Component Sourcing Strategies of Multinationals: An Empirical Study of European and Japanese Multinationals

COMPONENT SOURCING STRATEGIES OF MULTINATIONALS: AN EMPIRICAL STUDY

OF EUROPEAN AND JAPANESE MULTINATIONALS

Paul M. Swamidass* Auburn University

Masaaki Kotabe** The University of Texas at Austin

Abstract. This is a study of component sourcing decisions of Euro- pean and Japanese manufacturers for supplying their manufacturing operations in their home countries for export to the U.S. as well as their operations in the United States. Specifically, employing data from seventy-one multinational manufacturers of European and Japanese origin operating in the U.S., the study investigated the determinants of international sourcing decisions. The authors found support for the hypothesis that international sourcing could be explained using international plant location theory. The significance of this finding is that it offers a new theoretical framework to spur much needed research on the topic of international sourcing.

Sourcing decisions match intra-firm production sites with markets, and/or match intra- and inter-firm components suppliers with production sites. Further, in multinational firms, sourcing is an important part of global rationalization, which is the strategy of optimizing production and distribution

*Paul M. Swamidass is Associate Professor of Management and Associate Director of the Thomas Walter Center for Technology Management. He received his doctorate in operations management from the University of Washington, Seattle. This is his second publication in the Journal of International Business Studies. He has published in several research journals including Management Science, the Academy of Manage- ment Review, and the International Journal of Production Research. He is the author of the monograph, Manufacturing Flexibility (Waco, Texas: Operations Management Association). His research and teaching interests include manufacturing strategy, technology, manufacturing flexibility, and international manufacturing.

**Masaaki Kotabe is Assistant Professor of Marketing and International Business at the University of Texas at Austin. His research interests include global sourcing, competitive strategy, and cross-cultural comparative issues. His research has appeared in such journals as Journal of International Business Studies, Columbia Journal of World Business, International Marketing Review, and Journal of Marketing, among others. He is the author of Global Sourcing Strategy: R&D, Manufacturing, and Marketing Interfaces (New York: Quorum Books, 1992).

Received: September 1991; Revised: April & June 1992; Accepted: June 1992.

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82 JOURNAL OF INTERNATIONAL BUSINESS STUDIES, FIRST QUARTER 1993

decisions across an international network of facilities that depend upon each other for raw materials and components [Franko 1978; Kogut 1985; Kotler, Fahey and Jatusripitak 1985; Stopford and Wells 1972; Yoshino 1976]. Furthermore, sourcing decisions are used in integrating multinational operations for strategic advantage through the effective movement of components, subassemblies and finished products as imports and exports among the firns' various international units [Kogut 1985; Kotabe and Omura 1989; Porter 1986].

International sourcing could occur in the form of intra- or inter-firm flow of goods. Multinational firms create intra-firm trade between their various international units. Today, intra-firm trade managed by multinational firms is a sizable proportion of international trade. For example, according to the latest survey by the United Nations Centre on Transnational Corporations [1988], in the case of the United States, intra-firm trade accounts for about 30% of U.S. exports and about 40% of U.S. imports. For both Japan and Western European countries, intra-firm transactions account for approximately 30% of their total trade flows (exports and imports combined), respectively.

Inter-company sourcing at the multinational level from vendors external to the firm is also a significant part of international trade. Currently, the role of international sourcing from external (or independent) suppliers is growing because "in a global marketplace crowded with a myriad of competitive firms both from developed countries and developing countries, it has become easier for any multinational firm to source an increasing portion of its components for manufacture from outside suppliers" [Kotabe 1990].

Some forms of intra- and inter-firm sourcings from overseas suppliers by U.S. manufacturers (regardless of nationality of ownership) are encouraged by the U.S. tariff provisions for products imported under tariff items 9802.00.60 and 9802.00.80 of the U.S. Harmonized Tariff Schedule (formerly known as 806.30 and 807.00 of the Tariff Schedules of the United States until 1989). These tatiff provisions permit the duty-free reentry to the United States of U.S.-made components sent abroad for further processing or assembly. During 1985-88, U.S. imports under 9802 provisions increased by 142% to $74 billion, at a much faster pace than total U.S. imports, which rose by 27% to $437 billion.

Thus, intra- and inter-company trade by multinational firms is a sizable part of international trade. However, the topic of international sourcing, which touches several disciplines including international trade, business strategy and manufacturing strategy, has not received the attention it deserves from researchers.

PURPOSE

The purpose of this study is to empirically examine the determinants of various forms of international sourcing. First, the study investigates the determinants of component sourcing strategies of European and Japanese



COMPONENT SOURCING STRATEGIES 83

multinationals exporting to the United States, and secondly, it investigates the determinants of component sourcing strategies of European and Japanese multinationals manufacturing in the U.S. The dual focus of this study is significant because tariff barriers do not always have a uniform effect on finished goods, and semifinished components or raw materials. Most indus- trialized countries "admit raw materials virtually duty free, semiprocessed goods at moderate duties, and finished manufactures (especially of the labor- intensive variety) at high duty rates" (Kreinin [1987], p. 308). This differential effect of trade barriers on finished goods and semifinished goods makes it worthwhile to investigate and compare the sourcing practices of exporters to the U.S. and the sourcing practices of foreign manufacturers in the U.S.

LITERATURE

The Various Forms of International Sourcing

Consider the example in which a Japanese firm manufactures its product in Japan for export to the U.S., and then some years later, invests in a manufacturing facility in the U.S. to make the same product for sale in the U.S. In this case, it is not difficult to see that the sourcing decisions, once production shifts to the U.S., will undergo major changes. This is because, logically, there will be pressure to use more components from local U.S. manufacturers for reasons of convenience, proximity, transportation cost, tariff costs and flexibility. Further, the establishment of a plant in the U.S. may discourage the use of imported components that are subject to tariffs and excessive transportation costs. Additionally, foreign manufacturers, once located in the U.S., become familiar with local component suppliers, which makes it easier to source locally. Thus, the addition of a plant in a new location (U.S, in this example), switches production for export from Japan to production for local sale in the U.S. resulting in major changes in sourcing decisions.

International sourcing could originate in the home country of the firm, in a developed country (DC), developing country (some authors use the term, less developed country, LDC), or in the host country (local). Additionally, international sourcing could be intra-firm and inter-firm. Again, international sourcing could be used in making finished goods intended for local sale or for export markets. Thus, given the many forms of international sourcing, the explanations for international sourcing are varied and diverse. The following section proposes a simple framework to explain international sourcing.

Determinants of International Sourcing

According to Buckley and Pearce [1979], "[s]tandard location theory," which explains location decisions in terms of well-known variables such as cost, proximity to markets, etc., remains to be the "most important part of




sourcing policy decisions . . ." (p. 20). The stance taken by Buckley and Pearce captured in the quote above provides the underlying hypothesis of this study that international sourcing is at least partially determined by the same variables that determine international plant location decisions. In the international context, plant location theory is supplemented by foreign direct investment (FDI) theories which together explain international plant location in terns of barriers to trade, factor costs, transportation costs, exchange rate stability, market size, profitability in the host country, life cycle of the product, and the nationality of the firm making the location decision [Ajami and Ricks 1981; Buckley 1979; Dunning 1973, 1981; Swamidass 1990; Vernon 1966]. This list of determinants of international plant location decisions are defined as the eight independent variables for this study: (1) tariff and non-tariff trade barriers, (2) nationality-Europe or Japan, (3) stage in the product life cycle, (4) exchange rate, (5) transportation cost, (6) production cost, (7) growth in sales in the U.S., and (8) current profitability in the U.S. The rationale behind the inclusion of each of these independent variables is discussed below.

Trade Barriers. Tariff and non-tariff barriers are well-known determinants of import sourcing. Non-tariff barriers, which are intended to limit imports, take many forms including quotas, voluntary export restraints (VER), multinational trade agreements to restrict exports and imports, and administrative, technical and other regulations. A well-known VER was negotiated between the U.S. and Japan to limit Japanese export of automobiles to the U.S. during 1981-1986, while European autos were exempt.

Trade barriers encourage exporters to overcome the barrier by making a direct investment in the country imposing barriers. The effect of all barriers on imports is negative and consequently, this study expects trade barriers to have a negative impact on imported sourcing. Sometimes, the barriers are not applied uniformly against all nations. For example, the U.S. govern- ment offers preferential tariff and other treatments to LDCs to promote economic development. Since governments do not impose tariffs uniformly across nations, the effect of trade barriers on imported sourcing sometimes is to alter the origin of the import instead of discontinuing imports altogether; i.e., to overcome the negative effects of tariffs newly imposed by the U.S. on imports from Japan, Japanese firms may choose to import the same component from a different nation, whose exports to the U.S. are not subject to the tariffs in question.

Nationality. The importance of the nationality variable in multinational firm decisions cannot be easily overstated; "there exists a strong correlation between the nationality of a corporation and its operating strategy" (Davidson [1989], p. 147). Nationality as a determinant variable was studied here by investigating the practices of European and Japanese manufacturers.

There is evidence that sourcing patterns of European and Japanese firms are significantly different from those of U.S. firms. Generally, European finns




do relatively little foreign production for reimport to the home market, while Japanese firms manufacture components and products abroad, especially in Southeast Asia, primarily for export to countries other than Japan.

Among U.S. manufacturing facilities, Japanese subsidiaries reportedly tend to source (i.e., import) a higher portion of components from their home country than do European subsidiaries in the U.S. [Graham and Krugman 1989]. Japanese firms' propensity to import a greater proportion of their components from home is attributed to their relative inexperience in foreign operations, and their high standards for quality and dependable supply. Some studies of the behavior of multinational firms suggest that the more experienced these firms become, the more likely they are to increase local contents for their away-from-home manufacture [Vernon 1966, 1979].

Product Life Cycle. Vernon [1979] is credited with the idea that products in their mature and declining phase are often manufactured in developing countries by multinationals based in developed nations. Product life cycle plays a complex role in time and space in multinational manufacturing decisions of international firms. This phenomenon, called the international product cycle (IPC), accounts for the timing and location of product inno- vations, the nature of markets, economies of scale, and uncertainty in trade patterns [Kotabe 1989; Vernon 1966, 1979], and international direct investment [Davidson 1989; Kotabe and Omura 1989].

There are also other forces in action here. A multinational firm in one developed nation may not want to manufacture a new product in another developed nation for fear of disclosing its technological secrets to the nationals of another country. Therefore, the effect of PLC on the sourcing decisions of multinational manufacturers exporting to and manufacturing in the U.S. will depend on the recency of the technology involved, economies of scale relating to the component, the maturity of the product, standardization of the product to permit its manufacture anywhere in the world, and uncertain- ties associated with external procurement.

Cost. In the list of independent variables above, four variables are directly associated with cost: tariff costs, exchange rate, transportation cost and production cost. In addition to the body of classical economics literature, the importance of various forms of costs to sourcing decisions is stressed by many, including Carter, Narasimhan and Vickery [1988], and the MAPI [1986]. Kotler, Fahey and Jatusripitak [1985], based on the experiences of successful Japanese multinational firms, contend that the lowest cost in production and transportation is accomplished by multinational firms by the right match between markets and manufacturing sites for components as well as for finished products. Therefore, the hypothesis of this paper is that international sourcing decisions try to minimize sourcing costs given the constraints of limited sources, tariff barriers, the difficulty in switching suppliers in response to changes in sourcing costs, etc.




Market. In the list of independent variables above, growth in sales and profitability in the U.S. represent market-related factors in location decisions. The importance of markets to location decisions, and the importance of U.S. markets to multinational manufacturers is well recognized [Ohmae 1985]. Generally, growth and profits drive multinational firms. Therefore, this study hypothesized that multinationals prefer sourcing decisions that con- tribute to growth and profit in the U.S. market. Further, when market growth is anticipated in the U.S., local sourcing in the U.S. would be preferred for most components except for those components which can be produced or imported economically by the multinational firm.

This concludes our discussion of the rationale for choosing the eight independent variables. In the next section, we discuss the multivariate models we employed to investigate the influence of these eight variables on sourcing decisions.

MODELS

Two sets of linear multiple regression models were employed in our investigation. Using the first set of models, we investigated the determinants of four alternative component sourcing decisions for European and Japanese multinational manufacturers exporting to the U.S. market. The four sourcing alternatives modelled were: (1) from home-Europe (Western Europe was treated as one unit) or Japan, (2) from the U.S., the host country (3) from other developed countries (DC), and (4) from developing or less developed countries (LDC). Using the second set, four identical sourcing options for European and Japanese manufacturers engaged in manufacturing in the U.S. were modelled. Thus a total of eight sourcing decisions in two different manufacturing contexts (exporting to the U.S. versus manufacturing in the U.S.) were modelled. The pros and cons of the four sourcing decisions studied are presented below. In the following discussions, readers should note the unique outcome of the interactions between the independent variables and the different sourcing alternatives investigated.

First, LDC sourcing has the advantage of low labor costs and sometimes easy access to inexpensive raw materials; oil, agricultural and mined products are examples. LDC sourcing is generally suitable for manufacturing stand- ardized products, low in technology or past the maturity stage in the life cycle.

Second, sourcings from developed countries are generally appropriate when the manufacturer in the U.S. already has facilities in other developed countries and prefers to benefit from the economies of scale resulting from supplying the U.S. market. Further, developed country sources are suitable for advanced and high technology products.

Third, local sourcing (in the U.S. by foreign multinational manufacturers) offers the convenience of proximity to the assembly operation, and generally, the U.S. could supply most components. The reason for not sourcing locally in the U.S. may be due to relatively more reliable, economic facilities




operated outside the U.S. by the multinational firm, or its unwillingness to transfer proprietary technology to the U.S.

Finally, sourcing at home by European and Japanese manufacturers may be due to the desire to control quality, cost and technology of the product and to benefit from the economies of scale afforded by existing facilities at home. Further, the time to develop new, reliable and acceptable suppliers for technologically advanced products is normally very high, which makes it difficult for foreign multinationals to find substitutes for home country supplies.

The research design of this study consisted of the empirical estimation of the eight linear, multiple regression models described below:

A. The Case of European and Japanese Exports from Home Country: Model 1: Home country

sourcing = a, + ?b1j(xj)+ej ... (i = 1, 2, ..., 8, IVs)*

Model 2: U.S. sourcing = a2 + Yb2j(xj)+e2 ... (i = 1, 2, ..., 8, IVs) Model 3: Sourcing from

other developed countries = a3 + Eb3j(xj)+e3 ... (i = 1, 2, ..., 8, IVs)

Model 4: LDC sourcing = a4 + Eb4j(xj)+e4 ... (i = 1, 2, ..., 8, IVs)

*IV=independant variable

B. The Case of European and Japanese Manufacturing in the U.S.:

Model 5: Home country sourcing = a5 + Xb5j(xj)+e5 .-. (i = 1, 2, ..., 8, IVs)

Model 6: U.S. sourcing = a6 + ?b6i(xd)+e6 ... (i = 1, 2, ..., 8, IVs)

Model 7: Sourcing from other developed countries = a7 + ?b7j(xj)+e7 ... (i = 1, 2, ..., 8, IVs)

Model 8: LDC sourcing = a8 + ?b8j(xj)+e8 ... (i = 1, 2, ..., 8 IVs)

where, bhi are regression coefficients, and eh are error terms.

Why Eight Models? One could argue that once Models 1 through 3 and Models 5 through 7 are estimated, Models 4 and 8 will be self-evident without the need for separate regressions. At the very outset of this study, we were convinced that this would not be the case. Thus, the eight models are viewed as mutually independent although the measurement of the dependent variables as a percent of total sourcings implies that once the values of the dependent variables for Models 1 through 3 are known, the corresponding value for Model 4 is automatically determined. Yet, once the coefficients for Models 1 through 3 are estimated, the coefficients for Model 4 will not be automatically evident because (1) all eight independent variables may




not be statistically significant in every model empirically estimated, and (2) all firms participating in the study may not use all the sourcing options available to them; the data and the findings of the study confirmed this line of reasoning.

Stepwise Regression. Being an exploratory study in which the researchers were interested in identifying the determinants of international sourcing decisions, stepwise regression was the preferred analytical tool. Additionally, as explained later, a test for multicollinearity among the IVs proved to be positive; the use of the stepwise procedure overcame the problems caused by multicollinearity among the independent variables.

SAMPLE

The sample of firms for this study was selected from discrete products manufacturing industries, which included electronics, transportation equipment, scientific and photographic equipment, motor vehicles and parts, aerospace equipment, computers and office equipment, and industrial and farm equipment. The industries chosen are generally known to attract European and Japanese exports as well as foreign-owned manufacturing facilities to the U.S.

A total of 250 U.S. subsidiaries of European and Japanese firms (175 European and 75 Japanese) listed in the International Directory of Corporate Affiliations 1985/1986 [1985] were contacted. These foreign multinational firms were limited to those listed in the Fortune International 500 [Fortune 1986]. During fall 1986/winter 1987, questionnaires were mailed to the CEO of each subsidiary, requesting him (her) to identify one of its major products that has been introduced in the United States within the past ten years, regardless of the origin of the product. Out of the seventy-five responses received, seventy-one were usable (forty-three European and twenty-eight Japanese), with a response rate of about 28%. The seventy-one responses included a few with some missing data, which slightly altered the sample size during regression and other analyses to follow.

A majority of the respondents were from wholly owned subsidiaries or divisions of foreign manufacturers. About 17% of the responses originated from the parent firms in the home country (non-U.S.), .indicating that the questionnaire was forwarded to the non-U.S. parent by their affiliates in the U.S. Based on the titles declared in the responses, over 80% of the respondents were from top management which included presidents, vice presidents and directors, and the rest were functional managers. Our analysis of the respondents showed that the nationality of the multinational firms in the sample is similar to the nationality of the multinationals contacted. Further, our analysis showed that the sample is representative of the industrial affiliations of foreign firms contacted; the one exception being the motor vehicle industry, which is not adequately represented in the sample.

Two additional analyses were performed to examine if the "collected" data would introduce sampling bias. First, earlier respondents were compared




with later respondents on selected descriptive variables, including nationality, annual sales volume, corporate product policy, and type of product. The lack of significant differences in this comparison offered one evidence that this study may not suffer from nonresponse bias (cf. Armstrong and Overton [1977]). Second, to see if the job titles of the respondents had any impact on the way they responded to the questionnaire, the responses were compared across job titles (top management, functional manager, or director of corporate planning). As no significant differences were observed, there is no evidence to think that job titles of respondents may have biased the study. Our correspondence with executives/directors of corporate strategic planning at the headquarters of seven foreign multinationals operating in the U.S. (four European and three Japanese) confirmed that the CEOs of their U.S. subsidiaries were fully knowledgeable of their parent firms' policies relevant to this study.

MEASURES

Questionnaire Development

The questionnaire used to collect data for this study was part of a larger questionnaire with multiple research objectives. The questionnaire included, (1) one measure for the dependent variable, (2) nine items to measure trade barriers, exchange rate concerns and cost-related independent variables, (3) six items to measure U.S. market-attractiveness in terms of growth and profitability as independent variables, (4) one measure for product life cycle as an independent variable, (5) one measure for the country of the parent as an independent variable, and (6) one categorical variable to classify responses on the basis of whether the product was exported to the U.S., or manufactured in the U.S. by the foreign firm. The nine questions referring to trade barriers, cost and exchange rate concerns were derived from the discussions in the Literature section. A U.S. market- attractiveness measure developed by Burke [1984] for domestic finns was modified for this study, which focuses on the international side. Academic colleagues with expertise in the topic were consulted while prepar- ing the questionnaire. Once academic colleagues' suggestions were incorporated in the questionnaire, the entire questionnaire was pretested with executives/ directors in charge of corporate strategic planning at the headquarters of seven foreign multinationals (four European, three Japanese). Their inputs were used to refine the questionnaire. This process for questionnaire development was used to ensure its validity.

Dependent Variables

The dependent variable was measured as a percentage of total value of components sourced from five possible locations or options: European countries, Japan, U.S., other developed countries, and less developed countries (i.e., developing countries). Thus, all dependent variables were measured as percentages.




Since Models 1 through 4 investigated sourcing for exports to the U.S. from home country, and Models 5 through 8 investigated sourcing of U.S. manufacturing operations owned by European or Japanese firms, the questionnaire requested information on the country of origin of the product.

Independent Variables

Nationality and PLC Variables. The responses to direct questions in the questionnaire on nationality and product life cycle provided the needed measures for these two variables. Nationality was coded either 1 for Japan or 0 for Europe. Product life cycle was coded 1 to 4 representing four distinct stages in the life cycle (1=new stage, ..., 4=declining stage).

Cost and Market Variables. We developed composite measures for six independent variables covering cost- and market-related issues. As mentioned earlier, the nine cost-related items and the six market-attractiveness-related items were factor analyzed as the first step in reducing the items to mutually independent factors (i.e, variables).

The result of the factor analysis showed that the top six factors with eigen- values >1 were consistent with six independent variables relevant to this study. The loadings on all six factors were very polarized; each factor had a few items showing loadings in excess of .75 while other items showed considerably lower loadings. Given the polarized nature of item loadings, composite measures for the six factors were computed by averaging the scores for the items with loadings >.75 on the factor of interest. The top six factors, the factor names given to them, and the number of items with large loadings on each factor are listed below:

Market Barriers, Cost, and Exchange Rate Factors (1) Tariff and non-tariff barriers (four items; coefficient alpha=.88) (2) Transportation cost (two items; coefficient alpha=.87) (3) Manufacturing cost (one item) (4) Stable exchange rate (one item)

U.S. Market-Attractiveness Factors (5) Growth of market in the U.S. (two items; coefficient alpha=.86) (6) Current profitability in the U.S. (two items; coefficient alpha=.80)

FINDINGS

This section is presented in two parts. First, descriptive statistics are discussed as they provide interesting insights into the international sourcings of multinational firms listed in the Fortune International 500 [Fortune 1986]. Second, regression analyses are performed to examine whether or not consistent patterns of international sourcing would emerge.




Preliminary Results

The study was so designed that a responding firm either exported products to the U.S. from home country, or it manufactured the products in the U.S. for local use, but not both. Therefore, the initial step in the analysis was to segregate the questionnaires (i.e., cases) on the basis of their response to the question concerning the country of origin for their product sold in the U.S. If the country of origin was outside the U.S., the particular case was pertinent to Models 1 through 4 (thirty-five responses), and if the country of origin was the U.S., the particular case was pertinent to Models 5 through 8 (thirty-three responses).

Tables 1A and 1B show interesting results of our preliminary analyses that identify, (1) the number of firms using the eight different sourcing altematives and (2) the average percent sourced using each alternative. It is evident from the table that among the respondents, sourcings from other DCs and from LDCs were employed by only a relatively small number of firms. According to Table 1A, while the average percent sourced from other DCs and LDCs were insignificant at 2.5% each, the averages were substantially higher (17% and 21.3%, respectively) if the averages were computed by excluding the firms that do not employ these two types of sourcings, i.e., the firns that do employ other DC and LDC sourcings, source a substantial proportion of their imports from these countries. A similar phenomenon is observable in Table 1B.

Table 1A shows that home sourcing (local sourcing in Europe or Japan) for export is the dominant form of sourcing (88.5%), and in the case of U.S. manufacturing, components imported from home drops to 29.9%, which is still significant. The importance of local U.S. sourcing for these foreign manufacturers in the U.S. is a healthy 64.3%, nearly two-thirds of all sourcings.

Table 1A shows a great diversity in international sourcing among multinationals exporting to the U.S. For example, (1) Japanese manufacturers do not use other DC sources, and (2) they rarely use U.S. sourcing. In other words, practically all sourcings from the U.S. and other DCs are done by European multinationals. Notably, while no Japanese multinational exporting to the U.S. sourced from other DCs (Table 1A), three Japanese multinationals sourced from other DCs while manufacturing in the U.S (Table 1B); explanations for these sourcing preferences may emerge from future studies. This diversity in sourcing practices underscores and supports the need for examining the different sourcing decisions using eight distinct models proposed earlier.

Pure Assemblers and Localized Manufacturers. Table 1B shows that three (about 10%) European manufacturers in the U.S. sourced their production entirely with U.S.-made components, i.e., the three are purely localized producers. The same table shows that two manufacturers in the U.S. get 100% of their components from home; pure assemblers. Pure assembly and pure localized production are the two extremes in international sourcing. In




TABLE I The Popularity of the Various Component Strategies

A. Component Sourcing for Exports to the U.S.

Home U.S. Other DC LDC Sourcing Sourcing Sourcing Sourcing

Number of users (n=35) Total: 35 12 6 5 (European 20, Japanese 15) European: 20 11 6 3

Japanese: 15 1 0 2

Firms making 100% sourcing European 6 0 0 0 Japanese 12 0 0 0

Average percent sourced 88.5% 6.5% 2.5% 2.5% (total 100%)

Average percent when 88.5% 18.5% 17.0% 21.3% non-users are excluded

B. Component Sourcing for Manufacture in the U.S.

Home U.S. Other DC LDC Sourcing Sourcing Sourcing Sourcing

Number of users (n=33) Total: 27 31 5 5 (European 21, Japanese 12) European: 16 20 2 4

Japanese: 11 11 3 1

Firms using 100% sourcing European 1 3 0 0 Japanese 1 0 0 0

Average percent sourced 29.9% 64.3% 1.8% 4% (total 100%)

Average percent when 36.6% 68.5% 11.8% 26.4% non-users are excluded

this era of growing multinational production, the factors that cause purely localized production and pure assembly in a foreign country are worthy of investigation in the future; these are seldom researched topics of value to policy makers, researchers and practitioners.

Sourcing and the Time of Product Introduction. In order to test if U.S. sourcing by the multinationals exporting to the U.S. was a function of how long the product had a U.S. presence, we investigated the correlation between the year the product was introduced in the U.S. market and the percent of U.S. sourcing for the product. We found no significant correlation (r=.15, p=.38). In Table 1A, for the twelve exporters using components from the U.S., the average of the year of product introduction in the U.S. market was the year 1978.25 and for the twenty-two firms that did not use U.S. components, the corresponding average year was 1973.95 (we lacked data on one of the




twenty-three firms that did not use U.S. components). The difference was statistically insignificant (t=.92, p=.37). Therefore, the expectation based on Vernon's work [1966] [1979] that firms with longer U.S. presence would have more U.S. sourcing is not supported by our data. Follow-up investigations are needed to explain and to understand this finding.

In the case of U.S. manufacturing, we found that the more recent the introduction of a product in the U.S. market, the less the U.S. sourcing (r=-.33, p=.06). This is consistent with the expectations in the literature that mere assembly operations precede local sourcing of components. To complete this section on preliminary analysis, Table 2 shows the matrix of correlation between all the independent variables in the study.

Regression Analyses

Multicollinearity. Initially, multicollinearity among the independent variables was suspected. Yet, regression analyses were performed with all eight independent variables in the models. This resulted in condition index values that were unacceptable (i.e., the square root of the ratio of the largest eigenvalue to each individual eigenvalue); the condition index for Models 1 through 4 was 23.5, and 36.9 for Models 5 through 8, given that a condition index in excess of twenty indicates serious multicollinearity [Belsley, Kuh and Welsch 1980]. The use of stepwise regression in subsequent analyses overcame the problem of multicollinearity.

Sourcing Decisions for Exports to the U.S. The variable nationality (scored 0, 1 for European and Japanese nationalities, respectively), which appears in three of the four models in Table 3, has the most pervasive influence on sourcing decisions; however, based on the direction of the relationships between the independent variables and dependent variables, manufacturers from Europe and Japan appear to take diverse approaches to sourcing decisions, thereby confirming Buckley and Pearce [1979].

Based on R2 values for the four models, among the four strategies, the sourcing of components from LDC is the best explained (.42) followed by home sourcing (.35) and U.S. sourcing (.33). The high R2 values associated with the models in Table 3 make a compelling case for confirmatory studies beyond this exploratory investigation.

Component Sourcing for Manufacture in the U.S. Notable findings in Table 4 are, (1) when the importance of tariff and non-tariffbarriers increased, home sourcing increased (row 1, Model 5); (2) when the product matured, home sourcing decreased (row 3, Model 5) and U.S. sourcing increased (row 3, Model 6), and (3) growth in sales is negatively correlated with home sourcings (row 7). The last item is reasonable and consistent with the literature because as sales in the U.S. grow, local sourcing should become more attractive due to reasons of scale economies, cost, flexibility and proximity.




TABLE 2 Pearson Correlation Coefficients*

TARIFF IDNUM PLC EXCH TRANSP COST GROWTH PROFIT

TARIFF 1.00 .13 .13 .34 .56 .08 .10 .05 IDNUM 1.00 -.16 .20 -.05 .22 .11 -.08 PLC 1.00 .09 .07 .27 -.43 .10 EXCH 1.00 .33 .30 .08 -.01 TRANSP 1.00 -.01 .14 -.19 COST 1.00 -.08 -.13 GROWTH 1.00 .16 PROFIT 1.00

*full variable names spelled out below: TARIFF = Barriers IDNUM = Nationality PLC = Product life cycle EXCH = Exchange rate stability TRANSP = Transportation cost COST = Cost of manufacturing GROWTH = Growth in sales PROFIT = Short-term profitability

TABLE 3 Multiple Regression Models of Export Sourcing Strategies

of European and Japanese Multinationals

Nationality Code: Japan=1, Europe=0 Product Life Cycle Code: 1=New, 2=Growth, 3=Maturity, 4=Decline

Regression Coefficients

Model Number- 1 2 3 4 Sourcing Strategy- Home U.S. Other DC LDC

1. Tariff and non-tariff barriers -6.7** +2.2# 2. Nationality-European or Japanese +13.6* -10.5* +5.1I 3. Stage in the product life cycle +3.5 +5.7** 4. Exchange rate stability -3.1 5. Transportation cost +3.9* 6. Cost of manufacturing 7. Growth in sales 8. Short-term profitability in the U.S.

p .002 .003 .067 .006

.35 .33 .11 .42

#p<.10 *p<.05

**p<.01 n-31




In Table 4, based on R2, Model 5 for home sourcing explains a greater percentage of variations than any other model developed (R2=.46). It is notable that, unlike the sourcing for exports to the U.S. discussed above, the nationality of multinationals manufacturing in the U.S. had no discernible impact on sourcing alternatives; an interesting contrast in the behavior of multinationals that deserves better understanding through future investigations. The R2 values and statistical significance of the models in Table 4 are compelling reasons to go beyond the findings of this exploratory study.

Some Generalizations

Home Sourcing for Exports. Some findings of this study are more generalizable than others because they are based on a relatively large number of cases (e.g., Home Sourcing with thirty-five cases, Table 1A; Home Sourcing with twenty-seven cases, and U.S. Sourcing with thirty-one cases, Table 1B). In Tables 3 and 4, the sample size for the various models are somewhat smaller than what it appears to be in Tables 1A and 1B due to casewise deletion by the computer program when missing data was encountered (e.g., for Model 1, n=31 and not 35).

Model 1 shows that, as the importance of trade barriers increases, home sourcing for exports decreases. Additionally, Model 1 shows that Japanese firms source more at home than their European counterparts. This may be explained by the stronger and long-established supplier base used by Japanese manufacturers at home. Based on Model 1, we present the following propositions for future investigations:

Proposition 1: As the importance of trade barriers increases, home sourcing for exports to the U.S. will decrease.

Proposition 2: Japanese manufacturers exporting to the U.S. source more at home than their European counterparts because of Japanese manufacturers' stronger supply base at home.

Sourcing of U.S. Operations of Multinationals. Since in Table 1, home sourcing was employed by twenty-seven firms for supplying U.S. operations (Table 1B and Model 5), and U.S. sourcing was employed by thirty-one firms (Table 1B and Model 6), the findings of Models 5 and 6 are relatively more generalizable than the findings of other models. Thus, based on Models 5 and 6, we offer the following propositions:

Proposition 3: As product maturity increases, home sourcing of U.S. operations of multinationals decreases and local sourcing of U.S. operations of European and Japanese multinationals increases because foreign multinationals are able to find suppliers of mature technology in the U.S. with relative ease.




TABLE 4 Multiple Regression Models of Strategies for Sourcing

U.S. Operations of European and Japanese Multinationals

Nationality Code: Japan=1, Europe=0 Product Life Cycle Code: 1 =New, 2=Growth, 3=Maturity, 4-Decline

Regression Coefficients

Model Number- 5 6 7 8 Sourcing Strategy- Home U.S. Other DC LDC

1. Tariff and non-tariff barriers 10.1* 2. Nationality-European or Japanese 3. Stage in the product life cycle -27.7** +20.2** 4. Exchange rate stability 5. Transportation cost 6. Cost of manufacturing -12.1 # 7.6* 7. Growth in sales -14.9* 8. Short-term profitability in the U.S.

p .001 .018 .017

R 2 .46 .26 .19

#p< .1 0 *p<.05

**p<.01 n=29

Proposition 4: As sales in the U.S. increase, home sourcing of U.S. operations of European and Japanese multinationals decreases.

Proposition 5: As the importance of cost of manufacturing increases, local sourcing of U.S. operations of European and Japanese multinationals decreases.

Proposition 5 raises a question about the ability of U.S. suppliers to match the cost of imported components; additional studies are needed to understand this phenomenon.

The Significance of This Study

Based on Table 1, the number of observations for Models 3, 4, 7 and 8 show a skewed distribution; for example, in the case of Model 3, only six firms out of thirty-five have non-zero values for the dependent variables resulting in highly restricted variance, which would make it extremely difficult to unearth significant relationships between the independent variables and the dependent variables unless the independent variables are very strongly related to the dependent variables. Given that seven of the eight models were statistically significant, one must conclude that the dependent variables and independent variables are indeed strongly related.




As anticipated at the outset, the findings in Tables 3 and 4 show that a different mix of variables is associated with each decision. The significance and the magnitude of the R2 values for seven of the eight models estimated in Tables 3 and 4 support our case for estimating eight separate models here.

The significance of this study for research on international sourcing is that it has succeeded in showing that international plant location theory is a meaningful theoretical framework to explain international sourcing. It offers a valid new framework to launch more empirical studies on a topic that has attracted very few empirical studies.

Limitations of This Study

An obvious limitation is the cross-sectional, snapshot nature of the data used in the study. Yet, the strong relationships found in this exploratory work make a good case for more elaborate investigations in the future. Since there is some evidence that European and Japanese firms in the U.S. tend to concentrate in different industries, an industry variable may explain some of the differences in the sourcing practices of multinationals from these two regions. Given the many industries represented in our sample and the size of our sample, the effect of the industry variable could not be investigated here. It is recommended that future investigators should consider the industry variable in explaining the international sourcing decisions of multinationals, or they may want to control for the variable.

CONCLUSION

While international sourcing by manufacturing firms amounts to several hundred billion dollars a year, the phenomenon has received relatively little attention from researchers. One of the major hurdles to the investigation of international sourcing is data availability; data on intra- and inter-company international sourcing decisions are proprietary information that is difficult to obtain. In this study, we show that this hurdle could be partly overcome. However, the larger problem of obtaining intra-company sourcing data will remain to be a hurdle to researchers studying international sourcing decisions. As stands now, only the individual researcher's ingenuity in obtaining data can overcome this problemn.

Another reason for insufficient research on the topic is the absence of conceptual schemes to launch empirical investigations. In this context, the significance of this study is that it offers a new and simple conceptual scheme to investigate international sourcing. Our broader hypothesis derived from Buckley and Pearce [1979] is that international sourcing decisions are, at least partially, determined by the same variables that influence international plant locations. Collectively, the findings lend support to this rationale and they justify additional detailed empirical investigations of the implications of this hypothesis. For example, the hypothesis offers new avenues for




research by eliciting researchable statements such as, if international sourcing obeys international plant location theories, then, at least partially, international sourcing is a substitute for international manufacturing. The investigation of this substitutability should be an interesting and fruitful avenue for future research.

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Component Sourcing Strategies of Multinationals: An Empirical Study of European and Japanese Multinationals