Transfer Pricing Associates

Herd INstinct

post Thursday April 25, 2013


The decision to offshore and locate certain business functions requires a great deal of thought and analysis and these decisions should be carefully reviewed. While it seems obvious to meticulously evaluate the relocation of critical portions of a value chain, all too often large companies ignore the facts and data that is available, and simply join a larger movement and relocation. This mentality has led to major failures of certain companies because of the relocation of various business functions. In a recent article from The Economist, this is described as a “herd” mentality.

Relocating or offshoring business processes is not a new concept, but it is one that has grown in popularity in the recent years. This growth in locating different portions of the value chain outside of a home country is largely due to the growing connectedness of the global economy and overall increases and advancement of developing countries’ labor forces. The structure of the two largest French car manufacturers, PSA Peugeot Citroën and Renault is a clear example of how offshoring can determine the financial health of a company. Renault adopted a strategy of locating in very low cost countries, such as Slovenia, Romania, Morocco and Turkey while keeping only one quarter of their car production in France. In contrast to Renault, Peugeot Citroën kept a substantial amount of their manufacturing capacity in France. This has contributed to spiraling financial complications.
In contrast to the two auto companies, Zara, one of the largest clothing companies globally, has kept almost all of its clothing manufacturing nearby Portugal and Morocco or even in their home country of Spain. While the manufacturing costs compared to Bangladesh or China are greater, maintaining a close distance to their company headquarters has allowed for Zara to develop an extremely efficient supply chain that is highly responsive to the dynamic tastes of consumers. The close proximity to clothing designers and ability to quickly respond to consumer demands has created a considerable advantage for Zara compared to other clothing retailers.
An example of herd mentality is of two closely competitive technology companies that relocated major portions of their value chain to Malaysia. In this story, the first mover was able to save roughly 15% in labor and production costs. After seeing the first mover gain this advantage, the second tech company followed suit. Soon after both companies offshored part of their production, the companies drove up the wage costs and eventually eliminated any advantage of this relocation.
There are countless examples of companies that do not actually evaluate the decision to relocate or offshore. A result of this careless management is greater inefficiencies, very little cost savings, and eventually a lack of innovation because of the considerable distance between where the production and value chain is located and where research and development takes place. The combination of lagging innovation, spiraling costs and growing inefficiencies and outside shocks that can negatively affect a supply chain should force companies to critically review the decision to offshore.
Source:The Economist
Image Source: Free Digital Photos

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