Chapter 16
Global Sourcing
International Business
Strategy, Management
& the New Realities
by
Cavusgil, Knight & Risenberger
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Learning Objectives
1. Trends toward outsourcing, global sourcing,
and offshoring
2. Evolution of global sourcing
3. Benefits and challenges of global sourcing for
the firm
4. Implementing global sourcing through supplychain management
5. Risks in global sourcing
6. Strategies for minimizing risk in global sourcing
7. Implications of global sourcing for public policy
and corporate citizenship
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Global Sourcing: Shopping the World
• Along with competitors Reebok and Adidas in the athletic
shoes industry, Nike contracts out nearly all of its athletic
shoe production to foreign suppliers. These firms are
best described as brand owners and marketers, not as
manufacturers.
• Apple Computer sources some 70% of its production
abroad while focusing its internal resources on improving
its operating system and other software platforms. This
approach allows Apple to optimally utilize its limited
capital resources and focus on its core competences.
• Dell Inc. is another firm that relies extensively on a global
manufacturing network, composed largely of
independent suppliers.
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Global Sourcing
• Global sourcing is the procurement of products or
services from suppliers or company-owned subsidiaries
located abroad for consumption in the home country or a
third country.
• Also called global procurement or global purchasing,
global sourcing amounts to importing -- an inbound flow.
• It is an entry strategy that involves a contractual
relationship between the buyer (the focal firm) and a
foreign supplier. It involves subcontracting the
performance of specific manufacturing or services tasks
to the firm's own subsidiaries or independent suppliers.
• Global sourcing is classified as a low-control strategy to
the extent that the firm is buying from independent
suppliers through contractual agreements, as opposed to
buying from its own subsidiaries.
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Drivers of Global Sourcing
• Technological advances, including instant
Internet connectivity and broadband availability
• Declining communication and transportation
costs
• Widespread access to vast information
including growing connectivity between
suppliers and the customers that they serve;
and
• Entrepreneurship and rapid economic
transformation in emerging markets.
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Decision 1: Outsource or Not?
• Managers must decide between internalization
and externalization -- whether each valueadding activity should be conducted in-house or
by an independent supplier.
• This is known as the ‘make or buy’ decision:
“Should we make a product or conduct a
particular value-chain activity ourselves, or
should we source it from an outside contractor?”
• Firms usually internalize those value-chain
activities they consider a part of their core
competence, or which involve the use of
proprietary knowledge and trade secrets that
they want to control.
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Outsourcing
• Outsourcing refers to the procurement of
selected value-adding activities, including
production of intermediate goods or finished
products, from independent suppliers.
• This practice of externalizing a particular valueadding activity to outside contractors is known
as outsourcing.
• Firms outsource because they generally are
not superior at performing all primary and
support activities. Most value-adding activities
-- from manufacturing to marketing to aftersales service -- are candidates for outsourcing.
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An Example of Outsourcing
• Canon uses its core competencies in precision
mechanics, fine optics, and micro electronics
to produce some of the world’s best cameras,
printers, and copiers.
• Canon usually owns the value-chain activities,
such as R&D, that yield improvements in these
competences.
• By contrast, companies will usually source
from external suppliers when the sourced
products or services are peripheral to the firm’s
main offerings, can be obtained at lower cost,
or can be provided by specialized suppliers.
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Business Process Outsourcing (BPO)
• Business Process Outsourcing (BPO). The
outsourcing of business functions to
independent suppliers such as accounting,
payroll, and human resource functions, IT
services, customer service, and technical
support.
• BPO includes:
 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 technical support.
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Decision 2: Where in the World
Should Value-Adding Activities Be Located?
• Configuration of value-adding activity: The
pattern or geographic arrangement of locations
where the firm carries out value-chain activities.
• Instead of concentrating value-adding activities in
the home country, many firms configure these
activities across the world to save money, reduce
delivery time, access factors of production, and
extract maximal advantages relative to competitors.
• This helps explain the migration of traditional
industries from Europe, Japan, and the U.S. to
emerging markets in Asia, Latin America, and
Eastern Europe.
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An Example of Worldwide Configuration of Value Chain
• The German automaker BMW employs 70,000 factory personnel
at 23 sites in 13 countries to manufacture its vehicles.
• Workers at the Munich plant build the BMW 3 Series and supply
engines and key body components to other BMW factories
abroad.
• In the U.S., BMW has a plant in South Carolina, which makes
over 500 vehicles daily for the world market.
• In Northeast China, BMW makes cars in a joint venture with
Brilliance China Automotive Holdings Ltd.
• In India, BMW has a manufacturing presence to serve the needs
of the rapidly growing South Asia market.
• BMW must configure sourcing at the best locations worldwide,
in order to minimize costs (e.g., by producing in China), access
skilled personnel (by producing in Germany), remain close to key
markets (by producing in China, India and the U.S.).
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A Framework for Global Sourcing and Outsourcing
• The two strategic choices we just discussed lead us to
the framework in Exhibit 16.2.
• The focal firm can source from independent suppliers,
company-owned subsidiaries and affiliates, or both.
• Cells C and D represent the global sourcing scenarios.
• While global sourcing implies procurement from foreign
locations, in some cases the focal firm may purchase
from a subsidiary or affiliate located in the foreign
country (Cell C).
• This is known as captive sourcing, which refers to
sourcing from the firm's own production facilities located
abroad. Production is carried out at a foreign facility that
results from the focal firm's FDI activities.
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Contract Manufacturing:
Global Sourcing from Independent Suppliers
• A more likely scenario is when the focal firm can
procure from independent suppliers (Cell D).
• Contract manufacturing: An arrangement in
which the focal firm contracts with an
independent supplier to manufacture products
according to well-defined specifications.
• Global sourcing requires the firm to identify
qualified suppliers, develop necessary
organizational and technological capabilities to
locate and relocate specific tasks, and
coordinate a geographically dispersed activities.
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Examples of Contract Manufacturing
• Patheon, one of the world's leading contract
manufacturers in the pharmaceutical industry, provides
drug development and manufacturing services to
pharmaceutical and biotechnology firms worldwide.
• Patheon operates 11 factories in N. America and Europe,
producing over-the-counter drugs and several of the
world's top-selling prescription drugs for most of the
world's 20 largest pharmaceutical firms.
• Benetton employs contract manufacturers to produce
clothing.
• IKEA uses contract manufacturers to produce furniture.
• Contract manufacturing also offers firms the ability to
enter target countries quickly, especially when the
market is too small to justify significant local investment.
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Offshoring
• Offshoring is a natural extension of global sourcing. It
refers to the relocation of a business process or entire
manufacturing facility to a foreign country.
• MNEs are particularly active in shifting production facilities
or business processes to foreign countries to enhance their
competitive advantages.
• Offshoring is especially common in the service sector,
including banking, software code writing, legal services,
and customer-service activities.
• E.g., large legal hubs have emerged in India that provide
services such as drafting contracts and patent applications,
conducting research and negotiations, as well as
performing paralegal work on behalf of Western clients.
With lawyers in N. America and Europe costing $300 an
hour or more, Indian firms can cut legal bills by 75 percent.
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Offshoring Destinations
• India receives the bulk of developed nations’ relocated
business services. It has a huge pool of qualified labor
that work for wages as little as 25 percent of comparable
workers in the West.
• India is not the only destination of substantial outsourcing
work. Firms in Eastern Europe perform support activities
for architectural and engineering firms from the West.
• Accountants in the Philippines perform support work for
major accounting firms. Accenture has back-office
operations and call centers in Costa Rica. Germany
sources IT support services from the Czech Republic and
Romania. Boeing, Motorola, and Nortel do much of their
R&D in Russia. South Africa is the base for technical and
user-support services for English, French, and Germanspeaking customers throughout Europe.
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Jobs Most Conducive to Offshoring
• Large-scale manufacturing industries whose primary
competitive advantage is efficiency and low cost;
• Industries such as automobiles that have uniform
customer needs and highly standardized processes in
production and other value-chain activities;
• Service industries that are highly labor intensive, e.g.,
call centers and legal transcription;
• Information-based industries whose functions and
activities can be easily transmitted via the Internet,
e.g., accounting, billing, and payroll; and
• Industries such as software preparation whose outputs
are easy to codify and transmit over the Internet or by
telephone, e.g., routine technical support and
customer service activities.
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Not All Services Can Be Offshored
• Many jobs in the services sector cannot be separated from
their place of consumption. This limits the types of services
jobs that firms can move abroad.
• Personal contact is vital at the downstream end of virtually
all value chains. Other services are consumed locally.
• People normally do not travel abroad to see a doctor,
dentist, lawyer, or accountant. Consequently, many service
jobs will never be offshored.
• Through 2005, only about 3 percent of jobs in the U.S. that
require substantial customer interaction (e.g.,, those in the
retailing sector) have been transferred to low-wage
economies.
• By 2008, less than 15 percent of all service jobs have
moved from advanced economies to emerging markets.
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Strategic Implications of Global Sourcing
• Exhibit 16.3 explains the two strategic implications of the
two choices MNEs face: whether to perform specific
value-adding activities in-house or to outsource them,
and whether to concentrate each activity at home or
disperse it abroad.
• The 1st row indicates the degree to which management
considers each value-adding activity a strategic asset to
the firm.
• The 2nd row indicates whether the activity tends to be
internalized inside the focal firm or outsourced to a
foreign supplier.
• The 3rd row indicates where management typically
locates an activity.
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Outsourcing Decision is Activity Specific
• These decisions depend largely on the strategic
importance of the particular activity to the firm.
• E.g., firms typically consider R&D and design
activities central to their competitive advantage. As
a result, they are more likely to internalize these
functions, and less likely to outsource them to
outside contractors.
• In contrast, manufacturing, logistics, and customer
service activities tend to be more readily outsourced
and geographically dispersed.
• The decision is also a function of the firm's IB
experience and availability of qualified suppliers.
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Phases in the Evolution of Global Sourcing
• The first major wave emphasized the manufacturing of
input products and began in the 1960s with the shift of
European and U.S. manufacturing to low-cost countries
as geographically diverse as Mexico and Spain.
• Early observers pointed to the emergence of the
“modular corporation” and the “virtual corporation.”
• The next wave of global sourcing began in the 1990s
with offshoring. In addition to IT services and customersupport activities, other service sectors became part of
the offshoring trend.
• Today, business-process outsourcing in product
development, human resources, and finance/accounting
services has become very common.
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Magnitude of Global Sourcing
• The magnitude of global sourcing is considerable.
In 2005, India alone booked $22 billion worth of
business in answering customer phone calls,
managing far-flung computer networks, processing
invoices, and writing custom software for MNEs from
all over the world.
• Global sourcing has created more than 1.3 million
jobs during the past decade for India.
• Meanwhile, between 2000 and 2004, some 100,000
service jobs were outsourced each year from the
U.S. to other countries.
• In 2006, IT and business-process outsourcing
exceeded $150 billion worldwide.
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Leading Provider Countries
• China and India are major players in global
sourcing.
• Numerous other countries are active players as well.
• Exhibit 16.4 identifies key players by four
geographic regions.
• E.g., Cairo-based Exceed Contact Center handles
calls in Arabic and European languages for
Microsoft, General Motors, Oracle, and Carrefour.
• Russia is aiming at high-end programming jobs.
With its strong engineering culture, Russia has an
abundant pool of underemployed talent available at
wages about one-fifth those of the U.S.
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The 2005 Offshore Location Attractiveness Index by
A.T. Kearney
• Identifies 9 emerging markets in its list of the 10 most
attractive offshoring suppliers: India, China, Malaysia,
Philippines, Singapore, Thailand, Czech Republic, Chile,
Canada, and Brazil.
• In addition to Canada, the other advanced economy in the top
20 destinations is the U.S. (11th).
• The index emphasizes various criteria:
 Country’s financial structure (compensation costs,
infrastructure costs, tax and regulatory costs);
 Availability and skills of people (cumulative businessprocess experience and skills, labor force availability,
education and language, and worker attrition); and
 Nature of the business environment (the country’s political
and economic environment, physical infrastructure, cultural
adaptability, and security of intellectual property).
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Benefits of Global Sourcing
• Cost efficiency is the traditional rationale for
sourcing abroad. The firm takes advantage
of ‘labor arbitrage’ ─ the large wage gap
between advanced economies and emerging
markets.
• One study found that firms expect to save an
average of more than 40% off baseline costs
as a result of offshoring.
• These savings tend to occur particularly in
R&D, product design activities, and backoffice operations such as accounting and
data processing.
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Strategic Benefits of Global Sourcing
•
•
•
•
•
•
•
•
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.
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Challenges in Global Sourcing
• 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
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Global Supply Chain Management Capabilities
Greatly Enhance Global Sourcing
• Global supply chain refers to the firm’s
integrated network of sourcing, production, and
distribution, organized on a world scale, and
located in countries where competitive advantage
can be maximized.
• Sourcing from numerous suppliers scattered
around the world would be neither economical nor
feasible without an efficient supply-chain system.
• Boeing’s 787 Dreamliner jet provides a striking
example of how global supply-chain management
is making global sourcing feasible and, at the
same time, contributing to firm competitiveness.
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Facilitating Firms are also Responsible
for Global Sourcing
• Networks of supply-chain hubs and providers of
global delivery service are an integral part of
global supply chains.
• Many focal firms delegate supply-chain activities
to such independent logistics service providers
as DHL, FedEx, TNT, and UPS.
• Consulting firms that manage the logistics of
other firms are called third party logistics
providers (3PLs). Using a 3PL is often the best
solution for international logistics, especially for
firms that produce at low volumes or lack the
resources and the expertise to create their own
logistics network.
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Global Supply-Chain Networks
• A global supply-chain network consolidates a
firm’s sourcing, manufacturing, and distribution in
a few strategic locations worldwide so the firm can
concentrate these activities in countries where it
can maximize its competitive advantages.
• Exhibit 16.7 illustrates the stages, functions, and
activities in the supply chain.
• It reveals how suppliers interact with the focal firm
and how these, in turn, interact with distributors
and retailers.
• Each stage in the global supply chain
encompasses functions and activities that involve
the focal firm in sourcing and distribution.
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Supply Chain Management has Become
Sophisticated
• Costs associated with physically delivering a product to
an export market may account for as much as 40% of
total cost.
• Experienced firms make optimal use of information and
communications technology (ICT), which streamlines
supply chains, reducing costs and increasing distribution
efficiency.
• Managers use Electronic Data Interchange (EDI), which
passes orders directly from customers to suppliers
automatically through a sophisticated ICT platform.
• The UK supermarket chain Tesco greatly reduced
inventory costs by using an EDI system to link point-ofsale data to logistics managers. Technology allows Tesco
to track product purchases down to the minute.
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Logistics and Transportation
• Logistics involves physically moving goods
through the supply chain.
• It incorporates information, transportation,
inventory, warehousing, materials handling and
similar activities associated with the delivery of
raw materials, parts, components, and finished
products.
• Internationally, logistics is complex due to
greater geographical distances; multiple legal
and political environments; and the often
inadequate and costly nature of distribution
infrastructure in individual countries.
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Transportation modes
• International logistics typically involves multiple
transportation modes.
• Land transportation is conducted via highways and
railroads.
• Ocean transportation is handled through large container
ships.
• Air transportation involves commercial or cargo aircraft.
• Ocean and air transport are common in IB because of long
shipping distances. Ships are the most common
transportation mode.
• Sea transport was revolutionized by the development of 20and 40-foot shipping containers, the big boxes that sit atop
ocean-going vessels.
• Sea transportation is very cost-effective because one ship
can carry thousands of these containers at a time.
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Risks in Global Sourcing
1. Less-than-expected cost savings. Conflicts and
misunderstandings arise because of differences in the
national and organizational cultures between the focal
firm and foreign supplier. Such factors give rise to
cost-savings that are less than originally anticipated.
2. Environmental factors. Numerous environmental
challenges confront focal firms including: exchange
rate fluctuations, labor strikes, adverse macroeconomic events, high tariffs and other trade barriers,
and high energy and transportation costs.
3. Weak legal environment. Many popular locations for
global outsourcing have weak laws and enforcement
regarding intellectual property, which can lead to
erosion of key strategic assets.
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Risks in Global Sourcing (cont.)
4. Risk of creating competitors. As the focal firm
shares its intellectual property and businessprocess knowledge with foreign suppliers, it
also runs the risk of creating future rivals (e.g.,
Schwinn).
5. Inadequate or low-skilled workers. Some
foreign suppliers may be staffed by employees
who lack appropriate knowledge about the
tasks with which they are charged. Other
suppliers suffer rapid turnover of skilled
employees.
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Risks in Global Sourcing (cont.)
6. Over-reliance on suppliers. Unreliable suppliers may
put earlier work aside when they gain a more
important client. Suppliers occasionally encounter
financial difficulties or are acquired by other firms with
different priorities and procedures. Over-reliance can
shift control of key activities too much in favor of the
supplier.
7. Erosion of morale and commitment among homecountry employees. Global sourcing can create a
situation in which employees are caught in the middle
between their employer and their employer’s clients.
At the extreme, workers find themselves in a
psychological limbo, unclear about who their employer
really is.
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Strategies for Minimizing Risk
in Global Sourcing
1.
2.
Firms ought to go offshore for the right reasons.
The best rationale is strategic. Cost-cutting is often a
distraction from more beneficial, long-term goals such
as enhancing the quality of offerings, improving overall
productivity, and freeing up knowledge workers and
other core resources that can be redeployed to
improve long-term performance.
Need to get employees on board. Global sourcing
tends to invite opposition from employees and other
organizational stakeholders. Disaffected middle
managers can undermine projects. Poorly planned
sourcing projects can create unnecessary tension and
harm employee morale.
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Strategies for Minimizing Risk
in Global Sourcing (cont.)
3. Choose between a captive operation and a
contract with outside specialists carefully.
They should be vigilant about striking the right
balance between the organizational activities that
it retains inside the firm, and those that are
sourced from outside.
4. Choose countries and suppliers carefully. A
common reason for global sourcing failure is that
both buyers and suppliers tend not to spend
enough time upfront to get to know each other
well. They rush into a deal before clarifying partner
expectations, which can give rise to
misunderstandings and inferior results.
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Strategies for Minimizing Risk
in Global Sourcing (cont.)
5. The focal firm needs to invest in supplier
development and collaboration. The parties need to
exchange information, transfer knowledge,
troubleshoot, coordinate, and monitor.
• Management should collaborate closely with suppliers
in co-development and co-design activities. This also
enables the focal firm to tap into a stream of ideas for
new products, processes, technologies, and
improvements.
• Efforts to build strong relationships help create a
‘moral contract’ between the focal firm and the
supplier, which is often more effective than a formal
legal contract.
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Strategies for Minimizing Risk
in Global Sourcing (cont.)
6. Managers need to proactively safeguard interests:
• Encourage the supplier to refrain from engaging in potentially
destructive acts that jeopardize the firm’s reputation.
• Escalate commitments by making partner-specific
investments (such as sharing knowledge with the supplier),
allowing for ongoing review, learning, and adjustment.
• Share costs and revenues by building a stake for the supplier
so that, in case of failure to conform to expectations, the
supplier also suffers costs or foregoes revenues.
• Maintain flexibility in selecting partners by keeping options
open to find alternative partners.
• Hold the partner at bay by withholding access to IP and key
assets, in order to safeguard the firm’s interests for the long
term. If conflicts with the supplier become an ongoing
problem, one option for the firm is to acquire full or partial
ownership of the supplier.
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Potential Harm to Economies from Global Sourcing
• Critics of global sourcing point to three major problems:
Global sourcing can result in:
 Job losses in the home country,
 Reduced national competitiveness, and
 Declining standards of living.
• As more tasks are performed at lower cost with
comparable quality in other countries, high-wage
countries will eventually lose their national
competitiveness.
• Critics fear that long-held knowledge and skills will
eventually drain away to other countries, and the lower
wages paid abroad to perform jobs that were previously
done in high-wage countries will eventually pull down
wages in the latter countries, leading to lower living
standards.
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Effects on Local Community: A Case Study
• Electrolux, one of the world’s largest appliance makers, closed its
factory in Michigan and moved production to Mexico. The company
had been producing refrigerators in Greenville, Michigan, for nearly
40 years, providing 2,700 jobs.
• From the company's viewpoint, closing the plant made economic
sense. It had weak financial performance and costly labor. By
establishing a Maquiladora plant in Juarez, Mexico, Electrolux
sought to profit from low wages and take advantage of the El Paso
Foreign Trade Zone.
• From the local community's standpoint, however, the decision was
devastating. How could so many jobs be replaced in such a small
community? What would happen to the town’s social and economic
landscape?
• Assistance from labor unions and the State of Michigan were to no
avail. Concessions from the labor union, and over $100 million from
Michigan to Electrolux in tax breaks and grants were insufficient. It
did not help that Electrolux -- a Swedish company -- was perceived
as having little loyalty to the community.
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Can Jobs Offshored be Replaced?
• Proponents of global sourcing argue that
workers who lose their jobs due to offshoring
can find new work.
• Redeployment assumption may be overly
optimistic. It takes considerable time for laid-off
workers to find new jobs.
• According to one estimate, as much as 1/3 of
U.S. workers who have been laid off cannot
find suitable employment within a year.
• Even workers who do find new jobs may be
unable to achieve wages and work levels that
equal those of their former positions.
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Ethical and Social Implications of
Global Sourcing
• The prevalence of global sourcing has also raised
public debate about the role of MNEs in protecting
the environment, promoting human rights, and
improving labor practices and working conditions.
• The bar for global corporate citizenship has been
raised.
• Consider the case of foreign suppliers that operate
sweatshops -- factories in which people may work
long hours for very low wages, often in harsh
conditions.
• Sweatshops may employ child labor, a practice
that has been outlawed in much of the world.
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The Case for and against Sweatshops
• Those who defend moving production to low-wage facilities
abroad point to a lower standard of living as an explanation
for the low wages, and argue that their operations benefit the
community by providing needed jobs. The choice for local
workers is often between low-paid work or no work at all.
• They argue that the alternatives available to such workers
are even less desirable, such as poverty, prostitution, and
social problems.
• Opponents also argue that corporations that sell their
products in wealthy countries have a responsibility to pay
their workers according to basic Western standards,
especially when their products command high prices in
advanced-economy markets.
• Foreign companies that establish factories destroy the preexisting agricultural market that may have provided a better
life for laborers.
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Potential Benefits to National Economy
• First, by reconfiguring value chains to the most costefficient locations, companies reduce their production
costs and enhance their performance.
• Second, cost reductions and enhanced competitiveness
allow firms to reduce the prices that they charge their
customers.
• 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 activities. This
transformation has the effect of boosting the nation’s
productivity and industrial efficiency.
• Finally, declining wages may be offset by lower prices
secured for outsourced products or services. Hence
global sourcing tends to indirectly increase consumers’
purchasing power and lift their living standards.
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Public Policy Towards Global Sourcing
• From a public-policy standpoint, it is impractical
for a nation to adopt a unilateral policy against
global sourcing.
• Instead of seeking to restrict global sourcing, a
more appropriate role for public policy may be to
mitigate the harm that it can cause.
• Offshoring is a process of creative destruction. It
creates new advantages and opportunities,
while eliminating certain types of jobs and
adversely impacting particular economic sectors
and segments of the population.
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Public Policy Towards Global Sourcing (cont.)
If the loss of certain jobs is inevitable as a result of
offshoring, public-policy makers are better off taken some
proactive actions. Examples:
• Guiding employment towards higher value-added jobs by
stimulating innovation, for example.
• Keeping the cost of doing business relatively low.
Through economic and fiscal policies, development of
new technologies can be facilitated.
• Keeping the cost of capital needed to finance R&D
relatively low.
• Ensuring that the nation has a strong educational system,
including technical schools and well-funded universities
that supply engineers, scientists, and knowledge workers.
• Increasing worker flexibility so that those who lose jobs
can be redeployed in other positions.
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