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Accenture

Globalization is a reality affecting how companies worldwide formulate their business andprocurement strategies. Sourcing from global suppliers will fundamentally alter mostcompanies’ supply chain models and competitive cost positions.

Sourcing goods globally – developing strategies, capabilities and formal processes for acquiring materials from the most effective use of resources regardless of location – is not a new, or even revolutionary, practice. Many companies have been doing it for years. Recently, however, there have been large increases in: 1) the number of companies seeking to develop a more global supply base; 2) the variety of countries being viewed as sourcing candidates; and 3) the quantity and variety of items being pursued and acquired. This trend is certain to continue and grow. In fact, a 2004 Accenture survey reported that companies intend to nearly double their spend in low-cost countries and that they expect savings to increase by 37 percent over the next three years. Clearly, proficiencies in global sourcing are helping a great number of companies achieve – and even redefine – high performance.

Among all the low-cost countries on the world’s radar screen, none has received more attention than China. Nor is there another country whose continued growth is more certain. This paper focuses on the characteristics that have made (and will continue to make) China one of the world’s premier sources of supply. However, note that these lessons and observations apply to companies looking to tap any of the world’s emerging sources of supply, including Central/Eastern Europe, Mexico, India or other countries along the Pacific Rim.

Why Companies Are Seeking Alternative Supply Sources

As shown in Figure 1, price and competitive pressures continue to be the motivators that most companies cite for acquiring more items from low-cost countries. According to the 2004 Accenture survey, globalization of suppliers (that is, a supplier relocating to a low-cost region or country) also is an important driver. In the hightech industry, for example, many large suppliers have already moved a substantial portion of their operations to low-cost countries, such as China.

The flip side of the equation is the increasing attractiveness of countries from which new sources of supply might emanate. The criteria noted below are largely universal, although the examples refer to China specifically.

Abundance of low-wage labor: China has 941 million citizens between the ages of 15 and 59 (64 percent of its total population). The country’s average hourly wage for manufacturing is increasing, but is still lower than many other emerging markets, such as Mexico. China’s GDP per head is $980 compared to $6,260 for Mexico.[1]

Worker education: Almost 49 percent of China’s population has a middle-school or greater education. This is important because, as discussed in the next section, more and more companies are looking to low-cost countries for value-added products and services that transcend unskilled labor.

Size of export and domestic market: According to China’s National Statistics Bureau, the sum of China’s exports in 2003 was $326 billion – a 22.3 percent increase from 2001. Equally important, the country’s total domestic consumption in 2003 reached $495 billion – an 8.8 percent increase from 2001. This is a vital indicator because most companies pursuing global sourcing also hope to position their source countries or regions as future markets.

Market liberalization: In conjunction with regulatory changes, such as its entry into the World Trade Organization (WTO), China has committed to reducing tariffs from the current average of 24.6 percent to 9.4 percent by the close of 2005.

What Kinds of Products Are Best Suited To Global Sourcing?

Traditional labor-intensive products – items geared toward leveraging a country’s abundance of inexpensive labor – used to represent the bulk of products sourced from low-cost countries. In China, for example, consumer goods, clothing and textiles were the largest export product categories. Today, however, products with higher technology content are increasingly being exported as the Chinese manufacturing industry matures and as a growing number of global companies start sourcing directly from China. This is the direction that most low-cost countries will likely take: ramping up with laborintensive manufacturing, and then migrating slowly toward more skilled, higher-value products and services. As shown in Figure 2, there is also momentum away from natural resource exports. This is because China’s swift economic growth is placing greater internal demand pressures on natural resources.

Some of the best examples of global sourcing come from the high tech industry. In this business (known for razor-thin margins, hyper-aggressive competition and lightning-fast product life cycles), companies often have no choice but to source components and even complete products from Asia and other low-cost regions. Simply put, high tech’s old “vertical integration” model is passé. Most design and manufacturing activities now are outsourced to Asia, with leading- edge global sourcing strategies applied to minimize time to market and ensure lowest total cost.

Global Sourcing Differences and Challenges

Dramatic differences in low-cost countries’ culture, organization, relationships and technology prowess pose significant challenges for global sourcing. Some of those challenges include:

Supplier relationships and identification: Most companies have spent a great deal of time, energy and money to build a network of productive supplier contacts and relationships. In effect, they have created a system that works. Disrupting that system in favor of new sourcing opportunities (which many companies will have to do to remain competitive) is a formidable task. The process of supplier identification, for example, is often taken for granted in North America, since comprehensive information on suppliers nearly always exists, as does a standardized business language. Most companies also have experienced procurement and sourcing teams working in familiar territory. However, in low-cost countries such as China, supplier information is far more fragmented and thus more difficult to obtain and compare. These complications are enhanced by language differences and the need for new or retrained professionals with experience managing international buyers and suppliers.

Technology and information systems: IT systems and infrastructures are significantly less advanced and integrated in China, as they are in most low-cost countries and regions.

Supplier short-listing: During the solicitation, screening and short-listing process, stateside procurement teams have come to expect a generally high level of sophistication from their prospective suppliers. There are numerous reasons why this will change when they work with Asian, Central/Eastern European or even Mexican suppliers. In all of these venues, information is harder to acquire, consolidate and present due to systems limitations and language barriers. Quality standards and legal oversight may be lax, which means that due diligence responsibilities rest more heavil y with the buyer.

Relationship-based negotiation: Companies will need to incorporate an understanding of local business culture and relationships when negotiating for quality, service and price. This is particularly true in China, but it also is common to many less-developed countries. Without the right guanxi (relationships), for example, priority customer treatment in China is unlikely. The reality is that China’s emphasis on relationships often trumps commercial considerations. This is changing, but not quickly.

Approaches to Global Sourcing

Multinational companies generally have used one of three business models to source products from China and other countries. As shown in Figure 3, the key difference is the degree of sourcing commitment.

Trading agents: These entities help identify local suppliers, negotiate prices and follow up on order fulfillment and logistics. In effect, they operate as third-party service providers, which means less operational complexity and smaller investments for their clients. Companies must be particularly concerned about their own level of control, and about the technical knowledge and potential responsiveness of the trading agent.

Local joint ventures and wholly-owned foreign enterprises: In return for somewhat larger efforts and investments, companies typically gain a better understanding of their suppliers; tighter control over quality; and more opportunities to form longterm, direct relationships with suppliers. Of course, these benefits are accompanied by greater challenges, such as coordinating sourcing programs across plants in different countries and on different continents, as well as managing associated fulfillment, transportation and distribution activities.

International procurement offices for identifying, assessing and developing local suppliers: This approach is basically a shared services model, with specialized sourcing teams performing dedicated order and logistics management functions. Sponsorship from all affected business units and the ability to manage in-house or outsourced logistics functions are particularly key.

Of the three alternatives, establishing an international procurement office tends to be the most widely practiced and successful approach with large manufacturers. In addition to the basic benefits noted in Figure 3, international procurement offices generally offer the best opportunity to reduce sourcing costs and limit sourcing cycle times. The presence of an office also helps to ensure that all forms of procurement information are communicated to corporate business units worldwide. Overall, they are probably the best way to incorporate a new sourcing region or country into an established global supply chain. Typical capabilities of an international procurement office include:

• Local supplier identification/screening/negotiation;
• Purchase order management;
• Sampling, design and engineering support;
• Logistics coordination and management; and
• Quality assurance and control.

Some companies have successfully begun their sourcing journey by establishing a joint venture to ramp up local production and serve a local market. A year or so later, they launch an international procurement office that serves global as well as local markets, and increases overall sourcing value by accessing a broader range of sourced materials. This approach will continue to make sense in the future because it limits initial investments, identifies small problems before they become big ones and resolves issues before regulatory approvals and licenses are obtained.

The Future Is Now

Major global sourcing announcements by many of the world’s leading companies are evidence of a trend that will fundamentally alter most companies’ supply chain models and competitive cost positions. Nevertheless, there is no universal approach to managing sourcing operations in China or any other market. However, all global sourcing initiatives generally should begin with a somewhat generic, business-case-driven approach. The first critical steps are to identify and quantify the needs and then develop an overall global sourcing strategy – determining which categories are most suitable for alternative sourcing models and opportunities. Most companies then will need to perform a strategic sourcing exercise, during which they:

• Map current and optimal sourcing processes;
• Analyze total spend for each category;
• Develop a list of selection factors for assessing the value of current and prospective suppliers;
• Quantify the value and economy provided by the company’s current stable of suppliers;
• Identify potential new suppliers and assess their ability to meet the company's needs with greater efficiency and lower prices;
• Balance the perceived value of new, global suppliers against the potential difficulties associated with distance, culture and flexibility;
• Develop a global (standardized) negotiation strategy;
• Develop a global (standardized) request for quotation;
• Develop and send requests for proposal to current and prospective suppliers;
• Analyze bids returned by interested suppliers and develop a “shortlist”; and
• Negotiate with short-listed suppliers and make final choices.

Like most initiatives, the success of 21st century global sourcing efforts will depend on how well those behaviors mesh with each company’s business strategy, the degree of management buy-in and the business case that governs their deployment. But regardless of economic or political conditions, continued development of global sourcing capabilities and venues is inevitable. Any company that is serious about high performance recognizes that global sourcing is an increasingly core (price-of-entry) capability to their procurement operations.

Endnote

1 The Economist, “World in Figures 2005.”