Offshoringand Globalization of the

Value Chain

Torben Pedersen

Professor

Center for Strategic Management and Globalization

Copenhagen Business School

• Definitons

• Theories– Porter’s value chain– Modularization

• Case: Ecco – different offshoring strategies

• Highlights from an international survey

• Danish data on offshoring of advanced activities

• Case: Coloplast – Managerial and organizational challenges in offshoring

Agenda

Sourcing (onshore-nearshore-offshore)

.Location

Operator

Home country(onshore)

Foreign country(offshore)

ContractualPartner

(outsourcing)

(Onshore) outsourcing

Offshore outsourcing

Ourselves(insourcing)

Captive offshoring

(FDI)

Nearshore

Offshoring – Global trends

What is driving the offshoring?

• New information and communication technology makes it easier to codify and standardize activities

• New technology makes it possible to disconnect and disaggregate activities

– e.g. e-business, e-learning, library services

• New important markets like China and India is opening up and claiming their role in the world economy

Porter: A value chain approach

A change from dispersed to concentrated configuration strategies in which global sourcing plays a vital role

Inbound logistics

OperationsOutbound Logistics

Marketing and sales

Service

Procurement

Technology Development

Human Resource Management

Firm Infrastructure

A dispersed value chain configuration with low interaffiliate coordination

Marketing & Sales

USAUK

Japan

A concentrated value chain configuration with high inter-affiliate coordination.

China

Manufacturing

IT

India

Marketing & Sales

USA

R&D

Logistics

M&S

Ireland

UK

Mgt

What is driving the offshoring?

• New information and communication technology makes it easier to codify and standardize activities

• New technology makes it possible to disconnect and disaggregate activities

– e.g. e-business, e-learning, library services

• New important markets like China and India is opening up and claiming their role in the world economy

Configuration of value chain activities

Coordination of value chain activities

Dispersed Concentrated

Low

High

Lower coordination (I&CT) and transportation costs

New codification and standardization technology

Porter’s global value chain framework

Oprening of new markets

Global specialization

Take aways

- Offshoring

- Enabled by modularization/standardization

- Benefits: Location-specific advantages

- Comes at a cost: Increased coordination problem

The starting point

Value Chain

Input Process Output

Fine-slicing of the value chain

Value Chain

Input Process Output

Location and organization

Value Chain

Input Process Output

Choice of location and organization ?

Danish textile-companies outsourcing/offshoring

Concepts

Fine-slicing of the activity: OPTOutward Processing Traffic

(1985-1990)

CMTCut, Make and Trim

(1990-1995)

SODSourcing from own Design

(1995-2000)

Design Denmark Denmark Denmark

Logistics Denmark OutsourcingDenmark

OutsourcingDenmark

Procurement Denmark OutsourcingDenmark

Eastern Europe

Processing OutsourcingDenmark

Southern Europe Eastern Europe

Cutting OutsourcingDenmark

Eastern Europe Asia

Sewing Southern Europe Eastern Europe Asia

Packaging Southern Europe Eastern Europe Asia

Quality control Denmark Southern Europe Asia

Branding Denmark Denmark Denmark

Smiley of the value chain..

Input Output

Value Value addedadded

DesignDesign

Quality ControlQuality Control

CuttingCutting

Logistics Logistics

ProcurementProcurement

ProcessingProcessing SewingSewing

PackagingPackaging

Branding and marketingBranding and marketing

Processing

Value chain

Smiley of the value chain..

Input Output

Value Value addedadded

DesignDesign

Quality ControlQuality Control

CuttingCutting

Logistics Logistics

ProcurementProcurement

ProcessingProcessing SewingSewing

PackagingPackaging

Branding and marketingBranding and marketing

Processing

Value chain

Denmark

What is new about offshoring?

• Disaggregation of the value chain and re-location of some of these more disaggregated activities

• Sourcing motives are becoming more prominent than market seeking motives

• In particularly, China and India (1/3 of world population) are becoming active on the global scene

• Empirically:– The amount of offshoring has increased dramatically– The character of offshoring has changed to include service

and knowledge activities

ECCO A/S –

Optimizing Global Value Chain Economics

The history of ECCO• 1963 foundation of ECCO in Denmark

• ECCO over time aims to produce most comfortable and modern

footwear for work and leisure, focus on quality and comfort

• 2004 => 90% of production exported, mainly to US, Germany and

Japan

Denmark

(Foundation

of ECCO)

1963 1984 1991 1993 1998 2005

Portugal Indonesia Thailand Slovakia CHINA

Global Lifestyle Casual Footwear Brand Sales (in US$ million)

Rank Company 2002 2003 % change 1 Clarks 1,399 1,534 9,6% 29,2% 29,6% 2 ECCO 502 590 17,5% 10,5% 11,4% 3 Rockport 385 361 6,2% 8,0% 7,0% 4 Geox 208 329 58,2% 4,3% 6,3% 5 Birkenstock 270 300 11,1% 5,6% 5,8% 6 Bass 275 285 3,6% 5,7% 5,5% 7 Catterpillar 209 210 0,5% 4,4% 4,0% 8 Doc Martens 295 195 -34,0% 6,2% 3,8% Others 1,252 1,383 26,1% 26,7% Total $4,795 $5,187 8,2%

Composition of employees in ECCO by geography

0

2000

4000

6000

8000

10000

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Employees in Denmark Employees outside Denmark

Production of shoes (in pairs) 2000-2004

0500.000

1.000.0001.500.0002.000.0002.500.0003.000.0003.500.0004.000.0004.500.000

2000 2001 2002 2003 2004

Shoes produced in Denmark Shoes produced in Portugal

Shoes produced in Indonesia Shoes produced in Thailand

Shoes produced in Slovakia

Input Output

ValueValueaddedadded

Design and developmentDesign and development

Production of uppersProduction of uppers

Production processProduction process

Most complicated shoesMost complicated shoes

High-tech shoe productionHigh-tech shoe production

Branding and MarketingBranding and Marketing

Processing

Value chain

Denmark

Slovakia and Thailand

Thailand, China and Indonesia

Portugal

DistributionDistributionUSA and Denmark

Location of ECCO’s value chain activities

Home country

International sales

Outsourcing (% of all shoes)

Own production facilities (i.e. remaining % of shoes

Timberland USA 40 % 90 % Puerto Rico

Dominican Rep

Clarks UK ? 99 % (UK)

Ecco Denmark 90 % 20 % Portugal, Slovakia, Indonesia, China, Thailand

Geox Italy 45 % ? Slovakia

Romania

No one strategy fits all!

2006 Offshoring Research Network Survey Demographics

Duke University / Booz Allen Hamilton 2006 Offshoring Survey Demographics

537 firms surveyed in US, UK, Germany, Netherlands and Spain. Excludes third party service providers– 55% currently offshoring– 18% considering offshoring– 27% not considering offshoring– 1498 offshore functional

implementations

Major industries represented: Financial Services, Manufacturing, Telecom, Technology, Consumer, Media, Energy, Aerospace & Defense, Automotive

Functions Offshored: Includes IT, Customer Service, Business Processes, Engineering, Marketing, R&D, Product Development and Design

Forbes 100

Forbes 250

Forbes 500

Forbes 1000

Forbes >1000

Small (Not Ranked by Forbes)

Source: Duke University/Booz Allen Offshoring Research Network 2006 Survey

20%

13%

30%

11%

14%

12%

Percentage of Forbes companies in US sample

IT remains the most highly offshored function. The next offshoring frontier, however, is globalizing product and process innovation

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

IT

Product Development (R&D, Engineering, Product Design)

Admin. Business Processes (F&A, HR etc.)

Call Center / Help Desk

Procurement

Cu

mu

lati

ve

Pe

rce

nta

ge

of

Fir

ms

In

itia

tin

g O

ffs

ho

rin

g

Cumulative Percentage of Firms Initiating Offshoring by Function

Source: Duke University / Booz Allen Offshoring Research Network 2006 Survey

Access to qualified personnel and improving speed to market are growing faster as offshoring drivers than cost reduction

0

10

20

30

40

50

60

70

80

90

2004 2005 2006

% o

f R

es

po

ns

es

Ra

tin

g D

riv

er

as

“V

ery

Im

po

rta

nt”

an

d “

Imp

ort

an

t”

Survey Year

Cost Reduction

Access to Qualified Personnel

Competitive Pressure

Increased Speed to Market

Access to New Markets

Growth Rate of Offshoring Drivers Over Time

Source: Duke University / Booz Allen Offshoring Research Network 2006 Survey

Business Process Redesign

% o

f F

irm

s C

itin

g R

isk

as

“V

ery

Im

po

rta

nt”

or

“Im

po

rta

nt”

Survey Year

Managerial and organizational risks are growing while risks associated with external factors are declining.

Perceived Risks of Offshoring 2004 - 2006

Operational Challenges

Lack of Acceptance by Internal Clients

Political Backlash

Political Instability

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

2004 2005 2006

Loss of Managerial Control

Cultural Differences

Source: Duke University / Booz Allen Offshoring Research Network 2006 Survey

Lack of Acceptance by Customers

Offshoring of R&D leads to job growth onshore, while offshoring of back office functions is associates with job losses onshore

* On average, offshoring led to job creation

150

79

97

128

28

13

35

-40

-20

0

20

40

60

80

100

120

140

160

-10

0

10

20

30

40

Ave

rag

e #

em

plo

yee

s o

ffsh

ore

p

er

imp

lem

en

tatio

nA

vera

ge

# o

f job

s elim

ina

ted

o

nsh

ore

pe

r imp

lem

en

tatio

n

Average # of Employees Offshore vs. Average # of Jobs Eliminated Onshore

Source: Duke University / Booz Allen Offshoring Research Network 2006 Survey

Danish data on offshoring

of more advanced activities

Activities offshored (Representative survey of Danish firms, all sectors, Fall 2004)

Activities

Share of firms

2004 Expected 2007

Production 90 % 92 %

Logistics & purchasing

17 % 28 %

R&D 11 % 23 %

Adm. 9 % 16 %

Sales & marketing 6 % 11 %

The Wind-turbine company Vestas’ disaggregation of the value chain in R&D

”In Novo Nordisk 90 percent of our research and development is svead and only 10 percent are really creative”

Lars Guldbæk Karlsen, Vice-president of R&DNovo Nordisk

Disaggregating activities

Less More advanced tasks advanced tasks

R&D: Test, patenting New inventions, design

Production: Volume production Individual prototype or niche production

Marketing: Canvas and tele sales Advertisemen t, branding

IT: Service operations Programming, architecture

Administration: Bookkeeping & payroll Management

Data

•Survey: Total population of firms in Eastern Denmark with 10+ employees ( = 3.600 firms)

•1.504 firms responded (response rate 42%)– 1.158 firms (77%): no offshoring– 346 (23%) firms have offshored activities

• identified type of offshored activities and rated tasks whether less or more advanced tasks (Likert-scale, 1-5)

• 113 firms (8%) have offshored more advanced tasks

Heckman-model on 1.504 Danish firms

Whether to offshore

How advanced are the

offshored activities

Share of knowledge workers + +**Knowledge seeking +**

Number of offshored tasks +**

Capital investment - +Developed countries -

Captive offshoring -

Firm size +*** +Multinational company +*** +Financial performance -

Seeking cost advantages -**Market-seeking motive +

Take-aways

• The offshoring of more advanced tasks is conducted by experienced and knowledge-intensive firms seeking knowledge and talent abroad

• Not more common with captive offshoring to deleloped countries.

• Offshoring is best analyzed on a more disagrregated level and we need to know more about interdependencies and complementaries etc. between the different tasks

Strategies for control

Disaggregation af banking activities

Brands

Smiley..

Input Markets

VALUE CHAINVALUE CHAIN

Creative Creative innovativeinnovative

R&DR&DDesignDesign

MarketingMarketingBrandingBranding

ManufacturingManufacturing

White collar jobs

Blue collar jobs

High-cost countries

Low-cost countries

Education and payment of engineers

New engineers educated per year

Annual income in $ US

USA 59,536 75,000 (New York)

India 82,107 6,000 (Mumbai)

China 219,563 12,100 (Shanghai)

Russia 82,409 3,400 (Moscow)

Japan 104,478 71,500 (Tokyo)