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SO
2,3
Strategic outsourcing practices
of multi-national corporations
(MNCs) in China
240 Mingu Kang and Xiaobo Wu
School of Management, Zhejiang University, Hangzhou,
People’s Republic of China, and
Paul Hong
Information Operations and Technology Management,
College of Business Administration, University of Toledo, Toledo, Ohio, USA
Abstract
Purpose – The purpose of this paper is to present a research model and case illustrations that
explore strategic outsourcing practices for sustainable competitive advantages in the Chinese context.
Design/methodology/approach – This study is based on in-depth interviews of executives of
three multi-national firms (MNCs) from Switzerland, Korea and the USA that have been successfully
operating in China for more than seven years.
Findings – This paper discusses how three MNC firms in China maintain clear and disciplined
strategic outsourcing and achieve desired business outcomes. They race to the top by managing
strategic insourcing for high risk and high profit items while outsourcing low risk and high profit
leveraging items.
Originality/value – The paper presents a strategic outsourcing model and case studies of three
multi-national firms in China, which suggest both theoretical and managerial implications showing
how to implement successful outsourcing practices in the global market.
Keywords Strategic planning, Outsourcing, China, Multi-national companies
Paper type Research paper

Strategic Outsourcing: An
International Journal
Vol. 2 No. 3, 2009
pp. 240-256
# Emerald Group Publishing Limited
1753-8297
DOI 10.1108/17538290911005153
Introduction
With rapid wealth growth in emerging global economies, the basis of competitive
advantage is switching from internal competencies to network capabilities (McEvily
and Marcus, 2005; Mudambi, 2002; Zander, 1999). In the environment of networked
global economy outsourcing is regarded as an important strategic tool that allows
firms to concentrate one’s own core competencies for building flexible inter-
organizational capabilities (Kakabadse and Kakabadse, 2005; Lacity et al., 2008).
Outsourcing activities include transfer of non-core activities to suppliers for the
purpose of securing specialized expertise and lower costs. Manufacturing firms moved
their internal manufacturing and operations to lower cost countries. Reasons for such
outsourcing practices include low-cost strategy, proximity to foreign markets and easy
access to innovative capabilities.
In this highly competitive global environment, in recent years, the scope of
outsourcing has extended to include core business activities and innovative new
projects. Traditional low-cost manufacturing or limited outsourcing arrangements are
no longer adequate to ensure sustainable competitive advantage. Outsourcing is more
than a tool for functional value extension but strategic priority practice. The diverse
This research is supported by National Natural Science Foundation of China (Grant 70772047)
and National Planning Office of Philosophy and Social Science of China (Grant 07&ZD022).
sets of outsourcing benefits include lower cost, more investment on core competencies, Strategic
flexibility, reduction assets and complementary capabilities (Harland et al., 2005; outsourcing
Hansen et al., 2008). In the course of pursuing outsourcing benefits firms also face
serious challenges as well (Bahli and Rivard, 2003). According to the latest Bain practices
Survey, 77 percent of their research sample companies have outsourcing policy and yet
more half of the companies do not achieve the expected benefits from outsourcing.
Outsourcing risks involve disruptions of internal activities, loss of competitive base,
opportunistic behaviors, rising transaction and coordination costs, limited learning
241
and innovation and higher procurement costs in relation to the fluctuating currency
exchange rates (Kotabe et al., 2008). Firms carefully consider the benefits and risks and
optimize the outsourcing effects to sustain their long-term competitive advantages
(Rothaermel et al., 2006; Busi and McIvor, 2008; Lacity et al., 2008). Naturally,
outsourcing is becoming increasingly strategic (Gottfredson et al., 2005; Hoecht and
Trott, 2006).
In view of these growing opportunities and increasing challenges, this paper
intends to provide a useful framework for analyzing the outsourcing practices for
sustainable competitive advantages. The context of this paper is the changing Chinese
domestic market. We present a research model that illustrates various patterns of
outsourcing options. Three case details provide implications on the role of strategic
outsourcing. Lessons of strategic outsourcing practices in this paper may provide
useful insights to plan outsourcing practices in other emerging global economies.

Growing Chinese domestic market

With rapid growth of its economy over the past two decades, China has now significant
size of middle and upper class of consumers supporting huge domestic market.
Besides, China also offers cost-effective manufacturing competencies and innovative
outsourcing capabilities for multi-national corporations (MNCs) through its vast
network of socio-technological resources. In view of its growing engagements with
the world Chinese market has significant implications on global supply chain (Hong
et al., 2006).
Table I shows the size and the rapid growth rate of Chinese gross domestic product
(GDP). The average annual GDP growth rate of China for the past seven years is
9.9 percent. Chinese share of global GDP was only 6 percent in 1990, but with rapid
economic growth, its share of global GDP has grown 15 percent in 2006. 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 (Jing, 2007).
With its rapidly growing economy China has received huge foreign direct
investment (FDI). Table I also shows the size and the growth rate of FDI. Such influx of

2001 2002 2003 2004 2005 2006 2007

GDP (RMB, billion) 10,965 12,033 13,582 15,987 18,322 21,192 24,953
Growth rate (%) 8.3 9.1 10 10.1 10.4 11.6 11.9
FDI (US, billion) 46.8 52.7 53.5 60.6 60.3 69.5 74.8
Growth rate (%) 15.2 12.5 1.5 13.3 0.5 15.2 7.6 Table I.
GDP and FDI growth
Source: National Bureau Statistics of China of China
SO FDI also suggests the growing Chinese domestic market potential that many multi-
corporations intend to penetrate. According to Chinese Brand Strategy Association,
2,3 the potential size of affluent consumers that purchase high brand products is 160
millions, that is about 13 percent of the total population. This suggests that China has
the third largest consumer market in the world which is next to Japan and the 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
242 consumer market in the world.
The growing consumer market in China provides MNCs with expanding business
opportunities. At the same time, as in all other emerging global economies, MNCs need
to consider other risk factors of Chinese market. Recently, RMB (Chinese currency)
value is rising. Changes in labor laws and tax regulations affect firm’s profit level.
Rapidly evolving competitive landscape requires new capabilities for MNCs in China.
Besides, in this highly connected global economy MNCs in China are facing intense
competition with other global firms and Chinese-owned innovative local enterprises
(Wu et al., 2004, 2006).

Theoretical insights for outsourcing

Outsourcing is an important business practices (Gilley and Rasheed, 2000; Harland
et al., 2005). According to Embleton and Wright (1998), ‘‘outsourcing refers to the
concept of looking for expertise to handle certain business functions outside the
existing firm.’’ Lonsdale (1999) defines outsourcing as ‘‘the transfer of previously in-
house activities to a third parity.’’ The basic concept of outsourcing is the transferring
of internal functions to external entities. Gilley and Rasheed (2000) argued that
outsourcing may occur ‘‘through the substitution of external purchases for internal
activities and abstention of resources that have not been completed in-house.’’ Thus,
the two aspects of outsourcing are ‘‘substitution-based’’ and ‘‘abstention-based.’’
Sourcing is also further distinguished as ‘‘onshore insourcing’’ (insourcing within
county) and ‘‘Onshore outsourcing’’ (outsourcing within country). Sourcing between
countries is ‘‘offshore insourcing’’ and ‘‘offshore outsourcing.’’ In their analysis of 25
papers on offshoring King and Torkzadeh (2008) derived the concept of ‘‘inter-country
outsourcing.’’ They defined offshoring ‘‘as a form of outsourcing performed outside the
client organization’s home country.’’ The focus of this paper is on the outsourcing of
subsidiaries of MNCs that operate within China. This paper does not include ‘‘inter-
country outsourcing.’’ Therefore, in a strict sense this paper is not about offshoring.
Firms that start with FDI in other countries operate in somewhat different business
environment from their mother-firms. These foreign subsidiaries should pour
enormous resources to become similar to their mother-firms in terms of their in-house
capabilities. However, such resource investments may not necessarily guarantee their
competitive advantages. In this sense, outsourcing strategy in the countries that these
subsidiaries operate is quite essential for their sustainable competitive advantages.
For the meaningful analysis of outsourcing this paper draws from theoretical
insights – particularly transaction cost theory (TCT) of economics and resource-based
view (RBV) of strategic management. TCT is helpful in considering the impacts of
costs on key business decisions. In the outsourcing context firms consider both the
production and transaction costs. When the production cost savings of outsourced
work outweigh the additional transaction costs, firms consider using external market
mechanisms which may result in outsourcing activities (Carmel and Nicholson, 2005).
Loh (1994) investigates various cost factors related to an outsourcing decisions
(e.g. bargaining, influencing, managing and evaluating). In addition to the production Strategic
costs, firms pay close attention to the potential increase in all other transaction-related outsourcing
costs for offshore outsourcing as compared to its onshore outsourcing (Qu and
Brocklehurst, 2003). Other unexpected hidden costs are related to activities such as practices
lock-in, contractual amendment, unexpected transition and management, disputes and
litigations (Bahli and Rivard, 2003). According to TCT, firms may insource or
outsource activities depending on their relative transaction and production costs 243
implications.
In contrast to the TCT, which emphasizes cost minimization, the RBV emphasizes
value maximization of a firm through utilizing its resources (Das and Teng, 2000). RBV
argues that a firm has the ability to achieve and sustain competitive advantage if it
possesses resources that are valuable, rare, imperfectly imitable and non-substitutable
(Barney, 1991). Not all resources are strategically relevant within an organization. No
single organization may develop all the necessary capabilities in-house (Hobday et al.,
2005; Langlois, 1990). Firm’s ability to control and make critical capabilities is the most
important basis of competition (Gottfredson et al., 2005). Therefore, firms have to
ensure they have sufficient access to and control of valuable resources either internally
or externally. A firm’s critical resources that have high strategic value should be
preserved and exploited internally. On the other hand, it is beneficial for the company
to outsource any target activities that have low strategic value (Roy and Aubert, 2001).
For the sustainable competitive advantages firms continue 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).
Thus, TCT and RBV perspectives provide valuable insights for the business
rationale of outsourcing practices. Many researchers have found them useful in
explaining specific aspects of outsourcing decisions, processes and outcomes.
However, in view of increasing level of complexity of global outsourcing, TCT and
RBV might not be sufficient in fully exploring outsourcing-related business issues. The
emerging trends of global outsourcing require strategic aspects of outsourcing beyond
total cost reduction and organizational capabilities. In this context this paper examines
flexible outsourcing strategic practices that consider outsourcing risks and benefits.

Research model of strategic outsourcing

For the purpose of this paper we have adapted Kraljic’s purchasing portfolio
framework. Kraljic’s model classifies all the purchased materials in terms of profit
impacts and supply risks. By assessing the company’s situation with these two
variables, purchasing executives may assess the overall strategic supply position,
consider its purchasing options and reduce the overall risk associated with purchasing
decisions (Kraljic, 1983). After Kraljic presented his purchasing portfolio, it has been
adopted as a valuable tool for business research. Other researchers refined and adapted
Kraljic’s model for the study of purchasing portfolio (Caniëls and Gelderman, 2005a;
Gelderman and van Weele, 2005). Caniëls and Gelderman (2005b) in particular
analyzed the articles on purchasing portfolio (Elliott-Shircore and Steele, 1985; Hadeler
and Evans, 1994; Lilliecreutz and Ydreskog, 2001; Olsen and Ellram, 1997) and
suggested similarities of these models to that of Kraljic’s original model in terms of
dimensions, categories and recommendations. In view of the analysis and conclusion
of Caniëls and Gelderman (2005b) we adapt Kraljic’s portfolio model for the analysis
of outsourcing strategic patterns.
SO The patterns of purchasing and outsourcing decisions are similar in that both
2,3 consider the characteristics suppliers and the cost-benefit contents. Atkearney Survey
(Monczka et al., 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
244 respondents suggest that procurement has a high level of involvement in the
outsourcing strategy planning processes. In view of similar value process
characteristics we have adapted our strategic outsourcing matrix based on Kraljic’s
portfolio model. Our analysis focuses on the effective allocation of limited resources to
improve the management ability and optimize outsourcing benefits. Figure 1 shows
strategic outsourcing matrix. It has four different patterns – leverage, strategic, non-
critical and bottleneck items. We classify a firm’s products, services and activities on
the basis of two dimensions: profit impact and outsourcing risk. The profit impacts are
defined in terms of the cost reduction, economies of scale, 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 carefully consider 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 that exploits their profit
potential and enlarge their market share. Leverage items can be obtained from external
markets with low risks and these items allow the company to exploit its full profit
potential (Caniëls and Gelderman, 2005a, b; Gelderman and Weele, 2002). Firms may
adopt an optimum level of outsourcing with relatively low costs while committing their

Figure 1.
Strategic outsourcing
matrix and firm options
major resources on securing their core competencies. Substantial reduction in Strategic
production cost through outsourcing may enable firms to enlarge their market share
and achieve maximum possible profit impacts.
outsourcing
If profit impacts and outsourcing risks are high, firms may make strategic practices
partnership with outsourcing partners, or vertically control these items for long term
market advantageous position. Because of relative high transaction costs and high
strategic values, firms may prefer internally controlling these strategic items for their
long term market advantageous position. Outsourcing strategic items require
245
minimizing risk factors. Kraljic (1983) suggested three options (i.e. exploit, balance and
diversify) for strategic items based on supply market strength and company strength.
The key risk mitigation approaches for outsourcing strategic items include close
strategic partnership with suppliers and sourcing alternate partners for reducing the
risk of over-dependence on a single partner.
In the case of low profit impacts and low outsourcing risks, firms may pursue
business approaches that focus on efficiencies based on economies of scale. Since the
production costs of external market operations are lower than in-house operations,
non-critical items with low strategic values may dictate high level of outsourcing.
Highly specialized service operations too often employ outsourcing strategy that
ensures both cost-reduction through economies of scale and superior quality assurance
of products and services.
Where the outsourcing risks are high and profit impacts are low, firms may work
with alternate supply partners and assure supply availability. Bottleneck items may
increase risk factors (e.g. inventory shortage, on delivery issue, quality problem,
technical and market uncertainties). With the increasing numbers of bottleneck items
firms experience their business operations become more complex and accordingly
unexpected expenses multiply and yet value creation potential is limited. Getting
volume insurance and finding alternative sourcing partners may be considered in such
context (Gelderman and Weele, 2002). If any finished goods turn out to become
bottleneck items, these firm should consider withdrawing them from their market.

Case study methods

Case study is useful to explore questions of ‘‘how’’ and ‘‘why’’ (Yin, 2003). In this article
we use a explorative case study based on executive interviews. Our focus is
particularly to examine how foreign MNCs in China to implement strategic outsourcing
practices and to apply the relevance of our strategic outsourcing model in actual
business practices. Structured and follow-up interviews are conducted for the purpose
of case illustrations. Details of these interview questions are shown in the Appendix.
We selected the three firms for case study from MNC firms that implemented active
outsourcing practices and operated more than seven years in the greater Shanghai area
which is regarded as one of the centers of Chinese economic activities. The focus of the
two firms is for domestic demand in China, the other one (i.e. a traditional
manufacturing firm) targets both domestic and overseas demands. The first one we
chose is E-Land as a representative of SPA (Specialty Retailer Private Label Apparel)
because it has implemented complex supply chain practices and has positioned as a
successful business in China over the years. The second firm is Swatch Group as a
sample of the premium brand firms that grow fast within a short period of time. The
third firm is Ault that entered Chinese market and implemented outsourcing practices
from very early operation. It represents power supply manufacturers among typical
electronic manufacturers. We chose this firm to examine outsourcing practices of
SO component suppliers of electronic industry which has relatively longer years of
2,3 operation history in China. In-depth interviews were conducted using structured
interview questions. The interview participants were purchasing managers,
production managers and managers in charge of the localization of their component
parts. Initial interview lasted at least one and half hour. Additional information and
clarification were made through follow-up telephone interviews. We present the
background information of each firm that participated in the interviews. We further
246 discuss the findings in four parts:
(1) analysis of outsourcing portfolio;
(2) the optimal level of outsourcing;
(3) flexibility of portfolio strategy; and
(4) race to the top (value creation).

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 its early years of
operation in Korea, its key strategy was efficient production through outsourcing and
marketing through franchise style promotion. Its corporate priority ensures
maintaining the core competencies in terms of strategic planning, merchandising and
design. In 1994 E-Land started its marketing efforts in China. Different from its Korean
marketing strategy, it adopted premium brand strategy. The entire production was
outsourced in China. Different E-Land Korea’s franchising system, E-Land China
vertically integrated distribution functions. 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 covers most of
large cities and main department stores. In 2007, E-Land’s sales volume exceeds USD
300 million and its growth rate is more 100 percent than 2006.

Case 2: Swatch Group

Swatch Group, the world’s leading watchmaker, was formed in 1983 through the
merging of the two Swiss watch manufacturers ASUAG and SSIHS. Swatch’s original
intention was to re-capture its market share that had been lost during the aggressive
growth of Japanese companies such as Seiko. Based on its 157 manufacturing facilities
in Switzerland, it has successfully marketed 20 different brands in the global market
over the years. As core capabilities, Swatch focused on new style design,
manufacturing efficiency and brand power. Swatch Group penetrated Chinese market
in 2000. With its high vertical control of the production in Switzerland, it penetrated
Chinese market with efficient management of distribution strategy. Swatch launched
15 different brands in China, targeting all market segments, from low-end to high-end
brands. 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 (Power Supply) in the USA. With
rapidly losing its competitiveness with high cost of manufacturing in the 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 Strategic
organizational structures to be flexible and efficient. After operating Ault Korea, it outsourcing
strengthened its cost competitiveness through better management of purchasing and
practices
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. Afterward, Ault China did not remain as a mere 247
simple assembler. Instead, it adopted appropriate outsourcing strategy to
strengthening its internal and external core competencies for sustainable competitive
advantages in response to changing business environment.

Findings
(1) Analysis of outsourcing portfolio
As described in the above case summaries, these MNCs are successful through
strategic outsourcing practices by generating consistently high level of profits in the
Chinese market. Here, the key for their strategic outsourcing is to employ appropriate
strategy which carefully considers profit potential and risk factors. Figure 2 shows
application of strategic outsourcing matrix. E, S and A refers to E-Land, Swatch and
Ault, respectively. The horizontal axis shows continuum of risk factor (left – low, right –
high). The vertical axis is about 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.

Figure 2.
Application of strategic
outsourcing matrix
SO Our case examples provide valuable implications on strategic outsourcing choices
and business outcomes. For the leverage items, E-Land and Swatch outsourced
2,3 production and distribution functions with high level of outsourcing and they
successfully penetrated Chinese market and exploited the growing buying power. An
important competitive factor for SPA firms like E-Land is to securing timely and fast
delivery capabilities of diverse products that are sensitive to seasonal demand
fluctuations. As a foreign firm it takes enormous amount of resources (i.e. time, people
248 and money) to stabilize the management of the wide network of manufacturing
facilities in China. E-Land could penetrate in Chinese market fast through utilizing the
existing numerous specialized clothing manufactures in China. Besides, E-Land’s
effective outsourcing could achieve the synergy effect through the necessary level of
economies of scale that allowed the expansion of its market share in other countries
(e.g. Korea) as well as in China. Over the years E-Land has built highly flexible supply
system with an outsourcing network that includes more than 100 firms.
Swatch Group initially outsourced the sales function to minimize the market
entrance risk particularly by the lack of its brand awareness by Chinese customers. By
forming partnership with top local distributors such entrance risk was minimized and
in a short period of time it could establish its brand power. In this way, both E-Land
and Swatch Group utilized the local Chinese manufacturing and distribution resources
and minimized the need of heavy investment on their own. Thus, these two firms
achieved outsourcing effects in the leverage items.
For the strategic items, firms vertically controlled the items in-house for long-term
Chinese market. If the strategic items belong to the purchasing items, they made close
strategic relationship with suppliers. Swatch Group insourced product development and
production activities in Switzerland and maintained product innovativeness and premium
product quality and expanded the global market. E-land adopted differentiation strategy
(i.e. direct business marketing) in China, which is different from the franchise marketing –
its mother-firm practices in Korea. Having 1,500 sales outlets in 500 department stores it
established the premium value chain network that covered the vast regions of China and
therefore built a stable basis of long term sales growth. E-Land also constructed the high-
powered IT system to fulfill the critical needs of rapidly changing fashion apparel business
(i.e. fast, efficient and reliable information of production, supply availability and inventory
status) for the huge geographical areas of sales outlets. With this IT support, E-Land:
. managed production cost, supply quality and inventory level;
. ensured high level of customer satisfaction;
. discovered the changing demand patterns of customers in terms of fashionable
types and styles of products; and
. enhanced the competitiveness by rapid design, production planning and
inventory management.
Ault China vertically controlled a few critical component parts (e.g. plastic case,
transformer, cable assembly). Plastic case and transformer are important component
parts that impact the final product quality and cost structures. Ault China sourced
these components through their own production facilities to sustain desirable product
quality and cost reduction while Ault Korea outsourced the above parts. Ault mostly
outsourced low-end linear power supplies which were marketed mainly in the USA and
EU market, not Chinese market. Besides, Ault China decided outsourcing its non-core
products (e.g. linear power supply) from the most competitive Guangdong area power
supply manufacturers. They supplied linear power supply to Ault with superior Strategic
quality and competitive costs.
As Ault China attained stable level of production with increasing production
outsourcing
volumes problems arose. It faced mounting management challenges with increasing practices
level of investment needs for new production facilities, better equipments, and more
management personnel. To resolve these issues the Ault China management decided to
concentrate manufacturing high-end Switching Mode Power Supply (SMPS)
production and to outsource all other component parts.
249
Cable assembly items, on the other hand, should be supplied in small volumes and
diverse styles according to finished goods specifications. They are not available
through external suppliers and therefore Ault China decided to use their own internal
production lines. For plastic case and transformer items Ault China selected
outsourcing partners with close strategic partnership. The supplier chosen for
transformer was able to collaborate from the early stage of research and design
functions of product development and was willing to sustain close partner
relationships. With such commitment arrangement Ault China could minimize the
overall business risks. On the other hand, cable is a critical component that is needed at
the final assembly process and the timely acquisition was not always possible because
of its order characteristics in small volume and diverse styles. The management
adopted insourcing option for it. In this way, Ault China adopted both insourcing and
outsourcing options for the component parts that are regarded as strategic items. Thus,
decisions for strategic items require careful assessments of internal capabilities and
external supply environment, the level of insourcing and outsourcing and long-term
market position.
For the non-critical items, Swatch outsourced back office functions (e.g. import and
tax management processes) for efficiency. Swatch imports all the product items for
Chinese market and its internal capabilities are adequate for managing on their own.
However, these tasks require efficient processing. Swatch enhanced efficiency of
business processes with substantial overall cost reduction by utilizing external
professional expertise and relational competencies of Chinese local firms.
Fourth, for the bottleneck items, Ault has not adopted purchasing function, so it is
the big bottleneck item in China. Most of raw materials were supplied in Completely
Knock Down (CKD) form by Ault Korea. Assembling process by CKD led to serious
problems in Ault China production operation. Ault has produced multiple lines of
products with more 5,000 components parts list. Naturally, it experienced supply
shortage and long delivery problems which cause disruptions. Therefore, supply chain
issues between Ault Korea and Ault China were quite frequent and serious. In 2001,
Ault started sourcing alternate vendors in Shanghai areas and during the 1 year effort
they set up 100 percent purchasing system in Ault China. In this way, Ault secured its
cost competitiveness (10 percent cost down) and established speed delivery system.

(2) The optimal level of outsourcing

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 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.
SO Kotabe argued E-commerce may change the optimal point of outsourcing level. We
found firm’s core competences also can change the optimal point of outsourcing level.
2,3 Even though Eland and Swatch outsourced production and distribution activity with
high level of outsourcing, they successfully controlled outsourcing with high
outsourcing benefits. Eland have accumulated outsourcing skill long time in China, so
that Eland can manage 100 percent production outsourcing while ensuring high
quality and flexible delivery. Swatch, on the other hand, utilizes up to 90 percent of
250 their distribution activities in Chinese market through outsourcing partners by
utilizing its strong brand power and diverse scope of products. Therefore, firms need to
consider carefully their core competences before outsourcing decisions. Then, they
have to make decisions in terms of outsourcing items and outsourcing levels
considering strategic outsourcing matrix to sustain the competitive advantages.

(3) Flexibility of portfolio strategy

Outsourcing portfolio application requires careful consideration of the position of each
item based on risk factors and profit impact. Since risk factors and profit impacts are
different by product items, firm specific contexts and industry factors, outsourcing
executives prepare checklist, consider the details carefully and classify items in four
different categories and pursue outsourcing strategy. This research model suggests the
dynamic aspect of the outsourcing portfolio. The location of resources of firms is not
permanently fixed within the portfolio. Its position may move according to the changes
of business environment. Therefore, it is important to periodically check and examine
the underlying factors that affect the nature of outsourcing practices. Since the product
life of items and competitive conditions fluctuate, firms need to pursue flexible
portfolio strategy.
Swatch Group initially outsourced the distribution channel to minimize the market
entrance risk particularly by the lack of its brand awareness by Chinese customers. By
forming partnership with reputable Chinese distribution network such entrance risk
was minimized and in a short period of time it could establish its brand power. As it
penetrates Chinese market successfully and expands distribution network,
sophisticated after-sales follow-up and customer service becomes more and more
important to build a broad level of loyal customer base. Thus, in order to assess the
market condition and support after-sales service, it changed distribution strategy and
started to manage about 10 percent of distribution channel resources internally. Ault,
on the other hand, secured its competitive position through internal development and
production of the linear power supply products as strategic items. Later, with the
appearance of SMPS and the trends of light weight and smaller size linear power
supply products faced real risk in the profit impact. At this time, Ault outsourced
standardized linear power supply products based on mass scale order and predictable
demand from Guangdong region in China. In this way, Ault achieved the needed
competitive advantages through outsourcing linear power supply products with low
cost and high quality. At this time, linear power supply products were reclassified from
strategic to leverage items and sales of these products through outsourcing increased
up to 50 percent of the total sales. Among some of linear power supply products, high
premium products in small scale were developed and manufactured in-house. As the
profit impact of linear power supply products was deteriorating and with the
challenges of strong competitors linear power supply products were reclassified as
non-critical items. At this stage, even small-scale premium products were outsourced
as well. Eventually, linear power supply products were no longer listed as a part of
Ault’s business and it only maintains to the extent of customer after-sales services for Strategic
the previous sales. Thus, no particular product may provide permanent competitive
advantages. Therefore, each firm needs to consider the lifecycle of its products.
outsourcing
Outsourcing executives continue to evaluate the outsourcing portfolio according to the practices
lifecycles of the entire products, reclassify these items and manage the scope of
outsourcing with flexibility and strategic perspective.

(4) Race to the top (value creation)

251
In the emerging market, MNCs compete against the global firms. Four hundred and
ninety firms out of Global Fortune 500 have invested in China. The competitive
landscape is becoming much more diverse with the efficient low-cost performance by
Chinese local firms and innovative firms that expedite the effect of organizational
learning. Firms may either:
. race to the top by utilizing the business activities, products and services as the
leverage and strategic items; and
. race to the bottom by allowing them to be limited to the non-critical and
bottleneck items.
If a firm derives its primary sales from the bottom non-critical items, intense
competition eventually deprives it from sustainable competitive advantages in the
market. In this business environment MNCs need to minimize non-critical and
bottleneck items and maximize leverage and strategic items for their sustainable
competitive advantages. In brief, they must race to the top. It depends on how these
firms utilize their core network capabilities through effective combinations of their
outsourcing and insourcing sets of possibilities.
These three firms pursued ‘‘race to the top’’ strategy in China. E-Land, quite different
from its medium level brand strategy and franchising strategy in Korea, adopted high
premium strategy in China for brand conscious customers in China. E-Land outsourced
production and instead concentrated on design, marketing and distribution which have
higher profit impact in Chinese market. Swatch Group utilized the strategic
partnership with Chinese local distributors and appealed the broad spectrum of
customers that cover not only low and medium priced products but also high value
premium products. Ault China also focused on the development and production of
high-end SMPS and maintained its competitive position. Thus, these case firms entered
the Chinese market with their limited resources and pursued perpetual change
strategies by combining both insourcing and outsourcing for risk minimization and
maximization of profit impact. It is no longer feasible for any firms to prosper in
Chinese market with single dimensional focus (e.g. lost-cost strategy). Many foreign
firms in China increasingly face wage increases, exchange rates fluctuation and intense
competition. Some of unsuccessful firms move out of China and migrate into South
East Asia for low-cost advantages. However, successful firms all the more expand in
Chinese market through their effective use of strategic outsourcing practices. Highly
competitive firms continue to capture these growing market potential in a ‘‘race to the
top (leverage items and strategic items)’’ rather than in a ‘‘race to the bottom (bottleneck
items and non-critical items).

Discussion and conclusion

This paper provides an outsourcing typology in Chinese market with the particular
focus on strategic outsourcing. We present a strategic outsourcing matrix which
SO managers may find useful to analyze the outsourcing patterns in China. Firms need to
2,3 be aware of the particular market reality for their products and services outsourcing
strategy that optimizes with the combination of the overall profit impacts and risk
factors. The theory of portfolio model supported by case illustrations provides some
meaningful managerial implication. For appropriate application of outsourcing
portfolio model it is necessary to classify the position of each item according to risk
252 factors and profit impacts. Since risk factors and profit impacts are different by
product items, firm contexts and industry factors, outsourcing executives need to make
a list of checklist for evaluation and clarification and pursue particular outsourcing
strategy. For strategic items a firm usually considers insourcing for long-term
sustainable competitive advantages. In case of using outsourcing it is essential to
construct high level of strategic partnership through fairly sharing outsourcing risks
and profit impact. For leverage items high level of outsourcing may allow firms to reap
the high level of outsourcing benefits. Foreign firms using FDI of their mother-firms
may maximize the leverage items by outsourcing to local Chinese firms. On the other
hand, bottleneck items show the disadvantages of outsourcing most obviously. Firms
need to secure adequate level of supplier network for these bottleneck items and move
these items to leverage or strategic items through additional investment for the
development of substitution products. If these are finished products, it would be
desirable to stay away from this product lines as fast as possible. The key of
outsourcing strategy is to maximize the synergistic effect by combining both one’s own
and others’ core competencies. The key is to minimize the outsourcing risks while
maximizing profit impacts. The portfolio model presented in this paper suggest
dynamic nature of outsourcing options which require concerted efforts and due
diligence to evaluate one’s internal capabilities with the external outsourcing options in
the rapidly changing market environment. The findings of this study are based on
executive interviews of three firms. The intent of this paper is not to present a general
model for outsourcing practices. Instead, this model is intended to provide a useful
insight on how to achieve sustainable competitive advantages as MNCs enter Chinese
or other international markets with the resource constraints. Future research would
explore complex risk factors in view of rapidly changing global market environments
and suggest effective outsourcing practices in diverse business contexts based on more
robust outsourcing portfolio models.

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Appendix. Structured interview questions

The focus of the interview is your firm’s strategic outsourcing practices in terms of firm
description, market assessment decisions, core competencies and specific implementation issues.
For the purpose of this paper, your firm refers to the MNC’s subsidiary operations in China and
mother-company refers to the originator of MNC’s operations in China.
(1) Descriptions of MNCs’ mother company and Chinese operation decision
1-1. Your current job title and responsibilities? (This is to clarify whether the person is
able to answer the questions in relation to strategic outsourcing decisions)
1-2. Where is your firm’s mother-company located? What are the key products of your
firm?
How would you describe the core competencies of your mother-firm?
 1-3. When did your mother-firm start its subsidiary operation in China (hereafter this is Strategic
referred to your firm)?
outsourcing
1-4. What are the primary reasons for entrance to Chinese market? (e.g. cost advantage,
component parts acquisition, Chinese market penetration. . .)?
practices
1-5. What were the initial challenges or difficulties for the entrance in Chinese market?
What particular regional focus for the Chinese market?
(2) Macro-issues related to adoption of strategic outsourcing practices of your 255
firm
2-1. How would you describe the market environment of your firm in terms of growth
rates, Customer characteristics and competition intensity)
2-2. Who are your key competitors? What is your firm’s competitive position at this
time? (e.g., leader, follower and laggard?)
2-3. Does your firm have formal planning and evaluation process for SOP? What are the
primary issues for strategic outsourcing practices (SOP) in your firm?
2-4. Which activities are your firm currently outsourcing (e.g. Research and
Development, Marketing, Distribution, After sales service, Purchasing,
Manufacturing, Information technology, Accounting, Human resources, etc)?
(3) Strategic outsourcing decisions
3-1. How does your firm determine the needs/areas for outsourcing? Could you tell us some
specific organizational processes through which your firm assesses SOP decisions?
3-2. Do you regularly evaluate the profit impact of each of outsourcing activities? What
are the key criteria of selecting outsourcing firm?
3-3. What are the primary reasons for adopting outsourcing practices?
3-4. For Insourcing activities, what are the reasons you have chosen not to outsource?
(4) Outsourcing implementation
4-1. How many suppliers do you have? How does your firm differentiate suppliers based
on their value contribution?
4-2. How do you maintain partnership with your suppliers? How do you assess risk
factors of your outsourcing?
4-3. What are the main factors for success in outsourcing activities? Which outsourcing
problems did you experience(quality, hidden cost, contract, cultural, delivery
problems)?
4-4. What is the main tools for handling the information transfer with outsourcing
partners?
4-5. How does your firm reexamine outsourcing practices according to the changes in
management, product life cycle and technologies? Could you provide any specific
examples?
(5) Outsourcing results
5-1. Do you have any formal measures of the effects of outsourcing? If so, what are
they? (e.g. financial outcomes, quality results, core competences, delivery
flexibility,. . .)?
5-2. How do you correct any outsourcing failures or undesirable outsourcing outcomes?
SO About the authors
Mingu Kang is a PhD Student of School of Management, Zhejiang University, China. His
2,3 research interests are in outsourcing strategy and global manufacturing strategy.
Xiaobo Wu is Professor of School of Management, Zhejiang University, China and Director of
National Institute for Innovation Management (NIIM). Xiaobo Wu holds a doctoral degree in
School of Management from Zhejiang University. He is directing member of Steering Committee
of Management Studies of State Education Ministry of China and founder member of Centre for
256 International Manufacturing & Management, Cambridge University, UK. He has participated
over 20 research projects granted by NSF China and State Education Commission and four
international cooperative research projects granted by IDRC (International Development
Research Center) and CIDA of Canada mainly concerning the management of technology. His
research interests are in information technology and management change, managing
technological innovation and business strategy and global manufacturing strategy.
Paul Hong is Professor of Information Operations and Technology Management of College of
Business Administration at the University of Toledo, USA. Paul Hong holds a doctoral degree in
Manufacturing Management and Engineering from the University of Toledo. He also holds an
MBA and an MA in Economics from Bowling Green State University, USA and a BA from Yonsei
University in Seoul, Korea. His articles have been published in journals including European
Journal of Innovation Management, International Journal of Operations and Production
Management, Journal of Operations Management, Journal of Enterprise Information
Management, Journal of Knowledge and Information Management, International Journal of
Quality and Reliability Management, International Journal of Production Economics, Research in
International Business and Finance, International Journal of Logistics and Systems Management,
International Journal of Services Operations Management, Korean Journal of Tourism Research,
and Tourism Culture and Science. His research interests are in technology management,
operational strategy and global supply chain management. He is the research coordinator for
International Symposium and Workshop in Global Supply Chain. Paul Hong is the
corresponding author and can be contacted at: Paul.Hong@Utoledo.Edu

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