Describe the production managers' decision regarding whether to centralize or decentralize production facilities, and explain the benefits of vertical integration

What will be an ideal response?

An important consideration for production managers is whether to centralize or decentralize production facilities. Centralized production refers to the concentration of production facilities in one location. With decentralized production, facilities are spread over several locations and could even mean having one facility for each national business environment in which the company markets its products–a common policy for companies that follow a multinational strategy. Companies often centralize production facilities in pursuit of low-cost strategies and to take advantage of economies of scale–a typical policy for companies that follow a global strategy. By producing large quantities of identical products in one location, the companies cut costs by reducing the per-unit cost of production.
Transportation costs and the physical landscape also affect the centralization versus decentralization decision. Because they usually sell undifferentiated products in all their markets, low-cost competitors generally do not need to locate near their markets in order to stay on top of changes in buyer preferences. That is why low-cost producers often choose locations with the lowest combined production and transportation costs. But even these firms must balance the cost of getting inputs into the production process and the cost of getting products to markets. Key factors in the physical environment that affect the transport of goods are the availability of seaports, airports, or other transportation hubs.
Conversely, companies that sell differentiated products may find decentralized production the better option. By locating separate facilities near different markets, they remain in close contact with customers and can respond quickly to changing buyer preferences. Closer contact with customers also helps firms develop a deeper understanding of buyer behavior in local cultures.
When close cooperation between research and development and manufacturing is essential for effective differentiation, both activities are usually conducted in the same place. Yet new technologies are giving companies more freedom to separate these activities. The rapid speed of communications today allows a subsidiary and its home office to be large distances from each other.
Vertical integration is the process by which a company extends its control over additional stages of production–either inputs or outputs. When a company decides to make a product rather than buy it, it engages in "upstream" activities (production activities that come before a company's current business operations). For example, a carmaker that decides to manufacture its own window glass is engaging in a new upstream activity.
Lower Costs-Above all, companies make products rather than buy them in order to reduce total costs. Generally speaking, the manufacturer's profit is the difference between the product's selling price and its production cost. When a company buys a product, it rewards the manufacturer by contributing to the latter's profit margin. Yet a company often undertakes in-house production when it can manufacture a product for less than it must pay another business to produce it. Thus in-house production allows a company to lower its own production costs. Small companies are less likely than large ones to make rather than buy, especially when a product requires a large financial investment in equipment and facilities. But this rule of thumb might not necessarily hold if the company possesses a proprietary technology or some other competitive advantage that is not easily copied.

Greater Control-Companies that depend on others for key ingredients or components give up a degree of control. Making rather than buying can give managers greater control over raw materials, product design, and the production process itself–all of which are important factors in product quality. In turn, quality control is especially important when customers are highly sensitive to even slight declines in quality or company reputation.
In addition, persuading an outside supplier to make significant modifications to quality or features can be difficult. This is especially true if modifications entail investment in costly equipment or if they promise to be time-consuming. If just one buyer requests costly product adaptations or if there is reason to suspect that a buyer will eventually take its business elsewhere, a supplier may be reluctant to undertake a costly investment. Unless that buyer purchases in large volumes, the cost of the modifications may be too great for the supplier to absorb. In such a case, the buyer simply may be unable to obtain the product it wants without manufacturing it in-house. Thus companies maintain greater control over product design and product features if they manufacture components themselves.
Finally, making a product can be a good idea when buying from a supplier means providing the supplier with a firm's key technology. Through licensing agreements companies often provide suppliers in low-wage countries with the technologies needed to make their products. But if a company's competitive advantage depends on that technology, the licensor could inadvertently be creating a future competitor. When controlling a key technology is paramount, it is often better to manufacture in-house.