Supply Base Localization: A Different Look at Low-cost Country Sourcing

The trend to move manufacturing to low-cost regions is becoming pervasive. Companies of all sizes in nearly every sector of business in the United States and Europe are developing and implementing strategies not just to source from low-cost regions but also to actually produce goods in those countries. The reason is simple: low costs in high growth markets can create significant competitive advantage. There is one area of cost reduction, however, that has yet to be fully realized: ensuring that the supply base of a relocated manufacturing operation has been optimally localized.

Supply base localization is often the last of many operational aspects to be addressed when an overseas manufacturing site is established. Many companies place higher priority on activities such as greenfield-versus-brownfield investment analysis, hiring of local sales and service teams, relocation of manufacturing assets and technical resources, and the establishment of inbound and outbound logistics than they do on local sourcing strategies. Unless local content requirements, punitive import tariffs or logistics costs exist, it is very common for companies to maintain their current supply base in high-cost regions and simply have their suppliers ship to the new region, be it Mexico, China or Eastern Europe. While this is rarely intended to be a permanent strategy, it often stays in place for many years, essentially leaving a large savings opportunity on the table.

Weighing the Risks

In today's global economy, the opportunity costs of maintaining status quo are substantial, and the reasons to localize are compelling. First, a non-localized international inbound supply chain (be it Wisconsin to Mexico, Wisconsin to Shanghai, or France to Slovakia) creates a lead time and inventory cost burden on new manufacturing facilities. Second, as quality gaps for most components have all but disappeared in low-cost regions, a local supply base can deliver most components and inputs at a significant cost advantage over competitors in higher-cost regions. And third, a local supply base can grow from simply supplying the new facility in the low-cost region to supplying facilities on a global basis under preferred terms and conditions.

So why is it still common to find global suppliers in low-cost regions when alternate sources of local supply exist? In many cases, it's due to an "if it's not broken, why fix it" mentality. There is both effort and risk in re-sourcing any component, especially when internal resources, both technical and purchasing, may not exist or be fully ramped up in a given low-cost region. So even if savings of over 25 percent can be achieved, local manufacturing executives may not want yet one more task — and a potentially disruptive issue — on their plate, when their existing inbound supply chain is working well. Moreover, many companies simply lack purchasing staff that can look at all categories of spend across the manufacturing facility. While global commodity managers may be in place at corporate headquarters, they are equally challenged to find local supply alternatives.

When to Re-source

Despite these challenges, best-in-class companies are prioritizing supply base localization, either as part of the initial manufacturing relocation or in conjunction with an overall supply base optimization program that carefully analyzes total costs to determine whether local or global suppliers best meet cost and production requirements.

A tier-one automotive company, for example, prioritized supply base localization as it expanded manufacturing to China earlier this decade. The company recognized that qualifying parts from local Chinese suppliers in parallel with importing parts during the plant validation phase eliminated risk and future revalidation costs. Therefore this company placed a sourcing team on the ground six months prior to initial plant production, resulting in a highly localized supply base and maximum cost savings from the low-cost manufacturing strategy.

For companies that choose not to localize at launch, cost savings can still be generated while minimizing re-sourcing risk. For example, a leading global manufacturer of ATMs that had recently expanded its manufacturing footprint to China chose to localize its supply base for custom components that did not make economic sense to import from incumbent suppliers outside of China based on a total-cost-of-ownership analysis. Leveraging the technology, commodity expertise and low-cost-country sourcing services of Ariba to support its internal teams, the company identified and pre-qualified potential Chinese vendors, negotiated based on a comprehensive request for quote (RFQ) document and provided on-the-ground support for critical supplier transition and first article acceptance. As a result of the project, the company not only reduced the purchase price of the components, but also improved other total cost factors by significantly reducing lead times. This company is now looking at other opportunities throughout its global supply chain to ensure that it has optimized the usage of local suppliers whenever applicable.

Successful localization can be achieved post-launch by: 1) identifying the highest potential categories to localize through a total-cost-of-ownership analysis, 2) staffing a local team or utilizing a third party to find and negotiate with new suppliers, and 3) providing strong engineering support (often from the head office) to ensure smooth part transition with new local suppliers.

When China Is Not the Answer

While the argument for supply base localization is clear, the same total cost scrutiny is causing a review in many companies of their import sourcing strategy from low-cost countries, particularly China. An emerging trend among manufacturers shows an increase in re-sourcing components that had been sourced to Asian suppliers over the last few years, shifting instead to suppliers closer to home. What's causing this unsettling and disruptive activity? As sourcing teams (and their counterparts in finance) are getting a better handle on true total cost of ownership, a number of commodities are revealing themselves to be more costly when sourced from Asia versus from supply bases closer to home, such as Mexico for North America or Eastern Europe for Western Europe manufacturing bases. For example, analysis shows that with an average supply chain pattern, where non-material costs equal 25 percent of total costs (including all logistics and working capital costs), a Chinese source must be 22 percent lower in cost than a Mexico source to justify the move, often driving a Mexico sourcing strategy. According to a senior global sourcing executive at a tier-one automotive company, China is often not the best case and may not stand up to total cost scrutiny. And even when the savings are marginally higher from China, a China sourcing strategy may not be worth the risk if nearer regional options exist.

Offshore manufacturing and low-cost country sourcing have certainly revolutionized the manufacturing sector. As total cost analysis is being applied more frequently across the corporate spend base, it is revealing that a near-shore sourcing strategy often outweighs an Asia-only strategy for import sourcing, and that a supply base localization strategy for offshore manufacturing assets can generate significant savings, justifying the re-sourcing efforts. Companies that want to gain further competitive advantage in the global marketplace must not only embrace these concepts but arm their teams with the technology, expertise and services needed to identify these opportunities for savings and drive them to the bottom line.

About the Author: David Morgenstern is managing director of Low-Cost Country Sourcing for Ariba Inc.