Int. J.

Production Economics 58 (1999) 81—92

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 (MNC’s) 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 MNC’s 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 facility. In the ensuing process of production plann-

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-
hamed@wku.edu.
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 determining
which 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
PII: S 0 9 2 5 - 5 2 7 3 ( 9 8 ) 0 0 0 8 0 - 2
82 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92
significance of inflation rates on the firm’s 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 the
effects 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 supranational
corporation [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 world’s largest entities is enormous.
The 500 largest industrial corporations account for
80% of the world’s 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 world’s 14 richest countries. There are
a total of 37 000 globally operating companies
which 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 knowledge
and 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 firm’s competitive strategy. Globalization
means moving production facilities around to be-
nefit from the quickest brains or the cheapest labor
 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92
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 research
from 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 the
conditions 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
83
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 model
development 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 these
decisions 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
( j’s) in any facility f in 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
84 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92

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,
¹ set of time periods +1, 2, 2, t, 2, ¹,
D demand for product j in period t for market M
HKR
R revenue/unit of product j in market m
HK
C manufacturing cost/unit of product j in facility f
HD
C unit capacity retaining cost of facility f in period t
DR
S unit shipping cost from facility f to market m
DK
h unit inventory holding cost of product j in facility f in period t
HDR
º unit capacity changing cost in facility f
D
E exchange rate of currency of host country in period t
DR
p unit processing time of product j in US
H
e efficiency of facility f in producing product j compared to US
HD
Decision variables
CAP capacity of facility f in period t
DR
CAPCHNGCOST capacity changing cost of facility f in period t
DR
CAPRETCOST capacity retaining cost of facility f in period t
DR
MDCOST manufacturing and distributing cost of facility f in period t
DR
Q quantity of product j produced in facility f in period t
HDR
Q quantity of product j shipped from facility f to market m in period t
HDKR
I ending inventory of product j in facility f in period t
HDR
IHCOST inventory holding cost of facility of f in period t
DR

is captured by the input variable e .
HD
(1/e )p Q ) CAP ∀f, t (1)
HD H HDR DR
H CAPCHNGCOST
The nonzero and zero values for the decision vari-
able CAP indicate the existence and closures of
DR
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.
DR
"(1/E )"CAP !CAP " º ∀f, t. (2)
DR DR DR\ D
The above linear function is assumed based on
how 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.
 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92 85

3.3. Capacity retainment cost 3.7. Exchange rate function

This includes labor cost (salaries), machine main- The exchange rate is a random variable. The
tenance cost, and other costs related directly to the difficulty economists have had in finding an empir-
capacity, i.e. ically successful exchange rate theory is well
documented [18—20]. Nonetheless, a firm has to
CAPRETCOST "(1/E ) CAP C ∀f, t. (3)
DR DR DR DR forecast what it would be in the future to make
decisions. We will use the following linear function
for the exchange rate.
3.4. Manufacturing and distribution cost
E "(1#a t)E ∀f, (8)
DR D D
In any given period t, the manufacturing and where E is the base exchange rate and a is the
distributing cost to the markets the facility f caters D D
forecast coefficient for the exchange rate. A similar
to is: linear model has been developed by Harvey and
Quinn [21]. Their empirical model is based on the
DR
H


MDCOST "(1/E ) C Q # S Q
DR HD HDR
H K
DK HDKR  premise that the exchange rates are a function of
expectations. They used regression analysis on the
∀f, t. (4) data obtained from expectations surveys published
by Money Market Services International and noon
We assume that the distributing cost will be incur- buying rates in New York city reported by the
red by the facility f. The cost is expressed in Federal Reserve Bank of New York. Their linear
$ amount by incorporating the exchange rate E . model has a constant term and the second term
DR
reflects the change in the foreign currency price of the
dollar from one period of time to another (i.e., a time
3.5. Demand satisfaction function). Of course, any other model can be used.

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

3.8. Objective function
each market m has to be satisfied from some or all
facilities, i.e.
The objective is to maximize total profit. Since
the price per unit is constant (in all markets) and
D " Q ∀j, m, t. (5) the demand (of each market) has to be satisfied
HKR HDKR
D (constraint 5), the total revenue (over all markets) is
constant. The total revenue from all markets is
given by the following expression.
3.6. Inventory cost
(1/E )R D .
It is possible for a firm to produce more units of KR HKR HKR
R K H
products in one period and hold them in the inven-
As the total revenue is constant, the total profit
tory to satisfy the demand of the future period(s).
can be maximized by minimizing the total costs
This would incur inventory expense. The following
which include manufacturing and distribution
constraints capture the inventory and its cost ex-
costs, capacity changing costs, capacity retaining
pressed in $.
costs, and inventory costs. Hence, the objective
function is:
I #Q " Q #I ∀j, f, t, (6)
HDR\ HDR HDKR HDR
K Minimize +MDCOST #CAPCHNGCOST
DR DR
IHCOST "(1/E ) I h ∀f, t. (7) R D
DR DR HDR HDR #CAPRETCOST #IHCOST ,.
H DR DR
86 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92

The complete integrated production and distri- 4. Numeric examples

bution model (PDM) is
We demonstrate the usefulness of the model
Minimize +MDCOST #CAPCHNGCOST
DR DR through numeric examples. The following scenario
R D is considered in the examples. Table 2 shows the
#CAPRETCOST #IHCOST ,
DR DR input parameters.
s.t., We consider manufacturing facilities to exist (be
built) in US and India. We assume that the facilities
(1/e )p Q )CAP ∀f, t, (9)
HD H HDR DR make only one type of a product. The market
H demand for the product exists in US, European
CAPCHNGCOST
DR distribution center, and India. The input considers
"(1/E )"CAP !CAP " º ∀f, t, (10) increasing exchange rates for Europe and both in-
DR DR DR\ D creasing and decreasing rates for India. We con-
CAPRETCOST "(1/E )CAP C ∀f, t, (11)
DR DR DR DR sider three planning periods in our examples, and


the length of each planning period is as arbitrary as
MDCOST "(1/E ) C Q # S Q the number of periods in a planning horizon.
DR DR HD HDR DK HDKR
H H K The unit manufacturing time in the US is kept
∀f, t, (12) constant; however, this is different in India so that
each period can reflect the efficiency of operations.
D " Q ∀j, m, t, (13) The efficiency parameter represents the learning
HKR HDKR curve, labor skills, and technology difference. Unit
D
manufacturing cost in the US is kept constant, and
I #Q " Q #I ∀j, f, t, (14) different in India each period. However, unit rev-
HDR\ HDR HDKR HDR
K enue is kept constant in all three markets; but can
be changed to reflect inflation. In addition, the unit
IHCOST "(1/E ) I h ∀f, t, (15)
DR DR HDR HDR capacity retaining cost and unit capacity changing
H cost are kept constant in each period.
E "(1#a t)E ∀f, (16)
DR D D In our analysis, we consider five levels for the
All variables*0, Q’s*0 (integer). (17) initial capacities in both US and India. First,

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
 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92 87

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 as
Level 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 3—9. 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 4—9.
4.1. Common observations
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 also
invariant 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 required
is invariant of the exchange rate direction.

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
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

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.
88 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92

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 000’s.
E means Europe; I & IND means India.

Table 5
Results for increasing exchange rates (stronger $) and capacity Level B

Category Country Period 1 Period 2 Period 3 Total

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

IND $809 593 396 975 378 978 1 585 549
Capacity and utilzn. US 7500/100% 7500/100% 7500/100%
IND 12626/100% 12626/100% 12626/87%
CapCh$ 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
Distribution US E I US E I US E I

US 20 3 27 25 75
IND 11 10 3 8 12 14 8 66
Inventory 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- In the ensuing discussions, comparisons are made
ing total costs are smallest (of all cases) as initial with respect to the results of Level A. If the capaci-
investment in capacity development is not incurred. ties are at Level B, the profit decreases by 40.82%
 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92 89

Table 6
Results for increasing exchange rates (stronger $) and capacity Level D

Category Country Period 1 Period 2 Period 3 Total

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

IND $549 655 283 308 280 136 1 113 99
Capacity and utilzn. US 9300/100% 9300/100% 9300/100%
IND 9183/100% 9183/100% 9183/100%
CapCh$ 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
Distribution US E I US E I US E I

US 20 11 30 1 25 6 93
IND 3 10 7 12 8 8 48
Inventory US
IND 2.3

Total profit"$1 237 159.

Note: The results for Level E are same as above for capacity levels, utilizations, production and distribution, and capacity retaining
costs. Only the total cost is different which is $3 051 599 (due to capacity changing). The profit is $1 607 159.

Table 7
Results for decreasing exchange rates (weaker $) 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 $328 650 344 960 413 180 1 086 789
Capacity and utilzn. US 8350 /100% 8350 /100% 8350 /90%
IND 11000 /100% 11000 /100% 11000 /100%
CapCh$ US — — — —
IND — — — —
Capret$ US $292 250 292 250 292 250 876 750
IND $159 500 165 000 176 000 500 500
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 2.17
IND

Total profits"$2 295 219.

Optimal capacities as resulted from the model.

Quantities in 000’s.
E means Europe; I & IND means India.

($931 201) and total costs increase by 39.17% are at Level C, the profit decreases by 24.6%
($93 201). That is, the total increase in costs is ($561 201) and costs increase by 23.6% ($561 201).
incurred in adding capacity. When the capacities Lower cost is to be expected as lesser capacities are
90 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92

Table 8
Results for decreasing exchange rates (weaker $) and capacity Level B

Category Country Period 1 Period 2 Period 3 Total

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

IND $790 655 471 631 439 197 1 647 484
Capacity and utilzn. US 7500/100% 7500/100% 7500/100%
IND 12626/100% 12626/100% 12626/87%
CapCh$ US $525 000 — — 525 000
IND $404 035 — — 404 035
Capret$ US $262 500 262 500 262 500 787 500
IND $183 078 189 391 202 017 574 486
Distribution US E I US E I US E I

US 20 3 27 25 75
IND 11 10 3 8 12 14 8 66
Inventory US 2
IND

Total profit"$1 359 643.

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 $3 000 666 (due to capacity changing). The profit is $1 729 643.

Table 9
Results for decreasing exchange rates (weaker $) and capacity Level D

Category Country Period 1 Period 2 Period 3 Total

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

IND $557 703 274 743 326 710 1 159 156
Capacity and utilzn. US 9300/100% 9300/100% 9300/100%
IND 9183/100% 9183/100% 8000/100%
CapCh$ 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
Distribution US E I US E I US E I

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

Total profit"$1 262 423.

Note: The results for Level E are same as above for capacity levels, utilizations, production and distribution, and capacity retaining
costs. Only the total cost is different which is $3 097 886 (due to capacity changing). The profit is $1 632 423.

added as compared to Level B. With Level D, the profit decreases by 29.55% ($674 069) and costs
profits decrease by 45.77% ($1 044 069) and costs increase by 28.35% ($674 069). In changing from
increase by 43.91% ($1 044 069). With Level E, the one capacity to level to another level, the observed
 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92
decrease in profits equals the increase in costs
which is incurred because of a need to add
more capacity. Thus, this information will help
MNC’s 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).
91
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. The
effect 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, and
India 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., the
quality 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 period’s 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 total
cost 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].
92 Z.M. Mohamed/Int. J. Production Economics 58 (1999) 81—92
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 the
model 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 & Poor’s 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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