Low Cost Country Sourcing

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Low Cost Country Sourcing:
Driving through the steps required for success



Working with a supplier is somewhat like finding a spouse: choosing “the right one for you” is very important but learning the “rules of the household” and adapting those rules is often times as important if not more important. The process of finding, qualifying and solidifying the right global supplier relationships for your organization can help ensure a more robust supply chain. We have been tracking our client interest in Low Cost Country Sourcing (LCCS) and have found that among our industrial manufacturing clients in particular, over 50% have an interest in expanding their global supply base as a competitive advantage. In fact, most of our clients have some foreign suppliers today. However, many have not gone through a rigorous competitive process in selecting those suppliers and fewer still have optimized their extended/stretched supply chains. The relationships developed to date have been characterized as “one off.” Particularly, mid-tier industrial manufacturers have not yet begun to systematically manage the global supply chain. In some cases, these clients have allowed their suppliers’ U.S. subsidiaries to support the logistics around ordering from overseas locations. We believe that clients that develop the ability to more actively select and manage global suppliers will garner a competitive advantage in the short term and maintain competitive parity in the medium term.

Global Competency Centers

While China has been quite heavily profiled in the media recently, in fact off-shore customers and supplier are quite literally in every market as the Aberdeen research from March 2005 demonstrates below:

While it is true that some parts of the world offer lower average costs of supply than others, in general there has been significant research already done on “competency centers” around the globe (Silicon Valley, Motor City, Mumbai (Call Centers), Paris (Fashion)). While this research is well known, often commodity managers do not invest adequate time in finding similar less-well-known competency centers for their “buys”.

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Organizations need to find a “better supplier” not necessarily a “cheaper supplier.” Therefore, organizations should carefully examine location-specific competency centers and developing competency centers to meet the needs of your procurement organization. For example, did you know that Italy is the world-leader in winches for crane manufacturers? Hungry is a global leader of industrial planetary gearboxes? Procurement professionals need to have a better grasp on the global market for their commodities as well as related commodities. We recently supported a client conducting a “global competency center” exploration for their industrial supply base and found that Chinese suppliers are in very general terms, excellent complex assembly suppliers. Highly engineered product machining suppliers are often found in Eastern Europe. In fact, even if you can’t find a quality supplier for your particular application, these competency centers may well be better suited to adapt to your specification needs than other “low regional cost” suppliers simply because of the intense nature of the local competition in that particular niche.

Supplier Identification

We had one client that summed up his frustration by stating “I don’t know Chinese. I don’t know who I would select or how I would find low cost suppliers in other parts of the world.”

While we have found that internet and trade magazine research can significantly improve an organization’s ability to find alternative suppliers, often experience and existing contacts within the suppliers’ organization is far more valuable. Partnering with consultancies that have experience in China or have a presence in China often expands the list of potential suppliers as well as provides a basis for qualifying those suppliers.

Supplier Qualification

Qualifying suppliers requires the following critical capabilities regardless of where the supplier is located:

  1. The formulation of a robust set of questions that include historical, financial, operational, service, and reference information that paints a picture of the supplier’s ability to meet your current and future needs.
  2. Provide a representative sample of your buy to the suppliers for quotation. Request pricing based on varying assumptions. Gather as much price information as possible within the framework of still selling your business and the future opportunity to supply you.
  3. The “sell” of your organization’s potential business to the potential supplier. Often buyers forget that sourcing is a two-way street. Without adequate selling of the “wonders” of working with you (financially stable, pay on time, growing, easy to supply, etc), suppliers will not invest adequate resources in responding to your request for information. On this front, we have found most industrial manufacturers do not adequately sell their business to suppliers. Also note the issue of balance in information gathering: you want a robust set of information on both pricing and a variety of other dimensions without being overly burdensome to the supplier. If your RFQ is too painful, then your supplier may incorrectly (or correctly) realize that you are not going to be the “dream account.”
  4. Having the right supplier resource respond to the request for information. It is the job of the willing and interested buyer to seek out the right resource within the supplier to complete your RFI. Without the right due diligence, a buyer may find that a more junior resource within the supply organization is “hoarding” this great sales opportunity and may not be creative enough or have the authority to offer the deal that would be best for your organization.
  5. Check references and visit supplier facilities. Have more than just your procurement organization evaluate the suppliers. Cross-functional teams interacting with cross-functional supplier teams will yield not only the best choice for your firm but also drive greater acceptance of the selection process within your firm and adoption of the chosen suppliers.

In summary, qualifying suppliers requires the same fundamentals regardless of the supplier location. For overseas suppliers that may not know your company, you may need to invest even more time in selling your organization, supporting their questions, possibly investing in translation services or a consultant to support coaxing the supplier through the process in their native language.

Establishing a Global Supply Chain

According to John Ferreira, Industrial Manufacturing practice leader at Archstone Consulting, “Approximately 50% of the manufacturing clients we have talked with have already entered into a number of foreign sourcing relationships, and as such are not looking to determine where they should source, but rather they are looking for insight into “How do I best manage this extended network?”

Organizations seeking lower-cost supply markets need to fully understand that in doing so, your supply chain logistics requirement just increased exponentially. Using local freight carriers, freight forwarders, consolidators, port expediters, third-party international filing support, warehousing and domestic transportation providers add complexity. Organizations need to fully account for these incremental external costs in selecting international suppliers. Similarly, there are a number of supply chain flexibility and reactionary capabilities that can be compromised by having longer supply chains. Kanban-oriented plant shop-floors often have difficulty transitioning to suppliers that can’t easily fill cards in 3-7 days. (Local warehousing needed). Expediting parts becomes a significantly more expensive proposition. Long-awaited investments in improved demand planning suddenly become prerequisites. If you believe the hurdles of low-cost country sourcing are too high, chances are that the hurdles are yours. Establishing an extended supply chain requires significant architectural, planning and negotiating skills. Organizations need to have the ability to establish solid working relationships, plan in detail how this will work, and then make future commitments with the suppliers. It is much like designing a global shop floor.

Managing Extended Supply Chain Delivery Delays

Clients that have international supply chains often experience delays in getting products to their customers. Significant variability, predictability and visibility of supply are often the root causes of these customer fulfillment delays. The underlying factors that contribute to the supply problems include:

Process Variability

  • Transit and customs delays
  • Inconsistent delivery cycle times

Freight Market Transportation Issues

  • Increased congestion at ports
  • Inadequate number of dock workers
  • Increased homeland security
  • Limited container space
  • Trucker shortage
  • Congestion at major rail hubs

Your own supply chain inadequacies

  • Limited visibility of inbound shipments from Far East operations
  • “Just in time” inventory controls
  • Weak SLA’s in supplier or logistics contracts
  • Inability to plan accurately over the transportation lead time

Note that shipping delays and various network inefficiencies will more seriously affect highly seasonal sales concentrated industries, such as consumer electronics and other industrial and consumer products. This can lead to significant revenue losses at key times. According to a Logistics Management survey conducted in late November 2004, thirty eight (38%) of all shippers reported that they will lose some 4th quarter sales. Some industries have unique drivers behind this problem such as: overstocking of distributors, heavily concentrated customer base, minimal volume third-party manufacturing relationships, margins that dictate inventory and distribution cost management, or shrinking product lifecycles.

Order Management

With a stable extended supply chain comes the realization that “I have traded one set of problems (lack of cost competitiveness) for another, potentially more difficult problem” – the inability to vary customer responsiveness in the new environment. The real on-going “hang-over-like” problem in global sourcing is managing the supply network to meet changing customer needs in a market-beating, timely manner.

Questions we hear are:

  • What are the best practices I should be deploying to manage this network and what organizational structure do I need to support it?
  • How do I gain order visibility and inventory-tracking across the network?
  • How do I coordinate my network of partners and keep demand and supply synchronized efficiently? How do I change my order fulfillment priorities across this network?
  • How do I manage the network efficiently without adding inventory at every node?
  • What leading indicator metrics should I be monitoring to foresee network problems?

The anecdotal evidence heard from our clients is supported in a number of research studies including the following from the Aberdeen Group which asked participants to rate which factors garnered the highest “pressure rating” (“very influential”):

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Buyers with domestic suppliers have a false sense of empowerment when it comes to ordering goods from suppliers. Delays and other problems are often blamed on suppliers. Expediting can cover many “sins” internal to the buying, planning functions. All of those buyer short-comings suddenly become much more obvious in an extended supply chain environment.

With an extended supply chain, order-fulfillment lead time variability has increased dramatically. Supply certainty has dropped significantly. Expediting options are limited. Engineering change requests now require more planning as a buying organization may have at least 30-60 days of current specified materials in transit. In some cases, even the basics of tracking shipments can require multiple phone calls per order.

Some organizations have begun to creatively restructure their supply chain to eliminate non-value added steps or allow other value chain partners to manage portions of the supply chain more effectively than themselves. Several mitigating strategies include:

  • Redesigning the distribution network and ownership of network
  • Complete finishing / packaging of product on-shore – importing modules
  • Implement direct ship programs with larger retailers
  • Trade inventory for a “Common Information Model” to ensure that all supply chain participants are speaking the same language
  • Provide earlier notification to freight forwarder regarding readiness of shipment
  • Use an architecture-driven approach to technology that delivers seamless integration and rapid, flexible, and repeatable deployment to all trading partners

The warning: Organizations need to have significant demand planning, plant scheduling and materials management competencies prior to seeking low-cost international suppliers. If you don’t, the big night of celebration following the low-cost supplier deal team’s “big win” will become the hangover of order management that doesn’t go away with water, coffee and sleep.

Is it worth it?

Today, low cost country sourcing has shown an exceptionally high ROI for our clients. We are finding costs in certain industrial manufacturing supply bases that are 30-70% lower than the equivalent U.S. supply base. These cost reductions are across a surprisingly broad range of categories of spend – from labor intensive wire harness type activities to more heavily engineered machined components such as hydraulic cylinders.

However, will this price differentiation last forever? It won’t. For one, currency fluctuations could rapidly diminish the cost advantage incurred by lower-cost countries. For example, China is considering letting its currency float and if they do the cost advantage will deteriorate. Secondly, over a longer period of time, as competitors build out a more global supply base similar to yours, the competitive advantage will naturally deteriorate. Plus, as low-cost economies continue to mature, wages and the resulting costs will increase as well so that the cost advantage will eventually deteriorate. We foresee a time in the not-so-distant future when Shanghai will not be considered a low-cost location and, in fact, it is already not considered low cost for the apparel industry which has migrated to other less developed economies such as Vietnam and Indonesia. Much like one does not consider businesses in New York City to be “low-cost”, lower cost will be sought in increasingly remote locations of the world.

Given that the price advantage won’t probably last over the long-term (10-20 years) and may diminish over the short to medium term (3-10 years), does it still make sense to go through all the work? Yes. Cost savings garnered today can be invested in new product design, increased marketing and a variety of other brand/enterprise building initiatives that will ultimately lead to further competitive advantage over the non-acting market participants. Furthermore, as “piece-price savings” associated with LCCS diminish, there could be “total cost of ownership” enhancements from more developed countries that lead your organization to stop chasing the lowest piece price cost and start investing in developing the lowest total supply chain costs. With the proper investment in supporting operations processes, low cost country sourcing is not just an option, it is a requirement for competition.

About Archstone Consulting

Founded by consulting industry veterans, Archstone Consulting is a rapidly growing, independent strategy and operations management consultancy, specializing in operational transformations to help fund growth in the consumer packaged goods and retail, life sciences, manufacturing, and services sectors. Archstone Consulting offers unbiased advice, efficient execution and measurable results. Key areas include: strategic sourcing, procurement, low cost country sourcing, gray market, piracy and more. Combining deep vertical expertise with proven functional skills, the firm designs and implements organizational improvements through CFO advisory services, strategic initiatives, and operational improvement services. Design and delivery of sustainable results are the foundation of Archstone Consulting projects. Contact: Bob Derocher at 203.940.8220 or rderocher@archstoneconsulting.com.

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