global outsourcing and the risks involved

7/27/2019 global outsourcing and the risks involved

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SUPPLY CHAIN MANAGEMENT GLOBAL OUTSOURCING AND THE RISKS ATTACHED TO IT

BBA-7

DEPARTMENT OF MANAGEMENT SCIENCES



GLOBAL SUPPLY CHAIN

Global supply chain has been defined as:

“ A production process that is distributed over many countries , with production in one country

providing inputs to production in another, which in turn provides inputs to a third, and so on.”

“ A global supply chain refers to the network created among different worldwide companies

producing, handling, and distributing specific goods and/or products.”

With increased globalization and offshore sourcing, global supply chain management is

becoming an important issue for many businesses. Like traditional, supply chain management,

global supply chain management also faces a number of risks that pose serious threats to its

performance. The big difference between the risks of the two is that global supply chain

management involves a company's worldwide interests and suppliers rather than simply a local

or national orientation.

GLOBAL SUPPLY CHAIN RISKS

The three main risks associated with global supply chain are:

DEMAND RISK

PRICE RISK

EXCHANGE RATE RISK

DEMAND RISK

“ Demand risk is defined as the risk for a company that demand for a product will either exceed

their expectations and ability to meet the demand OR fall short of their expectations or leave

them with product they cannot sell .”

Demand risk is classified as external global supply chain risk caused by unpredictable or

misunderstood customer or end-customer demand. Demand risk mainly arises due to:

Increase in the prices of product or service as a result of increase in the prices of raw

materials or other costs associated with the supply chain. Customers may shift to

available competitors in the market offering slightly low rates thus reducing the

demand of product/service.

The income level of the targeted market may have shifted, thus changing their priorities

and needs and thereby affecting their buying pattern.



The general trends in customer’s taste may also disturb the forecasted demand of

supply chain.

New competitors arriving in the market and introduction of substitute product/service

can also lead global supply chain to face demand risk.

The inaccuracy on part of supply chain in determining the appropriate quantity of

goods and services to be produced may cause a shortfall or excess of inventory hence

increasing the global supply chain cost.

EXAMPLE

To satisfy certain country-specific requirements such as power supply and language driver,

Hewlett-Packard (HP) has to develop multiple versions for each model of their DeskJet printers.

Each version serves a particular geographical region (Asia-Pacific, Europe, or Americas). Due to

uncertain demand in each region, HP faced the problem of overstocking certain printers in one

region and under-stocking certain printers in other regions.

PRICE RISK

“ The risk arising due to uncertainty in the total global supply chain cost, which may be

contributed by one or more of the components of supply chain or due to earnings volatility,

unexpected financial performance, pricing changes, and bad management.”

Costs are incurred from the start of planning for each global supply chain throughout itsexecution and, therefore, are incurred along the entire end-to-end chain, from the supplier’s

supplier to the customer’s customer. A trade-off between global supply chain benefits and its

price is to be determined so as to estimate the total cost of global supply chain. Although

offshoring and other means of expanding global chain among different countries can reduce

costs associated with labour, raw materials, IT proficiencies, technology and other similar costs

but it also increases communication cost, transportation cost, capacity cost, facility cost,

information cost, delays in receiving cashflows, operating cost, legalities cost and other hidden

cost which are often overlooked by the company that opts for global supply chain. These small

yet necessary costs keep piling up thus taking the total cost to a higher level and exposing the

supply chain to price risk as they have been neglected in the past or due to otherenvironmental factors. Consequently, the total global supply chain cost exceeds the estimated

cost and company faces problems in managing the cost.

The most important factor that gives air to this risk is the rise in fuel prices. It is the backbone of

price risk as it affects all the components of global supply chain starting from rise in the prices

of raw materials to transportation cost. And transportation cost is associated with each level of

global supply chain. The cost of global supply chain then demands an increase in the price of



commodity that the company deals in thus forcing the cost on customer. Customers especially

those who are price sensitive look for substitute or competitor’s product and this causes a

decrease in sales volume.

EXHANGE RATE RISK

“ A form of risk that arises from the change in price of one currency against another. The risk

that an investor will have to close out a long or short position in a foreign currency at a loss due

to an adverse movement in exchange rates.”

Global supply chain of manufacturing companies aims at outsourcing labor to lower-wage

countries generally reducing production costs it has been growing rapidly in the past decade. Or

a manufacturing or merchandising company may outsource or establish their own supply chain

component to some other country to reduce cost or to expand their target market. Although it

can significant cost reduction opportunities it also exposes supply chain firms to various risks

including: foreign exchange risk, production disruption risk, quality risk, supplier default risk,

etc. Among these risks, foreign exchange risk is consistently considered to be on the list of top

concerns of global supply chain executives.

In today’s volatile market, the exchange rate of different currencies constantly fluctuate due to

the overall economic setback. This poses serious challenges to global supply chain as it spreads

across different countries and thus exchange rate fluctuations has a strong impact on their

cashflows.

EXAMPLE

In recent years, China has become BMW’s fastest-growing market, accounting for 14 per cent

of BMW’s global sales volume in 2011. India, Russia and Eastern Europe have also become key

markets.

Despite rising sales revenues, BMW was conscious that its profits were often severely eroded

by changes in exchange rates. The company’s own calculations in its annual reports suggest

that the negative effect of exchange rates totaled €2.4bn between 2005 and 2009. BMW did

not want to pass on its exchange rate costs to consumers through price increases. Its rival

Porsche had done this at the end of the 1980s in the US and sales had plunged.

BMW took a two-pronged approach to managing its foreign exchange exposure. One strategy

was to use a “natural hedge” – meaning it would develop ways to spend money in the same

currency as where sales were taking place, meaning revenues would also be in the local

currency.



However, not all exposure could be offset in this way, so BMW decided it would also use formal

financial hedges. To achieve this, BMW set up regional treasury centers in the US, the UK and

Singapore.

EFFECT OF THESE RISKS ON SUPPLY GLOBAL CHAIN

All the three risks discussed above mainly increase supply cost, decrease supply capability,

create discrepancy between forecast and actual demand, etc. Secondly, when all the factors

including transportation cost, handling, inventory, lost sales and market blocking are factored

in, the total cost may not be as attractive as the headline advantage for opting global supply

chain. As global supply chain involves extended and complex supply chain network, it cannot be

responsive to demand as local supply chain thereby leading to opportunity cost to be afforded

by the company due to loss of sales.

Demand Forecasts are typically a key input to global supply chain operations processes. Unless

the total time it takes to source, make and deliver product is less than the time customer is

willing to wait for delivery, an accurate forecast is needed. Demand risk results in insufficient

production levels, resulting in a shortage. While this may seem less damaging than an inventory

surplus, it still represents a lost opportunity for the global supply chain. When demand risk

frequency increases global supply chain fails to enjoy more efficient production, improve asset

utilization, and reduce or eliminate disruptions.

Global supply chain operating costs are under pressure today from rising freight prices, more

global customers, technology upgrades, rising labor rates, expanding healthcare costs, newregulatory demands and rising commodity prices. Rising fuel prices have affected most supply

chains through fuel surcharges or increased component and operating costs. Ultimately total

global supply chain cost increases. Exchange rate risk negatively effects the revenue of the

global supply chain.

RISK MITIGATION STRATEGIES

In order to reduce the impact of risks on global supply chain, one of the following or a mixture

of these strategies can be adopted.

FLEXIBLE SUPPLY STRATEGY

Global supply chain can make use of multiple suppliers to reduce cost risks. Specifically, when

firms have the flexibility to order from the supplier with the lowest cost. The firm has more

supply flexibility as the number of suppliers increases

HP faced demand risk in their global supply chain as they were not allowed to change their

order quantity once submitted Canon for the raw material of HP laser printer. To reduce the



demand risk arising due to inflexibility on part of ordering, Canon agreed to allow HP to adjust

their order quantity upward or downward by no more than a few percent. In this case, the

upward/downward adjustment limits capture the flexibility level of this supply contract.

MULTIPLE SUPPLIERS OR DITRIBUTORS

Having multiple sources of supply for a raw material reduces the impact of one source failing to

deliver materials. Specifically when demand rate risk is involved, firms can protect their global

supply chains by associating with more than one supplier.

FLEXIBLE CAPACITY

A global supply chain that has flexible capacity can reduce price, demand and exchange rate risk

as multiple products are now being stored at the same place which makes coordination and

communication much easier. Price reduces as one capacity provides room for many products

thereby reducing the price associated with each product’s capacity. The nature of installed

capacity and its ability to respond to demand and price risk can be improved by using flexible

manufacturing strategies include short yet fixed cycling horizons.

INVENTORY TIME CYCLES

The positioning of inventory in the global supply chain to buffer against demand risk, price and

exchange rate risk is very critical. With extended lead times associated with long distance

supply chain, more inventory piles up in the chain. Therefore TQM and JIT concepts can play an

important role in preventing such risks.

GENERIC MATERIAL INVENTORY

Using this strategy, firms intend to add only those products or unfinished items that can be

converted to a number of products or disposed at a fair price thereby provide shielding effect

against price, demand and exchange rate risks.

POSTPONEMENT

Global supply chain should be so designed that the major assembling or manufacturing plant is

established in one of the main hubs of target markets. This helps better forecast the demand

and also saves the firm from adverse affects of exchange rate risk.

global outsourcing and the risks involved

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