By John Brockwell
Is global sourcing really worth it?"
For a variety of reasons, executives at many companies are reconsidering whether or not they should be buying products from international sources. Companies are facing higher than expected costs of materials and labor, a declining U.S. dollar and rising fuel prices, while some are experiencing the persistent quality issues that we continue to read about in today's headlines.
Concerns regarding quality affect consumer choices. A Reuters/Zogby poll recently released on September 19 found that 78 percent of Americans worry about the safety of Chinese imports, and 25 percent have stopped buying food from China. In the poll, 35 percent of respondents were "very worried" and 43 percent were "somewhat worried" about the safety of Chinese goods.
Not only must executives be concerned with the quality and reputation of their own products and brand, but now there are risks of being associated with a larger brand — "Made in China." At a time when China has become the largest source of imports for the United States, company executives are evaluating their reliance on China-based suppliers. Though the government of China is working to improve their brand image by instituting and enforcing quality standards, it might not be enough to stave off buyers from reconsidering their sourcing decisions. International sourcing and procurement can have high rewards, but those rewards bring additional high risks.
Advantages of Global Sourcing
Many companies are still making procurement decisions based primarily on unit cost. The global explosion of connective technologies, well-educated workers and capital has made it possible to, almost literally, have the entire world compete for the opportunity to sell to your business. And with that competition comes a tremendous opportunity to reduce costs, especially labor cost. Of course, many companies procure goods from global sources for other reasons as well, including:
- Access to fresh research, design or specialized intellectual capital.
- Availability of new technology and capacity. Many companies source overseas because domestic suppliers lack the capacity and are not making the necessary investments to stay competitive.
- Plans to sell or service locally. Some companies source locally to help break the barrier to local market entry. Or their customers have now moved manufacturing processes to that country and want to be serviced locally.
- Proximity to raw materials.
- Superior quality. Many companies praise the quality of international source product compared to U.S. products. This is typically due to supplier investment in technology and capacity to attract global business as mentioned above.
Five Critical Questions
So how can procurement, supply chain and operations executives help their companies reap the rewards and mitigate the risks of global sourcing? By asking five key questions executives can make a richer decision about the initial transaction while establishing a framework to regularly evaluate the total product lifecycle:
1. What are the specific parameters and assumptions of this transaction that make this a good business decision?
- Payment Terms: What are the Incoterms and payment terms? Do the payment terms support our goals for Days Payable Outstanding? Do the payment terms negatively impact the supplier's working capital structure?
- Direct Costs: What are the cost of raw materials and labor that go into the process?
- Delivery Costs: What will be the total landed cost or delivered cost?
- Planning: Do the planning processes and information flows between our company and the supplier align (i.e., forecast, change orders, order lead times, lot sizes and set-up times, transit times, etc.)? How about between our supplier and their suppliers? What is the critical path set of parts we need to be concerned with?
- Working Capital: Will there be any additional working capital requirements for holding more inventory?
- Flexibility: What is the ability of the supplier to react to upside demand? What is the downside risk if the forecasts don't materialize?
- Quality: What are the required quality standards and where in the process does it make sense to inspect for quality?
2. What are the macro-economic and geopolitical assumptions that could impact this decision through the lifecycle of the program?
- Direct Costs: What are the forecasted raw materials, labor, and energy costs?
- Financial Impacts: What are the forecasted inflation rates? What are the forecasted currency exchange rates?
- Geopolitical Environment: What is the state of affairs between the supplier's country with the U.S., EU, and other markets for your product? Is there escalating trade sanction rhetoric? Are there specific anti-dumping or countervailing duty cases between the two countries for your industry? Any quotas or safeguard measures?
- Supply Chain Risk: What supply chain interruptions can be expected for this trade lane? Is there a risk of natural hazards, i.e., weather? Don't forget to anticipate labor strikes and the frequency of port congestion?
- Special Trade Preference Programs: Are there any duties on your product from this country? Are there any current or proposed Free Trade Agreements that could impact the product from this source?
- Other Government Requirements: What government agencies have jurisdiction of your product (for example, FDA, FCC, or EPA) and how does that agency view products from that source? Is there talk of increased inspections? Are the documentary requirements becoming more stringent?
3. How do we monitor all of these assumptions for changes?
- How timely can we monitor customer demand and alter forecasts?
- What sensing mechanisms can we build to monitor changes to raw material, labor and energy costs? At what point does an inflationary pressure create a problem?
- At what point does a shift in the currency exchange rate change make this a sub-optimal decision?
- What legislation or court cases are in progress that could change our assumptions? For example, recent U.S. legislation requires over the next five years that all maritime cargo be scanned in the foreign port prior to loading onto the vessel and three years for air cargo on passenger flights. If some ports are having issues with congestion now, then this may further exacerbate the problem.
- How can we identify and stop a quality issue before the goods are shipped?
- How can we be alerted to delays in the supply chain and how can we best react to those changes?
4. What are the alternative sources? And if there are none right now are we actively trying to develop alternatives?
- What are the alternatives not only for the product supplier, but also logistics providers, physical logistics routes, ports, etc.?
5. What is our exit strategy?
- Take a page out of the risk management playbook of stock traders and poker players that understand high risk and high reward. Know before you award the sourcing how much you're willing to risk and when you'll need to get out.
Is Global Sourcing Worth It?
Are the benefits of global sourcing really worth the challenge? Global sourcing can be a great tool to drive efficiency and help gain access to new markets. However, it is not a strategy to be undertaken with little thought and many assumptions. It's important to analyze the role global sourcing plays in your organization's overall strategic plan. Asking the right questions not only before making the sourcing decision, but also regularly throughout the lifecycle of the transaction can help mitigate your risk and improve the odds that the answer for your sourcing question is "Yes."
About the Author: John Brockwell is vice president for global trade management at JPMorgan. He has an extensive background in the global trade business and process evaluation, logistics planning and decision support systems. As the global supply chain management practice leader, his focus is on finding opportunities for businesses to optimize their international trade by improving costs, cycle times and quality and by minimizing risks. Supply & Demand Chain Executive named him one of the magazine's 2007 Pros to Know for his work in promoting awareness of the financial supply chain and the need to integrate the physical and financial value chains. More information at www.jpmorgan.com.