“Low-cost country sourcing”, it is perhaps the most provocative topic to hit the procurement field in decades. Some procurement executives are eager to share the amount of savings they've generated from sourcing in low-cost regions like China and India, while others are hesitant to even discuss the topic. It's been called the shortest path to bottom-line savings and it's been called un-American. Even the term applied to the concept (low-cost) has been debated for its emphasis on price over quality while the definition of "low-cost country" is subjective at best.
But no matter the opinion or perspective, one point is clear: If you're going to embark on low-cost country sourcing, you better do it right.
A 2007 report from AMR Research points out that low-cost country sourcing readiness includes "understanding and dealing with the additional risk of cultural differences, currency, time zones, connectivity, distance, logistics constraints, language and political instability. Doing low-cost country sourcing right involves more than just looking at costs and companies must revisit the strategy regularly".
From finding and evaluating overseas suppliers to calculating what their bid really means; from understanding the business culture and its impact on negotiations to managing the risks associated with moving your supply base—there's a lot to consider in low-cost country sourcing.
With this in mind, Purchasing has tapped the minds of some of the most experienced buying professionals to get their advice on low-cost country sourcing, focusing in five areas: Finding suppliers, determining total landed cost, negotiating with suppliers, managing risks, and managing the logistics process.
But no matter the opinion or perspective, one point is clear: If you're going to embark on low-cost country sourcing, you better do it right.
A 2007 report from AMR Research points out that low-cost country sourcing readiness includes "understanding and dealing with the additional risk of cultural differences, currency, time zones, connectivity, distance, logistics constraints, language and political instability. Doing low-cost country sourcing right involves more than just looking at costs and companies must revisit the strategy regularly".
From finding and evaluating overseas suppliers to calculating what their bid really means; from understanding the business culture and its impact on negotiations to managing the risks associated with moving your supply base—there's a lot to consider in low-cost country sourcing.
With this in mind, Purchasing has tapped the minds of some of the most experienced buying professionals to get their advice on low-cost country sourcing, focusing in five areas: Finding suppliers, determining total landed cost, negotiating with suppliers, managing risks, and managing the logistics process.
A) Plan on educating suppliers.
Searching for suppliers in low-cost regions of the world is a challenge to be sure, but there are a few rules of thumb that may help ensure a successful find:
- Look for pre-qualified suppliers that meet a minimum set of requirements.
- Don't expect suppliers to meet specifications exactly. All suppliers located in low-cost regions will need some development work.
After determining that expanding the search for a supplier of a particular component to a low-cost region would be favorable for the company, Jim Jordano, vice president of supply chain management at UTC Fire & Security in Farmington, Conn., and his team look to other United Technologies Corp. sister businesses -Carrier, Otis, Sikorsky, Hamilton Sundstrand, Pratt & Whitney- to learn if supply managers are sourcing similar parts in other countries. "It's a good way to get leads and knowledge of the market," Jordano says. Another source: Suppliers to UTC Fire & Security already doing business in the region.
One low-cost region where the company looks for suppliers is China. Jordano has a team of 23 commodity managers on the ground there whose job is to research the market and come up with potential sources of supply. "They attend trade shows, research the market and pre-qualify suppliers," he says. The evaluation consists of a series of telephone interviews and site visits.
It's rare for the team to locate a supplier that exactly meets UTC Fire & Security needs. These include quality, environmental health and safety, management capability and product knowledge. "Working on that assumption, we try to determine the level of development needed during our assessment," says Jordano.
And that is the heart of the matter. "The farther away the supplier is from the supplier we need them to be, the more difficult and lengthy the development process is going to be," he says. "Based on the investment needed, we have to determine whether the decision still makes economic sense." UTC businesses that identify potential suppliers in low-cost regions have corporate responsibility to develop the supplier to the company's rigorous standards, he adds.
B) Watch for hidden costs.
For Mark Thompson, sourcing manager at Des Moines, Iowa-based Pioneer Hi-Bred International, a biochemical company specializing in plant genetics, finding the total landed cost of the commodities he sources in China involved a bit of trial and error. At his previous job, Thompson and his team decided to source candles from China, they got nearly 50% savings even when they took extra freight and inventory costs into consideration. Overall they were able to save nearly $30,000 per container just by outsourcing to China. But when Thompson joined Pioneer and began outsourcing packaging and chemicals, he wasn't getting the same savings. "We were in situations where we brought in product, and after we realized how much we were throwing away, we had to add 6% more to the price," he says. Even though Thompson accounted for quality control costs, the defective products had a much more variable downstream impact than he'd anticipated.
Most guides to determining total cost remind buyers to keep in mind extra freight, inventory, insurance and documentation fees, costs that are simply part of doing business abroad and largely unavoidable. As Thompson and his team found out though, some unexpected costs from defective goods that slip by quality control can crop up much further down the supply chain. He says that buyers can avoid such surprises and maintain a cost-competitive offshore source by not cutting corners and maintaining good sourcing practices, like taking the time to visit a supplier and check their quality controls.
"My thought is if your savings are going to be greater than $10,000, that's going to pay for your trip right there," says Thompson. "You can burn yourself in thinking you have a good supplier without visiting them, it's your product, I would want to see how it's being made."
Another strategy Thompson employed was to negotiate a freight deal with his suppliers. Instead of making the supplier ship products from the plant all the way to the U.S., they were only responsible for getting the product to a port in Hong Kong. Consequently, turnaround time from supplier to port was reduced from up to seven days down to just one or two. On top of that, since the supplier didn't have to ship all the way to the U.S., Thompson was able to negotiate a better price for the product.
C) Be flexible in negotiations
Perhaps more than any other area of procurement, buyers negotiating with suppliers in low-cost regions can benefit from the experience of (and even the mistakes made by) others in their field. So rule number one is benchmark. Ask your peers what techniques work best in which regions and markets.
And rule number two: be flexible. Adapting your negotiation style and technique to suit the supplier's regional business culture can make all the difference.
David Harrison has a wide array of experience in doing business with suppliers in various markets. As director of global sourcing at Atlanta-based aluminum firm Novelis, Harrison says that there are some very subtle, but distinct negotiating strategies specific to certain regions that could be the difference between starting negotiations off on the right foot and ending them abruptly.
Harrison points out that when negotiating with suppliers in Dubai, for example, it's best to start slow and not state your immediate goals at the outset. "Just be friendly and kind, and open with them and work to understand their business prior to getting to your issue," Harrison says. "It's best not to take a direct approach. Be prepared for several meetings and have patience."
The indirect approach also works well in India, Harrison says, where politeness in business dealings is valued especially.
As with many regions, suppliers in Hungary and the Czech Republic like to take a more social approach to negotiations. "Small talk is very important in these regions," Harrison points out. "The typical American approach is often considered too direct at first. You have to help them get to your goals, but when the time comes be prepared to explain your needs clearly."
Where does the direct approach work best? Russia, where Harrison says it is best to state your goals up front and take a firm, but polite stand in negotiating. "They need to know you are in control of your business."
D) Dual source everything
"Managing risks when sourcing in low-cost countries is a lot like managing risks when sourcing from companies locally," says IBM CPO John Paterson. "It's just a little bit more complicated". OK, maybe a lot more complicated.
For example, says Paterson, beyond the usual concerns about supplier financial stability, capability and capacity, there are the possibilities of natural disasters in certain parts of the world. The Pacific Basin, for one, is particularly susceptible to earthquakes and tsunamis such as the one that occurred in Indonesia in July 2006. The Pacific Basin includes such countries as Australia, Thailand, Malaysia and India.
But it's not just natural disasters that can pose risks in those countries. "There are also geopolitical risks to watch," says Paterson. Some countries that are increasingly popular sourcing areas go through periodic bouts of political instability. Thailand, where Armonk, N.Y.-based IBM and other companies source electronics, underwent a coup in September 2006, and there were questions last month of whether a newly elected parliament would be allowed to convene.
All those factors can play a part in supply continuity, Paterson says, so managers have to make sure they consider all of them in their sourcing strategies. Best tactic, he advises: Develop dual sources, and have alternative sources in different parts of the world. Doing so increases the likelihood that manufacturers will be able to get the parts and materials they need if their primary sources in other low-cost countries can't deliver.
Dual sourcing can also help lessen the impact that can come from doing business with companies that have a reckless disregard for the environment or for the welfare of their own employees. Stockholders and customers who are very concerned with corporate social responsibility get unhappy with manufacturers who do business with suppliers with a poor environmental or employee-welfare record.
And, dual sourcing can also help avoid disruptions when suppliers deliver poor-quality parts. For that problem, however, manufacturers need a long-term strategy for building a more educated supply-management infrastructure. Says M. Eric Johnson, a management professor at Dartmouth College's Tuck School of Business in Hanover, N.H.: "Manufacturers should be investing in suppliers to get them up to Western standards on management practices and to get them to work with their own suppliers" to identify and eliminate risks.
E) Check the logistics infrastructure
In some ways logistics in China is easier than 10 years ago and in other ways it is still challenging, says Anthony Rakoczy, vice president, commodity management for Toronto-based Celestica.
"It is easier because it is more open and transparent," he says. "In addition, China has made it easier for the multinational logistics providers to come in. Also local domestic and indigenous providers are getting better, which is resulting in competition in the market as well," Rakoczy says.
He adds there is less red tape and bureaucracy than in the past with logistics and the infrastructure has improved greatly.
"In China the mapmakers can't keep up with the road builders," says Rakoczy, who is based in Hong Kong. "I often use a compass rather than a map because that's how quickly the infrastructure is being built up," he jokes.
He says it used to take three to four hours to go from Shanghai to Suzhou. Now there is a superhighway and it takes 15 minutes.
However, much of the improvements both in infrastructure and with the number of logistics providers are confined to coastal areas. Logistics is more difficult in the interior of China.
"Looking forward, the interior infrastructure will need to be improved because more manufacturing will head to the interior to take advantage of lower labor costs," says Rakoczy. That will mean roads, rails and airports will have to be improved, he says.
Rakoczy says logistics in India is another story. "India is more bureaucratic and there are tariffs for inbound goods and higher hurdles to import," he says. "That's why most companies produce in country for the in-country market."
One reason India is more bureaucratic is that it isn't really one country from a logistics point of view. "It is multiple districts that have their own way of handling logistics and their own infrastructure," Rakoczy says. "It is overall less developed and it may be the way China was 10 years ago."
By Staff -- Purchasing, 2/14/2008
Searching for suppliers in low-cost regions of the world is a challenge to be sure, but there are a few rules of thumb that may help ensure a successful find:
- Look for pre-qualified suppliers that meet a minimum set of requirements.
- Don't expect suppliers to meet specifications exactly. All suppliers located in low-cost regions will need some development work.
After determining that expanding the search for a supplier of a particular component to a low-cost region would be favorable for the company, Jim Jordano, vice president of supply chain management at UTC Fire & Security in Farmington, Conn., and his team look to other United Technologies Corp. sister businesses -Carrier, Otis, Sikorsky, Hamilton Sundstrand, Pratt & Whitney- to learn if supply managers are sourcing similar parts in other countries. "It's a good way to get leads and knowledge of the market," Jordano says. Another source: Suppliers to UTC Fire & Security already doing business in the region.
One low-cost region where the company looks for suppliers is China. Jordano has a team of 23 commodity managers on the ground there whose job is to research the market and come up with potential sources of supply. "They attend trade shows, research the market and pre-qualify suppliers," he says. The evaluation consists of a series of telephone interviews and site visits.
It's rare for the team to locate a supplier that exactly meets UTC Fire & Security needs. These include quality, environmental health and safety, management capability and product knowledge. "Working on that assumption, we try to determine the level of development needed during our assessment," says Jordano.
And that is the heart of the matter. "The farther away the supplier is from the supplier we need them to be, the more difficult and lengthy the development process is going to be," he says. "Based on the investment needed, we have to determine whether the decision still makes economic sense." UTC businesses that identify potential suppliers in low-cost regions have corporate responsibility to develop the supplier to the company's rigorous standards, he adds.
B) Watch for hidden costs.
For Mark Thompson, sourcing manager at Des Moines, Iowa-based Pioneer Hi-Bred International, a biochemical company specializing in plant genetics, finding the total landed cost of the commodities he sources in China involved a bit of trial and error. At his previous job, Thompson and his team decided to source candles from China, they got nearly 50% savings even when they took extra freight and inventory costs into consideration. Overall they were able to save nearly $30,000 per container just by outsourcing to China. But when Thompson joined Pioneer and began outsourcing packaging and chemicals, he wasn't getting the same savings. "We were in situations where we brought in product, and after we realized how much we were throwing away, we had to add 6% more to the price," he says. Even though Thompson accounted for quality control costs, the defective products had a much more variable downstream impact than he'd anticipated.
Most guides to determining total cost remind buyers to keep in mind extra freight, inventory, insurance and documentation fees, costs that are simply part of doing business abroad and largely unavoidable. As Thompson and his team found out though, some unexpected costs from defective goods that slip by quality control can crop up much further down the supply chain. He says that buyers can avoid such surprises and maintain a cost-competitive offshore source by not cutting corners and maintaining good sourcing practices, like taking the time to visit a supplier and check their quality controls.
"My thought is if your savings are going to be greater than $10,000, that's going to pay for your trip right there," says Thompson. "You can burn yourself in thinking you have a good supplier without visiting them, it's your product, I would want to see how it's being made."
Another strategy Thompson employed was to negotiate a freight deal with his suppliers. Instead of making the supplier ship products from the plant all the way to the U.S., they were only responsible for getting the product to a port in Hong Kong. Consequently, turnaround time from supplier to port was reduced from up to seven days down to just one or two. On top of that, since the supplier didn't have to ship all the way to the U.S., Thompson was able to negotiate a better price for the product.
C) Be flexible in negotiations
Perhaps more than any other area of procurement, buyers negotiating with suppliers in low-cost regions can benefit from the experience of (and even the mistakes made by) others in their field. So rule number one is benchmark. Ask your peers what techniques work best in which regions and markets.
And rule number two: be flexible. Adapting your negotiation style and technique to suit the supplier's regional business culture can make all the difference.
David Harrison has a wide array of experience in doing business with suppliers in various markets. As director of global sourcing at Atlanta-based aluminum firm Novelis, Harrison says that there are some very subtle, but distinct negotiating strategies specific to certain regions that could be the difference between starting negotiations off on the right foot and ending them abruptly.
Harrison points out that when negotiating with suppliers in Dubai, for example, it's best to start slow and not state your immediate goals at the outset. "Just be friendly and kind, and open with them and work to understand their business prior to getting to your issue," Harrison says. "It's best not to take a direct approach. Be prepared for several meetings and have patience."
The indirect approach also works well in India, Harrison says, where politeness in business dealings is valued especially.
As with many regions, suppliers in Hungary and the Czech Republic like to take a more social approach to negotiations. "Small talk is very important in these regions," Harrison points out. "The typical American approach is often considered too direct at first. You have to help them get to your goals, but when the time comes be prepared to explain your needs clearly."
Where does the direct approach work best? Russia, where Harrison says it is best to state your goals up front and take a firm, but polite stand in negotiating. "They need to know you are in control of your business."
D) Dual source everything
"Managing risks when sourcing in low-cost countries is a lot like managing risks when sourcing from companies locally," says IBM CPO John Paterson. "It's just a little bit more complicated". OK, maybe a lot more complicated.
For example, says Paterson, beyond the usual concerns about supplier financial stability, capability and capacity, there are the possibilities of natural disasters in certain parts of the world. The Pacific Basin, for one, is particularly susceptible to earthquakes and tsunamis such as the one that occurred in Indonesia in July 2006. The Pacific Basin includes such countries as Australia, Thailand, Malaysia and India.
But it's not just natural disasters that can pose risks in those countries. "There are also geopolitical risks to watch," says Paterson. Some countries that are increasingly popular sourcing areas go through periodic bouts of political instability. Thailand, where Armonk, N.Y.-based IBM and other companies source electronics, underwent a coup in September 2006, and there were questions last month of whether a newly elected parliament would be allowed to convene.
All those factors can play a part in supply continuity, Paterson says, so managers have to make sure they consider all of them in their sourcing strategies. Best tactic, he advises: Develop dual sources, and have alternative sources in different parts of the world. Doing so increases the likelihood that manufacturers will be able to get the parts and materials they need if their primary sources in other low-cost countries can't deliver.
Dual sourcing can also help lessen the impact that can come from doing business with companies that have a reckless disregard for the environment or for the welfare of their own employees. Stockholders and customers who are very concerned with corporate social responsibility get unhappy with manufacturers who do business with suppliers with a poor environmental or employee-welfare record.
And, dual sourcing can also help avoid disruptions when suppliers deliver poor-quality parts. For that problem, however, manufacturers need a long-term strategy for building a more educated supply-management infrastructure. Says M. Eric Johnson, a management professor at Dartmouth College's Tuck School of Business in Hanover, N.H.: "Manufacturers should be investing in suppliers to get them up to Western standards on management practices and to get them to work with their own suppliers" to identify and eliminate risks.
E) Check the logistics infrastructure
In some ways logistics in China is easier than 10 years ago and in other ways it is still challenging, says Anthony Rakoczy, vice president, commodity management for Toronto-based Celestica.
"It is easier because it is more open and transparent," he says. "In addition, China has made it easier for the multinational logistics providers to come in. Also local domestic and indigenous providers are getting better, which is resulting in competition in the market as well," Rakoczy says.
He adds there is less red tape and bureaucracy than in the past with logistics and the infrastructure has improved greatly.
"In China the mapmakers can't keep up with the road builders," says Rakoczy, who is based in Hong Kong. "I often use a compass rather than a map because that's how quickly the infrastructure is being built up," he jokes.
He says it used to take three to four hours to go from Shanghai to Suzhou. Now there is a superhighway and it takes 15 minutes.
However, much of the improvements both in infrastructure and with the number of logistics providers are confined to coastal areas. Logistics is more difficult in the interior of China.
"Looking forward, the interior infrastructure will need to be improved because more manufacturing will head to the interior to take advantage of lower labor costs," says Rakoczy. That will mean roads, rails and airports will have to be improved, he says.
Rakoczy says logistics in India is another story. "India is more bureaucratic and there are tariffs for inbound goods and higher hurdles to import," he says. "That's why most companies produce in country for the in-country market."
One reason India is more bureaucratic is that it isn't really one country from a logistics point of view. "It is multiple districts that have their own way of handling logistics and their own infrastructure," Rakoczy says. "It is overall less developed and it may be the way China was 10 years ago."
By Staff -- Purchasing, 2/14/2008
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