How to avoid the most common pitfalls of global sourcing
Global sourcing consultant provides advice on total cost analysis.
By Dave Hannon -- Purchasing, 2/23/2009 10:55:00 AM
It’s no secret to most purchasing organizations that global sourcing offers a host of cost benefits. But accurately calculating the costs included in global sourcing go much deeper than determining who’s selling the cheapest widget. And in today’s ever-more volatile economic environment the various components of a global sourcing cost analysis need to be revisited often. The contract terms you established two years ago with a supplier in a low-cost region may not be so low-cost today.
With that in mind, Purchasing.com recently spoke with global sourcing expert James Horrigan, senior director at Alaris Consulting in Chicago about how purchasing should be approaching the total cost analysis for global sourcing in today’s market.
Q: Certainly labor rates are a big factor in the total cost analysis for global sourcing. But what is the best source for labor rates in various global markets? How do you benchmark and forecast them?
We have used the International Labour Organization and the Bureau of Labor Statistics as well as other studies to benchmark labor rates in global markets. We compare their information as well as our own data and the variations of labor rates we’ve seen over the course of our procurement projects. For example, coastal China’s labor rates are traditionally higher than interior China so this can be a significant influencing factor when making sourcing decisions in China. Average salaries in Northern and Western China are 60% lower than Shenzen.
Q: We hear a lot of talk about incoterms. What are your recommendations for incoterms in global sourcing?
We use DDP (delivery duty paid) and CIF (cost, insurance and freight) terms when negotiating with international suppliers so that the selling terms are clearly understood. We find that when buyers don’t use these terms in the negotiation process there can be unfortunate surprises at the time of the first invoice.
Q: Logistics costs are becoming more volatile, making global sourcing savings more difficult to forecast. How should buyers calculate logistics costs in their global sourcing decisions?
We calculate logistics costs by looking not only at the freight costs but peripheral costs such as bunker fees, security costs and canal/corridor fees. We also take into account the cost of duties, tariffs and other fees, even if the supplier is selling their product under DDP terms. It’s extremely important to ensure proper product classifications when sourcing overseas. Companies need to do their own due diligence to not only understand the costs but protect themselves from incorrectly classifying products and paying the wrong charges.
Freight mode decisions are typically made based on the value of the product and shipping costs. For example, it makes sense to ship some high-cost electronic parts by air despite its higher cost because of the total size and value of the product. The offsetting inventory and potential obsolescence costs come into play there. But typically most consumer products will be shipped from overseas suppliers via ocean containers while some raw materials will be shipped as bulk freight because the cost of the material is lower and it is less time-sensitive.
Q: Is there an area of logistics that is often overlooked in the total cost analysis for global sourcing?
An often overlooked area in the freight mode decisions is the review of packaging process and materials. Depending on the product shipped and transportation mode chosen, product packaging must be given consideration for protection against damage, spoilage and corrosion. The wrong packaging can negatively impact the cost savings potential of a global sourcing model.
Q: Where do 3PLs fit into the logistics of global sourcing?
Third-party logistics providers (3PLs) can provide a tremendous service to buyers in a global sourcing model. If a company is not very sophisticated in international logistics the costs to hire a 3PL are usually offset through the expertise and transportation relationships that they have. They also can provide freight consolidation services that can drastically reduce overall shipping costs. However, like any other goods and service a company purchases, it is important to have a robust sourcing process to ensure that the right 3PL provider is chosen. The number of 3PLs in the market coupled with the drastic variations in value-added services that may or may not be warranted by the shipper requires detailed evaluation based on factors beyond price alone.
Similarly, when evaluating logistics operations on a global level it is imperative that a 3PL is aligned with the shippers’ global strategy. Often we’ll see a shipper rely on their existing 3PL for their operations in domestic China or India, only to be disappointed by the lack of responsiveness and capabilities these multi-national 3PLs are truly able to offer in overseas markets. This at times can result in companies bringing their logistics operations back in-house where they have tighter controls but higher operating costs. Evaluating the cost benefit of leveraging local logistics providers in other parts of the world requires a deep understanding of the infrastructure and regulatory impairments that exist.
Q: Product quality in global sourcing is a concern to buyers both in terms of safety and cost. How do you factor in the risk of a quality issue into the total global sourcing cost analysis?
Product quality cost evaluations need to start early in the sourcing process. Any savings on imported goods can quickly evaporate if that product needs to be re-worked at its final destination or if it is unusable. One way to calculate the risk of quality variations is to include the cost of larger inventory or safety stock levels as well as estimating the cost for returning defective parts.
Q: In the recent past, energy costs have taken a bigger role in the total cost analysis. How do they factor into the regions buyers are sourcing from?
There are two factors to consider with energy are cost and reliability. Sourcing from regions that have high energy costs is more of a concern when the products being sourced have high energy inputs (e.g. aluminum manufacturing). The higher the percentage of energy cost in the product, the more a buyer should consider sourcing from a region with lower energy costs, if possible.
But beyond the cost of energy, energy reliability can affect the costs of a much wider range of products being sourced. This can be a significant issue in developing countries where manufacturing growth outstrips energy production. In these cases manufacturing firms in some regions can be subject to rolling blackouts causing production delays. If your supplier is one of these, that can create major supply chain issues that offset the cost savings of sourcing from that region. In some cases it may even make sense for a buyer to invest in back up generator for their suppliers’ facility as an insurance policy.
Q: The cost of switching suppliers can be hard to put a number on. How can buyers know when the total savings will be enough to make the move worth it?
Most companies look to save a minimum of 15-20% in total landed costs before making a decision to source offshore. Companies typically expect that there will be a learning curve when they start with a new supplier and this will result in additional costs like expedited shipments, additional inventory carrying costs, personnel, etc.
Additionally, buyers need to consider the costs of transferring or building new tooling as a transition cost. Companies need to build a cushion against unexpected cost increases like exchange rate fluctuations and fuel surcharges.
Q: Are companies seeing value in international procurement offices (IPOs)?
More companies are evaluating the return on investment (ROI) for sourcing overseas by using an agent vs. as an international procurement organization. Our experience has been that generally, many firms can begin to generate value through an in-house procurement organization when sourcing in the region exceeds between $5-$10 million.
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