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CHAPTER 15
MANAGING INTERNATIONAL OPERATIONS
LEARNING OBJECTIVES:
15.1 Describe the elements to consider when formulating production strategies.
15.2 Outline the issues to consider when acquiring physical resources.
15.3 Identify the key production matters that concern managers.
15.4 Explain the potential ways to finance business operations.
CHAPTER OUTLINE:
Introduction
Production Strategy
Capacity Planning
Facilities Location Planning
Location Economies
Centralization versus Decentralization
Process Planning
Standardization versus Adaptation
Facilities Layout Planning
Acquiring Physical Resources
Make-or-Buy Decision
Reasons to Make
Lower Costs
Greater Control
Reasons to Buy
Lower Risk
Greater Flexibility
Market Power
Barriers to Buying
Raw Materials
Fixed Assets
Key Production Concerns
Quality Improvement Efforts
Total Quality Management
ISO 9000
Shipping and Inventory Costs
Reinvestment versus Divestment
Financing Business Operations
Borrowing
Issuing Equity
Issuing American Depository Receipts
Advantages of ADRs
Venture Capital
Copyright © 2019 Pearson Education, Inc.
Emerging Stock Markets
Internal Funding
Internal Equity, Debt, and Fees
Revenue from Operations
Capital Structure
A Final Word
A comprehensive set of specially designed PowerPoint slides is available for use with Chapter 15.
These slides and the lecture outline below form a completely integrated package that simplifies the
teaching of this chapter’s material.
Lecture Outline
I. INTRODUCTION
Essential to success in international markets are production strategies, including the decision to
centralize or decentralize production and standardize or adapt production to national markets.
II. PRODUCTION STRATEGY
Careful planning of production helps companies cut costs to become low-cost leaders and to
design new products or product features necessary for a differentiation strategy.
A. Capacity Planning
1. Assessing a company’s ability to produce enough output to satisfy market
demand.
2. If capacity now used is greater than the expected market demand, production
must be scaled back.
3. Countries have different laws regulating the ability of employers to eliminate
jobs; depending on the country, a firm may or may not need to give advance
notice of layoffs or plant closings.
4. If market demand is growing, managers must determine in which facilities to
expand production or whether additional facilities are needed to expand capacity.
5. Capacity planning is also extremely important for service companies.
B. Facilities Location Planning
1. Selecting a location for production facilities.
2. Key environmental factors in planning include the cost and availability of labor
and management, raw materials, component parts, and energy. Other factors
include political stability, the extent of regulation and bureaucracy, economic
development, and the local culture, including beliefs about work and important
traditions.
3. Reducing production costs through lower wages is often essential to keep
products at competitive prices, especially when labor accounts for a large portion
of total production. Lower wages must be balanced against worker productivity,
which is lower in developing and emerging nations.
4. Service companies must locate near their customers and consider customers’
needs when locating facilities.
5. Supply issues are important in location planning; the greater the distance
between production facilities and target markets, the longer it takes for
customers to receive shipments.
6. Marketing managers must compensate for delays by maintaining larger
inventories in target markets—adding to storage and insurance costs.
7. Shipping costs are greater when production is conducted far from target markets.
Transportation costs are a driving force behind the globalization of the steel and
potentially other industries.
8. Location economies
a. Economic benefits derived from locating production activities in optimal
locations.
b. Companies undertake business activities in a location or obtain products
and services from companies located there.
c. The key fact is that each production activity generates more value in a
particular location than could be generated elsewhere. The productivity
of a location is heavily influenced by labor and capital.
9. Centralization versus decentralization
a. Centralized production refers to the concentration of production facilities
in one location. Decentralized production spreads facilities over several
locations and could mean one facility for each business environment.
b. Companies often centralize production facilities in pursuit of low-cost
strategies and to take advantage of economies of scale.
c. Transportation costs and the physical landscape affect the centralization
versus decentralization decision.
d. Because they typically sell undifferentiated products in all markets, low-
cost competitors do not need to locate near their markets to respond to
changes in buyer preferences. They choose locations with the lowest
combined production and transportation costs.
e. Firms must balance the cost of getting inputs into production and getting
products to market.
f. Companies with differentiated products find decentralized production the
better option; locating separate facilities near different markets, they
remain close to customers and respond to buyer preferences.
g. When R&D and manufacturing must cooperate for differentiation, they
tend to be located in the same place, although today technology allows
for separate locations.
C. Process Planning
1. Deciding the process a company will use to create its product.
2. Low-cost strategies require large-scale production because producers want the
cost savings of economies of scale.
3. Differentiation strategies demand extra value by offering something unique, such
as superior quality, added features, or special brand images.
4. Availability and cost of labor in the local market is crucial to process planning; if
labor in the host country is cheap, a company opts for less technology and more
labor-intensive methods in production.
5. Standardization versus adaptation
a. Production processes must be standardized or adapted for different
markets.
b. Large production batches reduce the cost of producing each unit,
offsetting the higher initial investment in automation; costs are further
reduced as employees repeat the process and learn.
c. Differentiation demands decentralized facilities to improve local
responsiveness; these facilities produce for a national or regional market
and tend to be smaller. Eliminates economies of scale and increases per-
unit production costs. R&D costs are higher for products with special
product designs, styles, and features.
D. Facilities Layout Planning
1. Deciding the spatial arrangement of production processes within production
facilities.
2. Facility layout depends on the type of production process, which depends on a
company’s business-level strategy.
III. ACQUIRING PHYSICAL RESOURCES
International companies must acquire physical resources to begin operations. They must decide
whether to make or buy the components for production processes. What will be the sources of
any required raw materials? Will the company acquire facilities and production equipment or
build its own?
A. Make-or-Buy Decision
Deciding whether to make a component or buy it from another company.
1. Reasons to make
Vertical integration is the process by which a company extends its control over
additional stages of production—either inputs or outputs. When a company
makes a product, it engages in “upstream” activities: Production activities that
precede current business operations.
a. Lower costs
i. The company decides to make the products rather than buy them
in order to reduce total costs.
ii. Companies use in-house production when it costs less than
buying on the open market.
iii. Small companies are less likely to make rather than buy, except if
the company possesses technology or another competitive
advantage.
b. Greater control
i. Making rather than buying can give managers greater control over
raw materials, product design, and the production process itself—
all of which are important factors in product quality.
ii. Companies often undertake in-house production when persuading
a supplier to make special modifications to a product on their
behalf is difficult.
iii. Companies keep greater control over product design and features
if they manufacture components themselves.
iv. Companies also make rather than buy when buying requires
providing key technology.
2. Reasons to buy
a. Outsourcing is the practice of buying from another company a good or
service that is not central to a company’s competitive advantage.
Outsourcing results from continuous specialization and technological
advancement.
b. By outsourcing, a company reduces vertical integration and its overall
amount of specialized skills and knowledge.
c. “Stealth manufacturing” calls for outsourcing the assembly of computers
plus shipping to distributors and other intermediaries.
d. Outsourcing is catching on in the pharmaceutical, computer
manufacturing, and a new and interesting type of outsourcing seems to be
increasingly popular. The online forum called InnoCentive, which
connects companies and institutions seeking solutions to difficult
problems using a global network of more than 145,000 creative thinkers.
e. Lower risk
i. Social unrest or open conflict can threaten physical facilities,
equipment, and employee safety.
ii. Eliminate the exposure of assets to political risk by refusing to
invest in plants and equipment abroad; it can purchase products
from international suppliers.
iii. Eliminates the need to purchase expensive insurance coverage
needed in an unstable country. But does not completely shield the
buyer from disruptions; political instability can cause delays in
receiving needed parts.
f. Greater flexibility
i. Making in-house products that require huge investment in
equipment and buildings often reduces flexibility.
ii. Companies that buy products from one or more outside suppliers
retain or gain flexibility. Added flexibility is key in a change of
attitude toward outsourcing.
iii. Maintaining flexibility is important when the national business
environments of suppliers are volatile. Buying from several
suppliers or establishing production facilities in several countries
allows outsourcing from one location if instability erupts in
another.
iv. Volatility in exchange rates can increase or decrease the cost of
importing; by buying from multiple suppliers in several countries,
a company maintains the flexibility to change sources and reduce
risk.
v. Companies maintain operational flexibility by not investing in
production facilities; it can then alter its product line very quickly.
vi. A company has financial flexibility if its capital is not locked up
in plants and equipment; it uses excess capital to pursue
opportunities.
g. Market power
i. Companies can gain power in their relationships with suppliers by
becoming important customers.
ii. Sometimes a supplier becomes a hostage to one customer when
the supplier depends on a company with its production capacity;
if the buyer outsources elsewhere, the supplier has few other
customers.
iii. This situation gives the buyer significant control in dictating
quality improvements, forcing cost reductions, and making
special modifications.
h. Barriers to buying
i. Companies sometimes face obstacles when purchasing products
from international suppliers.
ii. The government of the buyer’s country may impose import tariffs
to improve the balance of trade.
iii. The services provided by intermediaries increase the cost of
buying abroad.
B. Raw Materials
1. The twin issues of quality and quantity drive many decisions about raw material
acquisition.
2. Some industries and companies rely almost exclusively on the quantity of locally
available raw materials.
3. Raw material quality has a huge influence on the quality of a company’s end
product.
C. Fixed Assets
1. Fixed assets are company assets such as production facilities, inventory
warehouses, retail outlets, and production and office equipment.
2. Companies can (1) acquire or modify existing factories, or (2) build new
facilities—called a greenfield investment.
3. Considering either option involves many individuals, such as production
managers, site-acquisition experts, legal staff, and public relations staff.
4. Local infrastructure must support proposed on-site business operations.
IV. KEY PRODUCTION CONCERNS
How manufacturing operation companies maximize quality and minimize shipping and
inventory costs, and important reinvestment-versus-divestment decisions.
A. Quality Improvement Efforts
1. Companies strive toward quality improvement for two reasons: costs and
customer value.
2. Quality products keep production costs low by reducing waste in valuable
outputs, reducing the cost of retrieving defective products, and reducing disposal
costs due to defective products.
3. Some minimum level of acceptable quality is an aspect of every product today.
A company that combines a low-cost position with a high-quality product can
gain a competitive advantage.
4. Improving quality is important for service providers; quality is complex because
a service is created and consumed at the same time. The interaction between an
employee who delivers a service and the buyer is part of service quality.
5. Activities conducted prior to service delivery are also important.
6. Total quality management
a. Emphasis on continuous quality improvement to meet or exceed
customer expectations. It places responsibility on each individual to focus
on the quality of output.
b. By continuously improving quality, a company differentiates itself from
rivals and attracts loyal customers.
7. ISO 9000
a. The International Standards Organization (ISO) 9000 is an international
certification that companies receive when they meet the highest quality
standards in their industries.
b. To become certified, companies must demonstrate the reliability and
soundness of all business processes affecting the quality of their
products.
B. Shipping and Inventory Costs
1. Shipping costs can have a dramatic effect on the cost of getting materials and
components to the location of production facilities.
2. Shipping costs are affected by a nation’s business environment, such as its level
of economic development, including the condition of seaports, airports, roads,
and rail networks.
3. Because storing inventory is costly, companies adopt just-in-time (JIT)
manufacturing—in which inventory is kept to a minimum and inputs to
production arrive exactly as needed. Although the technique was originally
developed for the automobile industry in Japan, it has quickly spread throughout
manufacturing operations worldwide.
4. JIT drastically reduces the costs of large inventories and reduces wasteful
expenses because defective materials and components are spotted quickly during
production.
C. Reinvestment versus Divestment
1. Managers need to decide whether to invest further in operations abroad or to
reduce or divest international operations.
2. Companies continue investing in markets requiring long payback periods if the
outlook is good.
3. Companies reinvest when a market is experiencing rapid growth. Investing in
expanding markets is attractive because potential customers may not yet be loyal
to the products of any one company or brand.
4. Companies scale back their international investments when it is apparent that
profitability will take longer than expected.
5. Problems in the political, social, or economic sphere can force companies either
to reduce investment or eliminate operations altogether.
6. Companies invest in operations offering the best return on investment; this
means reducing investments or divesting operations in profitable markets to
invest in more profitable opportunities elsewhere.
V. FINANCING BUSINESS OPERATIONS
Companies need financial resources to pay for operating expenses and investment projects.
They must buy raw materials and component products for manufacturing and assembly
activities. They need capital for expanding production capacity or entering new geographic
markets and financing to pay for training and development, to compensate workers and
managers, and to advertise.
A. Borrowing
1. International companies (like domestic companies) try to get the lowest interest
rates possible on borrowed funds.
2. Difficulties include exchange-rate risk, restrictions on currency convertibility,
and restrictions on the international flow of capital.
3. Borrowing locally can be advantageous, especially when the value of the local
currency has fallen against that of the home country. But companies are not
always able to borrow funds locally; they are forced to seek international sources
of capital.
4. A back-to-back loan is a loan in which a parent company deposits money with a
host-country bank, which then lends it to a subsidiary located in the host country.
(See Figure 15.1)
B. Issuing Equity
The international equity market (See Chapter 9) consists of all stocks bought and sold
outside the home country of the issuing company. This helps firms to access investors
with funds unavailable domestically. Yet getting shares listed on another country’s stock
exchange can be a complex process. Complying with all the rules and regulations
governing a stock exchange costs time and money.
1. Issuing American Depository Receipts
a. To maximize international exposure, non-U.S. companies list themselves
on U.S. stock exchanges. A non-U.S. company can list shares in the
United States by issuing American Depository Receipts (ADRs)—
certificates that trade in the United States and represent a specific number
of shares in a non-U.S. company.
b. International companies also use Global Depository Receipts (GDRs),
which are similar to ADRs but are listed and traded in London and
Luxembourg.
c. Advantages of ADRs: Buyers pay no currency-conversion fees, and there
are no minimum purchase requirements. Also, companies offer ADRs in
the United States to appeal to mutual funds because U.S. investment laws
limit the amount that a mutual fund can invest in companies not
registered on U.S. exchanges.
2. Venture capital
a. Venture capital is financing obtained from investors who believe that the
borrower will experience rapid growth and receive equity (part
ownership) in return.
b. Venture capitalists invest in new risky ventures because they can
generate large returns on investment.
c. The venture capital industry has become global.
3. Emerging stock markets
a. Companies in countries with emerging stock markets face two problems.
First, emerging stock markets are often volatile.
i. Investments can be either hot money—money that can be quickly
withdrawn in a crisis—or patient money—investment in factories,
equipment, and land that cannot be withdrawn easily.
ii. Large and sudden sell-offs of equity are signs of market volatility
that characterize emerging stock markets. Large sell-offs occur
because of uncertainty regarding the nation’s future economic
growth.
b. Second is the issue of poor market regulation.
i. Large local companies can wield influence over their domestic
stock markets; if domestic shareholders dominate such exchanges,
international investors may hesitate to enter.
ii. The problem lies in regulation that favors insiders over
international investors.
C. Internal Funding
Ongoing business activities and new investments can also be financed internally with
funds supplied by the parent company or its international subsidiaries.
1. Internal equity, debt, and fees
a. Time is needed for new subsidiaries to become financially independent;
so, parent companies finance operations.
b. Subsidiaries often obtain capital by issuing equity solely to the parent,
which benefits from an appreciating share price.
c. Parent companies lend money to subsidiaries during the start-up phase
and for new investments; subsidiaries with excess cash lend money to
parent or sister companies when they need capital.
2. Revenue from operations (See Figure 15.2)
a. Revenue is earned from the sale of goods and services; this source of
capital is the lifeblood of international companies and their subsidiaries.
b. For long-term success, a company must generate sufficient revenue to
sustain day-to-day operations; outside financing is required only to
expand operations or to survive lean periods.
c. A transfer price is the price charged for a good or service transferred
between a company and a subsidiary. Companies set subsidiaries’
transfer prices high or low according to their own goals (e.g., to minimize
taxes in a high taxation country).
D. Capital Structure
1. A company’s capital structure is the mix of equity, debt, and internally
generated funds that it uses to finance its activities.
2. Firms try to strike the right balance among financing methods in order to
minimize the cost of capital and risk.
3. Debt requires periodic interest payments to creditors such as banks and
bondholders. If the company defaults on interest payments, creditors can sue the
company or force it into bankruptcy; preferred stock equity holders can force
bankruptcy because of default.
4. Companies prefer not to carry so much debt in relation to equity that it increases
its risk of insolvency.
5. Debt appeals to companies because interest payments are deducted from taxable
earnings—lowering the taxes a firm must pay.
6. National restrictions can influence the choice of capital structure. Restrictions
include limits on international capital flows, the cost of local versus international
financing, access to international financial markets, and currency exchange
controls.
7. Choice of capital structure for subsidiaries is highly complex.
VI. A FINAL WORD
Whether an international company’s production activity involves manufacturing a product or
providing a service, it must acquire many resources before beginning operations. It needs to
resolve such issues as where it will get raw materials or components, how much production
capacity it needs, whether to construct or buy new facilities, the size of service centers, and
where it will get financing. The answers to these questions are complex and interrelated.
