Strategic Outsourcing for Sustainable Competitive Advantages:

Case studies of Multi-National Corporations (MNCs) in China

Mingu Kang
Ph.D. Student ,School of Management, Zhejiang University, P.R. China
zhedamingu@gmail.com

Xiaobo Wu
Professor of Management, Vice Dean, School of Management, Director, National Institute for
Innovation Management, Zhejiang University, P.R. China
xbwu@zju.edu.cn

Paul Hong
Professor, Information Operations and Technology Management, College of Business
Administration, University of Toledo, Toledo, OH, 43606, USA

Abstract
Increasingly, with rapid wealth growth of emerging global economies, the basis of
competitive advantage is changing from internal capacities to network capabilities. What
matters is not a company ownership of hard assets but rather its ability to fully utilize them to
capture the worldwide business opportunities. In this highly competitive global environment,
outsourcing is approached not as a functional value extension but strategic priority practice
for achieving sustainable competitive advantage. This paper presents a research model that
describes strategic outsourcing practices for sustainable competitive advantages in Chinese
context. Case studies include global firms from Switzerland, Korea and USA that have been
operating in China for more than seven years successfully. This paper discusses how each
firm maintains clear and disciplined strategic focus in achieving desired business outcomes.
Case studies of these firms in China may provide better understanding on how to implement
successful outsourcing practices in the Chinese market.

Key Words: Strategic Outsourcing; Emerging Global Economies; Sustainable Competitive

Advantages; Case Studies of MNCs in China

1. Introduction
With rapid growth of economics over the past two decades, China has significant size of
middle and upper class of consumers affording huge domestic market. Besides, China also
offers cost-effective manufacturing opportunities and innovative outsourcing capabilities for
multi-national corporations (MNCs) through its vast network of socio-technological resources.
Figure 1 and Figure 2 show the rapid growth of GDP and FDI. The average annual GDP
growth rate of China for the past seven years is 9.9%. Chinese share of global GDP was only
6% of in 1990, but with rapid economic growth, its share of global GDP has grown 15% of in
2006.
GDP(RMB, billion) Growth Rate FDI(USD, billion) Growth Rate
30,000 12%
80 16%

25,000 10% 70 14%

60 12%
20,000 8% 10%
50
8%
15,000 6% 40
6%
30
10,000 4% 4%
20 2%
5,000 2% 10 0%
0 -2%
0 0%
2001 2002 2003 2004 2005 2006 2007
2001 2002 2003 2004 2005 2006 2007

Figure 1: GDP Growth of China(2001-2007) Figure 2: FDI Growth of China(2001-2007)

Source: National Bureau of Statistics of China

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With continuous expansion of privately-held firms and massive inflows of foreign direct
investment, China have sustained such high rate of economic growth. Such rapid economic
growth in China enabled an impressive expansion of middle class which in turn contributes to
the social stability and the formation of huge consumer market (Zhang Jing, 2007). According
to Chinese Brand Strategy Association, the potential size of affluent consumers that purchase
high brand products is 160 millions that is about 13% of the total population. This suggests
that China has the third largest consumer market in the world which is next to Japan and USA.
Ernst & Young Survey Report predicts that by 2010, brand-conscious consumers will increase
up to 250 millions and by 2015, China is expected to have the second largest consumer
market in the world.

While the growing consumer market in China gives multi-national corporations expanding
business opportunities, other environmental factors also make Chinese market challenging
and risky as well. Recently, RMB(Chinese currency) value is rising. Changes in labor laws
and tax regulations affect firm’s profit level. Rapidly evolving competitive landscape in China
requires new capabilities for global companies in China. And MNCs in China are facing
intense competition with other lots of global companies and Chinese local innovative
companies(Wu, Xu et al. 2004; Wu, Ma et al. 2006). So, simply low cost based
manufacturing or outsourcing arrangements are not adequate in ensuring sustainable
competitive advantages. Considering these opportunities and risks, the purpose of this paper is
to provide an useful framework for analyzing the outsourcing practices for sustainable
competitive advantages in Chinese context. Three case details provide implications on the role
of strategic outsourcing to sustainable comparative advantages in Chinese market.

2. Research Background

Outsourcing Benefits and Risks

Increasingly, with rapid wealth growth of emerging global economies, the basis of
competitive advantage is changing from internal capacities to network capabilities (Zander
1999; Mudambi 2002; McEvily and Marcus 2005). In this highly competitive global
environment, outsourcing is more than a tool for functional value extension but strategic
priority practice.

Outsourcing may reduce operation costs and free up asset(Harland, Knight et al. 2005). In the
early 1980s, companies started outsourcing non-core activities to suppliers for the purpose of
securing specialized expertise and lower costs. Firms have moved their internal
manufacturing and operations to lower cost countries to seek competitive advantage. Reasons
for such outsourcing practices include low cost strategy, proximity to foreign markets and
easy access to innovative capabilities. In recent years, outsourcing is associated with attaining
firm’s competitive advantages. Through outsourcing, firms can access to external
technologies and increase operational flexibility and concentrate more on core business
activities and innovative new projects.

Outsourcing benefits include lower cost, more investment on core competencies, flexibility,
reduction assets and complementary capabilities. While outsourcing is associated with various
benefits, it can also be a serious risky factor (Bahli and Rivard 2003). Examples of
outsourcing risks are interface within activities, loss of competitive base, opportunistic
behavior, rising transaction and coordination costs, limited learning and innovation and higher
procurement costs in relation to the fluctuating currency exchange rates (Kotabe, Mol et al.
2008). According to the latest Bain Survey, 77% of their research sample companies have
outsourcing policy and yet more half of the companies do not achieve the expected benefits
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from outsourcing. If firms only focus on achieving short-term benefits of outsourcing without
considering these risk factors, they may fail to access original goals of outsourcing. Firms
need to carefully consider balancing the benefits and risks to maximize the outsourcing effects
on their long-term competitive advantages(Rothaermel, Hitt et al. 2006). In this sense, firm’s
approach to outsourcing is becoming increasingly strategic (Gottfredson, Puryear et al. 2005;
Hoecht and Trott 2006).

Strategic Outsourcing
For the meaningful analysis of outsourcing various theoretical insights are helpful.
Transaction Cost Theory (TCT) originates from economic perspective and Resource Based
View (RBV) is heavily applied in strategic management. Loh(Loh 1994) investigates the
consideration of various cost factors (e.g., bargaining, influence, administrative and
management, agency and decision-making costs) that are critical for an outsourcing decision.
Transaction costs are often disregarded because of the difficulty in quantifying the costs.
Firms need to consider both the production and transaction costs in relation to
outsourcing(Lacity, Willcocks et al. 1995). Other unexpected hidden costs are related to
activities such as contractual amendment, unexpected transition and management, lock-in and
disputes and litigations (Bahli and Rivard 2003). In addition to the production costs, firms pay
close attention to the potential increase in all other transaction-related costs(Qu and
Brocklehurst 2003).

Resource-Based View argues that a firm has the ability to achieve and sustain competitive
advantage if it possess resources that are valuable, rare, imperfectly imitable and non-
substitutable(Barney 1991). Not all resources are strategically relevant within an organization.
The goal of an organization is to ensure it has access to and control of valuable resources by
developing and securing all the relevant resources either internally or externally(Das and
Teng 2000). If a firm possesses critical resources that have strategic value, it is better to retain
the activity in-house. On the contrary, if the strategic value of target activities is low and no
internal resources are available to perform such activities, it is beneficial for the company to
outsource them(Roy and Aubert 2001). For the sustainable competitive advantages firms are
forced to rely on a multitude of outside suppliers for parts, software, knowhow and sales and
in doing so gain access to valuable resources and external capabilities(Langlois 1990).

In view of the above mentioned relevant theories, we have adapted Kraljic’s purchasing
portfolio for our analysis of outsourcing strategy(Kraljic 1983). In 1983, Kraljic introduced
portfolio approach for the use in purchasing and supply management. Karjic’s model
classifies all the purchased materials in terms of profit impacts and supply risks. By assessing
the company’s situation in terms of these two variables, purchasing executives may determine
the overall strategic supply position and accordingly exploit its purchasing power and reduce
the overall risk associated with purchasing decisions (Kraljic 1983). This purchasing portfolio
model is a useful tool for the analysis of outsourcing decisions because of close linkage
between purchasing and outsourcing (Caniëls and Gelderman 2005). Atkearney Survey(2005)
indicates a plausible causal link between the level of procurement involvement in the
outsourcing process and the degree of success achieved. Nearly 80 percent of survey
respondents say that their procurement organizations have a high level of involvement in the
strategic outsourcing processes. About two-thirds of the respondents suggest that procurement
has a high level of involvement in the outsourcing strategy planning processes.

In light of close relationship of purchasing with outsourcing we have derived strategic

outsourcing matrix out of Kraljic’s portfolio model. Our analysis focuses on the efficient
allocation of limited resources to improve the management ability and maximize outsourcing
benefits. Figure 3 shows strategic outsourcing matrix. We modified Kraljic’s purchasing
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portfolio for strategic outsourcing matrix and classified a firm's products, services and
purchased products on the basis of two dimensions: profit impact and outsourcing risk. The
profit impacts are defined in terms of the cost reduction, volume of activity, market
opportunity and customer effect. The outsourcing risks may be assessed in terms of technical
complexity, uniqueness of business process, business risk and entry level. Using these two
parameters, executives may consider carefully their business activities, products and
components for the effective outsourcing decisions. In a situation where the profit impacts are
high and the outsourcing risks are low, firms would be advised to develop expansion strategy
to penetrate and expand their market shares. If profit impacts and outsourcing risks are high,
firms need to make strategic partnership with outsourcing partners very carefully, or vertically
control these items for long term market share. In the case of low profit impacts and low
outsourcing risks, firms may pursue business approaches that focus on efficiencies and seek
economies of scale in production and sales. Where the outsourcing risks are high and profit
impacts are low, In this case, firms may try to source alternate partners for assuring supply.

Source : Modified from Kraljic, 1983

Profit Outsourcing Risk
Impact Low High
Leverage items : Strategic items :
Exploit market penetration and Insourcing for competitiveness
High
expansion of market with high Seek strategic partnership for long-
level outsourcing. term market position.
Non-critical items : Bottleneck Items :
Low Ensure efficient cost strategy Close partnership for assuring supply
for economies of scale Sourcing alternate partner

Figure 3: Strategic Outsourcing Matrix

3. Case illustration

Case 1: E-Land
Established in 1980, E-Land is a leading group of fashion retailer in Korea. E-Land has
successfully marketed mid-level casual brand in Korea. From the beginning its key functional
strategy was efficient production through outsourcing and marketing through franchise style
promotion. Its corporate priority has consistently maintained the core competencies in terms
of strategic planning, merchandising and design. In 1994 E-Land started its marketing effort
in China. Different from its Korean marketing position, the Chinese strategy was to premium
brand strategy. The entire production was done through outsourcing in China. The typical
problems for global firms that do outsourcing in China are trust issues in terms of quality and
delivery. To resolve these problems E-Land manage contracts with their outsourcing suppliers
in strictly tested contract terms, conduct post-purchase follow-up and adopt systematic
evaluations. E-Land ensures high quality production management of suppliers by utilizing
internal production and quality control teams. In this way E-Land adopts high level of
outsourcing strategy and achieved high volume flexibility without huge investment of
production lines and human resources. E-land focused on distribution and design capability.
Different E-Land Korea’s franchising system, E-Land China vertically integrated distribution
function. Currently, E-Land has introduced 15 different brands of products, including about
7,500 new items a year. Its operation network extends to 100 cities and 500 department stores
in China. It covered all main cities and main department stores. In 2007, E-Land’s sales
volume was more USD 300million, It’s growth rate is more 100% than 2006.

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Case 2: Swatch
Swatch was originally intended to re-capture market share lost by Swiss manufacturers during
the aggressive growth of Japanese companies such as Seiko. As core capabilities, Swatch
focused on new style design, manufacturing efficiency and brand power. Now, Swatch is the
largest watch maker in the world. Based on it’s 157 processing facilities in Switzerland, it has
successfully marketed 20 different brands in the global market over the years. Swatch group
penetrated Chinese market in 2000. With its high vertical control of the production in
Switzerland, it penetrated Chinese market with efficient managing and distribution strategy.
Swatch entrusts import, tax, consulting and human resource management to highly specialize
Chinese local firms. By utilizing their expert knowledge and relational competencies, Swath
enhanced productivity (e.g., cost reduction) and excellent risk management for changing
market conditions. Swatch has successfully made contracts with the largest Chinese wholesale
distributors and utilized the existing well-established national distribution networks. In this
way, Swatch has achieved rapid business growth while building brand images among Chinese
growing middle and upper class consumers. Swatch launched 15 different brands in China,
targeting all market segments, from low-end to high end brads. Sales volume in China became
the second largest among the global sales amounts of Swath Group during the short period.

Case 3: AULT
Ault has grown as a vertically integrated firm that handles product development, production
and marketing of AC-DC Converter in USA. With its rapidly losing its competitiveness
with high cost of manufacturing in USA, in 1987 Ault built its first factory in Korea. Ault’s
USA corporate functions focused on strategic management, marketing and product
development. It also streamlined its organizational structures to be flexible and efficient. After
operating Ault Korea, it strengthened its cost competitiveness through better management of
purchasing and production functions. In 1990s, it started manufacturing operations in a city
nearby Beijing China. In Shanghai it formed a corporation for marketing management and
product development. In its early stage of operations, Ault China focused on assembly
process to reduce manufacturing costs. Most of raw materials was supplied in Completely
Knock Down(CKD) form by Ault Korea. Assembling process for cost reducing by CKD led
to serious problems in Ault China operation. Ault has produced multiple lines of products
with more 5,000 components parts list. Naturally, it experienced material shortages and long
delivery problems. Supply chain issues between Ault Korea and Ault China were quite
frequent and serious. It’s a big bottleneck for satisfying customer need with on time delivery.
In 2001, Ault started sourcing alternate vendors in shanghai area and during the 1 year effort
they set up 100% purchasing system in Ault China. In result, Ault secured its cost
competitiveness (10% cost down) and established speed delivery system.

Ault China has vertically controlled some critical parts(e.g., plastic case, transformer) and
they decided moving these production operations to external partners to focus on end product
manufacturing. Besides, Ault China decided outsourcing it’s non-core end products(e.g.,
linear power suppliers) from the most competitive GuangDong area AC-DC manufacturers.
They supplied linear power supplier to Ault with high quality and more low cost. In this way,
Ault China has changed it’s supply chain system. Since it’s non-core businesses were handed
over to external supplier partners, Ault China focused on manufacturing high end Switching
Mode Power Suppliers(SMPS). Ault could survive in extremely competitive industry with its
constant adaptations to changing according to market reality. In this way, Ault has enhanced
its core competitiveness through sustained strategic development and persistent innovation.

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4. Findings
As shown in the above cases, multi-national corporations (MNCs) are successful through
strategic outsourcing practices in generating consistently high level of profits in the Chinese
market. However, outsourcing has serious negative impacts on business too. The key for
strategic outsourcing is to employ appropriate strategy which carefully considers profit
potential and risk factors.

Low Outsourcing Risk High

Leverage Items Strategic Items

High

Race to the Top

E: Market Distribution : insourcing
E: Production by outsourcing in China
S: Production : insourcing in Swiss
S: Distribution by outsourcing A: High end SMPS: in house
Transformer, Case: insourcing
-> outsourcing with strategic
partnership
Profit Impact

Focus on
Distribution
high level outsourcing R&D low level outsourcing
Brand
S: Outsourcing Import, Tax, A: Raw materials: Shortage,
HR for efficiency long delivery
Race to the Bottom

A: Linear Adapter - >

outsourcing for low cost and -> Sourcing alternate
high quality suppliers in China
Low

Non Critical Items Bottleneck Items

Figure 4: Application of Strategic Outsourcing Matrix

Figure 4 shows application of strategic outsourcing matrix. It has four different patterns—
leverage, strategic, non-critical and bottle-neck items. E, S and A refers to E Land, Swatch
and Ault respectively. The horizontal axis shows two continuum of risk factor(left-low, right-
high). The vertical axis is about two profit impact(up-high, down-low). The horizontal level is
about the degree of outsourcing (either low or high). The vertical level is about the strategic
direction—either race to the top or race to the bottom.

Our case examples show different strategic outsourcing choices and business outcomes. First,
Case companies focused on brand management, R&D and distribution as their core business.
For the leverage items, E Land & Swatch outsourced production and distribution functions
with high level of outsourcing and they successfully penetrated Chinese market and exploited
the growing buying power. For the strategic items, firms vertically controlled the items in
house for long term Chinese market. If the strategic items are purchasing items, they made
strategic relationship with suppliers. For the non-critical items, Swatch outsourced the
importing business processes for efficiency. Ault mostly outsourced low end linear adapters
which were marketed mainly in USA and EU market, not Chinese market. Fourth, for the
bottleneck items, Ault has not adopted purchasing function, so it is the big bottleneck item in
China. Ault instead sourced alternate suppliers in China and enhanced cost and delivery
competitiveness. In this way, bottleneck items become leverage items.

6
As shown above, these case examples indicate high level of outsourcing at the leverage and
non critical items. Case companies not only reduced cost but also enhanced their core
business outcomes by utilizing high level of outsourcing at these items. Because of low
outsourcing risks at these categories, companies could exploit buying power and access the
external capabilities for competitive advantage. In contrast, low level of outsourcing is
applied for strategic and bottleneck items. Case companies maintained their core business and
critical items within for sustainable competitive advantage. In the case of outsourcing critical
items, they outsourced these items to the close strategic partnership with external suppliers.
Case companies also rapidly expand Chinese market and race to the top by determining
appropriate level of outsourcing for their leverage and strategic items. Ault China do not keep
simple assembly production line and the low end production, but instead it has upgraded the
production facilities to high end production in response to the changing market demand. E-
Land has launched premium brands in China, quite different from their medium brand
strategy in Korea. E-Land has outsourced production activities and internally integrated its
value added activities in the areas of design and distribution) to implement its rapid market
expansion strategy in China. At these leverage and strategic items, top executives decisions on
the appropriate level of outsourcing and insouricng really matter for sustainable competitive
advantages.

Masaaki Kotabe and Mol (2008) argued that the outsourcing-performance relationship takes
on an inverted-U shape which suggests an optimal degree of outsourcing. The extremely high
degree of outsourcing may result in external relational inefficiency, technological dependence
and high transaction costs(Kotabe, Mol et al. 2008). The MNCs in China face many
challenges for successful outsourcing execution. Therefore, MNCs rather formulate their
long-term outsourcing strategy and clearly understand what particular factors affect the
optimal outsourcing level for sustainable competitive advantage. Kotabe and Mol (2008)
argued that e-commerce may change the optimal point of outsourcing level. We find core
capabilities (e.g., e-commerce) of any companies may also impact the optimal point of
outsourcing level. So, the first step for outsourcing is to identify the firms core of core
business(Gottfredson, Puryear et al. 2005). Then, Firms have to make decision for
outsourcing items and outsourcing levels, considering strategic outsourcing matrix to
maximize the competitive advantage.

5. Discussion and Conclusion

This paper provides an outsourcing typology in Chinese business contexts with the particular
focus on strategic outsourcing. We present a strategic outsourcing matrix which is useful to
analyze the patterns of outsourcing in China. This paper indicates strategic outsourcing
approach may improve firms to achieve substantial market growth in China. Since business
environment in China is becoming more challenging and difficult, more firms require to
compete beyond low costs and cost reduction measures in manufacturing. MNCs in China
consistently enhance their core capabilities while balancing the needs for the outsourcing and
insourcing for their sustainable competitive advantages. The realistic option for the MNCs in
China is to move toward high premium value goods, services and industries. MNCs should
seek to compete with emerging economies in a “race to the top (leverage items & strategic
items)” rather than in a “race to the bottom (bottle neck items & non critical items) ”.

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