THE ADVANTAGES OF BUY Buying component parts, or an entire product, from independent suppliers can give the firm greater flexibility, can help drive down the firm's cost structure, and may help the firm capture orders from international customers. Strategic Flexibility The great advantage of buying component parts, or even an entire product, from independent suppliers is that the firm can maintain its flexibility, switching orders between suppliers as circumstances dictate. This is particularly important internationally, where changes in exchange rates and trade barriers can alter the attractiveness of supply sources. One year Hong Kong might offer the lowest cost for a particular component, and the next year Mexico may. Many firms source the same products from suppliers based in two countries primarily as a hedge against adverse movements in factor costs, exchange rates, and the like. Sourcing products from independent suppliers can also be advantageous when the optimal location for manufacturing a product is beset by political risks. Under such circumstances, foreign direct investment to establish a component manufacturing operation in that country would expose the firm to political risks. The firm can avoid many of these risks by buying from an independent supplier in that country, thereby maintaining the flexibility to switch sourcing to another country if a war, revolution, or other political change alters that country's attractiveness as a supply source. However, maintaining strategic flexibility has its downside. If a supplier perceives the firm will change suppliers in response to changes in exchange rates, trade barriers, or general political circumstances, that supplier might not be willing to make investments in specialized plants and equipment that would ultimately benefit the firm. Lower Costs Although making a product or component part in-house-vertical integration-is often undertaken to lower costs, it may have the opposite effect. When this is the case, outsourcing may lower the firm's cost structure. Making all or part of a product in-house increases an organization's scope, and the resulting increase in organizational complexity can raise a firm's cost structure. There are three reasons for this. First, the greater the number of subunits in an organization, the more problems coordinating and controlling those units. Coordinating and controlling subunits require top management to process large amounts of information about subunit activities. The greater the number of subunits, the more information top management must process and the harder it is to do well. Theoretically, when the firm becomes involved in too many activities, headquarters management will be unable to effectively control all of them, and the resulting inefficiencies will more than offset any advantages derived from vertical integration.33 This can be particularly serious in an international business, where the problem of controlling subunits is exacerbated by distance and differences in time, language, and culture. Second, the firm that vertically integrates into component part manufacture may find that because its internal suppliers have a captive customer in the firm, they lack an incentive to reduce costs. The fact that they do not have to compete for orders with other suppliers may result in high operating costs. The managers of the supply operation may be tempted to pass on cost increases to other parts of the firm in the form of higher transfer prices, rather than looking for ways to reduce those costs.
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