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> Global Sourcing of Pharmaceutical Drug TrialsNearly 40 percent of clinical trials for new drugs in the pharmaceutical industryare now conducted in emerging markets such as China and Russia. It is estimatedthat by 2010, some two million people in India will take part in clinical trials.Where drug testing was once conducted mostly in developed economies, pharma-ceutical firms such as Pfizer increasingly prefer emerging markets because theyoffer clear advantages: (1) lower costs for recruitment of physicians and patients,(2) large potential patient populations, (3) diversity of patient populations andmedical conditions, and (4) less likelihood of patients taking other medicines thatcould interact with the drug under study.

It costs an average of $900 million to develop and bring a new drug to marketin the United States. More than half the cost relates to confirming drug safety andeffectiveness in trial phases on humans, as required by the U. S. Food and DrugAdministration (FDA) and similar agencies worldwide. Recruiting patients accountsfor 40 percent of the trial budget. Testing in emerging markets greatly reducesrecruitment costs. According to GlaxoSmithKline, a drug trial costs about $30,000on a per-patient basis in the United States and about $3,000 in Romania.

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1. Trends toward outsourcing,global sourcing, and offshoring

2. Evolution of global sourcing

3. Benefits and challenges of globalsourcing for the firm

4. Implementing global sourcingthrough supply-chainmanagement

5. Risks in global sourcing

6. Strategies for minimizing risk inglobal sourcing

7. Implications of global sourcingfor public policy and corporatecitizenship

Global SourcingGlobal Sourcing

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Firms typically outsource the trials to contract research organizations, which inturn hire physicians in local communities and hospitals to find patients. For example,subcontractors tested Merck’s Vioxx and Zocor drugs and many of Pfizer’s billion-dollar drugs in Russia and other developing countries before gaining approval inthe United States. Almost every major Western pharmaceutical firm is conductingclinical trials in hospitals across Russia. In a poor country with a dysfunctional med-ical system, patients often consider the trials a way to access medical treatment. Rus-sia’s centralized hospital system recruits patients for trials quickly, which shaves mil-lions of dollars and several months off the drug development process.

Nevertheless, offshoring of clinical trials raises questions about ethics and over-sight of this critical stage in the development of new medications. While the vastmajority of trials in emerging markets have been conducted without problems, somebreakdowns in ethical and scientific processes have occurred. For example, Pfizerwas sued for testing a meningitis drug on Nigerian children without their parents’consent, resulting in five deaths. Some trials endangered patients or were con-ducted without proper ethical review. Better oversight of this critical stage in the

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Trends Toward Outsourcing, GlobalSourcing, and Offshoring

As noted in the opening vignette, companies in the pharmaceutical industry cutproduct development costs and hasten speed to market by sourcing drug-test-ing processes from emerging markets. Focal firms shop around the world forinputs or finished products to meet efficiency and strategic objectives andremain competitive.

The search for the best sources of products and services is an ongoing task formanagers. In some cases, firms have moved entire value-chain activities such asmanufacturing to foreign locations. Nike Inc., along with competitors Reebok andAdidas in the athletic shoe industry, contracts out nearly all of its athletic shoeproduction to foreign suppliers. These firms are best described as brand ownersand marketers today, not as manufacturers. Similarly, Apple Inc. sources some 70percent of its production abroad while focusing its internal resources on improv-ing its operating system and other software platforms. This approach allowsApple to optimally utilize its limited capital resources and focus on its core com-petences. Dell Inc. is another firm that relies extensively on a global manufactur-ing network, composed largely of independent suppliers. See Exhibit 16.1 to learnhow Dell assembles components from suppliers in numerous locations for its DellInspiron notebook computer.1

Global sourcing is the procurement of products or services from independentsuppliers or company-owned subsidiaries located abroad for consumption in thehome country or a third country. Also called global procurement or global purchasing,global sourcing amounts to importing—an inbound flow of goods and services. Itis an entry strategy that involves a contractual relationship between the buyer (the

484 Chapter 16 Global Sourcing

development of new medications is warranted,but conducting drug trials properly can be chal-lenging. Emerging markets may lack theresources the FDA normally requires. One offi-cial asks “How do you meet proceduresrequired by the FDA in settings where electricityis going off two hours a day?”

In one case, the Nigerian trial for an anti-retroviral drug was shut down amid concernsthat researchers did not store the drugs or han-dle the scientific data properly. Where physi-cians in Russia normally earn $200 per month,a trial investigator there can make 10 times thatamount by recruiting patients into trials. Thisfinancial incentive raises potential conflicts fordoctors, some of whom may bribe patients toensure their participation in trials.

In emerging markets, some drug trials donot receive adequate attention from ethicsreview committees. One study found that aquarter of all trials in developing economiesdid not receive any local official review. Still,the U.S. approval process places a great bur-den on local review. The FDA is required to

inspect a certain proportion of trial sites. Nev-ertheless, in a recent year, despite more than500 drug trials in Russia alone at some 3,000sites, the FDA inspected only about 100 sitesworldwide. Of the international sites inspected,the FDA criticized more than 30 percent forfailure to follow protocol, and cited nearly 10percent for failure to report adverse patientreactions to trial drugs.

While the FDA is working closely with localgovernments with hopes that world ethical stan-dards will catch up with its regulations, pharma-ceutical firms are increasing their outsourcing ofdrug trials abroad. Trials will continue to shift toemerging markets in search of more patientswith faster recruitment at lower cost. <Sources: Bloch, M., A. Dhankhar, and S. Narayanan. (2006).“Pharma Leaps Offshore,” McKinsey Quarterly, July, p. 12; Engar-dio, Pete. (2006). “The Future of Outsourcing: How It’s Transform-ing Whole Industries and Changing the Way We Work,” BusinessWeek, January 30, p. 58; Economist Intelligence Unit. (2007). “U.K.Regulations: Tougher on Drugs,” April 11. Retrieved fromwww.viewswire.com; A. T. Kearney. (2007). Country AttractivenessIndex for Clinical Trials, A. T. Kearney Company. Retrieved fromwww.atkearney.com; Lustgarten, Abrahm. (2005). “Drug TestingGoes Offshore,” Fortune, August 8, pp. 66–71; PhRMA. (2007,March). Pharmaceutical Industry Profile 2007. March.

Global sourcing Theprocurement of products orservices from independentsuppliers or company-ownedsubsidiaries located abroad forconsumption in the home countryor a third country.

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focal firm) and a foreign source of supply. Global sourcing involves subcontract-ing the performance of specific manufacturing or services tasks to the firm’s ownsubsidiaries or independent suppliers. As illustrated in Exhibit 14.1 on page 420,global sourcing is a low-control strategy in which the focal firm sources from inde-pendent suppliers through contractual agreements, as opposed to buying fromcompany-owned subsidiaries.

Although global sourcing has been an established international businessactivity since the 1980s, it has gained new momentum in the current phase ofglobalization. Four key drivers are especially responsible for the growth of globalsourcing in recent years:

• Technological advances, including instant Internet connectivity andbroadband availability

• Declining communication and transportation costs• Widespread access to vast information, including growing connectivity

between suppliers and the customers that they serve• Entrepreneurship and rapid economic transformation in emerging markets

While firms had their early experience with the sourcing of merchandisegoods, in recent years they have increasingly subcontracted the performance ofbusiness processes and other services to subsidiaries and independent suppliers

Trends Toward Outsourcing, Global Sourcing, and Offshoring 485

LCD display from a factory in South Korea (Samsung or LG Phillips LCD), Japan (Toshiba or Sharp), or Taiwan (Chi Mei Optoelectronics, Hamstar Display, or AU Optronics)

Keyboard from a Japanese-owned factory (Alps) or a Taiwanese-owned factory (Sunrex or Darfon), all in China

Intel microprocessor from an Intel factory in China, Malaysia, the Philippines, or Costa Rica

Memory from a factory in Japan (Elpida), South Korea (Samsung), Taiwan (Nanya), or Germany (Infineon)

Motherboard from a Korean-owned factory in China (Samsung), a Taiwanese-owned factory in China (Quanta), or a Taiwanese-owned factory in Taiwan (Compal or Wistron)

Hard disk drive from a U.S.-owned factory in Singapore (Seagate), a Japanese-owned company in Thailand (Hitachi or Fujitsu), or a Japanese-owned factory in the Philippines (Toshiba)

Modem from a Taiwanese-owned company in China (Asustek or Liteon) or a Chinese-owned company in China (Foxconn)

Cooling fan from a factory in Taiwan (CCI or Auras)

Battery from a U.S.-owned factory in Malaysia (Motorola), a Japanese-owned factory in Mexico or Malaysia or China (Sanyo), or a South Korean or Taiwanese factory (SDI or Simplo)

Exhibit 16.1 Sourcing for the Dell Inspiron Notebook Computer

SOURCE: Adapted from Friedman, Thomas. (2005). The World is Flat, New York: Farrar, Straus, & Giroux

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located worldwide.2 For example, contractors such as Softtek in Mexico help U.S.banks to develop customized software, manage their IT systems, and performsupport and maintenance for commercial finance operations. Softtek has 3,500employees, mostly engineers, and outsourcing facilities in Brazil, Colombia, Peru,and Venezuela. Argentina, which boasts one of the best-educated workforces inLatin America, is aggressively promoting software development centers. The lowsalaries of software engineers (typically less than $12,000 a year) has persuadedsuch companies as Walt Disney, Peugeot, and Repsol to have web site design andsoftware development performed in Argentina.

In undertaking global sourcing, managers face two key decisions: (1) whichvalue-chain activities should be outsourced; and (2) where in the world these activ-ities should be performed. Let’s consider these two managerial choices.

Decision 1: Outsource or Not?Managers must decide between internalization and externalization—whether eachvalue-adding activity should be conducted in house or by an external, independentsupplier. In business, this is traditionally known as the make or buy decision: “Shouldwe make a product or perform a particular value-chain activity ourselves, or shouldwe source it from an outside contractor?” Firms usually internalize those value-chainactivities that they consider part of their core competence, or which involve the use ofproprietary knowledge and trade secrets that they want to control. For example,Canon uses its core competencies in precision mechanics, fine optics, and microelec-tronics to produce some of the world’s best cameras, printers, and copiers. Canonusually internalizes value-chain activities such as R&D because they yield improve-ments in these competencies. By contrast, firms will usually source from external sup-pliers those products or services that are peripheral to the firm’s main offerings, havea lower cost, or when the supplier specializes in providing the specific offerings. Bycontrast, firms will usually source from external suppliers when the sourced productsor services are peripheral to the firm’s main offerings, can be obtained at lower cost,or can be provided by suppliers specialized in providing the specific offerings.

By contrast, firms will usually source from external suppliers, products, or ser-vices that: are peripheral to the firm’s main offerings; can be obtained at lower cost;or can be provided by suppliers specialized in providing the specific offerings. Moreformally, outsourcing refers to the procurement of selected value-adding activities,including production of intermediate goods or finished products, from externalindependent suppliers. Firms outsource because they generally are not superior atperforming all primary and support activities. Most value-adding activities—frommanufacturing to marketing to after-sales service—are candidates for outsourcing.

Historically, outsourcing involved the acquisition of raw materials, parts, andcomponents from independent suppliers. More recently, outsourcing has extendedto include the procurement of services as well.3 The typical firm will outsource ser-vices such as accounting, payroll, and some human resource functions, as well astravel services, IT services, customer service, and technical support. This type ofoutsourcing is known as business process outsourcing (BPO).4 Firms contract withthird-party service providers to perform specific business tasks, usually as a meansof reducing the cost of performing tasks that are not part of the firm’s core compe-tencies or critical to maintaining the firm’s competitive position in the marketplace.BPO can be divided into two categories: back-office activities, which includes internal,upstream business functions such as payroll and billing, and front-office activities,which includes downstream, customer-related services such as marketing or techni-cal support.

Today in Europe, North America, Japan, and other advanced economies, fewfirms produce an entire product. Most firms contract out their peripheral activitiesto outside suppliers.

Outsourcing The procurementof selected value-addingactivities, including production ofintermediate goods or finishedproducts, from independentsuppliers.

Business processoutsourcing (BPO) Theoutsourcing of business functionsto independent suppliers, such asaccounting, payroll, humanresource functions, IT services,customer service, and technicalsupport.

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Decision 2: Where in the World Should Value-AddingActivities Be Located?For each value-adding activity, managers have the choice of either keeping theactivity at home or locating it in a foreign country. Configuration of value-addingactivity refers to the pattern or geographic arrangement of locations where the firmcarries out value-chain activities.5 For instance, to run its global network of pack-age shipping, DHL established offices in countries and cities worldwide. It also setup high-tech tracking centers in Arizona, Malaysia, and the Czech Republic. Thisconfiguration allows DHL staffers to track the locations of shipments worldwide,24 hours a day. DHL management chose these specific locations for shipment track-ing because, in a world of 24 time zones, they are each about 8 hours distant fromeach other.

Instead of concentrating value-adding activities in their home country,many firms configure these activities across the world to save money, reducedelivery time, access factors of production, and extract maximal advantages rel-ative to competitors. This helps explain the migration of manufacturing indus-tries from Europe, Japan, and the United States to emerging markets in Asia,Latin America, and Eastern Europe. Depending on the firm and the industry,management may decide to concentrate certain value-adding activities in justone or a handful of locations, while dispersing others to numerous countries.

For example, the German automaker Bayerische Motoren Werke AG (BMW)employs 70,000 factory personnel at 23 sites in 13 countries to manufacturesedans, coupes, and convertibles. Workers at the Munich plant build the BMW 3Series and supply engines and key body components to other BMW factoriesabroad. In the United States, BMW has a plant in South Carolina that makes over500 vehicles daily for the world market. In northeast China, BMW makes cars ina joint venture with Brilliance China Automotive Holdings Ltd. In India, BMWhas a manufacturing presence to serve the needs of the rapidly growing SouthAsia market. However, BMW’s profits have suffered in recent years due tohigher cost of raw materials such as plastics and steel. Management must con-figure BMW’s sourcing at the best locations worldwide in order to: minimizecosts (for example, by producing in China), access skilled personnel (by pro-ducing in Germany), remain close to key markets (by producing in China,India, and the United States), and succeed in the intensely competitive globalcar industry.

Global Sourcing from Subsidiaries versus Independent SuppliersThe two strategic choices we just discussed lead us to the framework in Exhibit16.2. The focal firm can source from independent suppliers, from company-owned subsidiaries and affiliates, or from both. In the Exhibit, Cells C and Drepresent the global sourcing scenarios. While global sourcing implies procure-ment from foreign locations, in some cases the focal firm may source from itsown wholly owned subsidiary or an affiliate jointly owned with another firm(Cell C). This is known as captive sourcing, which refers to sourcing from thefirm’s own production facilities located abroad. In this scenario, production iscarried out at a foreign facility that the focal firm owns through direct invest-ment. For example, Genpact (formerly Gecis Global) was a captive sourcingunit of General Electric (GE). With annual revenues of about $500 million and morethan 19,000 employees worldwide, Genpact is one of the largest providers of busi-ness-process outsourcing services. GE sold Genpact in 2005, and the supplierbecame an independent firm. While maintaining its work for GE, Genpact isnow free to seek other customers worldwide.6

Captive sourcing Sourcingfrom the firm’s own productionfacilities located abroad.

Configuration of value-adding activity The pattern orgeographic arrangement oflocations where the firm carriesout value-chain activities.

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Alternatively, the focal firm can procure intermediate goods or finished prod-ucts from independent suppliers (Cell D), an increasingly likely scenario. The firmexternalizes its production to foreign partners to harness their capabilities. Globalsourcing requires the firm to identify qualified suppliers, develop necessary orga-nizational and technological capabilities to relocate specific tasks, and coordinatea geographically dispersed network of activities.

Contract Manufacturing: Global Sourcing fromIndependent SuppliersThe typical relationship between the focal firm and its foreign supplier (Cell D inExhibit 16.2) may take the form of contract manufacturing, an arrangement in whichthe focal firm contracts with an independent supplier to manufacture productsaccording to well-defined specifications. Often, an explicit contract spells out theterms of the relationship. The supplier is responsible for production and adheres tothe focal firm’s specifications. Once the products are manufactured, the supplier turnsthem over to the focal firm, which then markets, sells, and distributes them. Inessence, the focal firm “rents” the manufacturing capacity of the foreign contractor.

In a typical scenario, the focal firm approaches several suppliers with prod-uct designs or specifications and asks for quotations on the cost to produce themerchandise, accounting for cost of labor, processes, tooling, and materials.Once the bidding process is complete, the focal firm contracts with the mostqualified manufacturer. Contract manufacturing is especially common in theapparel, shoe, furniture, aerospace, defense, computer, semiconductor, energy,medical, pharmaceutical, personal care, and automotive industries.

Patheon is one of the world’s leading contract manufacturers in the pharmaceu-tical industry. The company provides drug development and manufacturing servicesto pharmaceutical and biotechnology firms worldwide. Patheon operates 11 produc-tion facilities in North America and Europe, producing over-the-counter drugs andseveral of the world’s top-selling prescription drugs on contract for most of theworld’s 20 largest pharmaceutical firms. Patheon generates about half its sales inNorth America and the other half in Europe.7 Benetton employs contract manufac-turers to produce clothing, and IKEA uses contract manufacturers to produce furni-ture. Contract manufacturing also allows firms to enter target countries quickly,especially when the market is too small to justify significant local investment.

You have probably never heard of Taiwan’s Hon Hai Precision Industry Co., aleading contract manufacturer in the global electronics industry. Hon Hai works

Contract manufacturing Anarrangement in which the focalfirm contracts with anindependent supplier tomanufacture products accordingto well-defined specifications.

Value-adding activityis internalized

Value-adding activityis externalized (outsourced)

Exhibit 16.2The Nature of Outsourcing andGlobal Sourcing

Value-adding activity kept in home country

A BKeep production in-house, in home country

Outsource productionto third party providerat home

C DValue-adding activity conductedabroad (global sourcing)

Delegate production toforeign subsidiary oraffiliate (captive sourcing)

Outsource production toa third-party providerabroad (contract manu-facturing or global sourc-ing from independentsuppliers)

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under contract for well-known companies, churning out iPods and iPhones for Apple,PlayStations for Sony, printers and PCs for Hewlett-Packard, and thousands of otherproducts. In 2007, Hon Hai’s sales surpassed $40 billion. The firm employs some360,000 people in scores of contract factories worldwide, from Malaysia to Mexico.8

One advantage of contract manufacturing is that the focal firm—for example,Apple, Hewlett-Packard, or Sony—can concentrate on product design and market-ing while transferring manufacturing responsibility to an independent contractor.The contract manufacturer is likely to be located in a low-wage country and havestrengths in terms of scale economies, manufacturing prowess, and specific knowl-edge about the engineering and development processes of products that it handlesfor its clients.9 A major drawback of contract manufacturing is that the focal firm haslimited control over the supplier. Lack of direct ownership implies limited influenceover the manufacturing processes of the supplier, potential vulnerability to the sup-plier’s acting in bad faith, and limited ability to safeguard intellectual assets.

Offshoring

Offshoring is a natural extension of global sourcing. Offshoring refers to the reloca-tion of a business process or entire manufacturing facility to a foreign country. Largemultinational companies are particularly active in shifting production facilities orbusiness processes to foreign countries to enhance their competitive advantage. Off-shoring is especially common in the service sector, including banking, software codewriting, legal services, and customer-service activities. For example, large legal hubshave emerged in India that provide services such as drafting contracts and patentapplications, conducting research and negotiations, as well as performing paralegalwork on behalf of Western clients. With lawyers in North America and Europe cost-ing $300 an hour or more, Indian firms can cut legal bills by 75 percent.10

Firms generally offshore certain tasks or subactivities of business functions. Ineach of the business functions—human resources, accounting, finance, marketing,and customer service—certain tasks are routine and discrete. These functions arecandidates for offshoring, as long as their performance by independent suppliersdoes not threaten or diminish the focal firm’s core competencies or strategic assets.Examples of successful offshoring to foreign providers include billing and creditcard processing in finance, creating customer databases and recording sales transac-tions in marketing, and payroll maintenance and benefits administration in humanresources.

India receives the bulk of advanced economies‘ relocated business services.This sector in India has grown by as much as 50percent per year during the 2000s. The country’semergence as a major offshoring destinationresults from its huge pool of qualified labor whowork for wages as little as 25 percent of compara-ble workers in the West, combined with theworldwide economic downturn of the early2000s, which triggered multinational firms toseek ways to shave costs.11 But India is not theonly destination of substantial outsourcing work.Firms in Eastern Europe perform support activi-ties for architectural and engineering firms fromWestern Europe and the United States. Accoun-tants in the Philippines perform support work formajor accounting firms. Accenture has back-office operations and call centers in Costa Rica.Many IT support services for customers in Ger-many are actually based in the Czech Republic

Offshoring The relocation of abusiness process or entiremanufacturing facility to a foreigncountry.

Workers at a call center in Banga-lore support international cus-tomers. India has received thebulk of outsourced businessprocess services in recent years.

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and Romania. Boeing, Motorola, and Nortel do much of their R&D in Russia. SouthAfrica is the base for technical and user-support services for English, French, andGerman-speaking customers throughout Europe.12

Limits to Global SourcingNot all business activities or processes lend themselves to offshoring. Jobs most con-ducive to being offshored tend to be in industries with the following characteristics:

• Large-scale manufacturing industries whose primary competitive advan-tage is efficiency and low cost

• Industries such as automobiles that have uniform customer needs andhighly standardized processes in production and other value-chain activities

• Service industries that are highly labor intensive, such as call centers andlegal transcription

• Information-based industries whose functions and activities can be easilytransmitted via the Internet, such as accounting, billing, and payroll

• Industries such as software preparation, whose outputs are easy to codifyand transmit over the Internet or by telephone, such as routine technicalsupport and customer service activities.

In contrast, many jobs in the services sector cannot be separated from theirplace of consumption. This limits the types of service jobs that firms can moveabroad. Personal contact is vital at the downstream end of virtually all valuechains. Other services are consumed locally. For example, people normally do nottravel abroad to see a doctor, dentist, lawyer, or accountant.13 Consequently,many service jobs will never be offshored. For example, through 2005, only about3 percent of jobs in the United States that require substantial customer interaction(for example, those in the retailing sector) have been transferred to low-wageeconomies. By 2008, less than 15 percent of all service jobs have moved fromadvanced economies to emerging markets.14

In addition, many companies, such as Harley-Davidson in the United States,have their own reasons to keep production at home. A great proportion of thevalue added by Harley-Davidson is local. Harley-Davidson both assembles itsmotorcycles and procures key components such as the engine, transmission, gastank, brake system, and the headlight assembly in the United States.15 Harley’scustomers view the product as an American icon and tend to not tolerate produc-tion abroad. Another factor is labor union contracts, which limit management’sability to transfer core production abroad without union consent.

Strategic Implications of Outsourcing and Global SourcingExhibit 16.3 explains the strategic implications of the two choices firms face:whether to perform specific value-adding activities themselves or to outsourcethem, and whether to concentrate each activity in the home country or disperse itabroad. The Exhibit portrays a typical value chain, ranging from R&D and design,to customer service. The first row indicates the degree to which management con-siders each value-adding activity a strategic asset to the firm. The second rowindicates whether the activity tends to be internalized inside the focal firm or out-sourced to a foreign supplier. The third row indicates where management typi-cally locates an activity.

These decisions depend largely on the strategic importance of the particu-lar activity to the firm. For example, companies typically consider R&D anddesign activities central to their competitive advantage. As a result, they aremore likely to internalize these functions and less likely to outsource. In con-

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Evolution of Global Sourcing 491

trast, manufacturing, logistics, and customer service activities tend to be morereadily outsourced and geographically dispersed. The decision will also be afunction of the firm’s experience with international business and availability ofqualified suppliers.

Evolution of Global Sourcing

Global sourcing by the private sector now accounts for more than half of allimports by major countries.16 Global sourcing has changed the way companies dobusiness in all kinds of industries. For example, Steinway procures parts and com-ponents from a dozen foreign countries to produce its grand pianos. Similarly,retailers do extensive global sourcing: Most of the products sold by Best Buy, Tar-get, Wal-Mart, and Carrefour are sourced from suppliers in emerging markets.These retailers benefit by importing good-quality consumer products at low prices.

Phases in the Evolution: From Global Sourcing of Inputsto Offshoring Value-Adding Activities

The first major wave of global sourcing emphasized the manufacturing of inputproducts and began in the 1960s with the shift of European and United Statesmanufacturing to low-cost countries as geographically diverse as Mexico andSpain. Early observers pointed to the emergence of the modular corporation andthe virtual corporation in the context of global sourcing.17 Eventually, managersbegan to realize that tasks within most functions and value-chain activities aresubject to externalization if such a move serves to facilitate efficiency, produc-tivity, quality, and higher revenues.

Exhibit 16.3 Typical Choices of Outsourcing and Geographic Dispersion of Value-Chain Activities among Firms

ComponentManufacturing

Manufacturing or Assembly

Marketing and Branding

Sales,Distribution and Logistics Customer Service

Importance ofthis activity tothe firm as astrategic asset

Veryimportant

Low importance

Low to medium importance

Very important

Medium importance

Medium importance

Likelihood ofinternalizingrather than outsourcingthis activity

High Low Low toMedium

High Low to Medium

Low to Medium

Geographic configuration:Overall tendency tolocate activity athome or abroad

Usuallyconcen-trated at home

Usually dispersedacross various markets

Usually con-centrated in afew markets

Brandingconcentratedat home;Marketingconcentratedor dispersedto individualmarkets

Dispersed to individual markets

Dispersed toindividual markets, exceptcall centers,which are often concentrated

R&D Design

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The next wave of global sourcing began in the 1990s with offshoring, inwhich firms began to outsource specific value-adding activities in the servicessector to locations such as India and Eastern Europe. In addition to IT services(software, applications, and technical support) and customer-support activities(technical support, call centers), many other service sectors became part of theoffshoring trend. For example, in the health care sector, procedures such as CTscans and radiology evaluation are conducted in offshore locations. Consumersalso are engaged in so-called medical tourism, in which they travel to countriessuch as India and Thailand for such medical procedures as bypass surgery orappendix removal.

Today, business-process outsourcing in product development, humanresources, and finance/accounting services has become very common.18 Forexample, Microsoft has invested billions in India to add to its existing R&Dand technical-support operations there. Both Intel and Cisco Systems haveinvested billions to develop R&D operations in India as well. JP Morgan, alarge investment bank, has several thousand employees in India who haveevolved from performing simple back-office tasks, such as data entry to set-tling structured-finance and derivative deals—highly sophisticated bankingtransactions. India has reached a more mature stage in its development thanother emerging countries. It first served as a center for software applicationdevelopment and maintenance. Subsequently, Indian firms and local captiveoperations of numerous MNEs began offering low-cost back-office services.Most recently, India has developed a strong industrial base of its own in ITand other high value-added business processes. Wipro, Infosys, and TataConsultancy are among the most prominent players in global sourcing in thebusiness services, software development, and call center industries. NoteIndia’s prominence in this activity is in addition to that of the United States.While many of the firms are headquartered in the United States, much of theirwork is actually performed in India or other emerging markets.

Magnitude of Global SourcingThe magnitude of global sourcing is considerable. In 2005, India alone booked$22 billion worth of business in answering customer phone calls, managingfar-flung computer networks, processing invoices, and writing custom soft-ware for MNEs from all over the world.19 Global sourcing has created morethan 1.3 million jobs during the past decade for India. Meanwhile, between2000 and 2004, the United States outsourced some 100,000 service jobs eachyear.20 In 2006, information-technology and business-process outsourcingexceeded $150 billion worldwide.

Diversity of Countries That Initiate and ReceiveOutsourced WorkClearly, China and India are major players in global sourcing. The GlobalTrend feature highlights the ongoing rivalry between these two countries asthey compete to be the world’s leading destinations for global sourcing. Nev-ertheless, as noted in the opening vignette, numerous other countries areactive players as well. In terms of buyer countries, global sourcing is prac-ticed by firms all around the world. U.S. firms have led the trend with nearlytwo-thirds of total offshore service projects. In 2003, firms in the United Statesoffshored $87 billion of business services. In the same year, companies inother nations offshored to the United States $134 billion of business services.This insourcing supported a variety of relatively high-skilled U.S. jobs inengineering, management consulting, banking, and legal services.


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> GLOBAL TREND

China: Rivaling India in the Global Sourcing Game

For services, India is perhaps theworld’s leading offshoring des-tination. India is a popular des-

tination for software developmentand back-office services, such astelephone call centers and financialaccounting activities. India is one ofthe world’s leading centers in the ITindustry, thanks in part to the emer-gence of indigenous MNEs such asInfosys and Wipro. Infosys rivalsMicrosoft as one of the top softwaredevelopment firms worldwide.

Compared to India, however,China’s history as a supplier to theworld is longer. China is the center ofmanufacturing for countless Westernfirms. For example, the U.S. firmKeurig manufactures single-servingcoffee machines. After Keurig man-agement found that its coffee-makers were overpriced at $250each because of high manufactur-ing costs, the firm outsourcedmanufacturing to a partner inChina. The move allowed Keurig tobegin offering new models for as

little as $99. As a result, Keurig hasgreatly increased its sales.

China aims to surpass India in ser-vices outsourcing, and the Chinesegovernment is making huge invest-ments to upgrade worker training andthe quality of its universities. Chinahas three major advantages. First, thecountry is home to a large amount ofskilled, low-cost labor. It produces350,000 graduate engineers everyyear, almost four times that of theUnited States. Second, China has ahuge domestic market with rapid andsustainable economic growth. Third,the attitude of the Chinese govern-ment, long an obstacle to foreignfirms, is increasingly probusiness. Thegovernment has been developing arange of policies that favor foreignfirms that manufacture in China.

Nevertheless, China still hasnumerous pitfalls. The country is weakin intellectual property protection, hasa language and culture that foreignfirms find challenging, and lacks qual-ity infrastructure. Dealing with the

Chinese government is complicatedbecause of substantial bureaucracyand infighting among its various agen-cies. The resulting chaos hampers theability of Chinese entrepreneurs tolaunch and manage companies.

By contrast, India has better intel-lectual property protection, a work-force with English language skills, andinfrastructure that, although poor byadvanced-economy standards, isoften superior to that of China. Indiais likely to remain the global-sourcingleader in the services sector for sometime to come.

Sources: Economist. (2005b). “The Myth of ChinaInc.,” September 3, pp. 53–54; Farrell, Diana,Noshir Kaka, and Saacha Sturze. (2005). “EnsuringIndia’s Offshoring Future,” The McKinsey Quar-terly, Special Edition: Fulfilling India’s Promise;Hagel, John. (2004). Offshoring Goes on the Offen-sive: Cost Cutting is Only the First Benefit, TheMcKinsey Quarterly, no. 2, online journal; Inc. Mag-azine. (2006). “Singling Out a New Market,” Janu-ary, p. 46; Overby, Stephanie. (2005). “It’s Cheaperin China,” CIO Magazine, September 15. Retrievedfrom www.cio.com/archive/091505/nypro.html,December 10, 2005.

493

In Europe, forty percent of large firms report that they have outsourced ser-vices to other countries. The biggest European outsourcing deal of 2005—a $7 bil-lion, 10-year contract to manage 150,000 computers and networking software forthe British military—was awarded to a consortium led by EDS, a Texas-based com-pany.21 In Japan’s IT industry, 23 percent of firms have outsourced services abroad.

Exhibit 16.4 identifies key players in global sourcing by four geographicregions. For example, Cairo-based Xceed Contact Center handles calls in Arabicand European languages for Microsoft, General Motors, Oracle, and Carrefour.Russia is aiming at high-end programming jobs. With its strong engineering cul-ture, Russia has an abundant pool of underemployed talent available at wagesabout one-fifth those of the United States.

Singapore and Dubai have declared that their safety and advanced legal sys-tems give them an edge in handling high-security and business-continuity ser-vices. The Philippines draws on longstanding cultural ties and solid English skillsto attract call-center work. Central and South American countries use their Spanishskills to seek call-center contracts for the Hispanic market in the United States.22

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In addition to low labor costs, other attractions of offshoring include the ability toincrease productivity, improve service, and access superior technical skills.Recently, Vietnam has attracted considerable offshored business. With Europe as itslargest export market, outscored production in Vietnam doubled in the early 2000sbecause it offers modern but low-cost operations, skilled but less expensive labor,and access to local sources unencumbered by trade restrictions.

A.T. Kearney’s Global Services Location Index (www.atkearney.com) istopped by emerging markets only, including: India, China, Malaysia, Thailand,Brazil, Indonesia, Chile, and the Philippines. The United States is the onlyadvanced economy ranked in the top 21 destinations. To help firms identify coun-tries for outsourcing value-chain activities, the index emphasizes various criteria:the country’s financial structure (compensation costs, infrastructure costs, tax andregulatory costs), the availability and skills of people (cumulative business-process experience and skills, labor force availability, education and language,and worker attrition rates), and the nature of the business environment (the coun-try’s political and economic environment, physical infrastructure, cultural adapt-ability, and security of intellectual property).

Benefits and Challenges of Global Sourcing for the Firm

As with other international entry strategies, global sourcing offers both benefitsand challenges for the firm. Exhibit 16.5 provides an overview of these benefitsand challenges.

In terms of challenges, firms should pay special attention to the seven con-cerns mentioned in Exhibit 16.5. Many of these challenges arise if the focal firmis sourcing from independent suppliers abroad. The low-control nature ofglobal sourcing implies that the issues of identifying, screening, negotiating,and monitoring partner activities become highly critical to the success of thefirm. We elaborated on these issues earlier in the book, in Chapters 13 through15. An additional challenge is the vulnerability to adverse currency fluctua-tions. Potential cost savings from global sourcing can be offset by a weakeninghome currency. In this scenario, foreign-sourced products cost more to import.For example, if China allowed its currency to appreciate, then its exports are

Central and Eastern Europe

Exhibit 16.4Key Players in Global Sourcing byRegion

China and South Asia

Latin America and the Caribbean

Middle East and Africa

Top-RankedCountries

Czech Republic,Bulgaria, Slovakia,Poland, Hungary

India, China, Malaysia,Philippines, Singapore,Thailand

Chile, Brazil, Mexico,Costa Rica, Argentina

Egypt, Jordan,United ArabEmirates, Ghana,Tunisia, Dubai

Up-and-Comers

Romania, Russia,Ukraine, Belarus

Indonesia, Vietnam, Sri Lanka

Jamaica, Panama,Nicaragua, Colombia

South Africa,Israel, Turkey,Morocco

EmergingLocalProviders

Luxoft (Russia),EPAM Systems(Belarus), Softline(Ukraine), DataArt(Russia)

NCS (Singapore),Bluem, Neusoft Group,BroadenGate Systems(China)

Softtek (Mexico),Neoris (Mexico),Politec (Brazil), DBAccess (Venezuela)

Xceed (Egypt),Ness Technolo-gies (Israel),Jeraisy Group(Saudi Arabia)

SOURCE: Engardio, Pete. (2006). “The Future ofOutsourcing: How It’s Transforming Whole Industriesand Changing the Way We Work,” Business Week,January 30, p. 58.

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Benefits and Challenges of Global Sourcing for the Firm 495

likely to slow down, as it will be relatively more expensive for customers tocontinue to source from China.

In terms of benefits of global sourcing to the focal firm, there are two primaryreasons to pursue global sourcing: cost efficiency and the achievement of strategicgoals. Let’s consider these in turn.

Cost EfficiencyCost efficiency is the traditional rationale for sourcing abroad. The firm takesadvantage of “labor arbitrage”—the large wage gap between advanced economiesand emerging markets. One study found that firms expect to save an average ofmore than 40 percent off baseline costs as a result of offshoring.23 These savingstend to occur particularly in R&D, product design activities, and back-office oper-ations such as accounting and data processing. For example, a programmer in theUnited States with an IT-related college degree and five years of JAVA program-ming experience can expect to earn over $60,000 a year, plus benefits. In Banga-lore, the salary is likely to be around $6,000 including benefits. A Ph.D. statisticianin India earns up to $40,000 annually, compared with $200,000 in the UnitedStates. Most of the work that such Indian information workers perform can betransmitted instantly over the Internet. This wage discrepancy explains why firmslike IBM, HP, Accenture, Dell, HSBC, Citicorp, and JP Morgan have been growingtheir India operations by 30 to 50 percent a year during the 2000s.24

Achievement of Strategic GoalsIn addition to helping save the firm money, global sourcing can also help it achievelonger-term goals. This strategic view of global sourcing—called transformationaloutsourcing—suggests that a firm can achieve gains in efficiency, productivity, qual-ity, and revenues much more effectively by leveraging offshore talent.25 Globalsourcing can provide the means to speed up innovation, fund development pro-jects that are otherwise unaffordable, or turn around failing businesses. Firmsleverage global sourcing to free expensive analysts, engineers, and sales personnel

Benefits andChallenges of Global

Sourcing

Cost Efficiency• Improved bottom line profitability

Strategic Benefits• Faster corporate growth• Access to qualified personnel abroad• Improved productivity and service• Business process redesign• Increased speed to market• Access to new markets• Technological flexibility• Improved agility by shedding unnecessary overhead

Benefits Challenges• Vulnerability to exchange rate fluctuations• Partner selection, qualification, and monitoring costs• Increased complexity of managing a worldwide network of production locations and partners• Complexity of managing global supply chain• Limited influence over the manufacturing processes of the supplier• Potential vulnerability to opportunistic behavior or actions in bad faith by suppliers• Constrained ability to safeguard intellectual assets

Exhibit 16.5Benefits and Challenges of GlobalSourcing

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from routine tasks so they can spend more time innovating and working with cus-tomers.26 Global sourcing can be a catalyst to overhaul outdated office operationsand prepare for new competitive battles.

Often, both types of rationale—cost efficiency and achieving strategic goals—are present and are not mutually exclusive in a particular global sourcing activity.Whatever the primary motivation, the firm engaged in global sourcing can expecta variety of specific benefits, including:

• Faster corporate growth. By outsourcing various peripheral activities toexternal suppliers, firms can focus their resources on performing moreprofitable activities such as R&D or building relationships with cus-tomers. For example, global sourcing enables companies to expand theirstaff of engineers and researchers while keeping constant their cost ofproduct development as a percentage of sales.27

• Access to qualified personnel abroad. Countries such as China, India, thePhilippines, and Ireland offer abundant pools of educated engineers,managers, and other specialists. The ability to access a larger pool of tal-ented individuals, wherever they are located, helps firms achieve theirgoals. For example, Disney has much of its animation work done in Japanbecause some of the world’s best animators are located there.

• Improved productivity and service. Manufacturing productivity and othervalue-chain activities can be improved by global sourcing to suppliersthat specialize in these activities. For example, Penske Truck Leasingimproved its efficiency and customer service by outsourcing dozens ofbusiness processes to Mexico and India. Global sourcing enables firms toprovide 24/7 coverage of customer service, especially for customers whoneed around-the-clock support.

• Business process redesign. By reconfiguring their value-chain systems or reengi-neering their business processes, companies can improve their productionefficiency and resources utilization. Multinational firms see offshoring as acatalyst for a broader plan to overhaul outdated company operations.28

• Increased speed to market. By shifting software development and editorialwork to India and the Philippines, the U.S.-Dutch publisher WaltersKluwer was able to produce a greater variety of books and journals andpublish them faster. As the opening vignette describes, big pharmaceuti-cal firms get new medications to market faster by global sourcing of clini-cal drug trials.

• Access to new markets. Firms can tap emerging markets and technologies inother countries, which not only helps them better understand foreign cus-tomers, but also facilitates their marketing activities there. Firms can alsouse global sourcing to service countries that may be otherwise closed dueto protectionism. For example, by moving much of its R&D operations toRussia, the telecommunications firm Nortel gained an important footholdin a market that desperately needs telephone switching equipment andother communications infrastructure.

• Technological flexibility. By switching suppliers at a time when new, lessexpensive technology becomes available, firms are no longer as tied tospecific technologies as they would be if they produced the technologythemselves. Sourcing provides greater organizational flexibility and fasterresponsiveness to evolving consumer needs.

• Improved agility by shedding unnecessary overhead. Unburdened by a largebureaucracy and administrative overhead, companies can be moreresponsive to opportunities and adapt more easily to environmentalchanges, such as new competitors.


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Implementing Global Sourcing through Supply-Chain Management 497

Combined, these benefits give firms the ability to continuously renew theirstrategic postures. For example, Genpact, Accenture, and IBM Services are outsourc-ing specialists that dispatch teams to meticulously dissect the workflow of otherfirms’ human resources, finance, or IT departments. This helps the specialists buildnew IT platforms, redesign all processes, and administer programs, acting as a vir-tual subsidiary to their client firms. The contractor then disperses work among globalnetworks of staff from Asia to Eastern Europe and elsewhere.29

Industries that particularly benefit from global sourcing include those in labor-intensive sectors such as garments, shoes, and furniture, those that use relativelystandardized processes and technologies such as automotive parts and machinetools, and those that make and sell established products with a predictable patternof sales, such as components for consumer electronics. For example, diamond pro-cessing is a labor-intensive industry that uses standardized processes that result indiamond rings and equipment used for fine cutting. The diamond cutting industryhas been concentrated in Antwerp, Belgium, for the past five centuries. Recently,however, diamond cutting is being outsourced to firms in India that perform thework more cost-effectively and provide other advantages. China is also emergingas an important participant in diamond cutting.

Implementing Global Sourcing throughSupply-Chain Management

A major reason why sourcing products from distant markets has become a majorbusiness phenomenon today is the efficiency with which goods can be physicallymoved from one part of the globe to another. This efficiency is due to the sophisti-cated processes and strategies involved in moving products from one point—suchas from manufacturer to intermediaries—to another point—such as intermedi-aries to customers.

Global supply chain refers to the firm’s integrated network of sourcing, produc-tion, and distribution, organized on a worldwide scale and located in countrieswhere competitive advantage can be maximized. Global supply-chain managementinvolves both upstream (supplier) and downstream (customer) flows.

Note that the concepts of the supply chain and the value chain are related butdistinct. Recall that the value chain is the collection of activities intended todesign, produce, market, deliver, and support a product or service. The supplychain is the collection of logistics specialists and activities that provides inputs tomanufacturers or retailers. Skillful supply-chain management serves to optimizevalue-chain activities. Sourcing from numerous suppliers scattered around theworld would be neither economical nor feasible without an efficient supply-chainsystem. Even as a casual observer, one has to be impressed when seeing the vastcollection of products in a supermarket or department store that originated fromdozens of different countries. The speed with which these products are deliveredto end users is equally impressive.

Consider a striking example of how global supply-chain management ismaking global sourcing feasible and, at the same time, contributing to firm com-petitiveness. The roll-out of the first Boeing 787 Dreamliner jet in Everett, Wash-ington, in July, 2007, marked a new beginning for this aircraft maker. Several fea-tures of the new aircraft are unique. It is a fuel-saving, medium-sized passengerjet that uses carbon composite for the fuselage (instead of aluminum). It is light-weight and has spacious interiors and higher cabin pressure than other mod-els—for a more comfortable journey. However, the most remarkable aspect ofthe Boeing 787 Dreamliner jet is the extent of outsourcing. Boeing itself isresponsible for only about 10 percent of the value added of this new aircraft—the tail fin and final assembly. Some 40 suppliers worldwide contribute the

Global supply chain Thefirm’s integrated network ofsourcing, production, anddistribution, organized on aworldwide scale and located incountries where competitiveadvantage can be maximized.

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Kansas and Oklahoma (U.S.)Co: Spirit AerosystemsPart: Leading edges

JapanCo: Kawasaki Heavy IndustriesPart: Fixed trailing edge

JapanCo: Mitsubishi Heavy IndustriesPart: Wing box

JapanCo: Kawasaki Heavy IndustriesPart: Fuselage, wheel well

FranceCo: LatecoerePart: Passenger doors

Kansas and Oklahoma (U.S.)Co: Spirit AerosystemsPart: Forward fuselage

FranceCo: Messier-DowtyPart: Landing gear

Ohio (U.S.)Co: General ElectricPart: Engines

United KingdomCo: Rolls-RoycePart: Engines

North Carolina (U.S.)Co: GoodrichPart: Nacelles

JapanCo: Fuji Heavy IndustriesPart: Center wing box

Kansas and Oklahoma (U.S.)Co: Spirit AerosystemsPart: Engine pylons

AustraliaCo: Hawker de HavillandPart: Movable trailing edges

SwedenCo: Saab AerostructuresPart: Cargo doors, access doors

Washington (U.S.), Canada,AustraliaCo: Boeing FredricksonPart: Vertical tail assembly

Italy, Texas (U.S.)Co: Alenia/VoughtPart: Horizontal stabilizer,center fuselage, aft fuselage

Washington (U.S.), Canada, AustraliaCo: Boeing WinnipegPart: Wing-to-body fairing

KoreaCo: Korean Airlines-Aerospace DivisionPart: Wingtips

Exhibit 16.6 Where Boeing Company Sources the Components for its New 787 Aircraft

SOURCE: Tatge, Mark (2006), “Global Gamble,” Forbes, (April 17), pp. 78–80.

remaining 90 percent of the value. For example, the wings are built in Japan, thecarbon composite fuselage is made in Italy, and the landing gear is manufac-tured in France. As illustrated in Exhibit 16.6, components for the new 787 orig-inate from distant parts of the world. The global dispersion of manufacturingresponsibility allows Boeing to transform itself into a systems integrator andfocus on its core capabilities—design, marketing, and branding. Boeing alsoreduces the chance of a bottleneck at one plant holding up production of the air-craft. It is no longer at the mercy of the weakest link in the chain, which wasoften one of Boeing’s own plants.30

Networks of supply-chain hubs and providers of global delivery service arean integral part of global supply chains. Many focal firms delegate supply-chainactivities to such independent logistics service providers as DHL, FedEx, TNT,and UPS. Consulting firms that manage the logistics of other firms are called thirdparty logistics providers (3PLs). Using a 3PL is often the best solution for interna-tional logistics, especially for firms that produce at low volumes or lack theresources and the expertise to create their own logistics network.

A good example of how global supply-chain management has evolved can betaken from the ongoing European Union integration. The removal of border con-trols allowed supply-chain managers to redraw the maps of their sourcing anddistribution activities throughout Europe. Warehousing and distribution centerswere consolidated and centralized. Intel reduced shipping costs by at least 7 per-cent by consolidating its worldwide freight expenditures into four transportationfirms. As a result, from its 14 manufacturing sites around the world, Intelimproved on-time delivery and customer-service performance substantially.31


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Implementing Global Sourcing through Supply-Chain Management 499

A global supply-chain network consolidates a firm’s sourcing, manufacturing,and distribution in a few strategic locations worldwide so the firm can concentratethese activities in countries where it can maximize its competitive advantages.Exhibit 16.7 illustrates the stages, functions, and activities in the supply chain. Itreveals how suppliers interact with the focal firm and how these, in turn, interactwith distributors and retailers. Each stage in the global supply chain encompassesfunctions and activities that involve the focal firm in sourcing and distribution.When the focal firm deals with multiple products and demanding customersspread around the world, managing supply chains becomes more complex.

Costs associated with physically delivering a product to an export market mayaccount for as much as 40 percent of the total cost. Skillful supply-chain managementreduces this cost while increasing customer satisfaction. Experienced firms makeoptimal use of information and communications technology (ICT), which stream-lines supply chains, reducing costs and increasing distribution efficiency. For exam-ple, managers use Electronic Data Interchange (EDI), which passes orders directly fromcustomers to suppliers automatically through a sophisticated ICT platform. The UK-based supermarket chain Tesco greatly reduced inventory costs by using an EDI sys-tem to link point-of-sale data to logistics managers. Technology allows Tesco to trackproduct purchases down to the minute. Many canned foods that used to sit in Tesco’swarehouses for days or weeks are now received directly from suppliers.32

Supply-chain applications software enhances information sharing andimproves efficiency by helping the manufacturer and focal firm track interna-tional shipments and clear customs. Many firms digitize key documents such ascustoms declarations and invoices, which improves speed and reduces order pro-cessing costs and shipping procedures. Spain-based retailer Zara is a good exam-ple of firms that use EDI technology to optimize supply-chain management,inventory management, and responsiveness to consumer demands. The firm uses

Exhibit 16.7Stages, Functions, and Activities inthe Global Supply Chain

Suppliers Focal FirmIntermediaries and/or Retailers

Stage in supply chain

Sourcing, fromhome countryand abroad

Inbound materi-als; outboundgoods and services

Distributionto domestic customers or foreign customers(exports)

Major functions

Provide rawmaterials, parts,components,supplies, as well as businessprocesses andother services to focal firms

Manufacture or assemble components or finished products,or produce services

Distribute andsell products andservices

Typical activities

Maintain inven-tory, processorders, trans-port goods,deliver services

Manage inventory,process orders,manufacture orassemble products,produce anddeliver services,distribute productsto customers, retailers, or intermediaries

Manage inventory,place or processorders, produceservices, managephysical distribu-tion, provide after-sales service

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wireless personal digital assistants (PDAs) and instantaneous communicationswith its stores to carry out ongoing market research. These technologies haveallowed Zara to become a leader in rapid-response retailing. Like Zara’s, the bestglobal supply chains consist of reliable, capable partners all connected throughautomated, real-time communications. In an efficient global supply chain, thefocal firm and its supply-chain partners continuously communicate and shareinformation in order to meet the demands of the marketplace.

Logistics and TransportationLogistics involves physically moving goods through the supply chain. It incor-porates information, transportation, inventory, warehousing, materials han-dling, and similar activities associated with the delivery of raw materials, parts,components, and finished products. Managers seek to reduce moving and stor-age costs by using just-in-time inventory systems. Internationally, logistics arecomplex due to greater geographic distance, multiple legal and political envi-ronments, and the often inadequate and costly nature of distribution infrastruc-ture in individual countries. The more diverse the firm’s global supply chain,the greater the cost of logistics.

Competent logistics management is critical. For example, the California portsof Los Angeles and Long Beach handle over 40 percent of imports into the UnitedStates. Although the two California ports process over 24,000 containers per day,infrastructure deficiencies and increasing demand combine to result in longdelays, which translate into longer transit times and higher costs for U.S.importers. Because of delays, Toys “ ” Us had to build 10 extra days into its sup-ply chain, and MGA Entertainment lost $40 million in revenues when it could notdeliver its bestselling Bratz dolls on time to retailers.33 As a result of poor supply-chain planning, Microsoft’s Xbox 360 games console sold out soon after launch.Their scarcity led to high prices in unofficial channels. On eBay, Xbox consolessold for as much as $1,000, compared with the official price of about $400.34

Transportation ModesInternational logistics typically involves multiple transportation modes. Land trans-portation is conducted via highways and railroads. Ocean transportation is han-dled through large container ships. Air transportation involves commercial orcargo aircraft. Ocean and air transport are common in international businessbecause of long shipping distances. Ships are the most common transportationmode, even among countries connected by land bridges. Sea transport was revo-lutionized by the development of 20- and 40-foot shipping containers, the bigboxes that sit atop ocean-going vessels. Sea transportation is very cost effectivebecause one ship can carry thousands of these containers at a time.

The transportation modes involve several trade-offs. There are three consider-ations in choosing a particular mode: transit time is the amount of time it takes forthe goods to be delivered, predictability is the reliability of anticipated transit timeversus actual transit time, and the cost of transportation. For example, ocean trans-port is far slower, but also far cheaper, than air transport. Air transport is fast andextremely predictable, but costly. Given its high cost, air transport is the preferredtransportation mode in three common situations: to transport perishable prod-ucts, such as food and flowers, to transport goods with a high value-to-weightratio, such as jewelry and laptop computers, and to make emergency shipments,such as when a foreign customer urgently needs a missing part.

The use of air freight has increased dramatically since the 1970s, as the cost ofair transport has declined. Air freight accounts for only about one percent of thetotal volume but more than a third of the total value of international shipments.

R

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Risks in Global Sourcing 501

Land transport is usually more expensive than ocean transport but cheaper thanair freight. Ocean shipping from, for example, China to the United States, or fromEast Asia to Europe, takes two to four weeks, including customs clearance. Whiletimeconsuming, the cost of ocean freight is quite low, often accounting for lessthan one percent of a product’s final price.

Risks in Global Sourcing

Global sourcing is carried out by small and large firms alike. In many firms, initialinvolvement in international business takes the form of global sourcing (which,for such firms, can be viewed as inward internationalization). Based on the experi-ence gained through global sourcing, a firm may then progress to exporting, directinvestment, or collaborative ventures (outward internationalization). Global sourc-ing often leads to increased company awareness of international opportunities. Inthis way, global sourcing expands managers’ horizons by showing the way toexpand sales and other activities.

However, as with other business activities, global sourcing also involvesunexpected complications. In fact, studies reveal that as many as half of all out-sourcing arrangements are terminated earlier than planned. Specifically, globalsourcing involves seven major risks.35

1. Less-than-expected cost savings. International transactions are often more com-plex and costly than expected. Conflicts and misunderstandings arise because ofdifferences in the national and organizational cultures between the focal firm andforeign supplier. Such factors give rise to cost savings that are less than what man-agement had originally anticipated.2. Environmental factors. Numerous environmental challenges confront focalfirms, including exchange rate fluctuations, labor strikes, adverse macroeconomicevents, high tariffs and other trade barriers, as well as high energy and trans-portation costs. Firms sometimes find that the cost to set up a foreign outsourcingfacility is far greater than planned, due to the need to upgrade poor infrastructureor because the facility must be located in a large city to attract sufficient skilledlabor. As noted in the opening vignette, for example, inadequate energy systemsand other infrastructure problems in Africa compromised the testing of new med-ications developed by big pharmaceutical firms.3. Weak legal environment. Many of the popular locations for global sourcing(for example, China, India, and Russia) have weak laws and enforcementregarding intellectual property, which can leadto the erosion of key strategic assets. Manycountries are characterized by inadequatelegal systems, red tape, convoluted tax sys-tems, and complex business regulations thatcomplicate local operations.4. Risk of creating competitors. As the focal firmshares its intellectual property and business-process knowledge with foreign suppliers, it alsoruns the risk of creating future rivals. For exam-ple, Schwinn, long the leader in the global bicy-cle industry, created competitors by transferringmuch of its production and core expertise to for-eign suppliers. The suppliers acquired sufficientknowledge, became lower-cost competitors, andeventually forced Schwinn into bankruptcy(from which it eventually recovered).

Firms that undertake global sourcing may encounter problematic environmental factors, such as poor infrastructure in transportationsystems, as suggested by thisstreet scene in India.

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5. Inadequate or low-skilled workers. Some foreign suppliers may be staffed byemployees who lack appropriate knowledge about the tasks with which theyare charged. Other suppliers suffer rapid turnover of skilled employees, whofind jobs with more desirable firms. For instance, typical Indian operations inbusiness processing lose 20 percent or more of their workers each year andgood managers are often in short supply. Customer complaints about thequality of service led Dell to move its corporate call center from India back tothe United States in 2003.6. Over-reliance on suppliers. Unreliable suppliers may put earlier work asidewhen they gain a more important client. Suppliers occasionally encounter finan-cial difficulties or are acquired by other firms with different priorities and proce-dures. When such events occur, management at the focal firm may find itselfscrambling to find alternative suppliers. Overreliance can shift control of keyactivities too much in favor of the supplier. As more and more tasks are performedby the supplier, the focal firm may lose control of important value-chain tasks.Focal firm management should strive to maintain an appropriate balance ofpower between itself and foreign suppliers.7. Erosion of morale and commitment among home-country employees. Global sourc-ing can create a situation in which employees are caught in the middle betweentheir employer and their employer’s clients. At the extreme, workers find them-selves in a psychological limbo, unclear about who their employer really is. Whenoutsourcing causes retained and outsourced staff to work side by side, tensionsand uncertainty may arise, evolving into a sort of “us-versus-them” syndromeand diminished employee commitment and enthusiasm.

One firm that experienced problems in its early phases of global sourcing isthe London-based bank HSBC. Starting with one software-development centerin Pune, a satellite city of Bombay, the bank established development centers inChina and Brazil. When departments with tech needs at HSBC headquarterswould order large jobs from India, the outsourcing staff in Pune would complybut occasionally realize they had bitten off more than they could chew. While thecenter had technical skills, it lacked specific knowledge in the banking industry.For instance, HSBC asked the Pune staff to build an insurance product but soondiscovered the staff was unfamiliar with the insurance industry. HSBC manage-ment solved the problems by requiring bank experts from London to sit along-side the technical experts in Pune during project development.

Strategies for Minimizing Risk in Global Sourcing

The experience of firms with global sourcing so far reveals six managerial guide-lines for strategic global sourcing.1. Go offshore for the right reasons. The best rationale is strategic. The vast majorityof companies cite cost-cutting as the main reason for global sourcing. After thefirst year, however, most firms encounter diminishing returns in the amount ofmoney saved. Cost-cutting is often a distraction from more beneficial, long-termgoals such as enhancing the quality of offerings, improving overall productivity,and freeing up knowledge workers and other core resources that can be rede-ployed to improve long-term performance. To maximize returns, managementshould engage in substantive planning that examines tasks and subactivities ineach of the firm’s value chains. The analysis should aim to outsource those tasksin which the firm is relatively weak, that offer relatively little value to the bottomline, or that can be performed more effectively by others, yet are not critical to thefirm’s core competencies.


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2. Get employees on board. Global sourcing tends to invite opposition fromemployees and other organizational stakeholders. Disaffected middle managerscan undermine projects and other goals that offshoring seeks to achieve. Poorlyplanned sourcing projects can create unnecessary tension and harm employeemorale. Thus, management should seek to gain employee support for outsourc-ing projects. The decision to outsource should be based on reaching a consensusof middle managers and employees throughout the firm. Management shouldbe diligent about developing alternatives for redeploying laid-off workers, andinvolve employees in selecting foreign partners. Where labor unions areinvolved, management should seek their counsel and incorporate their views.For example, when management at Dutch bank ABN Amro decided to offshorenumerous accounting and finance functions, it took great pains to prepare thefirm’s large base of employees in advance. The bank set up a full-time commu-nications department to explain the move to middle managers and staff. Seniorexecutives held town hall meetings with employees and involved unions inmanaging the shift.36

3. Choose carefully between a captive operation and contracting with outside suppliers.Managers should be vigilant about striking the right balance between the orga-nizational activities that it retains inside the firm and those that are sourced fromoutside suppliers. An increasing number of firms are establishing their ownsourcing operations abroad. By owning the offshored facility, managementmaintains complete control of outsourced activities and retains control of keytechnologies and processes. For example, when Boeing wanted to outsource keyvalue-chain tasks, management established a company-owned center inMoscow where it employs 1,100 skilled but relatively low-cost aerospace engi-neers. The Russian team is working on a range of projects, including the designof titanium parts for the new Boeing 787 Dreamliner jet.37

4. Emphasize effective communications with suppliers. A common reason for globalsourcing failure is that both buyers and suppliers tend not to spend enough timeup front to get to know each other well. They rush into a deal before clarifyingpartner expectations, which can give rise to misunderstandings and inferiorresults. Partners need to maintain active communication and oversight. Forinstance, because production quality in an emerging market may vary over time,managers at the focal firm may need to closely monitor manufacturing processes.When partners do not share necessary information with each other, vaguenessand ambiguity emerge, followed by misunderstanding and frustration in out-sourcing projects.38 Poor cultural fit is also a potential problem. Guided by differ-ent business philosophies and practices, partners tend to approach the same issuedifferently. Effective communication is necessary to minimize misunderstandingsthat can diminish relationships between buyers and suppliers.5. Invest in supplier development and collaboration. When a business function isdelegated to a supplier, the parties need to exchange information, transferknowledge, troubleshoot, coordinate, and monitor. Over the long haul, variousbenefits emerge when the focal firm adjusts its processes and product requirementsto match the capabilities of foreign suppliers. Management should collaborateclosely with suppliers in codevelopment and codesign activities. Close suppliercooperation also enables the focal firm to tap into a stream of ideas for new prod-ucts, processes, technologies, and improvements. Efforts to build strong relation-ships help create a moral contract between the focal firm and the supplier, which isoften more effective than a formal legal contract.6. Safeguard interests. The focal firm should take specific actions to safeguard itsinterests in the supplier relationship. First, it can encourage the supplier to refrainfrom engaging in potentially destructive acts that jeopardize the firm’s reputation.Second, it can escalate commitments by making partner-specific investments

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(such as sharing knowledge with the supplier) on an incremental basis, allowingfor ongoing review, learning, and adjustment. Third, it can share costs and rev-enues by building a stake for the supplier so that, in case of failure to conform toexpectations, the supplier also suffers costs or foregoes revenues. Fourth, it canmaintain flexibility in selecting partners by keeping options open to find alterna-tive partners in case a particular supplier does not work out. Finally, the focal firmcan hold the partner at bay by withholding access to intellectual property and keyassets in order to safeguard the firm’s interests for the long term. If conflicts withthe supplier become an ongoing problem, unresolved by negotiations, one optionfor the firm is to acquire full or partial ownership of the supplier.

Implications of Global Sourcing for PublicPolicy and Corporate Citizenship

Global sourcing is controversial. The business community sees global sourcing asa way of maintaining or increasing business competitiveness. Others view it neg-atively, focusing on the loss of jobs. After IBM workers in Europe went on strikeagainst offshoring, shareholders at IBM’s annual meeting argued for an anti-off-shoring resolution. If the resolution had passed, it would have limited IBM’soptions to manage the firm, threatening company performance.

The general public is equally likely to be critical of offshoring. When the stateof Indiana awarded a $15 million IT services contract to a supplier that planned touse technicians from India to do some of the work, the Indiana Senate intervenedand cancelled the deal. Indiana is one of many public sector players that are con-tracting out services to foreign vendors in order to save tax dollars. The staterecently leased the management of the Indiana Toll Road to an Australian-Spanish

partnership for 75 years for $3.8 billion.Concerns about outsourcing and offshoring

are not new. In the 1970s and 1980s, when manu-facturing jobs were outsourced, labor unionsprotested about “runaway corporations.” Fortu-nately, bleak forecasts of job losses proved wrongas a result of economic expansion and job growthin the 1990s. In the United States, the proportionof jobs outsourced abroad each year is still lessthan 0.1 percent of total U.S. employment.

Potential Harm to Economiesfrom Global SourcingConcerns about the consequences of globalsourcing deserve serious attention. Critics ofglobal sourcing point to three major problems.Global sourcing can result in (1) job losses in thehome country, (2) reduced national competitive-ness, and (3) declining standards of living.Regarding the last two concerns, critics worrythat, as more tasks are performed at lower costwith comparable quality in other countries,high-wage countries will eventually lose theirnational competitiveness. Critics fear that long-held knowledge and skills will eventually drainaway to other countries, and the lower wagespaid abroad to perform jobs that were previ-


Global sourcing has sparkedprotests in many countries. Here,a union member protests IBM’spolicies of job outsourcing.

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Implications of Global Sourcing for Public Policy and Corporate Citizenship 505

ously done in high-wage countries will eventually pull down wages in the lattercountries, leading to lower living standards.

The biggest worry is job losses. For example, the number of U.S. jobs in thelegal industry outsourced to foreign contractors now exceeds 25,000 jobs per year.39

Some estimate that more than 400,000 jobs in the IT industry that were previouslyperformed in the United States have moved offshore.40 One study predicts that bythe year 2017, 3.3 million U.S. service jobs—with a value of $136 billion—will besent abroad.41 Critics say all of this amounts to exporting jobs.

Moreover, job losses result when companies increase their sourcing of inputand finished goods from abroad. For instance, Wal-Mart sources as much as 70percent of its merchandise from China. This has led public officials and concernedcitizens to form a protest group called Walmartwatch.com. The group claims thatmillions of U.S. jobs have been lost due to Wal-Mart’s sourcing from foreigninstead of U.S. suppliers.42 In addition to the advanced economies, however, joblosses are occurring in developing economies as well. For instance, El Salvador,Honduras, Indonesia, Morocco, and Turkey are restructuring as jobs in the textileindustry are gradually transferred to China, India, and Pakistan, where multina-tional clothiers can operate more efficiently.43

Consider the potentially devastating effect of wholesale job losses on a smallcommunity. Recently, Electrolux, one of the world’s largest household-appliancemanufacturers, closed its factory in Michigan and moved production to Mexico.The company had been producing refrigerators in Greenville, Michigan, fornearly 40 years, providing 2,700 jobs. From the company’s viewpoint, closing theplant made economic sense. Once the world’s largest refrigerator factory, it haddeveloped weak financial performance and costly labor. By establishing amaquiladora plant in Juarez, Mexico, Electrolux sought to profit from low wagesand take advantage of the El Paso Foreign Trade Zone just across the border inTexas. Management believed it was acting in the firm’s best interest andstrengthening its global competitiveness.

From the local community’s standpoint, however, the decision was devastat-ing. How could so many jobs be replaced in such a small community? Whatwould happen to the town’s social and economic landscape? Assistance fromlabor unions and the State of Michigan were to no avail. Concessions in terms oflower wages by the labor union, and over $100 million from Michigan to Elec-trolux in tax breaks and grants were insufficient for Electrolux to change its mind.It did not help that Electrolux is a foreign-owned company headquartered inSweden. Residents perceived the company had little loyalty to their community.In 2007, the Greenville plant was demolished. The town hopes to redevelop thesite for mixed usage, as riverfront condominiums, commercial space, and park-land. Most former workers found other jobs in the service sector, although typi-cally for less pay.44

Also recall the Boeing 787 Dreamliner aircraft. In the process of transformingitself from a manufacturer into a systems integrator, the company shed about38,000 jobs in the United States. It was also criticized for transferring technology toforeign partners.

From these examples, it is easy to see the clash of interests between MNEsand local communities. Proponents of global sourcing argue that workers wholose their jobs due to offshoring can find new work. But this may be overly opti-mistic. It takes considerable time for laid-off workers to find new jobs. Accord-ing to one estimate, as much as one-third of U.S. workers who have been laid offcannot find suitable employment within a year.45 Older workers are particularlyvulnerable. Compared to younger workers, they find it more difficult to learnthe skills needed for new positions. The rate of redeployment is likely to be evenlower in Europe, where unemployment rates are already high, and in Japan,where employment practices are less flexible. In Germany, the percentage of

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workers who are not reemployed within a yearof losing their jobs is as high as 60 percent.Under such circumstances, global sourcingmay increase the overall unemployment rate,reduce overall income level, and harm thenational economy. Even workers who do findnew jobs may be unable to achieve wages andwork levels that equal those of their formerpositions.

Ethical and Social Implications ofGlobal SourcingThe prevalence of global sourcing has alsoraised public debate about the role of MNEs inprotecting the environment, promoting humanrights, and improving labor practices and work-

ing conditions. In other words, the bar for global corporate citizenship has beenraised. Consider, for example, the case of foreign suppliers that operatesweatshops—factories in which people may work long hours for very low wages,often in harsh conditions.46 Sweatshops may employ child labor, a practice thathas been outlawed in much of the world. Those who defend moving productionto low-wage facilities abroad point to a lower standard of living as an explanationfor the low wages, and argue that their operations benefit the community by pro-viding needed jobs. They point out that the choice for local workers is oftenbetween low-paying work or no work at all. Others argue that the alternativesavailable to such workers are even less desirable, such as poverty, prostitution,and social problems.

Opponents of sweatshops argue that corporations that sell their products inwealthy countries have a responsibility to pay their workers according to basicWestern standards, especially when their products command high prices inadvanced-economy markets. Another argument is that the foreign companies thatestablish factories destroy the preexisting agricultural market that may have pro-vided a better life for laborers. In response to public pressure, some companieshave reduced or ended their use of such cheap labor. For example, apparel makersGap, Nike, and New Balance are notable for changing their policies after intensepressure from campus anti-sweatshop groups.

Potential Benefits to National EconomyThose in favor of global sourcing call attention to the benefits that it provides tothe national economy. Proponents advance four key arguments. First, by reconfig-uring value chains to the most cost-efficient locations, companies reduce their pro-duction costs and enhance their performance in an increasingly competitiveglobal marketplace. For example, Roamware Inc., a U.S. firm that sells computersystems to cell phone providers, saved thousands of dollars on a project to createan electronic database by hiring Pangea3, an Indian firm, to do the job instead ofrelying on a nearby supplier.47 As individual firms enhance their competitiveness,the national economy should strengthen as well.

Second, cost reductions and enhanced competitiveness allow firms to reducethe prices that they charge their customers. This benefits not only buyers but alsothe firms themselves, which become more price-competitive and enjoy greatermarket demand, which in turn stimulates job creation, offsetting much of theemployment lost to outsourcing.


Workers at a Nike factory in Vietnam, where Nike is thelargest private employer. Follow-ing charges that its foreign con-tract factories were run like“sweatshops,” Nike took stepsto improve working conditions.

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Implications of Global Sourcing for Public Policy and Corporate Citizenship 507

Third, by leveraging a flexible labor market and strong economic growth,countries that outsource may be able to shift their labor force to higher-value activ-ities. This transformation has the effect of boosting the nation’s productivity andindustrial efficiency. By concentrating resources in higher-value activities, firmscreate better jobs. Large software firms Microsoft and Oracle have simultaneouslyincreased both outsourcing and their domestic payrolls for higher-value jobs.48

Finally, declining wages may be offset by lower prices secured for outsourcedproducts or services. Hence global sourcing tends to indirectly increase con-sumers’ purchasing power and lift their living standards.49 For instance, Wal-Marthas been roundly criticized for sourcing most of its merchandise from China. Butthe practice allows Wal-Mart to resell the goods at low prices, which translatesinto higher living standards for Wal-Mart customers.

Public Policy toward Global SourcingThe consequences of global sourcing for the national economy and workers arenot yet fully known. A recent comprehensive study, carried out for the UnitedStates, argues that the official statistics understate the impact of offshoring on thenational economy.50 Digging deeper into the statistics, the study finds that importgrowth, adjusted for inflation, is faster than the official numbers show. The authorconcluded that more of the gain in living standards in recent years has come fromcheap imports, less from an increase in domestic productivity. This suggests thatreal GDP (gross domestic product) may be overstated. In contrast, the benefits thatU.S. consumers gain from trade are actually understated. An implication is thatthe United States’ living standards depend in part on the ability of foreign facto-ries to boost output and cut costs.

In short, the findings suggest that U.S. consumers may enjoy an even betterdeal from imports than previously thought. From a public-policy standpoint, it issimply impractical for a nation to prohibit global sourcing. A more enlightenedapproach is to mitigate the harm that global sourcing can cause.51 Offshoringamounts to a process of creative destruction, a concept first proposed by Austrianeconomist Joseph Schumpeter.52 According to this view, over time, firms’ innova-tive activities tend to make mature products obsolete. For example, the introduc-tion of personal computers essentially wiped out the typewriter industry, theDVD player eliminated the VCR industry, and so on. Similarly, just as offshoringresults in job loss and adverse effects for particular groups and economic sectors,it also creates new advantages and opportunities for firms and consumers alike.New industries created through the process of creative destruction will create newjobs and innovations.

If the loss of certain jobs is inevitable as a result of offshoring, public-policymakers are better off guiding employment toward higher value-added jobs bystimulating innovation, for example. Admittedly, this implies greater governmentintervention and is likely to produce positive outcomes only in the long run. Thepublic sector can reduce the unfavorable consequences of global sourcing. One ofthe best ways would be to keep the cost of doing business relatively low. Govern-ments can use economic and fiscal policies to encourage the development of newtechnologies by helping entrepreneurs reap the financial benefits of their workand keeping the cost of capital needed to finance R&D relatively low. Another use-ful policy is to ensure that the nation has a strong educational system, includingtechnical schools and well-funded universities that supply engineers, scientists,and knowledge workers. A strong educational system helps to ensure that firmscan draw from a high-quality pool of qualified labor. As firms restructure throughglobal sourcing efforts, increased worker flexibility ensures that many who losejobs can be redeployed in other positions.

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CLOSING CASE

508

Good Hopes for Global OutsourcingGood Hope Hospitals of California, Inc. (“Good Hope”)is a chain of nine hospitals in or near Los Angeles, SanDiego, and San Francisco. Founded in 1976, Good Hopeis run on a for-profit basis and management continuouslystrives for efficient operations. Andy Delgado is GoodHope’s Vice President for Finance and Accounting, andJoy Simmons is the senior manager in Information Tech-nology. The two executives needed to make significantcuts in operational costs in their respective areas.Extremely reluctant to lay off workers, they mutuallyagreed on a plan to outsource some work now done bycontractors in California to suppliers located abroad.

Delgado and Simmons believed that some of GoodHope’s ongoing business processes could be outsourced,including data processing for accounts receivable andaccounts payable, certain customer service applications,transcription of medical records, and some data processing.Both managers had heard about the benefits of globalsourcing but neither knew how to proceed. So, they beganto research their options.

The Downside of Global SourcingIn the course of their research, Delgado and Simmons alsolearned that services are frequently more challenging tooutsource than manufacturing. This is partly because it isusually more difficult to judge the quality of services thanthat of manufactured products. Firms that use globalsourcing sign legal contracts with suppliers binding them-selves to deliver promised levels of service. In reality, thereis much variation in the quality of services delivered. Toachieve satisfactory outcomes, the contracting firm shouldemphasize developing trust and understanding with thesupplier, especially critical in cross-cultural settings. Del-gado and Simmons wondered about the enforceability oflegal agreements in different country settings.

Another potential concern was the quality of work-ers. Some foreign suppliers cannot hire a sufficient num-ber of skilled managers to oversee the work performedby their staffs. Workers must be trained, supervised, andproperly motivated. Could Good Hope provide suchsupport and technical assistance?

Delgado and Simmons also read troubling storiesabout firms whose offshore operations proved to be morecostly than originally planned. They read about firms thatlost customers and jeopardized their reputations because ofpoor customer service received from abroad. Delgado andSimmons also worried about breach of confidentiality—towhat extent could they rely on foreign organizations tokeep patient data confidential? The various risks impliedthat Good Hope would need to interact closely and fre-quently with the external supplier, which would add sub-stantial costs in terms of negotiating, transacting, and mon-itoring, as well as international travel. Delgado and

Simmons realized they would need to approach globalsourcing very carefully.

Offshoring DestinationsDelgado and Simmons next focused their research on iden-tifying the most promising foreign locations for offshoring.Their investigation revealed that India was the most popu-lar choice for many types of services. The country’s out-sourcing sector had been growing at 25 to 50 percent peryear. India’s labor costs are 25 to 40 percent of those in theUnited States and English is widely spoken. The teamlearned that reputable firms such as IBM, Dell, and Citicorphad offshored numerous service operations to India.

Their investigation revealed that China was also apotential destination. The country has millions of suitableworkers and soon is expected to rival India as a providerof services such as insurance underwriting and back-office operations. Outsourcing costs are currently lowerin China than in India. However, a concern is China’s rep-utation for excessive regulation and bureaucracy. Del-gado and Simmons wondered if they could develop suffi-cient trust and understanding with partners in anunfamiliar and distant culture with language differences.

Eastern Europe also emerged as a promising location.The region is culturally similar to the United States, andwages in much of the region are on par with those in India.For example, while Indian accountants earn roughly $10an hour, wages are substantially lower in Bulgaria andRomania. The Czech Republic is a popular location and isthe site of business-process centers for firms such as DHL,Siemens, and Lufthansa. One expert claimed the quality ofwork in the Czech Republic sometimes surpasses the bestavailable in India. Even Infosys, the giant Indian IT firm, hasmajor support operations in the Czech Republic. But East-ern European countries sometimes have a shortage ofqualified labor, particularly among middle managers. Asthe region’s economies develop, social and health insur-ance costs are also increasing. Taxes can be high andbureaucratic governments hinder efficient business opera-tions. Corruption is a problem in some countries.

Delgado and Simmons also considered sites in LatinAmerica such as Chile, Mexico, and Costa Rica. Latin Amer-ica offered various attractions. In addition to being costeffective, it is much closer to the United States and gener-ally in the same time zone. Outsourcing customer service toLatin America also makes sense to Californians, many ofwhom speak Spanish as their first language. But Latin Amer-ica’s outsourcing infrastructure is still young, and Delgadoand Simmons worried about whether they could find anappropriate supplier. Numerous other outsourcing locationswere possible around the world. For Delgado and Sim-mons, the number of options was bewildering. Somehowthey had to reach a decision.

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Closing Case 509

Help from an Outsourcing BrokerThe executives sought the assistance of an outsourcingbroker, a consultant with expertise in finding subcontrac-tors and services suppliers abroad. Brokers are especiallyuseful for firms new to outsourcing or those that lack theresources to find foreign suppliers on their own. Eventu-ally the broker found a supplier in India that appearedwell suited to meet Good Hope’s needs. For example, fortranscribing doctor’s notes and other medical documents,Simmons learned that Good Hope would pay 12 centsper word, 5 cents less than charged by the firm’s currentsupplier in California. Simmons determined that GoodHope would save about $640,000 a year on medical tran-scriptions alone. When the accounting and customer ser-vice work were added to the mix, the executives discov-ered that Good Hope would save roughly $1.4 millionannually. Delgado was elated: “How else could we shaveso much from our expenses with so little effort? And bestof all, we don’t have to lay off any of our own workers.”

The Supplier FirmTo meet all their outsourcing needs, Delgado and Simmonssettled on a firm in Bangalore, India, known as BangSource.According to the outsourcing broker, BangSource had agood reputation and was already handling accounting, dataprocessing, transcription, and customer service operationsfor several large U.S. hospitals. BangSource expects to pickup many new accounts in Australia, Canada, and Europe.BangSource is located in one of the fastest-growing areas ofBangalore and buses in workers from all around the region.The outsourcing broker confided that although Bang-Source’s employee turnover rate was 25 percent, this wasconsistent with the rate at other outsourcing firms.

The consultant put Good Hope in touch with Mr. Singh,a manager at BangSource and recent graduate of one ofIndia’s numerous MBA programs. Mr. Singh explained thatBangSource had been in business for about 4 years and hadquickly achieved considerable expertise in various businessprocesses. BangSource had recently begun to hire com-puter engineers and marketing personnel, as the firm wasplanning to increase its outsourcing capabilities to includesoftware development and telemarketing.

The Situation One Year LaterIn the year following the signing of a contract with Bang-Source, Good Hope encountered various problems. Thecost of BangSource’s services proved to be significantlyhigher than what Mr. Singh had originally forecast. Process-ing of accounting and other data was more complex thananticipated, so costs had escalated. Also, BangSourceproved less efficient in addressing Good Hope’s customerservice queries, and required more telephone time andphone calls to address customer needs. Although the Indiancustomer service workers generally spoke perfect English,some had hard-to-understand accents and a few of GoodHope’s customers had complained. Various misunderstand-

ings arose between BangSource and Good Hope as man-agement at the respective firms attempted to refine activityprocessing. The problem was exacerbated by recent fluctu-ations in the rupee-dollar exchange rate, which sometimesinflated the cost of BangSource’s services even further.

In addition, while BangSource’s business hadincreased substantially in the previous year, provision ofelectrical power by the local energy utility had not keptpace, and BangSource occasionally experienced poweroutages and downtime of computer systems. Growingdemand for workers in the Bangalore area delayed hir-ing efforts, and BangSource was sometimes late in per-forming promised services due to a shortage of skilledworkers. BangSource also faced problems hiring enoughqualified managers, which further impaired the quality ofits accounting and call-center services.

Delgado and Simmons were disappointed andunsure whether Good Hope was better off today than ayear earlier. Top management was pressing the team tosolve the problems. As the pair prepared to fly to Indiato meet with BangSource management, they knew thatoutsourcing could succeed but they had to figure outhow to overcome the various challenges.

AACSB: Reflective Thinking, EthicalReasoning

Case Questions1. What motives and specific strategic goals can Good

Hope achieve by outsourcing to India? Identifystrategic goals that Good Hope could potentiallyachieve in the future.

2. What are the specific risks that Good Hope faced andpotentially faces in outsourcing the activities to India?

3. What specific guidelines should management atGood Hope have taken into account as it venturedinto global sourcing? What should Good Hope donow to resolve the problems it faces in outsourcingto BangSource?

4. Suppose that thousands of additional firms in Califor-nia decided to outsource their back-office activities(such as accounting, finance, and data analysis) toIndia. What would be the implications of such a trendto California’s workers and economy? What stepscould California take to reduce the potential harm toits citizens of widespread global sourcing? <

Sources: Dahl, Darren. (2005). “Outsourcing the Outsourcing,” Inc. Magazine,December, pp. 55–56; Economist. (2004). “A World of Work: A Survey of Out-sourcing,” November 13, special section; Economist. (2005). “The Rise ofNearshoring,” December 3, pp. 65–67; Economist. (2005). “India: The NextWave,” December 17, pp. 57–58; Engardio, Pete. (2006). “The Future of Out-sourcing: How It’s Transforming Whole Industries and Changing the Way WeWork,” Business Week, January 30, p. 58; Ewing, Jack, and Gail Edmondson.(2005). “The Rise of Central Europe,” Business Week, December 12, pp. 50–56;Human Resources Outsourcing Association Europe. (2007). “Outsourcing’sFuture Holds Major Surprises for Global Providers,” April 13, atwww.hroaeurope.com.

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510

Key Termsbusiness process outsourcing

(BPO), p. 486captive sourcing,

p. 487

configuration of value-addingactivity, p. 487

contract manufacturing, p. 488global sourcing, p. 484

global supply chain p. 497

offshoring, p. 489outsourcing, p. 486

SummaryIn this chapter, you learned about:

1. Trends toward outsourcing, global sourcing,and offshoringGlobal sourcing refers to the procurement of productsor services from suppliers or company-owned sub-sidiaries located abroad for consumption in the homecountry or a third country. Outsourcing is the procure-ment of selected value-adding activities, including pro-duction of intermediate goods or finished products,from external independent suppliers. Businessprocess outsourcing refers to the outsourcing of busi-ness functions such as finance, accounting, and humanresources. Procurement can be from either indepen-dent suppliers or via company-owned subsidiaries oraffiliates. Offshoring refers to the relocation of a busi-ness process or entire manufacturing facility to a for-eign country. Managers make two strategic decisionsregarding value-adding activities: whether to make orbuy inputs and where to locate value-adding activity—that is, the geographic configuration of value-addingactivity. Contract manufacturing is an arrangement inwhich the focal firm contracts with an independentsupplier to have the supplier manufacture productsaccording to well-defined specifications.

2. Evolution of global sourcingToday much of the growth in global sourcing is in theservices sector, in areas such as IT, customer support,and professional services. India has received the bulkof outsourced business services, while China is favoredfor manufacturing. But other countries, mostly emerg-ing markets, are viable outsourcing destinations aswell. Hundreds of billions of dollars of business ser-vices are outsourced to foreign suppliers annually. Thepotential for global sourcing remains huge. Certainconditions make countries popular recipients of out-sourced activity, including workers’ mastery of Eng-lish, a skilled labor force, low labor costs, and strongintellectual-property protections.

3. Benefits and challenges of global sourcingfor the firmGlobal sourcing aims to reduce the cost of doingbusiness or to achieve other strategic goals. For

some entrepreneurs, global outsourcing has pro-vided the means to turn around failing businesses,speed up the pace of innovation, or fund develop-ment projects that are otherwise unaffordable.Other benefits of global sourcing include faster cor-porate growth, the ability to access qualified per-sonnel, improved productivity and service, rede-signed business processes, faster foreign marketentry, access to new markets, and technological flex-ibility. Global sourcing also allows firms to focus ontheir core activities and continuously renew theirstrategic assets.

4. Implementing global sourcing through supply-chain managementThe efficiency with which goods can be physicallymoved from one part of the globe to another makesglobal sourcing feasible. Global supply chain refersto the firm’s integrated network of sourcing, produc-tion, and distribution, organized on a world scale,and located in countries where competitive advan-tage can be maximized.

5. Risks in global sourcingGlobal sourcing involves business risks, includingfailure to realize anticipated cost savings, environ-mental uncertainty, the creation of competitors,engaging suppliers with insufficient training, overre-liance on suppliers, and eroding the morale of exist-ing employees. Firms should approach global sourc-ing very carefully, with meticulous planning.

6. Strategies for minimizing risk in global sourcingFirms should develop a strategic perspective in mak-ing global sourcing decisions. Although cost cuttingis usually the first rationale, global sourcing is also ameans to create customer value and improve thefirm’s competitive advantages. It is a tool to enhancethe quality of offerings, improve productivity, andfree up resources that can be redeployed to improvelong-term performance. To make global sourcing suc-ceed, management should gain employee coopera-tion, emphasize strong supplier relations, safeguard

CHAPTER ESSENTIALS

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Chapter Essentials 511

its interests in the supplier relationship, and choosethe right foreign suppliers.

7. Implications of global sourcing for publicpolicy and corporate citizenshipGlobal sourcing is a means to sustain or enhance firmcompetitiveness, but can also contribute to job lossesand declining living standards. Some firms outsource

to suppliers that employ sweatshop labor. But attemptsto prohibit global sourcing are impractical. Govern-ments should enact policies in the home country thatencourage job retention and growth by reducing thecost of doing business and by encouraging entrepre-neurship and technological development. Public pol-icy should aim to develop a strong educational systemand upgrade the modern skills of the population.

Test Your Comprehension AACSB: Reflective Thinking, Ethical Reasoning

1. What are the differences between outsourcing, globalsourcing, and offshoring?

2. What is business process outsourcing? What are itsimplications for company strategy and performance?

3. What are the two strategic decisions that managersface regarding the firm’s international value chain,and what are their implications for company perfor-mance?

4. Identify the various benefits that companies receivefrom global sourcing. Why do firms outsource to for-eign suppliers?

5. What two countries are the most important globalsourcing destinations today? What are the basic dif-ferences between these two countries, and whatactivities are typically outsourced to each?

6. What are the characteristics that make countriesattractive as global sourcing destinations?

7. In what service industries are jobs commonly out-sourced to foreign suppliers?

8. What are the risks that firms face in global sourcing?

9. What steps can managers take to minimize the risksof global sourcing?

10.What are the major guidelines for strategic globalsourcing? What actions can management take tomake global sourcing succeed?

11.What are the advantages and disadvantages of globalsourcing to the nation? What public policy initiativesare likely to reduce the disadvantages of globalsourcing?

Apply Your Understanding AACSB: Reflective Thinking, Ethical Reasoning

1. Revisit the opening vignette at the beginning of thischapter. Assume you have started a new job as ajunior manager at a pharmaceutical firm. Manage-ment is considering outsourcing some of the firm’svalue chain to suppliers located abroad. Which activ-ities is the firm most likely to outsource? Identify thebenefits that your firm can obtain and the specificstrategic goals that it could potentially achieve byundertaking global sourcing.

2. Suppose your new job is at Intel, the world’s largestsemiconductor company and the inventor of themicroprocessors found in many personal computers.Intel combines advanced chip design capability witha leading-edge manufacturing capability. The firm iswell known for advanced R&D and innovative prod-ucts. Intel has much of its manufacturing done inChina, to take advantage of low-cost labor and aneducated workforce capable of producing Intel’sknowledge-intensive products. Intel has been step-

ping up its R&D activity in China and collaborateswith Chinese firms in new-technology development.Identify the risks that Intel faces in its operations inChina. What strategies and proactive measures canIntel management take to safeguard its interests?What long-term strategic goals does Intel achieve byoffshoring from China?

3. Global sourcing helps firms increase their businesscompetitiveness. But it also contributes to job lossesin the home country. Some firms outsource to suppli-ers that employ sweatshop labor. Attempts to pro-hibit global sourcing are impractical, so governmentstake other steps to reduce its limitations. What poli-cies should a government adopt to minimize theharm of global sourcing? What can governments inadvanced-economy countries do to minimize job lossor encourage job retention and growth? What cansuch governments do to reduce the problems associ-ated with sweatshops?

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tories. Suppose your future employer wants tooutsource a portion of its production to cer-tain developing countries, but is concernedabout the possibility of employing sweatshoplabor. Visit the Web sites of groups thatencourage minimum standards in labor condi-tions (for example, www.sweatshopwatch.org,www.aworldconnected.org, www.corpwatch.org,or enter the keywords “labor conditions” at glob-alEDGE™) and prepare a memo to youremployer that discusses the major concerns ofthose who advocate minimum labor standards.

3. Your firm just decided to outsource to Indiasuch back-office operations as accounting andbasic finance functions. Unclear on how to pro-ceed, management has asked you to find can-didate suppliers in India. As a first step, youdecide to check the online Yellow Pages (suchas yahoo.com or superpage.com) and searchfor appropriate Indian firms. Find three firms inIndia that specialize in business-process out-sourcing and examine their Web sites.Describe and compare the business-processservices that each firm provides. What selec-tion criteria should you use? Which firm seemsmost qualified and reputable for providing out-sourcing of business-process services?

Refer to Chapter 1, page 27, for instructions onhow to access and use globalEDGE™.

1. You work for a software company that aims tooutsource some of its software development to aforeign supplier. At present, you are consideringthree countries: Hungary, Mexico, and Russia. Youneed to learn more about the capabilities of thesecountries as sites for the outsourcing of softwaredevelopment and production. One approach is tovisit the research section of the World Bank(www.worldbank.org). At the World Bank Website, go to Topics, then on Information & Commu-nication Technologies (ICT), then on Tables. Foreach of the three countries, find and examine vari-ables that indicate the quality of the local soft-ware and IT environment. Based on your findings,which country appears strongest for meeting theneeds of your firm?

2. International labor standards are complex andclosely related to global sourcing. In particular,the use of sweatshops has attracted much atten-tion. A sweatshop is a factory characterized byvery low wages, long hours, and poor workingconditions. Some sweatshops employ children inunsafe conditions. Various prolabor groups advo-cate for minimum labor standards in foreign fac-

Internet Exercises(http://globalEDGE.msu.edu)

AACSB: Reflective Thinking, Ethical Reasoning, Use of Information Technology,Analytical Skills

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Management Skill Builder©CKR Cavusgil Knight Riesenberger

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A Smarter Approach to Global SourcingFirms now increasingly outsource many of their service activities in much the same way as man-

ufacturing firms outsource parts and components production. While the main motive for global sourcing isto reduce costs, other motives include the ability to achieve strategic goals and concentrate on the firm’s core com-petencies, allowing management to redirect resources to the most profitable uses.

Managerial ChallengeUndertaking global sourcing is risky and potentiallyexpensive. Choosing the wrong sourcing partner canlead to unexpected costs and complications. Man-agement at the focal firm must deal with foreignlegal systems, tax laws, and bureaucratic regula-tions. In some countries corruption is commonplace,and the firm may struggle to protect its core tech-nologies and know-how.

BackgroundThe top global sourcing locations include major cities inIndia, China, the Philippines, and Eastern Europe. Butthese locations increasingly suffer from shortcomings,particularly shortages of qualified workers, which arepushing up wages. High demand is straining localinfrastructure and has led to severe traffic congestion,frequent power outages, and communications black-outs. Other locations—such as Turkey, Thailand, SouthAfrica, Brazil, Mexico, Botswana, and Indonesia—areincreasingly attractive outsourcing destinations. Manycompanies are now seeking new foreign locations tooutsource their value-chain activities.

Managerial Skills You Will GainIn this C/K/R Management Skill Builder©, as aprospective manager, you will:

1. Learn the factors to consider when evaluatingcountries as potential locations for global sourcing.

2. Understand how these factors relate to maximizingcorporate competitive advantages.

3. Use the methodology of screening countries forsourcing potential.

4. Build research skills for planning company operations.

Your TaskAssume that you work for a large investment broker-age firm, such as Merrill Lynch, AIG, Goldman Sachs,or UBS Financial Services. Your firm performs variousbusiness process activities (such as accounting, finan-cial analysis, account reconciliation, data entry) thatresult in substantial ongoing expenses. To reducecosts, management has decided to outsource some ofthese activities to a foreign business-process subcon-tractor. Management sought the advice of a globalsourcing consultant, who advised that two coun-tries—Russia and Mexico—are particularly goodlocations for meeting the firm’s needs. Your task is tocomplete the final stages of the analysis by research-ing Russia and Mexico and recommending whichcountry better meets the brokerage’s sourcing needs.

Go to the C/K/R Knowledge Portal©

www.prenhall.com/cavusgilProceed to the C/K/R Knowledge Portal© to obtain theexpanded background information, your task andmethodology, suggested resources for this exercise, andthe presentation template.

AACSB: Reflective Thinking

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