Lowest cost isn't always the answer

Visit any western toy superstore, and most of the basic products will say 'Made in China' or, perhaps, Malaysia or Indonesia. Until, that is, you reach the Lego section. Suddenly, the boxes are more likely to identify Denmark, Switzerland or the US as the country of origin. It might seem logical that a global company, selling into a mul­titude of country markets and measuring its market share in global terms, should place produc­tion facilities wherever costs are lowest. But Lego, the privately-owned Danish company, has for years concentrated its manufac­turing in Europe and the US, argu­ing that this best satisfies design and quality requirements. For Lego the notion of cost is only a small part of the production pic­ture.

So how does a global company go about organising its manufac­turing network? The decision has become more complicated over the past two decades due to a number of factors. On the one hand, trade barriers across much of the world have declined sharply. Simultaneously, a range of new markets - notably in Asia and Eastern Europe - has opened to foreign investment.

This has made global produc­tion much more possible. But it has also reduced the need for many overseas plants. Markets that previously demanded local production facilities - because tar­iff levels made importing far too expensive - can now be supplied from other countries.

Plainly, in this newly-liberalised environment, basic manufactur­ing costs do become more signifi­cant. But there are limits to a pure­ly cost-driven approach. Many companies have built their current production structure through acquisitions over a number of years, rather than in a planned way.

Another problem is that costs themselves can be subject to rapid change, making today's Indonesia, for example, tomorrow's Hong Kong. This adds a further dimension to any global company's investment decision-making. The reality is that manufacturing busi­nesses also need to think: how quickly can we pull the plug?

Some companies have addressed this issue through what is called the 'part configuration' model. This involves selecting a number of regional manufacturing bases which are viewed as longer-term investments, and augmenting them with lower-skilled assembly plants, which can more easily be moved between markets.

The availability of suitable employees also needs to be exam­ined when investment decisions are being made. There may be close links between manufacturing and product innovation and if too much focus is put on low-cost assembly operations, product innovation tends to suffer.

Perhaps the hottest topic is whether a global company needs to be a producer at all. Outsourcing of production to other suppliers gives a company more flexibility, and fits well with a global strategy. A business may be better placed to supply differen­tiated products into different regional markets, and it can proba­bly adjust more swiftly to changing cost considerations. These operational advantages come in addition to the financial benefits of outsourcing, such as lower capi­tal employed.

But there can be pitfalls. Perhaps no company exemplifies the outsourcing trend better than Nike, the sports shoe group. On paper, its strategy of subcontracting the production of its shoes to local factories looks eminently sensible. But these arrangements have turned into a public relations disaster in recent years, as human rights campaigners have com­plained of 'sweatshop' conditions in many of the Asian plants pro­ducing Nike products. Lack of ownership, it seems, does not bring freedom from responsibility.

Discuss these questions.

1. What criteria do you think global companies use when they choose the location of theirmanufacturing operations around the world? Some examples are labour costs, education level of the local workforce, and political stability. Can you think of others?

2. It has become increasingly common for organisations to subcontract some aspects of their activity to outside companies. Typical examples are catering (the company restaurant) or security (protecting the buildings). What, in your opinion, are the advantages and disadvantages of subcontracting work
in this way?

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