Hidden Costs Of Offshore Sourcing

Aug. 10, 2007
Investigation and quick calculations can save manufacturers money.

Calculating the costs of offshore sourcing is a bit like buying a new car. The sticker price says one thing, but start adding on features (or in this case lead times) and you end up paying a lot more than you bargained for.

The trouble for purchasing professionals is that the accounting department only looks at the sticker price -- they don't consider transportation costs, duties, currency fluctuations, transit damage and delays, and myriad other scenarios that impact the cost of "cheap" offshore products and parts, according to Michael Harding, a principal of Harding & Associates, a consulting firm specializing in lean manufacturing and supply chain management.

Harding presented "Calculating the Impact of Increased Leadtimes of Foreign Purchases" at the recent Institute for Supply Management conference in Las Vegas.

To drive home the point of correctly calculating costs of offshore sourcing, Harding asked session attendees who they would buy from based on these three suppliers and respective unit prices: Able Corp., $12.25; Baker Ltd., $12.65; Couch Inc., $13.10.

Guide To Global Sourcing

To be competitive, companies must be able to fairly evaluate the balance of risks, costs and performance of a potential new supplier before making a global sourcing decision. To that end, the International Chamber of Commerce's ICC Legal Handbook on Global Sourcing Contracts aims to help small- and medium-sized companies navigate these international waters.

According to the handbook, the process can be made simpler by involving an outside agent, namely the local chamber of commerce. The local chamber can also supply lists of professionals in a given country, such as accountants, lawyers, surveyors and government licensing bureaus, to help conclude a sourcing agreement.

"This handbook helps small companies build a better business plan for global sourcing. It covers all the important steps, from structuring requests for information to moving on to requests for proposals to drafting contracts, evaluating suppliers and identifying possible loopholes," says Michael Hancock, co-chair of ICC's Task Force on Global Sourcing.

At first blush, Able Corp. appears to be the best choice.

Add just a bit of information (lead time) and a new supplier of choice emerges: Able Corp., $12.25, 10 weeks; Baker Ltd., $12.65, 7 weeks; Couch Inc., $13.10, 2 weeks.

Calculate the costs of carrying inventory (in this example Harding uses 1.5% per week), and in this hypothetical situation the new costs of the fictional widgets: Able Corp., $14.09; Baker Ltd., $13.98; Couch Inc., $13.49.

To determine the actual costs of lead time, "start with the cost of carrying inventory stated as a percent per year. Divide it by 52 to obtain the percent per week," notes Harding in The Supply Management Handbook (2006, The McGraw-Hill Cos. Inc.).

"Once an appropriate percentage has been determined, multiply it by the supplier's quoted lead time (in weeks). This becomes the multiplier for unit price."

The Costs of Carrying Inventory

Recognized Costs Approximate % per year
Interest rate of money 5-10
Taxes 2-5
Insurance 2-3
Space (occupancy and utilities) 7
Obsolescence reserve 7-20
Total 20-30
Unrecognized Costs Approximate % per year
Personnel (warehouse, inventory control, etc.) 10-15
Capital equipment (fork lifts, racks, etc.) 5-10
Computation costs (hardware + transactions) 3
Secondary quality costs (reinsertion) 5-10
Rework, handling damage, additional loss 5-10
Grand Total 50-75
Source: Michael Harding and Mary Lu Harding, Purchasing, 2nd ed., Barron's Educational Series

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