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Int. J. Production Economics 58 (1999) 8192

An integrated production-distribution model for a multi-national

company operating under varying exchange rates

Zubair M. Mohamed*

Department of Management & Information Systems, Western Kentucky University, Bowling Green, KY 42101, USA

Received 29 December 1997; accepted 20 April 1998

Abstract

Research modeling the production planning and logistics decisions for multi-national companies (MNCs) operating

under varying inflation and exchange rates is scanty. Decisions regarding the products to be made in different facilities,

and the markets which these facilities would serve are critical to the MNCs success. Also, decisions regarding when to

open, retain, and close facilities are equally important. These decisions are sensitive to both inflation and exchange rates.

Accordingly, we incorporate these parameters in the development of an integrated production planning and distribution

model for an MNC. We elicit the performance of the model through examples. Our results indicate profit reduces by as

much as 45.77% depending on the exchange rates, initial capacities, and restrictions imposed on the more profitable

facility. 1999 Elsevier Science B.V. All rights reserved.

Keywords: Production; Distribution; Multinational Corporation; Exchange Rate; Mathematical Modeling

1. Introduction

A vast amount of research literature that ad-

dresses many aspects under which a firm operates

exists. Two aspects related to our work include

production planning and product distribution. Un-fortunately, most of the work considers domestic

firms operating under conditions of low inflation

rates. Under these circumstances the above two

problems can be considered separately. Production

planning decisions pertain to selection of the prod-

ucts and the quantities to be produced in each

* Tel.: (502) 745-6360; fax: (502) 745-6376; e-mail: Zubair.mo-

[email protected].

facility. In the ensuing process of production plann-

ing, decisions regarding capacity hiring and

laying-off of labor, overtime, subcontracting, and

machine capacity levels are also made for some

planning horizon, usually, a one year period.

Distribution decisions pertain to determiningwhich facility(ies) would cater to the demands of

which market(s).

Research modeling the operational problems of

Multi-national Companies (MNCs) is scanty; how-

ever, the focus is changing. Recently, Kirca and

Koksalan [1] integrated production planning and

financial decisions for a domestic company operat-

ing in an environment of high inflation rates in

a developing country. Although they did not con-

sider an MNC, nonetheless, their finding of the

0925-5273/99/$ see front matter 1999 Elsevier Science B.V. All rights reserved

P I I : S 0 9 2 5 - 5 2 7 3 ( 9 8 ) 0 0 0 8 0 - 2


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significance of inflation rates on the firms perfor-

mance is still helpful as many MNCs operate under

high inflation rates in some countries. Recognizing

that the overall decisions for an MNC should con-

sider all facilities and markets, we fill the void by

developing an integrated production planning and

distribution model. Our model incorporates theeffects of changing and high inflation rates and

changing exchange rates under which a facility has

to operate in a host country.

The results from our model indicate that the

exchange rate and initial capacities of the facilities

have pronounced effects on the profits, capacities

needed to satisfy demand, and distribution of prod-

ucts. Thus, we see that the exchange rate not only

affects the functioning of the facility in the host

country, but also the functioning of the facility in

the domestic country. For the same demand, a de-crease in profits by as much as 45.77% can be seen

if the facilities do not have beginning optimal ca-

pacities and capacity of the more profitable facil-

ity(ies) is restricted.

The organization of this paper is as follows. First,

we describe the growing potential of the global

market and the MNC environment in Section 2. In

Section 3, we develop an integrated production

planning and distribution model suitable under

varying exchange and inflation rates for an MNC.In Section 4, we elicit the performance of the model

through examples and discuss results. In Section 5,

we draw conclusions.

2. MNC and its environment

Different terms abound for the multinational

corporation. They are: global, world, transnational,

international, supernational, and supranationalcorporation [2], [p. 356]. Likewise, there are vari-

ous definitions for an MNC. The United Nations

[3] defines MNCs as enterprises which own or

control production or service facilities outside the

country in which they are based. This definition is

economist oriented [4].

Quantitatively, for a firm to be regarded as

multinational, the number of countries of operation

is typically two, although the Harvard multina-

tional enterprise project required subsidiaries in six

or more nations [5], [p. 11]. Another measure is

the proportion of overall revenues generated from

the foreign operations 25% to 30% is the most

often cited [6]. For example, IBM has operations

in 132 nations, and 62.3% of its sales dollars are

from international operations [7]. The economic

power of the worlds largest entities is enormous.The 500 largest industrial corporations account for

80% of the worlds direct investment and owner-

ship of foreign affiliates [8]. Foreign direct invest-

ment in US totaled $408 billion in 1991 and, at the

same time, US direct investment abroad totaled

$421 billion [9].

According to the United Nations Conference on

Trade Development, in the past 25 yr the number

of transnational corporations have tripled to

24 000 in the worlds 14 richest countries. There are

a total of 37 000 globally operating companieswhich control about a third of all private-sector

assets and enjoy worldwide sales of about $5.5

trillion [10]. The revenues from abroad for Ameri-

can companies are now twice their export earnings.

There are several factors which have contributed to

the growth of international trade. Many countries

are liberalizing their import restrictions. In many

parts of the world, the economic boundaries are

collapsing as nations are now becoming more open

to international influences. Diffusion of knowledgeand technology has further propelled the growth.

However, managing global operations for a firm

are more difficult as it has to face different cultures,

values, rules, and varying degrees of business, pol-

itical, and economical uncertainties. In other

words, globally operating companies are faced with

far more ambiguity, both internally and externally,

than their domestic counterparts. There are other

factors which further deter the global competitive-

ness of a company. Shorter product life cycles,fragmented and saturated markets, more demand-

ing customers, consolidation and mergers of com-

panies, and rapid advances in processes/technology

always present a dynamic competitive situation.

Hence, in this environment, manufacturing and

operations excellence are critical factors for profit-

ability, and globalization is an essential component

of the firms competitive strategy. Globalization

means moving production facilities around to be-

nefit from the quickest brains or the cheapest labor

82 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 8192


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to position a firm competitively against its competi-

tion.

Despite the above difficulties, firms still expand

internationally for a variety of reasons. They can be

broadly classified into marketing factors, barriers

to trade, cost factors, investment climate, and gen-

eral categories. Relevant factors to our researchfrom the above categories include cost of produc-

tion (manufacturing) and distribution (logistics),

labor costs (capacity), expertise in production and

distribution (efficiency), currency exchange regula-

tions and stability of foreign exchange.

3. Model development

Initially, a firm has to decide whether it should

expand internationally or not. If it decides to be-come an MNC, then decisions related to produc-

tion strategy (mode), international location(s),

and operations have to be made. In this paper we

model the operations decisions of an MNC operat-

ing under varying exchange rates. The operations

decisions include determining the products to be

made in each facility, distribution of products to

various markets, inventory levels of products,

and capacity planning (acquisition, disposal, and

retaining).The production strategy refers to the decision(s)

that a firm makes from the available choices to

make/sell its products in foreign markets. The

available choices include direct import, joint ven-

ture, and wholly owned subsidiary. Kouvelis and

Sinha [11] develop and use a stochastic dynamic

programming model that considers exchange rate,

demand and pricing in their modeling of produc-

tion strategies. For each production strategy, they

develop optimal solutions and also investigate theconditions in which each strategy dominates the

others. A switching cost between production strat-

egies is considered, but the time required to imple-

ment the change is assumed to be insignificant.

However, in our modeling, we assume that the

choice has already been made and is not going to be

changed in the near future.

The next decision is where to locate a facility.

Several studies have shown that transferring pro-

duction to foreign locations is a viable alternative

for lowering production costs, entry into foreign

markets, and avoiding import (export) restrictions

to gain competitive advantage in domestic and

global markets. McDonald [12] claims that many

manufacturing companies are willing to locate

their facilities in any part of the world where they

can obtain cheap labor, more reliable materials,parts, subassemblies, vendors, and governments

which provide financial incentives. However, Hoch

[13] points out that many American firms fail to

recognize the potential of these investments lead-

ing to faulty facility location. Although consider-

able research exists pertaining to the facilities

location in domestic markets, work regarding inter-

national facilities location is very limited. Canel

and Khumawala [14] develop a model for interna-

tional facilities location and present a heuristic

solution to the problem. However, in our modeldevelopment we assume that this problem has been

solved.

As mentioned before, our model pertains to the

operations of an MNC and the decisions regarding

production strategy and facilities location have

been made. The question we address is: What are

the production and distribution decisions for an

MNC over a finite planning horizon? That is,

which products will be made where, which facilities

would cater to which markets, and how will thesedecisions change with respect to changes in infla-

tion and exchange rates. The objective of the MNC

is to maximize its profits. The notation given in

Table 1 is used in the model development. First, we

will discuss each constraint.

3.1. Capacity requirements

The capacity required to produce the products( js) in any facility fin any given period t should be

sufficient. It is a decision variable. We use an ag-

gregate measure for capacity in the sense that it

represents both labor and machine. Traditionally,

in aggregate planning models labor levels are

changed to meet the demand. Since each facility is

different, it has a different level of expertise in

producing the products. The differences stem from

skill levels of labors, training, and methods used in

producing the products. This difference in efficiency

Z.M. Mohamed/Int. J. Production Economics 58 (1999) 8192 83


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Table 1

Notation

Notation Remark

Input variables

J set of products +1, 2,2, j,2, J,F set of facilities +1, 2,2f,2, F,M set of markets +1, 2,2, m,2, M, set of time periods +1, 2,2, t,2, ,D

HKRdemand for product j in period t for market M

RHK

revenue/unit of product j in market m

CHD

manufacturing cost/unit of product j in facility f

CDR

unit capacity retaining cost of facility f in period t

SDK

unit shipping cost from facility f to market m

hHDR

unit inventory holding cost of product j in facility f in period t

D

unit capacity changing cost in facility f

EDR

exchange rate of currency of host country in period t

pH

unit processing time of product j in US

eHD efficiency of facility f in producing product j compared to US

Decision variables

CAPDR

capacity of facility f in period t

CAPCHNGCOSTDR

capacity changing cost of facility f in period t

CAPRETCOSTDR

capacity retaining cost of facility f in period t

MDCOSTDR

manufacturing and distributing cost of facility f in period t

QHDR

quantity of product j produced in facility f in period t

QHDKR

quantity of product j shipped from facility f to market m in period t

IHDR

ending inventory of product j in facility f in period t

IHCOSTDR

inventory holding cost of facility of f in period t

is captured by the input variable eHD

.

H

(1/eHD

)pHQHDR)CAP

DRf, t (1)

The nonzero and zero values for the decision vari-

able CAPDR

indicate the existence and closures of

a facility. We assume that the facilities can be cre-

ated and dismantled instantaneously.

3.2. Capacity changing cost

As the capacity between periods may change, an

expense may be incurred. We assume the cost per

unit change in capacity to be the same. Of course,

different costs structure for increase or decrease in

capacity can be easily incorporated into the follow-

ing constraint. These costs include procurement/

disposition of the equipment, hiring/lay-off of

workers, and other related costs.

CAPCHNGCOSTDR

"(1/EDR

)"CAPDR!CAP

DR\"

Df, t. (2)

The above linear function is assumed based onhow capacity planning is modeled in the literature.

Traditionally, a linear function is used for capacity

in the development of aggregate production plann-

ing [15] and capacity planning techniques such as

capacity planning using overall factors (CPOF),

capacity bills, resource profiles, and capacity re-

quirements planning (CRP) [16]. Capacity has usu-

ally been expressed in terms of standard hours [17].

Instead of a linear function, a step function can be

used but it will make the model more cumbersome.



5/12

3.3. Capacity retainment cost

This includes labor cost (salaries), machine main-

tenance cost, and other costs related directly to the

capacity, i.e.

CAPRETCOSTDR"(1/EDR) CAPDRCDR f, t. (3)

3.4. Manufacturing and distribution cost

In any given period t, the manufacturing and

distributing cost to the markets the facility f caters

to is:

MDCOSTDR"(1/E

DR)

H

CHD

QHDR#

H

K

SDK

QHDKR

f, t. (4)

We assume that the distributing cost will be incur-

red by the facility f. The cost is expressed in

$ amount by incorporating the exchange rate EDR

.

3.5. Demand satisfaction

In any given period t, the demand for product j in

each market m has to be satisfied from some or allfacilities, i.e.

DHKR"

D

QHDKR

j, m, t. (5)

3.6. Inventory cost

It is possible for a firm to produce more units of

products in one period and hold them in the inven-tory to satisfy the demand of the future period(s).

This would incur inventory expense. The following

constraints capture the inventory and its cost ex-

pressed in $.

IHDR\#Q

HDR"

K

QHDKR#I

HDRj, f, t, (6)

IHCOSTDR"(1/E

DR)H

IHDR

hHDR

f, t. (7)

3.7. Exchange rate function

The exchange rate is a random variable. The

difficulty economists have had in finding an empir-

ically successful exchange rate theory is well

documented [1820]. Nonetheless, a firm has to

forecast what it would be in the future to makedecisions. We will use the following linear function

for the exchange rate.

EDR"(1#

Dt)E

Df, (8)

where ED

is the base exchange rate and D

is the

forecast coefficient for the exchange rate. A similar

linear model has been developed by Harvey and

Quinn [21]. Their empirical model is based on the

premise that the exchange rates are a function of

expectations. They used regression analysis on thedata obtained from expectations surveys published

by Money Market Services International and noon

buying rates in New York city reported by the

Federal Reserve Bank of New York. Their linear

model has a constant term and the second termreflects the change in the foreign currency price of the

dollar from one period of time to another (i.e., a time

function). Of course, any other model can be used.

3.8. Objective function

The objective is to maximize total profit. Since

the price per unit is constant (in all markets) and

the demand (of each market) has to be satisfied

(constraint 5), the total revenue (over all markets) is

constant. The total revenue from all markets is

given by the following expression.

R

K

H

(1/EKR

)RHKR

DHKR

.

As the total revenue is constant, the total profitcan be maximized by minimizing the total costs

which include manufacturing and distribution

costs, capacity changing costs, capacity retaining

costs, and inventory costs. Hence, the objective

function is:

MinimizeR

D

+MDCOSTDR#CAPCHNGCOST

DR

#CAPRETCOSTDR#IHCOST

DR,.



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Table 2

Input parameters

Parameters US Europe (Germany) India

Period Period Period

1 2 3 1 2 3 1 2 3

Exchange rate 1 1 1 4.4 4.8 5.2 31.5 33 34.5

31.5 30 28.5

Demand 20 000 30 000 25 000 14 000 8 000 14 000 10 000 12 000 8 000

Unit mfg. time 0.3 h 0.3 0.3

Efficiency 1 1 1 0.5 0.55 0.6

Unit mfg. cost $2 $2 $2 Rs. 100 Rs. 90 Rs. 80

Unit revenue $25 $25 $25 120 120 120 Rs. 600 Rs. 600 Rs. 600

Unit cap. change cost $70 70 70 Rs. 1000 Rs. 1000 Rs. 1000

Unit cap. retain cost $35 35 35 Rs. 450 Rs. 450 Rs. 450

Unit dist. cost US $3 $15 $20

India Rs. 400 Rs. 300 Rs. 100

The complete integrated production and distri-

bution model (PDM) is

MinimizeR

D

+MDCOSTDR#CAPCHNGCOST

DR

#CAPRETCOSTDR#IHCOST

DR,

s.t.,

H

(1/eHD

)pHQHDR)CAP

DRf, t, (9)

CAPCHNGCOSTDR

"(1/EDR

)"CAPDR!CAP

DR\"

Df, t, (10)

CAPRETCOSTDR"(1/E

DR)CAP

DRCDR

f, t, (11)

MDCOSTDR"(1/E

DR)

H

CHD

QHDR#

H

K

SDK

QHDKR

f, t, (12)

DHKR"

D

QHDKR

j, m, t, (13)

IHDR\#Q

HDR"

K

QHDKR#I

HDRj, f, t, (14)

IHCOSTDR"(1/E

DR)H

IHDR

hHDR

f, t, (15)

EDR"

(1#

Dt)ED

f, (16)All variables*0, Qs*0 (integer). (17)

4. Numeric examples

We demonstrate the usefulness of the model

through numeric examples. The following scenario

is considered in the examples. Table 2 shows the

input parameters.

We consider manufacturing facilities to exist (bebuilt) in US and India. We assume that the facilities

make only one type of a product. The market

demand for the product exists in US, European

distribution center, and India. The input considers

increasing exchange rates for Europe and both in-

creasing and decreasing rates for India. We con-

sider three planning periods in our examples, and

the length of each planning period is as arbitrary as

the number of periods in a planning horizon.

The unit manufacturing time in the US is kept

constant; however, this is different in India so thateach period can reflect the efficiency of operations.

The efficiency parameter represents the learning

curve, labor skills, and technology difference. Unit

manufacturing cost in the US is kept constant, and

different in India each period. However, unit rev-

enue is kept constant in all three markets; but can

be changed to reflect inflation. In addition, the unit

capacity retaining cost and unit capacity changing

cost are kept constant in each period.

In our analysis, we consider five levels for theinitial capacities in both US and India. First,



7/12

Table 3

Summary of results

Capacity level Increasing exchange rates Decreasing exchange rates Percent change

Profit TC Profit TC Profit TC

Level A 2 281 228 2 377 530 2 295 219 3 435 090 !0.61 !2.36

Level B 1 350 027 3 308 731 1 359 643 3 370 666 !0.71 !1.84

% change !40.82 39.17 !40.76 38.42

Level C 1 720 027 2 938 731 1 729 643 3 000 666 !0.56 !2.06

% change !24.6 23.6 !24.64 23.23

Level D 1 237 159 3 421 599 1 262 423 3 467 886 !2.0 !1.35

% change !45.77 43.91 !45 42.41

Level E 1 607 159 3 051 599 1 632 423 3 097 886 !1.55 !1.49

% change !29.55 28.35 !28.88 27.22

Percentage is calculated with respect to decreasing exchange rates.

Percentage is calculated with respect to Level A.

Level A: Initial capacities set at optimal levels.

Level B: Initial capacities are zeroes (start-up).

Level C: Initial US capacity of 3000 units; India"5000 units.

Level D: Same as Level B but final Indian facility capacity)8000 units.

Level E: Same as Level C but final Indian facility capacity)8000 units.

facilities in both countries have optimal level capac-

ities (Level A). Second, both are start-up operations

(Level B). Third, there are initial capacities of 3000

units in US and 5000 units in India (Level C).

Fourth level is same as Level B with a restriction

that the final capacity in India not to exceed 8000

units (Level D). Finally, the fifth level is same asLevel C while restricting final capacity not to ex-

ceed 8000 units in India (Level E). While taking two

levels for the exchange rate in India, a 5;2 matrix

is considered. The results from the optimization

model are given in Tables 39. Before discussing

the effects of exchange rates and initial capacity

levels, we will first list the following common obser-

vations. Table 3 is a summary of the detailed re-

sults given in Tables 49.

4.1. Common observations

1. The total costs are always lower when the dollar

is stronger (increasing exchange rates). This is

because it is cheaper to operate the Indian facil-

ity although the cost of the US facility remains

same.

2. The total profit is always higher when the dollar

is weaker (decreasing exchange rates). This is

because the foreign currency is more worthy;

hence, more dollars can be bought for the same

money.

3. The total units produced and the capacity re-

quired for a given capacity level are independent

of the exchange rate direction.

4. Due to (3), the utilizations of capacities are alsoinvariant of the exchange rate direction. The

surplus capacity is not disposed because it is

cheaper to retain the capacity.

5. For capacity levels A, B, and C, the distribution

plans are the same and invariant with respect to

the exchange rates for a given capacity level.

6. For capacity levels D and E, the exchange rate

influences the distribution although the total

quantities produced in each facility remains the

same.

7. For a given capacity level, the capacity requiredis invariant of the exchange rate direction.

4.2. Effects of initial capacity when the exchange

rate is increasing

The highest profit is made for the same demand

when the initial capacities are optimal for both

facilities. The optimal capacities are 8350 units for



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Table 4

Results for increasing exchange rates (stronger $) and capacity Level A

Category Country Period 1 Period 2 Period 3 Total

Cost US $493 133 437 918 417 250 1 348 301

IND $345 150 328 680 355 400 1 029 229

Capacity and utilzn. US 8350/100% 8350/100% 8350/100%IND 11000/100% 11000/100% 11000/100%

CapCh$ US

IND

Capret$ US $292 250 292 250 292 250 876 500

IND $176 000 165 000 159 500 500 500

Distribution US E I US E I US E I

US 20 5.7 30 25 80.67

IND 8.3 10 8 12 14 8 60.33

Inventory US 2.2

IND

Total profits"$2 281 228.

Optimal capacities as resulted from the model.

Quantities in 000s.

E means Europe; I & IND means India.

Table 5

Results for increasing exchange rates (stronger $) and capacity Level B


Cost US $942 052 393 630 387 500 1 723 182IND $809 593 396 975 378 978 1 585 549

Capacity and utilzn. US 7500/100% 7500/100% 7500/100%

IND 12626/100% 12626/100% 12626/87%

CapCh$ US $525 000 525 000

IND $404 035 404 035

Capret$ US $262 500 262 500 262 500 787 500

IND $202 017 189 391 183 078 574 486


US 20 3 27 25 75

IND 11 10 3 8 12 14 8 66Inventory US 2

IND

Total profit"$1 350 027.

Note: The results for Level C are same as above for capacity levels, utilizations, production and distribution, and capacity retaining

costs. Only the total cost is different which is $2 938 731 (due to capacity changing). The profit is $1 720 027.

US and 11 000 units for India (Level A). The result-

ing total costs are smallest (of all cases) as initial

investment in capacity development is not incurred.

In the ensuing discussions, comparisons are made

with respect to the results of Level A. If the capaci-

ties are at Level B, the profit decreases by 40.82%



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Table 6

Results for increasing exchange rates (stronger $) and capacity Level D


Cost US $1 263 500 492 500 552 500 2 308 500

IND $549 655 283 308 280 136 1 113 99


CapCh$ US $651 000 651 000

IND $293 843 34 296 328 139

Capret$ US $325 500 325 500 325 500 976 500

IND $146 922 137 739 116 000 400 661


US 20 11 30 1 25 6 93

IND 3 10 7 12 8 8 48

Inventory US

IND 2.3


Note: The results for Level E are same as above for capacity levels, utilizations, production and distribution, and capacity retaining


Table 7

Results for decreasing exchange rates (weaker $) and capacity Level A


Cost US $493 133 437 918 417 250 1 348 301

IND $328 650 344 960 413 180 1 086 789


IND 11000/100% 11000/100% 11000/100%

CapCh$ US

IND

Capret$ US $292 250 292 250 292 250 876 750

IND $159 500 165 000 176 000 500 500


US 20 5.7 30 25 80.67

IND 8.3 10 8 12 14 8 60.33

Inventory US 2.17IND

Total profits"$2 295 219.

Optimal capacities as resulted from the model.

Quantities in 000s.

E means Europe; I & IND means India.

($931 201) and total costs increase by 39.17%

($93 201). That is, the total increase in costs is

incurred in adding capacity. When the capacities

are at Level C, the profit decreases by 24.6%

($561 201) and costs increase by 23.6% ($561 201).

Lower cost is to be expected as lesser capacities are



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Table 8

Results for decreasing exchange rates (weaker $) and capacity Level B


Cost US $942 052 393 630 387 500 1 723 182

IND $790 655 471 631 439 197 1 647 484


CapCh$ US $525 000 525 000

IND $404 035 404 035

Capret$ US $262 500 262 500 262 500 787 500

IND $183 078 189 391 202 017 574 486


US 20 3 27 25 75

IND 11 10 3 8 12 14 8 66

Inventory US 2

IND


Note: The results for Level C are same as above for capacity levels, utilizations, production and distribution, and capacity retaining


Table 9

Results for decreasing exchange rates (weaker $) and capacity Level D


Cost US $1 229 165 527 065 552 500 2 308 730

IND $557 703 274 743 326 710 1 159 156


IND 9183/100% 9183/100% 8000/100%

CapCh$ US $651 000 651 000

IND $293 843 41 510 335 353

Capret$ US $325 500 325 500 325 500 976 500

IND $133 148 137 739 128 000 398 887


US 20 8.7 30 3.3 25 6 93

IND 5.3 10 4.7 12 8 8 48

Inventory US 2.3

IND


Note: The results for Level E are same as above for capacity levels, utilizations, production and distribution, and capacity retaining


added as compared to Level B. With Level D, the

profits decrease by 45.77% ($1 044 069) and costs

increase by 43.91% ($1 044 069). With Level E, the

profit decreases by 29.55% ($674 069) and costs

increase by 28.35% ($674 069). In changing from

one capacity to level to another level, the observed



11/12

decrease in profits equals the increase in costs

which is incurred because of a need to add

more capacity. Thus, this information will help

MNCs measure the effect on profits when contem-

plating changing capacity levels. Relatively speak-

ing, the MNC is equally well off at any capacity

level. In terms of absolute numbers, it is advantage-ous to have some initial capacities at both facilities

and no limitation should be placed on the

final capacity level at the more profitable Indian

facility.

4.3. Effects of initial capacity when the exchange

rate is decreasing

As seen in Table 3, the effects that were discussed

under increasing exchange rates also apply here.The amount of impact on the profits and costs are

almost the same as the impact under increasing

exchange rates. That is, on a relative basis the

exchange rate direction does not have much impact

on the effects due to different capacity levels.

4.4. Effects of exchange rate direction at various

capacity levels

The highest profit is made when the capacities

are at Level A and the exchange rate is decreasing

(weaker $). Suppose the dollar is stronger, the profit

reduces by 0.61% ($14 000) and costs also decrease

by 2.36% ($57 560). The reduction in cost is due to

the fact that fewer dollars are needed to retain

capacity in India when the dollar is stronger. At

Level B (start-up operations) with stronger dollar

the profit decreases by 0.71% ($9616) and costs

reduce by 1.84% ($61 935). At Level C, the reduc-tion in profit is 0.56% ($9616) and costs reduce by

2.06% ($61 935). Since the amount of changes in

profits and costs are same (for Levels B and C), it

means that the performance with any initial capaci-

ties other than the optimal capacities is invariant of

the direction of exchange rates. At Level D, the

profit reduces by 2% ($25 264) and costs go down

by 1.35% ($46 287) with a stronger dollar. The

changes at Level E are the reductions in profit by

1.55% ($25 264) and costs by 1.49% ($46 287).

Again, the amount of impact due to changing

exchange rate is same regardless of initial capacity

and with a limitation placed on the final capacity in

India.

In summary, the worst effect of exchange rate

direction on profits is felt when there is a limitation

on the final capacity for the Indian facility. Theeffect is the least when a no limitation is placed on

the final capacity of the Indian facility. In the re-

sults the Indian facility is favored over the US

facility because the production and distribution

costs are lower and capacity changing costs and

retaining costs are also lower although the efficien-

cy is not high. Despite taking longer production

times to make the product in India, it is cheaper to

make and distribute products and to add and retain

more capacity in India. From the results, both

facilities take care of their domestic demands, andIndia satisfies about 50% to 92% of the European

demand based on the initial capacity levels.

Before concluding, we would like to re-empha-

size that excellence in manufacturing and opera-

tions is a key factor for survivability and

profitability. The critical factors which affect excel-

lence include response time, cost, and quality. It is

assumed that the quality of the product is the same

whether it was made in the USA or India. For

example, in the case of Fruit of the Loom Inc., thequality of the apparel made in their American,

Honduran or Mexican facilities is the same [22,23].

In our modeling the response time was satisfied as

each periods demand of each market was satisfied.

This was accomplished by incurring the least total

cost. The total cost includes production cost, capa-

city cost, and distribution cost which are affected

by variations in the exchange rate making them

either more or less expensive. Even though the

production time per unit is higher in India, the totalcost per unit is still less than the total cost per unit

from US operations. As a result, the model assigns

more capacity and higher production volumes to

the Indian facility so that global demand is satisfied

while incurring the least total costs, which should

lead to higher profits. This is true in the case of

Fruit of the Loom Inc. More and more production

is being carried out in their off-shore facilities and

by the end of 1997, about 90% of the sewing opera-

tions will be done in their off-shore facilities [23].



12/12

Globalization means moving production facilities

to position a firm competitively.

5. Conclusions

In this paper, we developed an integrated pro-duction and distribution model for a multi-national

company (MNC) operating in an environment of

changing exchange rates. The results from themodel yield some significant insights into the

planning of MNCs. Cost is the main determining

factor in deciding to which facility capacity should

be added. The efficiency of the operations is not

a critical factor. The MNC would make more profit

when the dollar is weaker since revenues from

abroad are higher regardless of the capacity levels

of the facilities. This is also seen to occur in reality.

For example, the MNCs in US earned a higher

profit in the first quarter of 1995 when the dollar

was weaker. Earnings growth for MNCs in the first

quarter of 1995 over the first quarter of 1994 has

been 23%. This compares to 19% earnings growth

for the Standard & Poors 500 for all of 1994 [24].

The effect of exchange rate direction is felt worst

when the capacity of the more profitable facility is

restricted. In terms of the operating capacity, high-

est profit is made regardless of the directional cha-nges of exchange rates when the facilities have

optimal capacities to begin with.

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