Behind the Cost-Savings Advantage

Multinationals are finding it increasingly important to match the strengths of their subsidiaries’ host economics to their strategic needs.

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Savvy multinationals opening up overseas operations should look for more than just a low-cost environment, say three researchers at the Irish Management Institute. They should look for a long-term relationship.

That’s what John Mangan, Kevin Hannigan and John Cullen deduced from annual surveys of executives at the 200 largest foreign-owned companies operating in Ireland. In their 2005 Irish Management Institute working paper, Matching MNC Subsidiary Location and Host Economy Development, they document the more than 80 responses they received from CEOs and CFOs for each of the past seven years, in which the executives ranked the factors considered most important for Ireland’s competitiveness.

Not surprisingly, the foreign executives reported the labor force to be among the most important issues. But it’s not just the cost of labor that’s on their minds. “We found that the quality of the labor force and particularly the quality of the management pool were critically important,” says Mangan, who is also Peter Thompson Professor of Logistics at the University of Hull Business School. The education system, skills, flexibility and availability of the labor force all counted among the top 10 of the 27 issues under consideration, along with corporate tax rates, and the transport and telecommunications infrastructure.

Furthermore, the rankings have remained relatively consistent over the period of the study, despite the dynamic structural change that Ireland’s economy has undergone in that time. That makes sense, says Mangan, because, although there are often lower-cost offshoring alternatives to a company’s current situation, the transaction costs of choosing one of those alternatives are often greater than any cost advantages that would accrue from the move. The authors suggest that the best offshoring decisions consider a number of factors that might outlast their transient cost-savings advantage.

Those factors will necessarily differ depending on the situation. “An MNC parent should look at its own strategic development and determine what long-term competitive advantage a host economy can offer to complement that,” says Mangan. Of course, since a company’s needs change over time, managers have to forecast future requirements. For example, some companies might expect to need more knowledgeable workers or suppliers who can innovate with new products, processes, services and technologies. Other companies might look for marketers who can tap into future domestic or regional consumer markets. Also, the development of a cluster of companies from a related industry can make a location attractive by amplifying both short- and long-term efficiencies. Over time, a cluster’s companies can all access a common pool of trained labor, marketing expertise, research capabilities, suppliers and service companies, and transport links.

In Ireland, for example, foreign investment began over a decade ago centered in manufacturing for high-tech industries such as personal computers, semiconductors and pharmaceuticals. Over time, manufacturing migrated away as lower-cost nations opened their doors. Still, multinationals didn’t pull up stakes. Their long-term advantages are now starting to come from areas like services, R&D and innovation. Apple Computer, for example, which has been manufacturing in Ireland since 1978, now uses as a base for non-manufacturing European activities, such as financial accounting, call centers and order management.

For its part, Ireland took steps to develop its human capital in a way that supported the specific needs of the multinationals doing business there — for example, encouraging science and engineering programs at the university level. In fact, just as companies’ needs change over time, so, too, does the host economy evolve. The question is whether or not the multinational and the economy can grow together.

Because the potential match between a company’s future needs and a country’s potential capabilities is a moving target, companies have to look at not only current conditions in a country, but also at the plans of the economy’s policy-makers. For example, an automobile manufacturer might look not only for cheap labor and convenient transport links, but also at the technical capabilities of local suppliers and the government’s infrastructure investment projects. Alternatively, a pharmaceutical firm might look not only for current tax breaks and patent protections, but also at whether local universities might produce medical associates who could staff a world-class research environment in the future. Otherwise, these companies could pay a premium to chase the cheapest labor around the world every few years.

For more information, contact John Mangan at j.mangan@hull.ac.uk.

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