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Globally Advantaged Manufacturing

Winning in the Downturn and Beyond

Focus

The Boston Consulting Group (BCG) is a global manage-ment consulting firm and the world’s leading advisor on business strategy. We partner with clients in all sectors and regions to identify their highest-value opportunities, address their most critical challenges, and transform their businesses. Our customized approach combines deep in-sight into the dynamics of companies and markets with close collaboration at all levels of the client organization. This ensures that our clients achieve sustainable compet-itive advantage, build more capable organizations, and secure lasting results. Founded in 1963, BCG is a private company with 66 offices in 38 countries. For more infor-mation, please visit www.bcg.com.

Globally Advantaged Manufacturing 1

Globally Advantaged Manufacturing

Winning in the Downturn and Beyond

Over the last decade and a half, a historic combination of falling trade barriers, low en-ergy and transporta-

tion costs, new access to plentiful la-bor, and relative currency stability led to a massive shift of sourcing and manufacturing from high-cost devel-oped countries to China, India, and other rapidly developing economies (RDEs). From 1997 through 2007, the value of goods made or sourced over-seas grew more than 9 percent per year on average, from $5.3 trillion to $12.6 trillion.

But in 2007, the tide seemed to be turning. The media began warning of rising oil prices, higher transportation costs, strengthening RDE currencies, rapid increases in RDE wages, and, in some cases, labor shortages. At the same time, many governments in developed countries were seeking to limit outsourcing to protect local jobs. There was talk of big multinational corporations (MNCs) pulling back from RDE-based sourcing and manufacturing. Then the global financial crisis hit in mid-2008. Amid plummeting oil and transportation costs, RDE currencies began rapidly depreciating. Sudden-ly, RDEs were cost competitive again.

Add to this whipsawing volatility (which shows no sign of abating) an-other critical dimension: the explo-sive growth of RDE markets. In 1990, RDEs contributed only 25 percent to global GDP, compared with 51 per-cent for the G7 industrialized na-tions. The RDE share grew to 42 per-cent in 2007 and is projected to overtake that of the G7 by 2009 (al-though it remains to be seen how the global downturn will affect these projections). Moreover, RDE demand for goods and services has surged over the last decade. India and China alone have about 2.5 billion consum-ers—a huge potential market with growing amounts of disposable in-come. For many products, RDE de-mand already outstrips that of more developed markets in terms of vol-ume. Given the price sensitivity of RDE markets, products often must be designed and manufactured local-ly to meet the necessary price points. MNCs that want to access these RDE markets will be in a stronger compet-itive position if they have a local manufacturing presence. Once built, RDE plants can serve both local and global demand.

Because of these factors and ongoing labor-cost savings, few MNCs can af-ford to turn their backs on RDE-based production. It is important to

keep in mind, however, that deci-sions about where to manufacture should be driven by more than just cost. For companies seeking a strate-gic edge over the competition, the far more complex—and critical—ques-tions are where to manufacture what products and how to set up a global-ly advantaged production network.

Choosing the Right Locations

Companies whose RDE strategies succeed over the long haul make sus-tained commitments to a small num-ber of choices and relationships. They systematically rebalance pro-duction among locations instead of doing so in an irregular manner. They recognize that ongoing volatil-ity, changing demand, and shifting cost dynamics will affect their choic-es of what products to make where—and for what markets. When making decisions about where to set up their global operations, compa-nies must weigh the tradeoffs of each location, taking three things into consideration: factor costs, sup-ply chain constraints, and the rela-tive strengths and weaknesses of dif-ferent RDEs.

Factor Costs. Low labor costs fueled the shift to RDE-based manufactur-

2 The Boston Consulting Group

ing and continue to play a critical role, despite wage increases in some areas. According to our analysis, the huge labor-cost differential between RDEs (where salaries ranged from $0.50 to $9 per hour in 2008) and de-veloped countries (with salaries from $15 to $45 per hour) is unlikely to change much in absolute terms in the short to medium term. Except for products that have minimal labor content or are very bulky and costly to ship, manufacturing still costs far less in RDEs than it does in the Unit-ed States or Europe, even when transportation costs are high and RDE currencies are strong. (See Ex-hibit 1.)

Labor costs vary widely by region. Although average wages in China grew by more than 150 percent from 1999 through 2006, they’re far higher in industrial areas such as the Pearl

River Delta than in the inland prov-inces. But productivity has grown, too—especially in the industrial clus-ters that attract highly skilled work-ers. In the less developed countries of India, Vietnam, and some areas of Mexico, wage rates are lower than those in China’s industrial areas, but the labor savings are offset by lower productivity rates, supply chain con-straints, and infrastructure challeng-es. Companies must consider these tradeoffs when deciding where to manufacture.

Other factor costs such as transporta-tion, tariffs, materials, currency ex-change rates, and energy vary from location to location and must also be considered. Because of the complex-ity involved in measuring this wide range of factors and their ongoing volatility, BCG has developed an ana-lytical model that quantifies the cost

tradeoffs among different locations and the impact of changing cost fac-tors or locations. (See Exhibit 2.) For example, our model shows that a U.S.-based engineering company could produce small aluminum cast-ings more cheaply in China but that Mexico would be more cost-effective for large iron castings because trans-portation costs would be lower. (See Exhibit 3.) The cost difference be-tween the two locations was so small, however, that a relatively mi-nor increase in China’s wage rate and its exchange rate against the dol-lar would make Mexico the less cost-ly choice for either type of casting.

Supply Chain Constraints. The global supply chain is another criti-cal factor in making RDE-based pro-duction decisions. Longer shipping times add cost, risk, and variability to delivery schedules. Shipping goods

3% Indexed costs

U.S. manufacturing Chinese manufacturing

11%

Indexed costs

Indirect costs

Indirect costs

Transportation

TransportationMachining

MachiningDirect labor

Direct laborMaterials components Materials

componentsRaw materials Raw materials

Import tax

No change in costsIncrease in costs

Early 2007 Early 2007 Mid-2008 Mid-2008

1818

18

18

100 103

2 3

2222

2020

20 21

19

7179

33

1011

46

1617

4 6

1617

19

100

80

60

40

20

0

100

80

60

40

20

0

Transportation costs affect domestic shipments, too

Other costs are rising in the United States, too

Ocean shipping is a minor element

Exhibit 1. Costs Have Risen, but RDEs Remain Very Competitive

Source: BCG experience.


Outputs (illustrative)

Product factors ◊ Dimensions ◊ Weight ◊ Labor content ◊ Material inputs Sensitivity analysis

“What happens if input X floats between

–Y% and +Z%?”

Scenarios

“If input X, Y, and Z go up by K%, how does that affect product costs

and decisions about location?”

Output

◊ Wage rates ◊ Productivity ◊ Transportation costs ◊ Transportation times ◊ Tariffs

Country factors

◊ Foreign exchange ◊ Cluster effects ◊ Risk factors

Other factors

Cost structure analysis

Trends infactor costs

Country costcomparison

10

5

0

50

0

40

20

0

Exhibit 2. BCG’s Analytical Model Quantifies the Cost Tradeoffs of Different Locations

Machined iron castings Machined aluminum castings

Costs ($) Costs ($)

21.1119.88

25.0127.72–6%

11%

30

20

10

0

30

20

10

0China Mexico China Mexico

Manufacturinglocation

Manufacturinglocation

Freight1 Overhead Indirect labor Direct labor Materials

Exhibit 3. Lower Shipping Costs from Mexico Offset Labor Savings in China for Some Products

Source: BCG case experience.1Based on a destination in the United States.

Source: BCG analysis.


from China to the United States or Western Europe can take as long as four weeks, on top of production time. When product design and de-mand are stable, a two-month lag time between order and delivery can be planned for and has less of an im-pact. But in industries in which styles change quickly or demand is unpre-dictable—such as the fashion busi-ness—long supply chains are a ma-jor disadvantage. Although airfreight can shorten cycle times, it is expen-sive and can largely negate labor sav-ings. Shorter supply chains yield greater flexibility.

Proximity also makes it easier to communicate with key buyers. The distance and time zone differences between Asia and the United States or Europe can make staying in touch—whether by phone or in per-son—a challenge. Moreover, for prac-tical reasons, certain products are better sourced closer to the end user. Such products include heavy or bulky items that are costly to trans-port; foods, plants, and other perish-ables that can’t withstand long tran-sit times; products with very short life cycles or highly volatile demand, such as fashion and high-tech goods; and higher-margin or customized products made in smaller volume.

In fact, in global business, proximity to developed markets is a key advan-tage that results in lower transporta-tion costs, easier communications, shorter supply chains, and greater flexibility. Mexico and Eastern Eu-rope border the United States and Western Europe, respectively, and have far lower labor costs than those of developed economies—albeit double to triple those in China. Still, the advantages of proximity can off-set the higher wages.

Supply-chain-management capabili-ties are also critical. Without the abil-ity to control variability, track inven-tory levels, and monitor capacity utilization across networks, an RDE production strategy will end up cost-ing more and delivering less. At their

worst, supply chain failures can drive vicious cycles of stockouts and missed sales, inventory pileups, deep discounting, high carrying costs, and inevitable write-offs. Supply chain variability can quickly erode margins.

The Strengths and Weaknesses of RDEs. RDEs vary greatly in the ad-vantages they offer global manufac-turers. Things to consider include in-frastructure, taxes, labor policies, regulations, currency strength, and exchange rates—all of which can af-fect the ease of doing business and the bottom line. Also critical is the RDE growth rate. Countries with large or emerging domestic markets are attractive targets because pro-duction facilities can serve both local and foreign customers.

For much of the last decade, China was the default location for many MNCs setting up manufacturing in RDEs. Besides having low-cost inputs such as labor and materials, China has the world’s largest domestic mar-ket, with 1.3 billion consumers. Moreover, a fast-developing infra-structure, favorable labor policies, and the tax benefits of its special ex-

port zones make it an excellent choice for long-term investments in manufacturing. India has been less attractive than China for global man-ufacturers because of its smaller do-mestic market, less developed infra-structure, and more restrictive labor laws. But things are changing, and more MNCs are setting up produc-tion facilities in India—especially for manufacturing electronics, automo-biles, and pharmaceuticals.

Unlike China, however, India’s man-ufacturing tends to be skill intensive rather than labor intensive. The lead-ing example is Bharat Forge, the world’s largest manufacturer of auto-mobile forgings, which has invested heavily in technology and a highly educated workforce. India turns out an estimated 400,000 engineers per year, second only to China, and has a large English-speaking population. But India’s infrastructure is more problematic. Poor roads, crowded ports, regular power shortages, and subpar airports undermine its role in the emerging global economy. Turn-around times at India’s ports are sluggish compared with Hong Kong’s extreme efficiency. The one excep-tion is India’s strong telecommunica-tions backbone, which has trans-formed the country’s business landscape.

Other RDEs with lower costs than China are emerging as viable manu-facturing locations, but shortcomings in infrastructure can create obstacles. For instance, a U.S. toy manufacturer found that labor and other costs were lower in Vietnam than in China. But Vietnam’s poor roads, capacity-con-strained ports, inflexible labor, rela-tively high inflation, and frequent la-bor strikes made it less desirable than China for production facilities.

Proximity to developed

markets is a key

advantage that results

in lower costs and

greater flexibility.


Building a Globally Advantaged Network

RDE-based production offers a range of potential advantages such as low-er product costs, access to new mar-kets, and the ability to better serve existing markets. But reaping all of these benefits takes time. In our ex-perience, most companies go through an evolution as they seek to find and deliver the right mix of price, products, quality, variety, time-liness, flexibility, customization, and service for specific markets in differ-ent parts of the world. This evolution takes them through three distinct stages: cost arbitrage, local advan-tage, and global integration.

Stage 1: Cost Arbitrage. In the first stage, cost arbitrage allows compa-nies to increase their profit margins, differentiate their products in ways

that would be economically infeasi-ble in higher-cost countries, or con-tinue making and selling products profitably when margins shrink. For more than a decade, RDE-based manufacturing was virtually a no-brainer owing to low-cost labor, ener-gy, and transportation. In that golden period, even a poorly executed strat-egy could deliver savings. Most MNCs shifted at least some portion of their manufacturing to take ad-vantage of the lower costs.

In industries in which fashion trends, technical obsolescence, or patent ex-piry can quickly turn winning prod-ucts into losing ones, RDE operations create new opportunities to lengthen product life cycles. For instance, pharmaceutical companies can pro-duce off-patent drugs and generics at low-cost RDE plants to extend prod-uct profitability.

This strategy isn’t without challeng-es, however. When RDE-based opera-tions are carbon copies of their home-country operations, cost sav-ings may be limited. Consider the fol-lowing case in point. After bench-marking a group of automotive plants set up by MNCs in China, we observed two things about the plants—that many were more costly than their home-country counter-parts and that performance varied widely among the plants. (See Exhib-it 4.) These differences in cost and performance were largely the result of how the plants were built and run, not their location. Instead of leverag-ing China’s inherent cost advantages, the plants were often clones of home-country operations, with high-ly paid expatriate managers, high-cost suppliers, expensive automation that negated the labor cost savings, and excessive allocation of global

Cost of Chinese plants as a percentage of home-country plants

!140

120

100

80

60

40

20

0Germansupplier

GermanOEM

Germansupplier

Germansupplier

Germansupplier

Germansupplier

Germansupplier

NorthAmericansupplier




Austriansupplier

EuropeanOEM

EuropeanOEM

FrenchOEM

Italiansupplier

Frenchsupplier

Frenchsupplier

Above 100 percent 100 percent Below 100 percent

Home-country-plant cost level

Exhibit 4. The RDE Plants of Some Multinational Corporations Cost More Than Their Home-Country Plants

Sources: Company interviews; BCG analysis.


overhead owing to a higher-than-av-erage employee head count. As a re-sult, these plants did not generate the expected cost savings.

Stage 2: Local Advantage. In the second stage, MNCs that are commit-ted to making a long-term invest-ment in RDE-based production begin to see that even greater savings can be realized by capitalizing on the specific advantages that each RDE offers. These MNCs begin operating more like local companies, adapting new ways of thinking and working that are better suited to the new en-vironment—without giving up their best practices from home.

A good example is Toyota’s produc-tion network for manufacturing its international multipurpose vehicles (IMVs), designed specifically for cost-sensitive RDE customers. Toyota set up manufacturing and assembly plants in key RDE markets such as India, Indonesia, and Thailand, and “complete knock-down” (CKD) plants in South Africa, the Philippines, and South America. The CKD plants re-ceive so-called knock-down kits with everything needed to assemble an IMV, but they are cheaper to set up and maintain because they don’t use expensive automation. They are sup-plied by a network of other RDE-based plants that make engines, gearboxes, and other key parts. The result is an RDE-based manufactur-ing ecosystem that designs, manufac-tures, and assembles vehicles for lo-cal markets.

Toyota exploited scale by aggregat-ing demand across RDEs into a few strategically located assembly plants and setting up single large-scale plants for engines and gearboxes. These larger plants were established

in areas such as Thailand, Brazil, and India—where Toyota could leverage the advantages of industry clusters. Moreover, the plants were designed to be lean and to take advantage of the lower cost of capital—the Indian plant, for instance, cost 40 percent

less than comparable Western plants—by using local materials, less automation, and local equipment where possible. Finally, Toyota made the decision to use local managers and suppliers to further localize op-erations.

Like Toyota, companies that gain a strategic advantage by successfully adapting to local conditions do four things: leverage scale, exploit the power of industry clusters, rethink the balance between labor and capi-tal, and set up lean, localized opera-tions.

Leveraging Scale. The cost advantages of RDEs allow companies to use scale—both large and small—to their strategic advantage. One way to keep costs low for greater global competi-tiveness is to build scale—and even superscale—by consolidating produc-tion facilities. In so doing, companies are able to create products on a mas-sive, world-leading level and increase capacity still more with relative ease, at relatively low cost.

Superscaling depends on low labor costs, but it’s not always just a labor-for-capital swap. Johnson Electric, a

global leader in small, precision elec-tric motors, invested heavily in mod-ernization and automation through-out the early 1990s. Although the company’s sales grew at double-digit rates during those years, its earnings remained flat. In the second half of the 1990s, its earnings quadrupled as the company harvested the benefits of its capital investments. Superscal-ing usually requires a fairly high lev-el of capital investment. Even so, the cost of equipment, land, facilities, and services in RDEs is low enough that companies can make these in-vestments and still deliver an enor-mous quantity of low-cost, high-qual-ity products.

LG Electronics uses this strategy for its microwave ovens and air condi-tioners, building large-scale plants in Mexico, China, Eastern Europe, and other RDEs to serve regional de-mand. The plants provide such a scale advantage that the company can offer more features and a wider range of products at a lower price than its competitors.

Opting for a number of small-scale operations is another way to leverage the lower costs of RDEs for global ad-vantage. Because plants cost less to build in developing economies, com-panies can reduce their minimum scale requirements by half or more and still have a profitable operation. And lower minimum scale offers dif-ferent strategic advantages. Compa-nies can not only diversify operating risk across more locations while still keeping costs low, but they can also have more specialized plants, which can often deliver higher quality and greater margins.

Exploiting the Power of Industry Clus-ters. Silicon Valley is the world’s

Greater savings can be

realized by capitalizing

on the specific

advantages that each

RDE offers.


best-known cluster, but it’s just one example of a general and well-docu-mented phenomenon: industrial de-velopment happens in clusters or ecosystems of interrelated compa-nies, suppliers, and service provid-ers. Clusters can grow as a result of public policy or the concerted effort of one or more companies trying to increase supply sources.

When a cluster takes off, it becomes self-sustaining. A city or region may become known as a prime location for a particular industry on the basis of access to resources, talent, or mar-kets. That reputation attracts more people and companies, which in turn builds and reinforces the cluster. But clusters can also wither. For instance, southern California’s share of the global aircraft and avionics industries has been declining since the 1970s, although the region still retains some aviation-related industries.

While the importance of clusters is well established in the business press and industrial-development policy, not all companies have been able to leverage them successfully. Yet clus-ters should be a critical component of any global manufacturing strategy. Industries and clusters are forming very quickly, reflecting the rapid pace of development in emerging economies. In the main coastal prov-inces of China, for instance, hun-dreds of industry ecosystems have taken hold in the last decade. Hyun-dai’s choice of Chennai, India, for producing small cars for global mar-kets reflects the emergence of that city as a hub for automobile produc-tion. Not all of these clusters will achieve world-class positions. Some will attain sustainable scale; others will plateau and then shrink as in-dustries consolidate in response to

competition and industrial-policy choices.

Cluster dynamics have critical impli-cations for RDE-based manufactur-ing. Because of clusters, regional ca-pabilities develop unevenly. To gain

an advantage, companies must lo-cate their plants in the right cluster and build a strong position. Even though land and labor cost more, clusters give companies access to scale and experience. Moreover, by building supplier relationships and trust, companies can reduce coordi-nation costs and increase reliability. LG, for instance, creates captive sup-plier parks—effectively walled clus-ters—and then replicates those sup-ply bases from one megaplant to another, building on past learning and relationships. LG manages its suppliers’ enterprise resource plan-ning (ERP) systems and tightly inte-grates their shared production proc-esses.

Because of cluster effects, locations that appear to be getting more ex-pensive may actually be getting more effective for companies with advantaged positions. (See Exhibit 5.) While country-level statistics show that productivity is increasing overall in major RDEs, location- and cluster-specific productivity is racing ahead of wages even though wages tend to be higher in growing clusters than in general RDE markets. With smart management and work de-

signs, superior local reputations as employers, and strong systems for developing people and suppliers, companies can outrun rising costs.

To leverage the power of clusters, a company must carefully evaluate the position it can reasonably hope to establish, given its size and resources. One small high-tech manufacturer deliberately chose a strong position in a relatively weak existing cluster to ensure its ability to attract talent and negotiate better contracts with suppliers. By contrast, a larger com-pany may be able to achieve a man-ufacturing advantage in a larger clus-ter or by independently seeding a new cluster.

Evolving industry dynamics have left high-cost locations in different parts of the world with no supplier base, so that companies in those areas have little choice but to manufacture in RDEs. Garments and toys are made largely in Asia. Hard disk drives and semiconductor production have also shifted almost entirely to Asia. Gener-ally, the movement of knowledge-based industries such as research and services tends to lag behind manufac-turing—but eventually, it will follow. Companies that don’t pursue RDE-based production may find them-selves trapped in a lengthy, rear-guard struggle as talent and knowledge flow to new centers of gravity.

Rethinking the Balance Between Labor and Capital. In RDEs, labor is a lower-cost alternative to capital. Instead of replicating their home-country plants, experienced companies capi-talize on this advantage by redesign-ing their products and manufactur-ing processes to reduce automation and increase labor. This lowers capi-tal investment significantly. For in-

Industry clusters

should be a

critical component

of any global

manufacturing strategy.


stance, an automaker with produc-tion facilities in China realized major savings by rigorously “manualizing” or semiautomating its noncritical auto-manufacturing processes such as glue application and wheel mount- ing. Similarly, a European automaker that built a new plant in Romania was able to keep capital investment low by sharply decreasing the level of automation. Rather than using 1,000 robots for welding and other tasks, the plant uses just one robot to install windshields—and 2,000 work-ers to do everything else. The cars take twice as many man-hours to as-semble as similar cars in Western Eu-rope but cost less to make because labor rates are considerably lower.

And consider another example. A global automaker recently designed a new plant in India to reduce its up-front investment in fixed assets by as

much as 35 percent compared with similar plants in Europe, without sac-rificing global standards for quality and safety. The plant reduced outlays for fixed assets by replacing equip-ment less often, using machines with less exacting specifications, decreas-ing automation, leasing more equip-ment, and cutting tooling costs by 50 to 60 percent compared with its plants in Europe and the United States. Built with local materials to save on construction costs, the plant also uses less space—Indian build-ings are lower because they don’t need ducts for heating or air condi-tioning and roofs don’t need to with-stand heavy snowfall.

Besides cutting costs, reducing capi-tal assets also increases flexibility. Because people are far more flexible than equipment, manufacturers can do shorter production runs and

make a wider variety of products much more cheaply than if they had to retool and reprogram robots or equipment. Many manufacturers start out thinking that they’ll make their most standardized products in low-cost countries. Then they realize that even bigger savings can be had by producing “high-touch,” custom-ized products because labor is so in-expensive.

Disposable plants are the ultimate example of flexible manufacturing. As much by necessity as by design, many capital-constrained RDE-based companies build short-lived, dispos-able plants—labor-intensive, dedicat-ed facilities for temporary mass pro-duction. Plants that are set up in this way can provide a relatively quick, low-risk entry to fast-moving mar-kets. With disposable factories, com-panies source equipment locally

◊ Scale from network-level sourcing and common processes

◊ Lean assets, processes, andnetworks

◊ Flexible production reduces the impact of logistics and currency costs

◊ Value of options for future response◊ Experience curve effects through

sharing of best practices◊ Greater access to managerial and

production talent

100.0 2.0 2.02.0 2.0

4.01.2 86.8

100

80

60

40

20

0Initial costs

without cluster

Scale

Lean andjust in time

Freight andforeign-

exchangerisk mitigation

Supplierprice

competitionJoint

experience

Accessto talent

Total costs withcluster benefits

Indexed cost

Example of the value of a cluster location versus an isolated assembly plant

Exhibit 5. The Value of Clusters Extends Beyond Factory Walls

Source: BCG analysis.


rather than importing complex, auto-mated systems. The factories are sim-ple to operate and maintain, ex-tremely lean when it comes to capital, and relatively inexpensive to repurpose. By contrast, when a state-of-the-art, capital-intensive plant be-comes obsolete, the company must either carry it or write it off—at a much higher cost.

Setting Up Lean, Localized Operations. Although costs in RDEs are lower overall than costs in developed coun-tries, the basic lean-manufacturing principle of cutting out wasted time, effort, and materials still applies—a fact that many companies lose sight of in their rush to get RDE plants up and running. Optimal cycle times, buffer stocks, and approaches to quality and “make it right the first time” may be different in a plant in China or India than one in Germany or the United States, but the princi-ples and mindset should be the same. Instead of replicating lean-plant designs from their high-cost lo-cations, however, companies should adapt their lean approach to local conditions. This often means making counterintuitive decisions. For in-stance, given the high turnover of employees in many RDE locations and the low cost of training people, it may be less expensive to simplify or “de-skill” tasks and build a pipeline of replacement workers and supervi-sors than to recruit experienced em-ployees and import costly expatri-ates as managers. Another common practice in RDEs is to use a mix of permanent and contract labor to keep labor costs low and provide more flexibility—especially when ex-port demand fluctuates.

Some MNCs are slower to learn the importance of localization than oth-

ers. An automotive company brought in an expatriate manager to build world-class dealerships in India—carbon copies of their dealerships at home. Customers loved the ambi-ance of these dealerships but balked at the high prices. Unlike its more

successful competitors, the automak-er never aligned its business model with the realities of price-sensitive markets, low dealer margins, and high real-estate costs.

Extending lean principles to the sup-ply base is another key aspect of lo-calizing operations. Many companies look strictly at cost when choosing RDE-based suppliers, focusing on how competitive one bid is com-pared with another. This approach assumes that all suppliers are equal-ly competent, which is rarely the case—maturity levels can vary wide-ly. To build a strong local supplier base, MNCs may need to think in terms of developing their suppliers, not just selecting them. For instance, a well-known consumer-goods com-pany had quality problems with the products it was manufacturing in China. Instead of installing costly quality-testing equipment, the com-pany set up a team to focus on im-proving the supplier’s operating ca-pabilities and reducing the quality problems over time. Moreover, some global manufacturers have as many as two development specialists for every buyer in their offshore-pro-curement groups—clearly a long-

term investment in the supplier base. These companies accept that com-petitors will benefit from the suppli-ers’ increased capabilities but are willing to accept the tradeoff.

Stage 3: Global Integration. In the third and most mature stage, compa-nies integrate their RDE-based plants into global manufacturing networks, going well beyond simple cost arbi-trage or local advantage. This strate-gy combines the best of the develop-ing and the developed worlds: the cost advantages, flexibility, and ambi-tious workforce of RDEs, and the marketing capabilities, sophisticated technology, and management depth of developed countries. These global networks serve a full range of cus-tomers—from RDE-based customers to high-end ones in developed mar-kets—by offering a variety of prod-ucts with different features and price points. Companies that reach this stage have worked through the chal-lenges of how to achieve a sustain-able competitive advantage through RDE-based manufacturing. (See the sidebar “Asking the Right Ques-tions.”)

India’s Bharat Forge has a globally integrated network strategy that pro-vides a high degree of flexibility. The company serves its customers in Eu-rope and the United States from at least two plants—one in a low-cost location and the other in a higher-cost location close to customers—and can rebalance capacity by shift-ing products and production steps between the plants. When a prod-uct’s profit margins drop as a result of competitive pressures, Bharat Forge can migrate production from high-cost plants to low-cost ones, which helps the company maintain its margins.

In the third stage,

companies integrate

their RDE-based

plants into global

manufacturing networks.


A global manufacturer of power equipment uses another form of this strategy. Three large-scale plants in different parts of Asia account for about 85 percent of the company’s total labor hours. High-cost locations close to customers in Europe and the United States account for the rest. While the Asian plants produce

standard, “as built” products for most market segments, the Europe-an and U.S. plants customize the products for specialized, high-end users. To make this strategy work, the company globally sources most components and standardizes pro-duction processes to assure consis-tent quality. A single ERP system en-

ables production and inventory coordination.

The low costs and falling trade barriers of the last decade made RDE-based sourcing

and manufacturing an easy decision. For a brief window of time, even an ill-conceived strategy could deliver savings. That window is closing, but heading home is not the answer. In most industries, a strong presence in RDEs is becoming more important than ever as markets develop and clusters of talent, suppliers, and com-petitors take off and shape the fu-ture. But the era of labor costs as the primary driver of RDE-based manu-facturing is coming to an end. In-stead, companies should seek to build globally advantaged manufac-turing networks that combine the best of the developed and develop-ing worlds—and confer a truly sus-tainable competitive edge.

To achieve a sustainable competi-tive advantage through RDE-based manufacturing, companies should ask themselves six questions:

Are we managing for competitive ◊advantage—or chasing costs to the bottom?

Are we leveraging local capabili- ◊ties to the fullest?

Are our RDE plants and supply ◊chains lean?

Do we have the right capabilities, ◊metrics, and accountabilities—and do our suppliers have them as well?

Are our legacy assets and mind- ◊sets holding us back?

Do we have a globally advan- ◊taged production network?

Asking the Right Questions


About the AuthorsArindam Bhattacharya is a partner and managing director in the New Delhi office of The Boston Consulting Group. You may contact him by e-mail at [email protected].

Jim Hemerling is a senior partner and managing director in the firm’s San Francisco office. You may contact him by e-mail at [email protected].

Benjamin Pinney is a principal in BCG’s Shanghai office. You may contact him by e-mail at [email protected].

Harold L. Sirkin is a senior partner and managing director in the firm’s Chicago office and the global leader of BCG’s Operations practice. You may contact him by e-mail at [email protected].

Bernd Waltermann is a senior partner and managing director in the firm’s Singapore office. You may contact him by e-mail at [email protected].

AcknowledgmentsThe authors would like to thank their colleagues Karthik Balasubramaniam, William Collis, Richards Gilbert, Frieda Hsu, and Kim Wee Koh for their contributions to this report. They would also like to thank Martha Craumer for her help in writing the report and Katherine Andrews, Gary Callahan, Kim Friedman, and Sharon Slodki for their contributions to its editing, design, and production.

For Further ContactBCG’s Operations practice and Glob-al Advantage Initiative jointly spon-sored this report. If you would like to discuss the issues in this report, please contact one of the authors.

For inquiries about the Global Ad-vantage Initiative, please contact one of its global leaders: Arindam Bhat-tacharya, Jim Hemerling, or Bernd Waltermann.

For a complete list of BCG publications and information about how to obtain copies, please visit our Web site at www.bcg.com/publications.

To receive future publications in electronic form about this topic or others, please visit our subscription Web site at www.bcg.com/subscribe.

© The Boston Consulting Group, Inc. 2009. All rights reserved.6/09

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