The Overseas Sourcing Decision

The Overseas Sourcing Decision

It can be difficult to discuss overseas sourcing without introducing emotion into the debate. But that’s what business people need to do. And knowledge of supplier Manufacturing Critical-path Times (MCTs) can help you do it.

First, let’s talk terms. What was initially described as overseas sourcing later came to be known as low cost country sourcing—a label advocated by its supporters and, in my opinion, introduced to bias the debate. For instance, how could anyone logically argue against wanting to source from a “low cost country?” The reality is that while overseas sources tend to be “low piece-price,” whether they are truly “low cost” remains a moot point. In order to remain impartial let’s agree to more accurately describe the overseas sourcing phenomenon that started in the 1990s for what it is: low piece-price country sourcing.

Don’t get the impression that I’m against sourcing overseas. I’m not, and over my career I have done a significant amount of it. I am in favor of doing whatever it takes to have a positive impact on the business. What I am NOT in favor of, however, is blindly following popular trends in a lemming-like way, something I believe a fair share of procurement organizations have done relative to low piece-price country sourcing. There are times when it is the right decision to source with overseas sources and there are times when it is not. MCTs bring focus to overseas sourcing decisions since it helps to more clearly define associated costs.

Some will probably argue that a Total Acquisition Cost (TAC) computation is the only thing needed to compare low piece-price country suppliers to domestic sources. If you are a regular reader of this blog (in particular, if you read the “Piece-Price Reduction Trap” entry), you understand that the length of a supplier’s “true” lead-times—their MCTs—ties directly into two types of financial impact not tracked in material variance:

1. Indirect costs tied to the infrastructure required at original equipment manufacturers (OEMs) to support supplier non-performance, i.e., scheduling, expediting, quality, etc.

2. Revenue related to supplier’s ability to support un-forecasted customer demand—an important profitability factor that also isn’t typically accounted for in OEM TAC formulas.

Since neither of these is tracked in material variance they are seldom included in TAC formulas. While the indirect costs I cite above are real and can be significant, for the remainder of this blog I will focus on the insight that MCT delivers on a supplier’s capability to support un-forecasted demand.

MCT isn’t just a lead-time metric of office and shop floor operations. It also includes the time needed to deliver products to a customer’s point-of-use. Most low piece-price countries are overseas and because of this suppliers located in them have longer MCTs due to logistics. You might argue that adding logistics time to MCT isn’t a fair measure of supplier capability. The fact is that sourcing overseas—low piece-prices or not—decreases supplier ability to support the order fulfillment needs of domestic OEMs because it typically adds weeks, if not months, to MCTs. If, by sourcing with a lower MCT domestic supplier, an OEM is able to reap profits associated with un-anticipated—incremental—demand then, logically, it makes sense to say that sourcing with a longer MCT low piece-price country supplier will likely expose an OEM to a certain amount of revenue loss, depending on the inaccuracy of the underlying forecast.

Should this potential loss of revenue be taken into account in your sourcing decisions? Absolutely. How to do this, then, becomes a critical issue. OEM TAC formulas tend to focus on things like logistics cost, currency risks, etc., both because they can be tied directly to material variance (the primary metric used to measure supply management performance), and they are easily quantified. On the other hand, supply management is seldom formally measured on whether its suppliers are able to support order fulfillment outside of what was forecast. In fact I’ve only heard of one company doing this, i.e., they added 1% to a quoted price for every week of supplier MCT. Good for them.

But what about you and the sourcing decisions you need to make? What do you do if you can’t quantify the risk to revenue that long MCT suppliers expose your company to? You use common sense and follow a couple simple rules:

• The shorter a product’s selling season, the greater the risk there is of incremental revenue loss by sourcing with long MCT suppliers. To understand why, all you need to do is think about toy availability during the Christmas sales season. Most toys come from overseas low piece-price country suppliers and, as a consequence, when forecasts underestimate demand, it is not unusual for a popular toy to be sold out shortly after Thanksgiving.  And those that market them find that this additional demand seldom lasts—dying out soon after Christmas—meaning that those potential incremental sales are lost forever. Think of how much more money toy sellers could make if they would source high-side demand potential toys with short-MCT suppliers, i.e., ones that could react to and satisfy unanticipated short-fuse demand?

• The greater the record of error in a company’s forecast—in both volume and model mix—the more the risk to incremental revenue by sourcing with long MCT suppliers. The shorter a supplier’s MCT, the greater the odds that it will be able to compensate for forecast error and satisfy demand. Note: New product introductions are particularly susceptible to forecast error, as are brand introductions through new marketing channels.

• Even though MCT is not a precise measurement, MCT comparison between potential sources is important. If there is a part MCT difference between suppliers approaching or exceeding 25% to 33%, it should be pretty plain that the importance of piece-price is being overshadowed as a primary sourcing factor by lead-time.

The safer, more traditional sourcing approach is for supply management professionals to focus on those factors that can be directly quantified to material variance, which often ends up getting translated by OEMs into measurements of personal and department performance. If you are good at this sort of thing, this strategy (using baseball terms) can deliver revenue “singles”—and perhaps even some “doubles”—which will be incrementally good for your company and (possibly) for your career.

But if you are willing to take some professional risk and along the way position your procurement function for a “seat at the table,” you’ll introduce the above concepts to your organization and include evaluation of low piece-price country supplier MCTs in your sourcing decisions. In doing so you will have the potential to deliver revenue “doubles,” “triples,” “home runs” and even the occasional “grand slam” as your company reaps the windfall-type profits associated with satisfying unanticipated incremental demand.

The next blog entry will start the process of merging Next Generation Supply Management with the concept of the Extended Enterprise.

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