Integral Logistics Management — Operations Management and Supply Chain Management Within and Across Companies

2.1.2 Assessing the risk of rising transaction costs from the outset, particularly with suppliers in low-wage countries

Intended Learning Outcomes: Present an overview of backsourcing, supplier development, and joint venture. Explain an example of the possible evolution of power over time with suppliers in low-wage countries.

The make-or-buy decision is rightly of strategic importance for any company that develops and manufactures products or services. If outsourcing proves unsuccessful, then either a new supplier must be determined or the generally costly decision to backsource must be made.

Backsourcing refers, according to [ASCM22], to processes that were previously handled externally but have now been reassigned internally.

Backsourcing may prove difficult or perhaps not even feasible after some time of out­sourcing. Typically, processes that were considered "non-strategic", e.g. processes that did not require core competencies, are subject to outsourcing. The appropriate skilled people and machines have left the company and cannot be re-sourced in a reasonable time.

Renewed outsourcing, on the other hand, leads to renewed search, initiation and agreement costs. If one had planned from the beginning to amortize these costs over a shorter period of time, then one might not have made the outsourcing decision at all. This means that the make-or-buy decision was based on too low an estimate of the transaction costs.

Outsourcing of processes to low-wage countries is quite popular. However, the low input costs are often not matched by effective suppliers. And even including the costs for supplier development, outsourcing still seems to be much cheaper than the previous insourcing.

Supplier development is, according to [ASCM22], technical and financial assistance given to existing or potential suppliers, in order to improve their quality and/or their due date performance.

Here it is important to assess the risk of increasing transaction costs in the medium and long term from the outset. A study of 16 cases in the development of Chinese suppliers [SnAl11] recommends focusing on the development of the power relationship. The red arrow in Figure (from [OeSc09]) shows the change in the power ratio. This took place within 4 years for products with high complexity, and in a shorter time for products with low complexity, due to the less long learning phase.

Fig.        Dependency and power model with time evolution of power progression at different product complexity, according to [OeSc09].

This finding, which is surprising at first glance, is due to the fact that the supplier's product quality is also used by other customers after its successful development. While the purchase quantity of the original customer, who actually develops the supplier, may grow in the single-digit percentage range per year, the supplier in the low-wage country often grows by more than 100% per year. If there are large and urgent orders from other customers (in China, for example, from the government), then the supplier must fulfill these first and can then no longer show enough interest in the original customer. The relationship becomes unreliable and eventually has to be abandoned by the customer.

Due to the geographical distance, the different economic environment and cultural aspects, many companies take care to directly control a supplier they develop in a low-wage country. However, this corresponds to a make decision. If it is not legally possible to operate a subsidiary, then a joint venture with a company in the country itself may be an option.

A joint venture is, according to [ASCM22], an agreement between two or more firms to risk equity capital to attempt a specific business objective.

A joint venture is also a possible approach to market access in countries with protectionist trade policies. See section 3.2.1. For the design of successful long-term supplier development see section 2.3.

Course section 2.1: Subsections and their intended learning outcomes