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A currency exchange rate-driven vs. strategy-driven analysis of global sourcing

Multinational Business Review, Spring 1996 by Murray, Janet Y

In the past decade, multinational firms have been adopting global sourcing strategy to remain competitive in the global market. This study employs product-level data in examining domestic vs. foreign sourcing activities of U.S. subsidiaries of foreign multinational firms. The results concluded that, among manufacturers with extensive international experience, the level of domestic vs. foreign sourcing used might be associated with strategy-related factors, rather than with currency exchange rate.

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Effective global sourcing is generally recognized to enhance a firm's competitiveness, so the concern for multinational firms is not whether to use global sourcing, but how to select an appropriate global sourcing strategy in achieving their business objectives. Firms make sourcing decisions in each of the two phases of production--component sourcing and assembly. In either phase, firms can choose to use domestic or foreign sourcing (the locational aspect), and internal or external sourcing (the ownership aspect). "Domestic sourcing" is when the sourcing firm and its suppliers are located in the same country (e.g., Honda in the U.S. sources from Nippondenso in the U.S.), while "foreign sourcing" involves sourcing from abroad (e.g., Honda in the U.S. procures from Nippondenso in Japan). A firm uses "internal sourcing" when it procures or assembles parts and components within the corporate system, either a parent from its subsidiaries, or subsidiaries from their parent or from other subsidiaries (e.g., Honda in the U.S. sources from its parent in Japan, or from other Honda subsidiaries located in the U.S.). "External sourcing" occurs when sourcing originates from independent suppliers on a contractual basis (e.g., Honda in the U.S. procures from ABC Company in the U.S., or from XYZ Company in Japan). These activities often cross national boundaries.

While many studies report dramatic increases in foreign sourcing by U.S. multinational firms [Machinery and Allied Products Institute (MAPI) 1986; Monczka and Guinipero 1984], others report the significant level of domestic sourcing used by these firms when serving overseas markets. In 1990, U.S. multinational firms generated $1.48 trillion in foreign sales through huge investments made in plants and operations overseas (i.e., domestic sourcing) [O'Reilly 1992]. Similarly, foreign multinational firms, in penetrating the U.S. market, often employ domestic (i.e., U.S.) sourcing as a means to overcome tariff and non-tariff barriers. Recently, more domestic sourcing has been used by these foreign multinationals, which is a result of their foreign direct investment in the U.S.-- either by establishing manufacturing plants or buying existing businesses. As of 1990, Britain had the largest total investment of over $120 billion in the U.S., and Japan, the second largest of over $70 billion [Fortune 1990].

According to macroeconomic theories, decisions related to domestic vs. foreign sourcing are greatly affected by currency exchange rates. However, recent economics literature [Baldwin 1988; Baldwin and Krugman 1989; Dixit 1989] suggests that microeconomic, firm-level strategic decisions have weakened currency exchange rate effects on domestic vs. foreign sourcing decisions. Consistent with these researchers, Swamidass [1993] recognized the diminishing importance of the role of cost and the increasing significance of strategy factors in influencing global sourcing decisions. Other researchers [Kotabe and Murray 1990; Kotabe and Omura 1989], in examining sourcing issues using micro-level (product) data, concluded that a product's market performance is positively related to the extent of which major (i.e., nonstandardized) components are sourced internally (i.e., within the corporate system). Major components often involve proprietary technology; therefore, sourcing these crucial components internally can enable the firm to maintain its competitive edge over its rivals. However, the sourcing of standardized (i.e., offthe-shelf) components does not have a significant impact on market performance.

Given the unique characteristics of major components and their critical influence on a product's market performance, their sourcing decisions mandate the firm to ensure the quality, technology, and dependable supply of these crucial components. This argument is consistent with Swamidass' [1993] assertion that, during the advanced stage of import sourcing, firms would likely source based on strategy, rather than cost factors. Although previous studies [Kotabe and Murray 1990; Kotabe and Omura 1989] concluded that internal sourcing of major components influences a product's market performance, there is no available research on the effects of domestic vs. foreign sourcing of major components on market performance. Consequently, we do not have a complete understanding of the strategic decisions relating to the sourcing of major components, which is critical to achieving the firm's or its products' performance objectives.

Business Services Industry

A currency exchange rate-driven vs. strategy-driven analysis of global sourcing

Multinational Business Review, Spring 1996 by Murray, Janet Y

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