Manufacturing

When should firms locate their manufacturing units in a high-cost country?

Manufacturing In High GDP Countries
Written by Shalique M.S

The trend of outsourcing some of the manufacturing tasks to low cost countries no longer seems to be an outright ingenious decision. Rather, fluctuating markets and changing international trade circumstances makes the decision making process a hard nut to crack. With the trade conflict between China and US creating headwinds, the global automobile sector is facing hard-won challenges. Volvo, owned by China’s Geely is for instance having an arduous time with the US-China trade war hurting the pace of expansion at its new U.S. factory in South Carolina, where it had plans to invest $1.1 billion and hire about 4,000 people.

Manufacturing location decision in a  country is not just a matter of cost of production, it is about the key linkages between the production, market, supply chain and product development. The decision is a strategic one which should not be based solely on the economic attractiveness but also on the organisational and technological interdependencies. When should we produce in a high cost environment? Since high GDP(Gross Domestic Product) per capita is positively correlated with the price of inputs required for manufacturing, the high cost countries can be equated with the countries with high GDP per capita such as the US($59,531.66), Singapore($57,714.3), Sweden($53,442.01) and Finland($45,703.33).

The strategic location decision making process of firms can be analysed based on three factors; coupling, specificity and formalisation.

Coupling: It measures the interdependencies between two organisations often measured on a scale of loose-tight continuum. In a loosely coupled organisation, the sub-systems can make the decisions independently and hence have more freedom. However, in tightly coupled systems, the functional interdependencies make many processes inseparable and leads to the formation of integrated value chains.

In the case of Production-Supply dyad, the coupling depends on whether the product is modular or integrated. An integrated product is somewhat tightly coupled than a modular product. Hence, the choice of various parts becomes critical in an integrated design.

In Production-Development dyads, tightly coupled systems exhibit the need for co-creation of value through joint product design and development which is again common in non-modular designs.

Finally, in the case of Production-Market Dyad, tight coupling arises when there is a need for the production in close vicinity to the market due to factors such as logistics cost, legal requirements to produce locally etc.

Specificity: This is commonly encountered when  decisions are formed on the basis of specific relationships between the stakeholders and varies according to context. Low specificity arises when there are multiple suppliers and heavy competition.

In the Production-Supply dyad, low specificity is exhibited in case there are numerous suppliers and each one is governed through contracts. However, certain dyads operating in a specialised supply chain with very few suppliers exhibit high specificity like defence and space exploration.

In the Production-Development dyad, high specificity arise when the development requires an in-depth understanding of the process and is process specific. This is common in the case of petroleum refining operations and its corresponding R&D wing that works on developing efficient and cost effective catalysts.

Finally, in the Production-Market dyad, high specificity refers to products which requires to tailer to specific markets. For instance, automobile producers needs to respond to local regulations such as specific emission norms in the European Union, interior design preferences in various markets etc.

Formalisation: Formalisation refers to the predetermined way in which tasks are performed. It leads to repeatability and efficiency in performing banal activities.

A high degree of formalisation in the Production-Supply dyad implies that Standard Operating Procedures can be applied in the manufacturing process. A low degree however calls for Make To Order (MTO) or Engineer To Order (ETO) thus calling for greater collaboration with the supplier.

A lesser degree of formalisation is common in the Production-Development dyad since organisations prefer continuous improvement and development.

Production-Market dyad is lesser formal in case the product needs to cater to local preferences. This is most common in the packed food and snack segment where local taste and preferences becomes critical for company success.

References

Canbolat, Y. B., Chelst, K., & Garg, N. (2007). Combining decision tree and MAUT for selecting a country for a global manufacturing facility. Omega, 35(3), 312-325.

Ketokivi, M., Turkulainen, V., Seppälä, T., Rouvinen, P., & Ali-Yrkkö, J. (2017). Why locate manufacturing in a high-cost country? A case study of 35 production location decisions. Journal of Operations Management, 49, 20-30.

 

 

 

 

 

About the author

Shalique M.S

Research Scholar, IIM Kozhikode

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