Wednesday, July 9, 2014

An Examination Of How Decisions Are Made To Offshore Production

This article was prompted by a decision that Phillips made to offshore production from a highly efficient light bulb plant in Sparta, Tennessee to Mexico.  The plant management team did an analysis and concluded that it would purchase the plant from Phillips.  They had no trouble raising the money to finance the purchase because the plant was more cost competitive than the plant that Phillips was relocating in Mexico.  Factory labor costs are only 10-15% of the total wholesale price, and Phillips was going to incur costs as a result of relocating that would make it uncompetitive in very competitive market.

The Phillips decision raised questions about the process used by management when they decided to offshore 70,000 US plants.  Two Harvard professors interviewed 1,767 executives who participated in relocation decisions, and they concluded that rigorous processes for making those decisions were far from universal.  Hidden costs were underestimated, and some of the advantages from locating in the US were ignored.  There seemed to be a bias against keeping plants in the US.

One of the motivations for offshoring is that Wall Street has a positive view of offshoring.  They give a short bump to the stock price after relocation decisions are made.  In the Phillips case, a strategic decision was made to concentrate manufacturing.  Once that decision was made it followed that the Sparta plant must be relocated in order to be consistent with the strategy.  The decision making process in many organizations is also affected by a firms culture.  Junior executives who are more directly involved in relocation decisions are reluctant to raise questions when they perceive that top management is in favor of offshoring production.  Many offshoring decisions may have resulted from a colossal failure of due diligence. 

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