Low Cost Country Sourcing:
A Blogger's Perspective
Low Cost Country Sourcing, often abbreviated LCCS, defined as a procurement or sourcing strategy in which a company sources materials from countries with lower labor and production costs in order to cut operating costs, is not a new subject. Moreover, it has had so much written about it lately that it can be dizzying for an average professional attempting to investigate the opportunity just to find a starting point. For example, searching for the complete phrase "low cost country sourcing" in Google generates over 42,000 relevant hits. Furthermore, it seems everyone and his dog has an opinion about low cost country sourcing, right cost country sourcing, best cost country sourcing, or just plain old global sourcing these days.
This, of course, makes it difficult to come up with a good wiki on the subject as well, regardless if one wants to take the angle of an introductory wiki, best practices wiki, or even a conceptions and misconceptions wiki. Thus, rather than trying to create a really good wiki on any one angle, the original authors decided to bring the best advice the blogsphere has to offer from the thought-leaders themselves.
After reprinting a great interview with Carl Greppin from Transpac Access, which answers some commonly asked questions, that can be found on eSourcing Forum (Part 1 and Part 2), this wiki will summarize some of the best advice that can be found on the leading sourcing and procurement blogs, including Spend Matters, Sourcing Innovation, Supply Excellence, Procurement Central, Strategic Sourcing Europe, and the European Leaders in Procurement blog. It then presents a blog bibliography that calls out a number of relevant blog entries in each of the major sourcing / procurement blogs.
An Interview with Carl Greppin
1a. There is still lots of buzz about low-cost country sourcing (LCCS). What should a company do to help it decide whether to pursue LCCS strategies?
A company should thoroughly review everything it buys and determine which materials are best suited for LCCS.
Criteria include: a) Savings - potential savings that could be attained b) Experience - the experience that the LCC supply base has with providing similar materials to the West c) Implementability - how easy it would be for the buyer to move materials to a new supply base
1b. Is it right for all companies?
Not necessarily. Some materials and services are better suited than others for LCCS. For some companies, such as those that provide services such as temporary labor in the United States, LCCS may not be a viable option.
2. Is LCCS only about using suppliers from other countries?
No - LCCS can also involve helping a company's domestic suppliers use LCCS for their supply base.
3. I hear one needs to conduct in-depth due diligence on new LCCS suppliers. What does that entail?
Due diligence entails getting thorough information from suppliers on items such as English speaking and writing skills, experience with providing materials to the West, equipment, capacity utilization, and other customers. Due diligence also entails conducting site visits to ensure provided information is correct, to inspect production and quality systems, and to determine if there is a workable chemistry between the buyers and the supplier.
4. What additional costs do I need to consider when determining whether to pursue a LCCS strategy?
There are a number of additional costs to consider. International transportation costs can be large, depending on the type of material being imported. Inventory carrying costs can be a factor since the buyer's Inventory Days will become higher. There will be customs and brokerage costs. And there will be additional administrative costs, especially in the first year, as the buyer spends effort to learn how to operate with LCCS suppliers.
5. What are the 'hot' low-cost regions now?
Right now, the 'hot' low-cost regions are China for manufactured materials and India for services.
6. Are some regions easier to work with than others?
Chinese suppliers tend to be responsive and reliable. Chinese suppliers are also becoming adept at dealing with buyers from the States, so this is currently a region that is fairly easy to work with.
7. What about language issues? Americans generally only speak English.
For India, suppliers tend to have good written English skills. Spoken English can be difficult because of different accents and because of poor telecom connections. A US buyer unfamiliar with speaking with people from India will need perhaps 5 or 10 hours of experience speaking on the phone with people in India before finding it easy to communicate by phone.
For China, suppliers tend to have working written English skills. Email serves as a good medium for communication. Phone discussions are more difficult - Chinese suppliers may have poor English skills, and cultural issues may preclude a meaningful conversation (e.g. a Chinese supplier may say 'yes' to mean 'I hear you' rather than to mean 'I agree').
8. Are there common 'red flags' we should know about before selecting a LCCS supplier?
A big one is if the supplier has a lack of experience providing material to the West.
9. When a company works with a 3rd party vendor to help identify, qualify and select a LCCS supplier, what range of deliverables should they expect?
The depth of service varies depending on the needs of the buyer. A buyer new to LCCS sourcing may want the 3rd party vendor to handle.
a) Getting information on suppliers through Requests for Information b) Eliciting quotes c) Conducting preliminary site visits d) Hosting US buyers to visit finalist suppliers e) Helping conduct final negotiations f) Helping with design g) Conducting first part approval h) Conducting production run quality audits i) Arranging transportation to the US j) Arranging customs clearance k) Arranging transportation from Port or Entry in the US to buyer site
10. What happens if something goes wrong? Can a 3rd party vendor help?
The 3rd party vendor can definitely help, especially if the buyer is new to LCCS sourcing. The 3rd party vendor can work with the supplier or the shipper to resolve production and delivery issues.
11. Are their commodities that should rarely be sourced via a LCCS supplier?
Commodities that are less frequently sourced are those that are expensive to ship because they cube out quickly or because they are very fragile, those that have short lead times, and those that are low volume and require frequent design modifications.
Some Blogger Insights
LCCS comes with a number of challenges. These include product quality, supplier quality, resource quality, logistics, reliable delivery, supply assurance, supplier bankruptcy, and the inherent complexity of remote supplier management. Furthermore, the reality is that even today, many large global organizations are not fully prepared to embark on ambitious LCCS projects.
First time LCCS projects, especially those that are poorly planned, are often wrought with budget overruns caused by underestimated transportation costs, additional inventory costs due to uncertain lead times and long order cycle times, bad data, and fluctuating demands.
There is a significant variation in supplier capability and sophistication in developing markets, in specific verticals in a specific developing market, and even within individual operations and factories. In China, a factory might have state of the art production equipment recently bought from a U.S. supplier (as a result of the weakening US dollar) but that same factory might not even have the capability to ship a standard palette.
Before selecting a supplier, it's important to meet with the supplier and conduct on-site visits and assessments. But it's even more important to do good research on the supplier in a pre-qualification process to make sure the supplier has a decent chance of living up to the requirements, or the organization might end up wasting a lot of time and money. Use third party information services such as those provided by Austin Tetra and Open Ratings, do reference checks, collect detailed information on operations and capabilities through eSourcing tools from the suppliers themselves, and have introductory calls and video-conferences before investing in the remote meetings and site visits required by a full qualification.
Culture can also present a challenge. Different cultures will run their business differently, people of different cultures will respond differently to the same situation, and "yes" does not always mean "yes, I can" or "yes, I will" - in some cultures "yes" means "yes, I hear what you are saying" or "yes, I understand". Cultural education, as well as the assistance from locals who understand both cultures, will likely be required.
Corporate Social Responsibility
Besides the challenges addressed in the last section, there are a number of issues around Corporate Social Responsibility (CSR) that need to be taken into account. After all, LCCS is not just about costs! Is the organization outsourcing to a sweatshop? Are you sure? The last thing the public relations department wants is to find out that a key supplier employes children and forces them to work twelve hour days, six days a week, in poor conditions at a wage that would be considered less than half of minimum wage in the country the supplier operates in.
Corporate Social Responsibility, if done right, can make the difference between a very poor sourcing decision and a very good one. Look at MAS Holdings. This company has seen double-digit annual growth while avoiding sweatshop conditions AND spending 3%-4% of costs on employee and philanthropic programs.
Steps for Success
The primary key to success is to take a total cost of ownership approach when evaluating a potential low cost country supplier - not just a total landed cost approach. This includes increased inventory carrying costs, duties, import and export taxes, and additional financing costs. Furthermore, this calculation must be updated regularly throughout the process, as it can often increase as one progresses further into a project. If the point is reached where the estimated savings are not worth the increased risk, the project should be dropped, at least with respect to the categories one was considering outsourcing.
Although Chinese factories have lower operating costs, the reality is that unless they allow the organization to purchase goods at least 20% to 25% cheaper than the organization's other sources of supply, by the time one factors in all of the costs associated with low cost country sourcing to China, one will find, especially if one works for an American company, that sourcing from Mexico will likely be more cost effective.
For a small and medium sized organization, which likely lacks at least some of the skills necessary to succeed in a low-cost country sourcing effort, a secondary key to success is to hire top-notch external expertise. It's true that the right consultant might not come cheap, but the value such a consultant can provide the organization will pay for the consultant many times over once a successful LCCS operation is in place. Just remember it's just as important to do homework on the firm or individual the organization intends to select as it is the supplier the organization intends to do business with. If the consultant thinks a bunker fee is a penalty for missing the green on the eighteenth hole, then the consultant is the wrong consultant for the project.
A tertiary key to success is not to overestimate the savings hype from the savings that are actually achievable. Most of the articles that quote "significant cost savings" are often referring only to the lower operating costs. However, when one factors in the increased transportation costs, which are rising yearly, increased inventory holding costs to buffer against longer lead times and unpredictable delays, import and export duties, and the cost of regular site visits required to build the partnership and guarantee quality, it's sometimes the case that sourcing from China is not much cheaper than sourcing from the factory down the street.
A good tactic when global sourcing is to take a lesson from investors and create a portfolio strategy to minimize the risk. Select two (or more) suppliers in two (or more) regions so that if a natural disaster hits one, the other is still available.
Another good tactic when global sourcing is to evaluate which ports the supply sources will be shipping to. Due to the over-reliance of American companies on China, many west coast ports are over taxed. Thus, one might want to consider Eastern Europe, South America, or even parts of Africa, which could be shipped to East Coast Ports.
Finally, one needs to recognize that low cost country sourcing in isolation is an incredibly short-sighted strategy. Given rising labor and commodity prices worldwide, tariff mongering, and emerging protectionist viewpoints on both sides of the ocean, it is not likely to yield anywhere near the savings that one might envision. Furthermore, it will not save a company in a downward spiral. In fact, it is likely to do the opposite and bring the company down faster.
Not only is China likely still the most popular country for low cost country sourcing, but it is definitely the most discussed destination. And despite the overwhelming favoritism still given to China in the press, the bloggers tend to agree that low cost country sourcing to China is on the tail-end of the boom. It's yesterday's opportunity.
China may still be among the lowest labor cost countries out there, but the lack of IP protection, poor infrastructure, looming energy crisis (with Northeast China expected to exhaust its power generation capacity by 2010 at the latest), and lack of local talent all add up to an inability to maintain its growth curve. It's booming supply chain sector is in danger of stalling due to a rapidly increasing talent shortage (which is making talent retention a significant challenge). And it's number one capability is still imitation, not innovation.
Dealing with a Chinese supplier can be a lesson in extremes. A Chinese supplier might have the latest equipment, and even the latest processes, and be able to produce quality goods on par with US suppliers, but not even have the capability to pack them onto a standard palette. The big cities may have hotels, restaurants, and stores for foreign visitors with set prices, but the tradition in China is to haggle over every price. Thus, a marathon bargaining session just to get to a quote is only the beginning, and one should be prepared! Plus, it's in the middle of a transition to a mass-production and mass-consumption society. That only adds to the confusion.
China needs to figure out how it is going to solve its infrastructure, energy, and talent crisis if it intends to compete effectively in the coming decades as its low cost advantage is eroding rapidly. Taiwanese manufacturers are already moving business from mainland China to Vietnam to take advantage of lower wages and operating rates.
As Jason Busch says, there [may be] many cups yet to wring from the tea tips when it comes to China sourcing, but the question remains what will be left, and what leaves we'll be drinking from.
Outsourcing to India is still going strong as well, especially in the IT, Engineering and Service Industries due to the fact that English is a commonly spoken second language. In general, India does offer superior engineering talent than most other countries due to its good University system. In addition to its engineers, its business leaders tend to have better academic training and, like its engineers, will invest more in systems and processes that are trusted by Westerners.
Some Final Thoughts
As the great minds have said, "Low cost country sourcing should not be about a place or a country, but the process of being able to move quickly and adapt". It should be about the best country, which, when possible, could be the home country. After all, regions that offer low costs often enjoy an influx of foreign investment, followed by a local boom, which can then stop them being the cheapest option. It is at this stage when a company needs to be able to either improve the supplier's productivity and lower the cost, or quickly change suppliers to a new low-cost area to insure that it remains competitive.
Moreover, LCCS becomes irrelevant as an enterprise starts to market and sell into low cost regions. Overall country competitiveness and flexible supply strategies quickly start to trump labor costs in these situations. Furthermore, the sluggish American economy and weakening dollar is slowly transforming the U.S. into an attractive supply and manufacturing region for foreign companies. While the U.S. is striving to move operations abroad, Japanese companies, especially in the automotive sector, are striving to move more and more production into the U.S. For example, the Toyota can now be stamped "Made in America".
LCCS by the Blog
In this section, links to relevant blog entries, as well as summarizing key points for each entry, are provided. It is our sincerest hope that that a reader will review many, if not all of these entries, as the different viewpoints, when taken in unison, will likely provide a much better picture of Low Cost Country Sourcing than a single document ever will.
European Leaders in Procurement
2006-10-21 Low-cost countries sourcing trends
- A recent survey from Efficio determined that the top concerns and challenges with low cost country sourcing, as determined by companies who source over a fifth of their spend from low cost countries, are:
- product quality
- supplier quality / resources
- complexity of remote supplier management
- MAS holdings has seen double-digit annual growth while avoiding sweatshop conditions and spending 3%-4% of costs on employee and philanthropic programs
2007-04-04 Talent Retention Problems Rise in the East
- The growth of China's booming supply chain sector is in danger of stalling due to increasing talent shortages
2007-06-06 Trouble Brewing Over New Indian Trade Zones
Notes that the Indian government just announced the formation of 24 Special Economic Zones (SEZs) in the country. As of posting, nine SEZs have been approved with 13 applications deferred.
- There is great variation in supplier capability and sophistication in developing markets
- A pre-qualification process to winnow down potential vendors before conducting onsite visits and assessments is important
- eSourcing applications can help companies of all sizes to qualify low cost country suppliers
- Major risks for LCCS include unreliable quality and delivery
- Out sourcing to Low Cost Countries can be a wise business decision in some cases but one needs to make sure one has done her homework and have a back up supplier ready for critical items as unexpected issues can come up.
2006-09-13 Avoiding the Perils of Going Global
- The perils of LCCS can be wrought from budget overruns caused by underestimated transportation costs, uncertain lead times, long order-cycle times, bad data, and fluctuating demands
- The solution is to get a better handle on supply chain cost, including the true cost of transportation, border-crossing issues, and higher levels of inventory against supply interruption, enabled by good processes, center-led procurement, and accurate, real-time visibility backed by solid web-based systems
2006-05-21 The end of the China Effect?
We cannot under estimate China’s effect on world economic growth over the last 15 years. The low wage Chinese economy has been a major influence on prices and in some instances deflation in most developed countries. But are the good times about to end? And if they do, what impact will this have on our Low Cost Country Sourcing strategies?
First, China has tentatively raised interest rates in an effort to slow growth. However, this intervention has had little effect with GDP increasing from 10% in Qtr4 of 2006 to approximately 11% in the first quarter of 2007…and that’s the official line real GDP and inflation could be a whole lot higher.
Secondly, the central bank allowed some limited realignment of the exchange rates (it is still estimated that the currency is some 15 – 20% undervalued). Since interest rate rises have had little effect it seems obvious that the Government will have to intervene in exchange rates to stem demand for exports.
Thirdly, in an effort to standardise the corporation tax system the Chinese Government are planning to increase the corporation tax for foreign companies from 15% to 25%.
Fourthly, if that wasn’t enough there are signs of wage inflation within the economy both in white colour and blue colour workers.
Finally, due to the developing worlds’ insatiable demand for commodities, prices are at an all time high. Since these are generally input costs it seems inevitable that output prices would need to rise to compensate.
2006-05-29 Beware of China Sourcing?
Quotes an article from Industry Week, which referenced a Boston Consulting Group study, that notes "In their rush to source from China many companies are blindly walking into a strategic trap. The trap is thinking that sourcing from China will result in lower product costs, when in reality the supply chain dynamics will, in many cases, drive up overall costs and reduce profitability".
The report provides some options instead of sourcing from China, including:
- Build “land-side” capacity at ports not yet overwhelmed by congestion.
- Explore shipping alternatives, such as air freight, “that may appear costly but may actually lower overall expenditures by reducing hidden costs.”
- Invest in “premiums” and “capabilities” — paying higher prices, for example, for priority service (”premiums”) or improving the company’s own abilities to move goods quickly and efficiently past or around congestion.
- Diversify supply with “multiple suppliers and supply points” or produce critical components and products domestically, accepting higher production costs as a tradeoff for lower supply-chain costs and reliable delivery schedules.
2006-04-21 India and China & Enterprise Software
- Large software vendors have been drawn to India and China as low-cost R&D centers
- India, with it's slice of highly educated knowledge workers, is a service industry play. China has that element to it, but the far larger opportunity seems to be providing the Manufacturing industry what they need
- Is there a chance of competing in India and China against the big guys? If the organization spends its time in-country and gets on-top of local requirements, the answer could be yes
The more you'll be investing into working in a country, the more in-depth your investigation ought to be. Consider just a few of the macro-forces at work that shape who is doing what, where, how, and why:
- trade relations
- economic development
- government regulations
- business trends
- commodity prices
Notes that the articles that quote the number of engineering graduates in China relative to the number of engineering graduates in the United States never give you the whole story.
- The grand sum of 250,000+ graduates accounts for engineers of all kinds—civil, software, mechanical, electrical, and so on. Many of them are civil and mechanical engineers who will spend a great deal of time in China’s interior and western regions building infrastructure.
- Although multinational corporations have been able to attract and retain the best in a one billion population—making for world-class talent, in my experience, the same cannot be assumed of the vast majority of Chinese firms. From a ground level perspective, I've witnessed many Chinese firms hurting from an inability to find and keep good engineering talent.
- I am not alone. I recently listened to a panel of speakers at the Asia America Multi-Technology Association's China Connect Conference, and listened to similar human resources woes of middle-sized US firms setting up shop and operating in China.
The simple fact is that even though hundreds of thousands of engineers are graduating every year, attracting and retaining solid engineering talent somehow continues to be a challenge for many US and Chinese firms in China.
Chinese companies have approximately $100 billion in accounts receivable with foreign companies--and the reasons behind this are often the same or similar fraudulent practices that many foreign companies complain about so often when they operate in China. Foreign companies sometimes just don't pay up. And what's a chinese vendor going to do?
- 26% - Trust between a supplier and buyer need to improve
- 19% - Delivery problem; high shipping cost or long delivery
- 19% - Problem with quality of products
- 14% - Communication problem and language barrier
- 10% - Security problem with internet trading
- 5% - Service offered by Chinese suppliers is lacking
- 2% - Response to customer is slow and poor
- 2% - Price is too high
Certainly, many of the issues listed are intertwined. But, the big, fuzzy concept of "trust" was the winner. Everybody's got to get their's first. It helps when you're building a relationship with a supplier, to put in the time and put yourself out there a little bit--share the risk. Of course, you complete all your due diligence about who you're dealing with as well. But it's important to remember where the other guy is coming from as well.
Discusses a recent article by the National Retail Federation, Monitoring has Chilling Effect on Vietnam Trade that discusses the results of the US government's decision to "monitor", and possibly take issue with, Vietnam's apparel exports because of anti-dumping (trade policy used by importing governments to counteract dumping or the export of goods below cost, for example by imposing duties or negotiating price increases). Several large US retailers that were sourcing apparel products from Vietnam have practically ceased their orders and are placing them with factories in other countries because of this possibility. Anti-dumping measures can have brutal and unpredictable consequences on a company's supply chain.
In this situation, a small business with a much simpler supply chain, involving one or a few factories in Vietnam, would be at great risk. Although large corporations with extensive supply chains in multiple countries will still lose some time in moving production elsewhere, they can react to these trade policy developments more quickly because they have vendors in other countries, more money, and more manpower to throw at the issue. The small company that is beginning offshore sourcing usually only sources from one country. Someone moving to Vietnam right away because they offered the lowest hard costs would now be facing a situation which could potentially threaten the entire supply chain and business. Even if they rushed to find sources in other countries to mitigate the risk, it would take months of lead time to find the right source, create and review samples, set up production, etc.
Ashton Udall discusses how he often has conversations with inventors taking products to market, who refuse the idea of working through anyone--be it a middleman, trade company, service provider, consultant, to find and partner with manufacturers in China. Why? They have found contacts via Alibaba or some other internet trading portal. They are already connected. Why would they want to pay someone to be in the middle to get connected when the internet circumvented all of that?
He notes that going through the Chinese government officials to find partners in China is going to be trouble. Although there are some times when working with the government is a good move, it can be dubious.
Furthermore, trading portals on the internet can be even more sketchy. He bottomline is, you have no idea who you're talking to and they probably have no idea what you're really trying to say. One of the first sourcing companies he worked with was another example of this--not the greatest network of suppliers and people. If birds of a feather flock together, so do suppliers and people with similar business styles. His advice? Find a China connection who does the kind of business you want to be dealing with in general. Work on getting connected to the correct individual on this side--whoever they are and however you can find them. If they are upstanding individuals and have been doing business successfully in China for years, chances are they are going to have found the right kind of network there.
Asks the question "why do Chinese companies steal your intellectual property?". References the post "Why Does China Copy Designs" from the DesignSojourn blog that focussed on the cultural and socioeconomic factors regarding the motivation of chinese companies to replicate, build-off-of, tweak, and steal existing product designs. It basically boils down to Culture and Education. "Fast forward to today, this is also similar to (I dare say) most design schools in China where students come from a rote learning high school background and are tought to follow instead of think. At school they look to famous designers and architects as examples, and their work naturally becomes very thematic or contain the safest forms of expression. Furthermore it is expected that Schools focus on technical skills instead of thinking skills, as learning about creativity is about following a set way of doing things."
The typical chinese person learns throughout their educational experience and upbringing that it's better to replicate something already proven than try and develop something new. And then there's the socioeconomic situation ... "When you grow up in a country where life is cheap, things do get brutal and money talks. There is no area for the softer aspects of the business, like branding, experience and emotive products etc."
Two basic concepts found throughout business, risk and return, are critical to the supply chain and sourcing. The problem is, it's much more fun to speculate about substantial returns and savings, than try to quantify, measure, and assess risk. Thus, risk, and potential sources of risk and their effect on return, often fall off the radar. Perhaps someone should coin the term "riskturn".
Discusses the Businessweek online article that there appears to be three waves of sourcing in China through which multinational companies are progressing.
Wave 1.0: Numerous U.S., Japanese, and European companies established corporate beachheads in China to implement their low-cost strategies. Stand-alone sourcing offices sprang up in Shenzhen, then Shanghai and other locations, and anyone with even a few years of sourcing experience became a hot commodity. During this initial phase, Western multinationals looking to source from China faced two significant hurdles: a dearth of qualified suppliers and a dearth of qualified sourcing people.
Wave 2.0: As sourcing matured, so did the suppliers. In a wide range of industries, from consumer electronics and IT equipment to automotive manufacturing, many Chinese suppliers moved far beyond being arm's length suppliers. They started to innovate and collaborate with their customers on component and product design, marking the transition to sourcing 2.0. Today, many of these same Chinese suppliers are designing new products for global markets as part of supply chains that are integrated into global procurement processes.
Wave 3.0: Today's China is the center of an economic maelstrom that grows larger and more powerful (and increasingly complex) every day. R&D centers originally set up to support product localization for the Chinese market are now going full force in developing new products for the global market. These rapid changes, which will continue to accelerate, mean that many Western companies have to rethink their global procurement operations. The announcement that IBM is moving its global procurement headquarters to Shenzhen is the most visible sign that sourcing wave 3.0 is underway—with China becoming the global center for procurement.
Multinational behemoths aside, where do the rest of small to mid-size businesses fall along this range? Ashton argues that those with the utmost experience in China are steeped in Wave 2.0. These small and mid-size businesses have discovered the benefits of close partnerships with key Chinese suppliers, through which they foster low level R&D on their projects by outsourcing the lower-end R&D functions to their suppliers. Many of these companies might still be trying to optimize, or simply contain, their supply chain challenges. But most are still in Wave 1.0. Some have begun in China, but are now seeking even lower costs in other countries. Some have developed a solid supplier base in China and are reaping the benefits of the cost-savings. Some are still sitting on the fence in terms of whether to go, how to go, or how much to commit.
For those small companies that stay relatively small, Ashton sees them slowly moving on to Wave 2.0, but perhaps not in as grand or focused a fashion. What he does see happening, is R&D and design services in other Asian countries, other countries in general for that matter, not only becoming accessible to these businesses, but feasible.
2007-07-11 Product Liability and China
Ashton notes that the media coverage of the recent China quality issues is a good thing because American consumers, and particularly retailers, need to become more aware of where their goods are coming from and in what conditions they are being produced--not in a hysterical and frenzied fashion as some might like us to behave. But we need to raise awareness of these issues and investigate them more thoroughly.
Having personally visited at least 75 factories in China in the last year, Ashton notes that factories in China come as varied as food retailers in the United States. You've got Mom-n-Pop stores, farmers markets, vending machines, regional grocery chains, roach coaches, national grocery chains, and more. Their setups, services, products, sizes, operations, management styles, locations, and customers come in every variation under the sun. So do factories in China.
For example, two factories may exist in the city of Chanzhou, China. They both are exactly the same--same number of workers, size of factories, types of machines, and products produced. Let's say they both produce shirts and jackets--garments. Factory A has a very professional-looking website, someone who speaks decent English with customers, and has purchased a counterfeit ISO 9001 certification to validate their quality systems with customers even though their quality systems are not up to par with U.S. standards. In addition, Factory A does not have a sewing needle detection machine or needle tracking program in place.
Factory B does not have a website in English. They do have staff that speaks an intermediate level of English. They do not present any international certifications, but they have been working successfully with foreign customers for over 7 years. They have and use their needle detection system as well as a needle tracking program. A U.S. company emails both factories looking for a supplier. They choose Factory A because Factory A displays the trappings of a good organization and they believe that such a factory would have good quality and safety control. They purchase 10,000 kids jackets, for ages 3 to 5 years, from the factory and sell them in the U.S. market . Eleven of the jackets sold contain sharp needle points. Nine of them don't cause any harm. One of them pierces a 3 year-old's neck and the child gets an infection. Another needle gets stuck under the skin of a little boy's arm and both require hospital attention. The angry parents find Lawyer X, who agrees to help them go after the US company for its negligence and make them pay dearly for the harm done to these children.
It doesn't take much to strike up a conversation with a Chinese vendor these days and send them money to make your product. Spare yourself from becoming a cautionary tale of Chinese product liability in the WallStreet Journal--do your homework and keep on top of quality. Investigate what safety standards your product must live up to. Understand how your products will be inspected: according to what criteria and when. And, for backup protection, carry a product liability insurance policy. This goes for suppliers in China or any low-cost country for that matter.
Like most news stories, the more the press covers the recent quality issues concerning China-made products, the more likely people will become ambivalent to the issue. But, for those of us involved with manufacturing in China, Asia, or anywhere for that matter, the subject will continue to be just as important. So where do we go from here? Where does China go from here? What have countries in China's situation done in the past in this situation?
China is not the only country to experience quality woes. But it may be surprising to learn that Japan was once in China's place. Japan, a country widely associated with companies that consistently produce high-quality products, once held China's title of "low-cost/low-quality" producer. Post World War II Japan's "Made in Japan" label was a symbol of low quality product.
Interestingly enough, a few Americans, such as Edwards Demming, whose ideas on statistical quality control processes were turned down by US automakers, were embraced by Japan and helped lay a foundation for Japan's culture of quality. Realizing quality as a path to growth and market share, Japan took quality very seriously and took several steps to infuse their business culture with the attitude and tools to build quality into their companies and production lines. And you see it when you walk a Japanese production line in a Chinese factory. They are consistently impressive and it speaks very well of a factory if they are supplying a Japanese company with product. Today, while every country has the occasional issue with quality, Japan is widely considered a world leader.
Whether or not China will follow a similar path as Japan is unknown. Generally speaking, countries in Asia have slowly moved up the value chain in terms of the benefits they provide. Low development countries are generally entered into by companies looking for low-costs. These companies are willing to go through, or find out that they will need to go through, a number of challenges to get an effective supply chain going in these countries.
Manufacturing commodity products comes with razor thin margins and cutthroat pricing competitions. There are two basic ways to get out of this business situation: 1) add to the value of the product you offer (ex. higher-quality products) or take on more valuable tasks for which customers will pay a premium (ex. R&D). 2) "Quality Fade", the deliberate and secretive habit of widening profit margins through a reduction in the quality of materials. Thus far, many Chinese companies have taken the path of least resistance and employed the "quality fade" approach.
The fact is such that if China wants to continue moving towards higher premium products and services, they will have to seriously address their culture of quality. This will take a great deal of time and effort. Japan is a case in point. The next few years will be very telling in terms of their initiatives in this area.
2005-01-24 Booz Misses the Boat
- One needs to take more than a total landed cost approach
- Inventory carrying costs generally increase
- Duty and import taxes can be significant
- There are finance and banking implications such as stricter payment terms, letters of credit, and cost of capital?
2005-02-25 On-Demand with Sean Harley and Stuart Burns
- There's a shortage of skills within smaller and medium-sized organizations
- There's often a significant gulf between what executives read and what is actually achievable in the mid-market
- In practice, the risk and implications are more serious than many organizations initially consider
2005-07-14 LCCS Success Stories
- Many companies, even large global organizations, are not fully prepared to embark on programs as complex and ambitious as LCCS alone
2005-11-18 The CPO's Summit: LCCS Learnings ...
- LCCS can be an over-hyped topic
- Calculating TCO early is critical, as is updating it continuously throughout the project
- A company will encounter a range of cultural, legal, tax/tarrif issues
- One can structure different types of relationships and develop supply bases of different characteristics
2005-12-19 Low Cost Country Sourcing: The Other Side
- Although sourcing from Asia offers stronger price-related advantages, many European companies are looking to Eastern Europe as their preferred source for manufacturing and tier-one suppliers
- LCCS is not just about lowering costs
- LCCS initiatives can make an organization more vulnerable to supply disruptions unless investments are made to mitigate and manage global supply risk
2006-01-19 Thomas Goes Global: Too Little, Too Late?
- There is still no global supply database panacea
2006-01-23 LCCS is Alive and Well in the Middle Market
- A number of issues can arise: packing issues, size tolerances, etc.
- A willingness to work with the LCCS supplier can result in surprisingly good results
2006-02-03 Catching Up Over Global Trade ...
- One should consider creating portfolio strategies to minimize global sourcing risk; it can be risky to invest the bulk of a firm's global sourcing efforts in a single region
2006-03-05 China Maglev Metaphors
- China is incredibly sophisticated in many ways, but not quite ready for prime time in others
- Many Chinese suppliers often appear sophisticated on the surface from a machinery and process perspective, but lack basic capabilities that can create unanticipated inconveniences (and added costs)
2006-03-09 Imitation as Core Competency
- There is a lack of intellectual property protection in China and this has implications for innovation
- Imitation is China's top capability
2006-03-22 Looking In, An Outsider is Not Impressed
- There is a common lack of attention to macro-risk issues among sourcing executives
- The over-dependence of U.S. firms to source from one country, China, is taxing West Coast ports
- Diversified sources of goods may be needed to reduce risk magnitude
- Better businesses need a better way of assessing global, economic, labor, and competitive changes so that better sourcing decisions can be made
2006-04-04 Ariba: Pounding the LCCS Table at Last
- One must ensure that the supply base of a relocated manufacturing operation has been optimally localized
- A China sourcing strategy may not be worth the risk if nearer regional options exist
2006-04-14 Barney, the Big Five, and LCCS
- A bunker fee is not a tax for missing the green on the 18th hole
- There are few firms in the market qualified to offer advice
- Japanese automotive OEMSs are increasingly localizing their supply base in the US while US producers are searching for low cost country sources of supply
- There is superior engineering talent in India relative to other low cost regions and the country has a strong emerging supply base in metals
2006-05-25 How Does India Look at China?
- China tends to respond faster than India
- Indian engineers and business leaders tend to have better academic training which leads to greater innovation while they also invest more in systems and processes which Westerners can trust
- Variability of order deliveries can grow massively when a buyer shifts from a domestic to a global supplier
- Other risks include:
- supplier bankruptcy
- port loading/unloading delays
- acts of nature
- actions by governments / government officials
- Mean time between failures gets much shorter as more players get involved
- The single most effective technique to mitigate risk is diversification
- The tea leaves in China have already floated to the bottom, and we're on the tail end of the boom
- There are many cups yet to wring from the tea tips when it comes to China sourcing, but the question remains what will be left, and what leaves we'll be drinking from
2006-06-21 Cummins Chugs to India for Global Sourcing
- India is better suited than China for a number of categories, especially in the metals arena, when it comes to lower production runs and greater precision
2006-07-11 Tuesday Musings on Global Sourcing
- Low-cost country sourcing is not about a place or country, it's the process of being able to move quickly
- Regions that offer low costs often enjoy an influx of foreign investment, followed by a local boom, which can then stop them being the cheapest option. It is at this stage when the process of quickly changing suppliers to a new low-cost area becomes necessary [that] purchasers must check continuously to ensure the countries they are using remain competitive.
2006-07-13 Global Sourcing: Does Innovation Matter?
- The cold facts speak for themselves: does the savings or efficiencies gained from an activity or process outweigh the risks that it introduces?
- Supply base localization efforts in China aimed at building local manufacturing capability to penetrate the regional Chinese and Asian markets remain a smart priority for global companies in my book.
- At least for the next few decades, we'll see labor arbitrage opportunities in Asia, South and Central America, Eastern Europe, and maybe even Africa.
- China specifically is probably on the back-half of the curve, or at least the current curve.
2006-08-07 India: Manufacturing Opportunity Knocks
- For MNCs, India could become either a dominant sourcing and manufacturing base in its own right (in auto components, custom-based and non-electronic products), or an alternative sourcing hub to China to avoid the risks inherent in single-country sourcing (e.g., in apparel)
- China needs to decide how it is going to compete in the coming decades once its low cost advantage is dissolved
2006-08-10 Vietnam: The Bowl of Pho is Half Full
- Taiwanese manufacturers are moving business from mainland China to Vietnam to take advantage of lower wage and operating rates
2006-10-16 India Looks to China for Sourcing
- Indian firms are now aggressively investigating China and South-east Asian countries for sourcing. Many are seeking to source higher value products from them.
- But given the logistics challenges and costs of importing products into India -- let alone moving cargo around in the country -- it is doubtful that sourcing decisions based primarily on labor arbitrage will have a long life in the region.
2006-10-26 The Lean Mean Problematic Grill Machine
- Buying organizations can reduce global sourcing waste and costs by focusing in on a few key areas.
2006-11-07 Is China Ford's Last Hope?
- Low cost country sourcing will never save a company in the throws of a painful downward spiral.
- Especially given the prospects of a global economic manufacturing downturn -- or at least a slowdown -- in the coming years, the importance of developing local suppliers for regional products and markets cannot be overemphasized.
- When it comes to supply risk, there are actually multiple Grinches -- which can show up as distance risk, cultural and geopolitical risk, and legal and accounting risk.
- Only a small minority of companies that source worldwide have a clear plan of action when something does go wrong
2006-12-28 2007 Global Supply Chain Resolutions
- Identify the right suppliers from the outset -- based on stability and performance, not just price
- Risk management and scenario planning is not just for big firms.
- Folks that source 80% of their requirements from low cost suppliers (often offshore) and 20% domestically are at a strategic advantage to firms that have made the shift to 100% offshore.
2007-01-30 When Global Sourcing Backfires
- Global sourcing initiatives often fall short of delivering expected savings because "the risks and costs of longer, more complex cross-border supply chains were not properly understood, tracked and managed
2007-02-13 China Sourcing -- In the Logistical Trenches
- One needs to be wary of logistical issues when sourcing internationally
- A company requires skills on two fronts for low-cost country sourcing:purchasing and logistics
- One should consider having supplier quality / supplier development feet on the street as well
- Low cost country sourcing, alone, is an especially short-sighted strategy (especially given rising labor and commodity prices worldwide, not to mention the tariff mongering, protectionist viewpoints of politicians on both sides of the isle today).
2007-03-19 India's Race to Move Beyond the Back Office
Notes that, as per an insightful Knowledge@Wharton article, India's manufacturing economy is hampered by poor infrastructure, bureaucratic red tape, and restrictive labor laws. While the contribution of services to the economy ballooned from 37% to 52% between 1990 and 2005, the contribution of the manufacturing industry increased only 2% from 25% to 27%.
2007-03-20 China Trade -- Going in One Direction
In February of 2007, China's trade surplus grew to a massive $23.7B, the second highest monthly surplus ever, which gave China a total surplus of $39.6B after the first two months of the year, which is triple the surplus accrued in the first two months of 2006.
The repercussions of this continually increasing surplus could be new tariffs and duties in the US and Western Europe as political populists and protectionists try to rein in the in the trade imbalance. Thus, anyone sourcing from China should not only be considering total cost of ownership today, but potential total cost of ownership tomorrow, before making a decision to source from China - especially in categories where the cost and time to switch suppliers -- and countries -- is significant.
Volatility in China is no different than volatility anywhere else - it's only more noticeable due to the degree to which the western world now relies on China for manufacturing and material goods production. Considering that in 2006, China's economy accounted for about one third in the total increase in world GDP and that China has been responsible for about 50% of the cumulative growth in economically sensitive commodities, such as oil and base metals, it's easy to see the effect that even a small blip in the Chinese economy can have on the west of the world.
So what can you do to protect yourself against the volatility caused by the Chinese economy, or any other economy, when buying products and value-added manufacturing services? First of all, understand what percentage of product cost is directly attributable to product cost and then what is the premium you are paying for value-add work performed by the supplier in the production process. Thirdly, you can create natural hedges by spreading the pricing of product bought between spot and forward pricing.
2007-05-14 Hidden Costs in the Chinese Supply Chain
According to an article in MHW Magazine, logistics costs in China are 18% of GDP, compared with just 10% for Europe and North America, primarily due to its infrastructure challenges.
The recently announced rate changes to China's VAT system is likely an attempt by China to keep China competitive on value-add products. Essentially, it appears that, like many developing countries before, China is using the export tariff system to discourage investment in some sectors of the economy and encourage development in others.
Points out an interesting article in a regional Maine newspaper that notes that US trade with China began back in 1784 shortly after the end of the Revolutionary War as a result of Britain blocking American trade with the British West Indies. A group of investors, led by a Philadelphia merchant, sent a ship to the Chinese port city of Canton to trade for tea. Trading expanded in 1844 after the British victory in the Opium wars which opened several more Chinese ports to American vessels by way of treaty.
Referencing an article in World Trade Magazine, this piece notes that distribution in India is hampered by three major factors: the infrastructure itself, the punitive taxation policies of the individual Indian states, and the fact that India is arguably the largest democracy in the world, even though all of the states are somewhat independently run. The independence granted to the states results in a lack of a national political consensus which makes it difficult for any enterprise to operate nationally.
Points out a recent BCG study on "The China Riptide" that dives into many of the landmines - as well as important mitigation steps to avoid unnecessary risk - that China sourcing creates from a logistical and supply chain perspective - such as lengthening supply chain and the overtaxation of US ports that are constantly congested in a form of virtual gridlock as they are just not built to handle the recent trade explosion with China.
Points out that many procurement organizations getting started in China -- or those who are not mired in China trade details -- don’t realize that much (and sometimes all) of the profit of their Chinese suppliers is tied up in the VAT rebate they get back from the government after each container ships. With the recent reduction and elimination of many VAT rebates, there are now a number of China sourcing deals that make less - or no - financial sense.
In raw materials sourcing, China prefers to source metals directly from the governments of the countries the raw materials come from in long-term off-take agreements that typically last 20-25 years rather than go through the London Metal Exchange. The London Metal Exchange, a consequence of the colonial economic construct, acts as a middleman and, like all middlemen, adds cost to each raw material purchase. The benefits of the exchange, besides being an open trading platform, are supposed to be assured availability and quality, among others, but it does not guarantee the availability to lock up long term supply - and for a country that needs a very large supply of raw materials to fuel its global growth, it is easy to understand why China is embarking upon the strategy that it is.
Stories like How one woman said 'No' to Chinese imports from the UK Daily Mail or http://news.yahoo.com/s/nm/20070628/us_nm/books_madeinchina_dc from Yahoo News may not seem very impressive because they don't have names like The New York Times or Wall Street Journal behind them, but this is where all great consumer revolutions begin. If this "movement" does actually gain steam, and more consumers come into the fold, costing retailers such as Wal-Mart money, there will be a change in how products are bought and sold within corporations. It doesn’t matter if it's rational or not. If American consumers decided they don't like the color Red, and weren't going to buy products packed with that dreaded color, there would be almost immediate changes made by the corporations to appease them. Thus, it's important that people start thinking about what would happen to their supply-chain if the anti-China consumerism mentality were to grow larger (or smear campaign by the media, depending on your viewpoint).
The double whammy of increased export trade tariffs and the reduction/elimination of Chinese VAT rebates have thrown many a buyer and supplier in a full blown tizzy since some companies think that "low cost country sourcing" or "global sourcing" is synonymous with "China Sourcing".
This posts discusses the importance of a proper LCCS strategy. Specifically:
- if you're not saving at least 35% on your parts/products, you should have two additional qualified suppliers - one domestic (or at least on the same continent) and one in another country or region
- even if you are saving at least 35%, if China is your sole source of supply, start looking now for potential alternate suppliers
- re-align your sourcing organization by skill
This is the fifth time since 2005 since rebates have changed and, cumulatively they will have a profound impact on the global supply market for certain commodities. Furthermore, the supply market for many of the products affected is already tight and this means that lead-times will become more extended and prices will be further strengthened just as consumers were expecting markets to begin to ease on the back of an expected slackening in the US market later this year.
This post presents some tips for North American Manufacturers to help them "right the ship" and take advantage of the increased costs that go hand-in-hand with China-based sourcing as a result of the new export tariffs and VAT rebate eliminations.
- be assertive and focus on your strengths and values as a preferred partner
- focus on the consistent costs
- focus on the fit - you speak their language, understand your vernacular, and your distribution costs are less, much less
- use your opponents weight to your advantage - advertise where your potential buyers are
Companies that source raw materials and manufactured goods throughout the globe need to have sound supply chain practices in place to insure that quality levels are maintained, regardless of where they source from. These practices should include:
- detailed supplier selection process that screens supplier manufacturing capabilities and quality systems
- robust on-site audit process to verify supplier systems and standards
- system whereby suppliers document product compliance and guarantee traceability with every shipment
- audit system to periodically check shipment compliance
- supplier scorecard that measures performance and compliance, and a corrective action system to drive continuous improvement
Remember that supply chains that are on the other side of the world need to be managed differently than supply chains down the road. It's easy to fall into the complacency trap and it often takes a few shocks to remind people of the risks that need to be mitigated in a global sourcing strategy. A critical area for companies to invest as they globalize their sourcing efforts is in-house supplier quality teams to work with suppliers, perform regular and unscheduled quality tests and trouble shoot problems on the ground in the supplier's home country, before they become significant issues in North America.
Global Sourcing is a very complex process with qualitative and quantitative factors sharing importance. Global sourcing creates a large number of options for sourcing professionals to consider during their supplier selection and supply allocation decision making process. Optimization can help with this dynamic decision making process by making sure every option has been considered, every stone turned.
It is important to understand the complexities (quantitative and qualitative) before venturing into global sourcing. The trade off analysis of qualitative and quantitative factors is a complex process -- much too complex to address with simple spreadsheets and what may have worked for another company may not work for yours. Scenario analysis, powered by optimization can do the 'leg work' for sourcing professionals by identifying the short list of options from all that are possible and bridging the gap between a sourcing strategy (people led) and its execution (computer led). Optimization based scenario analysis says 'tell me your strategy and I’ll show you its optimized execution plan'.
This posts notes how The New York Times picking up on the fact food safety concerns extend beyond Chinese imports. At a time when Chinese imports are under fire for being contaminated or defective, federal records suggest that China is not the only country that has problems with its exports ... In fact, federal inspectors have stopped more food shipments from India and Mexico in the last year than they have from China, according to an analysis of data maintained by the Food and Drug Administration." Furthermore, "federal inspectors refused produce from the Dominican Republic and candy from Denmark more often" than from China ... [Imports from the Dominican Republic alone were stopped 817 times last year, usually for containing traces of illegal pesticides].
The Chinese have a phrase to "describe people who make, sell or profit from fake or dangerously low-quality goods, in addition to the illicit products themselves. Literally translated, it means black-hearted." The phrase is "Hexin". Thus, contrary to the popular media, the Chinese are not out to produce poor quality products and take advantage of us.
2007-08-01 Factory Witch Hunts in China!
The post suggests that perhaps the solution to China's quality woes is to mandate a small export tariff or related tax that would go directly to funding more aggressive testing for certain classifications of products for the export market. Given low wage rates, China would have the potential to catapult itself ahead of other developing nations and existing superpowers from a product safety perspective while minimizing the costs involved by undertaking a program such as this. In addition, stronger product liability laws in China that would make the potential local and global law-suit costs of non-compliance make manufacturers think twice before cutting corners might be a good idea.
2007-08-10 Buick: Crap or Crème De La Crème?
Not only is Buick's supplier defect rate in China lower than in North America the cars, according to the Washington Post, are revered in the same way that Americans look at the BMW 3.0 CS and the original M5. This is because the Buicks in China are better than any most of us have ever seen or driven in the United States - solid and whisper-quiet, impeccable fit and finish, and awe-inspiring interior craftmanship. Why? According to a GM executive, "This is what the Chinese market expects from Buick."
So next time you get yourself worked up into a tizzy about China quality or safety issues, remember that GM historically made the clear corporate decision to produce cars with higher defect rates and quality issues in North America where such issues were long tolerated, while reserving the Lafite Rothschild of its product line for the Chinese market where such crap would not fly.
According to Walter Buczynski, "China is an interesting place to manage personnel. There are problems, starting with the educational system. Many classes are taught using memorization, and this can stifle creativity. Young workers seem to understand one way to do something but as soon there is a small change factor, then work stops or there is confusion. Giving project work may require constant follow up as to progress."
Furthermore, "an experienced person, with a Western company is a valuable commodity. Hiring them can be 20 to 30% higher than an equal with no western corporate experience ... then it is tough to retain them for more than a year or two, before they ‘jump ship’." In addition to cash, one strong motivator might be to give an aspiring Chinese executive the chance to immerse in international business cultures, especially the US. The United States often holds the same level of curiosity for the Chinese as China holds for us.
Quote's Brian Sommer of Services Safari who notes that he's "seen a number of Indian outsourcers report that rising wages, high attrition and a stronger Indian Rupee are not hurting sales or crimping profit margins. The Wall Street analyst reports seem to support the view. However, Nasscom is arguing the opposite saying that the Indian government needs to restore export incentives and/or other tax benefits to offset profit shortfalls caused by a rising currency." For those interested in comparative country economics, what’s most interesting here is that "India and China have two very different monetary policies. China is clearly following the export economy model Japan used so effectively during the 1960s and 1970s while India is allowing its currency to float".
Without question, the days of low-cost highly skilled Indian labor are behind us. While India's physical infrastructure may still looked like more like bombed out Beirut in certain areas than that of a fast growing economic superpower, there's no question that India's human capital infrastructure has arrived on the world stage -- both at home and beyond. And regardless of which classification that Brian suggests that individual Indian firms end of falling into, one thing is for sure. And that's each Indian firm will have to fend for itself in the open market without the same central -- and some might argue artificial -- monetary support that the centrally planned Chinese economy provides to the industries it wants to support.
The future of global trade depends on the willingness of procurement organizations to invest in supplier development and quality programs to apply local standards to products and services sourced around the world. Just as Dell learned with it's now famous call center issues in India, many manufacturers are now realizing that an underinvestment in supplier development and performance monitoring -- be it in China or the country next door -- can lead to catastrophic supply disruptions and/or significant negative PR.
One expert suggests that putting pressure on the Chinese to improve quality by investigating other low cost regions is a logical answer: "does it make sense for U.S. companies to look at other locations? Yes ... If I was sourcing heavily in China, I would be exploring alternatives like Vietnam and Cambodia [to put pressure on the Chinese]," one expert is quoted as saying. To this I would add the importance of working with Chinese suppliers to better understand their production and sourcing processes -- and to offer assistance and guidance where necessary. As I've harped on many times on this blog in the past, the Chinese are often very open to supplier development initiatives. But it's up to procurement and operations organizations to take the initiative before they're hit with quality or safety issues -- not after the fact.
2007-08-23 China: Investing in Inland Infrastructure
"Inland transport costs to the coast from provinces like Sichuan, for export to overseas markets, are often higher than the maritime transport cost from China to foreign destination ports, while inventory management, trucking and rail transport are currently inefficient." To help bring its inland infrastructure up to global standards, the Chinese government is investing in rail, among other areas, planning to spend "$20 billion on building and upgrading the country’s railway system, which should dramatically improve the ability to move containers in and out of inland regions from coastal port cities."
- China just does not have the physical infrastructure to maintain its current growth rate
- Northeast China is expected to exhaust power generation capacity by 2010!
- China, an emerging economy, is about to face a number of very significant problems simultaneously in a very short time frame - problems that the US, an established world superpower, has been battling for years with only limited success
2006-07-17 Innovation Always Matters
- Not all companies will be equipped to take advantage of the opportunities that exist and navigate their way around the quagmires of wage inflation, skilled employee retention, energy crisis, and over-extended infrastructures
- Freight costs are increasing around the globe, not just to, from, and in North America and parts of China can still be quite distant from other parts of Asia
2006-09-07 Can China be Innovative?
- It takes more than funding, stemming the "internal brain drain", and a protection of intellectual property rights to build a knowledge-based economy - it takes a culture
- A huge obstacle is the nature of China's educational system, which stresses conformity and does little to foster independent thinking
2006-09-08 Aisle Warfare in China?
- China is transitioning to a westernized mass-production and mass-consumption society
- As the China retail market expands, one might find that one will be low cost country sourcing in other parts of Asia for a growing China market while volume-based low-cost country sourcing in China for the North American market
- When securing partnerships with local retailers, be sure to factor in all of the incidental costs and fees that will be required to successfully promote the products being sourced
Summarizes the MFG.com and Aptium Global webinar on "Surviving China's Rapidly Changing Sourcing Tides" that discussed the current state of China sourcing amidst the frenzy induced by the current VAT rebate changes that went into effect on July 1 where China cancelled VAT rebates on approximately 553 products and reduced the VAT rebates on approximately 2,268 products. Typically, Chinese companies are supposed to pay 17% VAT when they sell a product. Until recently, the VAT rebates drastically reduced (or eliminated) this tax on exports - but now that they are being eliminated, some products could end up costing you 17% more.
The apparent purpose of the VAT Refund Change is to reduce the trade surplus, eliminate high energy consuming & resource intensive exports, avoid products triggering trade functions, and give China more spending power. As a result, there are will be increased export prices on lower value add products such as fasteners, extrusions, etc; serious financial pressures on Small and Medium enterprises in China with low margins, especially going through trading agents, and some of them will likely go out of business; and increased opportunities for imports into a growing, and opening, Chinese markets.
What is really important to note is that, despite the recent smear campaign (and despite the fact that since 2005, 431 Chinese-made goods have been recalled in Canada alone), many China suppliers consistently perform well and to high quality standards. For instance, MFG.com tracks ratings of all its suppliers, and 92% of China suppliers receive high or perfect ratings on quality, 96% of China suppliers receive good or excellent ratings on responsiveness, and 90% consistently deliver early or on time, giving them a rating of very good or excellent 72% of the time, and good or better 92% of the time. In other words, the vast majority care about the products they make and will work with you to correct any issues - but you have to manage them as you would your own plant and make sure quality materials, processes, and systems are being used.
Furthermore, as Mitch Free, founder of MFG.com, pointed out, the recent changes, despite the fact that they are a big deal and will continue to be a big deal, are not all bad news. First of all, they present an interesting opportunity for American Suppliers to bet aggressive and start to bring business back home. They will need to employ advanced technologies and a great strategy to do this, but that's not a bad thing. Furthermore, he also points out that this will force Chinese suppliers to elevate to a higher level of technology to compete, especially on lower value-add products, and this is good for everyone! Mitch, in responding to a listener question, also pointed out that a higher-value finished goods economy, like the one that matured in Japan and Korea is undeniably coming, but that the question is, as always, when. Due to China's sheer size, it's likely to take a long time. It's also up to the government, who appears to be in total control of their market with their power to control exports, give and take VAT rebates, alter the value of their currency, etc.
Summarizes the MFG.com and Aptium Global webinar on "Surviving China's Rapidly Changing Sourcing Tides" that discussed the current state of China sourcing amidst the frenzy induced by the current VAT rebate changes that went into effect on July 1 where China cancelled VAT rebates on approximately 553 products and reduced the VAT rebates on approximately 2,268 products. Typically, Chinese companies are supposed to pay 17% VAT when they sell a product. Until recently, the VAT rebates drastically reduced (or eliminated) this tax on exports - but now that they are being eliminated, some products could end up costing you 17% more.
Lisa Resiman, of Aptium Global, noted that there are a number of different factors impacted your China price. These factors, most of which are common to most Low-Cost Country Sourcing Destinations, include:
- raw material costs
- value-add services
- currency fluctuations and exchange rates
- export tariffs
- VAT and rebate rates
- packaging costs
- inland freight costs
- outbound ocean freight and air freight costs
The current situation with China is that multiple cost elements are increasing at the same time: raw material costs are consistently rising (as China consumes more and more raw materials for its own uses), exchange rates are falling with the weakening US dollar, China is under pressure to increase the value of its currency - further decreasing the favorable exchange US business are used to, and the VAT has been slashed or removed on over 37% of the total classifications.
The degree to which you are impacted ultimately depends on what savings percentage you are currently getting on the products you are sourcing, whether it's in the low 10% range, the medium 10% to 20% range, or the high 20% + range, and whether or not the products you are buying are value-add. If you're in the high savings range, chances are you're not going to be impacted much, if at all, by the recent VAT rebate reductions and eliminations and don't have much to worry about. The same holds true if you are in the medium savings range and are sourcing value-add products, which were not impacted by the recent cuts since China is trying to push those exports. But if you were in the low-savings range (which made sourcing to China a questionable decision in the first place), and especially if you were buying products with little or no value-add, chances are that you have been impacted by the recent VAT rebate reductions and eliminations, since those products with minimal value-add and those products very near to a raw material state have been hardest hit and, recently, have provided low savings opportunities.
What should you do? The first thing you should do is assess the impact of the recent changes (VAT rebate reductions and eliminations, rising material prices, weakened exchange rate) on your total landed cost, and, if necessary, your total cost of ownership. If the impact is significant, or significant enough to reduce your savings to the low end of the spectrum, then you need to consider reducing your risk by identifying other alternate sources of supply, including domestic sources and nearby sources. If global is the way to go, start thinking about Vietnam and India. It might also be time to start considering Mexico and Latin American sources of supply again.
If you've been moderately hit, for example, instead of saving over 20%, you're now saving only 10% to 15%, then, if you're buying from a trading company or importer, and your volume is significant enough, it might be time to consider a direct relationship or a new source of supply in China that would allow you to take advantage of a direct relationship.
Basically, if you're sourcing those products that are a good fit for LCCS, you might be okay, but you should still review your landed cost model. In general, a product is a "good fit" for LCCS if there is significant volume, the product can be made with (a mix of) unskilled and / or semi-skilled labor, production is regular and repetitive, technology sophistication can be leveraged, there are infrequent design and tool changes, the IP is not highly sensitive, the content is mostly (available) raw materials, JIT delivery is not required, and quality requirements are not unduly high.
And when you're considering sourcing from China in particular, you need to take the following considerations into account:
- China public policy is a form of political risk (tariffs, duties, rebates, etc.)
- Currency risks need to be considered (weakening US dollar, increasing pressure on China to raise the value of the Yuan)
- Security risk
- Supplier Capabilities (especially on the quality side - some are great, but as the recent recall scares in North America have proven, some are not)
- Shipping & Logistics Costs (especially from inland suppliers)
- Supplier Stability & Volatility (some suppliers are hit hard by the recent VAT rebate reductions and eliminations)
Lisa's analysis and advice concluded with the following:
- If you don't have a detailed TCO (Total Cost of Ownership) model, which includes a detailed landed cost model, develop one.
- Consider dual-source vs. sole source strategies - especially for low(er) cost categories.
- Near-shoring (e.g. Mexico) is another viable option and can help ensure steady supply.
- Supplier identification and qualification remain key activities - consider this carefully when looking at new countries.
- Don't let the hullabaloo get to you and rush to leave China. If your parts are (high) value add, you could still be doing quite well. Update your total cost model and price alternatives first before making hasty decisions. Remember the findings of the MFG.com survey we summarized in our last post, only 26% of IPO's (International Purchasing Organizations) are expecting purchase prices to increase by over 5% and only 18% of suppliers are expecting to need to increase purchase prices by over 5% as a result of the current VAT rebate reductions and eliminations.
Strategic Sourcing Europe
2006-04-19 A 'new China' for low-cost sourcing
- Sir Anthony Joliffe (a former Lord Mayor of London) believes the future of low-cost country sourcing lies in India and Brazil and that China will lose its competitive edge
- The approach commonly used by large supermarkets to continually drive down supplier prices is unsustainable and short-sighted
- "The only thing China offers is low-cost labour. When you take that out of the equation they can't really offer anything else."
- Near-shoring is still highly prevalent today and the situation will persist to a large extent at least until 2010 and at least half of the companies surveyed in a recent Ariba / SMI survey rank their home country among their three most important sourcing locations
2006-05-20 The Windy City: Blogger Turned Futurist
- According to Jason Busch, LCCS will become irrelevant as enterprises begin to market and sell into low-cost regions.
- Jason Busch also says that overall country competitiveness and flexible strategies will trump labor costs.
2006-07-21 Could the U.S. Be the Next Low Cost Country?
- There are early indications that a sluggish domestic economy, rising energy prices, and tightening financial policies are transforming the U.S. into an attractive supply and manufacturing region for foreign companies
- Even low-cost countries are now trying to capitalize on the weaker U.S. dollar by snatching up machinery and software from U.S. manufacturers in order to foster their next wave of growth
- U.S. manufacturers will be wise to consider socially responsible supply management and manufacturing strategies in developed and emerging markets around the globe
2006-08-30 New Supply Risk: Political Payback
- Supply managers may soon need to grapple with another nemesis: higher tariffs on key imports; Senate Finance Committee Chairman C. Grassley is pushing for the White house to cease U.S. tariff breaks to India & Brazil
2006-09-29 Is Near-Shoring Back in Vogue?
- A near-shoring strategy can add more flexibility and control over the end-product, transportation and handling costs, and enable a firm to quickly respond to style changes and spikes in demand.
- A NAM study released on this date found that U.S. manufacturers operate at 31.7% structural cost disadvantage to their foreign competitors.
- The disadvantage can be offset through a mix of supply strategies and policy changes; in particular, socially responsible supply strategies, policy changes to increase tax breaks for commercial investment in infrastructure and training, and increased investment in alternate energy and environmentally responsible materials.
2006-11-02 Supply Risk Antidote: Go Local?
- Avoiding possibly logistical snafus is one reason some manufacturers in the aerospace, high-tech, automotive, and healthcare industries pay a premium to source critical parts locally.
- Strategic sourcing should be less about finding the lowest cost supplier and more about aligning the sourcing and supply allocation decisions with the needs of the business.
- Engaging blindly in any supply strategy - whether buying from China or adopting technology - is a dangerous proposition.
- There are countless stories where companies lured by the low-cost country siren song have seen the material-cost savings of offshore supply evaporate due to the unforeseen 'hidden' costs of transportation, handling, and tariffs, changes in regulatory policy, or quality or performance issues with product or delivery.
- Supply management executives need to adopt a 'right-shoring' approach that defines sourcing strategies based on the objectives of the business first -- and on total supply costs (including material and landed costs) second.
2007-01-25 LCCS: CEOs See Opportunities and Risks
- A new Economist survey notes that CEOs cited global sourcing as the second-biggest force impacting the global marketplace
- CEOs no longer view sourcing from LCCS as a slam dunk for cost savings
- Executives now understand some of the risks involved with sourcing from emerging markets, which include skills shortage, logistical challenges, economic instability, and sustainable supply
2007-03-29 LCCS: It's a Lot Closer Than You Think
- Risks, lead-times, and hidden costs of emerging market hotspots -- particularly India and China -- should (soon) make these faraway regions less attractive as sourcing destinations
- Findings from a new study from A.T. Kearney, strongly suggest that near-shore destinations -- particularly Argentina, Brazil, Chile, Costa Rica, and Mexico -- could unseat traditional offshore regions, such as India and the Philippines
Notes that the Bush administration announced plans to levy new duties on imports from China, most likely in an effort to reduce the U.S. trade deficit with China that hit a record $233B last year.
Notes that a new study from Boston Consulting Group notes that the China sourcing opportunity, despite the recent import duties, export duties, VAT eliminations, and quality problems, is as great as ever.
The report offers a clear direction on the organizational, cultural, and supplier management strategies one needs to adopt to maximize the China sourcing opportunity for your company, as well as the hurdles that must be overcome, including internal resistance, varying levels of supply base development across industries and spend categories, and varying success of implementing sourcing and supplier management best practices.
2007-08-18 Fear and Loathing in Global Sourcing
Quotes an article in the USA Today that reports that some toy makers are bringing manufacturing back to the U.S. and that they plan to leverage their U.S. sourcing strategies as marketing weapons to win more shelf space at retail outlets and a greater share of concerned parents' wallets.
Michael Lamoureux, PhD
of Sourcing Innovation David Bush, Pro to Know