Strategic Outsourcing for Sustainable Competitive Advantages: Case studies of Multi-National Corporations (MNCs) in China Mingu Kang Ph.D. Student ,School of Management, Zhejiang University, P.R. China [email protected] Xiaobo Wu Professor of Management, Vice Dean, School of Management, Director, National Institute for Innovation Management, Zhejiang University, P.R. China [email protected] Paul Hong Professor, Information Operations and Technology Management, College of Business Administration, University of Toledo, Toledo, OH, 43606, USA Abstract Increasingly, with rapid wealth growth of emerging global economies, the basis of competitive advantage is changing from internal capacities to network capabilities. What matters is not a company ownership of hard assets but rather its ability to fully utilize them to capture the worldwide business opportunities. In this highly competitive global environment, outsourcing is approached not as a functional value extension but strategic priority practice for achieving sustainable competitive advantage. This paper presents a research model that describes strategic outsourcing practices for sustainable competitive advantages in Chinese context. Case studies include global firms from Switzerland, Korea and USA that have been operating in China for more than seven years successfully. This paper discusses how each firm maintains clear and disciplined strategic focus in achieving desired business outcomes. Case studies of these firms in China may provide better understanding on how to implement successful outsourcing practices in the Chinese market. Key Words: Strategic Outsourcing; Emerging Global Economies; Sustainable Competitive Advantages; Case Studies of MNCs in China 1. Introduction With rapid growth of economics over the past two decades, China has significant size of middle and upper class of consumers affording huge domestic market. Besides, China also offers cost-effective manufacturing opportunities and innovative outsourcing capabilities for multi-national corporations (MNCs) through its vast network of socio-technological resources. Figure 1 and Figure 2 show the rapid growth of GDP and FDI. The average annual GDP growth rate of China for the past seven years is 9.9%. Chinese share of global GDP was only 6% of in 1990, but with rapid economic growth, its share of global GDP has grown 15% of in 2006. GDP(RMB, billion) Gr owth Rate 30,000 12% FDI(USD, billion) Gr owth Rate 80 16% 25,000 10% 70 14% 60 12% 20,000 8% 10% 50 8% 15,000 6% 40 6% 30 10,000 4% 4% 20 2% 5,000 2% 10 0% 0 -2% 0 0% 2001 2002 2003 2004 2005 2006 2007 2001 2002 2003 2004 2005 2006 2007 Figure 2: FDI Growth of China(2001-2007) Figure 1: GDP Growth of China(2001-2007) Source: National Bureau of Statistics of China 1 With continuous expansion of privately-held firms and massive inflows of foreign direct investment, China have sustained such high rate of economic growth. Such rapid economic growth in China enabled an impressive expansion of middle class which in turn contributes to the social stability and the formation of huge consumer market (Zhang Jing, 2007). According to Chinese Brand Strategy Association, the potential size of affluent consumers that purchase high brand products is 160 millions that is about 13% of the total population. This suggests that China has the third largest consumer market in the world which is next to Japan and USA. Ernst & Young Survey Report predicts that by 2010, brand-conscious consumers will increase up to 250 millions and by 2015, China is expected to have the second largest consumer market in the world. While the growing consumer market in China gives multi-national corporations expanding business opportunities, other environmental factors also make Chinese market challenging and risky as well. Recently, RMB(Chinese currency) value is rising. Changes in labor laws and tax regulations affect firm’s profit level. Rapidly evolving competitive landscape in China requires new capabilities for global companies in China. And MNCs in China are facing intense competition with other lots of global companies and Chinese local innovative companies(Wu, Xu et al. 2004; Wu, Ma et al. 2006). So, simply low cost based manufacturing or outsourcing arrangements are not adequate in ensuring sustainable competitive advantages. Considering these opportunities and risks, the purpose of this paper is to provide an useful framework for analyzing the outsourcing practices for sustainable competitive advantages in Chinese context. Three case details provide implications on the role of strategic outsourcing to sustainable comparative advantages in Chinese market. 2. Research Background Outsourcing Benefits and Risks Increasingly, with rapid wealth growth of emerging global economies, the basis of competitive advantage is changing from internal capacities to network capabilities (Zander 1999; Mudambi 2002; McEvily and Marcus 2005). In this highly competitive global environment, outsourcing is more than a tool for functional value extension but strategic priority practice. Outsourcing may reduce operation costs and free up asset(Harland, Knight et al. 2005). In the early 1980s, companies started outsourcing non-core activities to suppliers for the purpose of securing specialized expertise and lower costs. Firms have moved their internal manufacturing and operations to lower cost countries to seek competitive advantage. Reasons for such outsourcing practices include low cost strategy, proximity to foreign markets and easy access to innovative capabilities. In recent years, outsourcing is associated with attaining firm’s competitive advantages. Through outsourcing, firms can access to external technologies and increase operational flexibility and concentrate more on core business activities and innovative new projects. Outsourcing benefits include lower cost, more investment on core competencies, flexibility, reduction assets and complementary capabilities. While outsourcing is associated with various benefits, it can also be a serious risky factor (Bahli and Rivard 2003). Examples of outsourcing risks are interface within activities, loss of competitive base, opportunistic behavior, rising transaction and coordination costs, limited learning and innovation and higher procurement costs in relation to the fluctuating currency exchange rates (Kotabe, Mol et al. 2008). According to the latest Bain Survey, 77% of their research sample companies have outsourcing policy and yet more half of the companies do not achieve the expected benefits 2 from outsourcing. If firms only focus on achieving short-term benefits of outsourcing without considering these risk factors, they may fail to access original goals of outsourcing. Firms need to carefully consider balancing the benefits and risks to maximize the outsourcing effects on their long-term competitive advantages(Rothaermel, Hitt et al. 2006). In this sense, firm’s approach to outsourcing is becoming increasingly strategic (Gottfredson, Puryear et al. 2005; Hoecht and Trott 2006). Strategic Outsourcing For the meaningful analysis of outsourcing various theoretical insights are helpful. Transaction Cost Theory (TCT) originates from economic perspective and Resource Based View (RBV) is heavily applied in strategic management. Loh(Loh 1994) investigates the consideration of various cost factors (e.g., bargaining, influence, administrative and management, agency and decision-making costs) that are critical for an outsourcing decision. Transaction costs are often disregarded because of the difficulty in quantifying the costs. Firms need to consider both the production and transaction costs in relation to outsourcing(Lacity, Willcocks et al. 1995). Other unexpected hidden costs are related to activities such as contractual amendment, unexpected transition and management, lock-in and disputes and litigations (Bahli and Rivard 2003). In addition to the production costs, firms pay close attention to the potential increase in all other transaction-related costs(Qu and Brocklehurst 2003). Resource-Based View argues that a firm has the ability to achieve and sustain competitive advantage if it possess resources that are valuable, rare, imperfectly imitable and non- substitutable(Barney 1991). Not all resources are strategically relevant within an organization. The goal of an organization is to ensure it has access to and control of valuable resources by developing and securing all the relevant resources either internally or externally(Das and Teng 2000). If a firm possesses critical resources that have strategic value, it is better to retain the activity in-house. On the contrary, if the strategic value of target activities is low and no internal resources are available to perform such activities, it is beneficial for the company to outsource them(Roy and Aubert 2001). For the sustainable competitive advantages firms are forced to rely on a multitude of outside suppliers for parts, software, knowhow and sales and in doing so gain access to valuable resources and external capabilities(Langlois 1990). In view of the above mentioned relevant theories, we have adapted Kraljic’s purchasing portfolio for our analysis of outsourcing strategy(Kraljic 1983). In 1983, Kraljic introduced portfolio approach for the use in purchasing and supply management. Karjic’s model classifies all the purchased materials in terms of profit impacts and supply risks. By assessing the company’s situation in terms of these two variables, purchasing executives may determine the overall strategic