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Published: August 25, 2004

 
 

When Offshoring Isn’t a Sure Thing

Gung ho for going global? Make sure to look beyond labor costs.

Illustration by Lars Leetaru
Outsourcing as a response to cross-border competition is hardly new. The shifting of jobs among companies, industries, or countries (what today is called offshoring) dates back to the advent of trading (and warring) among the ancient Greeks, Persians, Egyptians, and Phoenicians.

But the current political debate over outsourcing and its international counterpart, offshoring, represents only one dimension of global competition’s complex risks and rewards. Creating the optimal operational “footprint” is far more complicated than chasing low wage rates. If it were that simple, how would we explain the decades-long stream of direct foreign investment in U.S.-based production facilities by Japanese automakers? And why did the Haier Group Company, the budding Chinese multinational appliance manufacturer, decide recently to build a refrigerator plant in South Carolina?

At a minimum, global companies must explore the interplay among three factors when contemplating offshoring parts of their operations to other countries: transportation costs, labor intensity versus capital intensity, and market responsiveness.

To appreciate how these factors influence global operational strategy, consider three separate announcements from the global chip manufacturer Intel in April 2004: a $2 billion upgrade of an established chip facility in Chandler, Ariz.; a plan to add 1,000 new employees to its existing roster of 1,500 at its development center in Bangalore, India; and a $375 million investment to build a chip plant in Chengdu, China.

The reinvestment in Intel’s Arizona-based “Fab 12” factory (which was originally built in 1996 at a cost of $1.2 billion) aims to convert the semiconductor fabrication facility’s production from 200-millimeter wafer technology to state-of-the-art 300-millimeter wafers. The change was inspired almost entirely by the expertise of the plant’s work force, which has doubled in size to 4,000 employees since it opened eight years ago.

“This conversion will not only enable us to improve our capital efficiency by giving us more than twice the capacity at significantly lower costs, but it will enable us to utilize our experienced and talented work force in Arizona,” Intel said in a statement. In this decision, as in others, high U.S. labor rates were less of a concern to management than the capital costs of wafer fabrication. Indeed, Intel’s other 300-millimeter wafer “fabs” are similarly located in areas not known for low wages: Hillsboro, Ore.; Rio Rancho, N.M.; and Leixlip, Ireland.

Intel’s Bangalore expansion, by contrast, was most certainly motivated mainly by attractive wage rates and the limited capital investment required. Since digital software products can be quickly and cheaply transported by telephone lines, Intel was able to tap into highly educated but lower-paid Indian software engineers, thereby lowering its software development costs, enhancing its global competitiveness, and strengthening its local presence in India’s fast-growing market.

Even though there are significant wage advantages to employing Chinese labor, the Chengdu investment was largely an effort to expand Intel’s market presence in China. The sealing and testing activities of the Chengdu plant, which will employ about 675 people, place it near the customer end of Intel’s supply chain. That will allow the company to respond efficiently to the increasing market demand in China and the rest of Asia.

As Intel’s announcements in April underscore, a multinational company’s reach and range of business activities require it to address diverse strategic choices. And each investment made by a globally savvy firm requires a different response to the trade-offs among transportation, capital, labor, and market responsiveness (the lead time necessary to meet customer demands).

A look at how different companies in the consumer electronics value chain make offshoring decisions will help illuminate these trade-offs.

Transportation Cost
Think about the balance between transportation costs and low wage rates. Companies that naively source in less developed countries just to take advantage of lower wage rates routinely fail to account for transportation costs. To their chagrin, they discover that the price of road, rail, sea, and air transportation frequently offsets the savings from producing in developing countries.

 
 
 
 
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