Global Sourcing

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 Global Sourcing: Shopping the World

• Along with competitors Reebok and Adidas in the athletic

shoes industry, Nike contracts out nearly all of its athletic shoe
production to foreign suppliers. These firms are best
described as brand owners and marketers, not as
manufacturers.
• Apple Computer sources some 70% of its production abroad
while focusing its internal resources on improving its
operating system and other software platforms. This
approach allows Apple to optimally utilize its limited capital
resources and focus on its core competences.
• Dell Inc. is another firm that relies extensively on a global
manufacturing network, composed largely of independent
suppliers.
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 Global Sourcing

• Global sourcing is the procurement of products or services

from suppliers or company-owned subsidiaries located abroad
for consumption in the home country or a third country.
• Also called global procurement or global purchasing, global
sourcing amounts to importing -- an inbound flow.
• It is an entry strategy that involves a contractual relationship
between the buyer (the focal firm) and a foreign supplier. It
involves subcontracting the performance of specific
manufacturing or services tasks to the firm's own subsidiaries
or independent suppliers.
• Global sourcing is classified as a low-control strategy to the
extent that the firm is buying from independent suppliers
through contractual agreements, as opposed to buying from
its own subsidiaries.

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 Drivers of Global Sourcing

• Technological advances, including instant Internet

connectivity and broadband availability
• Declining communication and transportation costs
• Widespread access to vast information including
growing connectivity between suppliers and the
customers that they serve; and
• Entrepreneurship and rapid economic
transformation in emerging markets.

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 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 independent
supplier.
• This is known as the ‘make or buy’ decision: “Should
we make a product or conduct a particular value-
chain activity ourselves, or should we source it from
an outside contractor?”
• Firms usually internalize those value-chain activities
they consider a part of their core competence, or
which involve the use of proprietary knowledge and
trade secrets that they want to control.

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 Outsourcing

• Outsourcing refers to the procurement of selected

value-adding activities, including production of
intermediate goods or finished products, from
independent suppliers.
• This practice of externalizing a particular value-
adding activity to outside contractors is known as
outsourcing.
• Firms outsource because they generally are not
superior at performing all primary and support
activities. Most value-adding activities -- from
manufacturing to marketing to after-sales service --
are candidates for outsourcing.
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 An Example of Outsourcing

• Canon uses its core competencies in precision

mechanics, fine optics, and micro electronics to
produce some of the world’s best cameras, printers,
and copiers.
• Canon usually owns the value-chain activities, such
as R&D, that yield improvements in these
competences.
• By contrast, companies will usually source from
external suppliers when the sourced products or
services are peripheral to the firm’s main offerings,
can be obtained at lower cost, or can be provided
by specialized suppliers.
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 Business Process Outsourcing (BPO)

• Business Process Outsourcing (BPO). The

outsourcing of business functions to independent
suppliers such as accounting, payroll, and human
resource functions, IT services, customer service, and
technical support.
• BPO includes:
– Back-office activities, which includes internal,
upstream business functions such as payroll and
billing, and
– Front-office activities, which includes downstream,
customer-related services such as marketing or
technical support.
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 Decision 2: Where in the World
Should Value-Adding Activities Be Located?

• Configuration of value-adding activity: The pattern or

geographic arrangement of locations where the firm
carries out value-chain activities.
• Instead of concentrating value-adding activities in the
home country, many firms configure these activities
across the world to save money, reduce delivery time,
access factors of production, and extract maximal
advantages relative to competitors.
• This helps explain the migration of traditional industries
from Europe, Japan, and the U.S. to emerging markets in
Asia, Latin America, and Eastern Europe.

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 An Example of Worldwide Configuration of Value Chain

• The German automaker BMW employs 70,000 factory personnel at 23

sites in 13 countries to manufacture its vehicles.
• Workers at the Munich plant build the BMW 3 Series and supply
engines and key body components to other BMW factories abroad.
• In the U.S., BMW has a plant in South Carolina, which makes over 500
vehicles daily for the world market.
• In Northeast China, BMW makes cars in a joint venture with Brilliance
China Automotive Holdings Ltd.
• In India, BMW has a manufacturing presence to serve the needs of the
rapidly growing South Asia market.
• BMW must configure sourcing at the best locations worldwide, in
order to minimize costs (e.g., by producing in China), access skilled
personnel (by producing in Germany), remain close to key markets (by
producing in China, India and the U.S.).

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 A Framework for Global Sourcing and Outsourcing

• The two strategic choices we just discussed lead us to the

framework in Exhibit 16.2.
• The focal firm can source from independent suppliers,
company-owned subsidiaries and affiliates, or both.
• Cells C and D represent the global sourcing scenarios.
• While global sourcing implies procurement from foreign
locations, in some cases the focal firm may purchase from a
subsidiary or affiliate located in the foreign country (Cell C).
• This is known as captive sourcing, which refers to sourcing
from the firm's own production facilities located abroad.
Production is carried out at a foreign facility that results from
the focal firm's FDI activities.

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 Contract Manufacturing:
Global Sourcing from Independent Suppliers

• A more likely scenario is when the focal firm can

procure from independent suppliers (Cell D).
• Contract manufacturing: An arrangement in which
the focal firm contracts with an independent supplier
to manufacture products according to well-defined
specifications.
• Global sourcing requires the firm to identify qualified
suppliers, develop necessary organizational and
technological capabilities to locate and relocate
specific tasks, and coordinate a geographically
dispersed activities.

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 Examples of Contract Manufacturing

• Benetton employs contract manufacturers to

produce clothing.
• IKEA uses contract manufacturers to produce
furniture.
• Contract manufacturing also offers firms the
ability to enter target countries quickly,
especially when the market is too small to
justify significant local investment.

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 Offshoring

• Offshoring is a natural extension of global sourcing. It refers to

the relocation of a business process or entire manufacturing
facility to a foreign country.
• MNEs are particularly active in shifting production facilities or
business processes to foreign countries to enhance their
competitive advantages.
• Offshoring is especially common in the service sector, including
banking, software code writing, legal services, and customer-
service activities.
• E.g., large legal hubs have emerged in India that provide services
such as drafting contracts and patent applications, conducting
research and negotiations, as well as performing paralegal work
on behalf of Western clients. With lawyers in N. America and
Europe costing $300 an hour or more, Indian firms can cut legal
bills by 75 percent.

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 Offshoring Destinations
• India receives the bulk of developed nations’ relocated
business services. It has a huge pool of qualified labor that
work for wages as little as 25 percent of comparable workers in
the West.
• India is not the only destination of substantial outsourcing
work. Firms in Eastern Europe perform support activities for
architectural and engineering firms from the West.
• Accountants in the Philippines perform support work for major
accounting firms. Accenture has back-office operations and
call centers in Costa Rica. Germany sources IT support services
from the Czech Republic and Romania. Boeing, Motorola, and
Nortel do much of their R&D in Russia. South Africa is the base
for technical and user-support services for English, French, and
German-speaking customers throughout Europe.

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 Jobs Most Conducive to Offshoring

• Large-scale manufacturing industries whose primary

competitive advantage is efficiency and low cost;
• Industries such as automobiles that have uniform customer
needs and highly standardized processes in production and
other value-chain activities;
• Service industries that are highly labor intensive, e.g., call
centers and legal transcription;
• Information-based industries whose functions and activities
can be easily transmitted via the Internet, e.g., accounting,
billing, and payroll; and
• Industries such as software preparation whose outputs are
easy to codify and transmit over the Internet or by
telephone, e.g., routine technical support and customer
service activities.

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 Not All Services Can Be Offshored

• Many jobs in the services sector cannot be separated from their

place of consumption. This limits the types of services jobs that
firms can move abroad.
• Personal contact is vital at the downstream end of virtually all
value chains. Other services are consumed locally.
• People normally do not travel abroad to see a doctor, dentist,
lawyer, or accountant. Consequently, many service jobs will
never be offshored.
• Through 2005, only about 3 percent of jobs in the U.S. that
require substantial customer interaction (e.g.,, those in the
retailing sector) have been transferred to low-wage economies.
• By 2008, less than 15 percent of all service jobs have moved
from advanced economies to emerging markets.

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 Strategic Implications of Global Sourcing

• Exhibit 16.3 explains the two strategic implications of the two

choices MNEs face: whether to perform specific value-adding
activities in-house or to outsource them, and whether to
concentrate each activity at home or disperse it abroad.
• The 1st row indicates the degree to which management
considers each value-adding activity a strategic asset to the
firm.
• The 2nd row indicates whether the activity tends to be
internalized inside the focal firm or outsourced to a foreign
supplier.
• The 3rd row indicates where management typically locates an
activity.

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 Outsourcing Decision is Activity Specific

• These decisions depend largely on the strategic

importance of the particular activity to the firm.
• E.g., firms typically consider R&D and design activities
central to their competitive advantage. As a result, they
are more likely to internalize these functions, and less
likely to outsource them to outside contractors.
• In contrast, manufacturing, logistics, and customer
service activities tend to be more readily outsourced and
geographically dispersed.
• The decision is also a function of the firm's IB experience
and availability of qualified suppliers.

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 Phases in the Evolution of Global Sourcing

• The first major wave emphasized the manufacturing of input

products and began in the 1960s with the shift of European
and U.S. manufacturing to low-cost countries as
geographically diverse as Mexico and Spain.
• Early observers pointed to the emergence of the “modular
corporation” and the “virtual corporation.”
• The next wave of global sourcing began in the 1990s with
offshoring. In addition to IT services and customer-support
activities, other service sectors became part of the offshoring
trend.
• Today, business-process outsourcing in product development,
human resources, and finance/accounting services has
become very common.

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 Magnitude of Global Sourcing

• The magnitude of global sourcing is considerable. In

2005, India alone booked $22 billion worth of business in
answering customer phone calls, managing far-flung
computer networks, processing invoices, and writing
custom software for MNEs from all over the world.
• Global sourcing has created more than 1.3 million jobs
during the past decade for India.
• Meanwhile, between 2000 and 2004, some 100,000
service jobs were outsourced each year from the U.S. to
other countries.
• In 2006, IT and business-process outsourcing exceeded
$150 billion worldwide.

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 Leading Provider Countries

• China and India are major players in global sourcing.

• Numerous other countries are active players as well.
• Exhibit 16.4 identifies key players by four geographic
regions.
• E.g., Cairo-based Exceed Contact Center handles calls in
Arabic and European languages for Microsoft, General
Motors, Oracle, and Carrefour.
• Russia is aiming at high-end programming jobs. With its
strong engineering culture, Russia has an abundant pool
of underemployed talent available at wages about one-
fifth those of the U.S.

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The 2005 Offshore Location Attractiveness Index by A.T. Kearney

• Identifies 9 emerging markets in its list of the 10 most attractive

offshoring suppliers: India, China, Malaysia, Philippines, Singapore,
Thailand, Czech Republic, Chile, Canada, and Brazil.
• In addition to Canada, the other advanced economy in the top 20
destinations is the U.S. (11th).
• The index emphasizes various criteria:
– Country’s financial structure (compensation costs, infrastructure
costs, tax and regulatory costs);
– Availability and skills of people (cumulative business-process
experience and skills, labor force availability, education and
language, and worker attrition); and
– Nature of the business environment (the country’s political and
economic environment, physical infrastructure, cultural
adaptability, and security of intellectual property).

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 Benefits of Global Sourcing

• Cost efficiency is the traditional rationale for

sourcing abroad. The firm takes advantage of
‘labor arbitrage’ ─ the large wage gap between
advanced economies and emerging markets.
• One study found that firms expect to save an
average of more than 40% off baseline costs as a
result of offshoring.
• These savings tend to occur particularly in R&D,
product design activities, and back-office
operations such as accounting and data
processing.

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 Strategic Benefits of Global Sourcing

• Faster corporate growth.

• Access to qualified personnel abroad.
• Improved productivity and service.
• Business process redesign.
• Increased speed to market.
• Access to new markets.
• Technological flexibility.
• Improved agility by shedding unnecessary
overhead.

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 Challenges in Global Sourcing

• Vulnerability to exchange rate fluctuations

• Partner selection, qualification, and monitoring costs
• Increased complexity of managing a worldwide
network of production locations and partners
• Complexity of managing global supply chain
• Limited influence over the manufacturing processes
of the supplier
• Potential vulnerability to opportunistic behavior or
actions in bad faith by suppliers
• Constrained ability to safeguard intellectual assets

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 Global Supply Chain Management Capabilities Greatly
Enhance Global Sourcing

• Global supply chain refers to the firm’s integrated

network of sourcing, production, and distribution,
organized on a world scale, and located in countries
where competitive advantage can be maximized.
• Sourcing from numerous suppliers scattered around
the world would be neither economical nor feasible
without an efficient supply-chain system.
• Boeing’s 787 Dreamliner jet provides a striking
example of how global supply-chain management is
making global sourcing feasible and, at the same time,
contributing to firm competitiveness.

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 Facilitating Firms are also Responsible
for Global Sourcing

• Networks of supply-chain hubs and providers of

global delivery service are an integral part of global
supply chains.
• Many focal firms delegate supply-chain activities to
such independent logistics service providers as DHL,
FedEx, TNT, and UPS.
• Consulting firms that manage the logistics of other
firms are called third party logistics providers (3PLs).
Using a 3PL is often the best solution for
international logistics, especially for firms that
produce at low volumes or lack the resources and
the expertise to create their own logistics network.

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 Global Supply-Chain Networks

• A global supply-chain network consolidates a firm’s

sourcing, manufacturing, and distribution in a few
strategic locations worldwide so the firm can
concentrate these activities in countries where it can
maximize its competitive advantages.
• Exhibit 16.7 illustrates the stages, functions, and
activities in the supply chain.
• It reveals how suppliers interact with the focal firm and
how these, in turn, interact with distributors and
retailers.
• Each stage in the global supply chain encompasses
functions and activities that involve the focal firm in
sourcing and distribution.

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 Supply Chain Management has Become Sophisticated
• Costs associated with physically delivering a product to an
export market may account for as much as 40% of total cost.
• Experienced firms make optimal use of information and
communications technology (ICT), which streamlines supply
chains, reducing costs and increasing distribution efficiency.
• Managers use Electronic Data Interchange (EDI), which passes
orders directly from customers to suppliers automatically
through a sophisticated ICT platform.
• The UK supermarket chain Tesco greatly reduced inventory
costs by using an EDI system to link point-of-sale data to
logistics managers. Technology allows Tesco to track product
purchases down to the minute.

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 Risks in Global Sourcing

1. Less-than-expected cost savings. Conflicts and

misunderstandings arise because of differences in the
national and organizational cultures between the focal firm
and foreign supplier. Such factors give rise to cost-savings
that are less than originally anticipated.
2. Environmental factors. Numerous environmental
challenges confront focal firms including: exchange rate
fluctuations, labor strikes, adverse macro-economic events,
high tariffs and other trade barriers, and high energy and
transportation costs.
3. Weak legal environment. Many popular locations for global
outsourcing have weak laws and enforcement regarding
intellectual property, which can lead to erosion of key
strategic assets.

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 Risks in Global Sourcing (cont.)

4. Risk of creating competitors. As the focal firm

shares its intellectual property and business-
process knowledge with foreign suppliers, it also
runs the risk of creating future rivals (e.g., Schwinn).
5. Inadequate or low-skilled workers. Some foreign
suppliers may be staffed by employees who lack
appropriate knowledge about the tasks with which
they are charged. Other suppliers suffer rapid
turnover of skilled employees.

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 Risks in Global Sourcing (cont.)

6. Over-reliance on suppliers. Unreliable suppliers may put

earlier work aside when they gain a more important client.
Suppliers occasionally encounter financial difficulties or are
acquired by other firms with different priorities and
procedures. Over-reliance can shift control of key activities
too much in favor of the supplier.
7. Erosion of morale and commitment among home-country
employees. Global sourcing can create a situation in which
employees are caught in the middle between their
employer and their employer’s clients. At the extreme,
workers find themselves in a psychological limbo, unclear
about who their employer really is.

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 Strategies for Minimizing Risk
in Global Sourcing

1. Firms ought to go offshore for the right reasons. The best

rationale is strategic. Cost-cutting 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.
2. Need to get employees on board. Global sourcing tends to
invite opposition from employees and other organizational
stakeholders. Disaffected middle managers can undermine
projects. Poorly planned sourcing projects can create
unnecessary tension and harm employee morale.

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 Strategies for Minimizing Risk
in Global Sourcing (cont.)

3. Choose between a captive operation and a contract

with outside specialists carefully. They should be
vigilant about striking the right balance between the
organizational activities that it retains inside the firm,
and those that are sourced from outside.
4. Choose countries and suppliers carefully. A common
reason for global sourcing failure is that both buyers
and suppliers tend not to spend enough time upfront
to get to know each other well. They rush into a deal
before clarifying partner expectations, which can give
rise to misunderstandings and inferior results.

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 Strategies for Minimizing Risk
in Global Sourcing (cont.)

5. The focal firm needs to invest in supplier development and

collaboration. The parties need to exchange information,
transfer knowledge, troubleshoot, coordinate, and monitor.
• Management should collaborate closely with suppliers in
co-development and co-design activities. This also enables
the focal firm to tap into a stream of ideas for new products,
processes, technologies, and improvements.
• Efforts to build strong relationships help create a ‘moral
contract’ between the focal firm and the supplier, which is
often more effective than a formal legal contract.

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 Strategies for Minimizing Risk
in Global Sourcing (cont.)
6. Managers need to proactively safeguard interests:
• Encourage the supplier to refrain from engaging in potentially
destructive acts that jeopardize the firm’s reputation.
• Escalate commitments by making partner-specific investments
(such as sharing knowledge with the supplier), allowing for
ongoing review, learning, and adjustment.
• Share costs and revenues by building a stake for the supplier so
that, in case of failure to conform to expectations, the supplier also
suffers costs or foregoes revenues.
• Maintain flexibility in selecting partners by keeping options open
to find alternative partners.
• Hold the partner at bay by withholding access to IP and key assets,
in order to safeguard the firm’s interests for the long term. If
conflicts with the supplier become an ongoing problem, one
option for the firm is to acquire full or partial ownership of the
supplier.

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 Potential Harm to Economies from Global Sourcing

• Critics of global sourcing point to three major problems:

Global sourcing can result in:
– Job losses in the home country,
– Reduced national competitiveness, and
– Declining standards of living.
• As more tasks are performed at lower cost with comparable
quality in other countries, high-wage countries will eventually
lose their national competitiveness.
• Critics fear that long-held knowledge and skills will eventually
drain away to other countries, and the lower wages paid
abroad to perform jobs that were previously done in high-
wage countries will eventually pull down wages in the latter
countries, leading to lower living standards.

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 Can Jobs Offshored be Replaced?

• Proponents of global sourcing argue that workers

who lose their jobs due to offshoring can find new
work.
• Redeployment assumption may be overly
optimistic. It takes considerable time for laid-off
workers to find new jobs.
• According to one estimate, as much as 1/3 of U.S.
workers who have been laid off cannot find
suitable employment within a year.
• Even workers who do find new jobs may be unable
to achieve wages and work levels that equal those
of their former positions.

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 Ethical and Social Implications of
Global Sourcing

• The prevalence of global sourcing has also raised public

debate about the role of MNEs in protecting the
environment, promoting human rights, and improving
labor practices and working conditions.
• The bar for global corporate citizenship has been raised.
• Consider the case of foreign suppliers that operate
sweatshops -- factories in which people may work long
hours for very low wages, often in harsh conditions.
• Sweatshops may employ child labor, a practice that has
been outlawed in much of the world.

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 Potential Benefits to National Economy
• First, by reconfiguring value chains to the most cost-efficient
locations, companies reduce their production costs and
enhance their performance.
• Second, cost reductions and enhanced competitiveness allow
firms to reduce the prices that they charge their customers.
• Third, by leveraging a flexible labor market and strong
economic growth, countries that outsource may be able to
shift their labor force to higher-value activities. This
transformation has the effect of boosting the nation’s
productivity and industrial efficiency.
• Finally, declining wages may be offset by lower prices secured
for outsourced products or services. Hence global sourcing
tends to indirectly increase consumers’ purchasing power and
lift their living standards.

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