International Business and Trade GM0112, Global Sourcing (II)

1. International Business and TradeGM0112, Global Sourcing (II) Global sourcing strategies - The WHAT question Professor Bent Petersen Visiting Professor Global Sourcing - Fall 2010

2. Contents of today’s lecture • What drives global sourcing? • Global sourcing choices and strategies: The WHAT question… …decomposed into • Cognitive factors • Economic/strategic factors • Motivational factors - the ‘comfort zone’ of managers Global Sourcing - Fall 2010

3. What Drives Firms’ Global Sourcing? • Improved transportation technology (e.g. containerization) • Advances of I&CT (digitization!) • Market integration (emerging markets, WTO, lower trade barriers and lifted FDI restrictions) • Improved market institutions, such as: • Enforcement of IPR (e.g. TRIPS, WTO) • Industry standards • Certification, accreditation (e.g. ISO 9001; SEI/CMM) Global Sourcing - Fall 2010

4. Coordination of value chain activities Porter’s (1986) global value chain framework High Global sourcing Shrinking factor cost differentials Lower coordination (I&CT) and transportation costs Low Market Integration Configuration of value chain activities Concentrated Dispersed Global Sourcing - Fall 2010

5. Resource commitment to foreign sales effort (The Establishment Chain phenomenon) Equity (FDI) Contractual (outsourcing) Value chain specialization (Global sourcing) High (concentrated configuration / extensive coordination) Arm’slength (procurement) Low (dispersed configuration / sparse coordination) Geographical expansion of sales (The Psychic Distance phenomenon) Local Regional Global Global Sourcing - Fall 2010

6. Re-Configuring the Value Chain MNCs are in the process of a dual transformation of their value chains: • A surge from dispersed to concentrated configuration strategies in which global sourcing plays a vital role. • A surge in direction of a more fragmented (or ‘fine-sliced’) and modularized value chain in which offshore outsourcing plays a prominent role. Global Sourcing - Fall 2010

7. Typical US MNC re-configuration pattern 0.Point Zero: Dispersed, un-coordinated TNC units. • Establishment of (regional) Shared Services Centers Consolidation in terms of scale economies and transparent cost structures (establishment of ‘pinch points’). • Fragmentation and modularization of value chain activities. • Decision about location (on/near/off-shore?) and ownership (captive/JV/outsourced?). Global Sourcing - Fall 2010

8. 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. Global Sourcing - Fall 2010

9. Global sourcing choices and strategies: The WHAT question Global Sourcing - Fall 2010

10. 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? Global Sourcing - Fall 2010

11. Decomposing the WHAT question • Cognitive factors: What global sourcing opportunities are envisaged in the first place? HQ heuristics. Global mindset. Perceived risks. • Economic/strategic factors: What global sourcing is economic feasible? Exploitation of global factor cost differentials. Efficiency in MNC coordination, economizing on information costs. • Motivational factors: What global sourcing is ‘political feasible’ in the organization? Does global sourcing conflict with its ‘comfort zone’? Global Sourcing - Fall 2010

12. 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. Global Sourcing - Fall 2010

13. 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 Global Sourcing - Fall 2010

14. Outsourcing segments Discretion-Based Problemsolving (TDO) . Knowledge-based Processing (KPO) Rules-Based Processing (BPO) Basic Transactions (Project outsourcing) Global Sourcing - Fall 2010

15. ‘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”: Global Sourcing - Fall 2010

16. ETNOCENTRISM SC mgt GEOCENTRISM Corporate language KM (codification) HR Mgt Performance mgt Risk mgt Time zone mgt Global Sourcing - Fall 2010

17. 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. Global Sourcing - Fall 2010

18. Production cost savings versus extra transaction and transportation costs Global Sourcing - Fall 2010

19. Economic factors related to knowledge transfer • Standardization of operational procedures • Codification of operational procedures • Communication skills (e.g. language proficiency, corporate I&CT infrastructure) Global Sourcing - Fall 2010

20. 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) Global Sourcing - Fall 2010

21. 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) Global Sourcing - Fall 2010

22. 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) Global Sourcing - Fall 2010

23. 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. Global Sourcing - Fall 2010

24. Typical IT outsourcing stages Total Development Outsourcing Increasing dependency/irreversibility Knowledge Process Outsourcing Business Process Outsourcing Project outsourcing Potential loss of HQ control – Need for comfort zone extension Global Sourcing - Fall 2010

25. The ‘comfort zone’ of the sourcing firm Global Sourcing - Fall 2010

26. 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 • Reliance on intensive technology • Hand-offs (Kumar et al, 2009) • exist and fitting/integration • needed at both ends • Valuable, rare and in-imitable resources • Resources can be purchased in • factor markets • Substitutable resources • Reliance on long-linked technology Comfort zone extension: Managerial instruments to mitigate high coordination cost: e.g. modularization, transfer of personnel, standardization of routines (e.g. through ERP systems)

27. 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 Irreversible investment • Transfer stickiness • High degree of specialization • High asset specificity • Sunk investment • Resources are mobile • Low relocation costs • Low switching costs • General purpose technology Comfort zone extension: Managerial instruments to mitigate high investment risk: e.g. real options (Kogut & Kulatilaka, 1994), bonding efforts (Jensen & Meckling, 1976)

28. Comfort zone and discretionary judgmentallocated 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)

29. 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) Global Sourcing - Fall 2010

30. 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) Global Sourcing - Fall 2010

31. 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) Global Sourcing - Fall 2010