IS_World_Report_SCMR_LM_PSU_WP1123

Center for Supply Chain Research

Supply Chain Risks: Barriers to Manufacturing in Emerging and Developing Marketsby Danielle Gallagher, Research Assistant, Center for Supply Chain Research

ABSTRACT: This report was originally tailored to the request of an electronics manufacturer, to explore emerging markets and the political and economic barriers to direct investment. The various business risks that influence supply chain risk as a whole are discussed. Forty-one countries that represent emerging markets are represented by five macro indicators, with an overall regional analysis. The full report, available through the Center for Supply Chain Research, contains analyses for each country.

INTRODUCTIONSupply chains today are becoming increasingly global and complex, creating risk at every level of product development, manufacturing, and distribution. Approximately 42 percent of companies have global manufacturing footprints (Cohen et al., 4). Facing pressures to cut costs, especially labor and materials, companies have been turning to developing markets for facility locations. China represents one-third of off-shoring investments, and is a preferred location for manufacturing, followed by India and Eastern Europe (Cohen et al., 7). Manufacturing in emerging markets can bring a company closer to suppliers and raw materials, cutting transit time. Outsourced manufacturing also provides access to local markets, reducing the cost of distributing final products and sales costs.

Global operations, while helping to achieve cost savings and market penetration, undoubtedly are accompanied by risk. Among U.S. companies with revenue exceeding $1 billion, 73 percent experienced supply chain disruptions in the past five years (“Keeping Ahead of Supply Chain Risk and Uncertainty”).

Economic and non-economic forces must be considered to create a more complete picture of supply chain disruption risks. For a long-term investment approach, a manufacturing location should be appropriate to a company’s business model, and should be analyzed using a holistic definition of risk. This report presents supply chain risks associated with facility locations in emerging markets, the effects of supply chain risks, mitigation strategies, and an overview of select emerging markets.

EMERGING MARKET DEFINITION Table 1 describes some key characteristics of market maturity levels in emerging, developed, and developing markets. Many countries are transitioning from a lower lever to a higher one. To cover a wider range of opportunities, this report highlights both emerging and developing markets.

Table 1: Market Definitions

Adapted from Accenture’s ”Sourcing and Selling in Emerging Markets,”2008.

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Emerging

Undeveloped infrastructure and distribution

Fragmented industries

Low third party capability

Low cost labor availability

Developing

Mix of traditional and modern distribution channels

Increasing competition and consolidation of industries

Difficult to access sophisticated supply chain capabilities

Developed

Modern distribution channels

Intense competition

Easier to attract skilled talent

Processes and infrastructure which supports collaboration

SUPPLY CHAIN RISKS ASSOCIATED WITH OUTSOURCED MANUFACTURINGSupply chain risk is a complex equation of risks that a business encounters between raw material extraction and final product delivery. From supplier selection, to paying customs charges, to hiring or firing, supply chain managers should consider all aspects of risk while considering emerging markets for off-shoring. “Risk” is defined from a practitioner’s standpoint as having specific financial impact (Siciliano et al., 14). There often exists a distinct boundary between supply chain risk and financial risk in decision making processes, yet the two will naturally impact one another. Supply chain risk, if fully realized, will incur costs along the supply chain.

Supply chain risk can be considered as the probability of disruption occurring that impacts the flow of goods, information or funds in the supply chain. Disruption is the specific event that is a manifestation of the risk, and the financial impact is the dollarized damage caused by the disruption. While the risks of lost customer service and transit times are not financial metrics, they can be tied back into company effectiveness and profitability, and therefore should be considered as significant risks. Five main categories, listed in Table 1, provide an outline of main risk drivers.

Table 2. Supply Chain Risk Drivers

1. Trade RiskTrade risk centers on regulatory compliance, specifically dealing with the export and import of goods. Trade risk factors includes customs valuation, transshipment, government agency controls (consumer safety, trade regulations), anti-dumping and countervailing duties, requirements of free trade agreements & special trade provisions, export licensing and controls, and changes to the Harmonized Tariff Schedule (Siciliano et al., 14). The cost of compliance is two-fold: typical duties, and punitive fines. Government enforcement of customs – leading to hefty fines in the case of noncompliance – has been on the rise (Siciliano et al., 14). Such increased scrutiny and potential penalties have been noted as an area of concern for executives.

Security

Over 90 percent of world trade is accounted by overseas shipping, translating to a high value of goods that are subject to risk while in transit (Sarathy, 28). In addition to financial and regulatory trade risk, companies face the risk of cargo security while shipping raw materials, work in process, and finished goods. Terrorism, theft, and transfer of parasites and diseases, are all concerns that increase with outsourcing manufacturing in development markets. Having

inventory transported internationally subject to increased risk will also be reflected in higher insurance premiums (Sarathy 31).

Legislation

To ensure security of imports and exports, countries enact legislation to govern the movement of goods through maritime and air shipping. While legislation in itself is not a direct supply chain risk, it has a profound effect on the speed and ease with which materials can pass between facilities in different countries.

One newly minted law, effective January 2009, is the 10+2 rule, requiring importers to send 10 pieces of information to U.S. Customs before a shipment can depart from a foreign port, and then 2 pieces of information 24 hours before departure (Hyatt, 2). These additional requirements spur the need to more closely collaborate with supply chain partners, and potentially invest in new IT systems, incurring costs.

A piece of legislation that encourages supply chain security is the U.S. Maritime Transportation Security Act of 2002, which requires vessels and port facilities to assess the vulnerability of their property, and develop security plans.

Compliance Costs

The cost of compliance includes hiring outside consultants to assess trade compliance, time spent in training and testing, and fines in the case of non-compliance. These costs will impact the execution of manufacturing outsourcing, especially in the areas of shipping in raw materials and shipping out work-in-process or finished goods.

In the absence of heavily enforced customs, developing nations have their own version of trade risk. Delays in customs processing, bribery from officials, and erratic enforcement create financial costs and ethical dilemmas.

2. Political RiskPolitical risk covers several factors, including regime stability, religious tensions, bureaucracy, crime, corruption, and inter-state conflict.

Political Regime

The stability of a regime will have an effect on the operations of a business. Regulations will fluctuate with the regime, as will general safety, investment restrictions, and social unrest. In Cote D’Ivoire, there is political instability surrounding presidential elections and politically-motivated militia; businesses are reluctant to start up new business in the country, as they must take significant measures to protect assets and personnel (“Cote D’Ivoire,” PRS Group, 2008).

Social Elements

Social elements such as language, religion, and cultural practices must be factored into an off-shoring decision.

For many countries, religious considerations have a tangential, yet important, effect on business. Observances such as holidays and prayer rituals should be investigated, in preparation for operational planning. Religious and ethnic tensions leading to violence are also a factor in selecting facility locations.

1. Trade Risk2. Political Risk3. Geophysical Risk4. Economic Indicator Risk5. Operational Risk

Supply Chain Risks: Barriers to Manufacturing in Emerging and Developing Markets

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Bureaucracy

Bureaucracy, while creating a structure for political-business relations, can create frustrating barriers to smooth operations. Establishing operations in a new country can take an excessive amount of time, depending on the governmental system and process of approval. Backlogs in judicial systems can delay administration of justice, particularly in countries that have biased courts. Contract enforcement is a problem in many emerging markets; if a supplier, customer, or other business partner fails to honor contracts, companies run the risk of complex or even non-existent arbitration programs (PRS Group, 2009). Some countries do not recognize international court judgments. Law violations can impose financial damage; in Thailand, business regulations are classified under criminal law, instead of civil law, and can lead to very harsh penalties (“Thailand,” PRS Group, 2008).

Crime and Corruption

Corruption can occur at all levels of the government, and can particularly affect businesses in the area of customs and border protection, tax authorities, and organized crime linked with business operations. A recent poll of American companies operating procurement in Asia found that the average company lost 8.2 million dollars over a three year time span due to illegal bribes and kickbacks (Mooney, 1).

War, diplomatic tensions, embargoes, and inter-state conflict due to natural resource control will also contribute to political risk.

3. Geophysical RiskManufacturing operations are exposed to several kinds of risk association with the natural features of different nations. Poor infrastructure can impede distribution, especially in tandem with high levels of congestion. Natural disasters, while a temporary and infrequent occurrence for most countries, can wreak havoc on sourcing and manufacturing operations. About 14 percent of supply chain executives consider natural disasters a top-five risk concern (Atkinson, 2008). Human health factors, such as prevalent diseases affecting the population, can have crippling effects on the labor pool. Distance from suppliers should also be an important factor in deciding manufacturing locations, as disruptions can be magnified as the shipping distance increases.

4. Economic Indicator RiskGDP Growth

A healthy Gross Domestic Product is a good, if complete, snapshot of the state of the economy. It One critical component of GDP significance to supply chain operations is the investment in infrastructure, expressed as a percentage of GDP. One drawback to evaluating GDP as a factor for off-shoring is the fact that an undiversified, risky country can still have a stellar GDP figure due to positive performance of a few key sectors.

Inflation

Inflationary pricing can adversely affect the supply chain in many ways; rising prices in fuel incur higher transportation costs, rising food prices cause labor prices to rise, and both can compound to erode the financial health of operations in emerging markets.

Economic Diversification

If a country relied on a limited number of key sectors or resources for economic prosperity, companies are at risk if that resource or sector experiences a downturn.

5. Operational RisksOperational risk occurs in the day to day execution of the business, including labor, intellectual property, supply disruptions, commodity price volatility, internal product failures, and energy costs.

Labor

Labor is a large factor in locating manufacturing operations. Rigid labor conditions can make it difficult to hire and fire, and any labor reforms often take years to progress through legislation, causing reforms to be enacted infrequently (Doing Business 2009). Having high dismissal costs increase the difficulty of contracting the workforce and inhibits flexibility,

Intellectual Property

Intellectual property protection is a major concern of companies entering new markets. It is estimated that 82 percent of software in China is pirated, which poses risks for companies intending to operate in the region (“China,” PRS Group, 2008). Some countries such as India do not have trade secret protection in their legislation (“India,” PRS Group, 2008). According to a 2005 report by Business Insights, counterfeit pharmaceuticals, due to weak supply chain, security is a multi-billion dollar industry.

Supplier Financial Health

In China, the leading outsourcing destination by the numbers (1/3 of the value of investment), 70,000 companies went bankrupt in 2008 (Hyatt, p. 2). Made more significant given the economic climate, this represents a larger point – that supplier failure is a major supply chain risk. Supply failure is the most highly cited risk by supply chain professionals (O’Marah, 2008). Tightening credit markets globally are inhibiting supplier innovation and investment, and strong manufacturers may be able to increase supply chain security through gaining more control.

Input Risks

Material shortages also contribute to supply chain risk – if inputs are scarce at the manufacturing site, are expensive to hold in stock, or overly expensive to expedite, risk rises (Sarathy, 30). Internal product quality issues due to compromised inputs can facilitate defects through the entire supply chain. Energy cost volatility can be considered as an input risk; from 2008-2009, the level of risk cited by supply chain professionals for volatile energy costs rose 41 percent (O’Marah, 1).

IMPACTS OF SUPPLY CHAIN DISRUPTIONSupply chain risk can result in high inventory levels, lead time variance, longer cycle times, and decreased customer service (Sarathy 28). In a study by PriceWaterhouseCoopers of over 600 firms, it was shown that supply chain disruptions can hurt financial performance for up to two years after the initial incident (Hyatt, 1).



PWC also found that one day after a supply chain disruption was announced, the stock price of a company will fall, on average, 9 percent.

With internal quality failures, it often takes 4-6 weeks for a problem to be detected; this means that there is a large buffer of inventory that may be compromised (“Creating Effective Global Operations in a Multi-Polar World”). Manufacturing in emerging markets extended the pipeline, and can cause flawed or tainted products to travel large distances without being detected.

Supply chain failure can also lead to intangible disruption costs, such as loss of brand image and termination of business relationships (Manuj, 136).

MITIGATION STRATEGIESRisk management is a multi-step, iterative process, to identify, assess, and develop methods to avoid or mitigate potential disruptions (Sarathy, 29). Companies can bring risk to light by using a “vulnerability map,” pinpointing current and potential weak points in the supply chain structure (Sarathy, 30). In addition to a comprehensive corporate risk management strategy, a supply chain risk mitigation strategy includes built-in risk mitigation, having a comprehensive outsourcing selection process, and technological solutions.

Rank Your Risk

Risk of any type is a combination of the probability of loss, and the significance of that loss (Manuj, 135). This leads to each company having a unique risk profile, dependent on the scope of operations. High fashion retailers sourcing from Europe will have a high risk value on port congestion, since they are fast moving goods that obsolesce quickly; an electronics manufacturer that has a single source for a computer chip will certainly place supply failure above many other risks.

Dollarize the Risk

Creating a complete supply chain risk profile, including the costs of disruption if possible, will bring to light the severity of disruption. Some risks are easy to quantify, such as the value of lost sales if there is a three week delay in customs; others, such as natural disasters, cultural factors, and political regime stability, are more nebulous.

1. Build risk mitigation into the systemStarting with product design, risk management should be addressed at each juncture of the supply chain. One tool of proactive prevention is the concept of Total Quality Management (TQM), which focuses on treating root causes, instead of outputs (Sarathy 31). In addition to looking at the symptoms of a supply chain disruption (i.e. customer service levels), a company should measure and control inputs further up the supply chain; material shortages, new political embargoes, hurricane activity, and diseases affecting the work force can all affect ultimate customer service in some aspect, and are more manageable if monitored before a major breakdown.

Network Design

One important note for network design is that supply chains that focus on efficiency, with characteristics such as single sourcing, low inventories and low buffer stock, will be more vulnerable to supply chain disruption (Sarathy, 30).

Evaluate Supplier Capability

Identifying critical suppliers ahead of time is important, especially to isolate those that could have the greatest impact on your operations if disrupted (Hyatt, 3).

With credit tight and suppliers facing financial troubles, manufacturers may choose to take greater control by extending supply-chain financing to suppliers. In this situation, a bank will pay the supplier in return for accounts receivable provided by the downstream partner (“Inflation Highlights Supply-Chain Risks”). Once the accounts are settled, the downstream partner will reimburse the bank. This reduces the risk of unexpected lapses in payment and subsequent supply failure.

Vertical integration is a viable option for companies who have inputs that are particularly subject to supply chain risks. Acquiring suppliers will allow companies to exert more control over the flow of goods, streamline risk management across the supply chain, and react with a unified strategy.

Multiple Manufacturing Locations

Having more than one facility in a region significantly decreases risk of failure at one site. R.G. Berry, Wal-Mart’s sole supplier of slippers, sources from six to eight factories in China (O’Reilly, 28). During peak season, they expand to 20 facilities, expanding capacity to meet demand, and simultaneously mitigating risk due to natural disasters, local labor issues, and financial difficulties.

Explore Public Sources

For practitioners involved in the outsourcing and facility location process, there are several publicly available reports that provide a broad view of global issues and country statistics that can affect facility siting.

Table 3: Public Sources for Country Analysis:

Doing Business, Global Competitiveness, and Global Risks are published yearly. An additional source for macro trends in the business world, particularly on the topics of government, international conflict, and human factors is the Center for Strategic

ReportDoing Business Reports

Global Competitiveness Reports

Global Risks

World Factbook

Index of Economic Freedom

Publisher/SponsorWorld Bank

World Economic Forum

World Economic Forum

U.S. CIA

The Heritage Foundation & Wall Street Journal



and International Studies (http://www.csis.org), which regularly releases studies on major policy and business issues around the world.

Contingency Plan

Disaster and supply chain disruption can occur in even the most stable economies. Having a “back-up” plan, such as contingency manufacturing contracts built into the supply chain, will provide flexibility. In the Sixth Annual Global Survey of Supply Chain Progress, it was found that while significant progress had been made by industry leaders in supply chain risk management, formal contingency plans needed to be better defined.

3. Technology SolutionsSupply chain risk analysis can be enabled by systems that preemptively identify risks, and those that reactively map out mitigation strategies.

Many software packages have scenario planning; Insight, Inc.’s supply chain vulnerability software package assesses supply chain risk from raw material procurement to customer delivery, and tacks a cost onto vulnerabilities that exist within the system. It then creates a corporate risk strategy to proactively lessen the chances of disruption.

Early warning systems can alert supply chain managers about disruptions and assign responsibility, reducing the time between the actual disruption, and when action is taken (Sarathy, 31). The CFO of Cisco Systems, John O’Connor, uses an email alert system from an incident-monitoring service, and then consults his crisis-management dashboard to see how Cisco’s supply chain will be impacted (Hyatt, 1).

Tracking systems, such as RFID tags, can create inventory visibility. Having a real-time view of inventory can alert managers to the “symptoms” of supply chain disruption – slowed or stopped inventory flows – pinpointing the location and severity of the disruption.

4. Contract Outside Risk ConsultingFor companies who do not have internal risk management strategies or personnel, outside risk consulting is essential. Supply chain risk consulting is also valuable for larger companies evaluating large decisions such as outsourcing and supplier selection.

One unlikely source of risk consulting is the Customs-Trade Partnership Against Terrorism. Led by U.S. Customs and Border Protection, C-TPAT is a voluntary supply chain security program that can help private companies avoid risk from terrorism and simultaneously reduce the number of inspections on freight.

REGIONAL ANALYSISEach region, Africa; Asia/Middle East; Latin America; and Eastern Europe, is represented by five indicators in regional tables (turmoil, forecasted GDP growth, forecasted inflation, investment grade, and average literacy rate).

When considering an emerging market for outsourced

manufacturing, the concept of a “low-cost country” must be considered in a holistic sense. Even if total landed costs are low, there are other factors that may raise the cost of doing business, including lower levels of control and non-cost supply chain risk factors (Gampenrieder, 7).

While not representing a comprehensive risk analysis, the methodology highlights general statistics that will have an effect on business in these countries. The full report, available through the Center for Supply Chain Research, contains analyses for each country mentioned in the table. For each region, one country is highlighted:

Keeping in mind the global financial downturn, the statistics presented were generated in 2008, and may not accurately represent the ramifications of deteriorating economies through the projection period (2009-2013).

Table 4: Turmoil Risk Methodology

Source: PRS Group, Political Risk Yearbook 2008

Direct Investment Grade Methodology(Copied with permission from The PRS Group)

Note: The Direct Investment Grade is an index generated by the PRS Group, and is not used in the ranking methodology in this report. It should be viewed as an overall indication of the investment climate as affected by the political schema.

“A” Countries. Few restrictions on equity ownership in most industries; few controls on local operations, the repatriation of funds, or foreign exchange; taxation policy that does not discriminate between foreign and domestic business. Little likelihood that restrictions will increase, and little threat from political turmoil.

Africa: Botswana

Asia/Middle East: China

Latin America: Brazil

Eastern Europe: Russia

Low Risk. For countries with this rating, most discontent is expressed peacefully, and the extremely rare occurrences of violence from political causes almost never affect international business directly or indirectly.

Moderate Risk. These are countries in which international business can sometimes be affected by occasional riots, acts of terrorism, and significant levels of labor unrest or other kinds of discontent. High Risk. High-risk countries experience levels of violence or potential violence that could seriously affect international business.

Very High Risk. The turmoil level in such countries creates conditions that approach a state of war.

“B” Countries. Some threat on equity ownership, frequently in the form of a requirement for partial ownership by nationals; restrictions on local operations, particularly regarding local procurement; few restrictions on repatriation, but some exchange controls possible; some threat to business from political turmoil; and a possibility that restrictions and turmoil may increase.

“C” Countries. Considerable restriction on equity ownership, including a requirement that nationals hold a majority percentage; considerable restriction on local operations, repatriation, and foreign exchange; some taxation discrimination possible; and a serious threat of political turmoil. A good chance that restrictions and turmoil will remain high or increase during the forecast period.

“D” Countries. Considerable restriction on equity ownership, including a prohibition against equity ownership by foreigners; substantial regulation of local operations, repatriation, and foreign exchange; taxation discrimination; political turmoil that may present a serious threat. A good chance that restrictions and turmoil will remain high or increase during the forecast period.

AFRICADemocratization in Africa has been rising since the end of the Cold War, and by 2001, all of African countries except five have held multi-party elections (Barkan, 3). However, due to stalled and incomplete democratic processes where authoritarians retain effective control, Africa remains the least democratic region, excepting the Middle East; only 17% of nations are liberal democracies (Barkan, 3).

Annual economic growth has averaged around 6 percent over the last 10 years (Doing Business 2009). As a region, sub-Saharan Africa was ranked the lowest for business-friendly regulations, with an average ranking of 138 out of 181 for individual countries (Doing Business 2009).

For the labor force, African populations are expected to remain young; people between the ages of 15 and 29 will account for a disproportionately high percentage of the population, in some cases more than half (Gavin, 1). Challenges for African governments and foreign investors alike are to provide enough jobs to satisfy the burgeoning labor market. Labor regulations are rigid, particularly in the area of high dismissal costs.

Food insecurity has triggered riots in several nations including Cameroon, Burkina Faso, Somalia, Cote D’Ivoire, Senegal, and Ethiopia; these outbreaks have undermined political stability and economic development, and add to the risk of companies intending to invest (Gavin, 4).

A lack of economic diversification plagues many African countries. Angola, Congo, and Ghana in particular depend heavily on oil production and other natural resource extraction.

Table 5: Economic and Stability Statistics for Selected African Countries

Sources: International Monetary Fund – World Economic Outlook Database PRS Group – Political Risk Yearbook 2009, selected countries

BotswanaBotswana is considered the least corrupt country in Africa, and ranked as one of the top 10 economic policy “reformers” across the globe (“Botswana,” PRS Group, 2008; Doing Business 2009). Reform actions in starting a business, protecting investors, and trading across border were noted by the World Bank to be effective. Out of 181 countries, Botswana was ranked 38th (Doing Business 2009). For its total tax rate of 17.1 percent, Botswana had the 10th lowest tax rate in the world (out of 181 countries).

Political instability in neighboring Zimbabwe has drawn refugees into Botswana, increasing anti-immigration sentiments. Struggling with the highest levels of HIV/AIDS in Africa, leading to absenteeism and poor employee retention in the labor markets, Botswana has progressive programs to combat the disease.

An undiversified economy, high population growth, and a shortage of technical and managerial skills, are coupled with an unemployment rate of just under 20% (“Botswana,” PRS Group, 2008). The government is attempting to privatize many sectors, but is facing resistance from organized labor groups that would no longer be guaranteed the jobs in a more privatized economy; compounding with high unemployment, Botswana is experiencing a sensitive labor environment.

ASIA/MIDDLE EASTAsia

The continent of Asia encompasses a wide range of cultures, economies, and specific advantages and disadvantages to doing business. In a general sense, Southeast Asia has been traditionally targeted for low-cost, low complexity manufacturing; China is a prime destination for electronics and consumer goods manufacturing; India is well known for its IT outsourcing. However, with changing business landscapes, these general trends are



constantly shifting to meet market demands. Nine Asia-Pacific countries ranked among the top 30 in the World Economic Forum’s Global Competitiveness Report, including Singapore, Japan, Korea, Hong Kong, Australia, Malaysia, New Zealand and China. Asia’s high growth economies are investing about 6 percent of their annual GDP in infrastructure, which is a key factor in logistics (Elstrodt, 30).

Australia and New Zealand, while considered Asian countries in a broad geographical sense, have business strengths more similar to Western countries. Australia has flexible labor markets and strong private institutions, while New Zealand has strong ranking in low trade barriers, high quality education, and excellent investor protection (“Global Competitiveness Report,” 2009).

Political risk still has a hold in some Asian companies; for example, Thailand’s military coup in 2006, and subsequent electoral fraud has led to a weakening of government institutions, potentially impacting businesses operating in the area (Political Risk Report “Thailand”, 2009). Other issues affecting Asian countries include friction between the government and labor groups, evolving democratization tension, corruption, natural disasters such as hurricanes and earthquakes, rising food prices leading to social unrest, and lax enforcement of intellectual property rights.

A study sponsored by Capgemini and Prologis of 340 manufacturing companies suggested that in the next five years, India may surpass China as the most attractive manufacturing location, due to China’s rising labor, real estate, and manufacturing costs (Murphy, 1). Barriers such as poor quality infrastructure, bureaucratic inefficiency, and corruption are the top perceived risks for doing business in India (“Global Competitiveness Report”). Infrastructure in particular is consistently cited as a major barrier, as less than half of roads are paved, national highways account for only 2 percent of the road network, and congestion at ports is high.

Middle East

The rapidly expanding demand for oil from developed and BRIC (Brazil, Russia, India, China) countries has caused an upswing in capacity over the last decade (“Middle East@Risk”, 2). Up to 90 percent of Gulf exports are in hydrocarbons. Most Middle Eastern countries in the Gulf region are well integrated in global trade and financial flows, while others are still dominated enough by the state sector that they are largely sheltered from burgeoning development.

Short-term supply chain disruptions, such as interruption of petroleum flow, would have a severe effect on the economic well-being of the oil-producing Middle East countries (“Middle East@Risk, p. 6). In addition to physical disruption, financial risk exists for many countries; many Middle Eastern nations have their currencies pegged - matched to another currency for stabilization - to the U.S. dollar, and a sharp decline of the USD would cause inflation.

International terrorism, especially with militant groups independent of national affiliations, remains a political risk for companies intending to manufacture in the Middle East. America’s involvement in Iraq and Afghanistan, and the trailing reconstruction efforts, still spur violence; civilians are often targets of insurgent attacks, increasing the risk for incoming businesses (“Global Risks 2009”

p. 24). The ongoing Israel-Palestinian conflict presents a sensitive political situation, as the United States has bilateral agreements with Israel. Companies with different national origins must recognize their country’s affiliations with Middle Eastern countries, and plan accordingly for the accompanying risk.

Long term security issues include nuclear proliferation and the risk of militant groups acquiring nuclear arms.

Figure 6: Economic and Stability Statistics for Selected Asian and Middle Eastern Countries


ChinaIn 2006, a survey by the American Chamber of Commerce in China showed that business in China for American companies was good; 64% percent of respondents claimed that operations in China was ‘profitable’ or ‘very profitable,’ and one out of three respondents said that operations in China had higher margins than their other worldwide organizations (Hexter, 93).

Many western businesses are already entrenched in Chinese manufacturing, especially in coastal areas, but a new trend is leading companies into cheaper “hinterlands” further away from the coast (O’Reilly, 34). Although adding time and cost to the supply chain, inland manufacturing takes advantage of cheaper production capacity and labor.

In a 2009 survey by AMR Research, China was assessed to be the “world capital” of supply chain risk. Approximately 59% of respondents stated that China contributed the most to intellectual property infringement (compared to other nations) (O’Marah, 1). China also had similarly bad marks on supplier product quality failures, and internal product quality failures. Out of 181 countries, China was ranked 176 in ease of dealing with construction permits.

This data seems almost contradictory when compared with the World Economic Forum’s number 30 (out of 134) ranking for China on the Global Competitiveness Index Ranking.

In 2008, China enacted new priority rules for group redundancy dismissals, making it more difficult for employers to dismiss



employees during economic hardships (Doing Business 2009). Over 2007 and 2008, China cut the corporate tax from 33% to 25% (Doing Business 2009, p. 41).

Logistics is heavily regulated in China, leading to many companies forging relationships within the bureaucracy to navigate the laws at the local, regional, and national levels (Daniell, 47). Transportation can be as much as 50 percent higher than in more developed countries, leading to total logistics costs that can be 2-3 times the usual rates.

LATIN AMERICAThe region’s proximity to the United States, richness in natural resources, strong exports, and lower labor costs have made Latin America a contender in emerging markets for manufacturing. However, the economic growth that has made Latin America attractive in recent years is tempered by prohibitive environments for business; major indicators include higher cost of capital, lower levels of investment, and less developed capital markets (Elstrodt, 25). In 2006, inflation for Latin America fell to a 40-year low, relieving what had been a chronic problem for the region.

Political instability ranges from country to country, but political risk has been on a general decline for the region (Elstrodt, 28). About 55% of Latin American countries (including the Caribbean) follow liberal democratic governmental forms (Barkan, 4). A liberal attitude toward business and economic regulation that predated the 2001-2002 economic crises has given way to more protectionist trends (Elstrodt, 23).

Latin America ranked 4th out of 6 regions for business-friendly regulations, with an average country score of 92 out of 181, by the World Bank. Overregulation is a problem, leading to illegal and informal markets (Elstrodt, 25). The informal economy, often connected to organized crime, is a major risk to incoming businesses.

Investment in infrastructure is low in Latin America, accounting for only 3.5% of GDP (Elstrodt, 30). Major improvements are needed in logistics, transportation, sewage/water systems, and energy distribution. One bright spot in Latin America’s infrastructure is the Panama Canal’s $5 billion lock expansion project, expected to be completed in 2014 (Lozano).

Mexico in particular has been a bulwark of United States and Western European manufacturing for the last decade. Since then, the government has made big strides in achieving macroeconomic stability and market liberalization (“Mexico Competitiveness Report,” p. 5). One of Mexico’s strengths is its focus on efficiency and productivity, helping to drive operational costs down. Risks that still detract from its outsourcing appeal include rampant crime, poor educational systems, low per capita income, and an inflexible labor market (“Mexico Competitiveness Report,” p. 18).

Table 7: Economic and Stability Statistics for Selected Latin American Countries


BrazilThe condition of Brazil’s infrastructure is mixed; although transportation and power infrastructure are lacking, the quality of the telecom and network service infrastructure in Brazil is above that of China and India (Farrell, 7). Through 2010, Brazil is spending $894 million in port infrastructure as part of a three-year Program for Accelerating Growth (Lozano).

Manaus, which is a river port city in northern Brazil, has been drawing manufacturers such as Nokia, Samsung, Sony and Essilor (O’Reilly, 30). Its dual role as a South American transportation hub adds to the attraction of locating manufacturing.

Labor laws in Brazil, reflecting a general trend in Latin America, are inflexible, and create difficulty in hiring and firing employees (“Latin America’s Offshoring Potential”). Hourly wages average about 40% below United States labor costs (Farrell, 7). The outlook for college graduates was dim, as only 8-13% of Brazilian grads were qualified and suitable for employment by multinational companies (Farrell, 9). Weak English skills also detract from the perceived quality of the labor force. Labor productivity gains have been slow throughout the decade, creating a challenge for economic development (Fantoni, 17).

The “gray” market, or the value that companies evade in term of taxes and obligations to their workers, accounts for about 40% of Brazil’s GDP (Fantoni, 18). This includes copyright infringement, ignoring quality and safety regulations.

EASTERN EUROPE(The countries included in Eastern Europe vary according to different methods; the countries included in this study are loosely based on geography, excluding Western Europe. Russia is typically considered a transcontinental country).

Eastern Europe was ranked by the World Bank’s Doing Business report as the 2nd best region in regard to business-friendly regulations (coupled with Central Asia for survey purposes). Eastern Europe is becoming more flexible with the labor market – the Czech Republic make working hours more flexible, and Slovenia enacted reforms that eased restrictions on fixed-term contracts and reduced dismissal costs (Doing Business 2009). Over the last five years, these



governments have been the most active in increasing flexibility in labor regulations. Profit taxes are, by region, the lowest in Eastern Europe. Hungary, specifically, has a low corporate income tax, at 16 percent. However, higher labor taxes and contribution, brings Eastern Europe to a higher overall tax burden (Doing Business 2009, p. 40).

Eastern Europe is fractured in its participation in the European Union; Poland, Bulgaria, Czech Republic, Hungary, Romania, Slovakia, Slovenia, Estonia, and Lithuania are EU members. Belarus, Moldova, Ukraine, Albania, Bosnia, Croatia, Turkey, Republic of Macedonia, Serbia, and Montenegro are not members. UN Members are required to give equal tax burdens to foreign and domestic companies, theoretically leveling the playing field for taxation.

Wages in Eastern Europe are lower than in Western Europe, but still higher than wages in other emerging markets such as China and India. Levels of education are typically higher than other emerging markets, and there is a higher level of managerial talent in Eastern Europe (var. Political Risk Reports, PRS, 2009).

Organized crime and corruption are major barriers to business, especially in the Czech Republic, Romania, Russia, Slovakia, and Ukraine (var. Political Risk Reports, PRS, 2009.) However, Eastern Europe has an overall low turmoil ranking, as tensions and violence lingering from post-World War II, dissolution of the former Soviet Union, and the end of the Cold War have cooled, allowing many self-identifying states to peacefully separate from former, artificial blocs.

Table 8: Economic and Stability Statistics for Selected Eastern European Countries


RussiaThe collapse of the oil markets in late 2008 has contributed to economic problems in Russia (“Russia’s Economy: A New Sick Man”). In the first quarter of 2009, industrial output fell 15%, and GDP fell by almost 10%. Inflation has been high, reported to be 15% as of the second quarter of 2009.

Russia’s inefficient government and judicial systems that are not independent enough to adequately deliver justice cast a

shadow for potential investors (Global Competitiveness Report, 21). Bureaucracy and corruption are stifling productivity, and although land and labor are relatively inexpensive, construction is expensive and burdensome to obtain permits (“Russia’s Economy: A New Sick Man”). Russia has inadequate IT resources for current business needs, according to the World Economic Forum’s Network Readiness Index (O’Reilly, 33). However, it is predicted that the benefits of high growth and economic prosperity in Eastern Europe will bleed over into Russia, creating greater economic opportunities.

The 2008 Russo-Georgia conflict strained Russian-European relations, and led to questions about energy security and dependence (“Global Risk 2009”). Cutting off gas to Ukraine was another act that has added to Russia’s aggressive stance against its Central Asian neighbors.

CONCLUDING REMARKSAs companies look to mitigate supply chain risk, they should incorporate both non-economic and economic factors into their off-shoring decisions. Assessing the risk, attaching a financial impact to potential disruptions, and establishing a clear strategy that addresses supply chain risk will set the parameters for selecting an off-shoring location in an emerging market. Country analysis for outsourcing selection should be an ongoing process, using both up-to-date statistics and historical trends.

REFERENCESAnonymous. “Creating Effective Global Operations in a Multi-Polar World.” Accenture. 2008.

Anonymous. “Inflation Highlights Supply-Chain Risks.” Forbes Magazine. July 2008.

Anonymous. “Latin America’s Offshoring Potential.” McKinsey Quarterly. 2007 Special Edition. p. 6.

Anonymous. “Red Square Blues.” The Economist. 27 November 2008.

Atkinson, William. “The Big Trends in Sourcing and Procurement.” Supply Chain Management Review. May 2008.

Cohen, Shoshanah, et al. Global Supply Chain Trends 2008-2010. PRTM.

Daniell, Bob. “Organized Chaos (excerpt from “Made In China: Perspectives on the Global Manufacturing Giant”). Inbound Logistics. March 2008, p. 46-49.

Hexter, Jimmy and Jonathan R. Woetzel. “Bringing Best Practice to China.” McKinsey Quarterly. 2007 Issue 4, p. 93-101.

Farrell, Diana, Roshni Jain, and Bruno Pietracci. “Assessing Brazil’s Offshoring Prospects.” The McKinsey Quarterly. 2007 Special Edition. p. 7

“Global Risk Reports 2009.” World Economic Forum. 2009.

Hyatt, Josh. “Ready for Anything.” CFO Magazine. April 2009.

Heinz-Peter Elstrodt. “What Executives Are Asking about Latin America.” The McKinsey Quarterly. 2007 Special Edition. p. 23



“Inflationary Pricing Threatening To Destabilize Some Supply Chains.” Marsh Consulting. 2008.

Lozano, Leticia.“Time for Ports to Act.” The Journal of Commerce Online. 6 April 2009.

“ Manuj, Ila, and John T. Mentzer. “Global Supply Chain Risk Management.” Journal of Business Logistics. Vol. 29, No. 1, 2008. p. 133-155.

“Middle East@Risk.” World Economic Forum. 2007.

Mooney, Turloch. “Kickbacks, corruption and theft riddle procurement in Asia.” Supply Chain Asia. 2009.

Murphy, Sean. “Report: India to Challenge China As World Manufacturing Hub.” Supply Chain Management Review. 15 October 2007.

O’Reilly, Joseph. “GlobeSpinning.” Inbound Logistics. March 2008, p. 26-35.

Political Risk Reports. The PRS Group. 2009. Various reports.

“Russia’s Economy: A New Sick Man.” The Economist. 4 June 2009.

Sarathy, Ravi. “Security and the Global Supply Chain.” Transportation Journal. Washington D.C.: Fall 2006. Vol. 45, No. 4, p. 28.

“Slowing Growth? Less Cheery Economic Prospects for Africa.” The Economist. August 13, 2008.

“The Mexico Competitiveness Report 2009.” World Economic Forum. 2009. In affiliation with Harvard University.



Twenty years ago, The Pennsylvania State University recognized the need for a forum where industry leaders and academics could exchange ideas and advance knowledge in business logistics. In 1989, as the logistics profession was just gaining prominence, the Center for Logistics Research was founded to serve the needs of this growing community.

Today, the Center for Supply Chain Research (CSCR) is member strong and intellectually active in many facets of supply chain management and the enabling technologies used for collaboration, visibility, and integration.

Although the Center is still firmly rooted in traditional aspects of supply chain transportation, distribution, and procurement — our research also penetrates emerging areas including topics on sustainability, low cost country sourcing, risk management, demand driven supply networks, and human behavior modeling.

Our mission is to offer the supply chain profession our very best in research, education programs, symposia, benchmarking, and workshops for executive management and leadership. It is also to support Penn State and the Smeal College of Business in achieving research and education excellence in supply chain and information systems while integrating the college into the broader business community.

Our strong academic and industrial community has made CSCR a leader in Corporate Sponsorship, Research, Executive Education, and Benchmarking.

CORPORATE SPONSORSHIPCorporate involvement is critical in achieving this mission. Companies help to shape supply chain practice, identify emerging business issues, influence curricula, recruit Smeal students, and serve as the center for external networking and knowledge. Join us as we influence the future in supply chain and advance new thinking in this profession together.

We create comprehensive research and education partnerships through our Corporate Sponsors Program. Sponsors direct our research initiatives by identifying relevant supply chain issues that their organizations are experiencing in today’s business environment. This process addresses the needs of professionals in the field and encourages our researchers to advance the state of scholarship in the supply chain management field.

Benefits include:

• Corporate Sponsors Advisory Meetings

• Complimentary participation in our Supply Chain Career Fair

• Priority access to faculty affiliate center research

• Priority Enrollment and Discount Registration for all supply chain open-enrollment courses

• Company specific management support

• Web site access of research and archived presentations.

• “Quick Start” project support with timely literature reviews on a research topic of your choice.

RESEARCHThe Center supports supply chain research relevant to business practice, sensitive to global perspectives, interdisciplinary, and driven by a holistic approach to supply chain issues. We encourage research initiatives worthy of being published in a broad range of journals.

Our primary areas of research include IT enablement of supply chains, performance measurement/supply chain value, and collaborative processes and tools. Emerging and unifying areas of research include adaptive supply chains (RFID and demand-driven supply networks), supply chain security and resiliency, supply chain transformation, global trade, and closed-loop supply chains.

EXECUTIVE EDUCATIONThe Center sponsors the Supply Chain Leaders Forum and the R. Hadly Waters Supply Chain Symposium—two programs at Penn State focused on the evolution of robust supply chains in a global, digital economy.

The Center is also active in design and delivery of courses for executive management. We offer courses on an open-enrollment basis as well as custom-designed to your needs.

Supply Chain Leaders Forum

We connect leading supply chain professionals with academics twice a year to discuss business challenges organizations must address to remain competitive. These forums are uniquely formatted to drive purposeful discussion and to seek commonalities in business practice. Themes from prior leader forums include supply chain visibility, customization, flexibility, transformation, and globalization.

R. Hadly Waters Supply Chain Symposium

Our most popular annual supply chain event draws hundreds of professionals for a full day of plenary and concurrent sessions on supply chain issues. The symposium provides a platform for supply chain practitioners and educators to share their vision and experience on such topics as integrating supply chain processes and technology, agility in international logistics, transforming supply chains, and the future of supply chain management.

Open-Enrollment Course Offerings

Endorsed by the Council of Supply Chain Management Professionals, Penn State Executive Programs (www.smeal.psu.edu/psep/) and the Center for Supply Chain Research offer priority enrollment in courses such as Designing and Leading Competitive Supply Chains, Applying Lean Principles Across the Supply Chain, and Achieving Supply Chain Transformation, Building Global Supply Chains for Competitive Advantage, and World-Class Supply Chain Collaboration. These courses, taught by internationally recognized faculty, present relevant information that leading corporate, military, and government supply chain and logistics experts rely on to remain competitive.



BENCHMARKINGCSCR actively engages in the formation and leadership of benchmarking consortia across a number of supply chain areas. Currently, the Center facilitates four industry groups: customer service, global trade compliance, sales and operations planning, and transportation. Consortia members share quantitative and qualitative data for potential operational improvements within their organization. Each group meets two to three times per year to share best practices.

Customer Service

Companies significantly invest in the order-to-cash process from information support systems to physical infrastructure to dedicated customer service organizations. The mission of the Customer Service Benchmarking Consortium is to measure, study, analyze, and compare operational, tactical, and strategic processes to improve customer relationships and order management. Members, faculty affiliates, and industry consultants explore a variety of topics ranging from order placement technology to perfect order measurement to create value for their organization and trading partners.

Global Trade Compliance

Today’s business environment is truly global as companies search the world for sources of supply and market opportunities. These extended supply chains can be quite complex to manage as they span different trade lanes, policies, and geographies. The Global Trade Compliance Benchmarking Consortium addresses contemporary issues related to regulatory compliance, cargo security, C-TPAT, ISA, NAFTA, outsourcing best practices, classification, valuation/assists, record keeping, rules of origin, port congestion, and import data collection.

Sales and Operations Planning

The sales and operations planning (S&OP) process promotes internal and inter-company collaboration to balance supply and demand within an organization. The S&OP Benchmarking Consortium is a forum where industry leaders and academics develop a proactive approach to sales and operations planning. Meeting platforms focus on proven “best practices” in demand and supply planning, forecasting, collaboration, globalization, and processes. An S&OP knowledge management Web site has been developed to provide ‘member only’ access to proven processes, measurements, and tools used by fellow benchmark members.

Transportation

Transportation costs represent one of the largest cost components of a typical supply chain. The Transportation Benchmarking Consortium brings together prominent experts in academia, as well as public and private sector industry representatives to identify and mitigate current transportation management challenges that impact the bottom line. Participants share best-demonstrated practices in the areas of carrier capacity, procurement, transportation management systems, mode issues, regulatory concerns, and other topics.

Center for Supply Chain Research

Smeal College of BusinessThe Pennsylvania State University488 Business BuildingUniversity Park, PA 16802

[email protected]



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