Globalization and new strategies for growth

One size does not fit all markets

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Increasing complexity of international supply chains

Over the next three years, what increase do you expect to see to the following aspects of your company's operations?

Increasing complexity of international supply chains

Source: Globalization Index 2011

Note:Total base = 551 (companies with an international supply chain); scores shown = percentage of respondents

As companies take a global approach, they inevitably extend their value chain that comprises a multitude of internal and external stakeholders.

Two-thirds of our respondents say that they will increase their number of external partners over the next three years and over half say that their supply chain will become more complex.  

Increasing complexity of
international supply chains

Some companies have sought to address this by restructuring their business to achieve economies of scale and reduce duplication of effort at the local market level. They must balance the desire for standardization and the need to remain relevant to end-customers.

"Companies in effect need to look at every function in the business and assess the advantages and disadvantages of carrying it out locally or globally," says Kees van der Graaf, Executive-in-Residence at IMD, the business school. "A company's ability to make these decisions correctly will ultimately determine its success in global markets."

Some companies are reengineering their entire operating model around these decisions. General Motors, for example, intends to build 90% of its cars centrally around a core global architecture and then ship these to local plants where they can be adapted to local needs and tastes.

Their architecture must be flexible enough to deal equally with poor roads in India and smooth highways in the United States.

Companies must be flexible enough to capture new opportunities and respond quickly in the face of unexpected risks.

Companies must be aware that concentrating their supply chains exposes them to high levels of risk. Among our respondents, almost half expect that their supply chain will become more exposed to potential disruption over the next three years. Recent disasters, such as the explosion at the Fukushima nuclear plant in Japan, have emphasized the fragility of corporate supply chains.

Greater operational complexity implies greater cost for the business. In the past, many companies set up operations in rapid-growth markets as a way of reducing cost but rising labor costs are eroding these benefits.

Frank Braeken, Executive Vice President for the Africa region at Unilever highlights how costs can be much greater in Africa than in developed markets.

"This may come as a surprise to many, but everything is more costly, and increasingly so," he says. "A high level of inefficiency in many African markets, long delays at borders and a regulatory environment that is excessively complex forces us to keep higher than otherwise necessary working capital, which means that consumers pay too much for their products."

A combination of high operating costs and increased complexity is forcing companies to rethink their approach to operations.

Our recent report, Driving improved supply chain results: adapting to a changing global marketplace, explores the issues facing companies as they restructure their supply chains. Companies must be flexible enough to capture new opportunities and respond quickly in the face of unexpected risks.

Response: adapt your approach to new operational complexities

1. Integrate networks according to logically grouped markets.

A growing number of companies have developed hubs that can provide shared resources for in-country operations. This hub can provide that functions like procurement and finance close enough to customers to understand their specific needs.

"The big benefit of regionalization has been increased levels of competition and lower logistics costs through scaling up of manufacturing and logistics," says Braeken. "This feeds through into huge benefits for consumers in terms of lower prices."

Companies can design groups of adjoining markets to follow patterns of trade. Despite deepening levels of globalization, this still occurs largely within geographic regions.

"Many companies rightly conclude that they do not expect global free trade any time soon, but they do think that regional trade agreements will hold up," says Ghemawat. "They can therefore tailor their footprint to the reality of regionalization and still achieve some degree of economies of scale."

2. Rethink approaches to outsourcing.

A changing world requires companies to be adaptable and able to respond quickly to new opportunities and risks. Companies can increase their adaptability by shifting to a variable cost structure.

"In a volatile world, you need to be able to re-allocate resources quickly and if those resources are fixed and tough to move, then companies are going to find themselves in trouble," says Tyagarajan. "The more variable and flexible you can make your resources, the better."

Outsourcing can increase organizational flexibility and help companies deal with a high degree of complexity. The Indian telecom firm Bharti Airtel, for example, has outsourced everything apart from sales, marketing and finance.

This helped to reduce costs for customers in a price-sensitive market and gave the company the flexibility to expand into new markets such as Africa. "Companies like Bharti Airtel may be pioneering an approach where you have a simplified business model from the outset," says Radjou.

An increased reliance on outsourcing does not equate with an abdication of responsibility. Although it does raise questions over how companies select partners, particularly in distant markets where it may be more difficult to obtain reliable information about them.

"Even if you outsource your manufacturing, you are still seen as responsible for how that supplier treats its employees or maintains a level of environmental and social responsibility," says Khurana. "It's these informal rules that are increasingly affecting the legitimacy of organizational leadership and its license to operate."

3. Investigate the benefits of near-sourcing.

The financial crisis has re-awakened the debate about the role of business in society. Pure shareholder value creation is falling out of favor. In its place is a recognition that companies need to take into account the needs of a broader range of stakeholders.

Nowhere is this more apparent than in rapid-growth markets. With stakeholders including government, local communities and partners, the line can blur between the state and business. Governments can play a significant role in setting industrial policy and prioritizing investment.

Companies that enter rapid-growth markets often need to build infrastructure around them, which means that they are deeply involved in the development of the country itself, not just their own investment.

"You have to get involved in building up the institutions that will allow your company to operate," says Rakesh Khurana, Marvin Bower Professor of Leadership Development at the Harvard Business School.

"A lot of the institutional gaps exist precisely where the biggest growth opportunities lie, so companies need to think holistically about how they enter these markets and work with external stakeholders. They need to have a higher purpose that goes beyond pure economic logic and they need to think institutionally."

In the past few decades, companies have moved non-core functions, such as manufacturing offshore to low-cost destinations such as China. However, while the logic of these decisions still holds, a growing number of companies are questioning whether this long-distance relationship will be appropriate in the longer term.

More businesses are bringing their operations back to the local market, even if that is a high-cost country like the US.

There are numerous reasons for this growing trend:

  • Labor costs in China rise on average by 20% a year and high unemployment in countries like the US are narrowing the wage differential between the two markets
  • Volatile oil prices and currency fluctuations are increasing the cost of production and making it difficult to plan with certainty
  • Concern about the fragility of supply chains, which could be disrupted by anything from natural disasters to protectionist measures

"As long as oil prices stay high and as labor costs in Asia continue to rise, it increasingly makes sense for companies to bring their manufacturing back to North America," says Anne-Marie Slaughter, Bert G. Kerstetter '66 University Professor of Politics and International Affairs at Princeton University.

"Having a land-based, rather than an ocean-based, supply chain is starting to make a difference."