Embracing Global Resources for Local Advantages
David Alexander
In the midst of these economic challanges, decision makers need to understand the advantages of looking globally for positive domestic results. While jobs shrink in the U.S. it has been easy to cast a dark shadow with manufacturing outsourcing as the key culprit. Too often though we sit back and scratch our heads wondering why low value add jobs have moved offshore rather than strategize on how to effectively incorporate the benefits of low cost labor with supply chain initiatives here. For marketers in the U.S. the value propositions of product innovation, speed to market and service have to be the platform which separates winners from their competition.
In the April 8 Wall Street Journal, writer Tim Aeppel features Craftmaster Furniture and their story of winning market share while competitors flounder. By combining a solid offshore sourcing initiative for high labor components and unique upholstery with the need for quick turnaround time and service, CEO Roy Calcagne has "increased revenues by 4% in an $80 billion industry that has declined by 20% in the last six months. Craftmaster has even hired 75 additional workers in a factory that employs almost 500 according to Aeppel's article."
http://online.wsj.com/article/SB123879125297987681.html
Basically the company takes the approach of a nimble and responsive partner to their customer base, while maintaining margins through low cost country sourcing. This collaborative strategy is one that has continually proven effective in the U.S. and not immediately stereotyped for the demise of overpriced, low value jobs. See
http://www.baysourceglobal.com/PortlandBusinessJournal-BaySourceWhitePaper.pdf
A Conversation on doing business in China
The following is a recap of a January 21, 2009 panel discussion hosted by the Orlando Chapter of ACG (Association for Corporate Growth) on the ins and outs of doing business in China. David Alexander, president of BaySource Global www.baysourceglobal.com was one of the featured speakers along with Brian Su of Artisan Business Group and Jim Gaynor, CEO of Lightpath Technologies.
ACG Moderator: Discuss how this global recession has impacted doing business with and in China
Alexander: The Credit crisis affecting all industries. Volumes are down and many factories dependent on U.S. retail and consumer volume have closed. People are strongly revisiting “In-Sourcing” due to attrition in volumes. A local trade association predicts that by late January, Dongguan and its neighbors Shenzhen and Guangzhou will lose 9,000 of their 45,000 factories.“Many factories are looking at completely empty order books," warned Stephen Green, head of China research at Standard Chartered, who believes the export sector may even shrink next year. Green believes China will see 7.9% growth in 2009 - well below the double digit figures of the past five years.“Government statistics show that 67,000 factories of various sizes were shuttered in China in the first half of the year,” said Cao Jianhai, an industrial economics researcher at the Chinese Academy of Social Sciences. By year’s end, he said, more than 100,000 plants will have closed. The wave of factory closings began in Guangdong province, where the nation’s economic reforms were launched three decades ago. The region accounts for about 30% of China’s exports, but over the last couple of years, Shenzhen, Dongguan and other cities in the area have sought to clean up the environment and create an economy based more on services and higher-value products. Makers of labor-intensive goods such as shoes, garments and furniture no longer felt welcome.”Stanley Lau, deputy chairman of the Federation of Hong Kong Industries, a trade group with 3,000 members, has estimated that as many as 15% of the 70,000 factories run by Hong Kong businesspeople in the mainland will close this year. He says many more are likely to shut after Chinese New Year in February, when millions of migrant laborers will return home for several days. “Once workers go home, they can close down the factory quietly,” he said in an interview in Hong Kong.
ACG Moderator: Given this recession, specifically, how has the outsourced manufacturing space been impacted?
Alexander: People have been forced to re-analyze bringing manufacturing back due to lower volumes. Less scale means reduced leverage with factories. Reduced demand = longer lead times with higher volume/less frequent orders. Carrying costs of capital increases; customer response times impacted. IKEA for instance has recently opened a plant in Virginia.In an April survey of nearly 1,000 companies by RSM McGladrey, the number planning to move offshore fell by 20% from a year earlier
ACG Moderator: Further explore the costs of shipping/freight as they impact this model
Alexander: Increased energy costs toward the end of 08 meant freight as a % of COGS increased. There were fewer containers coming into port—first declines since 2006; down 1.5% from Nov 07. At $150 barrel 40’ container $8,000 vs. $3,000 a year ago or $100. At $200 it would be $15K. Through July 19, U.S. railroads had carried 5 million shipping containers, down 3.4% with the same period last year. Containers that slow to 23mph from 29MPH save 20% but this means freight lines have to add containers. However, freight increases alone not cause in wholesale trade pattern shift back to US mfg. The Economy is key driver. Higher fuel costs will also cause a shift in Lean inventory. May see proliferation in warehouses to be closer to customers. The Freight Transportation Services Index dropped 1.4 percent from October to November to 107.6, the lowest level since January, 2004. The index is down 4.9 percent from its historic peak of 113.1 reached in November, 2005, the Department of Transportation's Bureau of Transportation Statistics reported.
ACG Moderator: Discuss the Chinese economy both how it's being impacted by this economy internally and how externally the commodity markets are being impacted around the world.
Alexander: China's exports fell in November for the first time in seven years and manufacturing activity shrank in December for a third straight month. Material costs will always fluctuate globally and are consistent around the world. With fuel and energy costs subsiding a bit and with material costs softening, Labor is still the key driver for the feasibility of offshore manufacturing.
Still it seems like the economy is chugging along normally though. In the city where one colleague lives there were more than 4000 cars newly registered in the first week of Jan alone. This is a city of 3M people and the roads are already crowded. We are not sure how many weeks like that one in Jan. we can survive and still keep cars moving along. Also, remember, the Chinese are good at saving money. The China economy is predicted to be as large as U.S. by 2030. All this said, this crisis has been a time of reckoning. Americans are buying fewer Chinese DVD players and microwave ovens. Trade is collapsing, and thousands of workers are losing their jobs. Chinese leaders are terrified of social unrest. Having allowed the renminbi to rise a little after 2005, the Chinese government is now under intense pressure domestically to reverse course and depreciate it. China’s fortunes remain tethered to those of the United States. And the reverse is equally true. The Treasury conducts nearly daily auctions of billions of dollars’ worth of government bonds. For the past five years, China has been one of the most prolific bidders. It holds $652 billion in Treasury debt, up from $459 billion a year ago. Add in its Fannie Mae bonds and other holdings, and analysts figure China owns $1 of every $10 of America’s public debt. The Treasury is conducting more auctions than ever to finance its $700 billion bailout of the banks. Still more will be needed to pay for the incoming Obama administration’s stimulus package. The United States, economists say, will depend on the Chinese to keep buying that debt, perpetuating the American spending habit.Many firms in the auto, luxury, travel & tourism and real estate industries have begun reporting a significant decline in spend. Where the greatest opportunity lies, is in the rural economy. It is the economy that has lagged far behind the others - It is the economy that has more than 700 million people - It is the economy were small nominal gains can equate to large.
ACG Moderator: Discuss the idea of building markets in China coming from the U.S. or Europe
Alexander: According to The Kiplinger Letter, for 2009, trade will shrink worldwide by 2.1 percent to $115 billion and U.S. exports will drop 0.5 percent. It said the hardest hit areas will be machine tools, chemicals, plastics, mining gear and turbines, while medical products, farm goods and construction equipment should weather 2009 relatively well. Kiplinger predicted no worldwide growth for gross domestic products in 2009, and negative growth in the U.S. There are still good opportunities for growth. Certain products that sell well in China and come from USA are mostly niche items. Examples: Zippo Lighters, cosmetics from famous names like Estee Lauder cars, and famous brand clothing. Western brands will always be in demand.
ACG Moderator: Discuss how the Chinese government is impacting companies that want to either invest in China financially or via a joint venture or with manufacturing facilities - VAT rebates, and clean industry versus smokestacks
Alexander: In July, 07 VAT rebates were rescinded for 553 industries. The gov't just increased the VAT refund for exported goods to help with the economy. The price of raw materials is way down now so batteries, and other items have gone down in price about 30%. China will increase the export tax rebates for some machinery products as of Jan. 1, 2009, in a bid to alleviate cost burdens on exporters (back to 17%). The most recent increase took effect on Dec.1, covering 3,770 items of labor-intensive, mechanical and electrical products, or 27.9 percent of the country's total exports.
ACG Moderator: Discuss product quality concerns in Chinese manufacturing
Alexander: Any U.S. concern marketing a product manufactured in China is ultimately responsible for product/project management. This means clearly stating product specs and tolerances, material specs, defect rates, etc When we leave too much in the hands of Chinese manufacturers is when we run into issues.China does need better IT and process control. There is a lot of opportunity for IT/IS but also the Chinese don't know they need this. They don't even use part numbers in most businesses... Our biggest opportunity from US to China is to engrain our production management know-how. One of the main problems in producing quality here is that the workers and managers themselves don't know what to expect in a quality product because they don't consume such items. "They have no feel for what quality is."There is also little accountability for goods that fail after some time in service. Example: If you buy a new house, everything will be perfect when you buy it but things will soon start to break because they weren't made well. They might try to fix it but how can you fix a tile floor if all the tiles were installed following a standard that is not up to par? Example: they paint bare wood or walls without priming the wood first. The paint looks great for a year, then it lifts off in big sections but it’s too late for anyone to be accountable then. Your average Chinese homeowner has no idea how to paint or do other home repairs compared to the average American.This is why you need to have your interests well looked after. Also, a serious weakness of Chinese engineers is their reluctance to ask questions. This has to do with the cultural myth of “lose face.”Because of the importance of relationships and family sometimes they will hire their friend/family member instead of hiring the best person for the job. This also limits their success in some ways. Take Auto parts for instance. The Speed at which China has been industrialized means quality concerns and recalls are growing. Their revolution happened in a quarter of the time that ours did.The Chinese are unfamiliar with or don’t care about U.S. auto quality standards. Under federal law the importer of record is responsible for recalls and quality concerns. Many small importers (anyone can be importer) aren’t familiar with regulations and suppliers don’t have the capital to handle recalls.We also have to communicate the long term implications of the business opportunity to the Chinese factory. If they think a project is ‘one and done’ then this impacts price Everything is a negotiation.
ACG Moderator: Discuss the cultural differences especially as it relates to building relationships in China.
Alexander: The Chinese always consider their relationship with another person when they do business with that person. For example, they can never turn away from doing business with a friend even if there is a better product they should be seeking. At least they can't do it in front of everyone so they might do it secretly. The Chinese prefer to deal with people they know and trust. Western companies have to make themselves known to the Chinese before any business can take place. Furthermore, this relationship is not simply between companies but also between individuals at a personal level. The relationship is not just before sales take place but it is an ongoing process. The company has to maintain the relationship if it wants to do more business with the Chinese. The relationship sometimes begins based on money then moves to integrity and trustworthiness. Frequent contact is important.
ACG Moderator: Discuss other emerging markets such as Vietnam, South America and Mexico briefly as they relate to the evolution of the Chinese markets and increased shipping costs.
Alexander: Much is predicated on fuel costs. Also higher expenses, plus higher taxes and stricter enforcement of labor and environmental standards, are causing some manufacturers to leave for lower-cost markets such as Vietnam, Indonesia and India.Despite its huge pool of unskilled rural laborers, China's supply of experienced, skilled talent falls far short of demand. The gap has been pushing wages up by 10 percent to 15 percent a year.Inland cities like Luoyang and Wuhan, outside the traditional export zones of Guangdong and the Yangtze River Delta, near Shanghai are emerging. In inland China, wages still lag far behind the richer eastern and southern coastal areas.
Outsourcing to China not always simple
Sign Manufacturer Cuts Manufacturing Costs in Half by Outsourcing to China
By John Harney, Business Writer January 2009
Outsourcing manufacturing work to China is a cost-saving but often not a hassle-free undertaking, especially if your company does not have a liaison in place. This liaison must understand the manufacturing practices, expectations, culture, and pricing in China and how they differ from those in the United States and be able to effectively communicate that information to the U.S. office.
Creative Mailbox & Sign Designs is a manufacturer of mailboxes and signs that does $8 million a year in revenues and employs 65 personnel. It has three lines of business. The Residential line manufactures mailboxes and street signs for master plan communities; the Commercial lines does signage for office buildings; and the Department of Transportation line takes care of Department of Transportation signage for interstate and other highways.
It sounds like a simple enough business -- design a sign, send the design to China, and have them make it and send it back in quantity. Jamie Harden, CEO of Creative Mailbox & Sign Designs, says it's not that easy. "We had a relationship with a stamped aluminum outsourcer and manufacturer in China. We found quality inconsistency issues, poor communication, and lack of connectivity into their Asian organization," he says.
Harden might convey specs and other data and instructions to the U.S. liaison but had no direct communication with the Chinese portion of the business. The result was miscommunication and mistakes, which cut into Creative Signs' margins and held up manufacturing schedules. "We felt like we were buying a product instead of being in a situation where we could go through a more collaborative design process. It was not a real partnership," says Harden. "No pun intended, but we often felt like something was lost in translation," he adds. As a result, the company sought an outsourcing partner elsewhere.
Collaboration is key
Understandably, says Harden, "we were really looking for a service provider that would help us develop a partnership that would give us reliability, quality, effective communication, and good connectivity into Asia." Harden's company found exactly that when it phased out the existing outsourcing contract and teamed with BaySource Global www.baysourceglobal.com in June 2006. The company used BaySource to manufacture mailboxes for distribution into its Residential market, and BaySource proved to be both consultative and communicative from the get-go. "From the beginning they went out of their way to understand our needs," says Harden.
"We had e-mails and conference calls not only with David Alexander, president of BaySource, who runs the domestic side of things, but also with his partners in China; so we really had great connectivity right into that organization," says Harden.
Creative Mailboxes has in-house graphics designers who come up with images of the product, which they send via the Internet to Alexander. His team takes engineering drawings and specifications, and drops them as CAD drawings into BaySource manufacturing program. This helps the Chinese supplier determine the tooling process, which is necessary to be able to get a quote, according to Harden.
If the buyer can't provide CAD drawings, BaySource’s China team -- all trained in professional CAD shops in China -- can develop them for the client. BaySource then comes back with a proposal that states the tooling costs as well as the cost of the product. The supplier also provides a timeline, including how much turnaround time it will take from delivering initial drawings to providing a sample to finally delivering the product.
According to Harden, "We gave them the specifications but said, 'If you can add any value to the process, feel free to offer it.' So they came up with a few tweaks here and there to help us come up with a superior product. For instance, they designed a new latch for the mailbox and even went out of their way to find the paint we wanted to use."
Basically, Harden adds, "As they were doing design, they were sending us pictures to see if it looked right. Sometimes what happens is you lose so much time to market because the manufacturer wants to just do a sample -- with no pictures beforehand -- and send that to you." This is an advantage because if the sample is not right, the manufacturer has to repeat the new sample process.
The price is right
Harden readily admits that BaySource delivered "a quality product." What's more, the pricing was "extremely competitive." By outsourcing to China, his company was able to keep design/manufacturing cost of each unit to just $8. Harden estimates that if he'd have attempted manufacturing in the United States, it would have cost twice that.
The lower cost also gives Harden's company a healthy sales margin to work with since it sells the mailboxes for $30 a unit. Better margins obviously keep the company more competitive since it's now also coping with a weak U.S. economy.
A one-stop shop
According to Alexander, his company takes over the project from the start. "All we need to understand is whether a customer has ever outsourced a product before or if it's a product that's currently something its procurement department is obtaining from a domestic distributor." This gives BaySource a baseline from which to estimate its own and the customer's needs.
The China office handles the specs, engineering drawings, and samples as well as sets cost targets and annual volumes and the like. Then, says Alexander, "we take that project and match it with a capable factory in China."
BaySource therefore acts as a liaison between its customer and any of 50 factories it has bid on jobs. And Alexander acts as liaison between American customers and the BaySource Chinese operation.
The China team is manned with Chinese-speaking personnel as well as engineers. When BaySource visits the factories to explain the job and later to confirm that the factory is making products to the customer's specification, the personnel have to talk to one another in the same language. "I don't mean Chinese," says Alexander, "so much as one engineer talking to another. Because of the specialized terms, it takes an engineer to talk to an engineer."
For its efforts, BaySource nets a profit margin in the high single digits to low double digits. This keeps its services cost-competitive, particularly in an underperforming economy.
As Alexander is quick to point out, "More companies are doing business in China, so competition is increasing. The market will dictate what the costs will be. If we gouge a customer, we may lose them for good." At BaySource, therefore, good business strategies dovetail with ethical business practices, a situation that is increasingly rare these days.
Lessons from the Outsourcing Journal:
• Customers that outsource manufacturing to China should have an outsourcing supplier there that understands Chinese manufacturing practices, expectations, culture, and pricing and how they differ from those in the United States
• Ideally the outsourcing supplier should be a company that helps the customer develop a partnership that gives the customer reliability, quality, effective communication, and good connectivity into Asia.
• The supplier should present the customer with designs throughout the design and manufacturing process to ensure that the sample that results is correct. Otherwise, if the sample is defective, the customer loses valuable time to market in the process of creating a new sample.
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Copyright © 2009 - Everest Partners, L.P.
Instead of worrying about China, companies are better off embracing the opportunities.
Solutia Inc. Chief Executive Jeffry Quinn on Monday signed $182 million in contracts with companies from China, a country that looms large in his corporation's future as well as in the minds of many American executives.
Quinn was in a line of local industry leaders who put pen to paper and sealed deals with Chinese customers during a trade delegation conference at the Ritz-Carlton hotel in Clayton.
Among these, Ferguson-based Emerson sold $70 million in telecommunications and power-related equipment. And locally based soybean trade groups, representing companies such as Bunge, Cargill and ADM, closed deals worth nearly $5 billion.
"Solutia obviously is very pleased to participate in this event and have a small role in demonstrating the vitality of the St. Louis region, as a source of economic development and as a trading partner with China," Quinn said. The company, based in Town and Country, makes specialty chemicals and performance-enhancing window films.
As the U.S. economy lags, rapid growth and an expanding middle class make China an irresistible market for domestic companies.
Solutia, with annual sales of nearly $4 billion, said that 58 percent of its total revenue growth between 2006 and 2011 will come from China. That translates to total Chinese sales of $439 million in 2011, up from $166 million in 2006. These sales stem from lines of business that are becoming increasingly profitable as Solutia raises prices and improves logistics and manufacturing efficiency, Quinn said.
Solutia exports nylon resins and polymers to China from a plant in Pensacola, Fla., which played host to nearly 30 members of the trade delegation on Sunday. Solutia's products fill the holds of cargo ships returning to China after bringing loads of low-cost manufactured consumer goods to American shores.
The Asia-Pacific region is key in Solutia's strategy of transforming its under performing domestic nylon carpet-fiber business into a global supplier of resins and polymers for plastics.
Gone is the view of China as simply a place to outsource jobs and lower the cost of manufacturing. The booming nation is a market in its own right — in Solutia's case, for goods manufactured in the United States.
"We look at China not as a place to outsource production and find cheap labor, but as a vibrant market that needs and desires the quality products that Solutia produces around the world," Quinn said.
But that's not to say the company lacks investment in China — that was a key point in Solutia executives' closed-door remarks to that country's trade officials, the CEO said.
In China, Solutia produces tinted window films and, through a joint venture, makes heat-transfer fluid. Solutia recently disclosed plans to build a rubber-chemical plant. And its automotive and architectural window films are sold through more than 5,000 retail locations.
Zhou Lin, general manager for Liaoning Yinzhu Chem-Tex Group Co., said his company buys a type of nylon pellet produced at Solutia's plant in Pensacola and spins it into fibers. His company chose Solutia for the high quality of its products, but will deepen the relationship by seeking its advice on how to make technical advances.
Kingfa Science & Technology Co. also buys the nylon pellets for melting into plastic materials. It is mainland China's largest domestic engineered plastics compounding company, and is growing at a rapid clip — which will mean more business for Solutia, said Li Nan-jing, Kingfa's vice general manager.
The products of these companies — along with Hangzhou Youngchang Nylon Co., which also signed a contract with Solutia on Monday — are found in everything from industrial products to non-stick spatulas, and from electrical-outlet covers to under-the-hood car parts.
Solutia's drive to do business in China doesn't mean it is neglecting the American market, Quinn said. North America remains the company's biggest market in many product lines. However, China's economy is growing fast, as is demand.
"China is still a work in progress, and, like many of the developing economies around the world, there is certain room for improvement" in its openness to American goods, said Quinn. "But we have found the Chinese marketplace to be a very receptive market."
Five things you should understand before launching in China.
By David Alexander
You’ve just climbed in the taxi and are on the way back to your hotel after the closing dinner with the principals of your latest deal. As the QB in the deal process you’ve spent months cultivating a relationship with the owners, convincing them that out of all the groups courting them, your firm was the best fit in terms of culture, business philosophy and opportunities for future growth. With new resources in place, one of the first priorities identified is implementing a China strategy—something your firm could certainly make happen. Right?
Firms with multiple funds under management constantly consider the idea of opening a sourcing office in China, leveraging volume across multiple companies to drive costs down and margins up. No brainer, right? Here are some considerations when determining if such an investment is worthwhile.
1. Get to Break-Even
For any business of scale, it conservatively requires $1.5MM annually to operate a functioning “in-house” sourcing office in China today. This takes into account travel, relocation costs, salaries for just one expatriate staff member and a Chinese support staff typically consisting of sourcing individuals, project engineers, Quality inspectors, supply chain coordinators and the necessary admin support. This estimate does not even include the opportunity cost of valuable human resources and set-up dollars needed to get it up and running. In five years this means a firm will invest $7.5MM in incremental fixed costs.
Be sure to double the timeline and halve the payback. Setting up is the easy part. Becoming operationally efficient proves a little more elusive. Expect your operations leader to be hands-on, which could affect timelines on other domestic restructuring programs. On the ground support during the nascent phase is critical to long-term effectiveness of the Far East operation. In reality, if your goal is to achieve 20% savings (net of working capital adjustments) on components you have to be able to push $8MM in projects through each year for years 2-5. Do you have the $40MM in transfer projects to China from US manufacturers needed to get to break-even? If not, consider the variable cost option of a strategic sourcing partnership until such time that the in-house volume justifies the investment.
2. Beware those who claim they are “China Experienced.”
After purchasing a valve and fitting company, you inherit “Bill” who is quick to inform you that he has traveled to China numerous times and has even learned a few words of the local tongue. Single handedly, he’s “saved the company millions” overseeing outsourcing projects on behalf of the organization. With more China experience than anyone in the firm, he has impressed a number of partners with his knowledge and has even volunteered to move to China to establish your operation. Who better, right?
Bill might be proficient with his industry-specific knowledge of say, castings and forging suppliers, and may even have enough supply chain knowledge to be dangerous. However, how his ability to transfer his knowledge and experience to other products and to the critical elements of managing the new sourcing office can test his learning curve (at best) and inhibit execution speed. When you consider other daily administrative duties such as recruiting, personnel issues, financing and taxation details AND managing relationships with the Chinese and local governments, there’s hardly anytime left for sourcing! He has also relied heavily in the past on his company’s Quality personnel as well as those extensive resources provided by the handful of suppliers he’d worked with in China. Is Bill fully prepared and qualified to monitor these Quality details for your other operations?
Bill has never set up a business from scratch, let alone one in China, and probably lacks the broader business acumen to get the China sourcing company off the ground. Does Bill understand the difference between a “Rep office” and a WOFE (Wholly Owned Foreign Enterprise) and the tax implications of each?
Running a China sourcing office is a broad-based leadership role and requires solid general management instincts and experience. If integrated into the business effectively, the China sourcing office will interface with all elements of your US operations. Bill’s a great nuts & bolts guy but you need a heavy hitter.
3. Location, Location, Location
Manufacturing expertise tends to cluster in China. Should you really be in Zhejiang or is Guangdong Province better suited for your products? You have heard that manufacturing is moving north and west in China. Should you be going there? What type of product categories do you anticipate supporting from your new office, now and five years from now? What’s going on in the Mekong Delta? This region in Southwest Vietnam where the Mekong River meets the sea via distributaries could likely be the preferred next low cost sourcing hub in Asia. Could Cambodia and Laos be additional low cost frontiers? Many products are coming from India lately. Maybe you should have an office in Mumbai? Did Bill sign that five-year lease yet?
4. What does the Chinese government think about your business?
Regardless of the aforementioned, China remains the low cost factory of the world today and will continue as such for many years ahead. Did you know however, that the Chinese government has a clever system to encourage and/or discourage different industries to manufacture in China? Big cost advantages through generous VAT rebates can still be enjoyed by companies in “encouraged” industries while VAT rebates for businesses now falling in “discouraged” categories were eliminated last year, with a generous one week notice from the central government in Beijing.
Delivering a speech to the 1st session of the 11th National People's Congress (NPC) in March this year, Premier Wen Jiabao made known China's determination to end its position as a global center of “smokestack industries” or those energy-intensive, polluting and resource-based ventures. As a result VAT rebates for 1,115 commodities in these sectors were ended. Add in worldwide commodity price inflation, today’s soaring energy costs and a 15% appreciation of the Chinese RMB in the past 18 months and suddenly that 25% savings Bill got for your pipe fitting company may not be realistic across the board.
5. Scale
Flash forward to year-five and let’s assume your office has developed a business rhythm. You have a few successful projects under your belt and are finally realizing some savings on behalf of your portfolio companies, albeit not quite what you were promised. The sourcing team is working with 20 or so decent manufacturers. Independently though, each of your projects represent a small fraction of these factories’ overall volume since you are supporting only your U.S. businesses. You need to continuously look for opportunities to leverage scale. How can you do more business with fewer suppliers to ensure you have their ear on important schedule and quality issues?
The good news
PE firms with small and mid sized portfolio companies should do their homework before taking the plunge into China. There are firms in place today who have absorbed startup costs, are highly capable and experienced in running a China office, and are staffed with experienced sourcing experts, engineers and Quality personnel. These firms have a working knowledge of and ability to navigate China, the flexibility to respond and adapt to the changing landscape and command significant volume leverage with the factories with whom they work. When choosing a solution, carefully consider the variable cost option and work with a team who has only your best interests at the forefront of their activities—whose success depends on your success.
David Alexander is President of BaySource Global®, www.baysourceglobal.com a U.S.& China based Project Management firm who oversees Strategic Sourcing Initiatives on behalf of clients worldwide. BaySource is based in Tampa, FL and Mr. Alexander is a member of ACG.
Making It in China
May 12, 2008; Page R11
Any business relationship works best when both sides understand what the other expects. For U.S. companies working with Chinese business partners, that understanding can be particularly difficult.
The problem is that each side comes to the partnership with very different cultural and economic perspectives. Americans tend to view a business relationship as a win/win proposition -- a contract between two corporate entities designed for their mutual benefit in long-term profitability and growth.
In China, personal relationships among business partners are far more important, and the benefits foreseen in entering a partnership often are broader and focused more on the near term -- and not necessarily evenly balanced.
Any U.S. company that joins a Chinese partner without understanding these differences risks failure. The key to success is paying close attention to the relationship, both on a personal level and by implementing procedures to monitor the progress of the venture.
Several years ago, one of the authors of this article worked with a U.S. company in a nonexclusive partnership with a Chinese motorcycle manufacturer. That venture is a case study in the difficulties of a Chinese-American business relationship, and the importance of understanding and overcoming those difficulties.
Different Priorities
In the mid-1990s, a U.S. export-management firm established an alliance to purchase small motorcycles made in China, for sale to consumer markets in Latin America and Africa. The Chinese manufacturer agreed to produce motorcycles at its facility for export, while the U.S. company took charge of quality control, sales, distribution and after-sale service.
The basis of the relationship seemed clear enough, but from the beginning there were unstated differences in what the two sides hoped to accomplish.
The U.S. executives assumed that their Chinese partners shared their focus on ensuring long-term profitability by pleasing the venture's distributors and customers with quality motorcycles. But from the Chinese perspective, the relationship with the U.S. firm provided multiple opportunities, some of which had nothing to do with the venture's long-term profitability.
Think back to the mid-1990s. China was desperately short of foreign currency. So, first and foremost the Chinese saw the relationship as a source of regular inflows of U.S. dollars. In addition, the Chinese executives were more interested in the venture for what they could learn than for what they could earn -- they saw the Americans primarily as teachers. The Chinese managers knew nothing about selling their motorcycles outside of China. Through their affiliation, the Americans provided the Chinese with market insights and knowledge the Chinese would never have been able to acquire on their own.
These differences in focus between the American and Chinese sides would emerge later, much to the detriment of the venture.
Since the mid-1980s, the Chinese manufacturer had been producing about 450,000 motorcycles per year, all for its domestic market, under a licensing agreement with a Japanese auto company. But the performance of the motorcycles was poor. To ensure higher quality for this new partnership's motorcycles, the U.S. partner insisted on the use of Japanese imports for key engine components, in place of the inferior Chinese-made parts the manufacturer had been using. Both parties agreed that the U.S. partner would send an observer for the purpose of quality control, including confirmation that the Japanese components were being installed in the bikes.
The observer was a Chinese-American who had returned to China to explore newly available business opportunities. He was retained for one week each month by the U.S. company. Every time a monthly production run was scheduled, the observer would make sure that the Japanese engine parts were used on the motorcycles to be exported.
This system worked well for five years. Nearly 250,000 high-quality motorcycles were profitably produced and sold. Customers were pleased with the quality and service. But just as the Americans began to think of expanding the venture with the introduction of new product lines, a conflict arose between the two parties.
A Rift Opens
At the beginning of the sixth year, the observer representing the U.S. partner quit. The American executives chose not to replace him, assuming that after five years of high-quality production, the Chinese would continue using the Japanese parts for the export motorcycles. This decision was made without consulting the Chinese.
A few months later, the U.S. company began to receive complaints from customers about the quality of the motorcycles. The problem was the same everywhere: The engine would run well for the first 200 miles or so, then it would begin to smoke and eventually the engine would seize up, rendering the bike inoperable. It was quickly determined that the Chinese manufacturer had substituted poorly made Chinese parts for the specified higher-quality Japanese-made components.
From the American perspective, this is where the relationship went bad -- when the Chinese began using inferior parts. From the Chinese perspective, however, the removal of the observer was where the problems started, because it signaled a major change in the relationship between the two companies. While the Americans had viewed this person simply as a quality-control monitor in an overseas factory, the Chinese looked upon him as the personal representative of the U.S. company within the Chinese operation. The disappearance of this person, with no explanation and no replacement, was seen as a breach in the relationship. No longer strictly bound by the terms of that relationship in their minds, the Chinese partners acted in their own self-interest, cutting costs to maximize their profits.
Frictions Worsen
Efforts to resolve the problem caused greater friction.
Confronted with several thousand motorcycles that would require replacement parts as well as major servicing in 15 countries, the U.S. partner calculated that $400,000 would be needed just to begin to deal with the problem. The Chinese manufacturer was consulted, and it was decided that customer credits should be issued to maintain the integrity of the brand. Because of stringent foreign-exchange controls in China, the U.S. partner issued the customer credits. Both parties then agreed that they would meet in Shanghai later that year to negotiate how to share these costs.
Prior to the meeting in Shanghai, the Chinese sent a fax demanding that the Americans provide comprehensive documentation for every customer complaint. The Americans objected, but the Chinese wouldn't budge. This angered the Americans, who felt that both sides understood that the Chinese were to blame for the problem. In the end, the U.S. side compiled a report for each defective motorcycle, resulting in almost 50,000 pages of documentation.
The Americans were further distressed to learn that before any negotiations could occur, they would have to verbally present their findings on each motorcycle. The presentations were scheduled over a four-day period. On the second day, after presentations had been made for only about 200 of the motorcycles, the U.S. side decided that they had had all they could take. The two Americans stormed out of the room.
As the Americans were walking out of the building, one of the Chinese managers tracked them down. The Americans told him that if this continued, they would never buy another motorcycle from the Chinese. The ultimatum worked, at least in one sense -- the Chinese executives agreed to at last begin discussing how to cover the $400,000 of customer credits.
After more than six hours of further talks, the Chinese executives offered to pay half of the $400,000. Incredulous, the Americans again staged an angry walkout. In a repeat of the day before, the English-speaking member of the Chinese team caught up with the Americans. He explained the Chinese position, saying that the Americans were one-half responsible for the defective motorcycles because they had allowed their Chinese partner to violate the arrangement by using Chinese parts.
Eventually the U.S. side agreed to split the costs evenly, but bad feelings remained on both sides. Again, the Americans had failed to appreciate the importance of personal relationships to the Chinese. Rudeness and anger are out of place in China and are considered embarrassing. By having a public tantrum, the Americans looked like barbarians in the eyes of the Chinese. In addition, the Chinese viewed the American demands as unreasonable because in their minds it was the Americans who devalued the relationship in the first place.
The problems between the U.S. and Chinese partners ultimately were resolved.
Mark Twain is quoted as having once said that "Nothing is as weak as a relationship that has not been tested under fire." With a better understanding of Chinese thinking and with close monitoring, American companies in ventures with Chinese suppliers can keep those inevitable fires from spreading out of control.
--Dr. Thomas is an assistant professor of marketing and the associate director of the Taylor Institute for Direct Marketing at the University of Akron's College of Business Administration, in Akron, Ohio. Dr. Wilkinson is an associate professor at the College of Business at Montana State University, Billings. Dr. Hawes is a distinguished professor of marketing and the director of the Fisher Institute for Professional Selling at the University of Akron's College of Business Administration.
Outsourcing makes customers nervous. Here's how you can help reassure them.
Outsourcing makes customers nervous. Here's how you can help reassure them.
(FORUTNE Small Business) -- Dear FSB: My two partners and I own and operate our own factories in China. With the anti-China trend these days, how do we find companies that are looking to go overseas but do not have a trusted partner? We hold ourselves to U.S. and European standards, but we're still having to search for businesses to whom we can provide our contract manufacturing services.
- Carlos Valdes, World Manufacturing Group, Philadelphia, Pa.
Dear Carlos: When putting a Western face on an Eastern service, don't discount good old-fashioned face-to-face conversation.
This can be done at tradeshows, during one-on-one sales calls, or with networking among industry trade groups. Being completely transparent about your business reassures potential clients, so show photographs and encourage visits to your plant even if a client relationship hasn't been established yet. Be as detailed as you can with information about your years in service, references, number of employees, biographies of the management team, and products currently being rolled out of your plant.
Is sourcing in China worth it?
Most importantly, always be ready to discuss a worst-case scenario and a back-up plan, advises David Alexander, president of BaySource www.baysourceglobal.com , a Tampa, Fla., firm that assists U.S. companies in developing China outsourcing strategies.
Companies don't budget for failure, and anything you can do to reassure them that you have contingencies covered will help reduce indecision and anxiety. Be honest and realistic about cost projections, production rates and potential issues that may arise. Even if there are negatives, offset them by listing all the world-class quality standards that your plant has met (such as ISO or UL) and offering quality and service guarantees. For example, you could promise that no portion of the manufacturing will be subcontracted, and that all client phone calls will be returned within 24 hours.
"It is paramount to recognize and be able to articulate that the product being provided is actually a service," Alexander says. "A trusted set of hands mitigates the inherent risk associated with entrusting a project to an unfamiliar source in China."
Would you trust a plant in China? How do you convince customers your overseas operations are high-quality? Join our discussion.
Take your business global
With a little innovation, who needs outsourcing?
MRO Buying gets strategic
MRO buyers look ahead, and see more outsourcing, long-term planning, global buying and supplier alliances.
By Susan Avery -- Purchasing, 3/13/2008
There's no longer any question—the MRO buy is strategic.
Purchasing got an overwhelming response from readers to a recent survey on their role in the maintenance, repair and operations (MRO) buy. Of the purchasing professionals who responded to the poll, 88% say the buy is more strategic today than it was five years ago, and they provide evidence—success stories—to back up the statement.
Results of the survey show MRO purchasers have slashed the supply base and formed closer relationships with a smaller number of key suppliers. They've embraced technology for the procure-to-pay process; buyers at plant sites are placing orders directly with suppliers with which the company has national or regional contracts, often using online catalogs. For their part, MRO suppliers provide technical assistance to the plants, bringing in their suppliers (the manufacturers), when help with such activities as product substitution and demand management is needed.
...
So, what's next? Where is the MRO buy heading? What is happening today at companies in just about every industry across the nation provides some indication of what's to come for purchasing pros with responsibility for MRO, respondents say.
Other MRO purchasers say they expect to be sourcing for other divisions within their companies, and searching for suppliers with capability to provide goods and services to locations outside North America. Some seek supplier help with low-cost country sourcing efforts. Most of the survey respondents now are looking at MRO over the long term—something relatively new for many purchasers.
The sourcing operation at BNSF Railway Co. started to look at its MRO buy with an eye towards the strategic about two years ago. Since then, sourcing has worked to standardize processes and data and taken steps to rationalize the supply base, forming relationships with fewer suppliers or integrators that can do more than simply provide products to the company.
Aligning goals of both purchasing and supply organizations is key, says Doug Keady, director of strategic sourcing and contract governance for BNSF in Ft. Worth, Texas. "I challenge suppliers every time we talk," he says. In those discussions, Keady works to ensure suppliers understand the company's business and are willing to offer up their expertise to bring new ideas to the table.
Illinois Tool Works (ITW) in Glenview, Ill., started to look at MRO purchasing more strategically three to four years ago when management tapped Gary Anton to be vice president of corporate strategic sourcing. Until that time, each of the more than 700 business units at the decentralized company purchased MRO on its own. Anton's job is to rationalize the supplier base and leverage some of that spending.
He and his team set up national agreements with 15 industrial distributors; each of the suppliers provides the company with specific categories of products such as electrical, power transmission, fasteners, and general industrial supplies. "We believe we have the right supplier partners going forward," says Mike Kamradt, director of corporate strategic sourcing at ITW, who assumed his role late last year. He and Jeff Garing, MRO manager, are working to take these agreements to the next level. They're asking for guaranteed savings which they expect suppliers to deliver through such non-price aspects of total cost as inventory reduction, product substitution and demand management.
ITW has come a long way in a few short years. While the company doesn't mandate use of the preferred suppliers, Anton and his team are selling the benefits of working with fewer suppliers to the business units and are having some success. One of the company's preferred suppliers is reporting a five-fold increase in sales. They're also looking for suppliers with capability to provide goods and services in Europe. "We're not there yet, but we think eventually we will have synergies with our brethren across the pond to work on some things together," says Kamradt.
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.
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