CHAPTER 10

GLOBAL OUTSOURCING AND EQUIPMENT ACQUISITION

At the end of the chapter the students shall be able to:

 Discuss the opportunities for local suppliers in global outsourcing;

 Identify the cost associated in the outsourcing of materials;
 Give the advantages of the local entrepreneur in the global outsourcing of materials;
 Discuss the process of countertrading options;
 Give the role of purchasing in equipment and acquisition; and
 Discuss the process in equipment acquisition

The total level of global purchases has increased tremendously during the last two decades.
The availability of lower manpower cost in developing countries or those mostly in Asian region
became the backbone of economic development. China has dominated the export market in
terms of materials for toys, shoes, garments, and electronic devices and many others. In view of
this low cost of materials in China, most companies have set up their buying organizations to
take care of their purchases. These strategies are taken by most industrial companies in order
to use the leverage in creating lower prices for their products. Industrial local sourcing of
materials would hardly make a greater competitive advantage due to the cost of labor and other
input in the production.

The purchasing department of the outsourcing firm plays a major role in keeping the cost of
materials down. The trend goes to global outsourcing of materials to take advantage of lower
cost. The competitive market has to implement global sourcing as most firms have gone miles
ahead in keeping their products at lower costs. The once patriotic customers have gone to lower
cost products as the economy of the population shifted to affordable products. While quality is
the most important customer’s position in their purchase, price prevails when the difference is
too tempting to disregard.

The automotive and electronic industries survival in the competitive market hinges on the
lower cost of materials which are outsourced by most companies. While these could be an
opportunity for Philippines, the business condition in the local market has not taken advantage
of this opportunity. We need newer technology to produce new component products for the
export market. Our labor situation of increased manpower cost and unstable management labor
relations resulting in strikes be left to China and the neighbouring countries like Vietnam,
Cambodia, Thailand and others.

The Philippines must institute incentive programs that will develop technology and industries
that will support the world market’s needs for high value low cost materials. Government
incentives for foreign investors is not enough to win them back. Government must institute
programs where investors would not go through the rigorous process of red tape and
voluminous requirements before they could start operation in disguise of local corporate
protectionism.

We have the manpower complement and the skills to be competitive in the area of
producing materials for export.

The same cost of producing materials in our neighbouring countries is the same kind of cost
when it is produced locally. It involved raw materials, labor, technology and equipment
depreciation. The difference lies on the cost of labor which is about 75% lower when it is
sourced outside the Western countries. The cost of electivity that is used in the manufacturing is
also too high in the Philippines. This is another contributing factor in local sourcing that drives
investors to go to other Asian countries. The western manufacturing environment and those of
Japan has very expensive labor components. They cannot be competitive if the materials are
produced locally. Their strategy of outsourcing their material requirement made their competitive
advantages afloat in the business world of games.

The following are added costs in materials outsourcing:

1. Administrative cost- refers to the ordering process which involves communication,

documentation, salaries and wages of those involved in outsourcing including
transportation cost. The costs are:
a. Identification of reliable supplier
b. Program development and communicable linkages
c. Cost of delivery
d. Brokerage fees and incidental expenses including demurrage

2. Cost of maintain a foreign buying office

a. Rental of office space

b. Salaries of detailed purchasers
c. Relocation allowances and representation expense
d. Repatriation expense por travelling allowances

3. Common cost for imported and local source

a. Raw materials and direct labor cost is lower in developing countries

b. Transportation
c. Inventory cost
d. Lead time
e. Delivery cost is higher for imported materials
OUTSOURCING OPPORTUNITIES

As the new developing tiger of the Asian region, Philippines could be a new haven for the
production of new components for export to the western world. The country has abundant
supply of raw materials like copper, gold and other products which when turned into finished
products could be a source of material components. Foreign countries like Japan and China are
getting these materials form us then process these into raw materials or component parts.

The problem is that we are exporting these raw materials into other countries for final
processing. They are the ones reaping the bounty of being the supplier of materials to other
developed countries. We need to develop processing plants for these products if we are to be
competitive in the production of more components for exports. We have the technical and
manpower skills to do the task, we just need new investments in new machines and power
generating facilities using geothermal resource as these could be the resource of lower power
cost.

This will help develop our economy which is greatly dependent on our labor export to more
developed countries. Our educated population needs new employment opportunities. When
new employment opportunity is generated, they will be paying income taxes which could be the
true backbone of our economy. We should go into the direction of recalling our brain powers
who are being used by other countries to their advantage.

Government should look into these partnership opportunities. We need to open the door for
investments by establishing more export zones. These investments should be towards
countryside development by establishing more processing plants for raw materials and turn
them into exportable materials. When more export components are available then the direction
would be towards the assembly of these components into finished products. We can then be
more competitive due to our technical labor force and lower manpower cost.

ENTERPRENEURSHIP: THE DEVELOPMENT OF NEW HEROES

The present generation of new heroes in the country’s economic activities is focused on the
overseas employees who remit about 30 billion US dollars annually that helped sustain the
economy of the country. We are known as good workers for other nationalities. We have the
fluency to communicate in the international language and this made us the favourite employees
of foreign nationals.
Global outsourcing is the trend of the present and in the next generations as the
competitive world’s direction is towards quality product at a lower cost. Supply management is
becoming important to the survival of the world’s economy of the more advanced manufacturing
industries. The electronic industries and those in the apparel business will be out of business
without the supply of raw material components from the Asian region as the lower cost is more
important consideration.
The Filipino entrepreneurs are the sleeping giants taking bold steps towards these
business opportunities. The government programs on developing new industries must put
forward to take the lead in the supply chain of materials components for the world’s growing
electronic business. Our exports of electronic companies are focused on labor contracting for
the foreign companies that are based in the export processing zone.
The components entered our country tax-free and re-exported to the country of origin
where they are assembled and re-exported partly to our country as finished product.
Assemblers put on their brand name and exported them to other countries competitively due to
its lower cost of raw materials and labor cost. In effect, we were ‘fried with our own oil.’
The great advantage for Pinoy entrepreneurs could be the following:

1. Educated manpower
We have a high rate of educated manpower that could be used in the production of more
goods. Our employees can communicate in the international language and therefore
communication barrier is eliminated. Our literacy in computer knowledge is getting higher,
and this could be another plus factor when communicating overseas using the internet.

2. Quality issues
Pinoy is known as a good worker if given the right motivation and management
recognition for his talent and skills. Good quality product is the making of good skilled
worker and the technology. We can be quality driven as the competition hinges partly on the
ability of the workforce o inspect defects and develop work value.

3. Quantity
Since we have enough manpower at the disposal of the component supplier, we can
produce more products as needed by the outsourcing organization. Shipment of finished
products could be done in containerized form using the facilities of the developed ports in
Manila, Batangas or Cebu.

4. Distance
We are strategically located in the Pacific basin and accessible by sea and air
transportation which can be an easy way out to Western port or Japan. This will be a cost
advantage in terms of freight charges for export goods. Our developed port of exit and
entries can facilitate easy transport of component products that will reduce lead time
delivery.

5. Pipeline inventory management

It will be easy for the outsourcing firm to plan their inventory system when lead time is
shorter. Products or components could reach the destination by calculating the shipping
time available against available inventory in the pipeline. Since communication barrier is
eliminated with the use of computer-aided technology and the language facility, then
pipeline inventory management is more efficiently carried out.

6. Reduced overhead cost

The outsourcing company can reduce overhead cost as the cost of operating an
outsourcing office is competitive with other countries. Meanwhile, they can assign local
broker who can be trusted with product quality assurance. This is possible due to our
engineers and purchasing agents with facility to communicate technical information without
the need for translators.

7. Facility in negotiations
Knowledge of negotiations is a plus factor in outsourcing activities. Since we can directly
negotiate with the probable buyer through effective face to face negotiation or through
teleconferencing, the contract could be made without much problem. The language of the
 industry both in technical terms and those of business are similar with that of the western
pattern.

The following are the disadvantages for Filipino entrepreneurs:

1. Stability of manpower cost and labor management relations

The frequent change in labor cost is counterproductive for outsourcing organization. The
price of the component will change when the price of the labor component in the labor
production of goods goes higher. The unstable management-labor relations resulting in
either strike or lockouts are detrimental for long-term supply chain agreements. Buyers of
input components must be assured of quality products at the right cost.

2. Availability of local raw materials

Some materials are not available locally and if we have to import materials from China,
we may not be competitive in the local world market. The solution is to develop more
industries for local material supply. Let us process our own resources and turn these into
exportable or components.

3. Government regulations and red tape

The import-export entries at the Bureau of Customs must be streamlined for the
outsourcing business. These will generate more revenue for the government. Transactional
red tape should be eliminated as the business world of competition hinges on government
initiative in the interplay of exchange of goods and services.

4. Opportunism and protectionism

Or entrepreneurs have not opened their mindset for partnership and cooperation. Many
would like to take the larger share of the profit without considering the value of foreign
investments. We need new investors in plant equipment and facilities, new technology in
the production of goods and new machineries to make production more efficient. We are
more in trading where profit is assured and least in manufacturing where management
activity is more complex. Our objective in business is more on daily profit intake rather than
the long-term perspective of economic development and profitability.

COUNTERTRADING OPTIONS

Countertrade is the exchange of goods for goods in full or in partial payment of a sales
transaction. It is the practice of some progressive companies to remain in competitive position in
the world market. It is a flourishing business activity as companies buy and trade over greater
distance without having to do operation to the location where they wish to do business.

One of the advantages in this type of operation is the ability of the entrepreneur to
purchase goods anywhere in the world Through the use of modern methods of communication
which is the internet. This improved communication linkages and the greater transportation
availability allowed companies to get a mileage in the competitive market by buying goods from
distant countries where the cost of goods or component is cheaper and of good quality.

The following are some countertrade practices:

1. Offset
It is the practice of commercial compensation that requires as a condition for purchase of
goods or services are paid in terms of co-production, licensing agreement, sub-contracting,
overseas investment or technology transfer. Goods are paid not in monetary terms but in the
form of service or special agreements.

2. Co-production agreements
This arrangement involved that the purchaser is given a share in the manufacturing or
process of the foreign product using the brand name of the company. This is being
encouraged by the recipient organization to provide local employment and the transfer of
the needed technology. On the other hand, the granting foreign organization gains
competitive advantage with the low labor cost of the recipient organization and the
technical manpower base available locally.

3. Licensing agreements
Licensed production occurs when the recipient organization obtains a share of
production work for its owner. The licensing agreement may cover the assembly of the
entire product. The production of more complete product is made as the recipient company
developed the skills and technology in their manufacturing operation. The brand name of
the foreign company is attached to the local products.

4. Sub-contracting agreement
The major contractor for the production of goods or component products outsourced
some of the production to a foreign sub-contractor where labor and materials are available.
This could be the case in the export processing zone where some electronic components
are made. Some components are assembled locally and exported to the major contractor.

5. Joint venture arrangement

Many of the companies in the export processing zone are joint venture arrangement.
This provides transfer of technology and capitalization of the low labor cost in the local
organization. Foreign direct investments in the form of machineries, technical assistance
and capital investment requires counter capitalization in the form of plant facilities that
includes lands and buildings. Part of the management is locally sourced from the partner
organization.

6. Buyback arrangements
This is the process where the supplier of the machine, electronic equipment, tools and
equipment will accept as payments for the product produced by the buying organizations. As
an example, if the supplier of machineries for the local company needs tools that they can
 supply to other overseas company and these are already purchased from the local
organization, such export products could be arranged as payments for loans granted.

THE ROLE OF PURCHASING IN EQUIPMENT ACQUISITION

The acquisition of the capital equipment is a major of top management as it goes through
the process of careful analysis and evaluation. The firm’s financial health and the prospect of
greater saving for using more modern equipment in the production of goods are important
considerations. The acquisition of capital equipment involves the allocation and commitment of
funds as these expenditure requires significant amount of money. The decision to purchase is
made with the expectation that projected return will be for several years and when purchase is
made, it is not easily reversible.

While decision to purchase is vested on the higher level management team, the critical role
of the purchasing executive lies in the process of determining the most appropriate supplier of
the right equipment. Most equipment is pegged on the industry’s norms and negotiation goes
through the process of bidding. Sometimes, it is most cost effective to buy the equipment at an
auction than on the traditional sources. In the case of construction industry, there are second
hand equipment form Japan that are available for auction at very reasonable price that could be
used for specific projects.

Most equipment and machineries in the Philippines are imported or outsourced from other
countries. These require capital investments which are sourced in dollars or foreign currency
that needs approval from different government agencies like the Central Bank and the
Department of Finance. This tedious process of funds availability is not within the
comprehension of small time entrepreneur that made them afraid to upgrade or buy imported
new equipment or invest their limited capital for new venture in the production of components for
export, thereby a lost opportunity for the development of small time entrepreneur.

THE EQUIPMENT ACQUISITION PROCESS

1. Department requisition

The department initiates the purchasing of the new equipment due to obsolescence of
the existing facilities. The upgrading of equipment maybe due to non- competitiveness in
quality outputs or its economic use is not anymore viable. New equipment technology
would produce more products and less expense on labor component. The request is
measured on the organizational goal of productivity and economy and must be approved by
the department top executive or the plant manager.

2. Economic analysis on company goals and objectives

The new equipment acquisition must be consistent with the goals and objectives of the
company in terms of funds availability, its advantages of the competitive advantage and
future economic use on lower manpower cost. These objectives of the company are
important because the purchase of any major equipment will probably affect the plant
 capacity and production methods. The company’s competitive position in the industry for
many years will be assured. The objective of profit maximization is the end component of
the corporate goals and objectives.

3. Development of new project ideas

Progressive organization looks for new ideas and innovation that will make the
competitive in the industry. Competition is based on innovation and it provides a continuous
stream of new ideas and innovations requires brainstorming, analysis and careful planning
as investment in new equipment requires capital. Capital investment projects are grouped in
the following categories:

a. Replacement of old and obsolete equipment

b. Expansion program for existing new products
c. Development for more economical heating equipment
d. Economic source of power supply
e. Renovations and new construction

4. Financial and cash flow analysis

After careful analysis of the equipment viability in terms of its advantages and the
opportunity in market competitiveness and new product development, the financial aspect of
the project goes through process of evaluation.

The evaluation process will focus on the following:

a. Total capital investment to finance the project

b. The cash flow of the company in terms of payment scheme
c. Economic life of equipment

5. Economic evaluation

With the cash flow data analysis, the evaluation of financial process requirements can be
made with focus on the five most common methods of financing evaluation system. Each of
these methods measures the financial performance of each capital projects as we have to
determine the return of investments.

The following are the economic evaluation criteria:

a. Payback period
It refers to the number of years it takes to repay the initial investments. If the loans
were made to finance the investment, it must be able to generate income more than the
cost of money and it must generate profitability index for greater number of years.

b. Average return of investments

 It is the average cash flow after tax deductions from the initial investment is
computed in the relations with payback period and the profit index generated for life
span of the project.

c. Net present value

It refers to the value of peso or money related to the present exchange rate in the
money market. Since most equipment are purchased outside the country, the value of
the peso increases or decreases with the inflow or outflow of the foreign currency.

6. Profitability index in the use of new equipment

The new equipment must generate profit more than the present system. It must generate
more income due to work efficiency and decrease labor costs due to more system
improvement. It must produce better quality products that will increase market share with
lower costs and better quality.

7. Selection process

The final selection of the project or equipment will be based on the price quotations, the
terms of payment and the opportunity cost involved in the equipment acquisition. Bank
financing with longer time payment and lower interest rates may be the best options.

There are two options in equipment acquisition:

a. Direct sales with lease bac arrangement, the buyer- leasee obtains the title to the
property and pays rent on the title to the property and pays rent on monthly or annual
basis. The seller-leaser may buy back the equipment and sells it to another party at a
profit.
b. Operating lease- the leaser maintains the title to the property and the leasee pays rental.
This is very true in some construction companies that lease the equipment for a
specified period and when the project is completed, return the equipment to the leaser.

8. Project implementation and control

The implementation of the equipment acquisition is in the hands of the top executive or
board of directors. When the project is justified and the merits of the project are clearly
identified, then the approval for its implementation is a mater of rubber stamp process.

The entire project must be audited and must stay within the approved budgetary
allocations. Any deviation from the initial cost estimates must be monitored and corrective
actions must be put in place. The auditing process must monitor any deviations and identify
mismanagement and flaws that may alter the real objective of the project. If findings were
unsatisfactory, the project may be revised or replaced.