With Sir Alan Sugar’s electronics firm Amstrad pioneering low-cost country sourcing in the 1980s and European automotive companies now involved to the tune of billions of euros per annum, the strategy is neither new nor embryonic. Why then are so many companies, large and small, still reluctant to embrace this opportunity to both reduce cost and deliver strategic advantage? In our view, the issues are not so much within the emerging markets themselves, but are primarily to do with gaining stakeholder support at home for more radical sourcing strategies.
Globalisation is one of the defining political, social and economic forces of our time. In business terms, geographic borders are fading. Global sourcing is both a reaction to, and a trigger for, globalisation – witness the supermarkets’ strategy as they follow the seasons to deliver year-round fresh produce to our kitchens. Procurement executives are under pressure to maintain quality and access to innovation while reducing cost year on year. Yet a variety of research indicates that many organisations, in all industries, increasingly struggle to deliver against this challenge.
It is difficult to predict cost-saving potential without being specific about the particular commodity, country source, quality threshold and logistics requirement. However, the typical savings for manufactured product in China, India and South-east Asia can range from 10-50 per cent of standard Western costs, while for IT service provision, labour savings can run from 30-50 per cent.
Cost is king, but does not rule alone
Although cost is the primary driver, there are, of course, other motivators for low-cost country sourcing (LCCS). They include:
- To develop competition for existing domestic or regional suppliers.
- To create “local content” – an automotive supplier sourced raw leather in South Africa for car seats, some of which were later imported into that market, and was able to offset import duties as a result.
- To balance currency exposure – a simple case of matching purchases to sales in order to avoid negative swings in the currency markets.
- To engender support for a move into a new, possibly closed, market – for example, to get a foothold in the booming Chinese market a company sets up a joint venture with a local organisation with a ready-made network and supply base.
- To secure access to new technology or competitive technical capability. India has more people graduating in information technology every year than the total number of IT graduates in the UK.
Companies such as Infineon, a large semiconductor manufacturer, have been motivated to undertake LCCS to gain nearly all of these benefits. It has created a product assembly and an R&D capability in a development centre in Xian. As the Chinese semiconductor market is expected to grow to around $80 billion per annum by 2007, this provides a strong foothold in a fast-growing market.
Successful partnerships are often formed between the Western client company and the supplier in the emerging market. Nick Beighton, executive director with responsibility for sourcing at Matalan, a low-cost British retailer, says: “When countries are stabilising following periods of socio-political turmoil, it is often the textile and garment industry that is at the forefront of the emerging free-market economy. This clearly represents an opportunity for retailers such as ourselves.
“Within Matalan, we acknowledge our obligations to fledgling companies within emerging markets. We have a small team of supplier development engineers who help them to get started in their objectives of winning business in Europe.
“They provide advice on where to source raw materials, and how to set up factories, improve the effectiveness of equipment, manufacture quality products and manage supply chains. The result is that we get excellent products and best-in-class value from our suppliers in the emerging markets.”
However, for every positive experience like this, there are plenty of other scare stories to terrify the hesitant executive. In a survey of 115 senior supply chain executives, Aberdeen Group found that 65 per cent said there were significant challenges to LCCS. Quality, communication and the calculation and control of landed costs were three of the main ones mentioned.
There is no disputing that LCCS does mean longer supply chains, with producer and supplier often separated by thousands of miles and inconvenient time differences and language barriers. This complexity is often exacerbated by the following factors:
- Currency fluctuations – these can swiftly unravel gains in unit costs of production.
- Socio-economic and political uncertainty – South America, for instance, has gone through waves of boom and bust associated with foreign investment because of its political and financial instability.
- Concerns about quality and service – despite the fact that many organisations in low-cost countries have educated workforces and have adopted ISO 9001, kaizen, Six Sigma and other efficiency and quality improvement programmes.
- Loss of intellectual property – with piracy laws in East Asia, in particular, having failed to adequately protect copyright.
- Greater danger to continuity of supply – especially if mitigating strategies include increased inventory holdings.
In our experience, all of these issues can be resolved with a rigorous approach to sourcing. But it is important to recognise that there are other barriers too. Concerns about loss of image in your home market if global sourcing is perceived as merely a cost-cutting initiative or “job killer” is one. Examples of this include the negative public reaction to vacuum cleaner manufacturer Dyson’s decision to move its manufacturing offshore, and to financial services organisations for using Indian-based call centres.
The causes of internal resistance
Not surprisingly, then, the Aberdeen study also revealed that the formulation of strategy internally – in other words, resistance to change – was another major challenge when it came to LCCS. There are some powerful stakeholders who, when aligned against an initiative, can leave it dead in the water. We often see the following:
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Chief operating officer: has big concerns about relying on suppliers that are thousands of miles away, in terms of quality and security of supply. The COO will also be wary of the additional cost of inventory necessary to act as contingency against possible supply chain problems.
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Head of new product development: has concerns about working on new product development programmes with suppliers in distant countries.
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Logistics director: will regard the need to manage long supply chains, with several modes of transport such as air and sea freight, as being an unwelcome complexity.
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Finance director: worries about currency and complications on customs duties.
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Sales and marketing director: will be concerned about brand integrity if it becomes public knowledge that some key components of a prestige product come from, say, Romania or Vietnam.
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Purchasing: will normally be the strongest advocate of LCCS, but at a category level there will be real concerns about disruption associated with moving from the incumbent to the new source of supply.
We have seen excellent emerging markets propositions be killed quickly in the boardroom once the collective hostility of the CXO community has been expressed. The question is therefore how to get the type of stakeholder alignment that is necessary to make low-cost sourcing a success. Well, there is all the usual stuff that is part and parcel of any change programme: preparation of a good business case; training and communication, and in particular answering the old question of “what’s in it for me?”; and rigorous planning.
Then, of course, there’s proof of concept. A forklift truck manufacturer in the UK had 80 per cent of its sales in Europe but 70 per cent of its cost base in sterling. A group-led programme, including sister companies in mainland Europe, aimed to reduce this sterling reliance to 40 per cent. For one particular high-cost component – weights – this was not possible, as the two European foundries in France and the Netherlands were at full capacity.
Some out-of-the-box thinking simply asked where producers in Asia got their weights. The answer was China, using modern Japanese vacuum-moulding technology to produce good quality, surface-defect-free weights from scrap iron at below world scrap iron prices. Not only were the weights cheaper, but sourcing them from China would transfer 8 per cent of the cost from sterling to foreign currency. Senior stakeholders were initially sceptical, but samples and a test container that arrived on time with 100 per cent defect-free weights changed their view.
What gets measured gets managed
In our experience, however, the most effective way of getting senior stakeholders aligned to LCCS is by having objectives on low-cost sourcing “baked” into their performance contracts. In particular, it is vital that the CXO community has an objective that relates to a desired percentage of products being sourced from emerging markets. This would look something like “during the course of this financial year we will increase the amount of product sourced from emerging markets from 5 per cent to 10 per cent”. Similar objectives need to be developed for other key stakeholders so that the business is working towards a common objective.
Purchasing cannot drive a sustainable benefits programme without the proactive participation and encouragement of other key functions. But neither can it instigate the sort of performance measures that will drive senior stakeholders’ behaviour. What it therefore has to focus on is developing and gaining agreement on a global sourcing strategy that will, in turn, hopefully lead to the setting of such objectives and targets.
When thinking about such a strategy, consideration should be given to the following:
- What percentage of your third-party spending could lend itself to global sourcing? If the percentage is small and its financial impact minor, perhaps there are other initiatives that would provide a greater return on your investment – eg, proactive development and management of your existing supply base, and perhaps even encouraging your suppliers to embark on global sourcing instead of you.
- How business-critical and complex are the target goods and services themselves? If you are in fast-moving consumer goods, for example, the last thing you want is product burning up its limited shelf-life on the high seas en route from China.
- Can global sourcing contribute to your organisation’s strategic ambition? Is the company intent on opening up new markets, hedging its exposure to foreign currencies or domestic demand, or accessing innovation or skills, for instance?
- What is your long-term plan? Do you expect to move your production from low-cost country to even lower-cost country over time? If you do, this should influence your LCCS strategy as you need to make sure that you can “plug and play” suppliers to avoid the high switching costs that can diminish any benefits.
- Do you know enough about the target countries? How will you deal with barriers of distance, culture, time and language? If you are unsure, it may be best to seek the support of external experts.
Steve Gardener, service director with responsibility for after-sales product purchasing at construction equipment maker JCB, notes: “Today, Indian and Chinese consumers enjoy the same cars, washing machines and lawnmowers as we do. While there are local derivatives and flavours, the core product is becoming much more the same the world over. The advantage for purchasers is that import duties in China and India force them to source components locally, and that local source, if correctly identified, can then become a global source for identical products being built in Europe, North America and elsewhere.
“In this scenario, it is essential to ensure stakeholder buy-in from all territories in order to gain not only the benefit of low-cost country sourcing, but also leveraging global economies of scale. Otherwise, a mish-mash of sourcing strategies will significantly affect your competitiveness.”
The most successful global sourcing initiatives have required a broad stakeholder alignment, not only around benefits, but also investments and commitment. Bob Kickham, global supply and emerging economies procurement director at Diageo, says: “The differentiator between companies that do it well and companies that do it badly is the capability of the cross-functional sourcing management team. Companies embarking upon a programme of sourcing from emerging markets need to make whatever investments are necessary in building their competence and capability in managing the risk of an extended supply chain.”
In our experience, unless LCCS is a top 10 company initiative with senior executive support, the chances of success are limited. There are indeed horror stories out there, of those that tried and failed. However, possibly less visible are the other horror stories, of those that didn’t try and failed. At the very least, every organisation should find out if global sourcing is right for it, and find out quickly.
Denis Kenny (deniskenny@qpgroup.com), Marc Debets and Matthias Daemmig are managing directors of QP Group, a procurement and supply chain consultancy, based in the UK, France and Germany
