June 20, 2011
by Michael Power
PURCHASINGB2B MAGAZINE: MAY 2011
Picture it. You source electronic components from a supplier in southern China for significantly less than what it would cost to source down the street. Your calculations say you’ll see savings of between 20 and 40 percent. Sounds pretty good, right?
Problem is, low cost country sourcing (LCCS) isn’t necessarily that easy. Hidden challenges may spring up, including longer lead times, hidden costs and quality and specs that aren’t up to par. That’s not to mention the risks of natural disasters, port delays and other logistics hassles, labour unrest overseas and fluctuating currencies.
Where in the world?
But the challenges don’t mean organizations have stopped looking abroad for sourcing opportunities. The initial push in the 1990s towards China was followed by a retreat, as some companies felt they had been burned by the higher-than-anticipated costs of LCCS. Post-recession, many companies are returning to sourcing abroad.
So what’s new in the LCCS landscape? According to Harvinder Sembhi, vice-president of supply base solutions with Celestica Inc, the question of where to source depends on what industry you’re talking about.
“If you look at the electronics manufacturing industry specifically, you’ll see practically everybody in China,” Sembhi notes. Historically, the focus for electronics has been around Shanghai and southern China, especially the city of Shenzhen in Guangdong province. Those areas boast infrastructure such as facilities, buildings, roads, and supply bases that have developed as clusters, he says.
But rising labour costs along the country’s eastern seaboard have driven some organizations to regions further inland, such as Chengdu, the capital of Sichuan province, Sembhi says.
“There’s a lot of focus now around going further inland,” he adds. “China has done a good job around infrastructure in terms of highways, in terms of the logistics capabilities. In cities like Chengdu, there’s a lot of labour available. So rather than (workers) coming to the factories in the south, companies are going to those regions.”
While there’s a march among some companies into China’s interior, there’s also a trend towards “de-risking” supply chains by taking some procurement eggs out of the China basket, Sembhi says. Organizations are looking to other countries such as Vietnam. The strategy has led to limited success, he noted, since infrastructure there remains a challenge.
There are a lot of questions surrounding whether to source from India, where labour costs are starting to become slightly more attractive when compared to China, he notes. But India’s logistics infrastructure—as well as local supplier availability—remains limited.
“While India makes sense from a labour cost perspective, the fact [is] that they still don’t have a local supply base infrastructure,” he notes. “And then with the oil and the transportation, you have to take a balanced view around cost of freight. You still have to import a lot of components out of China, as an example. How does that balance out against efficiencies you drive through labour costs?”
Cheaper in the interior
David Morgenstern, senior executive at Accenture, notes cost was the main factor influencing companies to source from China’s interior. While the eastern coastal zones offered high-quality suppliers, the price tag remained higher than suppliers from the interior, he says. Still, challenges remained for organizations looking to source from new regions of China, including costs associated with raw materials and transportation.
“Internal transportation in China is certainly improving,” Morgenstern says. “But there are a fair number of hidden costs which need to be looked at. Costs of energy inputs, while in many cases subsidized, are important inputs into the calculation.”
Interest in sourcing from Vietnam depended on the industry, Morgenstern says. That country saw more traditional “cut-and-sew” operations—luggage, knapsacks or school supplies—rather than sophisticated technology or electronics components, he says.
“China has a significant supply chain in its own right, more so than Vietnam,” he says. “When you’re trying to source more complex raw materials, China is going to be a better bet.”
Still, for less complex items, Vietnam is picking up some of China’s share, Morgenstern says. As for India, he notes, the focus there remained on outsourcing services, with some pockets of manufacturing.
Total cost of ownership
While inexpensive labour influences companies to believe they can save money sourcing abroad, it’s important to consider all potential costs, says Sembhi.
A total-cost-of-ownership approach helps organizations realize the extent of the final bill for LCCS. Companies can then better plan for unforeseen contingencies such as high fuel prices, bad weather, freight costs or seaport and airport delays that get tacked on to the price of the goods. From there, organizations are able to compare that price with the cost of sourcing locally to decide which is best.
“The product price, which has the labour content baked in, is one angle to look at,” Sembhi says. “I think you’ve got to look at the time the product spends [in transit]. If it’s a bulky product, for example, it’s going to be more expensive to ship by air, so you ship by boat.”
Before deciding to source abroad, companies should also consider the range of logistics challenges faced when outsourcing to suppliers in distant locations, says Jim Ramsay, vice-president of international freight forwarding for UPS Canada. The longer the supply chain, the larger the risk something may go wrong.
Goods hit snags due to port congestion, language barriers or delays from natural disasters such as the eruption of the Icelandic volcano and the recent earthquake and tsunami in Japan.
“The longer the supply chain and the greater the distance the goods are moving, the more variability they’re going to be exposed to as they begin at their origin thousands of miles away,” Ramsay says.
Before wading too deep into LCCS’s waters, Ramsay recommends companies develop a sensitivity analysis around their decision. That involves investigating and considering factors affecting overseas supply, such as the effects of natural disasters or if the cost of transportation increases significantly. Next, organizations should consider drawing up a contingency plan to provide a back-up strategy.
Longer supply chain = higher inventory
While Asia remains a good choice to source smaller goods such as electronics, Mexico offers a “nearshore” option for organizations looking to build international supply chains for larger, bulkier products.
Whirlpool Canada produces front-load laundry machines and all the company’s top-mount and side-by-side refrigeration units in Mexico, says Susan Promane, director, supply chain, parts and service with Whirlpool. In fact, she noted, between 25 and 30 percent of the company’s product is manufactured in Mexico.
Setting up in that country has led to challenges, Promane said. For example, although closer than other LCCS options such as China, manufacturing in Mexico still means the company’s product is further away from the market than it was with local suppliers. That means a four-week lead time, rather than the two-days afforded by manufacturing its products in the northern US. Whirlpool must be careful to ensure its inventory levels are correct, as well as accurately forecasting future levels.
“You can’t react as quickly,” Promane says. “What it’s done is made us take a re-look at making sure we have the right safety stock—if you’re farther away the math says you’ve got to hold more inventory.”
LCCS has its place in the supply chains of many companies and the practice is unlikely to disappear anytime soon. But companies should ensure they take into account everything involved in doing business overseas—as well as having proper contingency plans— before diving in head-first. b2b