part six International Business Functions Page 498

Global Production and Supply Chain Management

17
LEARNING OBJECTIVES
After reading this chapter, you will be able to:
LO17-1 Explain why global production and supply chain management decisions are of central importance to many global companies.
LO17-2 Explain how country differences, production technology, and production factors all affect the choice of where to locate
production activities.
LO17-3 Recognize how the role of foreign subsidiaries in production can be enhanced over time as they accumulate knowledge.
LO17-4 Identify the factors that influence a firm’s decision of whether to source supplies from within the company or from foreign
suppliers.
LO17-5 Understand the functions of logistics and purchasing (sourcing) within global supply chains.
LO17-6 Describe what is required to efficiently manage a global supply chain.

Wrightstudio/123RF

Page 499
Blockchain Technology and Global Supply Chains

OPENING CASE
Global production and supply chain management are by design complex and geographically disjointed, especially in a multinational
corporation’s network of global supply chains. Each supply chain involves multiple companies, multiple links in the chain, and lots of
resource ties between these entities and links. Given such a dynamic and multifaceted setup, the nature of globalization with trade
barriers, varied policies worldwide, diverse cultural and environmental issues, and people from business and non-business functions
make it difficult to have a good handle on information that flows in global supply chains. It also makes it difficult to manage risk,
security, and value-added aspects of the chain. Every company wants just-in-time information at their disposal, but not every
organization in a global supply chain is willing or able to supply such information easily.
Meanwhile, many supply chain executives and corporate strategists make a compelling case that information flows in global
supply chains are perhaps more critical than even the flow of products, component parts, and raw materials. Timing in production
 relies on information flows. In particular, traceability is becoming an urgent requirement and a fundamental differentiator in many
supply chains (e.g., agri-food sector, pharmaceutical and medical products, high-value goods). Lack of information transparency in
these chains prevents organizations and customers from verifying and validating the true value of the product, component part, or
even raw materials. The cost involved in managing chain intermediaries, their reliability, and performance further complicate
traceability in the chain. In fact, both strategic and operational issues arise from these risks and lack of transparency.
To solve some of these supply chain issues, nearly all of the world’s leading companies use sophisticated enterprise resource
planning (ERP) and supply chain software. Some of the systems include connected manufacturing equipment to digital shipping
notices and RFID scanning. Most multinational corporations track the earliest origins of a shipment, often all the way to the recycling
bin, if needed. However, even with such tracking, most large companies have only limited information on where all their shipment is
at any given moment in the global supply chain even after investing heavily in their digital infrastructure. One of the core reasons for
this limited information is that even as supply chains are becoming more efficient, corporations often do not have an up-to-date
technology infrastructure to manage the chains. Then again, even if possible, not every organization in a global supply chain is
willing or able to supply such information easily.
Enter blockchain technology! Blockchains make it possible for ecosystems of supply chain partners (or any business partners) to
share and agree upon key pieces of information. Importantly, the partners can agree on the information without having to deal with all
the complex negotiations and power plays that come with setting the rules before handing over really critical business information.
Blockchains synchronize all data and transactions across the global network, and each supply chain partner can verify the work and
calculations of others. Such redundancy and crosschecking are why financial solutions like bitcoins and blockchain technology are
secure and reliable, even as they synchronize millions of transactions across thousands of network nodes weekly (blockchain is the
technology that underlies bitcoin).
Within supply chains, the core logic of blockchains means that no piece of inventory (e.g., raw material, work-in-process,
component parts, finished goods) can exist in the same place twice. If a product is moved from finished goods to in-transit, the
transaction status will be updated for everyone, everywhere, within minutes, with full traceability back to the point of origin. Such
traceability is important for a number of reasons. For example, if a company wants to negotiate procurement deals based on total
volume that the company and its subsidiaries and partners buy, a blockchain-based solution can facilitate the calculations of the exact
volume discount based on total purchasing. And in a trusting and transparent way, the companies involved can mathematically prove
that the calculation is correct because of the blockchain technology. Plus, the calculations can be done while preserving the privacy of
each company’s individual volumes.
Through blockchains companies gain a live, real-time digital ledger of all transactions and supply chain movements for all
participants in their supply chain network. While seemingly simplistic as a concept, the real-time feature involving a company and
companies in that company’s network would not have been a simplistic feature to implement without blockchains, given
transparency, trust, ability, and willingness problems. But with blockchain technology, companies can negotiate sourcing discounts
based on the total number of purchases they do: purchases done on their behalf by others, purchases done by business partners, and
purchases made by everyone else in the supply chain network. With a constantly refreshed digital ledger that incorporates data from
all relevant partners, a company can see the total volume regardless of who directed the purchase activity without each user having to
share its operational data with others. The efficiencies are real as well. Without blockchain’s “distributed ledger technology,”
companies would enlist lots of people to audit their orders to try to capture as much of these volume benefits as possible, but would
seldom be successful in capturing all aspects of the supply chain network.
Despite the many positives of blockchain technology, everything is not as optimistic as what the blockchain appears to be, not yet
at least. Investment, infrastructure, and implementation are concerns, especially on a worldwide scale. In a Deloitte survey reported in
The Wall Street Journal, a majority of organizations see a compelling case for the use of blockchain technology, but only one-third of
the business executives who participated in the study said that their companies had initiated implementation of the Page 500
technology. One issue is that large companies have legacy concerns with their current technology. Fitting blockchain
technology into existing systems around the globe is difficult, costly, and not as efficient as possible to reap the short-term, immediate
advantages that blockchain technology offers companies. Plus, worldwide, not all companies have the same opportunities to invest in
blockchain (due to costs, software compatibility, infrastructure, etc.), which means companies in any given supply chain network may
still not reap all the advantages expected by implementing blockchain technology.
Sources: “The Meaning of the Blockchain,” The Economist, January 8, 2019; Paul Brody, “How Blockchain Revolutionizes Supply Chain Management,” Digitalist Magazine,
August 23, 2017; “The Promise of the Blockchain Technology,” The Economist, August 30, 2018; Olga Kharif and Matthew Leising, “Bitcoin and Blockchain,” Bloomberg
BusinessWeek, November 2, 2018; Olga Kharif, “Blockchain, Once Seen as a Corporate Cure-All, Suffers Slowdown,” Bloomberg BusinessWeek, July 31, 2018; Christopher
Mims, “Why Blockchain Will Survive, Even If Bitcoin Doesn’t,” The Wall Street Journal, March 11, 2018.

Introduction
As trade barriers fall and global markets develop, many firms increasingly confront a set of interrelated issues. First,
where in the world should production activities be located? Should they be concentrated in a single country, or should
they be dispersed around the globe, matching the type of activity with country differences in factor costs, tariff barriers,
political risks, and the like to minimize costs and maximize value added? Single-country strategies may be efficient
operationally but often become ineffective strategically. For example, what if the company focused all of its attention on
one country for production and that country became politically or economically unstable? Some redundancy is usually
the best approach in both global production and supply chain management practices, and such redundancy often
demands that a company spreads its production and supply chains across countries.
 Second, what should be the long-term strategic role of foreign production sites? Should the firm abandon a foreign
site if factor costs change, moving production to another more favorable location, or is there value to maintaining
operations at a given location even if underlying economic conditions change? Value can come from cost inefficiencies.
Moving factory locations from one country to another solely due to cost considerations is usually not a strategic move.
Successful companies typically evaluate cost considerations along with quality, flexibility, and time issues. At the same
time, the cost is one of the most important considerations and serves as the starting point for discussion of making a
strategic move from one country to a more advantageous production home.
Third, should the firm own foreign production activities, or is it better to outsource those activities to independent
vendors? Outsourcing means less control, but it can be cost-efficient. Fourth, how should a globally dispersed supply
chain be managed, and what is the role of information technology in the management of global logistics, purchasing
(sourcing), and operations? Fifth, similar to issues of production, should the company manage global supply chains itself,
or should it outsource the management to enterprises that specialize in this activity? There are myriad options for supply
chain management by third parties. Few companies want to manage the full supply chain from raw material to delivering
the product to the end-customer. The question, though, is which portion of the supply chain should be managed by third
parties, and which portion should be managed by the company itself.
In addition, managing supply chains in general and the chains that are global in scope in particular is the key critical
aspect of realizing efficiencies in operations: Global supply chains connect global production with global customers. As
noted in the opening case, global production and supply chain management are, by design, complex and geographically
disjointed, especially in a multinational corporation’s network of global supply chains. Enter blockchain technology to
help! Blockchains make it possible for ecosystems of supply chain partners (or any business partners) to share and agree
upon key pieces of information. The strategic supply-chain partners can also agree on the information without having to
deal with all the complex negotiations and power plays that come with setting the rules before handing over Page 501
really critical business information. Through blockchains, companies gain a live, real-time digital ledger of all
transactions and supply chain movements for all participants in their supply chain network, offsetting issues concerning
transparency, trust, ability, and willingness problems that prevented such sharing before.
This chapter also includes illustrations of some of the best-operating global supply chain networks in the world.
Take a look at each and see what they do that is similar and different, and where they obtain both efficiencies and
effectiveness in their supply chains (e.g., P&G in the closing case; Alibaba in the end-of-the-book integrated case related
to Chapter 17; and IKEA and Amazon in the Management Focus features in the chapter text). One important aspect of
how these companies run their global supply chains is that they constantly think about the total costs of their chains. A
total cost focus of a global supply chain ensures that the goal is not necessarily to strive for the lowest cost possible at
each stage of the supply chain (each node in the chain), but to instead strive for the lowest total cost to the customer—
and, by extension, t he great es t val ue—
at the end of the pr oduct suppl y chain. Thi s m
eans t hat al l aspects of cost —-
including integration and coordination of companies in the supply chain—have been incorporated in addition to the cost
of raw material, component parts, and assembly worldwide. And these cost issues, as they relate to global logistics and
global purchasing—both considered supply chains functions in a company—have been strategically and tactically
addressed.

Strategy, Production, and Supply Chain Management

LO17-1
Explain why global production and supply chain management decisions are of central importance to many global
companies.
Chapter 13 introduced the concept of the value chain and discussed a number of value creation activities, including
production, marketing, logistics, R&D, human resources, and information systems. This chapter focuses on two of these
val ue creatio n activi ties —production and supply chain management—and attempts to clarify how they might be
performed internationally to (1) lower the costs of value creation and (2) add value by better serving customer needs.
Production is sometimes also referred to as manufacturing or operations when discussed in relation to global supply
chains. We also discuss the contributions of information technology to these activities, which has become particularly
important in a globally integrated world. The remaining chapters in this text look at other value creation activities in the
international context (marketing, R&D, and human resource management).
In Chapter 13, we stated that production is concerned with the creation of a good or service. We used the term
production to denote both service and manufacturing activities because either a service or a physical product can be
produced. Although in this chapter we focus more on the production of physical goods, we should not forget that the
term can also be applied to services. This has become more evident in recent years, with the continued pattern among
U.S. firms to outsource the “production” of certain service activities to developing nations where labor costs are lower
(e.g., the trend among many U.S. companies to outsource customer care services to places such as India, where English
is widely spoken and labor costs are much lower). Supply chain management is the integration and coordination of
logistics, purchasing, operations, and market channel activities from raw material to the end-customer. Production and
supply chain management are closely linked because a firm’s ability to perform its production activities efficiently
depends on a timely supply of high-quality material and information inputs, for which purchasing and logistics are
critical functions. Purchasing represents the part of the supply chain that involves worldwide buying of raw material,
component parts, and products used in manufacturing of the company’s products and services. Logistics is the part of the
supply chain that plans, implements, and controls the effective flows and inventory of raw material, component parts,
and products used in manufacturing.
Page 502

global EDGE OUTSOURCING

This chapter tackles a number of issues related to production, make-or-buy decisions, sourcing, and logistics. Outsourcing is one of the
most commonly discussed topics in news media and on the internet related to production and supply chains. In effect, the word
outsourcing sometimes even creates an “us against them” mentality (i.e., should the company outsource production or other activities to
entities outside its country borders, or should it use only domestic operations?). Often, the answer is more of a political issue than a
strategic resource issue. To stay competitive, companies typically opt for the best value to infuse into their supply chains. The
“Outsourcing” section on globalEDGE™ ensures that you have an updated set of data and knowledge on outsourcing
(globaledge.msu.edu/global-resources/outsourcing). For example, did you know that there is an International Association of
Outsourcing Professionals? Do you know what it does, its goals, and how many members it has worldwide?

The production and supply chain management functions (purchasing, logistics) of an international firm have a
number of important strategic objectives.1 One is to ensure that the total cost of moving from raw materials to finished
goods is as low as possible for the value provided to the end-customer. Dispersing production activities to various
locations around the globe where each activity can be performed most efficiently can lower the total costs. Costs can also
be cut by managing the global supply chain efficiently to better match supply and demand. This involves both
coordination and integration of the supply chain functions inside a global company (e.g., purchasing, logistics,
production and operations management) and across the independent organizations (e.g., suppliers) involved in the chain.
For example, efficient logistics practices reduce the amount of inventory in the system, increase inventory turnover, and
facilitate the appropriate transportation modes being used. Maximizing purchasing operations enhances the order
fulfillment and delivery, outsourcing initiatives, and supplier selections. Efficient operations ensure that the right location
of production is made, establishes which production priorities should be stressed, and facilitates a high-quality outcome
of the supply chain.
Another strategic objective shared by production and supply chain management is to increase product (or service)
quality by establishing process-based quality standards and eliminating defective raw material, component parts, and
products from the manufacturing process and the supply chain.2 In this context, quality means reliability, implying that
ultimately the finished product has no defects and performs well. These quality assurances should be embedded in both
the upstream and downstream portions of the global supply chain. The upstream supply chain includes all of the
organizations (e.g., suppliers) and resources that are involved in the portion of the supply chain from raw materials to the
production facility (this is sometimes also called the inbound supply chain). The downstream supply chain includes all of
the organizations (e.g., wholesaler, retailer) that are involved in the portion of the supply chain from the production
facility to the end-customer (this is also sometimes called the outbound supply chain). Through the upstream and
downstream chains, the objectives of reducing costs and increasing quality are not independent of each other. As
illustrated in Figure 17.1, the firm that improves its quality control will also reduce its costs of value creation. Improved
quality control reduces costs by
 FIGURE 17.1 The relationship between quality and costs.
Source: A. David Garvin, “What Does ‘Product Quality’ Really Mean?” MIT Sloan Management Review, Fall 1984, http://sloanreview.mit.edu/article/what-does-
product-quality-really-mean/.

• Increasing productivity because time is not wasted producing poor-quality products that cannot be sold, leading
to a direct reduction in unit costs.
• Lowering rework and scrap costs associated with defective products.
• Reducing the warranty costs and time associated with fixing defective products.
The effect is to lower the total costs of value creation by reducing both production and after-sales service costs.
This creates an increased overall reliability in global production and supply chain management.
The principal tool that most managers now use to increase the reliability of their product offering is the Page 503
Six Sigma quality improvement methodology. Six Sigma is a direct descendant of the total quality
management (TQM) philosophy that was widely adopted, first by Japanese companies and then American companies,
during the 1980s and early 1990s.3 The TQM philosophy was developed by a number of American consultants such as
W. Edwards Deming, Joseph Juran, and A. V. Feigenbaum.4 Deming identified a number of steps that should be part of
any TQM program. He argued that management should embrace the philosophy that mistakes, defects, and poor-quality
materials are not acceptable and should be eliminated. Deming suggested that the quality of supervision should be
improved by allowing more time for supervisors to work with employees and by providing them with the tools they need
to do the job. Deming also recommended that management should create an environment in which employees will not
fear reporting problems or recommending improvements. He believed that work standards should not only be defined as
numbers or quotas, but also include some notion of quality to promote the production of defect-free output. Deming
argued that management has the responsibility to train employees in new skills to keep pace with changes in the
workplace. In addition, he believed that achieving better quality requires the commitment of everyone in the company.
Six Sigma, the modern successor to TQM, is a statistically based philosophy that aims to reduce defects, boost
productivity, eliminate waste, and cut costs throughout a company. Six Sigma programs have been adopted by several
major corporations, such as Motorola, General Electric, and Honeywell. Sigma comes from the Greek letter that
statisticians use to represent a standard deviation from a mean; the higher the number of “sigmas,” the smaller the
number of errors. At six sigmas, a production process would be 99.99966 percent accurate, creating just 3.4 defects per
million units. While it is almost impossible for a company to achieve such perfection, Six Sigma quality is a goal to
strive toward. The Six Sigma program is particularly informative in structuring global processes that multinational
corporations can follow in quality and productivity initiatives. As such, increasingly companies are adopting Six Sigma
programs to try to boost their product quality and productivity.5
The growth of international standards has also focused greater attention on the importance of product quality. In
Europe, for example, the European Union requires that the quality of a firm’s manufacturing processes and products be
certified under a quality standard known as ISO 9000 before the firm is allowed access to the EU marketplace. Although
the ISO 9000 certification process has proved to be somewhat bureaucratic and costly for many firms, it does focus
management attention on the need to improve the quality of products and processes.6
 In addition to lowering costs and improving quality, two other objectives have particular importance in
international businesses. First, production and supply chain functions must be able to accommodate demands Page 504
for local responsiveness. As we saw in Chapter 13, demands for local responsiveness arise from national
differences in consumer tastes and preferences, infrastructure, distribution channels, and host-government demands.
Demands for local responsiveness create pressures to decentralize production activities to the major national or regional
markets in which the firm does business or to implement flexible manufacturing processes that enable the firm to
customize the product coming out of a factory according to the market in which it is to be sold.
Second, production and supply chain management must be able to respond quickly to shifts in customer demand. In
recent years, time-based competition has grown more important.7 When consumer demand is prone to large and
unpredictable shifts, the firm that can adapt most quickly to these shifts will gain an advantage.8 As we shall see, both
production and supply chain management play critical roles here.

TEST PREP
Use SmartBook to help retain what you have learned. Access your Instructor’s Connect course to check out SmartBook
or go to learnsmartadvantage.com for help.

Where to Produce

LO17-2
Explain how country differences, production technology, and production factors all affect the choice of where to locate
production activities.
An essential decision facing an international firm is where to locate its production activities to best minimize costs and
improve product quality. For the firm contemplating international production, a number of factors must be considered.
These factors can be grouped under three broad headings: country factors, technological factors, and production factors.9

COUNTRY FACTORS
We reviewed country-specific factors in some detail earlier in the book. Political and economic systems, culture, and
relative factor costs differ from country to country. In Chapter 6, we saw that due to differences in factor costs, some
countries have a comparative advantage for producing certain products. In Chapters 2, 3, and 4, we saw how differences
in political and economic systems—and national culture—influence the benefits, costs, and risks of doing business in a
country. Other things being equal, a firm should locate its various manufacturing activities where the economic, political,
and cultural conditions—including relative factor costs—are conducive to the performance of those activities (for an
example, see the accompanying Management Focus, which looks at the IKEA production in China). In Chapter 13, we
referred to the benefits derived from such a strategy as location economies. We argued that one result of the strategy is
the creation of a global web of value creation activities.
Also important in some industries is the presence of global concentrations of activities at certain locations. In
Chapter 8, we discussed the role of location externalities in influencing foreign direct investment decisions. Externalities
include the presence of an appropriately skilled labor pool and supporting industries.10 Such externalities can play an
important role in deciding where to locate production activities. For example, because of a cluster of semiconductor
manufacturing plants in Taiwan, a pool of labor with experience in the semiconductor business has developed. In
addition, the plants have attracted a number of supporting industries, such as the manufacturers of semiconductor capital
equipment and silicon, which have established facilities in Taiwan to be near their customers. This implies that there are
real benefits to locating in Taiwan, as opposed to another location that lacks such externalities. Other things being equal,
the externalities make Taiwan an attractive location for semiconductor manufacturing facilities. The same process is now
under way in two Indian cities, Hyderabad and Bangalore, where both Western and Indian information technology
companies have established operations. For example, locals refer to a section of Hyderabad as “Cyberabad,” where
Microsoft, IBM, Infosys, and Qualcomm (among others) have major facilities.
Of course, other things are not equal. Differences in relative factor costs, political economy, culture, and location
externalities are important, but other factors also loom large. Formal and informal trade barriers obviously influence
location decisions (see Chapter 7), as do transportation costs and rules and regulations regarding foreign direct
investment (see Chapter 8). For example, although relative factor costs may make a country look attractive as a location
for performing a manufacturing activity, regulations prohibiting foreign direct investment may eliminate this Page 505
option. Similarly, consideration of factor costs might suggest that a firm should source production of a certain
component from a particular country, but trade barriers could make this uneconomical.

MANAGEMENT FOCUS
IKEA Production in China
Founded in Sweden in 1943 by 17-year-old Ingvar Kamprad, IKEA is the largest furniture retailer in the world. We covered some
of the global strategy of IKEA in the opening case to Chapter 13. As mentioned, the IKEA name comes from its founder, Ingvar
Kamprad—an acronym of the founder’s initials from his first and last names (Ingvar Kamprad) along with the first initials of the
farm where he grew up (Elmtaryd) and his hometown in Sweden (Agunnaryd).
Beyond its founding in Sweden and its current headquarters in Delft, The Netherlands, IKEA presents an amazing global
supply chain story and production apparatus. IKEA is a multinational corporation where most of the company’s operations,
management of the more than 350 stores in 46 countries, and design and manufacturing of furniture are run by a trust, INGKA
Holding. It is the trust that is headquartered in Delft, Holland. Most of the furniture designs of IKEA products are still made in
Sweden, but the manufacturing of that furniture—or, really, the pieces that customers buy to put together into furniture—has been
outsourced to China and other Asian countries.
Considering that IKEA produces an assortment of some 12,000 furniture and related products, production capabilities and
capacities are at a premium for IKEA to sustain its market leadership in the world. To start, IKEA has a clear vision for the
products that it designs and produces. The company’s idea is to provide well-designed, functional home furnishings at prices so
low that as many people around the world as possible will be able to afford them. Importantly, the critical functions to make this
happen, such as global supply chains and global inventory management, work in concert to support IKEA’s distinctive value
proposition.
The Sweden-based home furnishing giant opened its first wholly owned manufacturing facility in China on August 28, 2013.
In a local move, the factory supports the rapid expansion in Asia and, especially, in China (the facility is located in Nantong,
Jiangsu province). As the largest sourcing country for IKEA, China accounts for more than 20 percent of its global procurement,
with about 300 local Chinese suppliers. The factory is also not far from IKEA’s two biggest warehouses, which are located in
Shanghai.
Sources: Lindsey Rupp, “Ikea, Dollar General CEOs Lobby Republicans in Tax Showdown,” Bloomberg Businessweek, March 7, 2017; D. L. Yohn, “How IKEA Designs Its
Brand Success,” Forbes, June 10, 2015; J. Kane, “The 21 Emotional Stages of Shopping at IKEA, From Optimism to Total Defeat,” The Huffington Post, May 6, 2015; J.
Leland, “How the Disposable Sofa Conquered America,” The New York Times Magazine, October 5, 2005, p. 45; “The Secret of IKEA’s Success,” The Economist, February
24, 2011; B. Torekull, Leading by Design: The IKEA Story (New York: HarperCollins, 1998); and P. M. Miller, “IKEA with Chinese Characteristics,” Chinese Business
Review, July–August 2004, pp. 36–69.

Another important country factor is the expected future movements in its exchange rate (see Chapters 10 and 11).
Adverse changes in exchange rates can quickly alter a country’s attractiveness as a manufacturing base. Currency
appreciation can transform a low-cost location into a high-cost location. Many Japanese corporations had to grapple with
this problem during the 1990s and early 2000s. The relatively low value of the yen on foreign exchange markets between
1950 and 1980 helped strengthen Japan’s position as a low-cost location for manufacturing. More recently, however, the
yen’s steady appreciation against the dollar increased the dollar cost of products exported from Japan, making Japan less
attractive as a manufacturing location. In response, many Japanese firms moved their manufacturing offshore to lower-
cost locations in East Asia.

TECHNOLOGICAL FACTORS
The type of technology a firm uses to perform specific manufacturing activities can be pivotal in location decisions. For
example, because of technological constraints, in some cases it is necessary to perform certain manufacturing activities
in only one location and serve the world market from there. In other cases, technology may make it feasible to perform
an activity in multiple locations. Three characteristics of manufacturing technology are of interest here: the level of fixed
costs, the minimum efficient scale, and the flexibility of the technology.
Fixed Costs Page 506

As noted in Chapter 13, in some cases the fixed costs of setting up a production plant are so high that a firm must serve
the world market from a single location or from very few locations. For example, it now costs up to $5 billion to set up a
state-of-the-art plant to manufacture semiconductor chips. Given this, other things being equal, serving the world market
from a single plant sited at a single (optimal) location can make sense.
 Conversely, a relatively low level of fixed costs can make it economical to perform a particular activity in several
locations at once. This allows the firm to better accommodate demands for local responsiveness. Manufacturing in
multiple locations may also help the firm avoid becoming too dependent on one location. Being too dependent on one
location is particularly risky in a world of floating exchange rates. Many firms disperse their manufacturing plants to
different locations as a “real hedge” against potentially adverse moves in currencies.
Minimum Efficient Scale
The concept of economies of scale tells us that as plant output expands, unit costs decrease. The reasons include the
greater utilization of capital equipment and the productivity gains that come with specialization of employees within the
plant.11 However, beyond a certain level of output, few additional scale economies are available. Thus, the “unit cost
curve” declines with output until a certain output level is reached, at which point further increases in output realize little
reduction in unit costs. The level of output at which most plant-level scale economies are exhausted is referred to as the
minimum efficient scale of output. This is the scale of output a plant must operate to realize all major plant-level scale
economies (see Figure 17.2).

FIGURE 17.2 Typical unit cost curve.

Source: Charles W. L. Hill and G. Tomas M. Hult, Global Business Today (New York: McGraw-Hill, 2020).

The implications of this concept are as follows: The larger the minimum efficient scale of a plant relative to total
global demand, the greater the argument for centralizing production in a single location or a limited number of locations.
Alternatively, when the minimum efficient scale of production is low relative to global demand, it may be economical to
manufacture a product at several locations. For example, the minimum efficient scale for a plant to manufacture personal
computers is about 250,000 units a year, while the total global demand exceeds 35 million units a year. The low level of
minimum efficient scale in relation to total global demand makes it economically feasible for companies such as Dell
and Lenovo to assemble PCs in multiple locations.
As in the case of low fixed costs, the advantages of a low minimum efficient scale include allowing the firm to
accommodate demands for local responsiveness or to hedge against currency risk by manufacturing the same product in
several locations.
Page 507
Flexible Manufacturing and Mass Customization
Central to the concept of economies of scale is the idea that the best way to achieve high efficiency, and hence low unit
costs, is through the mass production of a standardized output. The trade-off implicit in this idea is between unit costs
and product variety. Producing greater product variety from a factory implies shorter production runs, which in turn
implies an inability to realize economies of scale. That is, wide product variety makes it difficult for a company to
increase its production efficiency and thus reduce its unit costs. According to this logic, the way to increase efficiency
and drive down unit costs is to limit product variety and produce a standardized product in large volumes.
This view of production efficiency has been challenged by the rise of flexible manufacturing technologies. The
term flexible manufacturing technology—or lean production, as it is often called—covers a range of manufacturing
technologies designed to (1) reduce setup times for complex equipment, (2) increase the utilization of individual
machines through better scheduling, and (3) improve quality control at all stages of the manufacturing process.12
Flexible manufacturing technologies allow the company to produce a wider variety of end products at a unit cost that at
one time could be achieved only through the mass production of a standardized output. Research suggests the adoption
of flexible manufacturing technologies may actually increase efficiency and lower unit costs relative to what can be
achieved by the mass production of a standardized output while enabling the company to customize its product offering
to a much greater extent than was once thought possible. The term mass customization has been coined to describe 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.13 Flexible manufacturing technologies vary in their sophistication and
complexity.
One of the most famous examples of flexible manufacturing technology, Toyota’s production system, has been
credited with making Toyota the most efficient auto company in the world. Toyota’s flexible manufacturing system was
developed by one of the company’s engineers, Taiichi Ohno. After working at Toyota for five years and visiting Ford’s
U.S. plants, Ohno became convinced that the mass production philosophy for making cars was flawed. He saw numerous
problems with mass production.
First, long production runs created massive inventories that had to be stored in large warehouses. This was
expensive, both because of the cost of warehousing and because inventories tied up capital in unproductive uses. Second,
if the initial machine settings were wrong, long production runs resulted in the production of a large number of defects
(i.e., waste). Third, the mass production system was unable to accommodate consumer preferences for product diversity.
In response, Ohno looked for ways to make shorter production runs economically. He developed a number of
techniques designed to reduce setup times for production equipment (a major source of fixed costs). By using a system of
levers and pulleys, he reduced the time required to change dies on stamping equipment from a full day to three minutes.
This made small production runs economical, which allowed Toyota to respond better to consumer demands for product
diversity. Small production runs also eliminated the need to hold large inventories, thereby reducing warehousing costs.
Plus, small product runs and the lack of inventory meant that defective parts were produced only in small numbers and
entered the assembly process immediately. This reduced waste and helped trace defects back to their source to fix the
problem. In sum, these innovations enabled Toyota to produce a more diverse product range at a lower unit cost than was
possible with conventional mass production.14
Flexible machine cells are another common flexible manufacturing technology. A flexible machine cell is a
grouping of various types of machinery, a common materials handler, and a centralized cell controller. 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 settings on machines are computer controlled, which allows each cell to
switch quickly between the production of different parts or products.
Improved capacity utilization and reductions in work in progress (i.e., stockpiles of partly finished products) and in
waste are major efficiency benefits of flexible machine cells. Improved capacity utilization arises from the Page 508
reduction in setup times and from the computer-controlled coordination of production flow between machines,
which eliminates bottlenecks. The tight coordination between machines also reduces work-in-progress inventory.
Reductions in waste are due to the ability of computer-controlled machinery to identify ways to transform inputs into
outputs while producing a minimum of unusable waste material. While freestanding machines might be in use 50 percent
of the time, the same machines when grouped into a cell can be used more than 90 percent of the time and produce the
same end product with half the waste. This increases efficiency and results in lower costs.
The effects of installing flexible manufacturing technology on a company’s cost structure can be dramatic. The
Ford Motor Company has been introducing flexible manufacturing technologies into its automotive plants around the
world. These new technologies allow Ford to produce multiple models from the same line and to switch production from
one model to another much more quickly than in the past, allowing Ford to take $2 billion out of its cost structure.15
Besides improving efficiency and lowering costs, flexible manufacturing technologies enable companies to
customize products to the demands of small consumer groups—at a cost that at one time could be achieved only by
mass-producing a standardized output. Thus, the technologies help a company achieve mass customization, which
increases its customer responsiveness. Most important for international business, flexible manufacturing technologies
can help a firm customize products for different national markets. The importance of this advantage cannot be overstated.
When flexible manufacturing technologies are available, a firm can manufacture products customized to various national
markets at a single factory sited at the optimal location. And it can do this without absorbing a significant cost penalty.
Thus, firms no longer need to establish manufacturing facilities in each major national market to provide products that
satisfy specific consumer tastes and preferences, part of the rationale for a localization strategy (Chapter 13).

PRODUCTION FACTORS
Several production factors feature prominently into the reasons why production facilities are located and used in a
certain way worldwide. They include (1) product features, (2) locating production facilities, and (3) strategic roles for
production facilities.
Product Features
Two product features affect location decisions. The first is the product’s value-to-weight ratio because of its influence on
transportation costs. Many electronic components and pharmaceuticals have high value-to-weight ratios; they are
expensive, and they do not weigh very much. Thus, even if they are shipped halfway around the world, their
transportation costs account for a very small percentage of total costs. Given this, other things being equal, there is great
pressure to produce these products in the optimal location and to serve the world market from there. The opposite holds
for products with low value-to-weight ratios. Refined sugar, certain bulk chemicals, paint, and petroleum products all
have low value-to-weight ratios; they are relatively inexpensive products that weigh a lot. Accordingly, when they are
shipped long distances, transportation costs account for a large percentage of total costs. Thus, other things being equal,
there is great pressure to make these products in multiple locations close to major markets to reduce transportation costs.
The other product feature that can influence location decisions is whether the product serves universal needs, needs
that are the same all over the world. Examples include many industrial products (e.g., industrial electronics, steel, bulk
chemicals) and modern consumer products (e.g., Apple’s iPhone or iPad, Amazon’s Kindle, Lenovo’s ThinkPad, Sony’s
Cyber-shot camera, Microsoft’s Xbox). Because there are few national differences in consumer taste and preference for
such products, the need for local responsiveness is reduced. This increases the attractiveness of concentrating production
at an optimal location.
Locating Production Facilities Page 509

LO17-3
Recognize how the role of foreign subsidiaries in production can be enhanced over time as they accumulate knowledge.
There are two basic strategies for locating production facilities: (1) concentrating them in a centralized location and
serving the world market from there or (2) decentralizing them in various regional or national locations that are close to
major markets. The appropriate strategic choice is determined by the various country-specific, technological, and product
factors discussed in this section and summarized in Table 17.1.

TABLE 17.1 Location Strategy and Production

As can be seen, the concentration of production makes most sense when

• Differences among countries in factor costs, political economy, and culture have a substantial impact on the
 costs of manufacturing in various countries.
• Trade barriers are low.
• Externalities arising from the concentration of like enterprises favor certain locations.
• Important exchange rates are expected to remain relatively stable.
• The production technology has high fixed costs and high minimum efficient scale relative to global demand or
flexible manufacturing technology exists.
• The product’s value-to-weight ratio is high.
• The product serves universal needs.
Alternatively, decentralization of production is appropriate when
• Differences among countries in factor costs, political economy, and culture do not have a substantial impact on
the costs of manufacturing in various countries.
• Trade barriers are high.
• Location externalities are not important.
• Volatility in important exchange rates is expected.
• The production technology has low fixed costs and low minimum efficient scale, and flexible manufacturing
technology is not available.
• The product’s value-to-weight ratio is low.
• The product does not serve universal needs (i.e., significant differences in consumer tastes and preferences exist
among nations).
In practice, location decisions are seldom clear-cut. For example, it is not unusual for differences in factor Page 510
costs, technological factors, and product factors to point toward concentrated production, while a combination
of trade barriers and volatile exchange rates points toward decentralized production. This seems to be the case in the
world automobile industry. Although the availability of flexible manufacturing and cars’ relatively high value-to-weight
ratios suggest concentrated manufacturing, the combination of formal and informal trade barriers and the uncertainties of
the world’s current floating exchange rate regime (see Chapter 10) have inhibited firms’ ability to pursue this strategy.
For these reasons, several automobile companies have established “top-to-bottom” manufacturing operations in three
major regional markets: Asia, North America, and Western Europe.
Strategic Roles for Production Facilities
The growth of global production among multinational companies has been tremendous over the past two decades,
outdoing the growth of home country production by more than 10-fold.16 In essence, since the early 1990s,
multinationals have opted to set up production facilities outside their home country 10 times for every 1 time they have
opted to create such facilities at home. There is a clear strategic rationale for this; multinationals are trying to capture the
gains associated with a dispersed global production system. This trend is expected to continue going forward. Thus,
managers need to be ready to make the decision to open up a new production facility outside of their home base and
decide where to locate the facility.
When making these decisions, managers need to think about the strategic role assigned to a foreign factory. A
major consideration here is the importance of global learning—the idea that valuable knowledge does not reside just in
a firm’s domestic operations; it may also be found in its foreign subsidiaries. Foreign factories that upgrade their
capabilities over time are creating valuable knowledge that might benefit the whole corporation. Foreign factories can
have one of a number of strategic roles or designations, including (1) offshore factory, (2) source factory, (3) server
factory, (4) contributor factory, (5) outpost factory, and (6) lead factory.17
An offshore factory is one that is developed and set up mainly for producing component parts or finished goods at
a lower cost than producing them at home or in any other market. At an offshore factory, investments in technology and
managerial resources should ideally be kept to a minimum to achieve greater cost-efficiencies. Basically, the best
offshore factory should involve minimal everything—from engineering to development to engaging with suppliers to
negotiating prices to any form of strategic decisions being made at that facility. In reality, we expect at least some
strategic decisions to include input from the offshore factory personnel.
The primary purpose of a source factory is also to drive down costs in the global supply chain. The main
difference between a source factory and an offshore factory is the strategic role of the factory, which is more significant
for a source factory than for an offshore factory. Managers of a source factory have more of a say in certain decisions,
such as purchasing raw materials and component parts used in the production at the source factory. They also have a
strategic input into production planning, process changes, logistics issues, product customization, and implementation of
newer designs when needed. Centrally, a source factory is at the top of the standards in the global supply chain, and these
factories are used and treated just like any factory in the global firm’s home country. This also means that source
factories should be located where production costs are low, where infrastructure is well developed, and where it is
relatively easy to find a knowledgeable and skilled workforce to make the products.
A server factory is linked into the global supply chain for a global firm to supply specific country or regional
markets around the globe. This type of factory—often with the same standards as the top factories in the global firm’s
system—is set up to overcome intangible and tangible barriers in the global marketplace. For example, a server factory
may be intended to overcome tariff barriers, reduce taxes, and reinvest money made in the region. Another obvious
reason for a server factory is to reduce or eliminate costly global supply chain operations that would be needed Page 511
if the factory were located much farther away from the end customers. Managers at a server factory typically
have more authority to make minor customizations to please their customers, but they still do not have much more input
than managers in an offshore factory relative to the home country factories of the same global firm.
A contributor factory also serves a specific country or world region. The main difference between a contributor
factory and a server factory is that a contributor factory has responsibilities for product and process engineering and
development. This type of factory also has much more of a choice in terms of which suppliers to use for raw materials
and component parts. In fact, a contributor factory often competes with the global firm’s home factories for testing new
ideas and products. A contributor factory has its own infrastructure when it comes to development, engineering, and
production. This means that a contributor factory is very much stand-alone in terms of what it can do and how it
contributes to the global firm’s supply chain efforts.
An outpost factory can be viewed as an intelligence-gathering unit. This means that an outpost factory is often
placed near a competitor’s headquarters or main operations, near the most demanding customers, or near key suppliers of
unique and critically important parts. An outpost factory also has a function to fill in production; it often operates as a
server and/or offshore factory as well. The outpost factory can be very much connected to the idea of selecting countries
for operations based on the countries’ strategic importance rather than on the production logic of a location. Maintaining
and potentially even enhancing the position of the global firm in strategic countries is sometimes viewed as a practical
factor. For example, the fact that Nokia has its headquarters in Finland may result in another mobile phone manufacturer
locating some operations in Finland, even though the country market is rather small (about 5.5 million people).
A lead factory is intended to create new processes, products, and technologies that can be used throughout the
global firm in all parts of the world. This is where cutting-edge production should take place or at least be tested for
implementation in other parts of the firm’s production network. Given the lead factory’s prominent role in setting a high
bar for how the global firm wants to provide products to customers, we also expect that it will be located in an area
where highly skilled employees can be found (or where they want to locate). A lead factory scenario also implies that
managers and employees at the site have a direct connection to and say in which suppliers to use, what designs to
implement, and other issues that are of critical importance to the core competencies of the global firm.

THE HIDDEN COSTS OF FOREIGN LOCATIONS

There may be some “hidden costs” to basing production in a foreign location. Numerous anecdotes suggest that high
employee turnover, shoddy workmanship, poor product quality, and low productivity are significant issues in some
outsourcing locations.18
Microsoft, for example, established a major facility in Hyderabad, India, for four very good reasons: (1) The wage
rate of software programmers in India is one-third of that in the United States; (2) India has an excellent higher education
system that graduates many computer science majors every year; (3) there was already a high concentration of
information technology companies and workers in Hyderabad; and (4) many of Microsoft’s highly skilled Indian
employees, after spending years in the United States, wanted to return home, and Microsoft saw the Hyderabad facility
as a way of holding on to this valuable human capital.
However, the company found that the turnover rate among its Indian employees is higher than in the United States.
Demand for software programmers in India is high, and many employees are prone to switch jobs to get better pay.
Although Microsoft has tried to limit turnover by offering good benefits and long-term incentive pay, such as stock
grants to high performers who stay with the company, many of the Indians who were hired locally apparently place little
value on long-term incentives and prefer higher current pay. High employee turnover, of course, has a negative impact
on productivity. One Microsoft manager in India noted that 40 percent of his core team had left within the past 12
months, making it very difficult to stay on track with development projects.19
Page 512
 MANAGEMENT FOCUS
Amazon’s Global Supply Chains
Amazon.com Inc.—typically referred to as just Amazon—has ranked among the top companies for years in the “Gartner Global
Supply Chain Top 25” ranking. Other regular entries among the companies with the best global supply chains include Unilever,
McDonald’s, and Intel. Amazon is passing through about $200 billion in sales via its global supply chains and partnerships
annually, a staggering amount given that the company seldom takes possession in any true sense of the products that it channels to
customers from various companies.
Amazon is based in Seattle, Washington. It has now become the largest online retailer in the United States, surpassing
Walmart as the most valuable retailer by market capitalization (but Walmart’s revenue is still gigantic at about $500 billion
annually). Amazon started in 1994 as an online bookstore but has diversified to a variety of products, including music downloads,
furniture, food, and almost all consumer electronics. These days, customers can seemingly buy anything they need via the Amazon
platform. In the United States alone, roughly 150 million customers per month visit Amazon.com. But this massive availability of
products also puts a strain on Amazon’s global supply chains.
As customers, we have come to expect that Amazon will deliver whatever we buy in the shortest cycle time possible, often no
more than two days, especially if a customer is signed up for Amazon Prime. The Amazon Prime service includes free two-day
shipping (on many products), video streaming, music, photos, and the Kindle lending library for an annual fee (currently $99 per
year or $12.99 per month). All these services are welcomed by customers, but the free two-day shipping is really what drives the
Amazon Prime service.
The free two-day shipping (and myriad other shipping alternatives for a fee) requires Amazon to leverage its inventory
management practices, global supply chains, and technology to cost-effectively reach customers. Delivery speed and efficiency
require Amazon to have strategically located fulfillment centers worldwide that can be used by select vendors on the Amazon
platform. This includes strict requirements for packaging, labeling, and shipment. Amazon stores these vendors’ products in bulk
or in individual “pickable” locations.
So far, in addition to the United States, Amazon has retail websites for Australia, Brazil, Canada, China, France, Germany,
India, Italy, Japan, Mexico, the Netherlands, Spain, the United Kingdom, and Ireland. And, the Amazon Prime service places great
strain on Amazon’s supply chains where it is available in its worldwide locations (e.g., Canada, France, Germany, Italy, Japan, and
the United Kingdom).
In addition, Amazon’s customer service centers span some 15 countries worldwide. Plus, the company operates retail websites
for international brands such as Sears Canada, Bebe Stores, Marks & Spencer, Mothercare, and Lacoste. This means that Amazon
is benefiting from both its global supply chains for delivery of vendors’ products and its service as a technology supply chain
vendor to businesses.
Another interesting development—or, at least, idea at this stage—is the speculation that Amazon is thinking about launching a
global shipping and logistics operation that can compete with United Parcel Service (UPS) and FedEx. Of course, Chief Financial
Officer (CFO) Brian Olsavsky downplayed Amazon’s ambitions on this front. He said that Amazon was just looking to
supplement its delivery partners—not replace them—during the very busy peak periods like the holiday seasons.
Sources: Todd Bishop, “Amazon Sales Rises 22% to $43.7B, Profit Beats Expectations But Stock Slips on Revenue Miss,” GeekWire, February 2, 2017; Spencer Soper,
“Amazon Building Global Delivery Business to Take On Alibaba,” Bloomberg Technology, Feb r uar y9, 2016; V. W
a l t, “HowJ eff Bezos Ai ms t o Conquer t he Next Tr i l l ion--
dollar Market,” Fortune, January 1, 2016; B. Stone, “The Secrets of Bezos: How Amazon Became the Everything Store,” Bloomberg Business, October 10, 2013; and A.
Cuthbertson, “Amazon Buries Zombie Apocalypse Clause in Terms of Service,” Newsweek, February 11, 2016.

Microsoft is not alone in experiencing this problem. The manager of an electronics company that outsourced the
manufacture of wireless headsets to China noted that after four years of frustrations with late deliveries and poor quality,
his company decided to move production back to the United States. In his words: “On the face of it, labor costs seemed
so much lower in China that the decision to move production there was a very easy one. In retrospect, I wish we had
looked much closer at productivity and workmanship. We have actually lost market share because of this decision.”20
Another example of efficiency and effectiveness issues is highlighted in the accompanying Management Focus, which
looks at Amazon and its world-leading global supply chains.

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Page 513
 Make-or-Buy Decisions

LO17-4
Identify the factors that influence a firm’s decision of whether to source supplies from within the company or from
foreign suppliers.
The make-or-buy decision for a global firm is the strategic decision concerning whether to produce an item in-house
(“make”) or purchase it from an outside supplier (“buy”). Make-or-buy decisions are made at both the strategic and
operational levels, with the strategic level being focused on the long term and the operational level being more focused
on the short term. In some ways, the make-or-buy decision is also the starting point for operations’ influence on global
supply chains. That is, someone in the chain—within one firm—has to take the lead in deciding whether the global firm
should make the product in-house or buy it from an external supplier. If the decision is to make it in-house, there are
certain implications for that firm’s global supply chains (e.g., where to purchase raw materials and component parts). If
the decision is to buy the product, that decision also has certain implications (e.g., quality control and competitive
priorities management).
A number of things are involved in determining which decision is the correct one for a particular global firm in a
particular situation. At a broad level, issues of product success, specialized knowledge, and strategic fit can lead to the
make (produce) decision. For example, if the item or part is critical to the success of the product, including perceptions
among primary stakeholders, such a scenario skews the decision in favor of make. Another reason for a make decision is
that the item or part requires specialized design or production skills and/or equipment and reliable alternatives are very
scarce. Strategic fit is also important. If the item or part strategically fits within the firm’s current and/or planned core
competencies, then it should be a make decision for the global firm.
However, these are strategic decisions at a general level. In reality, the make-or-buy decision is often based largely
on two critical factors: cost and production capacity. Cost issues include such things as acquiring raw materials,
component parts, and any other inputs into the process, along with the costs of finishing the product. The production
capacity is really presented as an opportunity cost. That is, does the firm have the capacity to produce the product at a
cost that is at least no higher than the cost of buying it from an external supplier? And if the product is made in-house,
what opportunity cost would be incurred as a result (e.g., what product or item was the firm unable to produce because of
limited production capacity)? Unfortunately, many, and perhaps most, global companies think that cost and production
capacity are the only factors playing into the make-or-buy decision. This is simply not true!
Cost and production capacity are just the two main drivers behind make-or-buy choices made by global companies
when they engage in global supply chains. The decision of whether to buy or make a product is a much more complex
and research-intensive process than the typical global firm may expect. For example, how many times have we heard,
“Let’s move our production to China because we can get the same quality for a dime-on-the-dollar cost, and that will free
up production capacity that we can use to focus on other products”? Of course, dime-on-the-dollar cost is not the sole
relevant factor because we have to take into account the costs of quality control measures that have to be instituted, raw
materials that have to be purchased far away from home, foreign entry requirements, multiple-party contracts,
management responsibilities for the outsourced production operations, and so on. Ultimately, we are unlikely to end up
with a dime-on-the-dollar cost. But where do we end up and how do we get there? In other words, what are the core
elements that we should be evaluating when we are determining whether the correct decision is to make or to buy?
To facilitate your understanding of the make-or-buy decision, we have captured the dynamics of this choice in two
graphics that illustrate either operationally favoring a make decision or operationally favoring a buy decision (see
Figures 17.3 and 17.4). As shown in the figures, the core elements in both cases are cost and production capacity.
However, the other elements differ for each of the decisions and influence the choice differently. This means that we
need to evaluate each decision separately, not jointly. In fact, through this process, we may end up thinking that both a
make decision and a buy decision would be acceptable and strategically logical for our firm. Keep in mind that this
simply means that we have a choice; if both choices seem positive for your firm, choose the best one—the one that is the
best strategic fit with the least opportunity cost.
Page 514
FIGURE 17.3 Operationally favoring a make decision.
Source: Charles W. L. Hill and G. Tomas M. Hult, Global Business Today (New York: McGraw-Hill, 2020).
 FIGURE 17.4 Operationally favoring a buy decision.
Source: Charles W. L. Hill and G. Tomas M. Hult, Global Business Today (New York: McGraw-Hill, 2020).

The elements that favor a make decision—beyond the core elements of cost and production capacity— Page 515
include quality control, proprietary technology, having control, excess capacity, limited suppliers, assurance of
continual supply, and industry drivers (see Figure 17.3). So, the starting point is lower (or at least no greater) cost than
what we can expect when we outsource the production to an external party in another country (or another external party
in general). The limitation is that we must have excess production capacity or capacity that is best used by our firm for
making the product in-house.
After the cost and production capacity decisions have been explored and made (really, after the cost and production
hurdles have been overcome), the next set of decisions follows logically from the path in Figure 17.3. For example, if
quality control is important to the global firm, cannot be relied on fully if the part is outsourced, and is at the center of
the strategic core that customers expect from the firm, then the quality control issue favors a make decision. If there is
proprietary technology involved in making the product that cannot or should not be shared with outsourcing parties, then
the decision has to be to make.
The idea that limited suppliers may influence the make-or-buy choice in the direction of the make selection is
important as well. Specifically, it could be that some suppliers do not want to work with certain companies in certain
parts of the world. It could also be that a supplier cannot, because of various restrictions on production or location or
because of international barriers, follow the production of your firm’s products to wherever you see fit to locate your
production lines.
Naturally, if the firm has excess capacity that otherwise would not be productively used, the decision should favor a
make choice to allow that excess capacity to be used for the benefit of the firm in the global marketplace. Some
companies also simply want to have control over certain elements of their production processes. This affects the make-
or-buy decision in favor of the make choice.
A make decision is also favored if there is any chance that supply cannot be guaranteed if the firm moves its
production overseas. And, finally, the industry globalization drivers may dictate that a make decision should be the
choice for various trust and commitment reasons involving your industry and the marketplace that you engage with in
order to find success.
Now, some of these elements that favor make can probably influence a buy decision as well. Naturally, if one of the
make elements is not in favor of the make decision (e.g., if there is no excess capacity), this would suggest that the global
firm should think more seriously about a buy decision. However, again, the buy decision also involves a number of other
elements that are not necessarily factors in the make decision (see Figure 17.4). As with the make decision, after the cost
and production capacity decisions have been considered and made, the next set of decisions for the buy choice follow
logically from the path in Figure 17.4. For example, if the global firm has minimal restrictions on which firms or
companies it can source raw materials and component parts from, then a buy decision is more likely because outsourcing
production also increases the likelihood that other and/or more suppliers in those parts of the world will be used.
Another good reason to choose a buy scenario is if the firm lacks the needed expertise to make a product or
component part and the supplier or outsourced production choice has that expertise. Supplier competencies can affect the
decision in favor of a buy choice as well, especially if those competencies reside closer to the production facility that you
buy from than the ones that will be available if you make the product. Small volumes would also be a reason favoring a
buy decision; cost-efficiencies can seldom be achieved when only small volumes are produced.

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Inventory planning is also of critical importance. Even if your firm can make the product equally well in terms of
quality and expectations set, perhaps a better choice is to buy simply in order to strategically manage inventory (which is
a cost center in the global supply chain). In certain cases, even brand preference is a reason to go with a buy decision; for
example, many computer users favor Intel microchips in their computers, so many of the large computer Page 516
manufacturers opt to buy chips from Intel instead of making them in-house for that reason. And, of course, if
the item to be made is a so-called nonessential item that has little effect on the firm’s core competencies and what the
customers expect in terms of uniqueness, this is a factor in favor of a buy decision.

Global Supply Chain Functions

 LO17-5
Understand the functions of logistics and purchasing (sourcing) within global supply chains.
To this point in the chapter, we have emphasized global production, a component of the operations management of a
supply chain. Issues such as where to produce, the strategic role of a foreign production site, and the make-or-buy
decisions are the core aspects of global production. In addition to global production, three additional supply chain
functions need to be developed in concert with global production. They are logistics, purchasing (sourcing), and the
company’s distribution strategy (i.e., marketing channels). The latter—distribution strategy—is addressed in Chapter 18,
where we discuss marketing and R&D. Here we address logistics and purchasing. From earlier in this chapter, we know
that production and supply chain management are closely linked because a firm’s ability to perform its production
activities depends on information inputs and the timely supply of high-quality material (raw material, component parts,
and even finished products that are used in the manufacturing of new products). Logistics and purchasing are critical
functions in ensuring that materials are ordered and delivered and that an appropriate level of inventory is managed.

GLOBAL LOGISTICS
From earlier in this chapter, we know that logistics is the part of the supply chain that plans, implements, and controls
the effective flows and inventory of raw material, component parts, and products used in manufacturing. The core
activities performed in logistics are (1) global distribution center management, (2) inventory management, (3) packaging
and materials handling, (4) transportation, and (5) reverse logistics. Each of these core logistics is described in the next
paragraphs.
A global distribution center (or warehouse) is a facility that positions and allows customization of products for
delivery to worldwide wholesalers or retailers or directly to consumers anywhere in the world. Distribution centers (DCs)
are used by manufacturers, importers, exporters, wholesalers, retailers, transportation companies, and customs agencies
to store products and provide a location where customization can be facilitated. When warehousing shifted from passive
storage of products to strategic assortments and processing, the term distribution center became more widely used to
capture this strategic and dynamic aspect of not only storing, but adding value to products that are being warehoused or
staged. A DC is at the center of the global supply chain; specifically, the order-processing part of the order-fulfillment
process. DCs are the foundation of a global supply network because they allow either a single location or satellite
warehouses to store quantities and assortments of products and allow for value-added customization. They should be
located strategically in the global marketplace, considering the aggregate total labor and transportation cost of moving
products from plants or suppliers through the distribution center and then delivering them to customers.
Global inventory management can be viewed as the decision-making process regarding the raw materials, work-
in-process (component parts), and finished goods inventory for a multinational corporation. The decisions include how
much inventory to hold, in what form to hold it, and where to locate it in the supply chain. Examining the largest 20,910
global companies with headquarters in 105 countries, we find that these companies, on average across all industries,
carry 14.41 percent of their total assets in some form of inventory.21 These companies have 32 percent of their inventory
in raw materials, 18 percent of their inventory in work-in-process, and 50 percent of their inventory in finished goods.22
At the company level, Toyota (www.toyota.com) from Japan, one of the largest automobile firms in the world, has 8.71
percent of its total assets in inventory, with a mix of 26, 14, and 60 percent in raw materials, work-in-process, and
finished vehicles, respectively. Another example is Sinopec (www.sinopec.com), a petroleum firm and the largest firm
in China. Sinopec has 21 percent of its total assets in inventory, with a mix of 37, 43, and 20 percent in raw Page 517
materials and component parts, work-in-process, and finished goods, respectively. Note that Sinopec maintains
a much higher percentage of its inventories in work-in-process and a much lower percentage in finished goods than
Toyota does. This suggests that petroleum firms want more flexibility in deciding exactly how to formulate the finished
product. The company’s global inventory strategy must effectively trade off the service and economic benefits of making
products in large quantities and positioning them near customers against the risk of having too much stock or the wrong
items.
Packaging comes in all shapes, sizes, forms, and uses. It can be divided into three different types: primary,
secondary, and transit. Primary packaging holds the product itself. These are the packages brought home from the store,
us ual l y a retai l er, by the e nd-consum
er . Secondary packaging (sometimes called case-lot packaging) is designed to
contain several primary packages. Bulk buying or warehouse store customers may take secondary packages home (e.g.,
from Sam’s Club), but this is not the typical mode for retailers. Retailers can also use secondary packaging as an aid
when stocking shelves in the store. Transit packaging comes into use when a number of primary and secondary packages
are assembled on a pallet or unit load for transportation. Unit-load packaging—through palletizing, shrink-wrapping, or
containerization—is the outer packaging envelope that allows for easier handling or product transfer among international
suppliers, manufacturers, distribution centers, retailers, and any other intermediaries in the global supply chain.
Regardless of where the product is in the global supply chain, the packaging is intended to achieve a set of
multilayered functions. These can be grouped into (1) perform, (2) protect, and (3) inform.23 Perform refers to (1) the
ability of the product in the package to handle being transported between nodes in the global supply chain, (2) the ability
of the product to be stored for typical lengths of time for a particular product category, and (3) the package providing the
convenience expected by both the supply chain partners and the end-customers. Protect refers to the package’s ability to
(1) contain the products properly, (2) preserve the products to maintain their freshness or newness, and (3) provide the
necessary security and safety to ensure that the products reach their end destination in their intended shape. Inform refers
to the package’s inclusion of (1) logical and sufficient instructions for the use of the products inside the package,
including specific requirements to satisfy local regulations; (2) a statement of a compelling product guarantee; and (3)
information about service for the product if and when it is needed.
Transportation refers to the movement of raw material, component parts, and finished goods throughout the global
supply chain. It typically represents the largest percentage of any logistics budget and an even greater percentage for
global companies because of the distances involved. Global supply chains are directly or indirectly responsible for
transporting raw materials from their suppliers to the production facilities, work-in-process, and finished goods
inventories between plants and distribution centers, and finished goods from distribution centers to customers. The
primary drivers of transportation rates and the resulting aggregate cost are distance, transport mode (ocean, air, or land),
size of the load, load characteristics, and oil prices. As would be expected, longer distances require more fuel and more
time from vehicle operators, so transport rates increase with distance. Transport mode influences rates because of the
different technologies involved. The ocean is the least expensive because of the size of the vehicles used and the low
friction of water. Land is the next least expensive, with rail being less expensive than motor carriers. Air is the most
expensive because there is a substantial charge for defying gravity. Transportation rates are heavily influenced by
economies of scale, so larger shipments are typically relatively less expensive than smaller shipments. The characteristics
of the shipment also influence transportation rates through such factors as product density, value, perishability, the
potential for damage, and other such factors. Finally, oil prices have a major impact on transportation rates because
anywhere from 10 to 40 percent of most carrier costs, depending on the mode, are related to fuel.
Reverse logistics is the process of planning, implementing, and controlling the efficient, cost-effective flow of raw
materials, in-process inventory, finished goods, and related information from the point of consumption to the Page 518
point of origin for the purpose of recapturing value or proper disposal. The ultimate goal is to optimize the
after-market activity or make it more efficient, thus saving money and environmental resources. Reverse logistics is
critically important in global supply chains. For example, product returns cost manufacturers and retailers more than
$100 billion per year in the United States, or an average of 3.8 percent in lost profits.24 Overall, manufacturers spend
about 9 to 14 percent of their sales revenue on returns. Even more staggering, each year, consumers in America return
more than the GDP of two-thirds of the nations in the world. Just these sample numbers suggest that reverse logistics is
an incredibly important part of the global supply chain.

GLOBAL PURCHASING
As we defined it earlier in this chapter, purchasing represents the part of the supply chain that involves worldwide
buying of raw material, component parts, and products used in the manufacturing of the company’s products and
services. The core activities performed in purchasing include the development of an appropriate strategy for global
purchasing and selecting the type of purchasing strategy best suited for the company.
There are five strategic levels—from domestic to international to global—that can be undertaken by a global
company.25 Level I is simply companies engaging in domestic purchasing activities only. Often, these companies stay
close to their home base in their domestic market when purchasing raw materials, component parts, and the like for their
operations (e.g., a Michigan firm purchasing raw materials, such as cherries, from another Michigan firm). Levels II and
III are both considered “international purchasing,” but of various degrees and forms. Companies that are at level II
engage in international purchasing activities only as needed. This means that their approach to international purchasing is
often reactive and uncoordinated among the buying locations within the firm and/or across the various units that make up
the firm, such as strategic business units and functional units. Companies at level III engage in international purchasing
activities as part of the firm’s overall supply chain management strategy. At the level III stage, companies begin to
recognize that a well-formulated and well-executed worldwide international purchasing strategy can be very effective in
elevating the firm’s competitive edge in the marketplace. Levels IV and V both involve “global purchasing” to various
degrees. Level IV refers to global purchasing activities that are integrated across worldwide locations. This involves
integration and coordination of purchasing strategies across the firm’s buying locations worldwide. With level IV, we are
now dealing with a sophisticated form of worldwide purchasing. Level V involves engaging in global purchasing
activities that are integrated across worldwide locations and functional groups. Broadly, this means that the firm
integrates and coordinates the purchasing of common items, purchasing processes, and supplier selection efforts globally,
for example.
Beyond the domestic, international, and global purchasing strategies in levels I through V, purchasing includes a
number of basic choices that companies make in deciding how to engage with markets.26 The starting point is a choice
of internal purchasing versus external purchasing—in other words, “how to purchase.” We find that roughly 35 percent
of the purchasing in global companies today is internal (i.e., from sources within their own company), with 65 percent
being classified as external (i.e., from sources outside their company). The next decision, in both internal and external
purchasing, is to figure out “where to purchase” (domestically or globally). This takes us ultimately to the “types of
purchasing” (where and how) and the four choices for purchasing strategy: domestic internal purchasing, global internal
purchasing, domestic external purchasing, and global external purchasing.
The types of purchasing activities and strategies just discussed come with a set of generic options for the
“international arena.” But we all know that outsourcing and offshoring, along with many by-products and other similar
yet quite different options, exist in the purchasing world today. At this stage of the text, we feel it is important to go over
the outsourcing-related terms and options that companies have, especially the following terms that are often confusing to
understand, develop strategy around, and implement: outsourcing, insourcing, offshoring, offshore outsourcing,
nearshoring, and co-sourcing (see Table 17.2).

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Page 519

TABLE 17.2 Outsourcing Terms and Options

 Managing a Global Supply Chain

LO17-6
Describe what is required to efficiently manage a global supply chain.
The potential for reducing costs through more efficient supply chain management is enormous. For the typical
manufacturing enterprise, material costs account for between 50 and 70 percent of revenues, depending on the industry.
Even a small reduction in these costs can have a substantial impact on profitability. According to one estimate, for a firm
with revenues of $1 million, a return on investment rate of 5 percent, and materials costs that are 50 percent of sales
revenues, a $15,000 increase in total profits could be achieved either by increasing sales revenues 30 percent or by
reducing materials costs by 3 percent.27 In a saturated market, it would be much easier to reduce materials costs by 3
percent than to increase sales revenues by 30 percent. Thus, managing global supply chains is one of the strategically
most important areas for a global company. Four main areas are of concern in managing a global supply chain, including
the role of just-in-time inventory, the role of information technology, coordination in global supply chains, and
interorganizational relationships in global supply chains.

ROLE OF JUST-IN-TIME INVENTORY

Pioneered by Japanese firms during that country’s remarkable economic transformation during the 1960s and 1970s,
just-in-time inventory systems now play a major role in most manufacturing firms. The basic philosophy behind just-in-
time (JIT) inventory systems is to economize on inventory holding costs by having materials arrive at a manufacturing
plant just in time to enter the production process and not before. The major cost savings comes from speeding up
inventory turnover. This reduces inventory holding costs, such as warehousing and storage costs. It means the company
can reduce the amount of working capital it needs to finance inventory, freeing capital for other uses and/or lowering the
total capital requirements of the enterprise. Other things being equal, this will boost the company’s profitability Page 520
as measured by return on capital invested. It also means the company is less likely to have excess unsold
inventory that it has to write off against earnings or price low to sell.
In addition to the cost benefits, JIT systems can also help firms improve product quality. Under a JIT system, parts
enter the manufacturing process immediately; they are not warehoused. This allows defective inputs to be spotted right
away. The problem can then be traced to the supply source and fixed before more defective parts are produced. Under a
more traditional system, warehousing parts for weeks before they are used allows many defective parts to be produced
before a problem is recognized.
The drawback of a JIT system is that it leaves a firm without a buffer stock of inventory. Although buffer stocks are
expensive to store, they can help a firm respond quickly to increases in demand and tide a firm over shortages brought
about by disruption among suppliers. Such a disruption occurred after the September 11, 2001, attacks on the World
Trade Center and Pentagon, when the subsequent shutdown of international air travel and shipping left many firms that
r el i ed on global ly disper sed suppl i ers and t i ght l y man aged “j ust-in- t i m
e” suppl y chai ns wit hout a buff er stock of
inventory. A less pronounced but similar situation occurred again in April 2003, when the outbreak of the pneumonia-
like severe acute respiratory syndrome (SARS) virus in China resulted in the temporary shutdown of several plants
operated by foreign companies and disrupted their global supply chains. Similarly, in late 2004, record imports into the
United States left several major West Coast shipping ports clogged with too many ships from Asia that could not be
unloaded fast enough, which disrupted the finely tuned supply chains of several major U.S. enterprises.28
There are ways of reducing the risks associated with a global supply chain that operates using just-in-time
principles. To reduce the risks associated with depending on one supplier for an important input, some firms source these
inputs from several suppliers located in different countries. While this may not help in the case of an event with global
ramifications—such as September 11, 2001, in the United States, or the Tōhoku earthquake and tsunami on March 11,
2011, in Japan—it does help manage country-specific supply disruptions, which are more common. Strategically, all
global companies need to build in some degree of redundancy in supply chains by having multiple options for suppliers.

ROLE OF INFORMATION TECHNOLOGY

Web and cloud-based information systems play a crucial role in modern global supply chains. For example, by tracking
component parts as they make their way across the globe toward an assembly plant, information systems enable a firm to
optimize its production scheduling according to when components are expected to arrive. By locating component parts in
the supply chain precisely, good information systems allow the firm to accelerate production when needed by pulling key
components out of the regular supply chain and having them flown to the manufacturing plant.
Firms now typically use some form of a supply chain information system to coordinate the flow of materials into
manufacturing, through manufacturing, and out to customers. There are a variety of options for global supply chains.
Electronic data interchange (EDI) refers to the electronic interchange of data between two or more companies. Enterprise
resource planning (ERP) is a wide-ranging business planning and control system that includes supply chain-related
subsystems (e.g., materials requirements planning, or MRP). Collaborative planning, forecasting, and replenishment
(CPFR) was developed to fill the inter-organizational connections that ERP cannot fill. Vendor management of inventory
(VMI) allows for a holistic overview of the supply chain with a single point of control for all inventory management. A
warehouse management system (WMS) often operates in concert with ERP systems; for example, an ERP system
defines material requirements, and these are transmitted to a distribution center for a WMS.
Before the emergence of the internet as a major communication medium, firms and their suppliers normally had to
purchase expensive proprietary software solutions to implement EDI systems. The ubiquity of the internet and the
availability of web- and cloud-based applications have made most of these proprietary solutions obsolete. Less Page 521
expensive systems that are much easier to install and manage now dominate the market for global supply chain
management software. These systems have transformed the management of globally dispersed supply chains, allowing
even small firms to achieve a much better balance between supply and demand, thereby reducing the inventory in their
systems and reaping the associated economic benefits. Importantly, with most firms now using these systems, those that
do not will find themselves at a competitive disadvantage. This has implications for small and medium-sized companies
that may not always have the resources to implement the most sophisticated supply chain information systems.
Having at least some form of a supply chain information system to coordinate the flow of materials into
manufacturing, through manufacturing, and out to customers is paramount to be part of the global supply chain networks
that exist today. Now, enter blockchain technology as an additional layer in the systems! As we saw in the opening case,
blockchains make it possible for ecosystems of supply chain partners (or any business partners) to share and agree upon
key pieces of information. Importantly, the partners can agree on the information without having to deal with all the
complex negotiations and power plays that come with setting the rules before handing over really critical business
information. Blockchains synchronize all data and transactions across the global network. Through blockchains,
companies gain a live, real-time digital ledger of all transactions and supply chain movements for all participants in their
supply chain network. However, the added coordination-value that companies can achieve via blockchain technology has
at least, for now, short-term concerns as well. For example, fitting blockchain technology into existing systems around
the globe is difficult, costly, and not as efficient as possible to reap the short-term, immediate advantages that blockchain
technology offers companies. That said, coordination in global supply chains and networks is critically important for a
well-functioning system.

COORDINATION IN GLOBAL SUPPLY CHAINS

Consider how to turn an aircraft, and think in terms of coordination and leverage points. Traditionally, aircraft were
typically steered using an integrated system of ailerons on the wings and the rudder at the tail of the aircraft. In
comparison to the aircraft, the ailerons and rudder seem very small. However, leverage allows the coordinated effort of
the ailerons and the rudder to turn the aircraft. In other words, putting the right combination of a little leverage in the
right places together with a coordinated effort leads to incredible maneuvering ability for the plane. Global supply chains
are the same. Integration and coordination are critically important. Global supply chain coordination refers to shared
decision-making opportunities and operational collaboration of key global supply chain activities.
Shared decision making—such as joint consideration of replenishment, inventory holding costs, collaborative
planning, costs of different processes, the frequency of orders, batch size, and product development—creates a more
integrated, coherent, efficient, and effective global supply chain. This includes shared decision making by supply chain
members both inside an organization (e.g., logistics, purchasing, operations, and marketing channels employees) and
across organizations (e.g., raw materials producers, transportation companies, manufacturers, wholesalers, retailers).
Shared decision making is not joint decision making; it is decision making involving joint considerations. Shared
decision making helps in resolving potential conflicts among global supply chain members and fosters a culture of
coordination and integration. In most supply chains, certain parties are more influential, and shared decision making, at a
minimum, should include the critically important chain members.
To achieve operational integration and collaboration within a global supply chain, six operational objectives should
be addressed: responsiveness, variance reduction, inventory reduction, shipment consolidation, quality, and life-cycle
support.29 Responsiveness refers to a global firm’s ability to satisfy customers’ requirements across global supply chain
functions in a timely manner. Variance reduction refers to integrating a control system across global supply chain
functions to eliminate global supply chain disruptions. Inventory reduction refers to integrating an inventory Page 522
system, controlling asset commitment, and turning velocity across global supply chain functions. Shipment
consolidation refers to using various programs to combine small shipments and provide timely, consolidated movement.
This includes multi-unit coordination across global supply chain functions. Quality refers to integrating a system so it
achieves zero defects throughout global supply chains. Finally, life-cycle support refers to integrating the activities of
reverse logistics, recycling, after-market service, product recall, and product disposal across global supply chain
functions.

INTERORGANIZATIONAL RELATIONSHIPS
Interorganizational relationships have been studied and talked about in various contexts for decades. The two keys are
trust and commitment. If we always had 100 percent trust in relationships and 100 percent commitment to them, most
global supply chains would ultimately be efficient and effective. But we don’t! However, by looking at the building
blocks for global supply chains, we would also assume that not all relationships are equally valuable and that they should
not be treated as if they were. Two examples centered on upstream/inbound and downstream/outbound supply chain
activities can effectively be used to illustrate this point. Figure 17.5 focuses on the upstream (or inbound) supply chain
relationships, and Figure 17.6 focuses on the downstream (or outbound) supply chain relationships.

FIGURE 17.5 Upstream/inbound relationships.

Source: Charles W. L. Hill and G. Tomas M. Hult, Global Business Today (New York: McGraw-Hill, 2020).

FIGURE 17.6 Downstream/outbound relationships.

Source: Charles W. L. Hill and G. Tomas M. Hult, Global Business Today (New York: McGraw-Hill, 2020).

For the upstream/inbound portion of the global supply chain, the three logical scenarios of interacting organizations
are labeled as vendors, suppliers, and partners. Each scenario is based on the degree of coordination, Page 523
integration, and transactional versus relationship emphasis that the firm should adopt in partnering with other
entities in the global supply chain. For instance, a firm uses vendors to obtain raw materials and component parts through
a transactional relationship that can change easily. A given firm may use suppliers to obtain raw materials and parts and
maintain a relationship with those suppliers based on experience and performance. Another firm may engage with
partners to obtain raw materials and parts, maintaining a relationship based on trust and commitment.
For the downstream/outbound portion of the global supply chain, the three logical scenarios of interacting
organizations are labeled as buyers, customers, and clients. As with the upstream/inbound examples, each
downstream/outbound scenario is based on the degree of coordination, integration, and transactional versus relationship
focus that the firm should adopt in partnering with other entities in the global supply chain. One firm may sell products
and parts to buyers through a transactional relationship that can change easily. Another firm may sell products and parts
to customers and maintain a relationship that is based on experience and performance. Yet another firm may sell
products and parts to clients and maintain a relationship that is based on trust and commitment.
Having reviewed the three scenarios for the upstream/inbound and downstream/outbound portions of the global
supply chain, let’s look at the emphasis a global company should place on the relationships with each entity: the benefits
to be expected, favorable points of distinction, and resonating focus in the relationship.30 First, however, some basics on
value are appropriate. The value between nodes and actors in global supply chains is a function of the cost (money and
nonmoney resources) given up in return for the quality (products, services, information, trust, and commitment) received.
Basically, greater value is achieved if the quality is greater while the cost remains the same or is reduced or when the
cost is reduced and the quality remains constant.
A global company should allocate 20 percent of its efforts to the vendor category, 30 percent to the supplier
category, and 50 percent to the partner category in the upstream/inbound portion of the global supply chain. Likewise, a
global company should allocate 20 percent of its efforts to the buyer category, 30 percent to the customer category, and
50 percent to the client category in the downstream/outbound portion of the chain. In the vendor (upstream) and buyer
(downstream) portions of the supply chain, the benefits that can be expected include those typical of a transactional
exchange (costs equal to quality for the goods bought but not necessarily the best goods in the marketplace). In the
supplier (upstream) and customer (downstream) stages, the expectation is that the firm will receive all the favorable
points that the raw materials, component parts, and/or products have relative to the next best alternative in the global
marketplace. This takes into account the ideas that the costs are equal to quality for the goods bought and that the goods
are among the best goods in the marketplace. Finally, in the partner (upstream) and client (downstream) portions of the
supply chain, the benefits that the firm can expect to receive include the one or two points of difference for the raw
materials, component parts, and/or products whose improvements will deliver the greatest value to the customer for the
foreseeable future (quality greater than cost).

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Key Terms
production, p. 501
supply chain management, p. 501
purchasing, p. 501
logistics, p. 501
upstream supply chain, p. 502
downstream supply chain, p. 502
total quality management (TQM), p. 503
Six Sigma, p. 503
ISO 9000, p. 503
minimum efficient scale, p. 506
flexible manufacturing technology, p. 507
lean production, p. 507
mass customization, p. 507
flexible machine cells, p. 507
global learning, p. 510
offshore factory, p. 510
source factory, p. 510
server factory, p. 510
contributor factory, p. 511
outpost factory, p. 511
lead factory, p. 511
make-or-buy decision, p. 513
global distribution center, p. 516
global inventory management, p. 516
packaging, p. 517
transportation, p. 517
reverse logistics, p. 517
just in time (JIT), p. 519
global supply chain coordination, p. 521
 SUMMARY
This chapter explained how global production and supply chain management can improve the competitive position of
an international business by lowering the total costs of value creation and by performing value creation activities in
such ways that customer service is enhanced and value added is maximized. We looked closely at five issues central
to global production and supply chain management: where to produce, the strategic role of foreign production sites,
what to make and what to buy, global supply chain functions, and managing a global supply chain. The Page 524
chapter made the following points:

1. The choice of an optimal production location must consider country factors, technological factors, and
production factors.
2. Country factors include the influence of factor costs, political economy, and national culture on production
costs, along with the presence of location externalities.
3. Technological factors include the fixed costs of setting up production facilities, the minimum efficient scale of
production, and the availability of flexible manufacturing technologies that allow for mass customization.
4. Production factors include product features, locating production facilities, and strategic roles for production
facilities.
5. Location strategies either concentrate or decentralize manufacturing. The choice should be made in light of
country, technological, and production factors. All location decisions involve trade-offs.
6. Foreign factories can improve their capabilities over time, and this can be of immense strategic benefit to the
firm. Managers need to view foreign factories as potential centers of excellence and encourage and foster
attempts by local managers to upgrade factory capabilities.
7. An essential issue in many international businesses is determining which component parts should be
manufactured in-house and which should be outsourced to independent suppliers. Both making and buying
component parts are primarily based on cost considerations and production capacity constraints, but each
decision (make or buy) is also influenced by several different factors.
8. The core global supply chain functions are logistics, purchasing (sourcing), production (and operations
management), and marketing channels.
9. Logistics is the part of the supply chain that plans, implements, and controls the effective flows and inventory
of raw material, component parts, and products used in manufacturing. The core activities performed in
logistics are to manage global distribution centers, inventory management, packaging and materials handling,
transportation, and reverse logistics.
10. Purchasing represents the part of the supply chain that involves worldwide buying of raw material, component
parts, and products used in manufacturing of the company’s products and services. The core activities
performed in purchasing include development of an appropriate strategy for global purchasing and selecting
the type of purchasing strategy best suited for the company.
11. Managing a supply chain involves orchestrating effective just-in-time inventory systems, using information
technology, coordination among functions and entities in the chain, and developing interorganizational
relationships.
12. Just-in-time systems generate major cost savings by reducing warehousing and inventory holding costs and by
reducing the need to write off excess inventory. In addition, JIT systems help the firm spot defective parts and
remove them from the manufacturing process quickly, thereby improving product quality.
13. Information technology, particularly internet-based electronic data interchange, plays a major role in materials
management. EDI facilitates the tracking of inputs, allows the firm to optimize its production schedule, lets
the firm and its suppliers communicate in real time, and eliminates the flow of paperwork between a firm and
its suppliers.
14. Global supply chain coordination refers to shared decision-making opportunities and operational collaboration
of key global supply chain activities.
15. The depth and involvement in interorganizational relationships in global supply chains should be based on the
degree of coordination, integration, and transactional versus relationship emphasis that the firm should adopt
in partnering with other entities in the global supply chain.

Critical Thinking and Discussion Questions

1. An electronics firm is considering how best to supply the world market for microprocessors used in consumer
and industrial electronic products. A manufacturing plant costs about $500 million to construct and requires a
 highly skilled workforce. The total value of the world market for this product over the next 10 years is
estimated to be between $10 billion and $15 billion. The tariffs prevailing in this industry are currently low.
What kind of location(s) should the firm favor for its plant(s)?
2. A chemical firm is considering how best to supply the world market for sulfuric acid. A manufacturing plant
costs about $20 million to construct and requires a moderately skilled workforce. The total value of the world
market for this product over the next 10 years is estimated to be between $20 billion and $30 billion. Page 525
The tariffs prevailing in this industry are moderate. What kind of location(s) should the firm seek for
its plant(s)?
3. A firm must decide whether to make a component part in-house or to contract it out to an independent
supplier. Manufacturing the part requires a nonrecoverable investment in specialized assets. The most efficient
suppliers are located in countries with currencies that many foreign exchange analysts expect to appreciate
substantially over the next decade. What are the pros and cons of (a) manufacturing the component in-house
and (b) outsourcing manufacturing to an independent supplier? Which option would you recommend? Why?
4. Reread the Management Focus “IKEA Production in China,” and then answer the following questions:
a. What are the benefits to IKEA of shifting so much of its global production to China?
b. What are the risks associated with a heavy concentration of manufacturing assets in China?
c. What strategies might IKEA adopt to maximize the benefits and mitigate the risks associated with
moving so much product?
5. Explain how the global supply chain functions of (a) logistics and (b) purchasing can be used to strategically
leverage the global supply chains for a manufacturing company producing mobile phones.
6. What type of interorganizational relationship should a global company consider in the (a) inbound portion of
its supply chains if the goal is to buy commodity-oriented component parts for its own production and (b)
outbound portion of its supply chains if the goal is to establish a strong partnership in reaching end-
customers?

global EDGE research task globaledge.msu.edu

Use the globalEDGE™ website (globaledge.msu.edu) to complete the following exercises:

1. The globalization of production makes many people aware of the differences in manufacturing costs
worldwide. The U.S. Department of Labor’s Bureau of International Labor Affairs publishes the Chartbook of
International Labor Comparisons. Locate the latest edition of this report, and identify the hourly
compensation costs for manufacturing workers in China, Brazil, Mexico, Turkey, Germany, and the United
States.
2. The World Bank’s Logistics Performance Index (LPI) assesses the trade logistics environment and
performance of countries. Locate the most recent LPI ranking. What components for each country are
examined to construct the index? Identify the top 10 logistics performers. Prepare an executive summary
highlighting the key findings from the LPI. How are these findings helpful for companies trying to build a
competitive supply chain network?

CLOSING CASE
Procter & Gamble Remakes Its Global Supply Chains
Procter & Gamble (P&G) is the world’s leading manufacturer of consumer products. P&G, founded in 1837 by British
American William Procter and Irish American James Gamble, is headquartered in Cincinnati in the United States, and
the company has now been built into a $67 billion conglomerate. Within its portfolio, P&G has 21 billion-dollar brands
(e.g., Bounty, Crest, Tide), operates 130 plants staffed by 95,000 people, has some 70,000 suppliers around the world,
and sells its products in more than 180 countries. By all accounts, P&G has been a giant multinational corporation for
more than a century and will continue to be highly influential in consumer products for years to come.
At the same time, very few industries are as competitive as consumer packaged goods. Just think about the options
you now have compared with five years ago. In most cases, we as customers have many more options in every consumer
packaged-goods category than we did then. The global marketplace has a lot to do with this competitive environment.
Fragmentation and specialization in consumer products from more companies have resulted in more products and more
places from which to buy. The infrastructure for developing products, entering markets, and maintaining Page 526
customer relationships is more robust than ever, resulting in small- and medium-sized enterprises (SMEs)
being competitive with companies like P&G (which they could not have competed with just a few years ago).
This market competitiveness has led companies like P&G to constantly assess the efficiencies and effectiveness of
their production, operations, and global supply chains. For a long-standing industry titan like P&G, this increasingly
competitive global environment—see the figures in Chapter 1 that show the drastically increased international trade in
the last 20 years—has led to a newfound sense of urgency for P&G to get closer to both its customers and suppliers to
maximize diminishing margins while selling products at a competitive price. This is not an easy task, because margins in
the consumer packaged goods market are already very tight. That led P&G to evaluate and ultimately remake their global
supply chains.
P&G’s goal is to replenish at least 80 percent of the retail orders the company receives in less than a day. To be
able to do this, P&G redesigned its distribution network. The company has improved transparency throughout the end-to-
end supply chain, developed even stronger partnerships with its suppliers, and focused on maximizing synergy
throughout the production cycle. Given this focus on synergy and supplier partnerships, P&G now develops global
strategic supply chain plans jointly with (at least) its core suppliers. This is not to say that all 70,000 suppliers working
with P&G are involved, but the so-called “strategic suppliers” are very much entrenched in working together with P&G.
P&G’s 70,000 suppliers include chemical companies (e.g., Dow Chemicals, DuPont) that supply raw materials for
cleaning supplies; packaging companies (e.g., Diamond Packaging, Van Genechten Packaging) that supply packaging
materials for the company’s products; and indirect providers (e.g., Jones Lang Lasalle) that deliver services such as
warehouse maintenance and janitorial services. With the number and breadth of suppliers, P&G continuously focuses on
maintaining a strong supplier relations program. Guiding its supplier relations program, P&G has a set of core principles:
(1) Best Total Value, (2) Honest, Ethical, and Fair Dealings, (3) Externally Linked Supply Solutions, (4) Competition
and Collaboration, and (5) Supplier Incumbency.
P&G appears to be in the forefront of continually evaluating and, when needed, remaking its global supply chains
to maintain the titan position in the consumer packaged goods industry. Despite this success at being able to remake
itself so far, one can wonder if P&G, at some point, will run into difficulties competing with companies like Alibaba and
Amazon. Or, will Alibaba and Amazon simply continue to sell P&G’s products (instead of starting to market their own).
Alternatively, will companies like P&G be able to use their sophisticated global supply chains to expand into new
territories similar to what Alibaba and Amazon did not too long ago?
Sources: “Technology Has Upended the World’s Advertising Giants,” The Economist, March 28, 2018; Demitrios Kalogeropoulo, “Will 2018 Be Procter & Gamble’s Best Year Yet?” The
Motley Fool, November 12, 2017; and Matt Gunn, “How Supply Chain Transformation Saved P&G $1.2 Billion,” GT Nexus Commerce Network, April 29, 2015.

Case Discussion Questions

1. P&G is the world’s leading manufacturer of consumer products, but most customers do not really know the P&G
brand. Does that matter, or should P&G brand more of their products under the P&G brand (instead of Bounty,
Crest, Tide, and so on)?
2. Considering P&G’s massive product portfolio and the company’s enormous size, what global supply chain
efficiencies do you think P&G has that other companies cannot match given the size and scope of P&G?
3. Given P&G’s focus on synergy and supplier partnerships, how many of P&G’s suppliers do you think should be
labeled strategic, and how many should be considered just transactional relationships, and why?
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Endnotes
1. T. Hult, D. Closs, and D. Frayer, Global Supply Chain Management: Leveraging Processes, Measurements, and
Tools for Strategic Corporate Advantage (New York: McGraw-Hill Professional, 2014).
2. D. A. Garvin, “What Does Product Quality Really Mean,” Sloan Management Review 26 (Fall 1984), pp. 25–44.
3. See the articles published in the special issue of the Academy of Management Review on Total Quality
Management 19, no. 3 (1994). The following article provides a good overview of many of the issues Page 527
involved from an academic perspective: J. W. Dean and D. E. Bowen, “Management Theory and Total
Quality,” Academy of Management Review 19 (1994), pp. 392–418. Also see T. C. Powell, “Total Quality
Management as Competitive Advantage,” Strategic Management Journal 16 (1995), pp. 15–37; and S. B. Han et
al., “The Impact of ISO 9000 on TQM and Business Performance,” Journal of Business and Economic Studies 13,
no. 2 (2007), pp. 1–25.
4. For general background information, see “How to Build Quality,” The Economist, September 23, 1989, pp. 91–
92; A. Gabor, The Man Who Discovered Quality (New York: Penguin, 1990); P. B. Crosby, Quality Is Free (New
York: Mentor, 1980); and M. Elliot et al., “A Quality World, a Quality Life,” Industrial Engineer, January 2003,
pp. 26–33.
 5. G. T. Lucier and S. Seshadri, “GE Takes Six Sigma Beyond the Bottom Line,” Strategic Finance, May 2001, pp.
40–46; and U. D. Kumar et al., “On the Optimal Selection of Process Alternatives in a Six Sigma
Implementation,” International Journal of Production Economics 111, no. 2 (2008), pp. 456–70.
6. M. Saunders, “U.S. Firms Doing Business in Europe Have Options in Registering for ISO 9000 Quality
Standards,” Business America, June 14, 1993, p. 7; Han et al., “The Impact of ISO 9000.”
7. G. Stalk and T. M. Hout, Competing against Time (New York: Free Press, 1990).
8. N. Tokatli, “Global Sourcing: Insights from the Global Clothing Industry—The Case of Zara, a Fast Fashion
Retailer,” Journal of Economic Geography 8, no. 1 (2008), pp. 21–39.
9. Diana Farrell, “Beyond Offshoring,” Harvard Business Review, December 2004, pp. 1–8; and M. A. Cohen and
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Evidence (Oxford, UK: Oxford University Press, 1979). See also C. W. L. Hill and G. R. Jones, Strategic
Management: An Integrated Approach (Boston: Houghton Mifflin, 2004).
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Automation on Business Strategy and Organizational Structure,” Academy of Management Review 17 (1992), pp.
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Press, 1993); S. Kotha, “Mass Customization: Implementing the Emerging Paradigm for Competitive
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Faces of Mass Customization,” Harvard Business Review, January–February 1997, pp. 91–101; M. Zerenler and
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15. P. Waurzyniak, “Ford’s Flexible Push,” Manufacturing Engineering, September 2003, pp. 47–50.
16. Hult et al., Global Supply Chain Management.
17. F. Kasra, “Making the Most of Foreign Factories,” in World View, ed. J. E. Garten (Boston: Harvard Business
School Press, 2000).
18. “The Boomerang Effect,” The Economist, April 21, 2012; and Charles Fishman, “The Insourcing Boom,” The
Atlantic, December 2012.
19. This anecdote was told to one of the authors by a Microsoft manager while the author was visiting Microsoft
facilities in Hyderabad, India.
20. Interview by one of the authors. The manager was a former executive MBA student of the author.
21. Hult et al., Global Supply Chain Management.
22. Hult et al., Global Supply Chain Management.
23. D. A. Beeton, Technology Roadmapping in the Packaging Sector (Cambridge, UK: Institute for Manufacturing,
University of Cambridge, 2004).
24. J. A. Peterson and V. Kumar, “Can Product Returns Make You Money?” MIT Sloan Management Review 51, no.
3 (2013), pp. 85–89.
25. Hult et al., Global Supply Chain Management; and R. J. Trent and R. M. Monczka, “Achieving Excellence in
Global Sourcing,” MIT Sloan Management Review 47, no. 1 (2005), pp. 24–32.
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December 8, 2004, p. A1.
29. D. J. Bowersox, D. J. Closs, M. B. Cooper, and J. C. Bowersox, Supply Chain Logistics Management (New York:
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30. J. C. Anderson, J. A. Narus, and W. van Rossum, “Customer Value Propositions in Business Markets,” Harvard
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