Introduction
In this chapter, we look at the problems that Li & Fung and many other enterprises are facing and at the various solutions. We will be concerned with answering three central questions:
· Where in the world should productive activities be located?
· How much production should be performed in-house and how much should be out-sourced to foreign suppliers?
· What is the best way to coordinate a globally dispersed supply chain?
We will examine each of the three questions posed above in turn.
We used the term production to denote both service and manufacturing activities, since one can produce a service or produce a physical product. We defined materials management as "the activity that controls the transmission of physical materials through the value chain, from procurement through production and into distribution." Materials management includes logistics, which refers to the procurement and physical transmission of material through the supply chain, from suppliers to customers. Manufacturing and materials management are closely linked, since a firm's ability to perform its manufacturing function efficiently depends on a continuous supply of highquality material inputs, for which materials management is responsible.
The manufacturing and materials management functions of an international firm have a number of important strategic objectives. Productivity increases because time is not wasted manufacturing poor-quality products that cannot be sold. This saving leads to a direct reduction in unit costs.
· Increased product quality means lower rework and scrap costs.
· Greater product quality means lower warranty and rework costs.
The main management technique that companies are utilizing to boost their product quality is total quality management (TQM). TQM is a management philosophy that takes as its central focus the need to improve the quality of a company's products and services.
In addition to the objectives of lowering costs and improving quality, two other objectives have particular importance in international businesses. First, manufacturing and materials management must be able to accommodate demands for local responsiveness. Second, manufacturing and materials management must be able to respond quickly to shifts in customer demand. In recent years time - based competition has grown more important.
Where to Manufacture
Country Factors
We reviewed country - specific factors in some detail earlier in the book and we will not dwell on them here. Political economy, culture, and relative factor costs differ from country to country.
Another country factor is expected future movements in its exchange rate. Adverse changes in exchange rates can quickly alter a country's attractiveness as a manufacturing base. Currency appreciation can transform a lowcost location into a high - cost location.
Technological Factors
The technology we are concerned with in this subsection is manufacturing technology--the technology that performs specific manufacturing activities. The type of technology a firm uses in its manufacturing can be pivotal in location decisions.
Fixed Costs
But a relatively low level of fixed costs can make it economical to perform a particular activity in several locations at once. One advantage of this is that the firm can 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.
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.7 However, beyond a certain level of output, few additional scale economies are available.
The implications of this concept are as follows: The larger the minimum efficient scale of a plant, 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 relatively low, it may be economical to manufacture a product at several locations. As in the case of low fixed costs, the advantages are allowing the firm to accommodate demands for local responsiveness or to hedge against currency risk by manufacturing the same product in several locations.
Flexible Manufacturing (Lean Production)
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 one 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. Increasing product variety makes it difficult for a company to increase its manufacturing efficiency and thus reduce its unit costs. This view of manufacturing efficiency has been challenged by the recent rise of flexible manufacturing technologies. The term flexible manufacturing technology--or lean production as it is often called--covers a range of manufacturing technologies that are designed to reduce setup times for complex equipment, increase utilization of individual machines through better scheduling, and improve quality control at all stages of the manufacturing process. Flexible manufacturing technologies allow a 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. The term mass customization has been coined to describe this ability. Mass customization implies that a firm may be able to customize its product range to suit the needs of different customer groups without bearing a cost penalty. Research suggests that the adoption of flexible manufacturing technologies may increase efficiency and lower unit costs relative to what can be achieved by the mass production of a standardized output.10
Flexible manufacturing technologies vary in their sophistication and complexity.
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.
Improved capacity utilization and reductions in work in progress and waste are major efficiency benefits of flexible machine cells. Improved capacity utilization arises from the reduction in setup times and from the computer-controlled coordination of production flow between machines, which eliminates bottlenecks. The efficiency benefits of installing flexible manufacturing technology can be dramatic.
Product Factors
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. The opposite holds for products with low value-to-weight ratios. Refined sugar, certain bulk chemicals, paints, 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.
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 .
Locating Manufacturing Facilities
As can be seen, concentration of manufacturing makes most sense when:
· Differences between countries in factor costs, political economy, and culture have a substantial impact on the costs of manufacturing in various countries.
· Trade barriers are low.
· Important exchange rates are expected to remain relatively stable.
· The production technology has high fixed costs, a high minimum efficient scale, or a flexible manufacturing technology exists.
· The product's value-to-weight ratio is high.
· The product serves universal needs.
Alternatively, decentralization of manufacturing is appropriate when:
· Differences between 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.
· Volatility in important exchange rates is expected.
· The production technology has low fixed costs, 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 .
The Strategic Role of Foreign Factories
Initially, many foreign factories are established where labor costs are low. Their strategic role typically is to produce labor-intensive products at as low a cost as possible. They located their factories in countries such as Malaysia, Thailand, and Singapore precisely because each of these countries offered an attractive combination of low labor costs, adequate infrastructure, and a favorable tax and trade regime.
First, pressure from the center to improve a factory's cost structure and/or customize a product to the demands of consumers in a particular nation can start a chain of events that ultimately leads to development of additional capabilities at that factory.
A second source of improvement in the capabilities of a foreign factory can be the increasing abundance of advanced factors of production in the nation in which the factory is located.Their communications and transportation infrastructures and the education level of the population have improved.
For the manager of an international business, the important point to remember is that foreign factories can improve their capabilities over time, and this can be of immense strategic benefit to the firm. Rather than viewing foreign factories simply as sweatshops where unskilled labor churns out low-cost goods, managers need to view them as potential centers of excellence and to encourage and foster attempts by their local managers to upgrade the capabilities of their factories and, thereby, enhance their strategic standing within the corporation.
Make-or-Buy Decisions
International businesses frequently face sourcing decisions, decisions about whether they should make or buy the component parts that go into their final product.
The Advantages of Make
Lower Costs
It may pay a firm to continue manufacturing a product or component part in-house if the firm is more efficient at that production activity than any other enterprise. Boeing, for example, recently undertook a very detailed review of its make-or-buy decisions with regard to commercial jet aircraft . Its rationale was that Boeing has a core competence in the production of wings, and it is more efficient at this activity than any other comparable enterprise in the world.
Facilitating Specialized Investments
A variation of that concept explains why firms might want to make their own components rather than buy them. The argument is that when one firm must invest in specialized assets to supply another, mutual dependency is created. In such circumstances, each party fears the other will abuse the relationship by seeking more favorable terms.
Let us first examine this situation from the perspective of an independent supplier who has been asked by Ford to make this investment. The supplier might reason that once it has made the investment, it will become dependent on Ford for business since Ford is the only possible customer for the output of this equipment. The supplier perceives this as putting Ford in a strong bargaining position and worries that once the specialized investment has been made, Ford might use this to squeeze down prices for the carburetors. Given this risk, the supplier declines to make the investment in specialized equipment.
In general, we can predict that when substantial investments in specialized assets are required to manufacture a component, the firm will prefer to make the component internally rather than contract it out to a supplier. A growing amount of empirical evidence supports this prediction.
Proprietary Product Technology Protection
Proprietary product technology is technology unique to a firm. If it enables the firm to produce a product containing superior features, proprietary technology can give the firm a competitive advantage. The firm would not want this technology to fall into the hands of competitors. If the firm contracts out the manufacture of components containing proprietary technology, it runs the risk that those suppliers will expropriate the technology for their own use or that they will sell it to the firm's competitors.
The Advantages of Buy
Strategic Flexibility
The great advantage of buying component parts from independent suppliers is that the firm can maintain its flexibility, switching orders between suppliers as circumstances dictate. This is particularly important internationally, where changes in exchange rates and trade barriers can alter the attractiveness of supply sources. Sourcing component parts from independent suppliers can also be advantageous when the optimal location for manufacturing a product is beset by political risks. Under such circumstances, foreign direct investment to establish a component manufacturing operation in that country would expose the firm to political risks.
However, maintaining strategic flexibility has its downside.
Lower Costs
First, the greater the number of subunits in an organization, the greater are the problems of coordinating and controlling those units. Coordinating and controlling subunits requires top management to process large amounts of information about subunit activities. The greater the number of subunits, the more information top management must process and the harder it is to do well. Second, the firm that vertically integrates into component part manufacture may find that because its internal suppliers have a captive customer in the firm, they lack an incentive to reduce costs. The fact that they do not have to compete for orders with other suppliers may result in high operating costs. Third, leading on from the previous point, vertically integrated firms have to determine appropriate prices for goods transferred to subunits within the firm.
Offsets
Another reason for outsourcing some manufacturing to independent suppliers based in other countries is that it may help the firm capture more orders from that country. As noted in the Management Focus on Boeing, the practice of offsets is common in the commercial aerospace industry.
Trade-offs
Trade-offs are involved in make-or-buy decisions. The benefits of manufacturing components in-house seem to be greatest when highly specialized assets are involved, when vertical integration is necessary for protecting proprietary technology, or when the firm is simply more efficient than external suppliers at performing a particular activity.
When these conditions are not present, the risk of strategic inflexibility and organizational problems suggest that it may be better to contract out component part manufacturing to independent suppliers.
Coordinating a Global Manufacturing System
Materials management, which encompasses logistics, embraces the activities necessary to get materials to a manufacturing facility, through the manufacturing process, and out through a distribution system to the end user.
Materials management is a major undertaking in a firm with a globally dispersed manufacturing system and global markets. Consider the example of Bose Corporation, which is presented in the accompanying Management Focus.
The Power of Just-in-Time
The basic philosophy behind just-in-time (JIT) 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 saving comes from speeding up inventory turnover; this reduces inventory holding costs, such as warehousing and storage costs.
In addition to the cost benefits, JIT systems can also help firms improve product quality.
The Role of Organization
As the number and dispersion of domestic and foreign markets and sources grow, the number and complexity of organizational linkages increase correspondingly. In a multinational enterprise, the challenge of managing the costs associated with purchases, currency exchange, inbound and outbound transportation, production, inventory, communication, expediting, tariffs and duties, and overall administration is massive. A major requirement seems to be to legitimize materials management by separating it out as a function and giving it equal weight, in organizational terms, with other more traditional functions such as manufacturing, marketing, and R&D. According to materials management specialists, purchasing, production, and distribution are not separate activities but three aspects of one basic task: controlling the flow of materials and products from sources of supply through manufacturing and distribution into the hands of customers.
Having established the legitimacy of materials management, the next dilemma is determining the best structure in a multinational enterprise. In practice, authority is either centralized or decentralized.23 Under a centralized solution, most materials management decisions are made at the corporate level, which can ensure efficiency and adherence to overall corporate objectives. This is the case at Bose Corporation, for example. In large, complex organizations with many manufacturing plants, however, a centralized materials management function may become overloaded and unable to perform its task effectively. In such cases, a decentralized solution is needed.
A decentralized solution delegates most materials management decisions to the level of individual manufacturing plants within the firm, although corporate headquarters retains responsibility for overseeing the function. The great advantage of decentralizing is that it allows plant-level materials management groups to develop the knowledge and skills needed for interacting with foreign suppliers that are important to their particular plant. This can lead to better decision making. The disadvantage is that a lack of coordination between plants can result in less than optimal global sourcing. It can also lead to duplication of materials management efforts. These disadvantages can be attenuated, however, by information systems that enable headquarters to coordinate the various plant-level materials management groups.
The Role of Information Technology
As we saw in the Management Focus on Bose Corporation, information systems play a crucial role in modern materials management. 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.
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