Automakers’ Global Supply Chain Configuration Field Study

TouaregPassatJettaBeetleGolf Engine Germany Hungary Germany Poland Mexico Hungary TransmissionJapan Argentina Japan Argentina Japan Argentina Final Assembly SlovakiaGermanyMexico Brazil Country of Origin for VW Models Sold in U.S.: Major Components and Final Assembly

Jetta Transmissions Assembly Engines Customers

Global Supply Chain for Jetta U.S. Customers Poland Engines Japan Transmissions Mexico Assembly

VW International Strategy - Touareg Germany Japan Slovakia Hungary Transmission Final Assembly Misc. Steel & Engine U.S. Marketing

VW International Strategy - Jetta Germany Japan Mexico Poland Transmission Final Assembly Engine Misc. U.S. Marketing

The Context of Global Strategy and SCM

Reasons to “Go Global” Proactive Reasons o Exploit factor-cost differences across countries o Unique product o Technological advantage o Economies of scale o Growing foreign markets o Exclusive information o Attack rivals on home turf Reactive Reasons o Competitive pressure o Overcapacity o Declining domestic sales o Saturated home market o Under attack from foreign rivals

Going Global: Effect on Bottom Line ROI % Foreign Sales/ Total Sales

Factors/Issues of GlobalizationEconomic Political Cultural Technology Competitive Legal

The Context of Global Strategy and SCM: Today’s Topics o Globalization and Its Effects o Comparative Advantage o Global Supply Chains for Selected Automakers The International Political Economy (IPE) o Trade & Investment Policy o Role of Regimes (NGOs and Treaties) o Economic Integration o Foreign Exchange

What is Globalization? Perspective of Countries o How are countries connected globally? o How big is globalization? o Why does it happen? o Who’s doing it? o Is it connected to prosperity?

Global Top-20Politica Globalization Index = Political Engagement + Technology Contact/Transfer + Personal Contact + Trade and FDI Foreign Policy and A.T. Kearney Annual Globalization Report Czech Republic U.S. Singapore Ireland

Merchandise Exports (US$ billions) U.S. Germany Japan France UK Ire MexKor

Merchandise Imports (US$ billions) U.S. Germany Japan France UK Ire MexKor

Foreign Direct Investment - Out (% of World Total) U.S. Germany Japan France UK

Foreign Direct Investment - In (% of World Total) U.S. Germ Japan France UK

Comparative Advantage o Germany: o 10 units of factor inputs (labor & capital) to produce 1 keg of beer o 2 units of factor inputs (labor & capital) to produce 1 box of pretzels o United States: o 15 units of factor inputs to produce 1 keg of beer; o 5 units of factor inputs to produce 1 box of pretzels; Which country should manufacture and export only beer? Which country should manufacture and export only pretzels?

Comparative Advantage Germany: 10 labor  pretzels = 5 pretzels per beer * beer 2 labor US: 15 labor  pretzels = 3 pretzels per beer * beer 5 labor * Opportunity Costs … price of beer in terms of pretzels, using labor as common denominator = =

Comparative Advantage Germany: 10 labor  pretzels = 5 pretzels per beer beer 2 labor US: 15 labor  pretzels = 3 pretzels per beer beer 5 labor o Germany has absolute advantage in both beer and pretzels o U.S. has comparative advantage in beer, and should manufacture and export beer to Germany o Germany has comparative advantage in pretzels, and should manufacture and export pretzels to the U.S.

Growth in Trade Indexed: 1950 = Trade GDP

Fair Trade and Outsourcing …in the media …in politics

Countries don’t trade, companies do.

What is Globalization? Perspective of Multinational Corporations (MNCs) o Motivations for global operations and reach o How are companies engaging in globalization? o How big is their involvement? o What are the effects on managers, customers, employees, profits, etc.?

Extent of Globalization for MNCs Foreign Sales as Percent of Total Foreign Assets as Percent of Total Exxon72%64% IBM57%44% Ford31%44% General Electric32%48% Citigroup35%41% Hewlett-Packard55%52%

Orange = Percentage of exports to the U.S. by intra-firm trade (via FDI) to total exports (This is NOT volume of total exports) Green = Globalization Index

Growth in Trade and FDI Indexed: 1950 = Trade GDP FDI

Trade and Investment Policy

Free Trade?

Global Linkages Model Country A Country B Management Linkages Policy Linkages Trade and Investment Linkages

Country A Country B Managers choose to… Attack new markets Entry modes Shift manufacturing Alliances, Mergers, etc. Governments try … Tariffs, quotas FDI Regulations Effects are … Persistent Trade Deficit Loss of Jobs Higher Domestic Prices

How Nations Influence Trade and Investment Activity Through Policy o Overt/Visible Policies o Supporting/Strategic Policies o Follow-up Questions: o How well to these policies work? o What are the side effects? o Retaliation? o How might managers of MNCs respond?

USTR Definition of Trade Barriers o Government laws, policies, or practices that either: o Protect domestic products from competition o Artificially stimulate exports of particular domestic products

Overt Policy Alternatives o Restrict Imports (tariffs, quotas, VERs) o Restrict FDI o Incoming (F/X controls, local content) o Outgoing (tax code, expatriation disincentives) o Restrict Exports (DoD restrictive munitions) o Export Promotion (subsidies, tax credits) o Import Promotion (tax credits, favors) o FDI Incentives (subsidies for infrastructure, training & development, market access) o Preferential Govt. Procurement

Cost of Import Protection Japanese Rice Market Domestic Supply Domestic Demand Domestic Quantity Produced Domestic Quantity Consumed World Price

Cost of Import Protection Japanese Rice Market Domestic Supply Domestic Demand New Domestic Quantity Produced New Domestic Quantity Consumed World Price Tariff Price

Tariff Cost of Import Protection Japanese Rice Market Domestic Supply Domestic Demand New Domestic Quantity Produced New Domestic Quantity Consumed World Price Tariff Price Extra Revenue Deadweight Loss

Tariff Cost of Import Protection Japanese Rice Market Domestic Supply Domestic Demand New Domestic Quantity Produced New Domestic Quantity Consumed World Price Tariff Price Extra Revenue Deadweight Loss # Jobs saved? At what price?

Cost to Domestic Consumers per Job Saved Extra Revenue for Firm Tariff Revenue to Government Deadweight Loss $800 million + 10,000 jobs $80,000 /job =

What is Globalization? Perspective of Consumers vs. “Regular Joes” o Outsourcing o Cheaper Products vs. Job Loss o Fair Trade -- Product and Production Standards o Working standards o Living wage o Environmental standards

“Voluntary” Export Restraints

TMM-K Georgetown 1971 Honda2008 Acura MDX Managerial Responses to VERs F Shift Production to U.S. F Sell pricier, more profitable cars

Global Linkages Model Country A Country B Management Linkages Policy Linkages Trade and Investment Linkages

FDI: Host Country Perspective

FDI: Home Country Perspective

Globalization-related “Regimes”

Who “governs” or has extraterritorial policy reach for the following: o Cross-border Internet commerce o Ocean floor magnesium nodes o Sea of Tranquility o Microsoft’s copyright Windows XP in China o Mineral deposits in Antarctica o Greenhouse gases emissions o Geo-synchronous satellites o International airline routes o Dolphins killed in tuna nets

Country A Country B No Policy Trade/Investment Linkages Management Linkages Regimes as International “Soft Law” NGOs and Treaties

Law of the Sea Treaty o Outside territorial waters, anything goes o Early provisions: o Anti-piracy efforts o Access to and protection of shipping routes o Fishing rights o Recent: o Pollution o Over-fishing o Exploration and extraction of resources o (Oil, manganese, etc.)

Global/Comprehensive Regimes o United Nations

Functional Regimes: Military - Security o Nuclear Nonproliferation Treaty o NATO o Geneva Convention o Warsaw Pact (defunct)

Regional/Associative Regimes o European Union o NAFTA o ASEAN o OECD

Functional Regimes: Environmental o Montreal Protocol for Greenhouse Gases o Law of the Sea Treaty o Moon Treaty o Antarctica Treaty o UN-based Consumer Protection Guidelines

Functional Regimes: Economic o Air transport o Ocean shipping o Telecommunications o GATT / WTO o IMF o Gold standard (defunct)

Future Regimes o Internet commerce? o Animal rights? o Human rights? o Fair trade?

Non-Governmental Organizations Common NGOs that influence trade/FDI: o International Olympic Committee o Greenpeace o United Auto Workers Union o World Council of Churches o Save the Dolphins Organization o National Rifle Association o Amnesty International

Economic Integration

Global Linkages Country A Country B Management Linkages Policy Linkages Trade and Investment Linkages

Global Linkages Country A Country B Management Linkages Integration Trade and Investment Linkages

Regionalization of Economic Activity o Levels of Economic Integration o Free Trade Area o Customs Union o Common Market o Economic Union o Effects on trade and FDI patterns o Evolution toward worldwide integration o Impact on management of MNCs

Trade in Isolation 20% 100% 33% 15% 40% 10% Prevailing Tariff Rates on Imports

Free Trade Area 20% 100% 33% o No tariffs among members o Tariffs with non-members unchanged Consequences External Tariffs? Trade Creation? Trade Creation? Trade Diversion? Trade Diversion? Regional content? Regional content? Export jobs? Export jobs?

Trade and Investment in Isolation 40% 33% Cheapest Producer Imports

Trade Creation from FTA Formation 33% Cheapest Producer Imports

Trade and Investment in Isolation 40% 33% Cheapest Producer Imports

Trade Diversion from FTA Formation 33% Cheapest Producer Imports

Customs Union 33% o FTA plus... o Common tariff policy for non- members 33%

Common Market o Customs Union plus... o Reduction of non-tariff barriers among members No Non-Tariff Barriers Shift in International Strategy

Common Market £ DM FFDkK ÖS National Currencies Consequences Strain on F/X rates Strain on F/X rates …tax rates? …tax rates? …growth? …growth? …trade? …trade?

Economic Union o Common Market plus... o Single currency o Harmonization of Monetary and Fiscal Policies

Multilateralism in Trade and Investment Regimes: WTO Europe Pacific Rim North America

Regionalization/Triad: Building Block or Stumbling Block? EuropeanUnion PacificRim NAFTA

F/X

Trade, FDI, and the Economy trade deficit o Increase demand for Japanese computers – trade deficit inflationary o Increase demand for computer inputs (components, labor, etc.) – inflationary appreciates o Increase demand for Yen – appreciates decreases demand for Japanese computers o Stronger Yen increases U.S. prices – decreases demand for Japanese computers Computers Cash $$

Foreign Exchange o What is it? o Why does it change? o Risk for international managers o How to manage risk

A Medium of Exchange: The Linkage Between Currencies World Market for Euros World Market for Dollars Price = $ / € Price = € / $ S D S D $1.30 / € €.77 / $ Same “market”…different perspective.

Foreign Exchange Fluctuations and Volatility Index of Swiss Franc vs. Dollar 1990 =

Sharply Depreciating Peso vs. Dollar

Medium of Exchange for Foreign Goods German Market for BMWs Price of a BWM in Euros € 100,000 S of BMWs D for BMWs

Global Market for BMWs: Americans want to import BMWs from Germany Price of a BMW in Euros € 100,000 S D D’ € 110,000

World Market for Euros Price of a Euro in Dollars $1.30 / € S of Euros D for Euros

World Market for Euros: Americans need to convert Dollars to Euros Price = $ / € $1.30 / € S D D’ $1.35 / €

Linkage Between Currencies World Market for Euros World Market for Dollars Price = $ / € Price = € / $ S D S D $0.77/ €€ 1.30/$

Linkage Between Currencies World Market for Euros World Market for Dollars Price = $ / € Price = € / $ S D S D €.77/$ D’ S’ $1.30/ € $1.35/ € €.74/$

Other Forces Causing Change o Foreign Direct Investment o Foreign Portfolio Investment o MNCs o Government Debt Instruments o Currency Arbitrage and Speculation o Governmental Intervention o Official and Unofficial “pegs” o International Agreements (e.g., G-7, the Euro) o Posturing (e.g., “talking” the dollar down)

The Big Mac Index

Short-term F/X Management o Currency Hedges o Forward Contracts o Options o Negotiation of Ratcheted Pricing Schedule o Adjustment of Prices and Target Profits o Lower foreign prices to keep market share when home currency appreciates … lowers profit margin o Raise foreign prices to keep profit margins when home currency depreciates … less price competitive

Today: US Dealer to Import BMWs o Sales Contract: o Quantity: 100 BMW 750s o Price: € 100,000 each o Payment: Due in 3 months o Value of Sales Contract = o € 10.0 million o Spot Rate = $1.30 / € o $13.0 million

In Three Months: Payment is Due Uncovered Transaction o Euro appreciates o New spot rate = $1.35 / € o € 10.0 million o Adjusted Value of Sales Contract o “Risk penalty” = $0.05 per € traded o $13.5 million o US Dealer’s Loss = $500,000

Today: US Dealer to Import BMWs Hedged Transaction o Sales Contract: o Quantity: 100 BMW 535s o Price: € 100,000 each o Payment: Due in 3 months o Value of Sales Contract = o € 10 million o at 90-day Forward Rate = $1.305 / € o “Insurance premium” = $0.005 per € traded o $13.05 million

In Three Months: Payment is Due Hedged Transaction o Euro appreciates o New spot rate = $ 1.35 / € (Doesn’t matter!!!) o € 10 million o Adjusted Value of Sales Contract o Locked-in Forward Rate = $ / € o $13.05 million o Cost of Hedge (insurance premium) = $50,000

In Three Months: Payment is Due Hedged Transaction o Euro Depreciates o New spot rate = $ 1.25 / € o € 10 million o Adjusted Value of Sales Contract o Locked-in Forward Rate = $ / € (Spot better!!) o $12.5 million o Currency Windfall - Cost of Hedge = $450,000

Medium-Term F/X Management o Balance sheet hedge o Match foreign assets with same level of foreign liabilities in same currency o Cash flow hedge o Match foreign A/P with A/R in same currency

Long-Term F/X Management o Shift sourcing and procurement o Shift production o Cut costs / improve productivity

Volkswagen’s Global Supply Chain Revisited

Key Strategic Choices Location of Value-creating Activities and Linkages (flow) between VW Units U.S. Mexico Germany ??

Shift in IPE o How does a change in the IPE faced by VW force it to reconfigure its global/North American supply network? o NAFTA o F/X o Other factors?

Key Strategic Issues Facing VW o Regional content o Over-reliance on German imports o Lack of US or Mexico supply network o Increased competition in Mexico and US o Instability of Peso o Labor instability

Changes in Currency DM per $ Peso per $ Peso per DM

What do YOU recommend? Location and Flow: What do YOU recommend? U.S. Mexico Germany ??

What other strategies should VW try? o New models o Consolidate components & platforms o Marketing o HR policies o Other stuff?

New Products

Product Evolution

Missed Opportunities?

Design and Production Convergence Beetle GolfJetta Standard Components and/or Single Platform

VW Changes o VW Mexico makes $1.0 bil investment: o Cut supply costs o Reducing VW suppliers from 1,000 to under 100 o VW suppliers shifting production to low wage countries (including Mexico) o Considering US plant if 10-15% growth achieved

VW’s U.S. Marketing Efforts o Cross-promotion of Irish folk/new age band “Clannad” (1993; music in commercials) o $45 million U.S. advertising campaign focuses on popularity of Golf /Jetta in Europe (1993) o J.D. Power ranks Golf as “best in class” (1995) o Pushes “test drive outings” vs. rivals’ cars (1995) o Major focus group effort vs. rivals’ cars (1995) o “Drivers Wanted” campaign signals VW’s focus on age group; $45 million (1995) o “Duh, Duh Duh” … $70 mil ad campaign (1997)

The VW Family o Audi o Bentley o Bugatti o Rolls-Royce o Seat o Skoda o Volkswagen

VW’s North American Sales Number of Units