An investigation into offshoring and backshoring in the German automotive industry

TABLE OF CONTENTS

ABSTRACT

ACKNOWLEDGEMENTS

TABLE OF CONTENTS

LIST OF FIGURES:

LIST OF TABLES:

LIST OF APPENDICES:

LIST OF ABBREVIATIONS:

1. Introduction
1.1. Motivation
1.2. Reseach Objectives
1.3. Structure and Outline of the Research Project

2. Theoretical considerations
2.1. Industrial Location Theories
2.1.1. Industrial location theory according to Weber
2.1.2. Behaviouristic and institutional location approaches
2.1.3. Kinkel’s holistic model on location determinant factors
2.1.4. Porter’s Model “The competitive advantages of Nations”
2.2. International Foreign Investment Theories
2.2.1. Historical Development of Foreign (Direct) Investment
2.2.2. Classical and Neoclassical approaches
2.2.3. Monopolistic approach by Hymer
2.2.4. Vernon’s International Product Life Cycle Theory
2.2.5. Knickerbocker’s theory
2.2.6. Theory of Internalization
2.2.7. Dunning’s eclectical framework
2.2.8. Behaviouristic Approaches of FDI
2.2.9. New Trade and Location Theory
2.3. Summary of chapter 2

3. Globalisation within the Automotive Industry
3.1. Definition and structure of the automotive industry
3.1.1. Direct automotive industry
3.1.2. The indirect automotive industry
3.2. The history of the automotive industry in Germany
3.2.1. The automotive industry after the 1st world war
3.2.2. The automotive industry after the 2nd world war
3.2.3. Recent history of the automotive industry
3.3. Competitiveness of the automotive location Germany
3.3.1. Factors of success for the automotive location Germany
3.3.2. Challenges for the automotive location Germany
3.4. Situation of the German automotive industry
3.4.1. Turnover and Production
3.4.2. Decreasing domestic and international markets
3.4.3. Cost pressure and concentration process within the industry
3.5. Summary of chapter 3

4. Offshoring
4.1. The Historical Development of Offshoring and Production Relocation in Germany..
4.1.1. Development from 1871 until 1945 - The Roots of Production Relocation
4.1.2. The Historical Framework of Liberalisation from 1945 until 1970
4.1.3. The 1970s - The Emergence of Production Relocation in Post-war Germany
4.1.4. The 1980s - Fall of the German Electronic and Entertainment Industry
4.1.5. Since the 1990s - Relocation due to EU extension and market liberalisation
4.2. Terminology of Offshoring and Production Relocation
4.3. Forms of Offshoring and Offsourcing activities
4.3.1. Offsourcing activities in the form of indirect foreign investments
4.3.1.1. International Contract manufacturing
4.3.1.2. International Licensing agreements
4.3.2. Offshoring activities in the form of Foreign Direct Investments (FDI)
4.3.2.1. Joint Ventures
4.3.2.2. Wholly Foreign Owned Enterprises
4.3.2.3. Assembly production
4.3.3. Drivers and Motives for FDI
4.3.4. Scope of FDI in the German automotive industry
4.4. Scholarly Studies of Production Relocation and Offshoring in Germany
4.4.2. Mode and Size of Offshoring Operations
4.4.3. Target Regions for Offshoring Activities
4.5. Motives of Production relocation
4.5.1. Motives for Offsourcing/Offshoring activities in general
4.5.2. Motives for Offsourcing/Offshoring activities for the automotive industry
4.6. Cost for Offshoring/Offsourcing
4.7. Impacts of Offshoring and Offsourcing to the German labour market
4.7.1. General studies on FDI and Offshoring activities on domestic employment
4.7.2. Impacts on Germany and the automotive industry
4.8. Summary of chapter 4

5. Backshoring
5.1. Terminology of Production return relocation and Backshoring
5.2. Scholarly Studies of Backshoring and current state of research
5.2.1. Scope of Backshoring
5.2.2. Form and Size of Operation
5.2.3. Regions of origin for Backshoring activities
5.3. Reasons for Backshoring
5.3.1. Quality and labour related aspects
5.3.2. Cost related aspects
5.3.3. Coordination and start up cost
5.3.4. Cultural and network related aspects
5.4. Costs and Hindrances of Backshoring
5.5. Summary of chapter 5

6. Empirical Investigation of Offshoring and Backshoring in the automotive industry
6.1. Exploratory research questions and development of hypotheses
6.2. Methodology
6.2.1. Questionnaire Design and Construction
6.2.2. Population and database construction
6.2.3. Statistical methods of data analysis
6.2.4. Questionnaire Responses and Representativeness of the Sample
6.3. Current Degree of Internationalization of the automotive industry
6.3.1. Share of goods manufactured at foreign locations
6.3.2. Destination of goods manufactured at foreign locations
6.3.3. Complexity and capital intensity of foreign production
6.3.4. Regions of Foreign Direct Investments
6.4. Current Offshoring/Offsourcing activities in the automotive industry
6.4.1. Form and Size of current Offshoring/Offsourcing activities
6.4.2. Future plans and development for Offshoring activities
6.4.3. Target regions of Offshoring activities
6.4.4. Current reasons for Offshoring/Offsourcing activities
6.4.5. Subsidies and Offshoring activities
6.4.6. Satisfaction with foreign locations
6.4.7. Further aspects and determinants regarding Offshoring/Offsourcing activities
6.5. Current Backshoring activities in the automotive industry
6.5.1. Form and Size of Backshoring activities
6.5.2. Time sequence of Backshoring activities
6.5.3. Current regions of origin for Backshoring activities
6.5.4. Current reasons for Backshoring activities
6.5.5. Offshoring and Backshoring in comparison
6.5.6. Backshoring/Backsourcing - satisfaction and subsidies
6.6. Current influences of Offshoring and Backshoring to the German labour market ..
6.7. Recent development and future perspective

7. Summary and Conclusion
7.1. Summary of the study
7.2. Conclusion and future Outlook
7.3. Contribution of the study
7.4. Limitation of the study and area of further research

References:

ABSTRACT

Domestic market stagnation, cost pressures, intensified international competition and chances of emerging markets, have forced the German automotive industry to utilize international location advantages and thus production relocations have become the main strategy to survive in a globalized automotive market. These relocation activities are often viewed as being one-way directed and affected jobs are perceived as being permanent losses for the domestic economy. But in reality, relocation activities are becoming increasingly dynamic and since the turn of the century, more and more cases have been discovered, involving businesses that are returning their productions from abroad.

This study has involved exhaustive research to investigate the current scope and scale of Offshoring and Backshoring activities within the German automotive industry and its impact to the domestic labour market by means of a questionnaire survey.

The results of the more than two hundred survey responses show that Offshoring activities continue to proceed and a strong shift in Offshoring activities at present takes place from the Eastern European to Asian regions, resulting in agglomeration, “band wagon” effects as well as excess capacities especially in the Chinese market. The study further shows that relocation activities in the automotive industry nowadays do not necessarily result in higher earnings and constant cost savings but rather contribute to an increased competitiveness and to the future survival of the company. Beside ongoing factor price equalization within the age of globalization, a trend in Backshoring activities as stipulated by the media could not be observed so far. Above all, this can be drawn back on the high cost of Offshoring activities and low profit margins within the industry.

The findings of the study further concluded that Offshoring has indirectly contributed to the safeguarding of productive and especially non productive jobs at the domestic locations. Although anticipated by press and media, Backshoring does not have any impacts on the domestic labour market.

ACKNOWLEDGEMENTS

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LIST OF FIGURES:

Figure 1: Structure and Outline of the research project

Figure 2: Location factors according to traditional behaviouristic and institutional theories

Figure 3: Kinkel’s Model on Location Determinant Factors

Figure 4: ‘Porter’s Diamond’ adapted to the German Automotive Industry

Figure 5: International Product Life Cycle

Figure 6: Dunning’s OLI scheme

Figure 7: Steps of Internationalization

Figure 8: Global Competitivenss Ranking of Germany and selected countries

Figure 9: Hourly labour costs in manufacturing 2008

Figure 10: Development of labour cost in Germany and Eastern Europe since 2000

Figure 11: Corporate Tax rates 2008

Figure 12: Automotive Trade Surplus 2007

Figure 13: Domestic and Foreign production of German OEMs in 2007

Figure 14: German Automotive Production abroad

Figure 15: Development of Product Range and Life Cycles for Mercedes Benz until 2005

Figure 16: Supplier’s pyramid in the Automotive Industry

Figure 17: Concentration process in the global Automotive Industry

Figure 18: Summary of problems in the Automotive Industry

Figure 19: Structural changes in Germany

Figure 20: Long Wave Theory and German Offshoring activities

Figure 21: Matrix for Offshoring and Production Relocation

Figure 22: Forms of Offshoring and Offsourcing activities

Figure 23: Development of Patent & License Income and Expenditures Germany

Figure 24: Income and Expenditures from patents and licenses by regions in 2007

Figure 25: German Automotive FDI stocks by region

Figure 26: Comparison of production cost structure of OEMs and supplier in Germany

Figure 27: Cost for Offshoring/Offsourcing activities

Figure 28: Influence of hidden costs to Offshoring/Offsourcing calculation

Figure 29: Amortisation of Offshoring/Offsourcing costs

Figure 30: Development of Employment in the Automotive Industry:

Figure 31: Cost for Backshoring/Backsourcing activities

Figure 32: Overview questionnaire construction

Figure 33: Overview about research objectives and statistical methods

Figure 34: International activities in the German Automotive Iindustry

Figure 34: Internationalisation of Supplier and M&E

Figure 36: International activities in the Automotive Industry in regard to company size

Figure 37: Reasons for not operating foreign production locations

Figure 38: Share of goods manufactured abroad

Figure 39: Destination of goods manufactured abroad

Figure 40: Production process and complexity of foreign production

Figure 41: Establishment of foreign production locations within the past 5 years

Figure 42: Offshored/Offsourced the past 5 years

Figure 43: Planned Offshoring/Offsourcing activities within the next 5 years

Figure 44: Current and future target regions of Offshoring/Offsourcing activities

Figure 45: Current Motives for foreign investment and Offshoring/Offsourcing

Figure 46: Motives of foreign investment and Offshoring/Offsourcing by target regions

Figure 47: Production and Overcapacities in automotive production in China

Figure 47: Subsidies and foreign activity

Figure 49: Satisfaction with foreign production locations

Figure 50: Main determinants regarding Offshoring/Offsourcing activities

Figure 51: Share and chronological perspective of Backshoing/Backsourcing activites

Figure 51: Comparison Offshoring/Backshoring

Figure 53: Share and chronological perspective of Backshoing/Backsourcing activites

Figure 54: Reasons for Backshoring/Backsourcing activites

Figure 55: Reasons for Offshoring/Offsourcing & Backshoring/Backsourcing in comparison ...

Figure 56: Backshoring and further plans for Offshoring/Offsourcing activities

Figure 57: Correlation between level of internationalization and development of employment

Figure 58: Impacts of Backshoring/Backsourcing to domestic labour market and investment

LIST OF TABLES:

Table 1: Automotive Groups worldwide

Table 2: Largest Automotive Supplier

Table 3: Development German FDI stocks in the Automotive Industry

Table 4: German Studies about FDI and relocation activities

Table 5: German Studies about Backshoring/Backsourcing activities

Table 6: Differences of quantitative and qualitative research methods

Table 7: Methods of quantitative data collection

Table 8: Relocation activities to previous established production sites

Table 9: Summary of Empirical Study

LIST OF APPENDICES:

Appendix 1: Cover letter and Questionnaire German (original version)

Appendix 2: Cover letter and Questionnaire English (translated version)

Appendix 3: Example - Amortisation Time Automotive TIER I Supplier

Appendix 4: Goodness of Fit Test - Company Size and Company Type

Appendix 5: Difference of foreign production activity between Supplier and M&Es

Appendix 6: Dependency between company size and foreign production activity

Appendix 7: Differences between Supplier and M&E in regard to non- relocation factors

Appendix 8: Differences between Company Size in regard to non-relocation factors

Appendix 9: Cluster Analysis - non relocation factors

Appendix 10: Dependency of production region and market location of goods

Appendix 11: Correlation between foreign production technique and work or capital intensity..

Appendix 12: Correlation between Company Size/Type and degree of international activity

Appendix 13: Company Size and planned Offshoring/Offsourcing

Appendix 14: Share of foreign production and planned Offshoring/Offsourcing activities

Appendix 15: Company Size and market factors of Offshoring/Offsourcing activities

Appendix 16: Significance of cost factors in China and Eastern Europe

Appendix 17: Dependency between Company Size and Subsidies

Appendix 18: Company Size and degree of Satisfaction

Appendix 19: PCA results for influences and determinants regarding Offshoring/Offsourcing ..

Appendix 20: Association between Company Size and Backshoring/Backsourcing activities

Appendix 21: Production technique and Backshoring/Backsourcing activities

Appendix 22: Company Size and chronological perspective of Backshoring/Backsourcing

Appendix 23: Association between regions of Offshoring and Backshoring

Appendix 24: Motives for Backshoring/Backsourcing activities from respective regions

Appendix 25: Satisfaction with foreign production and Backshoring/Backsourcing activities

Appendix 26: Backshorers/Backsourcers and planned Offshoring/Offsourcing activities

Appendix 27: Degree of foreign activity and development of employment

LIST OF ABBREVIATIONS:

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1. Introduction

“When a good or service is produced at lower cost in another country, it makes sense to import it rather than to produce it domestically”¹

This standard economic theory which can be found in any freshman-level international business textbook clearly reflects modern enterprises strategies in today’s globalized world.

Also the automotive industry, one of the fastest growing sectors in the world and most important industries for industrialized nations, discovered the benefits of globalization in the middle of the 1990s and has since dramatically increased its degree of international production. The automotive industry has become a global, multi-location industry and the pace of this transition from largely national markets and national manufacturing to global manufacturing for increasingly global markets has been astonishingly rapid. Domestic market stagnation, cost pressures and changes in the structure of the industry on the one hand and immense cost differentials in developing countries and chances of emerging markets on the other hand, have forced the automotive industry to utilize international location advantages.

Thus, many auto-giants such as Volkswagen, Mercedes, BMW, Ford, General Motors, etc., and their major suppliers have shifted their production bases to Eastern Europe or Asia in order to withstand the challenges caused by the intensified global competition. Hence, Offshoring, often termed international production relocation, outsourcing, production fragmentation, delocalization, etc. has increasingly become important and has an enormous influence on the success and economic survival of the automotive industry. In particular the German automotive industry, with its largest concentration of automotive OEM plants and distinctive supplier structure is widely affected by this development.

Offshoring is a decision that involves high initial investments, lots of risks as well as opportunities and gains for the company in question. It is also subject to highly controversial media discussions and its assumed disruptive effects on employment have caused considerable concern among large groups of people and, by extension, politicians.

Whilst Offshoring in the automotive industry can be an excellent strategy to reduce costs, particularly through lower labour costs, there are hidden costs which companies often fail to include in their business plan when relocating abroad. Indeed, Offshoring is often done with little or no understanding of the true costs and the manager often tends to overestimate the benefits of foreign location advantages; in particular, their ability to get a well-performing plant operating offshore according to e.g. German standards.

Therefore, Offshoring and relocation activities may not always be one way directed. An investigation by the Fraunhofer Institute (published 2008) on the outward FDI of German firms shows that about one in five companies in the automotive industry is now returning its foreign production to Germany. This phenomenon has been widely covered by the media and even the London Times states “German companies retreat from the Eastern Front” (Woodhead, 2007). However, looking into details of the survey it becomes clear that statistical quantitative as well as qualitative data on the subject is very limited and that the information is mainly based on individual cases rather than on reliable and validated statistical data.

However, relocation and the establishment of new production plants is an expensive and decisive strategic decision-making process, which requires detailed planning as well as the consideration of the current and future company’s challenges, structure and strategy. Since location factors change over time, it is essential for the success of the automotive companies and industry to dynamically monitor and evaluate the actual as well as potential production locations around the globe. In this respect, the following question is raised:

“ Should I stay or should I go ? “ ²

1.1. Motivation

Automobiles are the “machines that changed the world” (Womack et. al, 1990) and do not only allow people to live, work and play in ways that were unimaginable a century ago but are also the single greatest engine of economic growth in the world (OECD, 2009). The total turnover of auto manufacturing worldwide in 2008 contributed $2.6 trillion, or around 4%, of world GDP. If vehicle manufacturing was a country it would be the sixth largest economy in the world and would be equivalent to the economic power of the United Kingdom (in terms of GDP).³

Building around 72 million vehicles annually requires the employment of about 9 million people directly in making the vehicles and the parts that go into them. According to the International Organization of Motor Vehicle Manufacturers, this is over 5 percent of the world’s total manufacturing employment (OICA, 2008). But in the global economy, not only the car manufacturers, but the multitude of companies along the entire automotive supply chain - including automotive suppliers, car dealers, and companies that provide financial, logistics, and consulting services - play an important role and rely on and are linked to automobile production. It is estimated that each direct auto job supports at least another 5 indirect jobs in the community. This results in at least 50 million jobs owed to the global auto industry. In addition, the automobile industry is also a major innovator, investing almost €85 billion in research (OICA, 2008), development and production and therefore plays a key role in the technological development of many industries and economic welfare of nations.

Thus international automobile production is a market which is understood as a place where all problems of a globalizing economy accumulate: automobiles are the single industrial manufacture which holds the highest share in world GDP and trade and contribute to the labour market and technological level of many industrialized countries. Due to its economic power and global presence, the effects of Offshoring and globalization therefore can be best researched and explained by this industry.

If one nation is known for cars, then it is Germany. Although the German automotive industry is only ranked number four in international comparison behind Japan, China and the USA in regard to units manufactured in 2008, it accounts for 14% of all jobs in manufacturing in Germany and thus displays the highest share when compared to other nations (VDA 2009). Since the invention of the first automobile by the German engineer and entrepreneur Carl Benz in 1886, this industry has come more and more into focus in light of increasing specialization tendencies of nations and international division of labour. Today it is an essential driver of innovation and the most important industry in Germany in terms of GDP contribution and export ratios (Statistisches Bundesamt 2008). With around 30 vehicle assembly plants in operation, Germany is home to the largest concentration of automotive OEM (Original Equipment Manufacturer) plants. Worldwide every fifth car comes from the production of a German manufacturer, and with Volkswagen, BMW and Daimler three German automobile manufacturers account for around 30% of worldwide revenues in the automotive industry. In addition, German suppliers also occupy top positions internationally, including mega suppliers such as Bosch or Siemens VDO (Automobilproduktion, 2009). The comparative strength of German automobile production is reflected in the economic success: manufacturers and suppliers together achieved an annual turnover of 330 billion Euros in the year 2008⁴. Three out of four cars manufactured in Germany are exported to foreign countries and 55% of the German trade surplus is contributed by the automotive industry (Statistisches Bundesamt 2008).

Bringing all these figures together, Germanys’ economic dependence of the automotive industry is unique in industrial nations. But this dependency makes the German economy and in particular the labour market more vulnerable to Offshoring and production relocations than any other country. Hence, the German automotive industry is widely exposed to global influences and therefore an ideal choice to research international investment, Offshoring and Backshoring tendencies and its effects to the labour market. Due to its dependence, distinctive market and supplier structure, the results can then potentially be transferred to other nations and industries. In this respect, this study aims to provide more contribution to the existing volume of knowledge and research in the field of locational science studies exemplified by the German automotive industry.

1.2. Reseach Objectives

In detail, the research examines the present degree of internationalization of the German automotive industry, current geographical and physical dispersion of international operations, the recent as well as future development and dimension of Offshoring and Backshoring tendencies as well as the respective motives and reasons behind the relocation decisions. Furthermore, the study provides an insight into the current competitiveness of the production location Germany and shows effects resulting from Offshoring and Backshoring activities on the German labour market. Summarized, the main deliverable outputs of research findings are as follows:

- To highlight the present stage of international competitiveness of the ‘Automotive Location Germany’
- To examine the present degree of internationalization of the German automotive industry
- To provide an analysis of the present and future stage and scope of Offshoring and Backshoring tendencies within the German automotive industry
- To investigate the present motives and reasons of Offshoring and Backshoring activities in the automotive industry as compared to previous findings from other research
- To provide insights about the present and future influence of relocation decisions on the German labour market

Beside these main objectives, the study deals in turn with a series of more detailed secondary issues, which include:

The determination of factors and motives why companies in the automotive industry have not established foreign production locations so far and solely remain and manufacture in Germany.

The present degree of satisfaction with the foreign production locations and respective determination factors. The degree of satisfaction and quality of the foreign location factors may determine whether the production relocation was successful or not. Statements regarding potential future Backshoring activities may thus be deduced from this information.

The actual extent to which foreign manufactured products are re-imported and manufactured for the domestic market and its potential impact on the German labour market. Increasing imports from foreign locations may lead to a decrease in the demand of domestic manufactured products.

1.3. Structure and Outline of the Research Project

To investigate Offshoring and Backshoring in the automotive industry, the dissertation is structured into into three parts: “theoretical considerations”, “desk research” and “field research”.

As production Offshoring and Backshoring activities are based on strategic location decisions, Chapter 2 first discusses the theoretical background of industrial locational theories as well as respective approaches concerning the international division of labour and foreign investment. In this respect, the present validity and applicability of each theory in the era of globalization is evaluated and it is discussed in which way these theories may explain or support Backshoring tendencies. Thus, this chapter provides an important foundation for further discussion in the research project.

The subsequent desk research (chapter 3 to chapter 5) then aims to provide background information about Germanys’ competitiveness in the era of globalization, the German automotive industry and Offshoring and Backshoring tendencies in general. It analyses and evaluates already existing information from various sources and published reports such as the ACEA (European Automobile Manufacturing Association), VDA (Verband der Deutschen Automobilindustrie - German Association of the Automotive Industry), WEF (World Economic Forum), Statistisches Bundesamt (Office of National Statistics), Fraunhofer Institzute, etc.

In this respect, Chapter 3 in detail analyses the current situation of the automotive industry in the Federal Republic of Germany. First, the study thereby provides a definition of the automotive industry and then highlights the industry’s impact on the German economy. The chapter further demonstrates which branches and industrial sectors are linked to the automotive industry and how many jobs are directly or indirectly depending on these industries in Germany. Subsequently the present competitiveness of the automotive location Germany as compared to other nations is discussed and analysed. The respective factors of success as well as challenges of the “production location Germany” are outlined. The historical development as well as the current situation of the automotive industry is then presented to illustrate the problems of the automotive manufacturers and suppliers in the era of globalization. Thus this chapter provides important background information for the subsequent analysis of German automotive production relocations.

Then Chapter 4 and Chapter 5 emphasise the core topic of the desk research and deal with the phenomena of Offshoring and Backshoring in general and the automotive industry in Germany in particular. Starting with a short abstract of the history of production relocations and its effects to the German economy in general, the section then provides a detailed definition for the term Offshoring. This is followed by a description of the different external and internal typologies of Offshoring and respective advantages, disadvantages and risk resulting from relocation activities. Then an analysis of past and recent scholarly studies in the field of Offshoring is conducted, exploring the scope and dimensions as well as the past and present motives of Offshoring activities in general. Also the cost and saving potentials associated with Offshoring activities are examined as well as the potential impacts of Offshoring to the German labour market. These issues are presented in general and in particular with regard to the automotive industry. The term Backshoring is elaborated in chapter 5. Again, a definition is provided and scholarly studies regarding the scope and dimension of backshoring presented. Linked to this are the cost for Backshoring and the discussion of the potential factors influencing the firms’ Backshoring decisions.

Since the desk research shows that further research work is justified in the field of Offshoring and Backshoring in the automotive industry, primary data is collected in the course of an empirical field study. In this regard, Chapter 6 then investigates the current scope, dimension as well as motives of Offshoring and Backshoring activities in the German automotive industry by conducting a quantitative mail survey on 1.700 German companies operating in the automotive industry. Based on the preliminary findings from the desk research, first the research hypotheses are developed. Next, the chapter outlines the survey methodology, the process of data collection necessary for the analysis, the structure and design of the questionnaire as well as restrictions and particularities evidenced during the research process. Further the statistical descriptive and analytical approaches to analyse the collected data are determined. The results of the empirical research are then presented, compared and evaluated in regard to the outlined objectives of this study, using SPSS, Excel and Power Point graphs. The section thereby also provides a short outlook of the current and future development of Offshoring and Backshoring activities in the automotive industry in view of the most recent worldwide development and economical crisis.

Last, the final Chapter 7 brings together the study results, outlining the key areas from each section of the report and discusses the findings in light of the current situation of the German automotive industry. In this respect the contribution and limitations of the study are outlined and recommendations and areas for future research projects are presented.

To allow for a better overview, a small introduction and summary is provided for each chapter. Figure 1 demonstrates the structure and sequential flow of the research project.

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Figure 1: Structure and Outline of the research project

2. Theoretical considerations

International relocation activities are not only based on location theories which focus on the optimal location choice that is mostly determined by the attractiveness of a site but also have to take into account the first step, the exit from the present domestic location. Thus, the first section of this chapter presents an overview about location theories and respective location determining factors in general before discussing international approaches. As international production relocations (Offshoring/Offsourcing) in general occur in the form of Foreign Indirect or Foreign Direct Investment (FDI), the theoretical approaches of FDI are used to explain the emergence and theoretical foundations as well as motives related to international production relocations and return relocations. In this regard, the study provides a brief overview of the historical situation and the historical development of FDI as these factors influenced the theories discussed in this chapter and help to explain why theories for foreign direct investment only came into being in the 1960s.

Then, the study outlines several selected theories in respect to its significance and importance. After a short description, each theory is discussed and evaluated according to its validity, as well as applicability to potential Backshoring and the automotive industry. Due to the limited evidence of Backshoring, no theory of its own has been developed for this phenomenon so far. However, backshoring can be explained with the lapse of the advantages and initial motives of foreign direct investments.

2.1. Industrial Location Theories

Industrial location theories basically provide the foundation for the theories of relocation and foreign investment and thus are closely interlinked with each other. In economical terms, the location of a business is the geographical place where it is situated. An industrial or production location is further determined by a value creating process of industrial goods and commodities. Thereby location theories deal with the optimum spatial localisation of economic activities or enterprises, as well as with the influence of the location on sales and profit.

Firm relocations differ from firm location because it explicitly takes account of the fact that one location is substituted for another (Pellenbarg et al, 2002). The firm has a history and this history is likely to have an influence on the locational outcome of the process. Investors generally have to make an initial decision on whether or not a location would be appropriate for an investment or not. Once established, further decisions may have to be made, in several cases, such as whether to retain the operation at the existing location or to relocate to a potentially new location. Therefore the locational outcome is conditional. Whilst location theory focuses on the optimal location choice, which is about locational factors, determining the attractiveness of a site, relocation takes the ‘push out’ of the present location into account. Such (re-) locating decisions are significantly influenced by the ‘location factors’. Generally, these factors represent location- and situation- specific features, requirements or influencing variables, which affect the company's objectives and thus influence success. Starting with the pioneering work by Weber (1909), which employed only a few quantitative variables, there are nowadays many theories determining the optimal location and industrial location factors for a company and respective production facility. In general these theories are classified into neoclassical, behaviouristic as well as institutional approaches.

The subsequent sections provides insights about selective approaches to location theories with focus on location factors. This provides the theoretical groundwork for further discussion about international investment, Offshoring and Backshoring within the German automotive industry.

2.1.1. Industrial location theory according to Weber

Alfred Weber’s publication ” On the location of industries” is commonly cited as the origin of industrial location science (Eiselt and Laporte, 1995). Weber (1909) introduced the concept of location factors which he defines as “factors constituting a precisely defined advantage that is realized if an economic activity is realized at a certain location or more generally at locations of a certain kind”. The choice of the location is determined by the existence and interaction of different location factors. According to Salmen, (2001) a location factor is only important if it influences the cost or profits of an enterprise and if its spatial availability differs in regard to quality and price. Thus different conditions result from different locations which have to be considered by the location choice of an enterprise.

Weber’s system is a rather static and closed approach which only concentrates on a few main factors. His “least cost theory of industrial location” tries to explain and predict the locational pattern of the industry at a macro-scale. It emphasizes that firms seek a site of minimum transport and labour cost. The point of optimal transportation is based on the costs of distance to the "material index" (the ratio of weight to intermediate products (raw materials) to finished product), the labour distortion (sources of lower labour cost may justify greater transport distances and become the primary determinant in production) as well as agglomeration effects (concentration of firms in a relatively small area). Thus, if production costs are the same everywhere, transport costs will govern the choice of location. Kinkel (2003) and Bea (2004) point out that market and sales factors are not considered in Weber’s approach since he assumes that demand is fixed and concentrated at a limited number of (known) locations (points). Furthermore it was widely felt that Weber’s assumptions were not fully realistic. According to Weber, full information regarding transport cost and economical conditions are the essential factors for a location decision (Pieper, 1994). Although modern communication technology meanwhile improved the information content, complete information of all decision makers can never be guaranteed; otherwise phenomena such as ‘backshoring’ would not exist. The belief that transportation costs today still play the major role in a firms’ location decision is questionable, and strongly depends on the development of the oil price as well as on the demand and supply of transport services. Due to the fast increasing logistic network and huge supply of transportation services financed by credits and equity capital within the era of globalization, it is now possible to dispatch all kind of products within the shortest time to every point of the world at extremely low costs. Nevertheless, the recent surge of the oil price in 2008 as well as the rise of shipment cost caused by acts of piracy also demonstrates that transport costs develop dynamically and are not always directing downwards.

Although Weber’s approach has many restrictions and has been widely criticised, his theory is the foundation of many further and newer approaches, for example by Pred, Behrens, Tesch, Isard and Smith, etc., in the field of locational science (Schätzl, 2003).

2.1.2. Behaviouristic and institutional location approaches

The behaviouristic approach was introduced to location theories by Pred (1967) and further developed by Behrens (1971) who empirically identified factors which were grouped into sourcing, transformation and sales factors. If one of the factors dominates the companies’ location decision, this can be referred to as location orientation. Behrens (1971) not only focused on the costs and financial factors (also often referred to as quantitative factors), which may derive from a location choice, but also takes non-financial market- and branch factors into consideration. When regional economic conditions show limited variations, the choice for a location may also be determined by non economical factors. This leads to the result that Behren’s approach (1971) does not only distinguish between monetary advantages, but moreover makes a qualitative comparison between different alternatives. Thus his model is classified as a behaviouristic approach as the ultimate goal and is not only profit maximation behaviour but also ‘satisficing’ behaviour.

The classical and behavioural approaches put the firm in the centre of the location decision-making process. However, firms are also influenced by society’s cultural institutions and value systems. As firms in general have to negotiate with local, regional or national governments, labour unions and other institutions, about prices, wages, taxes, and governmental orientated factors were later added to Behren’s work, especially in the context of the international location decisions. The institutional approach focuses on the rules that set the parameters for negotiations, contract law, as well as the negotiation power of the firm. Pellenbarg (2002) shows that whereas in the 1960s and 1970s the role of the government in relocating economic activities was large in Europe and the US, at least in the light of the many regional policy intentions in those days, nowadays it is more modestly seen as largely facilitating or inhibiting the locational choices of firms. Governmental facilitating factors are for instant infrastructure, zoning, subsidies and tax reductions. Fiscal incentives particularly influence the profitability of a firm’s location. In regard to governmental factors, a recent OECD report by Porter and Gallardo (2007) emphasized a need of strengthening relocation aftercare services provided by the government as this could have a positive influence on a firm’s decision to continue its operation at a particular location. Aftercare programme involves the provision of services to investors after their initial investment. While much effort and substantial resources, both financial and human, are dedicated to attract new entries of (foreign) businesses, after-care services appear to be given much lower priority by several governments. In the long term, a lack of effective after-care services for (foreign) investors can possibly lead to an erosion of the location advantage and attractiveness and may result in premature departures/closures of (foreign) enterprises. The institutional theory is more suitable for large firms that have more negotiating power and are able to exert a substantial influence upon things such as the political environment (Pellenbarg et al., 2002). Figure 2 provides an overview about summarized location factors considered by behaviouristic as well as institutional approaches.

Figure 2: Location factors according to traditional behaviouristic and institutional theories

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Source: adapted from Behrens (1971) and Pellenbarg (2002)

2.1.3. Kinkel’s holistic model on location determinant factors

Most of the traditional location theories so far have encountered two shortfalls. First, the limitation of environmental factors implies that the individual firm performance as well as its demand for networks is completely neglected. Second, there is no differentiation of the actual critical success factors with respect to the planned location strategy. In fact, different business objectives (e.g. market development, cost reduction, following key-customers or seeking for technology access) require different types of consideration to be made. More recent work by Kinkel (2004a) presents a new systematic model for location factors by adding performance factors and network demand in addition to the traditional categories of location factors offered by neoclassical, behaviouristic as well as institutional approaches. Kinkel assumes that it is not possible to properly evaluate a typically international location with only production and market factors.

A location’s potential can only be assessed if company-specific location factors (e.g. market access, transportation and distribution channels) are also taken into account. Consequently, performance indicators like productivity and quality of processes are crucial to a firm’s competitiveness. To differentiate from competitors, firm must demonstrate the potential for innovation. Moreover, flexibility of production processes and highly skilled workforce, for being able to rapidly adapt to changing customer requirements or fluctuations in demand, are necessary to generate competitive advantage. Network demand measures the quality of a location’s business networks and supporting industries, since further developments across industries and in the value chain will help to enhance synergy effects. Network clusters can lead to greater opportunities for innovation, enhanced productivity and thus increase a location’s competitiveness (Schiele, 2008). Therefore, the performance factors and network demand are also playing critical roles in the success of location decisions. Figure 3 shows the outline of Kinkel’s approach.

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Figure 3: Kinkel’s Model on Location Determinant Factors

Source: Kinkel (2004a)

2.1.4. Porter’s Model “The competitive advantages of Nations”

Porter (1990) tries to explain location decisions and strategies of firms with the competitive advantage of nations. Therefore Porter provides a good transition from traditional location theories to the theories of foreign direct investment as he considers the location decision on an international scale. According to his ‘diamond approach’, firms engaged in producing for the global market, will locate production based on four primary factors; namely, factor conditions, related and supporting industries, demand conditions and a firm’s strategy. In addition, these four elements are positively or negatively influenced by the government and risk taken by the company. Measures such as taxes, subsidies, governmental demand and implementation of safety and environmental standards can influence the forces and increase the competitive advantage of the national location as compared to other nations. These five competitive forces determine industry profitability and attractiveness and are important in shaping the prices that firms can charge, the costs they have to bear, and the required investments to compete in the industry. Increased interaction of the five forces leads to an improvement of the competitiveness of the respective production location and increase of agglomeration effects in the industry. Thus Porter combines the ideas of the neoclassical (cost advantages through factor conditions), the behaviouristic (firms strategies, structure) as well as the institutional approaches (governmental policies) in his model.

As Porter’s model was evolved during the 80s it is questionable if it is still applicable in the fast moving era of globalization and multinational investment. According to Rugman (1998) and Becker (2007a), the model does not explain what happens if companies choose to locate their production plants in different countries other than their headquarters. The model is restricted to the home base and does not apply to firms that act on a more international level than just being an exporter from a home base cluster. Rugman (1998) further stresses that the model is somehow static and does not take fast changes in the competitiveness of locations over time into consideration. As multinational enterprises tend to shift production around the world dynamically, the model does not sufficiently explain relocation tendencies. However, Porter’s approach offers a good explanation for the success of the German automotive industry. Empirical evidence in this regard has recently been shown by Sledge (2005) on a quantitative analysis of 50 automotive companies and qualitative analysis by Becker (2007a). Figure 4 provides an overview of ‘Porter’s diamond’ adapted to the German automotive industry.

Figure 4: ‘Porter’s Diamond’ adapted to the German Automotive Industry

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Source: adapted from Porter 1990

2.2. International Foreign Investment Theories

2.2.1. Historical Development of Foreign (Direct) Investment

In the latter half of the 1960s economic analysts became aware that multinational companies had become the most important contributors to growth in many modern industries and theoretical approaches for foreign direct investment only developed after the Second World War II (WWII) Up to that time, the prevailing Keynesian economic theory had prevented the identification of this phenomenon as it placed the focus of analysis upon national economics. As this study looks at theories developed after WW II the historical development of FDI before this period will not be further described. WW II involved the occupation and seizure of assets together with economic dislocation on an unprecedented scale and left even the most robust of international corporations in a precarious state by the end of 1945 (John et al., 1997). In the early post-war period, US firms took the leading role in helping to internationalize competition in many industries as they had the additional advantage of a decisive lead in technology. The modern multinational enterprises (MNE) are characterized by both the equity ownership and the ability to manage strategically the foreign affiliates at a distance which was only possible due to innovations in personal communications and organizational structures. Another favourable point for international investment was the political environment which helped to explain why internationalization via direct activities was possible on the scale witnessed in the last 50 years (Ietto-Gillies, G., 2005). Krugman and Obstfeld (2003) point out that the extent to which economic recovery benefited from liberalization, e.g. the lowering of the remaining trade barriers in Europe as an idea born out of the war experiences, is indicated by the fact that trade consistently grew more rapidly than the value of the world output before the energy crisis of the early 1970s. However, difficulties in many developing countries, coupled with a tendency for much international investment to seek out lucrative markets, meant that the activities of multinational corporations in the post-war years tended to increase the polarization between industrialized and less-developed countries, which often considered the multinationals as a legacy of colonialism/mercantilism or even a form of neo- colonialism/neomercantilism and reacted with expropriation to that threat.

The 1970s were marked by two oil crises which were the results of war between Israel and the Arab countries and the fall of the Shah in Iran (Krugman, and Obstfeld, 2003). The oil price quadrupled between October 1973 and March 1974, affecting not only private consumers but also the energy-consuming industry. The macroeconomic effect was that consumption and investment slowed down, and the world economy was thrown into recession. The second oil shock, originating in the fall of the Shah, produced effects that were neither as uniform nor as dramatic as those of the first oil shock. At the same time, the 1970s witnessed the growth of joint venture activities and various forms of non-equity foreign investments by multinational enterprises (Stopford and Dunning, 1983).

According to John et al. (1997), the 1980s witnessed a large increase in worldwide FDI due to mergers and acquisitions. Official data published by home and host countries and international agencies show that the value of the stock of FDI by MNEs in 1980 was some 89% greater than in 1975. The total value had grown to four times the value in 1967 and was nearly eight times greater than in 1960. The relative weight of exports in the sourcing of foreign markets declined in favour of direct sales by foreign affiliates. In the late 1980s, direct sales by foreign affiliates overtook sales through exports (Stopford, and Dunning, 1983). FDI had an increasing weight in relation to the capital formation for the world as a whole and for major areas and countries. Though there was a considerable increase between the early and late 1980s with stability and some decline in the 1990s the high FDI did not necessarily correspond to increased productive capacity in the host country (John et al., 1997).

According to Daniels and Lever (1996), the economy became knowledge-based and globalized in the 1990s. While levels of international trade in goods have risen steadily, there has been a much more rapid growth in services, especially in financial services. By the mid-1990s, the trade in financial instruments dominated the trade in material goods globally. The developed countries were responsible for most of the outward FDI, which was well over 85% although there was a declining trend. On the inward side, one of the most remarkable changes that took place during the course of this century was the shift in the shares of FDI that went to developed and developing countries. The share in the stock of inward FDI into developing countries had been reduced from about 63% in the beginning of the 20th century to 25.2% in 1994. Therefore developed countries are not only responsible for the largest share of outward FDI but are also the main recipients for FDI as they experience a cross flow of investments, e.g. the UK and the USA (John et al., 1997 and also Ietto-Gillies, 2005). The developing countries also experienced a considerable increase in FDI in the 1990s which was due to two factors: The effect of privatization programs especially in Central and Eastern Europe and the so-called 'China' effect meaning that China experienced an enormous growth in inward flows in the middle of the 1990s while FDI had considerable effects on China's trade and exports (John et al., 1997).

A major geographical development in the middle of the 1990s was the tendency for the formation of regional clusters of integration in the terms of both FDI and trade. There were only three major regions where the international flows tended to conglomerate: The USA, Japan and the European Union. This triad as a whole was responsible for over 80% of the outward stock of FDI and around 60% of the inward stock by 1995 (Daniels and Lever 1996).

There have also been sectoral changes in FDI flows during the last century. According to Krugman, P. and Obstfeld, M.(2003) the main objective of FDI before WW II was resource seeking with a view to secure raw material supplies through internalization in a process of backwards vertical integration. Therefore, FDI tended to be directed towards developing countries which often were colonies or former colonies of the investing developed countries. After WW II, FDI shifted from resources to an efficiency-seeking objective. Since the mid-1970s, however, modern economies have increasingly focused on the production of services rather than physical goods. With the creation of the World Trade Organization (WTO) in 1995, services were included within the purpose of the WTO which serves as a basis for negotiating future trade rounds.

The relevance of the primary sector has declined considerably for the industrialized countries, but its share in less developed countries has remained fairly steady at just over 20%. The move towards manufacturing and services is accompanied by increased research intensity. As technology is becoming more global, research and development (R&D) laboratories are being spread in more offshore facilities resulting in worldwide R&D networks between MNEs, supplier, universities and states. John, R (1997) point out, that it is often applied research that is located in foreign affiliates rather than basic research which remains so far fairly centralized. As developed countries depend more and more on the so-called intellectual property instead of physical capital, the WTO tries to handle this issue with its Agreement on Trade-Related Aspects of Intellectual Property.

These historical developments influenced the development of FDI theories within their specific time period and have to be kept in mind when discussing these approaches in respect to Offshoring and Backshoring activities.

2.2.2. Classical and Neoclassical approaches

The classical Trade Theories of absolute and comparative advantage, developed by Adam Smith (1789) and David Ricardo (1817) only provide very limited contribution to the explanation and emergence of FDI as both considered the immobility of production factors labour and capital. The later developed neo classical approach of Hecksher and Ohlin in the 1920s assumed the mobility of production factors within each country but not between countries. According to Hecksher and Ohlin, the differences in relative cost emerge from differences in the relative amounts of production factors especially labour and capital with which the countries are endowed rather than on productivity differences as stated by Smith and Ricardo. Due to the immobility restriction of factors in both approaches these theories rather explain international trade e.g. exports rather than foreign direct investments.

Though Ohlin in 1933 referred to “The mechanism of international capital movements ” his view is limited to portfolio investment and no distinction is made towards direct investment. In Ohlin’s view the movement of capital take place through reparations or gifts from a borrowing to a capital importing country. According to Hymer (1976) and Grimwade (2000), this is an indication that capital movements for Ohlin are not directly linked to production activities. Nurske (1933) and Iversen (1935) approaches are also based on the neoclassical assumptions but are also limited to portfolio investment rather than direct investment. For Nurske and Iversen, capital movement takes place due to interest rate differentials. Iversen (1935) in this respect points out, that ‘foreign investment involves higher risk than domestic investments. Thus lenders expect higher interest abroad more than at home.

Corden (1974) and Hirsch (1976) further developed the neoclassical trade theories by underlining assumption of foreign direct investment flows. This approach considered the mobility of production factors and tries to explain why enterprises might prefer or choose foreign direct investment rather than exporting the goods. Hence, a company may choose to export if total export costs are lower than production cost in the foreign country (considering transport as well as the controlling cost of the foreign location). Thus, FDI is considered as a substitute for exports.

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¹ Greg Mankiw, Harvard Professor and Head of the White House Council of Economic Advisors, published in the Economic Report of the President, USA 2004

² The Clash, from their album Combat Rock.(1981)

³ in 2008, the GDP of the UK equaled $ 2,64 trillion (Worldbank, 2009)

⁴ Combined revenues of NACE Code 34 (Manufacture of motor vehicles, trailers and semi-trailers) + 35 (Manufacture of other transport equipment)