Creating a Global Web

One result of Clear Vision's kind of thinking is the creation of a global web of value creation activities, with different stages of the value chain being dispersed to those locations around the globe where value added is maximized or where the costs of value creation are minimized. Consider the case of General Motors' (GM) Pontiac Le Mans cited in Robert Reich'sThe Work of Nations.⁷ Marketed primarily in the United States, the car was designed in Germany; key components were manufactured in Japan, Taiwan, and Singapore; assembly was performed in South Korea; and the advertising strategy was formulated in Great Britain. The car was designed in Germany because GM believed the designers in its German subsidiary had the skills most suited to the job. (They were the most capable of producing a design that added value.) Components were manufactured in Japan, Taiwan, and Singapore because favorable factor conditions there--relatively low-cost, skilled labor--suggested that those locations had a comparative advantage in the production of components (which helped reduce the costs of value creation). The car was assembled in South Korea because GM believed that due to its low labor costs, the costs of assembly could be minimized there (also helping to minimize the costs of value creation). Finally, the advertising strategy was formulated in Great Britain because GM believed a particular advertising agency there was the most able to produce an advertising campaign that would help sell the car. (This decision was consistent with GM's desire to maximize the value added.)

In theory, a firm that realizes location economies by dispersing each of its value creation activities to its optimal location should have a competitive advantage vis-à-vis a firm that bases all its value creation activities at a single location. It should be able to better differentiate its product offering and lower its cost structure than its single-location competitor. In a world where competitive pressures are increasing, such a strategy may become an imperative for survival (as it seems to have been for Clear Vision).

Some Caveats

Introducing transportation costs and trade barriers complicates this picture somewhat. Due to favorable factor endowments, New Zealand may have a comparative advantage for automobile assembly operations, but high transportation costs would make it an uneconomical location for them. Transportation costs and trade barriers explain why many US firms are shifting their production from Asia to Mexico. Mexico has three distinct advantages over many Asian countries. First, low labor costs make it a good location for labor-intensive production processes. In recent years, wage rates have increased significantly in Japan, Taiwan, and Hong Kong, but they have remained low in Mexico. Second, Mexico's proximity to the United States reduces transportation costs. This is particularly important for products with high weight-to-value ratios (e.g., automobiles). And third, the North American Free Trade Agreement (see Chapter 8) has removed many trade barriers between Mexico, the United States, and Canada, increasing Mexico's attractiveness as a production site for the North American market. Although value added and the costs of value creation are important, transportation costs and trade barriers also must be considered in location decisions.

Another caveat concerns the importance of assessing political and economic risks when making location decisions. Even if a country looks very attractive as a production location when measured against all the standard criteria, if its government is unstable or totalitarian, a firm might be advised not to base production there. (Political risk is discussed in Chapter 2.) Similarly, if the government appears to be pursuing inappropriate economic policies, production at that location might be ill-advised, even if other factors look favorable.