21. Novelette: So You Want to Build a Plant in a Foreign Country
The decision to locate a plant in a foreign country can be triggered for many reasons. Most of them are cost related or to maintain or increase market share of sufficient sales to justify the plant in the first place. Whereas the decision to build the plant in a foreign country is made by a board of directors, operations people make it happen.
A conversation took place between our CEO and the President of a not-so-small South American country. We currently have 80% of the market share of all engines and parts imported into that country. A threshold of $50 million in sustainable business was reached last year and was used to determine whether we should build a plant there. The engines we export to them are used extensively for the country’s farming equipment and automobile industries and impact their two primary exportable food and automobile products. In addition, these products are highly taxed by the government and are viewed as strategically important to the nation. As a result, the president of the country informed our CEO that because of high unemployment rates, the government preferred the engines be produced in their own country to provide employment opportunities. The CEO was also informed they would give huge financial incentives to both automobile and farming industries to produce more products. Those dollars are the “carrot” for us, because when production increases, our engines and parts will be are used. However, the “stick” was clearly defined by the president in the form of new protectionist policies directed against all importers of these strategic industries. There are only three very small manufacturers that we compete against in the country. What the protectionism policies mean to us is that a small local manufacturer in the country with 1% or less of the market share of any products we export to them could issue a complaint, effectively ending our entire market in that country for those products. The president knows our firm has contributed substantially to the government’s bottom line, tax-wise, and knows the quality of our products is desired by this nation’s firms, who currently use the engines and parts in their vehicle-assembly operations. Recognizing our joint willingness to work together, the President of the country contacted our CEO to explain things well ahead of any public announcements. The CEO believed that for the continued successful long-term nature of our relationship we need to build a manufacturing facility in this nation and have it up and running within two years. The CEO also saw how operating a plant here could work out for the benefit of the organization. If we became a local producer, we could file complaints about other importers, who currently are our competition, and as a result gain more market share. So, the CEO promised the President that the facility would be up and running in two years. Like any typical CEO, she turned the matter over to her VP of Operations, me.
I have worked on other facility location projects before and know what needs to be done. Like any major project, developing a plan for the location and building of a new plant requires assembling a team to manage the project. In addition to the VPs of the Divisions who are impacted and their staff, I called upon the corporation-level VP of International Sales and staff to be brought into the process to make sure there are sustainable sales, to identify barriers to entrance in the country, and other risk factors. They have to determine what the pricing is going to be, if we have a current dealer distribution system in place, and whether it will change. The marketing plan has to be well articulated to show the market what the competition is going to do when we build the plant. We also have to have lawyers to deal with necessary contracts. Other decisions involving the CEO and Board will have to be made concerning identification of investors. Operations people will have to determine who will run the plant. We must also have the local real estate help us in procuring land, aligning contractors to build the plant, and completing necessary documents. Negotiations must take place with local people regarding who is going to buy the land, design the building, see to construction, and determine the project manager. During that effort, local employees have to be hired. Typically, the first person hired is the plant manager; the second person is the human resource (HR) director. Some would argue the HR person should be hired first; after all, the HR person might not like the project manager the operations people recommend.
The entire supply chain must be set up. Which staff members will come from local talent and which will be from other countries? Are third-party logistics (3PLs) going to help with logistics or will it be insourced completely? To set up the supply chain, I turned to the director of international operations, who is under our VP of International Operations, and will have a production control person and a procurement person comprising the team to handle setting up the facility. In the United States, we would call this Director a Manager, but to better aid in global communications, the term Director is a better title. The Director’s team will travel to the foreign country to begin planning and recruitment efforts. They will be aided by corporate procurement and will establish sourcing for the supply chain. There will be some commodity items that we don’t need to spend much time on to validate their quality level, but for other items that are strategically important to the nature and structure of our product, we will handle this locally in the foreign country. We will bring those materials back to our U.S. facilities to test them in a production part approval process (PPAP). This will ensure our engineered design and specifications are properly understood by the suppliers of the new facility. PPAP is commonly used in the automotive supply chain to establish confidence in component suppliers and their production processes. There should be no resistance to using this approach to validate quality. After the products and parts have successfully gone through the PPAP tests, we will certify the foreign local suppliers. We will also implement a quality control plan to monitor quality over a period of time after the facility comes online to ensure both the suppliers and the new facility maintain quality. We have seen that some firms from China show the best pieces and then what they deliver on a regular basis is just not comparable in quality. Some suppliers like to substitute the materials without informing the purchaser. They think nothing of changing specifications on materials used in products or parts. It looks the same, but the performance is much less than expectations. Based on my experience, China just doesn’t yet have the kind of quality controls in commodities necessary for our products.
After I delivered the initial orientation on where and why the organization was going to build a new plant, Tyler, the Corporate VP of International sales, asked, “Bill, this is one of those situations where we are going in regardless of the sales. You explained what our CEO believed were good reasons. What additional factors can you share with me about reasons why we need this plant?”
“Tyler, while your ongoing research shows the local sales have recently grown to meet our normal triggering level of sustainable sales, there are other cost-related reasons why building a plant in this country is a smart move. First, the cost of shipping our metal-intensive parts to that country for assembly is very expensive. Containers to ship goods there run $4,000 to $5,000 per container. That puts us at a competitive disadvantage to any home-grown manufacturer; and while we don’t have many yet, it would be best for us to maintain and even grow our market share by having that cost reduction show up in reduced prices for our customers. With government incentives, the home-grown manufacturers will seek to grow at our expense unless we soak up most of the incentives ourselves. Another important point is the opportunity to leverage our currency against their currency, which is relatively weak. We can gain substantially by the exchange rates as things stand now. Also, although we normally go into a country to reduce our total cost of products, sometimes there are economic factors that we can take advantage of. The government’s plan to give our customers incentives to spend money on our products is a great opportunity for us to cash in. Their government knows this and wants us there to do just that. If we get in with our current market share, we could end up putting protectionism on other importing competitors who might want to come in and compete against us. We could actually pick up 90% or more of the market,” I explained.
“Bill, why haven’t we gone into this country before this?” asked Tyler.
Not wanting to state the obvious, I replied, “Tyler, several years ago there was an explosion that killed the President and other important officials in the government. At that time, it was a very unstable country in which to run a business. In the last year, things have calmed down politically and socially, and our board of directors believes it has recently become stable enough to warrant the risk of opening a production facility. Another factor is the promised, but not yet delivered, government incentives program the CEO was told about by the country’s president. A similar program was announced in an Asian country where we have a facility. The announcement had the effect of our customers not buying anything for several years while they waited for the incentive. Why should they buy something now when the government is going to give them money and free interest rates in the future? So, most of the big-ticket sales stopped in anticipation of the purchases being offset by the government’s incentive program. A couple of years went by before the incentive showed up. The loss in sales during that period so negatively impacted our facility that we almost closed it. We learned, as a result, not to be motivated by the promise of a government to put money in our pockets. However, we started up a plant in China because the government put in place protectionist policies of a 30% import duty. We were sending our product into the country and found we were competing against ten other local manufacturers. The increased duty motivated us to open a plant to avoid it. Fortunately, the volume of sales increased, because we didn’t face the duty other importers did, and it justified the plant economically. The longer term outlook for this plant is continued growth as we meet the growing market in China.”
“Bill, will we have any local barriers to entrance? As a marketing person, I have run into those big time, and they are really costly after the fact,” Tyler stated.
“Yes Tyler, I agree with you, but in this case we have a disadvantage that we will turn into an advantage by eliminating barriers to entrance. There is one person who owns exclusive rights to all the engines and parts that are shipped into the foreign country. He is very politically connected and owns all the distribution centers in the country to house all the import products. Now, as you know, we use lean management principles in our operations and supply chain. As such, we don’t even use distribution centers; we ship directly to the customers. Because we will have a manufacturing plant right in the country, it will render this distribution monopolist redundant; but given how politically connected he is, we have to include him in the business. So we are planning on giving him some of the ownership in the production facility. He, in turn, will be asked to help use his connections to get the necessary licenses with the government and to help us set up our supply chain without the use of distribution centers,” I said.
“Bill, I have been involved in plant locations where we have sold ownership in our facilities, but is it normal that we give away ownership rights to individuals in the foreign counties?” asked Tyler.
“Without this distribution monopolist, we would not be able to do anything in the country. In terms of ownership, we have plant in Colombia. It’s a 90/10% arrangement, where we own 90%. Some of the people down there own 10% of the plant, because we need them for their relationships with the government or businesses in Colombia. We will do the same for this new plant being built in the foreign country. Of course, we will take precautions to ensure we maintain control. We will set up a board of directors who understands the country very well. The board will consist of key stakeholder owners, including lawyers who have a vested interest in the plant and will perform legal services for us, bankers who help fund and maintain the registered capital that needs to be available for the operation, and the plant manager representing our organization. We have to put our team in there. They will understand our need for reporting structures and understand the ownership responsibilities. We have learned to be careful in allowing locals to hire important or key employees. For example, we would want to have the comptroller from the United States so that we can be assured of reporting the financials in a timely and accurate manner. This is an ethics situation, as well. You don’t want a person from the foreign country reporting to another person from the same country, where backdoor deals could pop up and the plant manager gets cut out of the information flow. We don’t want to set up conflicts of interest. To help monitor all of this, we will we do board meetings through video conferencing to our U.S. corporation headquarters with our CEO and comptroller in the room. Ultimately, we have the final say on board of director decisions.”