Strategies for Strategic Sourcing

Dec. 17, 2007
While some manufacturers have assumed the potential risk of buying from international sources, many still are giving them the cold shoulder.

There are a variety of reasons for executives today to question the practice of global sourcing, but it always seems to come back to one word -- quality. Valid reasons or not, many of them are reconsidering whether they should be buying products from international sources at all, according to John Brockwell, vice president of global trade management for JPMorgan.

A recent Reuters/Zogby poll found that 78% of Americans worry about the safety of Chinese imports, and 25% have stopped buying food from China. In the poll, 35% of respondents were "very worried" and 43% were "somewhat worried" about the safety of Chinese goods.

At a time when China has become the largest source of imports for the United States, Brockwell contends that many company executives are reevaluating their reliance on China-based suppliers. "Though the government of China is working to improve their brand image by instituting and enforcing quality standards, it might not be enough to stave off buyers from reconsidering their sourcing decisions," Brockwell says. "International sourcing and procurement can have high rewards, but those rewards bring additional high risks."

So how can procurement, supply chain and operations executives help their companies reap the rewards and mitigate the risks of global sourcing? By keeping the following factors in mind, Brockwell says executives can make better decisions about the initial transaction -- while establishing a framework to regularly evaluate the total product lifecycle.

Set Specific Parameters

Choosing a supplier is a big decision no matter where they happen to be based, so start by asking yourself some of the same questions you would for any other potential source. First, the decision should include payment terms that support your goals for days payable outstanding -- without having a negative impact on the supplier's working capital structure.

Once you take a close look at your costs (direct costs, delivery costs, etc.), make sure planning processes and information flows between your company and the supplier all align. There should be a certain level of cohesion for things like forecasts, change orders, order lead times, lot sizes, and setup and transit times. Keep in mind, the same criteria should also be used between your supplier and their supplier.

Additional working capital may be required at some point, so you should know if anything will be available for holding more inventory. That gives you flexibility, which will help enable your supplier to react to upside demand. If the forecasts don't materialize, there could be downside risk, and you'll of course need to know how much. Lastly, and possibly most importantly -- are quality standards. Once required standards are determined, buyers need to schedule quality inspections at appropriate times in the process.

Be Aware of Outside Influences

Suppliers are subject to the same unforeseen market shifts as the buyers themselves, but some parts of the world are more susceptible than others. Investigation into an area's forecasted raw materials, labor and energy costs can give you a good idea what's in store for the future. Different areas will also vary in how the inflation rates are forecasted. The same goes for currency exchange rates.

Depending on the region, the geopolitical environment can change on a dime, so make sure you take into consideration the state of affairs between the supplier's country and the U.S., European Union and other markets for your product. There could be escalating trade sanction rhetoric, specific anti-dumping or countervailing duty cases, or quotas and safeguard measures. Any of them could affect your decision.

A variety of potential holdups to the supply chain could also prove challenging -- ranging from natural hazards and interruptions to a trade lane, to labor strikes and frequent port congestion. Similar problems might not prevent a shipment but could raise your final cost.Examples include duties on your product from another country or proposed free trade agreements that impact the product from this particular source. Government involvement could stem from agencies with jurisdiction over your product (FDA, FCC, or EPA) and how that agency views products from that source. If inspections increase, documentary requirements also could become more stringent.

Have an Exit Strategy

Monitoring assumptions for change can be tricky, but as is the case with any supplier, knowledge is key. Find out in how timely a way your staff can monitor customer demand and alter forecasts. This could involve building sensing mechanisms to monitor changes to raw material, labor and energy costs. It could provide useful data as to at what point inflationary pressure creates a problem, as well as shifts in the currency exchange rate.

Legislation or court cases might be in progress, which also could change your assumptions. For example, recent U.S. legislation requires over the next five years that all maritime cargo be scanned in the foreign port prior to loading onto the vessel, and three years for air cargo on passenger flights. If ports are having issues with congestion, then this may further exacerbate the problem. As a result, there needs to be a way to identify quality issues before the goods are shipped. There also needs to be a way for your company to be alerted to delays in the supply chain so that you can react quickly and efficiently.

Even if everything checks out, it's a good idea to explore alternative sources. If you don't have any, develop a few. These alternatives should not only provide a backup for the product supplier, but also for logistics providers, physical logistics routes, ports, etc. In the end, there is always risk involved, so Brockwell suggests to always have an exit strategy. Take a page out of the risk management playbook of stock traders and poker players -- know before you award the sourcing how much you're willing to risk and when you'll need to get out.

Is It Worth the Challenge?

While global sourcing can be a great tool to drive efficiency and help gain access to new markets, it shouldn't be undertaken with little thought and a lot of assumptions. It is important to analyze the role global sourcing plays in your organization's overall strategic plan. Asking the right questions not only before making the sourcing decision, but also regularly throughout the lifecycle of the transaction can help mitigate your risk and improve the odds that the answer for your sourcing question is "Yes."

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