Cheap, but is it worth it?
IBM's John Paterson, Nortel's Jeff Townley, and Freescale's Tom Linton are just some global CPOs relocating to Asia to hand-pick the proverbial low hanging fruit.
Industry watchers are predicting more CPOs from large MNCs will follow suit - and they are probably right. Put under continuous pressure to deliver bottom line savings in mature home markets, it comes as little surprise that more CPOs are looking to source in low cost and potentially high growth countries.
Studies have also shown increasing interest in sourcing in Asia, and particularly in China: B2X's survey of American companies found that nearly 41% were "interested" or "very interested" in purchasing goods from China. Another study by Boston-based Aberdeen Group also found that CPOs rated low-cost country sourcing (LCCS) a top priority, predicting that companies plan to double their spending with offshore suppliers in the period between 2004 and 2008.
Of course, the cost benefits of sourcing in the low cost BRIC (Brazil, Russia, India and China) countries are hard to ignore. According to Ariba, with its low minimum wages, these countries can sometimes provide goods 62% cheaper than those produced in the US and Western European suppliers. The figure alone is enough to pique the interests of CPOs and CFOs who are constantly on the lookout for better bargains.
The pressure to deliver bottom line savings is even more pronounced now, Robert Santoli, president and founder of Procurement Analytics says, making sourcing in BRIC countries even more enticing.
"There has been a lot of corporate pressure on CPOs to deliver savings. The bar has been raised," Santoli says. "Now we're seeing organisations tying personal goals and bonuses in with savings - they're not joking around anymore."
Santoli has over 20 years of experience in spend management under his belt and with this has started his own strategic spend reduction consulting company based in the US.
Despite being pro-LCCS and its cost savings, Santoli warns of possible hidden costs when sourcing in these countries, especially where the CPO is not physically present.
Danger: hidden costs ahead
"The biggest, most risky element when sourcing in China or other emerging countries is timing. CPOs have to understand that processes take longer in emerging countries than they do in the west," Santoli says.
More specifically, companies planning to source in low-cost countries should allow about four months lead time, coupled with a generous dose of risk management, he says.
"The problem is that procurement people can't do anything until the sales, designers and top management finalise what they need," Santoli states. "The reality of this is that all these people are either busy or travelling and it's hard to get a final answer. By the time everything is finalised, there isn't enough lead time for procurement to source from China."
A longer-than-usual lead time is needed not just because processes take longer but also to allow wriggle room for supply chain disruptions. "Locating a manufacturing facility or dealing with a supplier location far away from a port involves a much higher cost and associated lead-time risk when compared to a western country," says Ravi Kumaraswami, Ariba's managing director of Asia Pacific. Some of the risks that have been brought to light when sourcing in China include certain sectors becoming capacity constrained, ports getting increasingly congested, escalating worker salaries and intellectual property theft.
Further, basic infrastructure like roads, railways and ports may not be as established as they are on home turf, making these low-cost countries potential supply chain traps, says Boston Consulting Group (BCG).
"In their rush to source from China, many companies are blindly walking into a strategic risk," write Kevin Waddell and George Stalk Jr, experts at BCG in their new report Surviving the China Riptide: How to Profit from the Supply Chain Bottleneck.
"The risk 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 two experts believe these supply chain risks should be sufficient reason for US and European companies to move their manufacturing back to Mexico or Central and Eastern Europe, despite the comparatively higher wage costs.
According to Stalk and Waddell, supply chain disruptions seriously undercut the ability of manufacturers and retailers to satisfy customer demands. They also add costs by forcing companies to increase inventories, juggle production and shipping schedules, and discount the prices of goods that weren't in the right place at the right time.
The greatest cost of all, however, the BCG experts say, is the hidden cost of "unrealised" profits companies lose when they can't meet their customers' needs.
Santoli however, advises companies to try a different route. "It's all about better planning," he says. "If you have 8-12 weeks lead time, you're in good shape to source in emerging countries."
Kumaraswami too, agrees that CPOs should manage their lead times better and plan ahead. "There are ‘choke points' in both the Chinese and Indian systems that can severely impact supply chain efficiency," he says. "These choke points could be congested roadways, badly maintained bridges and roads, delays at the state border crossings, potential interruptions from bad weather or even piracy and robbery.
For example, a recent Ariba study found that a 1,350 mile truckload shipment from Calcutta to Mumbai was found to take about eight days, spending 32 hours waiting at toll booths and checkpoints at an average speed of about 11 km/hr. Comparatively, a similar trip distance in Europe would take two to three days.
"Transit time computation should take into consideration potential delays at the ports, or at these choke points in the system," Kumaraswami says. "It is prudent for western companies operating in low cost countries to make adequate cost provisions for expedited shipping in case of emergency."
Product quality at risk?
While Mattel's recent recalls of as many as 18 million China-made toys have put many parents on high alert, many supply chain and procurement directors believe this has merely put a dent in China sourcing.
"In the light of recent ‘Made-in-China' product recalls, there may be an immediate ‘avoid China-made products' syndrome," says Dr Lye Wei Moon, vice president of operations at YCH.
Dr Lye believes there will be no indication that companies will shift their sourcing to other countries simply because the move does not fundamentally address the problem of quality control.
"China will still continue to offer a compelling proposition with its low cost base and government incentive schemes," Dr Lye says.
One thing is for sure, the product recalls have raised a clarion call for better supplier evaluation, design specifications and supply chain control.
"In the long run, the recent product recall issue will benefit the Chinese industry as it provides an impetus for companies to enhance their supply chain integrity and for suppliers and even subcontractors to raise their standards," Dr Lye says.
The movement of the CPO
While globalisation has spawned numerous nuggets of advice for sourcing remotely, large corporations are still keen on sending their CPOs to Asia to source for the products themselves - and with good reason.
"The procurement function is a lot to do with having the human touch, creating a relationship," Santoli says. "More CPOs are moving to low cost countries these days because they want to be the main point of contact and establish a relationship with the supplier."
It also wouldn't hurt to be physically present to know exactly how long the entire process takes, as well as be present to put out any supply chain fires along the way.
Placing a CPO in the sourcing country will ensure that quality can be checked before goods are sent back to the consumer markets of Europe or the US, says Nis-Peter Iwersen, vice president of International Procurement at Danfoss.
Danfoss, which aims to have 40% of all products sourced from low cost countries by 2008, of which 50%-80% are sourced from China, believes LCCS strategies is a total business strategy, meaning there must be consensus from all business units, and not procurement alone.
"It is important to have a clear process and outline what TCO savings potentials exists before setting up aligned targets for it," says Iwersen.
At the end of the day, CPOs are moving nearer to their suppliers to get to know them better. "With the CPO where the supplier is, they have a better sense of exactly how long it takes to offshore, they can do site visits and ensure the manufacturer stands by the product he supplies," states Santoli.
It's all about making more informed purchasing decisions, he says.
Box: True story
Robert Santoli, president of Procurement Analytics, shares a bad experience he had when sourced glassware in China for a large global company.
Santoli said his company had specifically told the China supplier exactly which shade of green he needed, and provided them with a colour swatch for comparison. “However, when they were all manufactured, they were the wrong green.
“We ended up with over 250,000 glasses of the wrong colour, and our supplier just didn’t want to bear the added cost. That’s how it typically happens in China – suppliers normally ask for the money upfront.”
What’s worse is that China currently still lacks legal backing for when these situations arise. “When something like this happens in the states, there are ways to solve it through the law. That’s not really the case in China right now,” he says.
Tip Box
Evaluating suppliers and negotiating contracts in low-cost countries:
• Fully research your supplier prior to engagement
• Demonstrate proper business etiquette and professionalism
• Gauge your contact, level in the organisation and his/her group profile
• Ensure business economics is a win-win opportunity for both and present a long-term vision for the partnership
• Implement and enforce rigid timelines
• Gauge transportation and logistics requirements carefully
• Have knowledgeable on-group local resources
• Communicate regularly with your supplier
- Ravi Kumaraswami, Managing Director, Asia Pacific, Ariba