contract Manufacturing Arrangement in which the focal firm contracts with an independent supplier to manufacture goods according to well-defined specifications; e.g., Nike, Ikea Example Patheon is a leading contract manufacturer in the pharmaceutical industry, providing drug development and manufacturing for pharmaceutical and biotechnology firms worldwide. It operates 11 factories in North America and Europe, producing over-the-counter drugs and numerous top prescription drugs for leading pharmaceutical firms. One type of sourcing is called “contract manufacturing,” in which a company contracts with another company to make goods according to its specifications. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Offshoring A natural extension of global sourcing, it refers to the relocation of a business process or entire manufacturing facility to a foreign country. MNEs shift production of goods or processes to foreign countries to enhance their competitive advantages. Common in the service sector, including banking, software writing, legal services, and customer service activities. Example Large legal hubs have emerged in India, which provide services such as drafting contracts and patent applications. Because lawyers in North America and Europe can cost $300 an hour or more, Indian firms can cut legal bills by 75 percent. Offshoring is common in the service sector, including banking, software code writing, legal services, and customer-service activities. Large legal hubs have emerged in India, which provide services such as drafting contracts and patent applications, conducting research and negotiations, and performing paralegal work, all on behalf of Western clients. In each of the business functions—human resources, accounting, finance, marketing, and customer service—certain tasks are considered routine and discrete. Examples of functions successfully offshored to foreign providers include billing and credit card processing in finance, creating customer databases and recording sales transactions in marketing, and payroll maintenance and benefits administration in human resources. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Nature of Global Sourcing Depending on the firm’s choice of whether to internalize or externalize outsourcing, there are still a few decisions to be made, as shown in this matrix. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Scope of Global Sourcing Many jobs in the services sector cannot be separated from their place of consumption, such as retailing. Other services are consumed locally, such as those provided by doctors, lawyers, and accountants. The firm’s reputation can be harmed by having jobs performed abroad. Labor union contracts often restrict global sourcing. Easily outsourced jobs tend to be in industries: —That benefit from efficiency and low cost —That have uniform processes and customer needs —In the service sector that are labor intensive —Whose outputs are easily transmitted via the Internet Not all business activities or processes lend themselves to global sourcing. Many jobs in the service sector cannot be separated from their place of consumption. People normally do not travel abroad to see a banker, doctor, dentist, or accountant. By 2008, fewer than 5 percent of jobs in the United States that require substantial customer interaction (such as in retailing) had been transferred to low-wage economies. Jobs most conducive to being sourced abroad tend to be in industries characterized by: ■ Large-scale manufacturing whose primary competitive advantage is efficiency and low cost ■ High labor intensity in product and service production, such as garment manufacturing and call centers Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Choices in Outsourcing Value Chain Activities This exhibit explains the strategic implications of the two choices firms face: Whether to perform specific value-adding activities themselves or to outsource them, and whether to concentrate each activity in the home country or disperse it abroad. The exhibit portrays a typical value chain, ranging from R&D and design to customer service. The first row indicates the degree to which management considers each value-adding activity a strategic asset to the firm. The second row indicates whether the activity tends to be internalized inside the focal firm or outsourced to a foreign supplier. The third row indicates where management typically locates an activity. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Overview on India Leading offshoring destination for software development and back-office services, such as call centers and financial accounting activities A leading world center in the IT industry, employing more than two million people Strong English language skills Abundant pool of educated engineers, managers, and other specialists Low labor costs India is perhaps the world’s leading offshoring destination for software development and back-office services, such as telephone call centers and financial accounting activities. India has better intellectual property protection, a workforce with English language skills, and infrastructure that, although poor by advanced economy standards, is often superior to that of China. It is likely to remain the global-sourcing leader in the services sector for some time to come. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Key Players in Global Sourcing by Region Firms based in advanced economies outsource the most services by volume. U.S. firms have led by offshoring over 50 percent of their service projects. More than 75 percent of major U.S. financial institutions send a portion of their IT work offshore. In Europe and Japan, the majority of large firms outsource some of their services, most often to China and India, followed by countries in Eastern Europe, Latin America, and the Middle East. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Benefits of Global Sourcing Cost efficiency, due to lower wages abroad, leading to improved profitability Ability to achieve strategic goals Faster corporate growth Access to qualified personnel Improved productivity and service, especially when a task is outsourced to a firm specialized in that task Business process redesign Increased speed to market Access to new markets Technological flexibility Improved agility by shedding unnecessary overhead Cost efficiency is the traditional rationale for sourcing abroad. The firm takes advantage of the large wage gap between advanced economies and emerging markets. Global sourcing can also improve a firm’s ability to achieve strategic goals. The strategic view of global sourcing—called transformational outsourcing—suggests that just as the firm achieves gains in efficiency, productivity, quality, and revenues by leveraging offshore talent, it also obtains the means to turn around failing businesses, speed up innovation, restructure operations, and fund otherwise-unaffordable development projects. Global sourcing allows the firm to free expensive analysts, engineers, and managers from routine tasks to spend more time researching, innovating, managing, and generally undertaking high-value-adding activities that contribute more productively to increasing company performance. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Risks in Global Sourcing Lower-than-expected cost savings Environmental factors, such as exchange rate fluctuations, trade barriers, and labor strikes Weak legal environment, which can affect protection of intellectual property Inadequate or low-skilled workers Overreliance on suppliers Risk of creating competitors Erosion of morale and commitment among home- country employees due to outsourcing jobs However, there are risks associated with global sourcing. Establishing an outsourcing facility can be surprisingly expensive, due to the need to upgrade poor infrastructure or locate it in a large city to attract sufficient skilled labor. Other risks include environmental factors, such as currency fluctuations, tariffs, and other trade barriers. Inadequate legal systems, inadequate or low-skilled workers, the risk of creating competitors, and the erosion of morale and commitment among home-country employees are additional risks that managers should consider. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Annual Salaries of Typical Outsourcing Workers This exhibit reveals typical salary levels of BPO and IT workers in various countries. One study found that firms expect to save an average of more than 40 percent on baseline costs as a result of offshoring, particularly in R&D, product design activities, and back-office operations such as accounting and data processing. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Annual Salaries of Typical Outsourcing Workers This exhibit shows the large differences in salaries among different countries in Asia. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Strategies for Minimizing Risk Go offshore for the right reasons. The best rationale is strategic, such as enhancing the quality of offerings, improving productivity, and freeing up core resources. Get employees on board. Poorly planned sourcing projects create unnecessary tension with existing employees. Choose carefully between a captive operation and a contract with outside suppliers. Strategies to minimize risk include going offshore for the right reasons. The best rationale is strategic. Cost cutting is the main reason, but it is often a distraction from more beneficial, long-term goals, such as enhancing the quality of offerings, improving overall productivity, and freeing up knowledge workers and other core resources that can be redeployed to improve long-term performance. Another important strategy is to get employees on board. Global sourcing can invite opposition from employees and other organizational stakeholders. Disaffected middle managers may undermine projects and other goals that offshoring seeks to achieve. Also, choose carefully between a captive operation and contracting with outside suppliers. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Strategies for Minimizing Risk (cont.) Choose suppliers carefully. There are many options. A sourcing broker can help. Invest in supplier development and collaboration. Proactively safeguard interests, such as key assets and the firm’s reputation. Safeguard interests in terms of maintaining the firm’s reputation, building a stake for the supplier, keeping open options for finding alternate partners if needed, and withholding key intellectual property. Additional ways to minimize risk include choosing suppliers carefully. Finding and managing foreign suppliers is complex. Suppliers may engage in opportunistic behavior or act in bad faith. Also, invest in supplier development and collaboration. When a business function is delegated to a supplier, the parties need to exchange information, transfer knowledge, troubleshoot, coordinate, and monitor. Finally, the focal firm should take specific actions to safeguard its interests in the supplier relationship. If conflicts are unresolved by negotiations, one option is to acquire full or partial ownership of the supplier. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Global Supply Chain Management Global supply chain: The firm’s integrated network of sourcing, production, and distribution, organized on a worldwide scale, and located in countries where competitive advantage can be maximized. Sourcing from numerous suppliers scattered around the world requires efficient supply-chain management. Third party logistics providers (3PLs) and independent logistics service providers, such as FedEx, TNT, and UPS, are useful facilitators. A global supply chain is the firm’s integrated network of sourcing, production, and distribution, organized on a worldwide scale and located in countries where competitive advantage can be maximized. Global supply-chain management includes both upstream (supplier) and downstream (customer) flows. The supply chain is the collection of logistics specialists and activities that provides inputs to manufacturers or retailers. Skillful supply-chain management serves to optimize value-chain activities. Sourcing from numerous suppliers scattered around the world is neither economical nor feasible without an efficient supply-chain system. Networks of supply-chain hubs and providers of global delivery service are integral parts of global supply chains. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Third Party Logistics Providers Running a business as far flung as DHL’s package delivery service requires support offices around the world. This delivery boat travels the Amstel River in Amsterdam. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Stages, Functions, and Activities in the Global Supply Chain This exhibit is a matrix that shows the typical activities that are performed by suppliers, focal firms, and intermediaries in the global supply chain. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Features of Global Supply Chain Management The costs of physically delivering a product to an export market may account for as much as 40% of the total cost. Firms use information and communications technologies (ICTs) to streamline operations, reducing costs and increasing distribution efficiency. Logistics involves physically moving goods through the supply chain. It incorporates information, transportation, inventory, warehousing, materials handling, and similar activities associated with the delivery of raw materials, parts, components, and finished products. Costs of physically delivering a product to an export market may account for as much as 40 percent of the good’s total cost. Experienced firms use information and communications technologies (ICTs) to streamline supply chains, reducing costs and increasing distribution efficiency. Logistics physically moves goods through the supply chain. It incorporates information, transportation, inventory, warehousing, materials handling, and similar activities associated with the delivery of raw materials, parts, components, and finished products. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Major Sources for Components of the Boeing 787 Boeing’s new 787 Dreamliner is a fuel-saving, medium-sized passenger aircraft that uses carbon composite for the fuselage instead of aluminum. It is lightweight and has spacious interiors and higher cabin pressure than other models, which provide a more comfortable journey. However, the most remarkable aspect of the Dreamliner is the extent of outsourcing used to create it. Boeing is responsible for manufacturing only about 10 percent of the jet’s value—the tail fin and final assembly. Some forty suppliers worldwide contribute the remaining 90 percent. The global dispersion of manufacturing responsibility has allowed Boeing to transform itself into a systems integrator and to focus on its core capabilities—design, marketing, and branding. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall Transportation Modes Land transportation is via highways and railroads. Ocean transportation is via large container ships. Air transportation involves commercial or cargo aircraft. Ocean and air transport are common in international business because of the long distances. Ocean transport is the cheapest and most common. Ocean transport was revolutionized by the development of 20- and 40-foot shipping containers. International logistics usually make use of multiple transportation modes, including land, ocean, and air transport. Land transportation is conducted via highways and railroads, ocean transport is via container ships, and air transport is via commercial or cargo aircraft. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Corporate Social Responsibility Global sourcing can lead to three major problems in the home country: Job losses Reduced national competitiveness Declining living standards MNEs may be ineffective at or indifferent about: Protecting the environment Promoting human rights Labor practices and working conditions abroad Critics worry that, as more tasks are performed at lower cost with comparable quality in other countries, high-wage countries will eventually lose their national competitiveness. Long-held knowledge and skills will eventually drain away to other countries, they fear, and the lower wages paid abroad will eventually pull down wages in the home country, leading to lower living standards. A major concern is job losses. The number of jobs in the U.S. legal industry outsourced to foreign contractors now exceeds 25,000 per year. Some estimate that more than 400,000 jobs in the United States IT industry have moved offshore. Projections are that more than three million jobs will be outsourced from the United States by 2015. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Useful Public Policy for Minimizing the Harm of Global Sourcing Global sourcing involves creative destruction. It may eliminate jobs, but it creates new advantages and opportunities that benefit firms, increase profits, and often lead to the ability to create better jobs. Governments should strive to: Keep the cost of doing business low (e.g., via appropriate economic and fiscal policies) Ensure a strong educational system that supplies engineers, scientists, and knowledge workers Maximize worker flexibility to help those who lose jobs find other positions The consequences of global sourcing for the national economy and workers are not yet fully known. A recent comprehensive study carried out for the United States found that import growth, adjusted for inflation, is faster than the official numbers show. The study author concluded that more of the gain in living standards in recent years has come from cheap imports and less from increased domestic productivity. U.S. consumers may thus enjoy an even better standard of living from imports than previously thought. Public policy should strive to mitigate the potential harm global sourcing can cause. Governments can use economic and fiscal policies to encourage the development of new technologies by helping entrepreneurs reap the financial benefits of their work and keep the cost of capital for financing R&D low. Another useful policy is to ensure the nation has a strong educational system, including technical schools and well-funded universities that supply engineers, scientists, and knowledge workers. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. This concludes our discussion of global sourcing. Copyright © 2012 Pearson Education, Inc. publishing as Prentice Hall