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Sourcing From China–It’s Not a Panacea

Recently, a colleague emailed me an intriguing article from the Detroit News entitled, “China losing cheap labor allure…More U.S. companies find savings are drained by errors, shipping costs and engineering changes.” The article goes on to describe a US based wire harness manufacturer that moved some operations to Mexico in 2000—in search of lower labor costs. They then closed more US based operations to move them to Honduras in January 2004. And finally, last summer they signed a JV with a wire harness manufacturer in China.

Does this sound like a reasonable progression for a company seeking lower and lower cost sources of labor? Perhaps. But today, despite large investments, the company has yet to produce a single part out of its JV in China.

It is one thing to set up an entire operation in Mexico where language barriers are typically easier to overcome and where the supporting logistics infrastructure, geographic proximity to the US and similar business hours make for easier sourcing/operations decisions. It is quite another thing to outsource even a single component to China. In short, the “control factor” has an economic advantage that tends not to get calculated into the savings equation.

Many manufacturers are making the move to China not just to source parts and ship them back to the States (though many do so). Rather they are making the move to establish a market presence and build their brand within China. In the automotive industry, for example, they have come to China to support JIT and sequencing activities for their major OEM customers.

Don’t Discount the Benefits
We have long argued that there are both benefits and risks to sourcing from China. The benefits can be numerous:

1. Substantial cost savings (our rule of thumb is 25–40% piece part savings is required once you add in all of the new costs from sourcing from China)
2. Increased market knowledge and new sales channels—sourcing from China is a logical first step to determine how to sell into China
3. Latest engineering and manufacturing processes—this isn’t always true but can be for certain parts and components.

There are other benefits in sourcing from China. These include: hedging supply risk, currency hedging and developing an opportunistic sourcing scenario when the price of a commodity or product is in a state of flux.

Weighing the Risks
But the benefits can only be realized if firms understand all of the potential risks associated with sourcing from China. Our experience indicates that many companies, particularly small and mid-sized companies make big mistakes the first time out. The main challenges are as follows:

1. Selecting the right products to move offshore and selecting the right products to keep with current suppliers (and by the way, big companies make this mistake too!)
2. Qualifying overseas suppliers
3. Maintaining supply chain flexibility
4. Keeping inventory carrying costs down and managing stock levels throughout an extended supply chain
5. Ensuring that suppliers produce and ship products that meet quality standards and developing a process to handle defective materials
6. Ensuring the products selected have a long enough product lifecycle to prevent product obsolescence in the middle of the order cycle

There are many additional risks that companies must consider when sourcing from China, so whilst China sourcing has its place to play in making US manufacturing companies more competitive it is clearly not a panacea for all companies or all products.

Download our whitepaper to learn more about what your company ought to be considering when sourcing from China.

Stuart Burns is Managing Director of Aptium Global where he leads the firm’s practice in Europe and Asia.

The Victimization of the Incumbent Supplier

In the purchasing and supplier world, no words conjure up as much passion and resentment as the words reverse auctions. Reverse auctions are electronic tools that allow a buyer to post an RFQ and then invite qualified bidders to ‘bid down’ the price of goods. Reverse auctions have become standard operating procedure for larger companies.

What’s most interesting to me is that small and mid-sized companies are just now beginning to reap cost savings like their larger brethren by deploying these dynamic pricing approaches. But not all companies like reverse auctions. In fact, many of our small and medium-sized ‘buyer’ clients state that they do not like reverse auctions because they only “hammer down the incumbent supplier.”

Now, if I had a dollar for every time I have heard that statement, well, I wouldn’t be writing this article. But the time has come to set the record straight on this “hammering down of the incumbent supplier.” Somehow, the incumbent supplier has become a victim in the sourcing process thanks to reverse auctions. But I strongly disagree with this victimization. It’s a bit like feeling sorry for the Yankees because they “earned” what should have been a victory over the Boston Red Sox.

But enough of the baseball analogies—before you incumbents start throwing rotten tomatoes at your screen, let us examine some of these popular stereotypes and offer an alternative point of view.

Many buyers state their incumbents have “been with us for a long time…they helped us develop a particular product, capability etc.” Some claim that their incumbents have made significant technical or financial investments to work with a particular client or a particular program. This is the supplier “hook,” or guilt trip that many will use when they play the incumbent card to emotionally defeat the reverse auction process before it begins.

Second, many buyers from small and mid-sized companies say, “we are getting the best pricing from our incumbents because they have told us so…in fact, we haven’t had a price increase in five years.” Often this line will be followed by “we believe that we already buy world class.” This argument is the supplier “line”.

Finally our buyer clients tell us that “there is nobody else that can supply this type of product, with this quality that can meet our delivery requirements (e.g., JIT).” This argument is the supplier ‘sinker’.

Let’s take a look at each of these arguments one by one and dispel some common misperceptions.

1. The supplier has been with us for a long time and has helped us to develop a particular product or capability. The truth is any of us would be willing to pay a slight premium for an on-going relationship with someone that we can trust but how much is too much? Would you pay 20–25% above market value for a hair cut? Perhaps but what about for groceries? What about prescription drugs? Don’t feel sorry for the incumbent when they make this argument. The fact of the matter is that the buying company has likely been handsomely paying the incumbent for these product development costs.
2. The alarm bells should go off if your organization has not extracted price concessions from your incumbent suppliers in the last few years! And in markets with large raw material inputs, have you been able to hold your prices with your customers with no erosion during the past few years? Even in markets which face rising commodity prices, companies can still gain price concessions by conducting reverse auctions. Steel stampings and plastic injected molded parts, if competitively bid can yield double digit savings.
3. Monopoly supply markets do exist but they are indeed rare. A friend who sources rail cars has told me that there is only one supplier in the world for certain types of cars (okay, we might buy that one). Activated carbon for the automotive industry appears to be another but metal stampings (whether they are made on a 200 ton press or a 1000 ton press) can be supplied by multiple companies. Even items with tight technical specifications, tolerances etc can usually be supplied by a range of suppliers. The fact is, for most industrial parts and materials, multiple supply options exist and many of those suppliers can produce high quality parts that meet tough JIT requirements.

So by conducting a reverse auction, are you really “hammering the incumbent?” On the contrary: our experience is that it is usually the buying organization that has been “hammered.” This is because buyers almost always give the benefit of doubt to their incumbents. But better incumbents will actually share some cost-savings with their clients and often avoid a reverse auction in the first place. There are also benefits to incumbent and challenger suppliers for participating in a reverse auction, see our previous issue of Gunpowder.

But for those suppliers who won’t play ball at first and complain about being singled out, it’s almost always easy to dispel their protests with even limited analysis. And it is our experience, in fact, that strong incumbents will perform well in reverse auctions once they realize that this is how a sourcing decision will be made.

Given this, small to mid-sized buying organizations should relish the reverse auction. These tools create level playing fields and a transparency to market pricing that simply can not be accomplished any other way. And never be fooled by incumbent squawking. Get them on the field and let them play by your rules. And put their hammer away once and for all.
Tune in next issue for our case study on the supplier “Hook, Line and Sinker” and how we debunked these myths for one of our clients.

Lisa Reisman is Managing Director of Aptium Global where he leads the firm’s practice in North America.

Suppliers: Bring Your Checkbook

Over the years, there's been many an effort to make suppliers pay for access to buyers. But historically, many of these "supplier pays" models have been by intermediaries, such as FreeMarkets (in its early days) and other online channels for suppliers, such as marketplaces and indirect procurement portals. Even Ariba recently announced that it would be adding fees to suppliers that make frequent use of the Ariba Supplier Network (ASN).

But recently, I've spoken with a number of large buying organizations who are beginning to make suppliers bring their checkbooks to meetings (well, almost). In virtually all cases, there's a twist that goes along with these new supplier fees. For example, take the case of a large global technology-related company (I've blinded the exact industry to protect my source) that charges winning suppliers in reverse auctions to pay a fee to get the business. Obviously, this is fancy budgeting to get suppliers to offset the sourcing software and other costs associated with negotiations, but suppliers do indeed cut checks to the buying organization when they receive business.

Other companies charge suppliers when they register and maintain information on a supplier portal. One large global diversified conglomerate charges over $3000 a year to its suppliers to gain access to their supply portal to list their goods and services in their online catalog system. By my calculations, knowing the number of suppliers in question, this more than covers the cost of software, staffing, and other expenses associated with maintaining an online eProcurement and catalog requisitioning system. This gives "profit from procurement" an entirely new meaning!

I know of other large buying organizations considering a similar move as well. Many reason that suppliers happily spend thousands of dollars flying to sales meetings, and some of that cost could be re-allocated to off-set the technology investments that the buying organization makes to make it easier for suppliers to transact with them.

But charging suppliers is not just limited to offsetting software (and associated) costs. In the travel and hospitality industry, I've heard of one company that lets suppliers sponsor their bi-annual supplier conference. While the buyer bills this as “advertising” for attending suppliers, it certainly raises an ethical eyebrow about whether “sponsors” would be favored over non-sponsors in the sourcing process when it comes to new contracts. In this case, the buying organization has put a stake in the ground and has said that sponsorship will have no impact on contract award decisions, but regardless, visibility at events like this can help reinforce brand and other subjective criteria that buyers—who are in attendance—rely on during award decisions. Talk about a captive audience!

Is there a slippery slope by making suppliers pay—either at the point of sale, for access, or from an advertising perspective? At this point, I'm not sure. But to be careful, buying organizations should ground supplier-pays business models in tight, well-thought out businesses cases, lest they start down a path from which they can’t return.

What do you think? What is your experience? Are you considering such a model yourself? Post a comment or drop me a line: jbusch@spendmatters.com.

This newsletter is published by Aptium Global Inc a direct material advisory firm based in Chicago, IL. With offices in the UK, China, India and a network of global associates, Aptium Global works with small and medium sized manufacturing companies to save money on direct material purchases. Smaller companies face the same cost pressures as the Fortune 500, yet often lack budgets for cost reduction services. Aptium Global works with organizations on a pay-as-you-save™ basis, minimizing impact on cash flow and maximizing impact on the bottom line. We aim to publish this newsletter on a monthly basis but reserve the right to miss a few deadlines here and there.