10 tips to better China sourcing
Best practices in low-cost country sourcing
By William Atkinson -- Purchasing
Everyone in the supply chain seems to have a "China story" these days. Either they found dramatic savings and saved their company a boatload of cash, or they got burned by a fly-by-night supplier and vow never to source overseas again. But, as in most things, when it comes to sourcing in China, success is as much dependent on the preparation as the execution.
One bit of good news is that, if you have experience with any type of sourcing overseas in general, it should give you a leg up when sourcing in China specifically, according to James Ullum, managing partner with Louisville, Ky.-based Source International, a global manufacturing outsourcing company. "I was at a conference recently on sourcing in Latin America, and it was striking to me just how much similarity there was to sourcing in China," he says. "I think, in general, the tips for buying offshore are almost universal."
1. Set a clear China strategy
Gordon Smouther, senior industry advisor with the Center for Supply Chain Management at Rutgers University in Newark, N.J. says most companies are sourcing in China and similar countries for two reasons. "One is the long-term goal of establishing a market presence in the country in order to serve the economy," he states. "The other is a more short-term goal to take advantage of some of the low-cost capabilities and labor in the area."
2. Consider going direct
In the past, a lot of companies that were sourcing in China were going through brokers, because they didn't know the players in China, and they didn't have the ability to manage quality, according to Bob Sullivan, a director with Southfield, Mich.-based AlixPartners, a consulting and financial advisory firm. "One of the big pushes these days is to go direct," he states. One reason is that some brokers were charging a 10–12% fee, which dramatically reduced the savings potential of sourcing overseas. "We worked with one client to help them go direct and were able to take almost 30% out of the cost structure," he states.
A second reason for going direct is control. "When you're dealing with highly engineered products, you don't know what the broker looks at in the factories," he notes. "You need to have your own eyes on the process."
3. Improve supplier evaluation
The most critical step is to select the right partner, according to Source International's Ullum, who adds that buyers "need to check references, verify that the suppliers have adequate capital, quality systems, and capacity, and that they buy from reliable sources." Then find out what the priorities are for the supplier's factory. For example, some are focused more on quality, some on price, and some on fast production.
4. Build relationships
Ullum points out that building and maintaining a strong relationship with the supplier may be more important in China than anywhere else because business is based more on relationships there than it is in some other countries, especially the U.S.
Jan Palmen, new-product development commodity manager for Ingersoll-Rand Security & Safety in Colorado Springs, Colo., agrees. "While it is not unique to sourcing in China, you first have to establish relationships," Palmen says. "For example, as a commodity manager, I can call almost any supplier in the U.S., introduce myself, and then ask if they would be willing to put together a quotation. This tends to be a straight business transaction."
In China, he says, it is necessary to establish a relationship first, and this is usually done through an intermediary, such as a U.S. representative of the Chinese company.
5. Convey clear expectations
According to Palmen, buyers need to be very clear about what they want from Chinese suppliers due to things like language barriers and metric conversions. "It is particularly important to have robust and thorough documentation," he emphasizes.
Ullum agrees. "Be sure to clearly define your expectations and specifications," he states. Some companies in China, he says, don't understand the requirements of the U.S. market, such as the importance of things like cosmetic appearance. "A lot of U.S. companies aren't used to having to do this, because they have either made things in their own factories or have purchased them from other U.S. suppliers that understand the market better," he says.
In addition, it is important to put requirements in writing. The more you assume, the more problems you will have. Conversely, the more reference points you can provide, the more likely the factory will deliver what you expect. Source International does this in three ways: a written bill of materials and quality specs, physical samples, and mechanical drawings.
"You also need to create and explain performance requirements," continues Ullum. "This includes information on what the product is supposed to do and what the testing protocol is." In sum, consider: What will your customer do with the product once they receive it? And does this product meet those requirements?
And an equally important step: Get the supplier's agreement. "I have never seen anything more powerful than—as simple as it may seem—having a reliable person in the factory actually sign the specifications," points out Ullum. This may require a bilingual document, because there may be some misinterpretations in an English document.
6. Address intellectual property issues
It is important to ensure protection of intellectual property when sourcing in China, especially in terms of design and tooling. While legal documentation and contracts can help, AlixParters' Sullivan believes it is actually more important to have commercial leverage.
"Getting a contract enforced in China, even with good legal representation, is a challenge," he cautions. Commercial leverage means having other business there, such that if the company compromises your intellectual property, they risk losing a lot of other business.
7. Create technology teams
When moving technologically driven business into China, it is very important to have teams focused on the process on both sides of the ocean, according to Sullivan. This requires a great deal of coordination. "You need your technical guys in the U.S. working with the technical guys at the factory," he says. "They often don't speak the same language. However, my experience with engineers is that, once you get them working together, even if they don't speak the same language, they figure out how to work together on their own after a while."
8. "Trust, but verify"
You may be surprised to know the words of Ronald Reagan apply to global sourcing, but they do. "You want a good partner and a trusting relationship, but you need to check on things," Ullum explains. A complete quality monitoring program, either conducted by a third party or your own company's personnel, is essential to ensuring that the product shipped meets all of the specifications and performance criteria that are agreed to. "Even one bad shipment can do serious damage to the procurement department's credibility and wipe out projected savings quickly," he cautions.
Sullivan agrees. "You need a local presence, where you can get to the factories on a regular basis," he states. Relationships matter, but it's more than just that. It gets back to control. You need to qualify the actual pieces of equipment and tools that your products are running on. "If you don't have your own eyes on these, then you really don't know what's happening," he notes. "A Chinese company can promise that your products will run on certain equipment, but you may find out that things have changed once you actually go there and look."
9. Be open to R&D projects
According to Sam Datta, regional director, sourcing and procurement practice lead, southeast region, for Chicago-based Grant Thornton, a lot of companies want to involve suppliers more closely in R&D, but have been nervous about doing so with Chinese suppliers.
"It is possible to do this in China, but you have to be careful and work very closely with those suppliers," he says. The biggest challenge is finding qualified suppliers to handle the needs of U.S.-based firms. "You need to look at their processes, technologies, innovation, and other capabilities," he suggests.
Once you select suppliers, you have to treat them as though they are next door to you, and you have to have your own people over there to make sure they are doing what you need. Working closely also helps to resolve the potential problems related to intellectual property (patented information) and concerns that they will do reverse engineering, according to Datta.
10. There's more to global sourcing than China
Finally, don't just automatically assume that China is the best place to source everything. The global supply and business landscape is constantly changing and it is important to keep up with these changes as you are making current and future sourcing decisions.
Certainly, China is an excellent place to look first. "Even though there are other countries getting involved, China still has the overwhelming majority of low-cost country sourcing business," says Sullivan.
Smouther suspects China could be getting to a tipping point, where labor costs are increasing, so the low-cost labor advantage is beginning to erode a bit. "Other countries, such as Vietnam, are gaining popularity for low-cost labor," he notes.
Sullivan adds that the Chinese government is also revising the tax structure, reducing value-added tax rebates on a commodity-by-commodity basis. The strategy is designed to try to push very low value-added business out of China and focus on the higher value-added business. Sullivan also echoes one of Smouther's comments. "There are a lot of other rising stars, particularly Vietnam, where labor rates are about half of what they are in coastal China," he states.
In addition to Asian markets, Sullivan adds that now "we are finding that Mexico's star is rising again, and some business that went to China is now coming back to Mexico." In addition, new business that would have once automatically gone to China is now giving Mexico a hard look, not only because it is becoming more competitive, but because of logistics costs and the inventory impact.
Offshoring Pleasures and Pitfalls
Does it or doesn't it pay?
Robert B. Aronson, Senior Editor Manufacturing Engineering
The loss of many manufacturing jobs to overseas sources or "offshoring," is a serious concern and the subject of a lot of debate. Statistics and reports are available supporting both the positive and negative aspects of this event. They range from concluding, "US manufacturing is about to die," to "No problem, nothing to worry about."
Much data on offshoring is subject to question because of the variety of ways many sources, including the Federal government, report data. For example one company may report product manufactured domestically and overseas together. Others report them separately. But unquestionably, US jobs are being lost. In addition to offshoring being added to our new buzzwords, so has the word "deployees." It indicates those who have lost jobs or business because of offshoring.
The offshoring situation is not a case of deciding if you will or won't be involved. The issue is how much it will influence your work and what you can do about it.
Offshoring may not last forever. Offshoring will be with us for the foreseeable future. But, there are indications it will not be as pervasive as it is today.
The middle class in advanced Asian countries, particularly China and India, is growing. Workers demand higher wages and more of the population is becoming a market for their own country's products, thus reducing the drive to export.
There is also evidence that Asian countries are becoming more willing to carry out reforms, such as protecting intellectual property, and honoring patents. Such moves take away some of the negative factors of offshoring.
Stories of quality problems with overseas suppliers are common. But the recent problems with lead in paint and hazardous materials in imported grain and pet food have done a lot to shake confidence in Chinese products in general.
It also caused the Chinese government to change, or at least report they are changing, quality-control regulations. They have also executed a few officials reportedly to blame for the problems.
For those faced with an immediate decision as to whether or not to try offshoring, and if so, how deeply, here are some comments by those who have been involved with this situation.
One of the first suggestions given to manufacturers who want to avoid an offshore arrangement is to evaluate their own operations to determine what can be done to reduce production costs. And this means all costs. Many companies make decisions on a limited number of cost factors, chiefly machine operation and associated labor. More accurate evaluations look at costs from the time the raw material comes in until it's shipped, plus any support or warranty action that might be required.
Among the more prominent techniques for cutting at-home manufacturing costs is the Design for Manufacture and Assembly (DFMA) software developed by Boothroyd and Dewhurst (Wakefield, RI). It is software that combines Design for Assembly (DFA) and Design for Manufacture (DFM) programs. DFA software reduces part complexity by consolidating parts into multifunctional designs. DFM helps identify parts that can be improved and indicates what the cost of the new part might be. The result is a design that can be optimized while the product is being developed. DFMA therefore provides a way to evaluate and understand the cost effects of design decisions. The result can be a lower-cost product.
Many companies neglect to take advantage of the latest technology, so production techniques and equipment becomes dated. Or, cost-saving opportunities are ignored in the rush to meet immediate needs. A minimal change in equipment or process often can significantly lower costs.
One option to the yes or no offshore question is a partial yes. Some companies, after a thorough evaluation of their production costs, decide to offshore only those parts where there are significant data supporting the change.
Companies such as BaySource (Tampa, FL) www.baysourceglobal.com specialize in this work, chiefly with small and midsize companies who want to get work done in China.
"We have saved a number of companies from going out of business by arranging for them to have only those parts they cannot make economically go overseas," says company president David Alexander. It is chiefly those that require a lot of low-talent labor.
Setting up any offshoring is safer with competent help. Team 2000 (Austin, TX) is a training and consulting organization that specializes in dealing with India. Company President Rai Chowhary admits, "Offshoring decisions are a real minefield, particularly because there are no hard and fast rules. Every situation is very product and process specific."
It is not just the small companies that have trouble. "Many US manufacturers have been swept into offshoring in the lemming-like rush to cut labor costs, andthe herd mentality that anything made offshore will be very beneficial," says Chowhary. "Often, in a short time, they find there are problems they had not counted on."
For example, there is the case of a large manufacturer who committed to a long-term agreement for a major number of parts with an offshore supplier, without thorough investigation. When the overseas-made parts started showing up, it was found they needed a lot of rework before they were in a usable condition. As a result, special repair shops had to be set up in the US to rework the parts. The parts kept coming because of commitments made earlier and so did the rework costs.
"This does not mean it can't, or shouldn't, be done," says Chowhary, "But it has to be done carefully with the guidance of someone who knows the capabilities of the foreign suppliers as well as the real needs of the US manufacturer. I have advised many of my clients not to go overseas because their particular needs could not be met overseas at a cost advantage to them."
False assumptions are a frequent cause of offshoring problems. A survey sponsored by technology providers E2open (Redwood City, CA) and Manugistics Group (Rockville, MD), found that many companies that had elected to offshore have unexpected logistics costs as well as erratic delivery times. The report concludes: "If you just do it based on pricing negotiations and have not thought through the logistics of delivery, assurance of supply, flexibility of supply, and quality, your total cost very quickly outweighs the price savings you made in the negotiations up front." The report also notes that, too often, companies look at the current design of a product and naturally, but mistakenly, assume that its redesigned predecessor will cost the same amount to produce.
Properly managed, offshoring can be a profitable move. As Gisbert Ledvon of Charmilles (Lincolnshire, IL) notes, "To remain competitive you have to recognize you are operating in a global environment." He suggests those considering such a move stay with parts that need a high degree of low-skilled labor such as simple drilling, punching, or bending processes.
"Another area where overseas help may be beneficial is start up cost," Ledvon comments. "For example, if someone needs a complex die that requires a lot of hand polishing, that might best be done overseas."
Ledvon also notes now this might be a good time to reverse offshoring to some degree. The US dollar might make US goods more attractive to overseas buyers.
Both good and bad results from offshoring are reported by Mike Rickabaugh, president of Livonia Tool and Laser (Livonia, MI). In one case his company, which specializes in laser cutting and steel stamping, benefited from low-quality Chinese work.
On a contract for metal stampings used for industrial shipping containers, a company had to quickly fill an order. It was placed with a Chinese manufacturer. The Chinese ignored the spec to make caster holes in the braces. Casters are critical to this type of container, so the container maker had to quickly farm out all the Chinese parts to have them reworked so he could meet a contract obligation. As a result, Rickabaugh gained a customer.
And it isn't just toys that the Chinese have painted improperly. "We know of other contracts with the Chinese that were cancelled when the buyer, warned by the toy-painting scandal, found his Chinese-manufactured products tested high for lead content," says Rickabaugh. "Several US manufacturers that discovered the same problem now specify American production only.
"You don't always know why the Chinese beat you out on price," Rickenbaugh explains. "It's strange, but we have found that the more weight a product has the tougher it is to beat the Chinese price." For example, his company makes two brackets used for container bracing. "One part's weight was just one pound, and we beat the price on that easily. But the Chinese, making a second part weighing two pounds, using the same processes with comparable machines, were cheaper. Possibly it's an issue with shipping costs or the raw material," he observes.
Vicount Industries (Farmington Hills, MI), is a contract manufacturer with about 25 employees that has been in business for over 30 years. About 90% of their customers are in the auto market, and much of their work involves the manufacture of stamping dies.
The company uses advanced processes, such as laser scanning and 3-D modeling, to establish designs and evaluate manufacturing processes.
"About four years ago, we began looking at some help from overseas suppliers," says company president Leonard Lavoy. "On our own we began a dialogue with some Indian companies. We now have a supplier producing low-tech parts for us. These parts require a significant amount of labor because of set up and handling. So far that has worked out well."
Currently, Lavoy is working through a broker to evaluate some Chinese suppliers.
"Overall, our experience has been on the positive side. We did not lose any workers. In fact, offshoring allowed personnel and machine time to handle more detailed work.
"I would caution any shop considering using an overseas supplier to be sure of their capabilities before you jump in. I find the work quality from India and China below what I would expect from a US company. You have to be as certain as possible that they can do what you expect them to do," he concludes.
It's not practical to make all products or parts offshore. According to a recent Boothroyd and Dewhurst report, the "don't try it" list includes products that:
- Need some highly automated process,
- Have a weight or size that incur high shipping or air-freight charges,
- Require scheduling flexibility,
- Require engineering and design changes to ensure quality, and
- Have intellectual rights and/or patents that may be copied and marketed less expensively.
What the CFOs Think
A survey of CFOs and senior financial executives by Alix Partners LLP (Southfield, MI), a global restructuring, consulting, restructuring, and financial advisory services firm, gives both positive and negative views on offshoring. They looked at selling and general administrative trends at 35 blue-chip North American companies and divisions. Their survey found:
- Outsourcing projects were already under way at 55% of the respondents.
- Within the next two years 74% reported either continued or planned outsourcing.
- The hoped-for cost savings of 15%, or expected operational improvement such as enhanced flexibility and access to best practices, was not enjoyed by 60%.
- Expertise and stability of the overseas supplier was most important for 48% of those surveyed.
- Reduced cost was the key factor for 31%.
- Outsourcing projects were considered less than fully effective by 38% of midsize companies, and 15% reported being worse off.
- Among companies taking six months or more to implement their outsourcing programs, 40% realized savings only after two years or more, while 20% realized no savings at all. But, all companies that carried out their implementations in six months or less realized their expected savings.
The survey also found that the top two reasons for not outsourcing SG&A functions are reluctance to count on overseas suppliers for highly critical parts or products and the perceived risk of losing confidential information.
Alix Partners analysts concluded that companies don't look 'inward' enough, to adequately prepare for all that successful outsourcing demands inside their own companies. Internal resource issues placed well above poor vendor performance, when it came to major problems with outsourcing. "The overriding reason companies aren't getting the returns they want," said Neal Ganguli, co-leader of the survey and a director at AlixPartners, "is they don't ... adequately prepare themselves for all that successful outsourcing demands inside their own organizations."
An executive summary of the survey is available at <!-- var username = "nganguli"; var hostname = "alixpartners.com"; document.write('' + 'nganguli@alixpartners.com' + ''); //--> nganguli@alixpartners.com.
Here's What You Need to Know
Here, a sampling of the questions taken from an 80-question survey developed by Team 2000. It is suggested you know the answers before committing to any offshoring deal.
- What is driving you to outsource: Because others are doing it? Cost, quality?
- If you are outsourcing to save cost, how long is your planning horizon?
- Do you have a cost-benefit analysis for the short and long term? What does this analysis include?
- How will you deal with rejects and rework? Where will this work be carried out? At whose expense? Is that specified in your contract?
- What about delays? What assurance do you have on delivery time?
- What do you know about the suppliers and their capabilities? What is the source of your information?
- How will your product be packaged to prevent damage or pilferage during shipping?
- Is your staff conversant with the culture in which the supplier is located? Can they accurately pick up the true meaning of what is said? For example, what does the potential supplier mean by "soon," "accuracy," or "best possible?"
- How much does the supplier know about the ultimate use or function of your product? And, how do you know that your supplier understands this?
Private Label Use to Grow
Many distributors are facing that crucial question at this point in their business evolution, weighing the decision of what to do with the "date that brought them to the dance." Early on in most models, distributors leveraged the brands they carried to solidify their position within their target markets. The brands represented the "Seal of Approval" that the DSRs carried in their bag. What do you do however, when there is no longer a national brand requirement on a line where little tangible value is in the brand's product lines or where a product has become "commodified?" Some national branded companies make the decision easy, exiting the space for a respective line and the margin erosion in a category deems it unprofitable to support a line. However, when the Distributor is held hostage to a certain brand and the brand no longer remains cost competitive, the distributor needs to make a choice. The key is does the distributor have the clout and relationships with their book of business to pull off stocking a private label line of goods to compete with a branded line.
In Modern Distribution Management, Adam Fein discusses the "Pros" of embarking on a private label program. For the branded guys, they had better take note for the Distributors' leverage is growing as brand support continues to dwindle in non traditional retail channels. BaySource Global www.baysourceglobal.com is working with distributors in various industries such as boating and marine, building products, and agricultural to help them in their strategic sourcing initiatives in China, sourcing items that executives have identified as being lost leaders. Better defined, these are items where there is no brand requirement, yet the actual products are commodities that a distributor must carry for the every day functionality to their customer base.
Questions to ask are:
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Do we have economies of scale or volumes to justify sourcing direct from China?
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Do we have someone on board to "champion" the management of offshore sourcing?
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Are we jeapordizing our business relationship with the branded incumbant in bypassing them to source direct and will this affect my costs on other items?
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Have we determined realistic target costs for the items that we will take offshore? If we obtain these costs have we factored in other crucial benchmarks such as carrying cost of capital for additional days on hand of inventory, physical plant requirements (storage)?
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Are items we intend to source directly protected by patents or other measures?
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Do we have the necessary information to have the product(s) manufactured offshore such as material specifications, quality requirements and standards, ratings, drawings, samples--note this is where resources have to be relegated to championing the project.
Strategy will strengthen but also strain relationships
In his book, Facing the Forces of Change, Adam J Fein, Ph.D discusses the evolution ofPrivate label products—products branded by a wholesaler-distributor—and how they represent a break from the more traditional wholesale distribution approach of reselling manufacturers’ branded products. Facing the Forces of Change®: Lead the Way in the Supply Chain, discusses private label strategies by wholesaler-distributors will expand substantially over the next five years.
Fein asserts that Wholesaler-distributors will need to build new capabilities in manufacturing and design in order to create products with unique, premium benefits. They will also have to select the right opportunities for private labels and manage the new supply chain risks associated with global sourcing.
Today, according to Dr. Fein, "an average, 43 percent of wholesaler-distributors currently sell their own private label products, although there are substantial differences between the six major product types in our study. For example, almost one-half of building materials wholesaler-distributors currently offer private label products, compared to only 23 percent of contractor supplies wholesaler-distributors." Fein goes on to say "the lower costs and ready availability of overseas sourcing opportunities in Asia and South America accelerate the ability of wholesaler-distributors to get their own value-priced private label products manufactured. About 57 percent of wholesaler-distributors with private labels currently source their private label product from an overseas plant. By 2012, 81 percent of these wholesaler-distributors expect to be sourcing overseas.
According to Fein, Private label products offer three major benefits to wholesaler-distributors:
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Buy-side margin. Private label products can be priced lower than comparable national brand products, especially when sourced directly from an overseas manufacturer. Since private label products are less expensive to purchase, a distributor can earn a higher margin even when the products are priced at a discount to national brand products. This option simultaneously grows margins for the distributor and aligns the distributor more closely with its customer’s objectives.
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Sell-side profitability. A wholesaler-distributor’s private label products offer the opportunity for increased profitability by capturing the branded margin that would otherwise flow to an upstream manufacturer. The distributor also gains the ability to control the entire profit stream from production to sale, allowing for more flexible sales compensation models and higher commissions to drive sales. For example, a distributor can reduce the advertising overhead of a national brand manufacturer, especially on certain products for which customers see no value differentiation.
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Differentiated product assortment. A private label brand name can be exclusive to a wholesaler-distributor and provide a point of differentiation. For example, some wholesaler-distributors find that they can fill gaps in the marketplace by offering the good (value) alternative in a good/better/best hierarchy. Availability can be another point of differentiation. A private label product can be sourced from multiple manufacturing companies and this gives a distributor the opportunity for more consistent product availability than when sourcing from uniquely branded manufacturers.
More can be found in his Facing the Forces of Change®: Lead the Way in the Supply Chain, which is available online from the National Association of Wholesaler-Distributors at (http://www.mdm.com/stories/fein3701.html)
*Pembroke Consulting is not in any way affiliated with BaySource Global or its China office Eastlink Global Ltd.
China Outsourcing Advice
Linking East and West, BaySource andEastlink Global Ltd represents a “safe pair of hands” for companies looking to do business in Asia today. Focused on innovative new products and manufacturing components, Eastlink Global is committed to building long-term partnerships with industry-leading companies who share our values of integrity, transparency and uncompromising customer service.In Asia today “Everything is possible… yet nothing is easy” however, our on-the-ground team is dedicated to providing the day-to-day execution needed to ensure your company’s success. Our extensive manufacturing networks, design engineering, program management capabilities and robust logistics infrastructure provide the “end-to-end” solution needed to win in today’s fast-paced environment. Partnering with BaySource and Eastlink Global allows you to instantly unlock the opportunities and benefits of working in Asia, optimizing cost savings and mitigating execution risk. Allow us to help navigate your next outsourcing initiative here in Asia. www.baysourceglobal.com
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