Global sourcing, production sharing and modes of entry into international business

1. Global sourcing

Global sourcing means buying raw materials, components, finished goods or services from wherever in the world they are cheapest or best, instead of only from domestic suppliers. Apple buys chips, displays and assembly services from suppliers in Taiwan, Korea, Japan, China and, increasingly, India; Western banks source back-office and software work from Indian IT firms.

Reasons: lower cost; access to quality, technology or materials not available at home; reliability of supply; meeting local-content rules in the buyer’s market; and counter-trade obligations.

Problems: longer lead time, exchange-rate risk, quality control at a distance, dependence on a single foreign supplier (exposed by the COVID-19 shutdowns), protection of intellectual property, and political risk. The current response is the “China plus one” policy: keeping a second source in another country, which has helped Indian electronics assembly.

2. Production sharing

Production sharing (Peter Drucker’s term, 1977) is the splitting of the production process into stages carried out in different countries, each stage located where it is done most efficiently: design and research in a high-income country, labour-intensive assembly in a low-wage country, final marketing in the consumer market. It is also called fragmentation, outsourcing across borders or the global value chain.

• Example: a laptop designed in the United States, with a processor made in Taiwan, memory from Korea, and assembly in China, Vietnam or India.
• Advantages: lower total cost, use of each country’s comparative advantage, employment and skills in developing countries, faster delivery to many markets.
• Disadvantages: coordination costs, vulnerability to a break anywhere in the chain, transfer-pricing disputes, and criticism over labour conditions in supplier factories.

Global sourcing is the buying side; production sharing is the making side. Both rest on the same idea, that no single country is the cheapest place for every stage.

3. Types of international business

A short note on types groups international business into: (i) export and import trade (merchandise and services); (ii) contractual entry (licensing, franchising, management contracts, turnkey projects, contract manufacturing); and (iii) investment entry (joint ventures, wholly owned subsidiaries, mergers and acquisitions, portfolio investment). The modes below fall into these three groups.

4. Modes of entry

(a) Exporting

Indirect exporting uses an intermediary in the home country — a merchant exporter, export house or trading house — so the firm needs no foreign knowledge. Direct exporting means the firm itself deals with foreign buyers, agents or distributors, or sets up an overseas sales branch. Exporting needs little capital and is the usual first step, but transport costs and tariffs may make it uncompetitive.

(b) Licensing

The licensor allows a foreign licensee to use a patent, trade mark, design or know-how in return for a royalty. Low cost and low risk, and a way round import barriers; but the licensor has little control over quality and may create a future competitor. The legal side is covered in the International Trade Economics note on foreign collaboration and technology transfer agreements.

(c) Franchising

A fuller form of licensing used for services: the franchisor gives the whole business system (brand, recipes, operating manuals, training) and the franchisee pays a fee and royalty. KFC, Pizza Hut and Subway entered India this way.

(d) Contract manufacturing and management contracts

Under contract manufacturing a foreign firm makes the product to the brand-owner’s specification; the brand-owner markets it. Under a management contract a firm manages an enterprise owned by others for a fee — common in hotels (Marriott or Hilton managing a hotel owned by an Indian company).

(e) Turnkey projects

A contractor designs, builds and commissions a complete plant and hands over the “key” to the owner ready to operate. Indian firms such as L&T and BHEL have executed turnkey power and infrastructure projects abroad, often financed by EXIM Bank lines of credit.

(f) Joint venture

A foreign and a local firm jointly own a new company, sharing capital, risk, profit and control. The local partner brings market knowledge and government contacts; the foreign partner brings technology and brand. Disputes over control and profit can end the venture (Hero Honda separated in 2011).

(g) Wholly owned subsidiary

The foreign firm owns 100 per cent, either by a greenfield investment (building new) or by acquisition (buying an existing firm, as Walmart bought Flipkart in 2018, or Tata Steel bought Corus in 2007). Maximum control and profit, maximum risk and cost. In India this depends on the sectoral caps and routes of the FDI policy (see the note on FDI policy).

(h) Strategic alliance

A cooperative arrangement without (or with only a small) equity link, to share research, distribution or technology — airline code-sharing alliances such as Star Alliance (of which Air India is a member) are the familiar example.

How this is examined

For the 10-mark modes question, a short opening on why the choice matters, the table, then each mode with meaning, merits, demerits and an example, ending with the factors governing choice. The production-sharing note needs the definition (with Drucker’s name), the laptop example, and two lines each on advantages and problems. If “global sourcing” is set, add the China-plus-one point to show current awareness.