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KANG Min-Hyung

How to Cope with Risks of Global Production System

KANG Min-Hyung

Feb. 26, 2010

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The recall of around 10 million vehicles since the end of last year by Toyota Motor Corporation, a name once synonymous with quality, is shocking. With side effects from excess cost reduction and expansion of offshore production being blamed, caution about the risks of globalized production is heightening. The production method has mushroomed since the 1980s, beginning with US and Japanese companies, and delivered many gains, including improved price competitiveness, indirect bypassing of trade barriers, stronger adaptability to local markets and avoidance of currency exchange rate losses. However, the relocation of production bases and diversification of supply chains also carry risks such as loss of tacit knowledge, insufficient management of inventory and quality and the technology leakage.

Korean companies have increasingly employed global production systems since 2000 to cut costs and make inroads into overseas markets. While it is necessary to bolster competitiveness by expanding global production, it is also crucial to systemically analyze the possible risks related to quality decline and core technology outflow and formulate preemptive countermeasures.

Based on origin and domain, there are five types of risks than can stem from building a global production network. The first is faulty quality at overseas factories. It is difficult to find and develop skilled labor at overseas plants while transplanting the headquarters' quality management system, so a drastic expansion of overseas plants can cause even more difficulty. Toyota aggressively expanded overseas production after 2000 to combat worsening profitability caused by the strong yen and trade conflicts. But Toyota's domestic production system was not perfectly transplanted to overseas plants and quality problems occurred. Along with rapid expansion overseas, Toyota also pursued excess cost reduction through so-called " squeezing water from a dry towel," further aggravating the level of quality. These trends hindered stable overseas relocation of Toyota's core production system, contributing to the automaker's massive recalls.

The second risk is poor quality coming from overseas parts suppliers. It may be difficult to develop a close, cooperative relationship with overseas suppliers and that could hinder continuous quality improvement or easily identifying the causes of any flaws.

Add to this the pressure of excess cost cuts on suppliers, the quality of parts quality can deteriorate further. For example, faced with sales plunges in 2003-2004, Nokia shifted its strategy and tapped into emerging markets like China and India, while expanding production of low-priced mobile phones. To do so, the Finnish company demanded low prices from overseas parts suppliers, and that eventually led to poor quality control. Consequently, Nokia in 2007 recalled 46 million batteries for mobile phones that then Matsushita Electric (currently Panasonic) had supplied, and in 2009 recalled 14 million mobile phone battery chargers manufactured by China's BYD.

The third risk is the loss of proprietary technology to overseas rivals. It occurs when core technology is transferred to overseas plants. It is facilitated by personnel changing jobs since management of human resources is more difficult in overseas plants compared to domestic operations. Honda Motorcycles started production in China in the 1980s and was successful until the mid 1990s, but market share plunged thereafter as local companies introduced Honda lookalike motorcycles. It was found that the design blueprint and technology were leaked from Honda's China plant and the company failed to quickly address the fact that counterfeiting is easy in China due to lack of protection of intellectual property rights.

The fourth risk is weakening ability to negotiate with overseas parts suppliers. The expansion of global production system has encouraged parts companies to expand supply sites across the globe. They support companies trying to advance into overseas markets while promoting design and performing basic research besides manufacturing parts. This makes companies largely dependent on them and erodes their ability to negotiate with the suppliers. For example, when a supply shortage of poly silicon, a material for semiconductor wafers developed a few years ago, Japanese companies like ShinEtsu and Sumco which have more than 60% of the world wafer market, imposed a 10% price hike on its customer. They also required contract changes that included extension period and number of required orders.

The last risk is conflict with overseas governments and consumers. If overseas plants and parts suppliers are negligent in observing environment-friendly standards and managing labor conditions, they can cause conflicts with their host countries. They may also suffer complaints from consumers. When melamine was found in Nestle products made in China, Nestle reacted passively since only a small amount of industrial chemical was found and it did not pose a serious health risk. This intensified consumer outcry and Taiwan and Saudi Arabia ordered Nestle to recall all of its products.

Toyota 's recalls imply that poor quality from overseas plants can happen to any company. As complexity rises due to the growth of product technology, the importance of quality control is also rising. However, managing is difficult as regional border of production becomes wider.

t is thus important to not only utilize the advantages of global production but also to prepare for possible risks related to quality decline and technology leakage and reacting swiftly when a problem occurs. A company that possesses high customer trust will be hit particularly hard when a problem occurs so a thorough post-management of the problem is crucial to retain customers. Meanwhile, a global expansion of production system means an expansion into various social and cultural areas. Thus the globalization strategy of spreading the headquarters' key competitiveness across the world should harmonized with localized strategy that considers the features of the area. Besides the risk of quality slippage, companies need to devise a comprehensive set of measures on risks ranging from technology leakage, weakening of negotiation ability and conflict with overseas governments.

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