INDEX
INTRODUCTION
I THE DELOCALISATION PROCESS AND EVOLUTION OF THE CHINESE
ECONOMY
I.1 Definitions
I.2 The Choice of a New Location
I.2.1 Delocalisation Drivers
I.3 How to Delocalise Successfully
I.4 Delocalisation Benefits
I.5 Delocalisation Risks
I.6 Delocalisation Consequences
I.6.1 Employment Effects of Outsourcing
I.7 The Context: A Brief History of the Chinese Economic Evolution II COSTS AND COST MANAGEMENT SYSTEMS' RELEVANCE IN THE
OUTSOURCING PROCESS II.1 Delocalisation Costs
II.1.1 Interaction Intensity & Interaction Distance
II.2 The Total Cost of Ownership
II.3 Role of Cost Management Systems
III MANAGEMENT CONTROL SYSTEM DESIGN WITHIN MULTINATIONAL
ENTERPRISES
III.1 Headquarters-Subsidiaries Relationships
III.2 Control Methods in Multinational Enterprises
III.3 Variables Influencing Management Control System and Cost Management System Design
III.3.1 Company Strategy
III.3.2 Evolution of Accounting Instruments
III.3.3 Product Life Cycle
III.3.4 Productive Process and Technologies
III.3.5 Organisational Structure and Size
III.3.6 Inter-Firm Relationships
III.3.7 National Culture
IV A CASE STUDY: EVIDENCE FROM A CHINESE JOINT VENTURE
IV.1 The Company
IV.2 The Interviews
IV.3 Considerations
CONCLUSIONS BIBLIOGRAPHY
INTRODUCTION
Despite the acknowledged relevance of Cost Management in literature, few researchers have analysed the consequences of the delocalisation process from a Cost Management perspective, yet the increasing number of offshoring contracts – as highlighted by several authors – is an interesting topic to focus on.
In the first chapter, I will analyse the delocalisation process from a general point of view, by taking into consideration the delocalisation motives, benefits, risks and consequences, the offshoring drivers and the key factors in choosing the most suitable location. Moreover, since the empirical evidence comes from a Chinese Joint Venture, I will provide a brief summary of the current economic situation in China.
In the second chapter, after a deep analysis of the delocalisation costs, I will analyse some recent TCO frameworks.
In the third chapter, I will focus on the MNEs context, by analysing the main characteristics of the headquarters-subsidiaries relationships, the control methods commonly used to manage subsidiaries and the variables influencing the Management Control System and Cost Management System design.
In the fourth chapter, I will describe The Company and analyse the interviews, to support or reject the Hypotheses made in the previous chapters. Finally, I will argue the reasons why the TCO frameworks introduced in the second chapter are probably not taken into consideration within this company.
I THE DELOCALISATION PROCESS AND
EVOLUTION OF THE CHINESE ECONOMY
I.1 Definitions
Offshoring has become a widespread practice in the industrialized world. The American Heritage Dictionary defines outsourcing as “The procuring of services or products … from an outside supplier or manufactures in order to cut costs.” Some people intend “outside” to mean outside the firm and others outside the country. Both are commonly used1.
Trade in goods and services is a two-way street. Most countries receive outsourcing from other countries as well as outsource to others, so the word “insourcing” has been used to intend the amount of outsourcing a country receives2.
Often people confuse the terms offshoring and outsourcing. Offshoring refers to the process of sourcing and coordinating tasks and business functions to other countries. Outsourcing, instead, denotes distribution of products or services by an external provider (i.e., one outside boundaries of the firm). Offshoring may include both in-house (captive or international insourcing) and outsourced activities. Outsourcing, in turn, may occur both domestically (onshore) and abroad (offshore)3.
Hijzen et al. (2011) have identified two main motives for establishing an affiliate abroad: the market-seeking (or “horizontal”) motive and the factor-seeking (or “vertical”) motive.
With horizontal FDI (Foreign Direct Investment) the firm replicate abroad the same activities as those performed domestically, in order to serve local or neighbouring markets while avoiding trade barriers and transportation costs. Companies decide to delocalise to affirm their position in Emerging Markets. They represent huge market opportunities: a missed exploitation could affect
1 Amiti and Wei, 2005. 2 Amiti and Wei, 2005. 3 Lewin et al., 2009.
competitiveness of companies. Since governments in most developing nations carry out attractive economic incentive programs for FDI, offshoring also allow local market access that would otherwise be cost prohibitive. For instance, the Chinese government impose a huge duty (as high as 200%) on imported cars that few people can afford. Produce in China lowers the price of the car at level that more and more Chinese people can afford4.
This type of investment doesn't change significantly the way the production process is organized in the parent firm.
Vertical FDI imply to transfer stages of production abroad: offshoring is intended as the practice of outsourcing operations overseas, usually by companies from industrialized countries to less-developed countries, with the intention of reducing the cost of doing business.
Chief among the specific reasons for locating operations outside a corporation’s home country are:
lower labour costs;
more lenient environmental regulations; less stringent labour regulations;
favourable tax conditions; proximity to raw materials.
Recently, interest has been directed to so-called complex FDI strategies, where foreign affiliates may be established because of a combination of horizontal and vertical motives, or where MNEs (Multi National Enterprises) may consist of several foreign affiliates, some of which horizontal and other vertical. As a result, we can take into consideration Nassimbeni's work (2006). The author groups the reason for sourcing abroad into three main categories:
gaining access to cheaper resources and the intensification of international competition;
establishing a presence in new markets; obtaining access to distinctive resources.
As shown above, is clear that companies start to produce abroad for different reasons. If they are interest to serve local and neighbouring markets, since the quality of life, the costs of resources used and the currency are different in the native market and in the new market, I state the first Hypothesis as follow:
H1. MNEs are used to sell the same products at different prices in different markets.
Offshoring's definition can be specialized according to the type of activities that are relocated abroad: material offshoring will define the relocation of production activities (e.g. assembly) and service offshoring the relocation of service activities (e.g. call centre operations, back office activities, …)5. Service outsourcing has been steadily increasing but is still at very low levels: material outsourcing is at much higher levels than service outsourcing.
Garner (2004) suggests that service activities are more likely to be offshored if they are:
LABOUR-INTENSIVE → labour represent a high fraction of total costs;
INFORMATION-BASED → the output of the activity can be delivered electronically across national borders;
CODIFICABLE → the activity can be reduced to a set of simple rules and routinised instructions;
HIGHLY TRANSPARENT → the information to be exchanged between the offshoring firm and the related party overseas is clear and easy to be measured and verified.
Activities can be outsourced from one firm to another domestic firm, to a “nearshore” firm (one that is located on the same continent or in an essentially similar cultural environment), or to a “farshore” firm (one that is located on a different continent or in a considerably different cultural environment)6. Activities might be nearshored of farshored taking into consideration the fit between firm demands and
5 Crinò, 2009. 6 Raiborn et al., 2009.
location characteristics.
Ternaux and Kolarova (2007) in their work explain the differences between externalisation strategies of firms outside their country of origin and internationalisation strategies of MNEs. Delocalisation is often a matter of separating manufacturing sites from places where goods are consumed. Delocalisation in a strict sense is transfer to a host country all or part of goods or service production, and cessating of their production by the parent enterprise. Recourse to an external supplier for an activity which was previously carried out within the company is also a case of externalisation. Some other forms of investment developed during these years are referred to as “New Forms of Investment” (NFI). These enable multinationals to control foreign companies without (or with very little) capital input7. NFI have the advantages of linking the multinational to the host country over a long period without shell out large amounts of capital, dissociating production know-how from financial expertise, and activating a leverage effect to the benefit of the multinationals. The host country has to provide most of the capital and sometimes assumes debts for this purpose. It is also worth citing different forms of alliance or cooperation between companies, such as “Strategic Business Units”, which are alliance between multinationals that privilege a global approach to products without taking account of geographical areas. Other companies establish a headquarters outside the country of origin, which serves all subsidiaries in a particular region. Many medium-sized companies have also acquired an international dimension and are practised in FDI. Small and Medium-Sized Enterprises (SMEs) with an international dimension have to teach the multinationals: small size is often associated with efficiency, and there's also scope for network operations by micro-enterprises (downsizing), which can improve their performance through cooperation. The choice of localisation more and more is an integral part of the strategies of companies, usually independently of their size: offshoring is motivated by a combination of environmental pressure, efficiency and
7 These are foreign subsidiary companies (branches) where the multinational has less than 50% of capital.
They may take the form of: licensing agreements, technical aid, franchising, production sharing agreements, industrial cooperation, management contracts or service and co-financing agreements.
competitive pressure8.
I.2 The Choice of a New Location
“Globalization has altered the competitive dynamics of nations, firms and industries”9. Indeed, it is becoming evident that the centre of gravity of production and exports is moving towards new high-performing players in low-cost economies. The migration of production worldwide has proceeded in waves since the 1950s10. Localisation decisions nowadays often go beyond national borders and they are not confined to industry11. For a company, choosing a new location is not simple. The decision to discharge some organizational activities to an outsider can only be made after careful cost-benefit analysis12. These are the most important things to take into consideration:
demand for different goods and services; different input markets;
different clients' needs.
The most important factors that influence localization choices are represented in the following figure13.
8 Tate et al., 2009. 9 Gereffi, 1999. 10 Lyberaki, 2011.
11 Ternaux and Kolarova, 2007. 12 Raiborn et al., 2009.
Location choice is strictly related to the drivers of offshoring (if a firm is motivated by cost, choosing a low-cost location is important)14. These drivers are explained in the following section.
I.2.1 Delocalisation Drivers
The reason most often given for outsourcing is cost savings. By delocalise non-core activities to an external partner, a company engaging in business process outsourcing (BPO) may increase profitability and create value, respectively, for the company's shareholders and customers15. Cost savings may be achieved because the outsourcing vendor operates in an offshore location that has a lower pay scale than a domestic firm.
Since projected cost savings is a viable reason to consider outsourcing, companies should also consider this for other two reasons16. First, outsourcing enables companies to leverage vendor competencies in highly specific areas. Offshoring may increase corporate flexibility, obtained by having access to the latest and most effective
14 Roza et al. 2011. 15 Raiborn et al., 2009. 16 Raiborn et al., 2009.
Factors that impact on Costs
Factors that impact on Service and Revenues Labor Cost Land Cost Energy Costs Logistic Costs Local Factors Labour Ability Land Adequacy Company Image Client Accessibility
technology, confirmed methodologies, and best practices. This situation can be achieved without the necessity for the company to build and maintain complex and expensive infrastructures. Thus, the firm can invest its funds in more profitable activities. Second, due to outsourcing, companies have the possibility to eliminate the distraction of managing peripheral functions and, thus, develop long-term core competencies. Companies can focus on improving critical measures related to time-to-market, quality, customer satisfaction, and responsiveness, once the firm is free to focus on essential strategic competencies17. This clearly explain that, when firms outsource parts and components from foreign suppliers, do not only want to save cost, but often also obtain access to new technologies or higher quality products, or to establish a foothold in new markets18.
Cost motives are often considered to be the most important offshoring's drivers. However, other motives, like acquiring human capital19 or firm growth20 are also mentioned in the literature.
In their paper, Roza et al. (2011) study three different groups of offshoring drivers.
In the first place, scholars apply Transaction Cost Economics (TCE) to explain cost drivers of offshoring21. In brief, it is worth to remember that transaction costs can be divided into ex-ante (before contracts are closed, i.e. the identification of suppliers) and ex-post (after contracts are closed, i.e. supplier monitoring) transaction costs22. Considering this, companies will outsource just activities for which the benefit obtained, considering the increase in income as well as the reduction of costs, is greater than the transaction costs incurred23.
Low labour costs alone are not enough in explaining the offshoring cost driver, due to the fact that offshoring increases transaction costs and this might (partly) offset
17 Raiborn et al., 2009. 18 Holweg et al., 2011. 19 Lewin and Peeters, 2006b. 20 Lewin and Peeters 2006a. 21 Farrell, 2005.
22 Williamson, 1979. 23 Bustinza et al., 2010.
savings24. Production decision are always based on more than labour costs. Pickles and Smith (2011) found that sourcing decision also depend on the level of service that producers are able to offer in combination with a short turn-around time from order to delivery. The level of “service” required can be measured in different ways, each impacting on the geographies of sourcing decisions and production networks:
time to market;
response time to changes; quality and handling reliability;
delivery logistics (trucks direct to stores versus ships to brokers for transhipment).
It is important to notice that transaction costs may increase by internationalisation processes due to uncertainty involved. Companies may be able to reduce the total costs of labour (production efficiency) and transaction below the level in the home country but there might be “invisible” costs like communication related costs25 or set-up costs26when offshoring services. On the other hand, it can happen that offshoring could decrease transaction costs. Available IT and communication systems have importantly decreased transaction costs27:digitalisation has decreased transaction costs dramatically and in this way unlocked gaining access to lower labour costs at offshore locations. Information and Communications Technology (ICT)28 modify spatial coordination rather than changing localisation schemes. ICT have two specific spatial effects. On the one hand, ICT do much to develop coordination capacities between existing locations. Thus, they reinforce geographical polarisation. On the other hand, ICT increase the degree of mobility by increasing efficiency of “nomad” workers, who connect with customers or partner at a distance. Their overall effect is, therefore, paradoxical: they favour delocalisation, but also present an alternative to delocalisation29.
24 Stratman, 2008.
25 Stringfellow et al., 2008. 26 Ellram et al., 2008. 27 Ellram et al., 2008.
28 Ternaux and Kolarova., 2007. 29 Brousseau and Rallet, 1999.
By the way, the potential for cost reduction alone is no longer enough to justify offshoring. Companies are shifting from cost-driven offshoring to a multidimensional value proposition for their offshore operations.
The Resource-Based View explains the second group of driver, named resource drivers. From this point of view, offshoring is caused by the availability of, for example, qualified employees or capabilities for business process redesign at offshore locations30: the Resource-Based View explain how organizations try to acquire a unique combination of strategic resources and gain sustainable competitive advantage31. The resources can be divided in physical resources, human resources and organizational resources32.
Resource drivers focus on knowledge-seeking and efficiency-seeking. A company needs to maintain and improve its competitive position and, to reach this goal, the firm might also search at different locations. Gaining access to personnel and technologies gives firms the opportunity to become more efficient.
The third category of offshoring drivers is represented by entrepreneurial drivers. Entrepreneurship is about “carrying out new combinations”33; it implies the capability to identify new opportunities and to develop the resource base needed to pursue the opportunities34. The relocation of business functions makes firms in the position to get closer to potential customers and other opportunities.
A brief summary of Roza et al. (2011) categorization can be illustrated in the following Table.
30 Lewin and Peeters, 2006b. 31 Tate et al., 2009.
32 Barney, 1991. 33 Shumpeter, 1934.
Table 1: Offshoring Drivers
Offshoring Drivers Theoretical
Perspective Effect Examples, Drivers ORN
35
Cost Drivers Transaction Cost
Economics Use low costs (summed production and transaction costs) at offshore locations to decrease
cost levels at domestic location
Labour cost Other cost savings
Resource Driver Resource -Based View
Use resources at offshore location to improve efficiency of current operations at domestic location
Gaining access to qualified personnel
Business process redesign Improved service levels Entrepreneurial
Driver Entrepreneurship Theory Use entrepreneurship to address new resource combinations to
realise new business opportunities
Part of a larger global strategy Increasing speed to market Differentiation strategy Access to new markets
Roza et al. (2011) investigate the differences in offshoring strategies of small, medium-sized and large firms. At the end of their work, they find that large firms use offshoring as cost and resource strategy, are relatively often farshoring and relocating competence exploiting functions36.
I.3 How
to Delocalise SuccessfullyMost production processes can be split up into several steps, some of which are possibly shifted abroad: the decision to offshore an individual production step depends not only on production and offshoring costs for that particular step, but also on the location of preceding and subsequent steps. Facing a trade-off between selecting the cheapest location for an individual step and sustaining additional transport costs, firms may tend to produce together several parts of the production chain in one country – even if this implies that some steps are not performed at the cheapest location. The existence of transport costs combined with the predetermined sequence of production steps is sufficient to group together production steps. A rather modest reduction of transport costs may substantially increase the volume of trade in intermediate inputs and the extent of vertical FDI. These are the reason why, despite large offshoring
35 Offshoring Research Network.
36 Offshoring activities might be divided into competence exploiting and competence creating activities.
Functions are divided between:
Finance/Accounting, HR, Marketing & Sales, IT, Call Center, Procurement, Logistic Services; Engineering, R&D, Product Design.
potential in terms of cost advantages for individual production steps, firms may choose to perform these steps in the native firm, since they are firmly close to adjacent steps. On the one hand, firms may be unwilling to offshore certain production steps, although, considered in isolation, these steps could be performed at lower cost abroad. On the other hand, minor changes in the cost of offshoring or technological innovations affecting the structure of the production process may result in the relocation of considerable parts of the production chain all at once37.
Offshoring decision are usually made on the bases of visible costs. From a pure cost perspective, it would seem to make sense to outsource as much as possible to offshore sites where labour is less expensive than in industrialized countries. However, it is important to look at other unexpected visible costs, such as labour turnover rate, transporting employees to work and the cost of updating infrastructure38.
When a company decide to delocalise, it has to take into consideration possible difficulties due to the distance and cultural differences. Handley and Benton (2013) review the literature about this topic and summarize the work of different authors. At the end, they found that the main things to take into consideration are:
GEOGRAPHIC DISTANCE refer to the physical proximity or spatial separation between the customer and the service provider.
GEOGRAPHIC SEPARATION contributes to the complexity of the outsourcing engagement in two ways. First, complexity has been associated with lower levels of team familiarity. To improve familiarity, firms have to provide opportunities for team members to interact and socialize. These efforts are more challenging and costly when the organizations are not proximal. Geographic separation also complicates the customer firm's ability to monitor the provider's behaviours and outcomes.
CULTURAL DISTANCE reflect potential challenges that arise due to differences in norms, values and institutions. These imply lower levels of
37 Harms et al., 2012. 38 Stringfellow et al., 2008.
familiarity and greater behavioural uncertainty. Difficulties are not related to physical separation, but rather the lack of a shared cultural context.
GEOGRAPHIC DISPERSION is about difficulties related to the relationship between the number of sites or locations and corresponding management difficulties. Work distributed among more locations globally contribute to grater information load, diversity and uncertainty: geographic dispersion is a salient contributor to the overall complexity of outsourcing.
Consequently, the criteria used by companies in their choice of localisation of productive activities are not all endogenous to the company, but also take into consideration the international economic space and territories where it seems favourable to locate all or a part of their productive activities, or where presence is important in order to capture market share39.
Successful analysis has to take into consideration all the opportunities and the risks that can follow the delocalisation process.
Table 2: Delocalisation Risks & Opportunities40
Opportunities Risks
Labour cost reduction Country risk related to political and social instability Availability of raw materials and energy at low prices Transfer of production know-how to local competitors Chance to remain in the market supporting increasing
price competition
Loss of reputation
Presence in growing markets Significant increase in logistic costs and in the lead-time
Tax and legal advantages Potential growth in labour costs in the coming years Potential partnership with competitors Limited ability of the board in small-size companies in
coordinating activities in different countries
More details about the previous figure are explained in the following sections.
I.4 Delocalisation Benefits
The search for distant suppliers and the delocalisation of production stages can allow input sourcing at more favourable cost conditions, but also access to market,
39 Ternaux and Kolarova, 2007. 40 Anzivino and Lazzaro, 2011.
especially emerging ones, and integration into global networks: outsourcing can help a company operate in an increasingly competitive global marketplace.
Almost all of the authors on this subject come to the conclusion that firms should focus on activities in which they possess a competitive advantage and externalise those in which competing companies have a specific competitive advantage41. Firms that have outsourced could and should become more efficient and expand production and employment in other line of work. If firms relocate their relatively inefficient parts of the production process to other countries, where they can produce more cheaply, they can expand their output in production stages for which they have comparative advantage. This productivity benefits can translate into lower prices generating further demand and hence create more jobs42. For instance, in 2003 Delta Airlines outsourced 1000 jobs to India, but the US$25 million in savings allowed the company to add 1200 positions in reservation and sales within the US.
Relocation of production may offer some opportunities in the direction upgrading within a global value chain. This involves new prospects and new bonds. Flexibility in sourcing decision and competition among subcontractors has the effect of limiting the capacity of subcontractors to raise production costs without significant loss of output. This is the result of the prevailing oligopolistic structures in advanced countries and of competitive conditions in developing country manufacturing. From the point of view of local producers, participating in a global value chain is an “effort-intensive” process involving opportunities but also risks and unanticipated traps43.
Schwörer (2012) describes different channel through which offshoring may affect productivity:
1. a static efficiency gain may arise when firms focus on their core competencies and offshore their less productive activities to foreign suppliers;
2. offshoring may come along with restructuring processes which reduce inefficiencies;
41 Venkatesan, 1992. 42 Amiti and Wei, 2005. 43 Lyberaki, 2011.
3. interact with foreign suppliers may generate benefits due to learning externalities;
4. offshoring may rise productivity if the imported input varieties are of higher quality or better match with the specific needs of the firms;
5. offshoring to low-wage countries lowers the marginal production costs and raises profits, which creates resources for additional R&D investments.
As competition intensifies, four possible types of response are open to firms, if they want to be competitive in the global marketplace44:
increasing internal operations' efficiency; create or improve inter-firm linkages;
introducing new products and/or improving old products;
changing the mix of activities within the firm and/or moving the focus of activities to other links in the chain.
From the point of view of the smaller and/or newer global player, the success seems to lie in their capacity to move from the mere assembly of imported inputs to a more integrated and higher value-added form knows as full package supply or Original Equipment Manufacturing (OEM) production45. This usually involves making the transition from a mere low-cost sub-contractor of a foreign company into developing multi layered global sourcing networks where low-wage assembly takes place elsewhere (i.e. where labour costs are lower). Such transition require for the firm that intend delocalise the ability to distinguish between value added and non-value added activities, in order to outsource just the second type of activities and allow the firm to focuses only on its core business.
In conclusion, outsourcing may help companies becoming more efficient, have access to new skills and resources, and focus on the core competences. This can happen only if the benefits are achieved and contribute to the company's goals, objectives, and competitive advantage46.
44 Lyberaki, 2011. 45 Lyberaki, 2011. 46 Raiborn et al., 2009.
I.5 Delocalisation Risks
Capasso et al. (2013) briefly talk about the differences between local outsourcing and long distance outsourcing. The first one is the mechanism by which specialization and flexible recombination of specialized functions are achieved. Its local character relates, first of all, to cost advantages. As the transaction cost approach suggests, outsourcing to local suppliers is more beneficial because firms can more rapidly monitor the quality of the input and services provided by subcontractors. Long distance outsourcing, on the other hand, can generate:
longer lead times; larger inventories;
communication and coordination problems;
difficulties in contractual specification and monitoring.
A Deloitte Consulting Report found that 62% of outsourcing firms indicated that they required more management resource than they initially estimated. Companies who outsource may be surprised by unexpected costs and complications. Local highways and transportation networks may be inadequate. Also electricity may not be as assuredly available as in the Western Countries47. Although this might be true, there are companies able to delocalise successfully. For this reason, I made an Hypothesis as follow:
H2. Those firms that delocalise successfully abroad, after some years, understand how
to lower unexpected costs, becoming more efficient.
Considering other situations that can compromise the companies cost savings after the delocalisation process, in literature it is possible also find that typical Indian operations48 in business processing often lose 15-20% of their work forces each year49. Based on this, I assume that:
H3. In order to lower Labour Turnover Rate and labour costs, MNEs over the time
47 Weidenbaum, 2005.
48 Examples may be: call centers and offices handling payroll, accounting, and human resource functions
(Weidenbaum, 2005).
tend to offer their employees more comfortable working conditions. Among the causes of the firms' disappointing performance50 are: insufficient understanding the complexity of the engagement;
poor communication and coordination between stakeholders (internal and external);
inadequate contractual provisions;
ill-defined and incomplete performance measurement system.
Aron et al. (2005) categorized the risks associated with outsourcing as following. They can take four different forms:
STRATEGIC RISKS, caused by activities or actions that vendors may take deliberately as part of a profit-maximizing strategy. This kind of risk results from opportunistic behaviour of one or both parties.
OPERATIONAL RISKS, caused by the breakdown in operations at the vendor location. They are a by-product of the complexity of operations, the geographic separation between client and vendor, the cultural gap between environments of them, or the limitations of the communication and transmission systems between the two.
INTRINSIC RISKS OF ATROPHY, that are an inevitable by-product of the process of outsourcing (i.e. the company loses the control of people or the new employees are not enough qualified).
INTRINSIC RISKS OF LOCATION, caused simply to move activities to remote locations (i.e. geopolitical risks, sovereign risk or exchange rate risk). All the risks above, in the short term or in the long term, can seriously affect the company’s business. In the next chapter, it will be possible to understand the importance of using the Cost Management System in order to focus on specific risks and make particular deductions to avoid dangerous effects of the delocalisation process. Probably, as shown above relatively to the risks and the bad performances the
companies have to face after the outsourcing process, management accounting currently remains far removed from its function as a developer of strategic decisions and as a support function for corporate planning and coordination processes51.
I.6 Delocalisation Consequences
An importan contribution about this subject is recently made by Schmeisser (2013), who review the offshoring literature and group together all the main articles about this topic. He categories the consequences of offshoring in Profit&Sales related and Resource&Capability related.
Are intended in the first group the impacts that the delocalisation practice has on the offshoring organisation's economic success. An important contribution is the one made by Coucke and Sleuwaegen (2008), who state that firms from developed countries, after the delocalisation process have better chances of success in situations of increased local competition and domestic market penetration by foreign MNE affiliates. A positive and significant relationship between outsourcing and firms' export sales of final goods is revealed, which is positively moderated by firm's export experience and is stronger in cases in which the firm imports intermediate goods from the respective export market52. This is supported by Di Gregorio et al. (2008), who find empirical evidence that offshore outsourcing of knowledge-intensive (administrative and technical) services by small- and medium-sized enterprises increases their sales at an international level.
A second group of studies focuses on the impact that offshoring has on the development of the offshoring organisation's resource and capability stocks. The main contribution about this position is the one made by Jensen (2012). The author focus on service companies and at the end of the work conclude that offshoring of advanced service influences firms' resource stocks through the external acquisition of resources and through the internal accumulation of resources. Nieto and Rodríguez (2011) findings are also interesting. The authors work achieve the conclusion that R&D
51 Brandau and Hoffjan, 2010. 52 Bertrand, 2011.
offshoring has a positive effect on innovation performance with greater effect on product than on process innovations.
Using ORN 2009 Survey Data, we can summarise the outsourcing outcomes by industries as follow53.
Table 3: Outsourcing Outcomes by Industry54
Outcome Overall Finance and Insurance
High Tech Manufacturing Retail and Consumer Goods
Software Retail and Consumer Goods Increased Productivity/Efficiency 63% 54% 64% 75% 63% 63% 20% Increase in Firm's Overall
Competitiveness
54% 52% 60% 75% 63% 68% 50%
Improved Organisational
Flexibility 49% 54% 45% 83% 57% 63% 60%
Better Focus on Core Competencies
48% 44% 36% 58% 86% 42% 40%
Improved Service Quality 47% 42% 44% 58% 43% 42% 40% Better Access to Qualified
Personnel
46% 53% 20% 25% 43% 42% 60%
Firm Growth 40% 33% 30% 42% 29% 68% 40%
Better Access to New Markets 20% 3% 10% 42% 29% 26% 20% Breakthrough Process
Improvements 20% 12% 10% 42% 43% 26% 20%
Major Product Innovations 17% 0% 0% 42% 29% 32% 20%
Analysing Table 3 data, we can see how it can be different the offshoring process' effect based on different kind of industries. A comparison of responses to the offshoring outcome question reveals that finance companies' offshoring outcomes lag behind the other five industries in some important areas. In particular, finance and insurance respondents do not find that their offshoring efforts let to “Major Products Innovations” (0 percent), “Better Access to New Markets” (3 percent), or “Breakthrough Process Improvements” (12 percent). 42 percent of respondents from manufacturing companies, on the contrary, say that their offshoring efforts have led to improvements in each of these same areas. However, only 25 percent of manufacturing
53 Lewin et al., 2009.
54 Source: Duke University / Archstone Consulting Offshoring Research Network 2005 U.S. Survey, Duke
University / Booz Allen Hamilton Offshoring Research Network 2006 Survey, Duke University / The Conference Board Offshoring Research Network 2007/2008 Survey, and Duke University / The Conference Board Offshoring Research Network 2009 Survey.
respondents find that offshoring has led to “Better Access to Qualified Personnel”, even though 61 percent of them say this is an important driver of offshoring55.
I.6.1 Employment Effects of Outsourcing
Since reduction of labour costs is one of the most important reason why manufacturing companies decide to delocalise, it is worth try to understand the consequences of the delocalisation process on employment.
The expansion of offshoring and foreign activities of firms concern the developed countries about the effects that these phenomena may produce on the domestic employees. Companies have been blamed for contributing to the labour market weakness by relocating jobs in foreign countries, but empirical evidence does not support this view: the effects of offshoring on total employment are in fact very small. More recently, service offshoring has been blamed for exposing white-collar workers with high skill levels to the risk of relocation. The few studies treating with this issue have, on the contrary, shown that service offshoring shifts the composition of white-collar employment in favour of these workers and against those with the lowest skill level56.
Crinò (2009) has deeply analysed this topic in his work. Above all, he pointed up that in Europe, due to lower wage flexibility, the fluctuation in relative skilled labour demand has caused less dramatic increases in wage inequality, accompanied by significant improvement in relative skilled employment and in unemployment for the unskilled. Moreover, material offshoring drives the developed countries towards a new labour market equilibrium, constituted by lower relative wages and unemployment for the unskilled; the consequence is a deterioration in the economic fortune of these workers relative to the skilled. There are two other channels through which material offshoring may affect national workers. First, material offshoring may make labour demand more elastic, by making more simple the possibility for firms to change domestic workers with less expensive foreign employees. Second, workers may be
55 Lewin et al. 2008. 56 Crinò, 2009.
exposed to unfavourable short-run employment dynamics, for instance by forcing them to move to low-wage industries and by raising the risk of job losses.
Egger and Egger (2001) find that there is a negative effect of international material outsourcing on the productivity of low-skilled workers in the short run, but a positive effect in the long term. If companies relocate the unskilled-intensive parts of the production process from skill abundant countries to unskilled-abundant countries, outsourcing will increase the relative demand for skilled labour in the skill-abundant country and also increase the skill premium.
Service offshoring, generally, has small negative effects on total employment, and tends to shift the composition of the workforce in favour of high-skilled white-collar employees. There two explanations about this57. First, although rapidly growing, service offshoring is still too limited to influence labour market significantly. Second, despite some jobs could be moved in other countries, service offshoring also contribute to create new jobs at home. This happens through at least three channels58:
Service offshoring imply a more efficient allocation of activities, whereby firms offshore non-core productive activities and focus on those they can carry out more efficiently. As a result, firm's productivity increase, average costs fall and firms become more competitive by reducing their average product prices; this, as a result, stimulates additional demand for the firms' products and raises domestic employment.
Service jobs created abroad stimulate increasing demand for goods and service produced at home; consequently, service offshoring creates new opportunities at home, and through this channel rises domestic employment.
Service offshoring makes financially reasonable projects that would otherwise be cost prohibitive for the domestic firm; starting the project creates domestic jobs that would be not exist.
Once an MNE has delocalised, it can easily shift employment from the parent to
57 Crinò, 2009. 58 Crinò, 2009.
the affiliate in response to a relative decline in foreign wages. It is not possible to predict exactly the behaviour of parent employment due to a change in affiliate wages. The effect results on the relationship between foreign and domestic labour in the MNE's technology: if the two types of labour are substitutes, a fall in foreign wages will motivate the MNE to increase foreign workers and to reduce domestic ones; if, on the contrary, they are complements, a fall in foreign wages will induce the MNE to raise both domestic and foreign employment59.
Considering Crinò's work (2009), main conclusions can be summarized as follows:
Material offshoring was an important determinant of rising wage inequality during the 1980s. It worked mainly by lowering relative labour demand for employees with the lowest skill levels. The effects of production transfer within MNEs have been limited, probably because only a fraction of offshoring takes place within the boundaries of these firms.
Material offshoring seems make labour demand more elastic and increase the risk of job losses. However, existing evidence is too limited to define the exact magnitude of these effects.
Service offshoring producers at most small negative effects on total employment. Instead, it changes the composition of the work force in favour of high-skilled white-collar employees.
MNEs tend to substitute domestic and foreign labour in response to changes in relative wages across countries.
These results suggest that the effects of offshoring and MNEs' activities are mostly concentrated on specific groups of workers, especially those with low skill levels.
I.7 The Context: A Brief History of the Chinese Economic Evolution
The socialist market economy of the People's Republic of China is the world's second largest economy by nominal GDP and by purchasing power parity after the
United States.
China, economically frail before 1978, has again become one of the world's major economic powers with the greatest potential: in the 22 years following reform and opening-up in 1979 in particular, China's economy developed at a remarkable rate (with growth rates averaging 10% over the past 30 years and a spectacular expansion of external trade of more than 15% a year), and that momentum was maintained into the early years of the 21st century.
After its accession to the World Trade Organization (WTO) in 2001, the People's Republic of China emerged as a prominent destination for production offshoring. China's abundance of low-skilled and low-cost labour underscores its comparative advantage in low-technology intensive products. In 2003, it was already the sixth largest economy (at market exchanges rates), the fourth-largest global trader and premier recipient of FDI globally60. In the following figure it is possible to observe the location choice factors for offshoring to China61.
60 Greenaway et al., 2008.
Although China is still a “global sweatshop” with a strong specialisation in the labour-intensive commodities produced for economically developed countries (by importing machinery, raw materials and exporting processed goods), there are signs of technological upgrading in number of selected sectors in China, noticeably electronics, computers and telecommunications equipment62.
62 Li et al., 2012. 9% 4% 24% 3% 5% 33% 4% 3% 15%
Distribution of Client Companies Offshoring to China by Industry
FSI
Healthcare and Pharma Manufacturing Professional Services Retailer and Consumer Goods Software and IT Services Telecommunications Transportation and Logistic Other
Low Cost of Labour Talent Pool Available High Level of Expertise Other Costs (Besides Labour) Matches Languages Requirements Location of Preferred Service Provider Co – locating with Existing Offshore Business Processes Facilities Quality of Infrastructure Political Stability in Host Country Co – locating with Existing Offshore Manufacturing Plants Supporting Existing Customer Locally Access/Increased Speed to Local Market Local Government Incentives High Regional Growth Potential Cultural and Linguistic Proximity Geographic Proximity Prior Local Contacts and Expertise Avoiding Problems of Offshoring “Hot Spots” (e.g. Wage)
0 10 20 30 40 50 60 70 80 90
The Chinese economic environment is recently changing: forecasts show a declining growth rate, more strict environmental policies being effectively enforced, wages rising quickly and raw materials becoming more expensive. At the same time, Chinese firms are becoming more innovative and thus becoming stronger competitors in the global market. The manner in which China is considered the World’s Factory, specifically in the historic era, is slowly disappearing: China's growing pool of high-skilled labour means it is climbing the production and export rate; many high-tech companies are now based in China and attract highly qualified labour; regions initially involved in labour-intensive assembly of electronic components, have gradually developed into suppliers of electronic parts and components63.
Since the initiation of economic reforms in 1990, Jiangsu has been a hot spot for economic development, and now has the highest GDP per capita of all Chinese provinces (in 2011, per capita GDP was 52,448 Yuan = US$ 7.945). On the other hand a wealth gap between the prosperous south and poorer north has led to unequal economic growth. Cities like Nanjing, Suzhou and Wuxi have GDP per capita around twice the provincial average, making South Jiangsu one of the most prosperous regions in China.
Although adversely affected by the global economic crisis that started in 2007, the Chinese economy has continued to grow rapidly, maintaining a strong trade performance. The rapidly expanding export sectors in the coastal areas nonetheless provide tens of millions of – mostly low-skilled – jobs and an important source of local government revenue. The Chinese government is well aware of the dangers of a low-value added export-oriented economy. China is therefore seeking to move up the value-added chain in part to maintain the long-term competitiveness of export sectors as comparative costs increase64.
63 Greenaway et al., 2008. 64 Li et al., 2012.
II COSTS AND COST MANAGEMENT SYSTEM'S
RELEVANCE IN THE OUTSOURCING PROCESS
II.1 Delocalisation Costs
In the first chapter, it was underlined that there are different delocalisation drivers. Since this paper focuses primary on the cost consequences after the delocalisation process, in this chapter the reader will find a literature review about the specific kind of costs to consider before starting the offshoring process and new information need that follow.
Holweg et al. (2011) propose to consider three basic types of cost in global sourcing: static, dynamic and hidden costs.
Static costs are the most evident factor: lower labour cost often make global sourcing appear as an attractive option, and considering continuously decreasing logistics costs, the cost of offshored products is often lower compared to domestic suppliers. Static costs include:
production cost per unit;
transportation cost and additional customer clearance;
insurance or handling charges that might be incurred on a regular basis.
Such a static assessment does not reflect the dynamic dimension of the sourcing decision: the assumption underlying an analysis that considers just static costs is that demand is stable and does not vary in the long-term.
In reality, a company have to take into consideration the dynamic nature of the phenomenon. Since customer demand fluctuates, additional pipeline and safety stock will be required to take into account this effect and ensure uninterrupted supply. Product variety amplifies the need for additional stocks and these stocks need to be cleared before new products can be introduced, unless firms are ready to deal with the resulting obsolescence. Additionally, stocks-outs and lost sales can cause other dynamic costs, due by long transportation lead-times and the cost for obsolete
materials ordered. The working capital increase, and become necessary for the firm to finance its incurring some additional costs.
Finally, other dynamic costs can arise when products are urgently required, are not shipped in time or their quality cannot be considered acceptable. In this case, high cost for expedited shipments (such as air-freight) may incur.
A further cost category can be described as hidden costs. These are costs that are not related to the actual supply chain operation, but impact on the business environment. There are different kind of situations that can cause emerging of hidden costs, like currency fluctuations, changing energy cost, and changes in the political climate or regulatory framework. Generally, these costs are difficult to predict, and will incur on an irregular basis, such as cost resulting from additional travelling expenses required to coordinate the relationship or even the provision of resident engineers to solve ongoing problems.
Stringfellow et al. (2008) consider invisible costs also as hidden communication-related costs associated with the use of foreign service providers. For them, invisible costs refers to the costs that are not always apparent to firms who make the decision offshore services to different locations. These costs may be categorised as:
invisible costs associated with reduced customer service quality;
invisible costs due to ineffectiveness (taking longer time and expending more effort to do the same amount of work correctly).
The central issue of Stringfellow et al. (2008) study is how to determine invisible costs. Even if the authors take into consideration service companies, their findings can be also useful in manufacturing companies.
Just as the word “invisible” implies, it is probable that the company may not be able to explicitly and accurately quantify them, but it is worth try to identify factors that influence those invisible costs.
The authors define that invisible costs are mainly generate from the characteristics of services. In the first place, compared to manufacturing where output is tangible, they remember that some services have high portion of intangible components, which are hard to articulate. It became very difficult to understand how to
offshore a service that has intangible parts and is hard to articulate. Second, an aspect discussed is the customer involvement in the service process. It is true that manufacturing does not need customer presence during production, but some services require customer involvement – from being physically present during the service process to actively involved in co-production of services. The implication is figure out how to facilitate this customer involvement in real time and across distance. Third, it is underlined that a very important issue in the service sector is service quality. Offshoring appears to carry with it the risk of alienating customers, and possibly even losing business permanently if the service experience is negative. Also in a manufacturing company, the loss of revenue from an alienated customer and the cost of attracting new customer are situations that can generate invisible cost. This is not often considered in the decision to offshore. To avoid invisible costs due to image damage and loss of consumers,
H4. MNEs try to act in order to increase products' quality and preserve the external
environment.
Holweg et al. (2008) take into account other possible emerging situations after the delocalisation process is done. There is a potential cost associated with losing Intellectual Property Rights (IPR) and providing technological support to suppliers in foreign markets. These suppliers may use this knowledge to supply ones competitors and/or compete with their past customers in local or international markets. A further important factor of hidden costs is the potential labour cost's increase. Labour costs are quickly rising in many developing countries, so buyers, in the negotiation process, may find that prices have risen, requiring them to switch suppliers, leading to additional transaction costs. Companies new to offshoring may not anticipate some hidden costs, including local recruitment, staff retention, and government and vendor relations. It is also recommended consider costs involved in the transfer of knowledge and know-how from the country of origin to that of the provider, as well as the subsequent costs related to data transfer, which can sometimes mean extra expenses, for example, to have an additional bandwidth or reinforce security measures65. Another
factor behind declining cost savings may be the types of functions initially outsourced. These initial implementations almost always exceed expectations for cost savings. Barney et al. (2009) refer to two surveys in the field of information systems that reported that 30 to 50% of the companies involved in offshore outsourcing had cancelled their contracts. Ebert (2007) claim that 20% of outsourcing contracts are cancelled in the first year. The main reasons for terminating outsourcing contracts are unmet expectations of cost savings and the necessity to protect intellectual property66.
In brief, we can summarise the most important cost categories to take into consideration in order to have a successful offshore process as follow.
Table 4: A framework for financial assessment of global sourcing67
Static Cost Dynamic Cost Hidden Cost
Purchase price ex-factory gate Increased pipeline and safety stock due, which is amplified by demand volatility and product variety
Labour cost inflaction due to rising standards of living and competition of labour market Transportation cost per unit, assuming
no expected delays or quality problems
Inventory obsolescence due to long logistic lead-times, e.g. in case of quality problems
Currency fluctuations, in particular for cases of artificially pegged currencies Customs and duty to clear a shipment
for export Cost of lost sales and stock-outs, asthe supply chain is unresponsive to shifts in demand
Rise in transportation cost, e.g. due to higher oil price and carbon offset costs
Insurance and transaction costs Expedited shipments, e.g. air-freight, to ensure uninterrupted supply
Overhead for managing the international supply base, including travel cost or cost for local personnel in the supplying markets
Cost of quality control and compliance with safety and environmental standards
The loss of intellectual property to contract manufacturers
Search costs and agency fees to identify and interact with local suppliers
The risk of political and economic instability or change Difficulties of articulation of the output, especially for service offshoring
Customer involvement (in real time and across distance) in the service process
The loss of revenue from an alienating customer and the cost of attracting new ones
II.1.1 Interaction Intensity & Interaction Distance
Stringfellow et al. (2008) coin the term interaction intensity and postulate that it influences the invisible costs of offshoring. Interaction intensity represent the degree to which customers interact with service providers and is largely determined by service content/offering and service processes. Service content is “what” service firms offer to customers.
Cultural and language barriers impact the quality of interaction, especially in the service offshoring context. Geographic distance also impact interaction, since time zone differences determine if service providers and customers are awake at the same
time. The authors coin also the term interaction distance to describe the combined effects of cultural, language and geographic distance between service providers and customers.
The authors define that, for realise an effective interaction, three conditions are needed:
the presence of a suitable communication channel; the existence of a common language;
the existence of a common system of interpretation.
Unfortunately, achieve an effective interaction in the offshoring context is difficult for different reasons: geographic differences compromise the availability of effective communication channels, language differences make uncertain the existence of a common language and cultural differences imply possible interpretation difficulties.
The authors characterise offshoring locations as low-, medium- or high interaction distance. For example, relative to Italy, Switzerland and Croatia would be classified as countries with low interaction distance, since in some areas of both countries people speak fluently Italian, both share a border with Italy and are historically connected with our country. On the other hand, Spain would fall in the medium interaction distance category. This is based on the fact that for Italian native speakers is quite simple comprehend Spanish and there are also certain commonalities between these cultural environments. Other European countries, such as Romania or Slovenia, might also be classified as being of medium interaction distance from Italy, because lots of people there speak Italian, but there are some relevant cultural differences. Countries such as China and Vietnam would be classified with the highest interaction distance from Italy, since they present formidable language and cultural barriers, in addition to being geographically remote.
Table 5: Offshore interaction intensity and viability of offshore locations68
Low interaction distance
offshore locations distance offshore locationsMedium interaction High interaction distanceoffshore locations Low interaction
intensity Cost savings too low Cost savings may be too low Excellent fit Medium interaction
intensity Cost savings may be toolow Excellent fit Invisible costs likely toohigh
High interaction
intensity Excellent fit Invisible costs likely too high Invisible cost too high
As shown in the previous Table, there are situations in which delocalise – especially in service context – does not seams to be the best choice. It is essential to determine if the activity to be outsourced requires very frequent communication between customer and provider. If this is the case, there should not be much distance between them, as this would make real-time communication difficult because of the different time zones69. The employees of some offshore service providers are forced outside the normal working hours in their home country, to be available to customers at convenient hours. Researches with shift workers have shown that working unusual shift is negatively associated with employees job satisfaction70 and it is possible to find in literature confirm that dissatisfied customer service representatives are associated with reduced levels of customer service71.
The authors state that when service offerings are well defined, the service process is standardised with simple judgements involved and process steps are sequential, offshoring this type of service is relatively easy. If properly trained, offshoring service employees can perform this type of tasks as effectively as domestic service employees while the amount of labour savings is considerable. If these are the circumstances, is also a good option offshore manufacturing activities. On the contrary, offshore some type of service is much more challenging. This happen when:
service offerings are complex and barely defined;
service process cannot be standardised or requires complex judgements;
68 Source: Stringfellow et al., 2008. 69 Gonzalez et al., 2006.
70 Zedeck et al., 1983.
process step are reciprocal;
service employees who interact with customers cannot rely on any scripts, but rather on expert knowledge;
excellent communication skills are a must to delivering this type of service product.
If this type of service has to be delocalised for cost reasons, nearshoring is deeply recommend. Only realities that are close to the customer geographically, linguistically and culturally can facilitate the offshoring process and increase the chances of success.
II.2 The Total Cost of Ownership
Despite the importance of cost in global sourcing, just few authors have proposed comprehensive cost-based decision frameworks for assessing global sourcing decision. Three of this frameworks will be reported in this paragraph. These studies consider the adoption of a Total Cost of Ownership (TCO) approach in different way. In the first one, are presented the steps to follow to implement the TCO adoption. In the second one, the authors presented a complete costs' list to take into account when a company decide to compare different alternatives. In the last one, a mathematical approach to the problem is discussed, in order to allow the company to effectively calculate the different costs of different possible choices.
The first study taken into account is the one presented by Wouters et al. (2005). This study looks the adoption of TCO as a cost accounting application that facilitates purchasing decision-makers to combine value and price in making sourcing decisions. TCO support a firm's relationship with suppliers to make decisions related to sourcing strategy. TCO analysis quantifies the acquiring costs involved, both transaction costs related to purchasing activities (for example, ordering freight, quality control, etc.) and the costs related to poor quality (for example, rejection, rework, and warranties)72.
The authors underline that understanding and trading-off the various costs
related to sourcing decisions is relevant, since the increased emphasis firms that operate in business markets are placing on value-based market offerings. Following this logic, TCO also facilitates companies in dealing with pressure in their customer markets and making the purchasing function more value oriented.
The model proposed includes eight constructs and the relationships among them that explain a successful adoption of TCO. This model is shown in the following figure73, which is considered in four parts.
First, the critical constructs for TCO adoption are success in using TCO initiatives for sourcing decisions and basing performance review and reward on TCO improvements.
The success of TCO initiatives in this study relates to the financial gains and concrete results derived from using TCO analyses for sourcing decisions.
TCO based performance review and reward means that improvements in the firm's TCO of acquired offerings are used as a significant component of performance review and reward.
The literature supports the relationship between the adoption of new cost accounting systems and the performance evaluation, because this provides to employees incentives to attend to and use the new information74. Because of the challenges of implementing TCO analyses, the authors expect that, if the organisation experiments more success with TCO initiatives, it is more inclined to use TCO for performance review. Moreover, TCO provides to senior management evidence and support to make corresponding changes in the performance review and reward system.
Considering the next step, information's adequacy of the TCO and experience with conducting value analysis are presented as the constructs to connect TCO adoption and management commitment.
Information's adequacy of TCO refers to the availability and reliability of TCO information to support sourcing decisions. The quality of TCO information would be an important factor: implementing TCO model requires data at the supplier-level to quantify all the costs involved in the sourcing process and to compare alternative offerings. These costs are caused by numerous purchasing-related activities, that are executed at different places, within the customer organisation and across the value chain with supplier. Since sourcing decisions may impact costs of the customer firm as well as supplier costs, TCO should involves supplier cooperation and information sharing.
Value analysis experience, labelled by the authors “TCO experience”, refers to the extent of experience that the customer firm has with quantifying the total cost of different alternatives. This is an important factor for the structural improvement of TCO information and for the success of TCO initiatives.
The third part is about management commitment. This consists on the top
management support for TCO activities and of commitment from functional managers for using TCO analyses for decision making.
Top management support in this study relates to the initiatives for developing and using TCO information receive from top management, instead functional area management commitment is about the support that functional departments' managers express for using TCO initiatives for sourcing decisions.
This study found that top management support and functional – non-accounting – commitment to improve cost information are important factors for the adoption of TCO. Top management plays a crucial role in supporting new cost accounting practices and will support the introduction and application of TCO tools for sourcing decisions when purchasing, considering customer market conditions, has become a strategic and truly cross-functional process.
Finally, competitive pressure in the outsourcer firm's own customer market and the strategic orientation of the purchasing function are presented by the authors as antecedent constructs for managerial commitment to TCO initiatives. They propose the existence of market-related factors, such as competitive pressure in customers markets and strategic purchasing orientation, that are relevant on TCO adoption.
The strategic purchasing orientation refers for the authors to the importance of purchasing for contributing to help in realise the company's strategy and the involvement of line-management and cross-functional processes in procurement.
In order to check if their study was confirmed through empirical evidence, the authors interviewed several managers, asking them about their firm's TCO experience. At the end of numerous phone calls, emails and roundtable discussions, the researchers found that there is a certain order of steps to take in implementation.
Top management support is required, but, first of all, the purchasing strategy must show a commitment to value-based purchasing. Purchasing orientation has to take a cross-functional approach and analyse total cost/value considerations gains top management support for TCO initiatives. Top management support should incite functional management to use TCO initiatives for sourcing decisions. From management commitment to TCO adoption is necessary first getting a value analysis
