12-6d Transfer Pricing

Two pricing strategies will often trigger allegations of dumping: (1) if the home-country firm sets a price in the foreign market below what it charges the domestic market; and (2) if the price is above what it domestically charges, but below the marginal cost needed to move the product overseas and sell it there.

Many firms, especially large MNCs, have overseas subsidiaries to which they will sell products; the subsidiary, in turn, will resell the product. The prices a company charges its overseas subsidiaries, known as transfer prices, come under close scrutiny by taxing authorities in both the home country and the host country. These bodies often allege that a transfer price is set not to maximize profits but to minimize taxes. In order to deal with this possibility, taxing authorities often stipulate that the prices charged must be an arms length price, that is, a price that the overseas market is willing to pay.

Reality Che C k lO-6

Using the Internet, research the prices of several products in one or more foreign countries and compare them to their prices in the home country where the goods are produced. What factors do you think determine the foreign prices? Do you think any of the prices are artificially high or low in one country or another?

LO-7

Discuss aspects of customer service required for goods and services that are globally marketed.

12-7 Developing the International

Customer Service Mix

Providing greater levels of customer service to foreign customers is becoming a more important responsibility for international marketers. Companies that are considering purchasing from a vendor located in a foreign country will often make a choice based upon their perceptions of the vendor’s willingness and ability to perform various services for them. And, for the same reason, current foreign customers are likely to become more loyal.

The emphasis that foreign companies place upon customer service is largely driven by the fact that there may be thousands of miles between them and their overseas vendors. In addition, as products and prices have become more similar, foreign prospects and customers will look at other factors to make a purchase decision. Often, the deciding variable will be the customer service that will be provided.

What kind of customer service is important to overseas buyers? Examples include deliveries (on-time and accurate), installation of equipment and machinery, problem solving, explaining and honoring warranties, repairs, accepting returns, providing emergency shipments, shipping products that are already assembled, handling documentation for exports and imports, and consistency of the order-cycle length.

How important is customer service compared to products and prices? According to extensive research by the Forum Corporation, “When the all-important issue of customer service is examined, it has been estimated that customers are five times more likely to switch vendors because of perceived customer service problems than for price or product issues.” In addition, by having a higher standard of customer service, a share of wallet (the percentage of purchases in a category a buyer gives to one vendor) may be increased by as much as 80 percent.27

Companies must guard against providing too high a level of service, however. When customers do not respond in some desirable way (such as giving a vendor more business) or when the costs associated with providing a higher level of customer service are very high, firms may be overcommitting resources. They also need to be sure that their customer service is reliable. Reliability includes receiving shipments on time; order accuracy, completeness, and condition, getting repairs done on time; consistency of product quality, and so on.

transfer prices

a price a company charges its overseas subsidiaries

arms length price

a price that an overseas market is willing to pay

share of wallet

the percentage of purchases in a category a buyer gives to one vendor

reliability

performance of various aspects of customer service that meets customer expectations

eConoMiC PersPeCtives Toyota’s Safety Recalls

In 2009–2010, Toyota was forced to recall millions of its automobiles from around the world due to significant safety problems. Its president, Akio Toyoda, and other executives were required to appear before the U.S. Congress to explain how they would deal with the situation in the United States. Many reasons have been offered to explain Toyota’s problems. It had veered away from its focus upon customer satisfaction and emphasis on making improvements and, instead, pushed to increase its worldwide market share from 11 percent to 15 percent.

Most experts pointed to problems Toyota experienced with its suppliers that can be divided into three categories. Tier-one suppliers, such as Bosch, Delphi, and Tenneco, deliver large integrated systems directly to Toyota. Tier-two suppliers provide parts and components to Toyota and the Tier-one vendors. Tier-three suppliers provide Tier-one suppliers with a single component.

Toyota had deviated from usual industry practice by naming favored Tier-one suppliers as the sole source of particular components. This resulted in close collaboration and a sense of mutual benefits. (Western manufacturers, on the other hand, award short-term contracts through bidding processes.) Such collaboration was largely responsible for the company’s successful implementation of its famed “just-in-time” manufacturing strategy, in which component parts were received exactly when they were needed to enter the production process, which significantly reduced inventories and their attendant costs.

When Toyota began an aggressive expansion program in 2008, it needed to rely upon Tier-two and Tier-three suppliers, many of whom were located outside Japan. These suppliers were not subject to the same control that Toyota had over its Tier-one suppliers, and quality issues arose as a result.

In 2014, Toyota again was forced to recall 6.4 million vehicles due to minor flaws found in 27 models. Although the company took the blame, its reputation for quality was again tarnished.

Questi O ns:

1) What should Toyota do about the recall problem? 2) Why were the earlier recalls necessary? 3) How can you explain the need for the 2014 recall?

Source: “The Machine That Ran Too Hot,” The Economist, February 27, 2010, p. 74; “Another 6.4 Million Dents,” BusinessWeek, April 14–20, 2014, p. 25.

An important aspect of customer service is how customer complaints are handled. Often, it takes only a single poorly handled complaint to result in a lower level of satisfaction, thereby increasing the probability that the customer will choose another company. The astute company welcomes complaints, because if they are handled properly, they will prevent customer defection, increase loyalty, improve sales, and result in customers spreading favorable word-of-mouth comments. Jay Narivaha, senior vice president of the customer service consultancy, Technical Assistance Research Programs, says that customers who have problems resolved are more loyal than those who don’t have problems.28 Companies should fear noncomplainers. These are customers who don’t make their concerns known but simply defect to another vendor, leaving the previous supplier with less business and no information as to why.

By listening to customer complaints, several airlines became aware of travelers’ dissatisfaction with flights containing large numbers of unruly, loud, and crying children. In response to these concerns, Air Asia and Malaysian Airlines began segregating travelers from those accompanied by children, and Singapore Airlines is offering child-free zones for passengers willing to pay extra. Some airlines do not allow children in business class.29

When complaints from customers arise, the most effective strategy is to deal with them immediately. The importance of immediately responding to complaints is emphasized at British Airways. Sir Colin Marshall, British Airways’ chairperson, says, “We try to make it clear to employees that we expect them to respond to customers on the spot—before a customer writes a letter or makes a phone call.”30 And British Airways follows another important tenet: even if the effort to immediately take care of a problem is not perfect—some mistakes occur—“it is better to make the effort than do nothing.”31

Customer service is an important component of companies’ international marketing programs.

Feature Photo Service/Newscom

Another rule of thumb: Employees should be granted empowerment to immediately address problems. They should not be forced to consult with a distant superior, and they should be given enough resources so that they can make an adjustment that will be meaningful to the aggrieved customer. Employees at Ritz Carlton International Hotels, for example, have the leeway to spend up to $2,000 to address a guest’s grievance on the spot.32

Reality Che C k lO-7

Talk to a friend or acquaintance who has traveled or lived overseas. Ask them to compare the quality of customer service they found when shopping in department stores in foreign countries to that which they experience when shopping in U.S. department stores.

Summary

Companies will perform the same activities in their international markets as they do domestically, but may have to perform them differently. Analyzing international markets is necessary if companies want to be successful in those locations.

Standardization involves a company employing the same marketing strategies in its international markets as it does in its domestic market. Adaptation signifies that those strategies are different.

When companies develop new products for overseas markets, they usually employ a number of steps. Once products are introduced to foreign markets, the product life cycle (PLC), can be used to help marketers decide how to modify the product’s marketing mix over time. Products in the decline stage are usually considered for elimination due to their poor performance.

There are several advantages to locating R&D facilities only in domestic locations, and there are some positives in having R&D operations in foreign countries. Counterfeiting of U.S. products costs companies billions of dollars annually and may hurt their reputations.

There are four elements in a company’s international promotion mix. Advertising reaches large audiences at low-costs per contact. Personal selling is very effective, but at a high-cost per contact. Sales promotion consists of a number of approaches to reaching international markets. One of the most important of these are trade shows that provide several benefits, such as drawing interested prospects to the exhibit booth and the possibility of a large sales volume being attained.

empowerment

aspect of customer service that allows employees to take care of customer problems immediately, without having to consult superiors

Publicity involves stories (negative and positive) about a company, its products, and its executives, that appear in various media such as newspapers, magazines, and on television.

A direct channel of distribution strategy refers to an international marketer not using channels to reach foreign customers; an indirect approach employs channels of distribution, such as agents and distributors. Physical distribution is storage and transportation that are used to move products to overseas purchasers. Freight forwarders are important in facilitating companies’ overseas physical distribution programs.

Companies’ costs, the attractiveness of competitor products and their prices, and how much marketing support is given to products are factors, among others, that must be considered when prices are set for products and services in international markets. Charges of dumping can be brought against companies whose prices undercut competitors’ prices in foreign markets. When companies set a transfer price for their international subsidiaries, they need to be aware of tax policies in both the home country and the host country.

Customer service is an increasingly important responsibility for international marketers; it is a major factor in determining why customers switch to other vendors and how vendors can increase their business.

Key Terms

market potential, p. 290 sales potential, p. 290 marketing research, p. 292 marketing intelligence system (MIS), p. 292 standardization, p. 294 adaptation, p. 294 glocalization, p. 294 global product, p. 295 concept testing, p. 296 business analysis, p. 296 market testing, p. 296 commercialization, p. 296 product life cycle (PLC), p. 296 product elimination, p. 297 reverse strategy, p. 297 vertical publication, p. 299 horizontal publication, p.299 indirect strategy, p. 301 direct strategy, p. 301 agent, p. 302 distributor, p. 302 physical distribution, p. 302 freight forwarder, p. 304 containerization, p. 304 intermodal transport, p. 304 dumping, p. 306 gray marketing, p. 306 transfer price, p. 307 arms length price, p. 307 share of wallet, p. 307 reliability, p. 307 empowerment, p. 308

ChapTer QuesTions

1. Why do companies need to research their international markets? 2. What are the three major markets that exist in all foreign markets? 3. What is the difference between standardization and adaptation? 4. How can use of the product life cycle assist international marketers? 5. What are the advantages of using trade shows to promote products in international markets? 6. What are some of the disadvantages that can result when companies use channels of distribution to market their products overseas? 7. What are the advantages of using freight forwarders? 8. How can companies competitively set international prices while avoiding allegations of dumping? 9. How should companies deal with international customers who complain?

Mini Case: M ARKETINg Equ INE -R ELATED PRODu CTS TO I NTERNATIONAL M ARKETS

The Horse Place is a retailer that sells horse tack (saddles, saddle pads, bridles, reins, etc.) and supplies (grooming products, vitamin supplements, leg wraps, etc.). The Horse Place does not have a storefront. Its promotional strategy relies upon the Internet, classified ads, and one-third page ads in publications such as Horse and Rider, Horse Illustrated, and Dressage Today.

Until 2010, its products were exclusively sold in the U.S. domestic market. Its suppliers were primarily located there, but the retailer’s owner, Mary Jones, had recently begun sourcing from suppliers in India. She considered their products to be excellent quality at about half the price she was paying domestic vendors.

The interaction with her Indian vendors prompted Mary to consider selling her merchandise in foreign markets. She believed that these had excellent potential for the kinds of products carried by The Horse Place. A cursory analysis of secondary sources resulted in the conclusion that Argentina, Brazil, Mexico, France, the United Kingdom, Russia, and Germany represented the most promising opportunities.

Mary decided that she would use the Internet, classified ads, and one-eighth page ads to promote her products overseas. But she intuitively felt that these options would not be enough. Although her experience with her Indian vendors would provide some insight, she realized that selling to international markets would require her to think creatively.

Mary knew that she did not have the required funds to establish an overseas manufacturing facility. Even if she did, she was concerned about the risk involved. For the same reason, she was reluctant to open up a sales office. Eliminating these alternatives left her considering two strategies: licensing and exporting.

Questi O ns:

1) What are the advantages and disadvantages of using licensing and exporting? 2) Will Mary need to use the services of a freight forwarder? If so, what specific services? 3) Are there any other countries, besides those mentioned, that might be important markets for

The Horse Place’s products?

Should Companies Marketing Their Products to International Markets Charge Lower Prices in Developing Markets than They Do in Developed Markets?

POINT COuNTerPOINT

This question has become more important in recent years as developed nations reach out in a variety of ways to lesser-developed ones. Examples include the G-20 nations providing the International Monetary Fund with $1 trillion in April of 2009 to assist developing nations experiencing economic problems, and the United States supplying greater levels of economic aid to developing nations in Africa.

Point Companies in developed nations have a noblesse oblige to improve the standard of living for people in developing countries that are less fortunate than people in developed countries. Aside from this argument, if the standard of living in poorer nations is improved, there would be more income to purchase more products from companies in developed nations that are charging the lower prices. If the products include prescription drugs, life expectancies in developed countries will also be improved. COuNTerPOINT Companies have the major obligation to their stockholders, not to individuals in developing countries. Stockholders benefit if the prices of the stocks they hold increase in value. This is most likely to occur if profits are increased. Charging lower prices may jeopardize a company’s profits; lower prices may lead to allegations of dumping. Another option may be to give the products away. With the tax savings achieved, the company’s profits may exceed those obtained by selling the products at lower prices in developing markets.

What Do You Think?

Which viewpoint do you support, and why? Use the Internet to learn more about this issue and come up with your own argument.

inTerpreTing global buSineSS newS

For many countries, international tourism is big business. As globalization continues, total tourism dollars in the world’s economy will significantly increase and both large and small nations will benefit from increased expenditures by visitors. Specific industries, such as lodging, airlines, restaurants, souvenir shops, and international attractions, including museums, art galleries, theme parks, wildlife preserves, and musical and concert venues, will strive to gain larger shares of tourist expenditures.

In 2013, worldwide tourism receipts reached $1.16 trillion. The United States led the world with $140 billion in international tourism revenues, followed by Spain ($60 billion), France ($56 billion), China ($52 billion), Macau ($52 billion), Italy ($44 billion), Thailand ($42 billion), Germany ($41 billion), United Kingdom ($41 billion), and Hong Kong ($39 billion). France drew the most visitors (85 million), with the United States (70 million), Spain (61 million), China (56 million), and Italy (48 million) rounding out the top five. Turkey, Germany, United Kingdom, Russia, and Thailand completed the top ten.

Some international travelers will spend more than others when visiting other countries and are, therefore, prime targets for countries’ marketing programs. For example, the average expenditure in 2013 for visitors to the United States was $2,590, but visitors from Brazil, China, India, Australia, and Argentina were well above $5,000 per visit.

Reasons why people visit foreign countries can help marketers to target their promotional efforts. These include leisure, recreation and holidays, visiting friends or relatives, business, studying or teaching, attending conventions or conferences, and religious and pilgrimage reasons.

Galeries Lafayette, the large French department store headquartered in Paris, makes a concerted effort to get tourists to shop in the Paris store. Literature about the store is available through foreign travel agents and on flights into Paris. Brochures, which offer a 15 percent discount, are located in hotel lobbies. Executives estimate that tourists represent 10 percent to 15 percent of its revenues.

Source: Travel data found in the 2015 World Almanac.

Questi O ns:

1) Do you have an idea as to the percentage of the world’s total expenditures that are spent on tourism?

2) Why do you think a small destination, Macau, ranks fifth in tourism receipts? 3) What reasons can you give for visitors to the United States from Brazil, China, Australia,

India, and Argentina spending more per visit than travelers from other countries?

porTfolio projeCTS

explore your own Case in Point: what Marketing strategy Does your Company use in its international Markets? After reading this chapter, you should be prepared to answer some basic questions about your favorite company: 1) What products are sold in the company’s international markets? Do they vary by country or by region?

2) What types of promotion does your favorite company emphasize in its international markets? Do they differ from those used in its domestic market? 3) What kinds of distribution channels are being employed in your company’s international markets?

4) Does your company appear to be charging the same prices for its products that are being marketed to specific countries? How can you address that the prices may be quoted in different currencies?

Develop an international strategy for your own small business: Collecting information about the Mexican Market for educational Products

You are the market analyst for a small company that sells educational programs for improving the mathematics skills of high school students in both domestic and international (European) markets. The company is considering marketing these same products to Mexico. An assessment of the Mexican market needs to be completed before a final decision to enter this market is made. Your boss asks you to give him “the numbers.” 1) What preliminary data should you collect about the Mexican market? 2) How will you proceed to collect these data? What secondary sources could you use? 3) What critical data do you need to provide your boss so that he can decide if the company should expand into Mexico?

ChapTer noTeS

1“Vinchel Contemplates Market Expansion Strategies,” Case developed by Richard T. Hise and David Barcan, support provided by USAID and The Eurasia Foundation. 2“Chinese Students Major in Luxury Cars,” BusinessWeek, December 23–January 5, 2014, pp. 23–25. 3“Where the Company Car is a Porsche,” BusinessWeek, January 14–20, 2013, pp. 18–19. 4World Factbook, Central Intelligence Agency, 2014. 5M. Kripalani and D. Rocks, “India Plays Catch-Up in Africa,” BusinessWeek, May 26, 2008, p. 55. 6C. K. Prahalad, “A Special Report on Globalization,” The Economist, September 20, 2008, p. 10. 7A. McConnon, “Gerber is Following Kids to Preschool,” BusinessWeek, August 18, 2008, p. 64. 8R. T. Hise and R. Bartlett, “Developing a Marketing Intelligence System for Companies’ European Operations: Mary Kay Cosmetics Experience,” paper presented to Academy of Marketing Science Cultural Perspectives on Marketing Conference, Puebla, Mexico, September 2004. 9L. Lin and L. Patton, “Where’s the Colonel When You Need Him?,” BusinessWeek, May 20–26, 2014, pp. 20–22. 10D. Kiley, “One World, One Car, One Name,” BusinessWeek, March 24, 2008, p. 63. 11I. Fowler and M. Srivastava, “Tata’s Nano Hits a Speed Bump,” BusinessWeek, August 11, 2008, p. 30. 12M. Boyle, “A Different Kind of Oil Boom,” BusinessWeek, July 27–August 4, 2013, pp. 22–23. 13G. Edmondson and K. Kervin, “Stalled,” BusinessWeek, September 29, 2003, pp. 54–56; G. Edmondson, C. Dawson, and K. Kervin, “Designer Cars,” BusinessWeek, February 16, 2004, pp. 55–61; G. Edmondson, “Daimler Fumbles Are Firing Up Europe’s Shareholders,” BusinessWeek, April 19, 2004, p. 56. 14P. Laya, “Blockbuster Is Still a Hit South of the Border,” BusinessWeek, February 10–16, 2013, pp. 23–26. 15P. Burrows, “Boom Time for Secondhand iPhones,” BusinessWeek, May 27–June 2, 2013, p. 46. 16G. Motevalli, “Iran’s Latest Headache: A Brain Drain,” BusinessWeek, May 12–18, 2014, pp. 18–19. 17R. Jana, “Inspiration from Emerging Economies,” BusinessWeek, March 28 & 30, 2009, pp. 36–38. 18M. Mawad, “France Wants the Profits From French Inventions,” BusinessWeek, June 17–23, 2013, pp. 17–18. 19D. Rocks and A. Halperin, “Stalking the Copycats,” BusinessWeek, August 18, 2008, pp. 62–63. 20A. Marshall, “The Fatal Consequences of Counterfeit Drugs,” Smithsonian, October 2009. Accessed 9/19/10 at www.smithsonianmag.com/ people-places/Prescription-for-Murder.html. 21A. Narayanan, “Pick Up. Your Ad Is Calling,” BusinessWeek, April 21–27, 2014, pp. 19–20. 22J. Hempel, “IBM’s All-Star Salesman,” Fortune, September 29, 2008, pp. 110–118. 23M. Sharma, “Amazon and eBay Inch into India,” BusinessWeek, January 27–February 2, 2014, pp. 32–33. 24International Maritime Organization, “Piracy in the Waters off Somalia.” Accessed 9/19/10 at www.imo.org/home.asp?topic_id=1178. 25M. Ihlan, “The Foreigners at the Top of LG,” BusinessWeek, December 22, 2008, pp. 56–57. 26G. Chon, “Iran’s Cheap Goods Stifle Iraq Economy,” BusinessWeek, March 28 & 30, 2009, pp. 36–37. 27R. Whiteley, The Customer Driven Company (Boston: Addison-Wesley, 1991) 28R. Jacob, “Why Some Customers Are More Equal Than Others,” Fortune, September 19, 1995, pp. 215–224. 29D. Fickling and H. Lee, “Paying Extra for Whine Free Flying,” BusinessWeek, September 23–29, 2013, pp. 23–24. 30Harvard Business Review 31Prokesch. 32Jacob.

CH 13

Global Operations and Supply-Chain Management

Kim Steele/Photodisc/Jupiter Images © C Miller Design/Getty Images

After studying this chapter, you should be able to:

LO-1 Explain what global operations management is and how it operates.

LO-2 Describe the advantages and disadvantages of global procurement, and compare the reasons why companies outsource and insource.

LO-3 Identify the advantages and disadvantages of global production.

LO-4 Discuss the considerations for locating and relocating production facilities.

LO-5 Illustrate the benefits of global supplychain management, and describe how the Internet and enterprise resource planning systems are affecting global supply chains.

Cultural Perspective

Global Supply-Chain Management at Lenovo

Lenovo Group Limited is a multinational computer technology corporation based in the People’s Republic of China. Lenovo develops, manufactures, and markets desktop and notebook personal computers, workstations, servers, storage drives, and information technology management software. In 2005, Lenovo acquired the former IBM PC Company Division that marketed the ThinkPad line of notebook PCs for approximately $1.75 billion. In 2014, Lenovo was the world’s largest personal computer vendor by unit sales.

Lenovo recently decided to invest $30 million in new manufacturing plants in Mexico and India, as part of a strategy to compete with rivals Hewlett-Packard and Dell in major markets outside China. Lenovo will assemble computers at a new factory in Monterrey, Mexico, approximately 150 miles from the Mexico–U.S. border and in close proximity to customers in the United States—the world’s largest PC market. The Monterrey plant will be Lenovo’s largest manufacturing investment outside of China and will employ 750 people to assemble desktop and notebook computers for key markets in the Americas region, including the United States, Canada, and Brazil.

Lenovo will also open a smaller manufacturing facility in the northern Indian state of Himachal Pradesh in order to gain better access to customers in India, one of the PC industry’s fastest-growing markets. This plant will be Lenovo’s second facility in India and will employ 350 people.

Chief Executive Bill Amelio proposed the new manufacturing plants in Mexico and India in order to improve Lenovo’s supply chain. Mr. Amelio joined Lenovo after working several years for Dell, where he served as senior vice president of the Asia-Pacific and Japan region. Dell is well-known for the speed of its supply chain. In turn, Mr. Amelio hired Gerry P. Smith, a supply-chain expert from Dell, to map Lenovo’s global distribution network and identify inefficiencies. The network “looked like spaghetti,” said Mr. Smith.

Locating manufacturing plants closer to customers helps get products into buyers’ hands faster by reducing shipping times and will also reduce shipping costs. Shipping a computer from China to the United States can take 30 days, while shipping a computer from Monterrey to the United States would take three to four days. The shipping cost would decrease proportionally to the decrease in shipping time. Although Lenovo had previously subcontracted manufacturing to third-party companies in Mexico, the majority of its products were still made in China.

Lenovo is very motivated to increase its presence into the United States, where it depends upon sales of ThinkPad laptops to business customers. The company now aims to tap into the U.S. consumer market by selling Lenovo-branded products through retail stores in the United States. Lenovo controls more than 18 percent of the global PC market, and with its U.S. market share at 10 percent, Lenovo ranks in the top four U.S. PC firms.1

Note: On February 2009 Yang Yuanqing replaced Bill Amelio as CEO of Lenovo.

LO-1

Explain what global operations management is and how it operates.

production system

the system that businesses use to produce products

manufacturing system

a production system in which goods dominate the value of the product

service system

a production system in which services dominate the value of the product

Introduction

In an endless quest to achieve a sustainable competitive advantage, businesses, such as Lenovo, Boeing, Volkswagen, and Sony, have increasingly used global operations and supply-chain management as competitive weapons. In this chapter, global operations management and its associated business functions—procurement, production, logistics, and research and development—are defined.

The factors that firms take into account when considering whether to procure domestically or globally, including outsourcing and insourcing decisions, are analyzed in detail. Interrelated strategic decisions—which production facilities to own and where to locate the facilities—are also discussed. In addition, the relocation of production facilities is explored.

Next, global supply-chain management is discussed. In the current business environment, the level of competition has been elevated from “company A versus company B” to the supply chain of company A versus the supply chain of company B. The benefits of improving global supply-chain management are illustrated using a real-world company. The coordination and collaboration required in successful supply chains has been made possible by information technologies, such as the Internet and enterprise resource planning systems. The impact of these two information technologies in global supply-chain management is explained in the last section of this chapter.

13-1 Global Operations Management

Businesses exist to create goods and services. Goods include automobiles, airplanes, and computers. Services include health care, entertainment, and consulting. It is important to note that most firms produce and sell products that involve a combination of goods and services. In some products, the value of the goods dominates the value of the services, for instance, buying a car (the good) with a warranty (the service). In other products, the value of the services dominates the value of the goods, for example, spending a night at a hotel. In this example, the service entails the use of the room and hotel facilities, while the goods include the consumed electricity, water and toiletries, and food (if breakfast is included). For brevity, this chapter will use the word product to encompass the combination of goods and services that the customer receives.

A production system is a system that businesses use to create the goods and services or to produce the products. When the goods dominate the value of the product, the production system is typically called a manufacturing system. When the services dominate the value of the product, the production system is commonly called a service system. The production systems of Honda Motor Company, the Boeing Company, and Toshiba Corporation, would be called manufacturing systems. In contrast, the production systems of the Fred Hutchinson Cancer Research Center, the Walt Disney Company, and the consulting firm Accenture, would be called service systems. Sometimes the product value is not clearly dominated by the goods or the services provided; for example, a fine restaurant could be considered both a manufacturing system and a service system.

A production system can be modeled as a system that begins with inputs and creates from them outputs via a production process. Exhibit 13.1 illustrates this model.

In this model, the inputs may include materials, land, labor, machines and equipment, energy, and information. The outputs represent the desired goods and services. And the production process may consist of one or more transformations which could be:

• physical, as in manufacturing • locational, as in transportation

EXHIBIT 13.1 A PRODUCTION SYSTEM MODEL

Suppliers Inputs Production Process Outputs Customers

© Cengage Learning 2014

• informational, as in consulting • psychological, as in entertainment • physiological, as in health care • exchange, as in retailing • storage, as in warehousing

At Boeing, the transformation is physical, and the outputs are airplanes. At the Fred Hutchinson Cancer Research Center, the transformation is physiological, and the outputs are healthy patients. Some of the inputs for Boeing include aluminum, titanium, glass, engines, buildings, machines, engineers, and workers. Some of the inputs for the Fred Hutchinson Cancer Research Center are medical supplies and drugs, buildings, doctors, nurses, staff, medical equipment, and laboratories. In both examples, additional inputs include energy and information—airplane designs for Boeing, and medical protocols for the Fred Hutchinson Cancer Research Center. The sites where production takes place are called production facilities. For Boeing, production facilities include manufacturing and assembly plants, and for the Fred Hutchinson Cancer Research Center, production facilities include hospitals and clinics.

Products can be conceptualized as being integrated by several goods and services called components. For instance, two components of a car that are goods could be the engine and the tires, and two components that are services could be the inspection of the car prior to delivery and the transportation of the car from the factory to the dealership. In turn, the components will need to be produced from raw materials. The raw

imagebroker/Alamy Limited

production facility

the site where production takes place

components

goods and services that integrate a product

raw materials

materials used to produce components

production stages

steps in the production process

operations management

the management of the direct resources that are involved in the production system of a business organization materials may include goods and services, too. For example, two raw materials of the engine that are goods could be stainless steel and aluminum, and two raw materials that are services could be the quality-control engineers that will inspect the engine as it is being assembled, and the logistics personnel that will move the engine around the factory from work station to work station. If the product is mostly comprised of services—for instance, taking a Caribbean cruise or spending a day at Disneyland—although it is not necessarily straightforward, it could also be possible to identify the components and raw materials in these products.

When a production process involves several steps, these steps are called production stages. Depending upon the complexity of the production process, different production stages may need to be assigned to different production facilities. Consider Boeing that assembles commercial airplanes at its Renton and Everett production facilities in Washington state. Boeing also manufactures some of the components of those airplanes at its Auburn and Frederickson production facilities in Washington state, its Portland production facility in Oregon, its Winnipeg production facility in Canada, and its Sydney and Melbourne production facilities in Australia. Production stages can also be present at businesses with service systems. A patient arriving at an emergency room, for example, may be taken first to radiology, then to surgery, and lastly to intensive care, all of which represent production stages.

Operations management refers to the management of the direct resources that are involved in the production system of a business organization. Until recently, operations management was mostly applied in manufacturing firms and was called manufacturing management or production management. To include applications in service industries, the name was changed to production and operations management, or just operations management. Following current practice, the text will use the term operations management to include the management of both manufacturing systems and service systems. In addition, when all of the production system direct resources originate from and reside in only one country, the term domestic operations management will be used. In contrast, when one or more of the production system direct resources originate from or are located in more than one country, the term global operations management will be used. Companies with global operations management include Boeing, Volkswagen, Lenovo, the Walt Disney Company, Accenture, and Cemex S.A.B. de C.V. The emphasis in this chapter is specifically upon global operations management.2

Most of the activities in operations management can be grouped into four business functions: procurement, production, logistics, and research and development. Procurement is responsible for the acquisition of goods and services. Production is responsible for the transformations required by the production process. Logistics is responsible for the movement of materials in the production system. Research and development (R&D) is responsible for the design of new products. Note that procurement, logistics, and R&D are service functions in both manufacturing and service systems. Within operations management, these four business functions can be classified as domestic or global. One example is Boeing, which buys from thousands of suppliers in more than 100 countries, but only has production facilities in the United States, and thus practices global procurement and domestic production. As a second example, Dell, which has manufacturing plants in Brazil, Ireland, Poland, and the United States, and R&D centers in China, India, Singapore, Taiwan, and the United States, practices global production and global R&D.

REALITY CHECK LO-1

Select a product that you recently purchased. Do some research to establish whether the company that produced the product practices global operations management.

13-2 Global Procurement

Business enterprises face the strategic decision to determine the organizational boundaries of the firm. In operations management, this entails deciding for the production system which components and raw materials should be produced in-house and which components and raw materials should be acquired from suppliers. This decision traditionally has been called the make-or-buy decision. Beginning recently, the term “sourcing decision” has been used as a synonym for this process. As an example of the sourcing decision, should Boeing make the engines of its commercial airplanes or buy them from suppliers such as General Electric, Rolls Royce, and Pratt & Whitney?

The term “make” not only applies to production but to logistics and R&D as well. As an example of a logistics sourcing decision, should Dell own (“make”) a fleet of trucks to deliver its computers to customers, or should Dell contract (“buy”) the delivery service from UPS and FedEx? As an example of a R&D sourcing decision, should a pharmaceutical company perform all clinical trials in-house (“make”), or should the pharmaceutical company contract (“buy”) with university hospitals or other external entities to perform the trials? Moreover, the sourcing decision applies to service systems as well. Consider the Hilton Hotels Corporation with more than 3000 Hilton branded hotels across the world. Should Hilton provide (“make”) its own maid services or should Hilton contract (“buy”) maid services from one or more suppliers?

A related strategic decision that business firms face is whether or not the making or buying processes should be global. Consequently, the following four alternatives are possible: make domestically, make globally, buy domestically, and buy globally. When a company buys globally, it is said that the company is practicing global procurement. When a firm globally produces goods or services, it is said that the firm is practicing global production. The same can be said for global logistics and global R&D. The remainder of this section will present the advantages and disadvantages of global procurement.

LO-2

Describe the advantages and disadvantages of global procurement, and compare the reasons why companies outsource and insource.

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make-or-buy decision

determining which components and raw materials should be produced in-house and which components and raw materials should be acquired from suppliers; also called the sourcing decision

global procurement

when a firm buys components and raw materials globally

global production

when a firm produces goods and services globally