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Outsourcing Of Manufacturing Unit

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Question:

Discuss about the Outsourcing of Manufacturing Unit.
 
 

Answer:

Introduction:

In contemporary business world, with the advent of Globalization, the term “outsourcing” is becoming a common and significant one. Outsourcing, by a company or industry, in the broad sense of the term, means relocating or transferring a part or whole of their functional activities from the location of their initial operations to some convenient location (Primarily offshore) (Morschett, Schramm-Klein and Zentes 2015). The multinational corporations mainly do this with their headquarters situated mostly in developed economies and the relocations are usually done in developing or semi-developed growing economies to take advantages of their low cost of production, less rigidity in labour policies and growing infrastructure as well as market. This report discussed about one such manufacturer, the Raque Food Systems and its potential prospects and problems in outsourcing its production activities (Oshri, Kotlarsky and Willcocks 2015).

Raque Food Systems:

Founded as early as in 1975, the Raque Food Systems is one of the pioneers in the industry of food packaging machineries and is currently a world class manufacturer of industrial food packaging machines and a primary supplier of the same, especially to the Frozen Food industries. With offices in the United States of America and in the United Kingdom, the Raque Food System now has thirty two manufacturing plants and they ship their products all over the world. The company has this unique ability of designing and customizing any of its products according to the need if its customers, which adds tremendously to their goodwill and reputation in the global market and is a vital reason behind the substantial demand of their products worldwide (Raque.com, 2017).

Being stationed mostly in the USA and UK, one of the primary issues the company face is that of comparatively low profit margin as both the counties, being highly developed ones, have high manufacturing costs and strict minimum wage laws which hurt the interests of the company and its shareholders (Raque.com, 2017). On requests of the shareholders, to find out cost reducing alternatives, the company is considering outsourcing of its manufacturing sector to some other countries with lower production costs in general. Outsourcing, in this case can be a better option for the company, especially if it is done in some developing countries with expanding infrastructure, labour abundance and comparatively flexible labour and wage policies, which are beneficial for production activities of the company.

The initial research by the company has come up with two potential candidates, Malaysia and Mexico, showing credentials and possibilities for outsourcing. The report tries to analyse the economies of both the candidate countries and pros and cons of outsourcing the production activities of the Raque Food Systems in these countries, depending upon their infrastructures, labour markets, amenities, policies, market prospects, political aspects and cultural diversities.

Potential Candidates:

Malaysia:

With 13 states and 3 federal territories, the country is a constitutional monarchy, situated in the heart of South East Asia and is a beautiful example of multi-cultural society with diverse ethnicity. The Malays, Indians and Chinese form the major share of the Malaysian population and with Kuala Lampur as the capital city, Malaysia is currently emerging as one of the primary economic giants in the global scenario showing huge potentials and future prospects (Jomo 2016).

 

Mexico:

The country is the second largest economy in Latin America, making its place in the global market as a major oil exporter. With Spanish as the main language and Christianity as the primary religion, the country has a huge underutilizes labour base and a wide socio-economic gap among its population, which makes availability of cheap labour easy and brings the country in the list of potential candidates (Sánchez and Luna 2014).

General Information:

Economic Overview:

Malaysia, with a population of around 29 million, has a GDP of around 296 billion USD, an impressive per-capita GDP of nearly 9502 USD and a stable GDP growth rate of 4.8%. the economy remains a major global source of electronic products, net exporter of crude oil and one of the largest producers of tropical hardwood and rubber. With time, the country has been showing impressive figures in Foreign Direct Investments (Mundial 2013).

Figure 1: FDI in Malaysia

(Source: Theglobaleconomy.com, 2017)

From the above chart, it can be seen that the FDI has considerably increased in the country post 2009 and the country experienced a massive upsurge in the FDI (12.3% approximately) in 2011, indicating that it is increasingly becoming one of the primary countries of interest for most of the MNCs which want to outsource their operations. In 2015, the country recorded a FDI of 10.96 billion USD (Ahmed 2012). The sectors, experiencing the major inflow of investments by the foreign MNCs are mainly manufacturing sector (50%) and service sector (27%). The economy has a unemployment rate of 3.3% and maintains a highly stable equilibrium with less economic fluctuations and consistent growth trends, thereby making the country a major centre of attraction for outsourcing (Jomo 2016).

Mexico has population strength of 121.1 million, with the GDP of around 2.2 trillion USD and a GDP per capita of around 17,530 USD. The country experiences a 2.5% growth rate in GDP (Much lesser than that of Malaysia, indicating that Malaysia shows much bigger prospects in future expansion) (Ajagbe and Ismail 2014).

Figure 2: FDI in Mexico

(Source: Theglobaleconomy.com, 2017)

The above figure shows the flow of FDI in Mexico, over the past few years and as it can be seen, FDI has considerably decreased post 2016. The main chunk of the FDI flow in the country is in the manufacturing sector like that of Malaysia. The primary reasons behind this fall in FDI are the increasing rates of crimes, drug trades (Which forms one of the primary negative issues of this economy) and lack of constructive reforms in the industrial sector of the economy, as well as the tax structure of the country (Robles, Calderón and Magaloni 2013). This shows that the country, though still popular among the investors, is fast losing out to its more competent counterparts due to lack of credibility. The unemployment rate in Mexico is currently 4.3%, which is much higher as compared to Malaysia (Sánchez and Luna 2014).

Economic Forecast:

On September 2010, the Government of Malaysia introduced an Economic Transformation Programme or the ETP and the Government Transformation Programme or the GTP, with the vision of making the country one of the highest income nations by the year 2020 (Mundial 2013). The significant role of one of the primary component of this ETP is promoting the country as top investment attraction and outsourcing location for the foreign multi-national corporations and the growth in the private sector of the country has been impressively high since then (Ahmed, E.M., 2012). The launch of the Tun Razak Exchange in 2012 has also attributed to the prospects of the country as a major investment destination. There is a high possibility of negotiation of a Free trade agreement between Malaysia and the European Union (EU) and of partnership of the country at a Trans-Pacific level, both of which can improve the business environment of the country manifold and attract even more global investors as well as MNCs in future (Khan, Liew and Ghazali 2014).

 


However, the country does have several non-favourable issues which have the potential to hamper their economic and industrial growth. Firstly, the country, being one of the Asian Giants, faces stiff competition from the other Asian Economic Giants like China, Indonesia or Vietnam (Sánchez and Luna 2014). China, though seeing a decline in growth of its economic and business possibilities in the current global scenario, still remains one of the largest manufacturers in the global market and enjoys a huge market for their products. Therefore, it draws a substantial amount of FDI, along with the growing economies like Indonesia and Vietnam, thereby, posing a tough competition to Malaysia in terms of attracting FDI (Forbes.com, 2017). Another threat faced by the country is the threat of terrorism and piracy, which the country often faces in its waterways and shipping tracks. This makes the investors a little sceptic, especially those who have to transfer or ship raw materials and finished products through this channel. However, in spite of these threats, Malaysia is garnering enormous attention of the foreign investors and the country is projected to experience economic boom in the years to come. From an enormous amount of 187 million USD in 2010, the outsourcing in the business process has increased to over 700 million USD in 2015 and is expected to increase further in the coming years (Ajagbe and Ismail 2014).

Mexico, on the other hand, has experienced a boom in its economy right from the start of the new age Globalization. Its huge labour resources, providing for a cheap labour base, has been the primary advantage of the country, due to which the country has attracted substantial amount of FDI in the last few years. However, the country saw a massive setback in its economy in 2015-2016, one of the main reasons behind this being the frequent turbulence in the country’s economic and political conditions, contributing to the instability of the country and making it less attractive in the eyes of the foreign MNCs gearing up for outsourcing (Sánchez and Luna 2014). This is because no company wants to shift its base or production sector to a location, which in spite of having cheap and abundant source of labour has a disturbed and volatile business environment. The country currently has a high inflation rate and is expected to remain at an economic growth rate of 2% in 2017-2018 (Anderson 2013).

Infrastructure:

The main reason for Malaysia becoming one of the primary centres of attraction of the foreign investors with time is its dynamic and integrated overall infrastructure, which contributes hugely in creating an efficient and competent business and production environment. The country is a fast growing technological giant, with a mixed cultural workforce, consisting mainly of Malays, Indians and Chinese, all of whom are known for their efficiency and productivity in the worldwide labour market (Forbes.com, 2017). The labour force in Malaysia is multi-lingual, skilled and with English proficiency. Moreover, the with the projected development of the TRX or the Tun Razak Exchange, a new and more production augmenting economic structure is expected to develop in the country (Razak 2013). Malaysian economy also provides all around cost effectiveness for the investors in terms of affordability. Not only in terms of labour resources or in terms of materials required for production, benefits are also there in terms of real estates, lands, overall transport costs within the country and other basic amenities and facilities like schooling and health care, thereby making the country even more lucrative for outsourcing by the MNCs (Ahmad, Jabeen and Khan 2014).

 


In order to make itself more attractive in the eye of the global investment market, Malaysia stresses on building a strong and world class integrated connectivity in terms of robust transport facilities and high speed internet connectivity all over the country. The business environment of the country is unique in the sense that it is stable as well as dynamic. It is dynamic in the sense that the country has been and is still expanding its economic possibilities by improving, innovating and improvising its economic and industrial sectors. On the other hand, the country seldom experiences economic or socio-political turmoil and labour or worker unrest, thereby making it a stable economy and fit for production and for attracting the outsourced production units of many MNCs (Aziz 2012).

Table 1: Ranking of countries in terms of business compatibility

(Source: Aman et al. 2012)

From the Table 1, it is evident, that Malaysia is currently performing quite well in the economic indicators such as financial attractiveness, skills and efficiency of the country’s workforce and business environment. The total score of the country in terms overall prospect of the country as a business destination, is 5.99, which is quite high and just after huge developing economies like India and China (Maelah et al. 2012). Malaysia being comparatively a much smaller economy, has been performing impressive, thereby making itself one of the most preferred destinations for the outsourcing of the MNCs, especially those who want to outsource their manufacturing sector offshore. The Raque Food System, therefore, can consider this country as one of their possible candidates for outsourcing their manufacturing unit (Razak 2013).

The above table also shows the performance of Mexico in terms of the same economic indicators. It can be seen that where Malaysia secures te third position in the global scenario, scoring an impressive 5.99 in the over-all index, Mexico lies a little lower than Malaysia, at the sixth position with an overall score of 5.72. The main indicator, where Mexico scores much less than Malaysia, is the overall business environment (Anderson 2013). This may be because unlike Malaysia, Mexico experiences frequent and long-term unrests in the economic and political scenario. The illegal activities and drug related issues of the country are also quite high and unsettling and due to an unstable economic scenario, the country has failed to develop its overall infrastructure over the time, thereby slowly losing its place to other countries like Malaysia (Pan, Widner and Enomoto 2012).

Trade Policies:

For facilitating the overall economic expansion of the country and for attracting global investments, the Malaysian Government has formed several favourable policies in their ETP. The Government primarily offers lucrative tax solutions and huge subsidies for the foreign companies to attract more FDI. There is no income tax until the first ten years of the investment and investment tax allowance for five years in Malaysia (Aziz 2012). Apart from that, it also offers facilities and benefits like freedom of ownership, freedom to borrow capital and resources from the global market, beneficial cyber laws and laws protecting intellectual properties of the companies operating in Malaysia, absence of censorship in internet, and competitive tariff rates (Maelah et al. 2012).

Cultural Differences and Risks:

One of the primary hurdles that can be faced by a company in outsourcing its operations to offshore locations is that of the cultural and socio-political diversities (Morschett, Schramm-Klein and Zentes 2015). In case of Malaysia, the risks arising due to these particular differences are low. This is because, firstly, the country is a multi-lingual one, with an overall high English proficiency as major share of the population consists of Indian and Chinese. Therefore, communication and understanding of instructions are not that difficult for the workers. Political risks are also low in this country due to its stable and productive environment. The risks are higher in case of Mexico as it is culturally more constricted. The primary language being Spanish, the language barrier is more and politically too the country is far more unstable with frequent turmoil and unrest (Robles, Calderón and Magaloni 2013).

 

Advantages of moving to Malaysia:

For the Raque Food Systems, there are several benefits of moving the manufacturing unit to Malaysia. Firstly, the country is a source of cheap, English knowing, skilled labour (Ranking 43/197 in the global yearly minimum wage estimates, where UK ranks 1/197 and USA ranks 9/197, higher ranks implying higher minimum wage) (Pan, Widner and Enomoto 2012). The constant technological innovations and building of an excellent infrastructure, complemented by investor friendly trade policies make the country the most feasible candidate for the Raque Food Systems to outsource their production to increase cost effectiveness (Rani et al. 2013). Due to robust transport network, shipping can also become smooth from this country. Malaysia also enjoys a strategic location and is a gateway to the tremendously lucrative vast Asian and the Middle East markets, which adds to its credibility as the offshore location for outsourcing for the company (Raque.com, 2017).

Disadvantages of moving to Mexico:

Mexico, though having a bigger worker base and more affordability compared to Malaysia, loses its credibility to big extent due to its overall unstable economy and upsurge of political unrests and illegal activities. Labour base in Mexico, though bigger in number, are less skilled than Malaysia. The infrastructure, trade policies, tax breaks are also not that favourable for attracting outsourcings by the foreign MNCs as it can create hurdles in shipping of their products. The cultural and lingual barriers are also high in this country with respect to its competitors (Robles, Calderón and Magaloni 2013).

Discussion:

From the above discussion, it can be seen that for the Raque Food Systems, cost cutting can be massively done by relocating their production unit to offshore location, preferably Malaysia and not Mexico, though the latter has a bigger labour base. Outsourcing to Malaysia will reduce their labour costs significantly as is evident from the minimum wage statistics discussed above. Malaysia, being a labour intensive as well as technologically sound and stable economy will be beneficial for the concerned company not only in terms of cost effectiveness but also in terms of providing markets for their products.

 

References:

Ahmad, S.Z., Jabeen, F. and Khan, M., 2014. Entrepreneurs choice in business venture: Motivations for choosing home-stay accommodation businesses in Peninsular Malaysia. International Journal of Hospitality Management, 36, pp.31-40.

Ahmed, E.M., 2012. Are the FDI inflow spillover effects on Malaysia's economic growth input driven?. Economic Modelling, 29(4), pp.1498-1504.

Ajagbe, M.A. and Ismail, K., 2014. Factors influencing venture capital assessment of high growth companies in Malaysia. International Journal of Entrepreneurship and Small Business, 21(4), pp.457-494.

Aman, A., Hamzah, N., Amiruddin, R. and Maelah, R., 2012. Transaction costs in finance and accounting offshore outsourcing: a case of Malaysia. Strategic Outsourcing: An International Journal, 5(1), pp.72-88.

Anderson, C., 2013. Mexico: the new China. New York Times, 27.

Aziz, R.A., 2012. New Economic Policy and the Malaysian multiethnic middle class. Asian Ethnicity, 13(1), pp.29-46.

Forbes.com (2017). Forbes Welcome. [online] Forbes.com. Available at: https://www.forbes.com/sites/forbesasia/2014/08/25/manufacturing-beyond-china/#a85ccfb30482 [Accessed 11 Aug. 2017].

Jomo, K.S., 2016. Growth and structural change in the Malaysian economy. Springer.

Khan, R.A., Liew, M.S. and Ghazali, Z.B., 2014. Malaysian construction sector and Malaysia vision 2020: Developed nation status. Procedia-social and behavioral sciences, 109, pp.507-513.

Maelah, R., Aman, A., Amirruddin, R., Sofiah, Auzair, M. and Hamzah, N., 2012. Accounting outsourcing practices in Malaysia. Journal of Asia Business Studies, 6(1), pp.60-78.

Morschett, D., Schramm-Klein, H. and Zentes, J., 2015. Outsourcing and Offshoring. In Strategic International Management (pp. 361-384). Springer Fachmedien Wiesbaden.

Mundial, B., 2013. Doing business 2013: smarter regulations for small and medium-size enterprises. The World Bank.

Oshri, I., Kotlarsky, J. and Willcocks, L.P., 2015. The Handbook of Global Outsourcing and Offshoring 3rd Edition. Springer.

Pan, M., Widner, B. and Enomoto, C.E., 2012. Growth and crime in contiguous states of Mexico. Review of Urban & Regional Development Studies, 24(1?2), pp.51-64.

Rani, U., Belser, P., Oelz, M. and Ranjbar, S., 2013. Minimum wage coverage and compliance in developing countries. International Labour Review, 152(3-4), pp.381-410.

Raque.com, P. (2017). Food Packaging Machinery | Raque Foods | Baking Packaging Machinery. [online] Raque.com. Available at: https://www.raque.com/ [Accessed 11 Aug. 2017].

Razak, D.S.N.T., 2013. Malaysia's Transformation: Propelling Malaysia to Developed Nation Status. Harvard International Review, 35(2), p.26.

Robles, G., Calderón, G. and Magaloni, B., 2013. The economic consequences of drug trafficking violence in Mexico. Poverty and Governance Series Working Paper, Stanford University.

Sánchez, G.V. and Luna, A., 2014. Slow growth in the Mexican economy. Journal of Post Keynesian Economics, 37(1), pp.115-134.

Theglobaleconomy.com (2017). Malaysia Foreign Direct Investment, billion dollars - data, chart | TheGlobalEconomy.com. [online] TheGlobalEconomy.com. Available at: https://www.theglobaleconomy.com/Malaysia/fdi_dollars/ [Accessed 11 Aug. 2017].

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