Devising and executing a successful global sourcing strategy may be the most complex analysis a supply chain organization undertakes. And the irony is, the more you learn about it and the keeper you get into a global sourcing strategy, often the more complex it gets. As companies continue to expand their supply bases, they learn—sometimes the hard way—about the hidden cost pitfalls that can send a global sourcing strategy right into the ditch.
With that in mind, Purchasing recently tapped the expertise of several global sourcing experts in various sectors of the supply chain for their thoughts on what hidden cost factors could creep up and undo the savings a global sourcing plan seeks to achieve.
Cost #1: Internal expenses
One of the most difficult costs to uncover in a global sourcing analysis may be the increased internal costs of doing business with suppliers in various overseas markets. While it is sometimes buried in budgets up and down the supply chain, research from the Procurement Strategy Council estimates that the resource intensity of sourcing in unfamiliar markets with unsophisticated suppliers could erode forecasted savings by 4–5%.
Dan Ostrosky, director of global sourcing at aerospace firm Goodrich in Charlotte, N.C., points out that in dealing with suppliers that have different levels of maturity, some suppliers require more help than others. "Developing a smooth flow of product and communication with those suppliers can be a hidden cost," Ostrosky says. "It may involve having more people on the ground there longer or traveling to their location more often, which can be difficult to forecast."
John Brockwell, a supply chain vice president within J.P. Morgan's Global Trade Services unit in New York agrees. "If you need to send quality engineers over to review the supplier's manufacturing or you need to audit that location—sending that team can vary in cost based on where it is and how often you have to send a team there."
Brockwell points out that something as simple as the time differences in working with overseas suppliers can alter the work hours and habits of internal employees, which can increase overtime, reduce productivity or otherwise alter the costs.
And Ostrosky adds that increasing global sourcing requires having the right skillsets on the team, which can increase overall cost structures. For example, the skillsets required to manage a contract manufacturer in Singapore are not the same as those needed to manage a component supplier in the U.S., so depending on the current makeup of your sourcing organization, some new, more costly talent could be required to achieve the benefits of global sourcing. Forecasting and including such cost increases into an overall global sourcing program may impact the breadth or extent of the program's global reach.
Cost #2: Supplier health
The increased risk and associated cost with a supplier bankruptcy is getting more attention in most global sourcing analyses lately. Getting visibility into a supplier's finances in an overseas market is not always as easy as running a Dun & Bradstreet report.
"One of the changes we have made in the past six to nine months has been a deeper look at the financial stability of the suppliers we source from be they in China, India or North America," says Ostrosky. "And therein lies the challenge in assessing the true risk in global sourcing. In doing business with smaller shops in overseas markets, we incur a risk because we can't ascertain their financial state as easily as we could a large, public U.S. company."
Ostrosky also says in the current market, he is taking a closer look at the industries his suppliers at home and abroad are selling into. Goodrich's supply base is also selling into the automotive industry. In the past, that was an advantage because the revenue from the higher-volume automotive business kept suppliers healthy and strong. Today, not so much.
And in some business cultures, supplier companies are not always eager to point out challenges or problems to its customers. The answer, says Ostrosky, is developing a deeper relationship with suppliers so they are more willing to share pertinent information that can help guide your sourcing decisions.
Cost #3: Post-contract lull
While most sourcing teams understand there is a lot of work that needs to be done on the front end of the global sourcing process, there is an associated risk of moving on too quickly to the next sourcing project after a contract is set with a given supplier. Rather than waiting a year to review a contract's cost impact when it's up for renewal, it's wise to monitor the performance of suppliers involved with that contract in the weeks and months after the contract is put in place because various costs can change.
That means more than monitoring the performance of the component or material supplier for cost increases or changes. It means tracking logistics providers' costs and performance as they get up to speed, it means tracking the data from customs brokers to ensure products are flowing smoothing and it means monitoring the impact on inventory levels and costs. If those costs change and it goes unnoticed, it can eat away at your ROI quickly.
"Most companies don't have a good handle on how costs are accruing in the short-term after the contract takes effect," says Greg Johnsen, executive vice president and co-founder of Oakland, Calif.-based GT Nexus, an online global trade and logistics portal.
"There are many things to change in your supply chain based on the right data that can improve top line, bottom line, reduce risk, improve inventory turns, etc." Johnsen says. "We're at the beginning of a different era where people grasp that data they couldn't touch before."
Cost #4: Duty and tariff changes
No global sourcing analysis can be deemed truly comprehensive without a thorough understanding of all of the possible duties, tarriffs and trade agreements that apply to the product now and in the future. A change in one of those of agreements during the life of a contract could dramatically impact the cost and savings on the product being sourced. Typically this requires purchasing work with other parts of the supply chain including finance, treasury or other experts with global trade and compliance knowledge.
When it comes to the costs associated with duties and tariffs, Rajiv Saxena, vice president of supply chain solutions with APL Logistics in Oakland, Calif. says it's difficult to provide a definitive dollar range because there are significant variations from country to country. "There are also variations depending on how product is classified: Is it finished? Unfinished? Partially assembled? Or fully assembled?"
Brockwell says one company he knows of estimated that a given product would be duty-free based on its classification, which was incorrect. When the correct classification was applied—only after the sourcing decision had been made—the product was subject to a 4% duty, which severely cut the benefit of sourcing from that region.
"And other times, we see companies paying a duty on a product but later learn that if they brought the separate components in individually, it would be duty free and reduce the overall costs," he says. "So understanding how your bill of materials may be rearranged to reduce your exposure to duties can impact your global sourcing savings. Typically these duties are not a surprise—it takes months for an anti-dumping duty case to get decided, for example."
Brockwell points out that customs brokers fees, while seen as a necessary step in the global sourcing process, should be tracked to ensure they do not offset the savings targets.
Cost #5: Contract non-compliance
As important as contract compliance is in general, it is even more important with suppliers in overseas markets. Why? Because, as research from the Procurement Strategy Council points out, "supplier identification, qualification, and on-boarding tend to be very resource-intensive in emerging markets, yet typical cost models omit these, accounting only for ongoing management costs."
And when buyers resist buying on or compliance with these contracts, the volume of spend covered by the agreement is diminished, which in turn reduces the overall level of savings achieved.
In short, if the purchasing organization works hard to negotiate a successful global sourcing deal, it needs to be promoted and leveraged to its fullest extent.
Cost #6: True inventory costs
Certainly sourcing from a supplier in an overseas market will likely increase inventory and safety stock levels and their associated costs. But exactly how—and to what level of detail—the inventory cost is analyzed and modeled can have a dramatic impact on the savings achieved by sourcing overseas.
"A lot of companies don't do the full inventory carrying-cost analysis—that cost includes more than just the weighted average cost of capital," says J.P. Morgan's Brockwell. "It's the utilities and taxes to store the goods, scrap and obsolescence. Inventory decisions have to include what you do with the inventory once it gets here. That could mean scrapping 30% of the product you buy in some cases."
APL's Saxena says companies should, to some extent, err on the high end of calculating how much additional inventory will be needed to keep supply chains moving smoothly. "Interest, depreciation, insurance and product obsolescence also need to be factored in," he says. "And higher inventory could require that you increase warehousing space, which also means increasing your need for equipment, warehouse personnel and the costs associated with them."
Brockwell says beyond the physical cost of inventory, there could be a cost associated with how those higher inventory levels and longer supply lines impact your company's ability to react to market trends. For example, if a product's demand spikes or falls, your inventory model may be what allows you to adjust to those trends so you can either capitalize by filling demand for a hot product or avoid writing off millions in unused or obsolete inventory. And that level of risk, if it is so perceived, needs to be included in a financial analysis of a global sourcing strategy.
Cost #7: Logistics volatility
The logistics cost piece of a global sourcing analysis is not as cut-and-dried as it perhaps may seem. Anyone tracking ocean freight rates in the Pacific over the past two years can attest to the increasingly volatile nature of freight rates, for starters. In a lot of ways, forecasting the future logistics costs on a given global sourcing contract is more art than science.
Certainly, the distances goods travel in a global sourcing strategy will be longer than when sourcing domestically and, thus, logistics costs tend to increase. But it goes much deeper than that. The transportation modes and carriers are likely to change and supply lines may become less predictable, which should be considered in a total cost model.
For example, most of the freight from Asia to the U.S. moves via water, and Saxena says given the cost differential between air and water that's not likely to change anytime soon. "However there's no denying that moving to production or suppliers further away increases the likelihood that your company might have to use air freight more often if delivery contingencies arise. That's why I recommend that companies at least allot something in their landed cost calculation for the occasional expedited move. Otherwise they could be setting themselves up for some sticker shock."
Brockwell agrees that while it makes sense to estimate the total cost based on a full container price, there needs to be an estimate of the risk and cost that you may incur by having to ship premium air at times to meet demand or offset long leadtimes. Typically, that includes looking at historical shipping patterns and data to gauge the risk.
Cost #8: Technology
Tracking product flow in a global sourcing model could require new levels of technology in your supply chain, which will increase costs as well. "As a rule, the more miles, modes and players your company's supply chain involves, the more robust its visibility systems will need to be and the more you'll probably have to pay to get those systems," says APL's Saxena. "My recommendation when you're comparing the merits of one venue vs. another is to pay close attention to the kinds of systems you'd need for managing the inventory flow from each. Then put a price tag on those systems and see what the price differential is."
GT Nexus' Johnsen says data collection and its associated technology can have true upside in its impact on a globally sourced product's profitability. "If it's a product that has a high transportation rate component and that transportation cost component is cut in half, the profit on that product increases significantly," he says. "So knowing how those logistics costs impact overall profit margins and changing the sourcing decisions based on those profitability changes can really put supply chain in the position of bringing profitability to the business."
Johnsen says more buyers are including a global supplier or supply chain partner's ability to provide key data in their supplier selection process.
Cost #9: Quality breakdowns
It's no secret that global sourcing in many cases means balancing a planned cost savings with a possible risk of less reliable product quality. Unreliable quality levels in a product or the timeliness of the production from overseas factories may impact profitability as well. On a broad scale, a product recall is very expensive.
But more likely, the cost impact of varying quality will be more subtly buried in your supply chain. For example, Goodrich's Ostrosky points out that when selecting a contract manufacturer for a small or low-cost product, there may be a temptation to use a lower-quality contract manufacturer to improve the profit margin on the product. But if the contract manufacturer's quality affects delivery of the part or increases the number of failures, it could wind up costing more than originally forecasted and wipe out the global sourcing ROI.
While there are clearly many costs—hidden and obvious—to consider in building a successful global sourcing strategy, the majority of experts agree that the benefits are more than plentiful enough to make global sourcing a true cost savings.
In the words of a recent Procurement Strategy Council report: "Traditional models assessing the costs of global sourcing most often consider higher logistics and inventory costs due to longer supply chains, greater management costs to oversee remote and (often) unfamiliar supplier relationships, and higher taxes and duties. While these costs can reduce net savings by roughly half, emerging markets still provide a significant cost advantage of upwards of 25% savings."
By David Hannon -- Purchasing, 3/12/2009
With that in mind, Purchasing recently tapped the expertise of several global sourcing experts in various sectors of the supply chain for their thoughts on what hidden cost factors could creep up and undo the savings a global sourcing plan seeks to achieve.
Cost #1: Internal expenses
One of the most difficult costs to uncover in a global sourcing analysis may be the increased internal costs of doing business with suppliers in various overseas markets. While it is sometimes buried in budgets up and down the supply chain, research from the Procurement Strategy Council estimates that the resource intensity of sourcing in unfamiliar markets with unsophisticated suppliers could erode forecasted savings by 4–5%.
Dan Ostrosky, director of global sourcing at aerospace firm Goodrich in Charlotte, N.C., points out that in dealing with suppliers that have different levels of maturity, some suppliers require more help than others. "Developing a smooth flow of product and communication with those suppliers can be a hidden cost," Ostrosky says. "It may involve having more people on the ground there longer or traveling to their location more often, which can be difficult to forecast."
John Brockwell, a supply chain vice president within J.P. Morgan's Global Trade Services unit in New York agrees. "If you need to send quality engineers over to review the supplier's manufacturing or you need to audit that location—sending that team can vary in cost based on where it is and how often you have to send a team there."
Brockwell points out that something as simple as the time differences in working with overseas suppliers can alter the work hours and habits of internal employees, which can increase overtime, reduce productivity or otherwise alter the costs.
And Ostrosky adds that increasing global sourcing requires having the right skillsets on the team, which can increase overall cost structures. For example, the skillsets required to manage a contract manufacturer in Singapore are not the same as those needed to manage a component supplier in the U.S., so depending on the current makeup of your sourcing organization, some new, more costly talent could be required to achieve the benefits of global sourcing. Forecasting and including such cost increases into an overall global sourcing program may impact the breadth or extent of the program's global reach.
Cost #2: Supplier health
The increased risk and associated cost with a supplier bankruptcy is getting more attention in most global sourcing analyses lately. Getting visibility into a supplier's finances in an overseas market is not always as easy as running a Dun & Bradstreet report.
"One of the changes we have made in the past six to nine months has been a deeper look at the financial stability of the suppliers we source from be they in China, India or North America," says Ostrosky. "And therein lies the challenge in assessing the true risk in global sourcing. In doing business with smaller shops in overseas markets, we incur a risk because we can't ascertain their financial state as easily as we could a large, public U.S. company."
Ostrosky also says in the current market, he is taking a closer look at the industries his suppliers at home and abroad are selling into. Goodrich's supply base is also selling into the automotive industry. In the past, that was an advantage because the revenue from the higher-volume automotive business kept suppliers healthy and strong. Today, not so much.
And in some business cultures, supplier companies are not always eager to point out challenges or problems to its customers. The answer, says Ostrosky, is developing a deeper relationship with suppliers so they are more willing to share pertinent information that can help guide your sourcing decisions.
Cost #3: Post-contract lull
While most sourcing teams understand there is a lot of work that needs to be done on the front end of the global sourcing process, there is an associated risk of moving on too quickly to the next sourcing project after a contract is set with a given supplier. Rather than waiting a year to review a contract's cost impact when it's up for renewal, it's wise to monitor the performance of suppliers involved with that contract in the weeks and months after the contract is put in place because various costs can change.
That means more than monitoring the performance of the component or material supplier for cost increases or changes. It means tracking logistics providers' costs and performance as they get up to speed, it means tracking the data from customs brokers to ensure products are flowing smoothing and it means monitoring the impact on inventory levels and costs. If those costs change and it goes unnoticed, it can eat away at your ROI quickly.
"Most companies don't have a good handle on how costs are accruing in the short-term after the contract takes effect," says Greg Johnsen, executive vice president and co-founder of Oakland, Calif.-based GT Nexus, an online global trade and logistics portal.
"There are many things to change in your supply chain based on the right data that can improve top line, bottom line, reduce risk, improve inventory turns, etc." Johnsen says. "We're at the beginning of a different era where people grasp that data they couldn't touch before."
Cost #4: Duty and tariff changes
No global sourcing analysis can be deemed truly comprehensive without a thorough understanding of all of the possible duties, tarriffs and trade agreements that apply to the product now and in the future. A change in one of those of agreements during the life of a contract could dramatically impact the cost and savings on the product being sourced. Typically this requires purchasing work with other parts of the supply chain including finance, treasury or other experts with global trade and compliance knowledge.
When it comes to the costs associated with duties and tariffs, Rajiv Saxena, vice president of supply chain solutions with APL Logistics in Oakland, Calif. says it's difficult to provide a definitive dollar range because there are significant variations from country to country. "There are also variations depending on how product is classified: Is it finished? Unfinished? Partially assembled? Or fully assembled?"
Brockwell says one company he knows of estimated that a given product would be duty-free based on its classification, which was incorrect. When the correct classification was applied—only after the sourcing decision had been made—the product was subject to a 4% duty, which severely cut the benefit of sourcing from that region.
"And other times, we see companies paying a duty on a product but later learn that if they brought the separate components in individually, it would be duty free and reduce the overall costs," he says. "So understanding how your bill of materials may be rearranged to reduce your exposure to duties can impact your global sourcing savings. Typically these duties are not a surprise—it takes months for an anti-dumping duty case to get decided, for example."
Brockwell points out that customs brokers fees, while seen as a necessary step in the global sourcing process, should be tracked to ensure they do not offset the savings targets.
Cost #5: Contract non-compliance
As important as contract compliance is in general, it is even more important with suppliers in overseas markets. Why? Because, as research from the Procurement Strategy Council points out, "supplier identification, qualification, and on-boarding tend to be very resource-intensive in emerging markets, yet typical cost models omit these, accounting only for ongoing management costs."
And when buyers resist buying on or compliance with these contracts, the volume of spend covered by the agreement is diminished, which in turn reduces the overall level of savings achieved.
In short, if the purchasing organization works hard to negotiate a successful global sourcing deal, it needs to be promoted and leveraged to its fullest extent.
Cost #6: True inventory costs
Certainly sourcing from a supplier in an overseas market will likely increase inventory and safety stock levels and their associated costs. But exactly how—and to what level of detail—the inventory cost is analyzed and modeled can have a dramatic impact on the savings achieved by sourcing overseas.
"A lot of companies don't do the full inventory carrying-cost analysis—that cost includes more than just the weighted average cost of capital," says J.P. Morgan's Brockwell. "It's the utilities and taxes to store the goods, scrap and obsolescence. Inventory decisions have to include what you do with the inventory once it gets here. That could mean scrapping 30% of the product you buy in some cases."
APL's Saxena says companies should, to some extent, err on the high end of calculating how much additional inventory will be needed to keep supply chains moving smoothly. "Interest, depreciation, insurance and product obsolescence also need to be factored in," he says. "And higher inventory could require that you increase warehousing space, which also means increasing your need for equipment, warehouse personnel and the costs associated with them."
Brockwell says beyond the physical cost of inventory, there could be a cost associated with how those higher inventory levels and longer supply lines impact your company's ability to react to market trends. For example, if a product's demand spikes or falls, your inventory model may be what allows you to adjust to those trends so you can either capitalize by filling demand for a hot product or avoid writing off millions in unused or obsolete inventory. And that level of risk, if it is so perceived, needs to be included in a financial analysis of a global sourcing strategy.
Cost #7: Logistics volatility
The logistics cost piece of a global sourcing analysis is not as cut-and-dried as it perhaps may seem. Anyone tracking ocean freight rates in the Pacific over the past two years can attest to the increasingly volatile nature of freight rates, for starters. In a lot of ways, forecasting the future logistics costs on a given global sourcing contract is more art than science.
Certainly, the distances goods travel in a global sourcing strategy will be longer than when sourcing domestically and, thus, logistics costs tend to increase. But it goes much deeper than that. The transportation modes and carriers are likely to change and supply lines may become less predictable, which should be considered in a total cost model.
For example, most of the freight from Asia to the U.S. moves via water, and Saxena says given the cost differential between air and water that's not likely to change anytime soon. "However there's no denying that moving to production or suppliers further away increases the likelihood that your company might have to use air freight more often if delivery contingencies arise. That's why I recommend that companies at least allot something in their landed cost calculation for the occasional expedited move. Otherwise they could be setting themselves up for some sticker shock."
Brockwell agrees that while it makes sense to estimate the total cost based on a full container price, there needs to be an estimate of the risk and cost that you may incur by having to ship premium air at times to meet demand or offset long leadtimes. Typically, that includes looking at historical shipping patterns and data to gauge the risk.
Cost #8: Technology
Tracking product flow in a global sourcing model could require new levels of technology in your supply chain, which will increase costs as well. "As a rule, the more miles, modes and players your company's supply chain involves, the more robust its visibility systems will need to be and the more you'll probably have to pay to get those systems," says APL's Saxena. "My recommendation when you're comparing the merits of one venue vs. another is to pay close attention to the kinds of systems you'd need for managing the inventory flow from each. Then put a price tag on those systems and see what the price differential is."
GT Nexus' Johnsen says data collection and its associated technology can have true upside in its impact on a globally sourced product's profitability. "If it's a product that has a high transportation rate component and that transportation cost component is cut in half, the profit on that product increases significantly," he says. "So knowing how those logistics costs impact overall profit margins and changing the sourcing decisions based on those profitability changes can really put supply chain in the position of bringing profitability to the business."
Johnsen says more buyers are including a global supplier or supply chain partner's ability to provide key data in their supplier selection process.
Cost #9: Quality breakdowns
It's no secret that global sourcing in many cases means balancing a planned cost savings with a possible risk of less reliable product quality. Unreliable quality levels in a product or the timeliness of the production from overseas factories may impact profitability as well. On a broad scale, a product recall is very expensive.
But more likely, the cost impact of varying quality will be more subtly buried in your supply chain. For example, Goodrich's Ostrosky points out that when selecting a contract manufacturer for a small or low-cost product, there may be a temptation to use a lower-quality contract manufacturer to improve the profit margin on the product. But if the contract manufacturer's quality affects delivery of the part or increases the number of failures, it could wind up costing more than originally forecasted and wipe out the global sourcing ROI.
While there are clearly many costs—hidden and obvious—to consider in building a successful global sourcing strategy, the majority of experts agree that the benefits are more than plentiful enough to make global sourcing a true cost savings.
In the words of a recent Procurement Strategy Council report: "Traditional models assessing the costs of global sourcing most often consider higher logistics and inventory costs due to longer supply chains, greater management costs to oversee remote and (often) unfamiliar supplier relationships, and higher taxes and duties. While these costs can reduce net savings by roughly half, emerging markets still provide a significant cost advantage of upwards of 25% savings."
By David Hannon -- Purchasing, 3/12/2009
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