There was a rapid expansion in trade, investment and finance across national boundaries in the late 19th century, largely due to trade liberalisation. A century down the line, world exports increased from $61bn in 1950 to $6338 billion in 2000. Globalisation was, and probably is, clearly, the word of the day. Deregulation and liberalisation on a global level, was followed by globalisation (Nayyar, 2006).
The onset on globalisation has given rise to the terms outsourcing and offshoring. While outsourcing refers to subcontracting a business process to a third party company, offshoring means the transfer of a business activity to another country.
This report attempts to understand better the underlying reasons and motives for a company to outsource and offshore its business processes, by analysing various economic theories on international operations of a multinational enterprise with respect to the leading clothing and apparel MNE, Hennes and Mauritz, popularly known as H&M today.
After a brief introduction to the company and an overview of the fundamental business processes of the company, a closer look is taken at the outsourcing and offshoring activities of H&M. These processes are then evaluated with relation to theories brought forward by economists Coase, Williamson, Hymer and Dunning.
Hennes & Mauritz (H&M) was founded in 1947 in Sweden by Erling Persson. It was first established as a store for women named Hennes, meaning ‘hers' in Swedish, and was later renamed Hennes and Mauritz after Persson acquired the inventory of Mauritz Widforss, a hunting equipment store. This is known today as H&M (H&M Annual Report, 2008).
It has set up its business concept as a drive “to offer (customers) fashion and quality at the best price”. Ann-Sofie, Head of Design, H&M says “At H&M, you should be able to mix different trends and concepts. There should be something for everyone” (H&M Annual Report, 2008).
Currently H&M has around 1800 stores in 35 countries across North America, Europe and Asia. It aims to increase its number of stores by 10% - 15% per year, simultaneously increasing sales in existing stores. H&M also offers online shopping in 7 countries (H&M Corporate Website).
In 2008, H&M focussed mainly on its designs; it collaborated with top designers and introduced a collection concentrated on organic cotton. It also emphasized on Corporate Social Responsibility (CSR) by setting in motion a new sustainability strategy. Under this, close ties are established with its suppliers, setting sustainable social and environmental standards. Special importance is given to employees' human rights and simultaneous consideration is given to the effects of its production on the environment (H&M CSR Report, 2006).
H&M today is a widely accepted brand of top notch fashion clothing and accessories. Rolf Eriksen, CEO, H&M says “H&M for me is a business based on teamwork, humility and respect for people...[but]...we are cost-conscious and have a competitive instinct that makes us aim for constant improvements” (H&M Annual Report, 2008). It has seen massive expansion on a global level in the past 7 years and is constantly looking at new avenues to make its mark in.
H&M BUSINESS MODEL
The H&M head office is located at Stockholm, Sweden. It houses around 100 designers and centrally plans its collections. Continuous inspiration is drawn from fashion capitals, trade fairs etc. in order to keep in touch with globally dynamic fashion trends. While overall collection themes are decided upon a year in advance, latest trends are sensed on short notice (H&M Corporate Website).
The designers at the Head Office work with the procurement department, which in turn liaises with production offices in various supplier countries. These offices report back to the procurement department with information on the best suppliers, which helps in placing final orders. The finished merchandise is first transported to distribution centres located in each market. On unpacking, final products are transported to individual stores (H&M Corporate Website).
OUTSOURCING AND OFFSHORING ACTIVITIES IN H&M
H&M outsources its production activities, i.e. it does not own any production plants. Instead, it has around 800 selected suppliers located mainly in Asia and Europe. These include particularly low-wage countries like Turkey, Bangladesh, Indonesia, India etc. (H&M Corporate Website).
In order to maintain some degree of control over production activities, H&M has set up about 20 production offices in selected countries. Production Offices help the company maintain an effective Information and Communication Technology (ICT) Network. They take care of the key issues of time, quality and quantity; they make sure that the right quantity of merchandise is manufactured and distributed to stores at the right time, stressing on superior quality at all times (H&M Corporate Website).
Employees at local production offices test inspect sample clothing, and thus bringing down lead time to a competitive level (Databank Consulting, 2004). Apart from this, auditors regularly inspect work conditions and monitor environmental effects of manufacturing activities.
This reflects the considerable investment made by H&M on establishing and maintaining these production offices.
DRIVERS FOR OUTSOURCING AND RELATED THEORIES
The key drivers for H&M to outsource production to global suppliers are as follows:
By transferring production activities to countries manufacturing good quality products, with the benefit of low cost labour, low cost of inputs, etc; H&M achieves high levels of cost effectiveness (McIvor, 2005). Moreover, the company saves on initial start-up costs of plant, equipment and building.
Since the fashion industry is ever-changing, the ability to modify production patterns plays a significant role in the company's profit margin. Clothes in greater demand can be or re-ordered where as those moving slower require lower order levels (Databank Consulting, 2004).
While H&M can reach finished products to its stores in as low as 20 days, other competitive players struggle; Zara being the only competitor with a lower lead time of 15 days. However, lead time may not be the only factor that governs a fashion merchandiser's success. Rolf Eriksen says, “...In fact, the shortest lead time possible is not always favorable; only a proper lead allows us to reach the optimum equilibrium among price, time and quality” (China Business Feature, 2007).
Through outsourcing, H&M can focus on its core competency, which is designing. This assists the company to specialise on more value-adding activities and outsource the more routine activity i.e. production (McIvor, 2005).
John Dunning, in his paper, explained the factors a company would consider before moving abroad. Dunning's approach to internationalization includes decisions regarding Ownership, Location and Internalisation advantages - also called the OLI Framework (Ietto-Gillies, 2005).
Ownership-specific endowments refer to the ‘internal' advantages that a firm may possess which affects its efficiency of resource usage. Dunning refers to three different types of ownership advantages: The first is the advantages a firm may have over another firm operating in the same location. The second advantage is one that a firm enjoys over a new firm in the industry. The third variety of ownership advantages refer to the benefits a company obtains from its multi-nationality (Dunning, 1993). Location advantages refer to those aspects unique to a particular country which would draw foreign companies and Internalization advantages are those which may give a firm an intensive to internalise its operations rather than lease or rent them to external firms (Ietto-Gillies, 2005).
In the case of H&M, the first and third type of ownership advantage is applicable. H&M has an ownership advantage through its ability to produce the trendiest clothing and reach it to individual stores in an extremely competitive lead time of 20 days, owing to the efficiency of its worldwide suppliers. Also, through outsourcing its production, H&M obtains the skill and know-how wherein its in-house designers have the ability to create new clothing patterns at rapid paces, thus making design its core competency. Another asset advantage is its corporate culture, which promotes flexibility and adaptability (TIME Magazine, 2004). Under the third variety of ownership advantage, H&M benefits simply from its multi-nationality. H&M has an advantage from using supplier from varied economic environments, e.g. Turkey in Europe and Bangladesh in Asia, where it is better positioned to take advantage of the different market conditions and factor endowments specific to these supplier countries.
In terms of location advantage, H&M gains from choosing specific suppliers in emerging economies like China, India, Turkey, Syria etc. The factor endowments of these countries give H&M a specific advantage in outsourcing its operations to these locations. These countries benefit from lower input costs, labour costs, energy costs, relaxed legal and trade barriers etc. which lower production costs for H&M to a great extent.
The internalization advantage of the eclectic paradigm does not apply to H&M. In the clothing and apparel industry, adaptability of the firm according to local and international wants and demands plays a crucial role. For this very reason, H&M believes in outsourcing and delegating its manufacturing assignments to other companies and focusing its resources on design.
DRIVERS FOR OFFSHORING AND RELATED THEORIES
H&M offshores its information technology activities. The major drivers for this form of offshoring are as follows:
This appears to be the fundamental reason for a firm to internalise its operations. Production offices makes each supplier sign the H&M Code of Conduct, devised in the year 1997, to ensure that they comply with environmental and safety regulations (H&M CSR Report, 2006). This helps H&M keep a watch on the functional aspects of its suppliers. Moreover, these offices ensure rapid response times for information sent out from the headquarters to different parts of the world.
H&M ensures better flexibility of data transfer between the head office in Stockholm and 800 independent suppliers. Production offices are able to collaborate with suppliers to ensure flexibility in its supply chain, which is needed in the textile industry owing to its dynamic nature (Oh & Kim, 2007).
Effective ICT Network
H&M production offices help establish an efficient communication network between the headquarters and suppliers. Timely shared information ensures smooth flow of merchandise, giving it sufficient time to complete orders (Oh & Kim, 2007). The sale made of each style of product is monitored through this ICT network.
By keeping this network internal in nature, H&M is able to protect its know-how, where its skills to achieve superior levels of lead time at lower costs is kept within the company.
COASE, 1937; WILLIAMSON, 1975
Ronald Coase was the first economist to explore the reasons for the existence of firms, through the concept of 'transaction costs'. According to Coase, there is “a gap...between the assumption that resources are allocated by means of the price mechanism and the assumption that this allocation is dependent on the entrepreneur-co-ordinator” (Coase, 1937). In order to bridge this gap, it is essential to compare costs involved in carrying out transactions in the open market to the costs incurred in organizing resources internally (Ietto-Gillies, 2005). Allocating resources based on the price mechanism involves transaction costs, which is why a firm should consider managing its activities within the firm rather than externalising them.
Oliver Williamson further expanded on the Transaction Cost Theory by analysing the organisation of a firm's operations based on its drive to economize transaction costs. To explain the arguments for a firm to internalise, he introduces three concepts (Ietto-Gillies, 2005):
i. Bounded Rationality - due to imperfect information available about the market. According to Williamson, the problem of bounded rationality of an entity increases with an increase in the complexity of the environment. For this reason, Williamson argues that a firm should consider internalising its activities.
ii. Opportunistic Behaviour - External parties have a tendency to operate solely with motives of self-interestt. This opportunistic behaviour is likely to be more problematic for a firm when its activities involve fewer external forces, making internal operations a better form of protection from opportunistic behaviour.
iii. Asset Specificity - Assets of a firm turn out to be more productive when they are used together than when kept separately. According to Williamson, the assets of a firm will bear higher returns when utilised as a whole.
In the case of H&M, should its ICT network be outsourced, several transaction costs may have to be incurred due to transactional imperfections in the market. This refers to the asymmetry of information available to all the buyers and sellers in the market. The transaction costs H&M may incur are the costs of searching for appropriate software or partners to perform its information transfer activities, costs of bargaining and negotiating with global suppliers, legal costs to settle on final production contracts and costs to enforce its specifications to ensure its external collaborators perform their duties. For this reason, it can be concluded that H&M would be better placed setting up a wholly owned production office to internalize its ICT activities and minimize its transaction costs.
Additionally, by establishing production offices in its major sales markets, the negative effect of bounded rationality on its profitability is reduced as there is a higher tendency for perfect knowledge to be available within the different H&M merchandise suppliers across the world. The local employees at the production offices ensure timely and uniform distribution of information between the offices at other locations. Through this, H&M is safeguarded from the aggressive strategies of its competitors. By internalising its ICT network, H&M is assured that the important information transferred between its global suppliers is kept within the company; it is further assured of better quality of information transfer with minimal distortion.
Stephen Hymer put forth the first developed theory explaining international operations of a company. He introduced the fundamental difference between portfolio investment and direct investment as the desire for ‘control' and the key reasons for a firm to consider Foreign Direct Investment (FDI). Direct investment gives a firm control over its business operations abroad, whereas portfolio investment does not. The primary assumption in Hymer's theory is the existence of an imperfect market, caused by imperfections in the goods market, factors market, and additional interference by the government in production activities (Ietto-Gillies, 2005).
Hymer explained two main reasons for a firm to desire control over its international operations. Type I, called direct investment, refers to a firm's intentions to use its resources prudently. An investor looks to maintain control of its operations in order to uphold the safety of his/her investment abroad, especially due to the existence of an atmosphere of distrust in international transactions. Type II, called international operations, refers to a situation where firms are motivated to control its foreign operations with a view to gain market power (Hymer, 1976).
Since all of the manufacturing activities of H&M are outsourced, it would like to gain a certain degree of control over its international operations in order to secure returns on its international investments. In other words, H&M looks to control its international operations under Type I as its main driver to set up production offices is not to consolidate market power.
In the case of the determinants of its FDI, the first motive is the ‘specific advantage' H&M gains over its competitors. Every production office has its own quality team to ensure compliance to its specific Code of Conduct (H&M Annual Report, 2008). Once H&M exploited all its local opportunities in Sweden, it moved on to other countries. This advantage of having an owned production office gives H&M a competitive advantage. Apart from this, H&M enjoys the benefit of 'diversification' of its risks, by opening its own stores in other countries, thus diversifying its risks of failure in one particular country.
There have been a number of theories regarding the international operations of multinational enterprises. It is clear that there isn't one particular theory which can explain the operations of a company in totality as an individual company's operations are independent of economic theories and reflect the company's functional and operational strategies. The international operations of H&M can be described as a blend of theories, each related to the outsourcing and offshoring activities of the company.
H&M looks to reduce its costs of production, thus outsourcing all its manufacturing activities to more experienced suppliers located primarily in emerging economies. At the same time, to establish a middle ground in terms of control over the manufacturing activities, it has opened production offices to monitor the manufacturing activities and ensure effective data transfer.
Due to the dynamic nature of the business environment and the emergence of organisations such as the WTO, IMF, trade arrangements, and above all, the establishment of the internet, the corporate world today has become far more open to the concept of outsourcing than it has ever been. According to Gartner Inc., in light of the recent economic slump, organisations which do not outsource will consider outsourcing business processes to focus more on their core functions (Gartner Inc. Press Release, 2009). Thus, this trend of increased outsourcing and offshoring activities is certainly on the rise for the years to come.
- China Business Feature. (2007, May 8). Fashion Magnates' Supply Chain Contest. Retrieved December 14, 2009, from China Business Feature Website: http://www.cbfeature.com/china_cio/news/fashion_magnates_supply_chain_contest
- Coase, R. (1937). The Nature of a Firm. Economica New Series, Vol. 4, No. 16 , 386-405.
- Databank Consulting. (2004). Electronic Business in the Textile, Clothing and Footwear Industries. European Commission.
- Dunning, J. (1993). Trade, Location of Economic Activity and the Multinational Enterprise: A Search for an Eclectic Approach. In J. Dunning, The Theory of Transnational Corporations (pp. 183-218). London: Routledge.
- EMCC Case Study. (2004). Industrial change in the textiles and leather sector: Hennes & Mauritz. Retrieved December 01, 2009 from http://www.eurofound.europa.eu/emcc/publications/2004/ef0465en_1.pdf
- Gartner Inc. Press Release. (2009, January 15). Gartner Says Outsourcing Will Continue to Grow in 2009 Despite Economic Slowdown . Retrieved December 11, 2009, from Gartner Research Web site: http://www.gartner.com/it/page.jsp?id=856713
- H&M Annual Report. (2008). Business Concept, Goals and Strategy.
- H&M Annual Report. (2008). CEO Interview.
- H&M Annual Report. (2008). H&M 2008 in Figures.
- H&M Annual Report. (2008). Our Responsibility.
- H&M Corporate Website. (n.d.). About H&M. Retrieved December 12, 2009, from http://www.hm.com/gb/abouthm__abouthm.nhtml
- H&M CSR Report. (2006). Our Responsibility.
- Hymer, S. (1976). A Comparison of Direct and Portfolio Investment. In S. Hymer, International Operations of National Firms (pp. 1-31). The MIT Press.
- Ietto-Gillies, G. (2005). Dunning's Eclectic Framework. In G. Ietto-Gillies, Transnational Corporations and International Production (pp. 112-119). Edward Elgar Publishing Limited.
- Ietto-Gillies, G. (2005). Hymer's Seminal Work. In G. Ietto-Gillies, Transnational Corporations and International Production (pp. 59-63). Edward Elgar Publishing Limited.
- Ietto-Gillies, G. (2005). Internalisation and the Transnational Corporation. In G. Ietto-Gillies, Transnational Corporations and International Production (pp. 97-109). Edward Elgar Publishing Limited.
- McIvor, R. (2005). Drivers for Outsourcing. In R. McIvor, The Outsourcing Process (pp. 21-23).
- Nayyar, D. (2006). Globalisation, History and Development: A Tale of Two Centuries. Cambridge Journal of Economics, 30 , 137-159.
- Oh, H., & Kim, E. (2007). Strategic Planning for the US textile industry in the Post-quota Era. Journal of Fashion Marketing and Management , 246-269.
- TIME Magazine. (2004). Spring and Design 2004. Retrieved December 15, 2009, from TIME Magazine Online Edition: http://www.time.com/time/2004/style/020904/article/inside_the_h_m_fashion_01b.html