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Working Papers

To Offshore or Not To Offshore: Sourcing and Location of Commonality in Multiplant Networks
Download Paper (PDF 623 K / 47 pages)

Lauren Xiaoyuan Lu, Jan A. Van Mieghem
October 10, 2005

Abstract

Moving production facilities to low-wage countries provides an opportunity for cost reduction, but comes with disadvantages of increased logistic costs and foreign trade barriers. This paper examines the offshoring decision from a network capacity investment perspective. We analyze a firm that manufactures two products to serve two geographically separated markets using a common component and two other product-specific components. The common part can be transported between the two markets that have different demand and financial characteristics. Two strategic network design questions arise naturally in this context: (1) Should the common part be produced centrally or in two local facilities? (2) If a centralization strategy is adopted for the common component, which market should the facility be located in? We present a transportation cost threshold that captures costs, revenues, and demand risks, and below which centralization is optimal. The optimal location of commonality crucially depends on the relative magnitude of price and manufacturing cost differentials but also on demand uncertainty. Incorporating scale economies further enlarges the centralization's optimality region. Finally, we translate our results into managerial insights for assessing the value of offshoring through direct capacity investment.

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