Clearly, make-or-buy decisions involve trade-offs. The benefits of making all or part of a product in-house seem to be greatest when highly specialized assets are involved, when in-house production is necessary for protecting proprietary technology, when the firm may build valuable capabilities over time if it continues to perform an activity in-house, or when the firm is simply more efficient than external suppliers at performing a particular activity. When these conditions are not present, the risk of strategic inflexibility and organizational problems suggest it may be better to contract out some or all production to independent suppliers. Because issues of strategic flexibility and organizational control loom even larger for international businesses than purely domestic ones, an international business should be particularly wary of vertical integration into component part manufacture. In addition, some outsourcing in the form of offsets may help a firm gain larger orders in the future.
STRATEGIC ALLIANCES WITH SUPPLIERS
Several international businesses have tried to reap some benefits of vertical integration without the associated organizational problems by entering strategic alliances with essential suppliers. For example, there was an alliance between Kodak and Canon, under which Canon built photocopiers for sale by Kodak; an alliance between Microsoft and Flextronics, under which Flextronics built the Xbox for Microsoft; and an alliance between Boeing and several Japanese companies to build its jet aircraft, including the 787. By these alliances, Kodak, Microsoft, and Boeing committed themselves to long-term relationships with these suppliers, which have encouraged the suppliers to undertake specialized investments. Strategic alliances build trust between the firm and its suppliers. Trust is built when a firm makes a credible commitment to continue purchasing from a supplier on reasonable terms. For example, the firm may invest money in a supplier—perhaps by taking a minority shareholding—to signal its intention to build a productive, mutually beneficial long-term relationship.
This kind of arrangement between the firm and its parts suppliers was pioneered in Japan by large auto companies such as Toyota. Many Japanese automakers have cooperative relationships with their suppliers that go back decades. In these relationships, the auto companies and their suppliers collaborate on ways to increase value added by, for example, implementing just-in-time inventory systems or cooperating in the design of component parts to improve quality and reduce assembly costs. These relationships have been formalized when the auto firms acquired minority shareholdings in many of their essential suppliers to symbolize their desire for long-term cooperative relationships with them. At the same time, the relationship between the firm and each essential supplier remains market mediated and terminable if the supplier fails to perform. By pursuing such a strategy, the Japanese automakers capture many of the benefits of vertical integration, particularly those arising from investments in specialized assets, without suffering the organizational problems that come with formal vertical integration. The parts suppliers also benefit from these relationships because they grow with the firm they supply and share in its success.32
Alliances are not all good. Like formal vertical integration, a firm that enters long-term alliances may limit its strategic flexibility by the commitments it makes to its alliance partners. As we saw in Chapter 12 when we considered alliances between competitors, a firm that allies itself with another firm risks giving away key technological know-how to a potential competitor.
• QUICK STUDY
1. Describe the advantages of making all or part of a product in-house.
2. What might be lost in the long run if a company outsources production to a foreign entity?
3. Under what circumstances might it make sense to outsource production to a foreign entity?
4. Why might an international business want to enter into a strategic alliance with key suppliers?