International Business and TradeGM0112, Global Sourcing (II)

Global sourcing strategies- The WHAT question

Professor Bent PetersenVisiting Professor

1Global Sourcing - Fall 2010

Contents of today’s lecture

1. What drives global sourcing?

2. Global sourcing choices and strategies: The WHAT question…

…decomposed into a) Cognitive factorsb) Economic/strategic factorsc) Motivational factors

- the ‘comfort zone’ of managers

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What Drives Firms’ Global Sourcing?

1. Improved transportation technology (e.g. containerization)

2. Advances of I&CT (digitization!)3. Market integration (emerging markets, WTO,

lower trade barriers and lifted FDI restrictions)4. Improved market institutions, such as:

Enforcement of IPR (e.g. TRIPS, WTO) Industry standards Certification, accreditation (e.g. ISO 9001; SEI/CMM)

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Configuration of value chain activities

Coordination of value chain activities

Dispersed Concentrated

Low

High

Lower coordination (I&CT) and transportation costs

Market Integration

Porter’s (1986) global value chain framework

Shrinking factor cost differentials

Global sourcing

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Local GlobalRegional

Arm’s length(procurement)

Contractual(outsourcing)

Equity (FDI)

Value chain specialization(Global sourcing)

Low (dispersed configuration/ sparse coordination)

Geographical expansion of sales(The Psychic Distance phenomenon)

Resource commitment to foreign sales effort

(The Establishment Chain phenomenon)

High (concentrated configuration/ extensive coordination)

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Re-Configuring the Value Chain

MNCs are in the process of a dual transformation of their value chains:

1. A surge from dispersed to concentrated configuration strategies in which global sourcing plays a vital role.

2. A surge in direction of a more fragmented (or ‘fine-sliced’) and modularized value chain in which offshore outsourcing plays a prominent role.

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Typical US MNC re-configuration pattern

0. Point Zero: Dispersed, un-coordinated TNC units.1. Establishment of (regional) Shared Services

Centers Consolidation in terms of scale economies and transparent cost structures (establishment of ‘pinch points’).

2. Fragmentation and modularization of value chain activities.

3. Decision about location (on/near/off-shore?) and ownership (captive/JV/outsourced?).

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MNC example: American Express

1990s: 46 sites carrying out travel related services.– Process duplication and inconsistencies– Lack of customer focus– Inflexible, legacy applications

1993: 3 regional shared services centers in Phoenix USA, Brighton UK, Gurgaon India.

2000s: The Indian captive center provides services to Amex units outside Asia, thereby becoming a global sourcing center.

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Global sourcing choices and strategies:

The WHAT question

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The WHAT question What should be done “at home” at what abroad?

What should be done for local use (i.e. dispersed value chain activities) and what for global use (i.e. concentrated value chain activities)?

Reformulation: Which production factors/inputs (labor, human and physical capital, raw materials, intermediary products, etc.) should be sourced at home, which abroad? Which for local/global use?

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Decomposing the WHAT question1. Cognitive factors: What global sourcing opportunities are

envisaged in the first place? HQ heuristics. Global mindset. Perceived risks.

2. Economic/strategic factors: What global sourcing is economic feasible? Exploitation of global factor cost differentials. Efficiency in MNC coordination, economizing on information costs.

3. Motivational factors: What global sourcing is ‘political feasible’ in the organization? Does global sourcing conflict with its ‘comfort zone’?

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Cognitive factors Global sourcing as a learning process (like the

‘Uppsala model’). Bounded rationality, cognitive limitations.

“Went for cost, stayed for quality (Dossani & Kenney, 2003).

Overconfidence of inexperienced MNCs See also Maskell et al. (2007) about offshore

outsourcing learning processes: The scope of offshored activities is broadened with experience.

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Broadening the scope of Business Process Outsourcing

Examples of back-office activities that – through digitization – are being outsourced to Indian firms (i.e. offshore BPO):

IT Finance & Accounting Debt collection Payroll administration HR operations R&D processes

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Outsourcing segments

..

Basic Transactions (Project outsourcing)

Rules-Based Processing (BPO)

Discretion-Based Problemsolving (TDO)

Knowledge-based Processing (KPO)

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‘Drifting’ into global sourcing

Is global sourcing a result of a deliberate or emergent strategy?

Global sourcing implies a re-orientation of managerial mindset from etnocentrism to geocentrism.

In any case global sourcing is more than supply chain management… SCM is just the ”tip of the iceberg”:

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GEOCENTRISM

Corporate language

HR Mgt

Risk mgt Time zone mgt

Performance mgt

KM (codification)

ETNOCENTRISM

SC mgt

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Economic/strategic factors Cost savings are still driving global sourcing… …but “access to qualified labor” is quickly gaining

importance (No 2 factor in services). “Race for talent” Global sourcing of “Product development” is gaining

importance – in particular among SMEs! Knowledge transfer costs, including costs of

standardization and codification, seem to be underestimated by (Danish) MNCs.

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Production cost savings versus extra transaction and transportation costs

Benefits Extra costs Percentage

100 100 20-25

75

5-10 5 70 10-15 5

10 5

50 50

25

0

Production costs in

high costs countries

Labor Deprecia-tion

Materials, components and tooling

Scale. LCC manufac-

turing costs

Logistics costs (e.g.

transportation)

Other management

costs

Duties Landed cost from LCC

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Economic factors related to knowledge transfer

Standardization of operational procedures Codification of operational procedures Communication skills (e.g. language

proficiency, corporate I&CT infrastructure)

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Coloplast on standardization

“At that time we had three different divisions [in Denmark], and they had their own

systems of everything: their own way of documenting things, their own way of

analyzing things, and – as an example - their own clean room instructions.”

(Project Director, Coloplast China)

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Coloplast on codification

“In the beginning the Danish organization had the task to prepare the documentation

around the equipment and the know-how - transfer meaning operation, training…”

(Local Quality and Business Improvement Manager of Hungarian operations)

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On codification & language

“A lot of the knowledge is sitting in the head of the operators. They know what they are doing so they do not have to write down. So we have to take the

knowledge from the operators, put it down on paper and translate it into English.”

(Transfer Manager, Global Operations Unit)

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Motivational factors

Comfort zone of managers: Global sourcing has to unfold within the ‘comfort zone’ of the decision-makers (the management). How much ‘control loss’ is acceptable? What is political feasible? Can managers leverage on global sourcing while still keeping in control?

Comfort zones of other stakeholders: When engaging in global sourcing managers have to consider the interests of various stakeholders : home country employees, labor unions, NGOs, politicians, and the ‘public opinion’ (CSR!!) in general.

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Typical IT outsourcing stages

Project outsourcing

Business Process Outsourcing

Knowledge Process Outsourcing

Total Development Outsourcing

Potential loss of HQ control – Need for comfort zone extension

Incr

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The ‘comfort zone’ of the sourcing firm

Global Sourcing - Fall 2010 25

The comfort zone and inter-dependency THEORETICAL FOUNDATION: Resource-based view (Barney e.g. 1991),

Competence-based theory (Prahalad & Hamel, 1990) Degree of inter-task interdependence is a key determinant of inter-site

interaction and communications (Thompson, 1967; Van de Ven, 1976)

Independence Interdependence

• Resources can be purchased in factor markets• Substitutable resources• Reliance on long-linked technology

• Reliance on intensive technology• Hand-offs (Kumar et al, 2009) exist and fitting/integration needed at both ends• Valuable, rare and in-imitable resources

Comfort zone extension: Managerial instruments to mitigate high coordination cost: e.g. modularization, transfer of personnel, standardization of routines (e.g. through ERP systems)

The comfort zone in relation to irreversibility

THEORETICAL FOUNDATION: Industrial economics including transaction cost economics (Baumol & Willig, 1981; Williamson, 1975)

Strategy is essentially about irreversible decisions (Ghemawhat, 1991)

Reversible investment

Comfort zone extension: Managerial instruments to mitigate high investment risk: e.g. real options (Kogut & Kulatilaka, 1994), bonding efforts (Jensen & Meckling, 1976)

Irreversible investment

• Resources are mobile• Low relocation costs• Low switching costs• General purpose technology

• Transfer stickiness• High degree of specialization• High asset specificity • Sunk investment

Comfort zone and discretionary judgment allocated to the local operator

THEORETICAL FOUNDATION: Organizational Learning, Dynamic Capabilities Exploration and exploitation complement each other, there must be a balance

between the two (March, 1991)

Exploitation Exploration

•Discovery•Innovation•Independent judgment in execution

•Implementation•Efficiency•High control by home firm

Managerial instruments to mitigate loss of formal control: e.g. socialization, (O’Donnell, 2000), boundary spanners (e.g. expats), transfer of personnel (Edström & Galbraith, 1977; Grant et al, 2002)

Coloplast on HQs’ comfort zone (resistance)

“You will understand; when you take a decision of transferring a certain amount of production out of

Denmark to somewhere else, you also transfer power. They used to be responsible for a big area,

a lot of machines and a lot of employees - and suddenly, you can see that this is going to

diminish.”

(Former Manager of Coloplast’s Hungarian operations)

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Coloplast on HQ resistance (cont’d)

“There was an unspoken resistance towards the transfer of production equipment. It was not so

much a resistance that was embedded in the Danish blue collar workers or the technicians taking part in the transfer [to Hungary]. In my experience, it was the resistance that was in the head of the leaders

and managers responsible for production in Denmark”

(Manager of Coloplast’s Hungarian operations)

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Coloplast on job security

“The main success factor in our offshoring processes was the job-offering guarantee that

we gave to the Danish workers all along. I think that had we not done that, people

would not have worked with us.”

(Director, Wound Care)

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