Nine tips for low-cost country sourcing
Wayne Forrest -- Purchasing, 9/1/2005 2:00:00 AM
U.S. companies in greater numbers have heard—and are heeding—the siren's call to source products and parts overseas to reduce overall costs and compete more aggressively at home. A recent study by the Boston-based Aberdeen Group found that CPOs rate low-cost country sourcing (LCCS) a top priority over the next three years, and that companies plan to double their spending with offshore suppliers by 2008. The report also found that purchases from low-cost countries have average cost savings of 10-35% compared to U.S. and Western Europe suppliers. Those numbers alone will gain the interest of U.S. manufacturers, which are always looking to make the most of every penny spent.
While the LCCS road looks smooth on the surface and the cost benefits are enticing, there are potholes the size of moon craters for companies that do not properly prepare for all the potential hazards along the way. With that in mind, here are some tips from industry experts on how to successfully implement an LCCS strategy.
TIP 1: Calculate all the costs by getting everyone involved
Time and time again, companies do not take into account all the expenses incurred in LCCS and fail to consider the needs of the entire business and its various units.
"You don't want procurement to just go out and save money by getting the cheapest supplies," says Chris Sawchuk, practice leader for procurement and supply chain at The Hackett Group in Atlanta. "Procurement organizations pursuing LCCS need to understand what is happening from an overall business standpoint."
Sawchuk recommends creating a cross-functional team that includes procurement, engineering, supply chain and finance people who can coordinate the most efficient and productive LCCS plan. By doing so, a company can best anticipate actual savings and set realistic goals and expectations.
Preliminary results from a Hackett Group study on successful global sourcing show that companies save approximately 19% on parts price savings alone. Add expenses, such as shipping costs, duties, tariffs, IPO operations, inventory and other charges, and the savings dwindles to less than 17%—an important 2% difference when plotting financial targets and presenting results to the CFO.
TIP 2: Protect against the theft of intellectual property
"You need to unbundle intellectual property," says David Morgenstern, managing director of low-cost country sourcing for Ariba in Sunnyvale, Calif. In other words, when moving to low-cost regions of supply, a procurement organization should have multiple sourcing strategies, whereby different overseas companies supply one of several parts. Collect the components—and don't forget to make sure ahead of time they are compatible—and assemble the final product in the U.S. for improved manufacturing and distribution control.
TIP 3: Conduct in-depth due diligence on LCCS suppliers
It is dangerous for a company to simply look at an overseas supplier's website, get a quote for the goods, check a few references and start to do business. Buyers should specifically pre-screen any supplier, most of all a LCCS supplier, before entering into a contractual arrangement, advises Morgenstern.
"If you were to find 50 suppliers on the Internet, I guarantee 40 of them are traders," he adds. "The risk is that you are buying from multiple parties under the guise of one, unless you go to that country and kick the tires."
Morgenstern recommends sending a commercial and technical team of procurement staff, supply and quality engineers to conduct due diligence on a potential supplier on-site. Ideally, a U.S. company should establish an international purchasing office (IPO) in the supplier's country. If that cost is prohibitive, he suggests working through a third-party consultant or broker—after extensive due diligence as well—to minimize delays and product liability issues.
"You could end up with a scenario that maybe the first sample parts pass muster, then you see a dramatic drop-off in quality," Morgenstern says. "We highly recommend a sustained approach of supplier on-boarding."
TIP 4: Establish your own international purchasing office
While the upside is a company's full control of its IPO and LCCS strategy—as opposed to depending on an agent or broker—it could take more than a year for benefits to materialize.
Be warned, an IPO isn't cheap and requires a long-term commitment. In its June report, the Aberdeen Group estimates that establishing an IPO could cost between $1 million and $2 million for an office with 10 employees or fewer in Hong Kong, Taiwan or China (the hottest spots for an IPO right now). Recruiting and training local talent could take as long as 12 months.
TIP 5: Consolidate the number of suppliers
When you find the right low-cost country supplier, use them. By consolidating supplier networks and focusing more spending with a handful of key suppliers, companies can generate more than $50 million in savings per $1 billion of spending and significantly reduce the cost of procurement, concludes a July report from The Hackett Group.
"As you reduce your suppliers, you will get incremental savings, as well as risk reduction, because you're spending your crucial time with a crucial few [suppliers]," notes Hackett Group Director Pierre Mitchell.
Companies will realize savings, in part, by increasing purchase volume from a single supplier; there will be fewer or no surprises, because the company will be familiar with the supplier; and, by locking in critical capacity and early availability of product, it will mitigate supply risk and the chance of a shortage.
TIP 6: Rely on commercial terms of a contract, not the written word
There is much truth to the adage "Money talks." In the U.S., if a company pays a supplier in advance for raw materials and the supplier reneges on the contract, the buyer can sue for damages and reimbursement. It is not so easy in many overseas countries, especially in China, says Ariba's Morgenstern. This makes the terms of a supply contract especially important in LCCS.
Morgenstern advocates not paying for goods up front, but linking final payment to quality inspections and documentation. It also may be wise to withhold some money through the warranty period of parts and components from a new LCCS supplier as a risk mitigation strategy.
TIP 7: Negotiate a long-term supply contract for critical parts
Nothing will prompt the firing of a CPO faster than a parts shortage on a successful product line, especially if it is a new product line Wall Street investors are anxiously awaiting to fulfill their expectations. Moving to LCCS can falsely sway buyers to shorter-term contracts in the hope of jumping to the next low-cost region. That's risky. Procurement organizations are better off to set up long-term contractual coverage for essential parts (with the right suppliers), especially components that feed the company's most profitable products.
"A top priority is continuity of supply," says The Hackett Group's Mitchell. "Do an analysis of what you're buying for the most crucial products and supplies. It's amazing how many companies don't do that."
TIP 8: Go beyond sourcing
Effective sourcing organizations never stop advancing their techniques. "There is a false sense of security when they get huge savings early on, thinking that they have accomplished all there is to accomplish," says Jeffrey Ryan, senior vice president at Verticalnet of Malvern, Pa. Instead of saying to the procurement staff, "Here is what we need; go find a way to buy it better and cheaper," Ryan says sourcing must have the procurement team identify internal operations where there is inefficient use of the supply market. Verticalnet advocates a concept it describes as Beyond Sourcing, which begins with a cost and feasibility study for shifting supply and expanding capacity; combining product formulation and sourcing functions to reach the most viable solution; rethinking the logistics network and mode selection simultaneously; and identifying demand management improvements to optimize the use of an existing well-designed supply solution. If the evaluations are done correctly, the savings from low-cost country supply will be automatic.
TIP 9: Be patient—but have an exit strategy
Supplier assessment and development, leadtimes, benefits and cost savings all take longer in an LCCS program. "Immature suppliers and developing infrastructures tend to make leadtimes longer in nearly all low-cost countries," notes Aberdeen Group's June report.
In addition, low-cost countries will not stay low cost forever. Have an exit plan ready ahead of time should conditions change, whether it be price hikes for the product, political upheaval, or currency fluctuations. The plan should cover what to do about intellectual property and how the contract and production will be phased out.
Now Playing: 
