Executive Briefings

Challenge of Sourcing, Inventory, Distribution in Eastern Europe

Many companies have elected to offshore their purchasing business competencies and capacity to regions with low labor costs in order to save money and free up organizations' assets. Obviously, the Far East, especially China, is hot at the moment, but countries in Eastern Europe also remain a frequent choice for multinationals to locate production facilities.

In parallel, the customer base is changing for many international companies. Heretofore, most European consumers have been concentrated in a banana-shaped region extending from the northwest of London through Germany to Milan. Approximately 350 million Europeans with very high buying power live in this region.

Yet today, the customer base is being enriched by the customers located in the Eastern European countries (75 million people, GDP growth rate 4.5 percent). Consequently, the so-called banana will now take the shape more or less of a boomerang. The respective areas within Eastern Europe in which consumers have particularly high buying power are more geographically dispersed than in Western Europe.

As a supply chain manager witnessing these changes you have to answer the following key questions concerning your supply chain:

• What is the future optimal sourcing strategy?

• What is the future optimal inventory strategy?

• What is the future optimal distribution structure?

Sourcing
A strategy of sourcing from different origins compels companies to thoroughly analyze which gateways would be optimal for shipping through when bringing goods into Europe. Does it make sense to ship goods from Asia to a central European distribution center in, for example, Rotterdam or Antwerp, and then redistribute these goods to regional warehouses?

It may make more sense to ship goods from Asia directly to regional warehouses through other European ports such as Hull, Giao Tauro, St. Petersburg, Constanza or even Koper in Slovenia. It is not a given that the traditional northern seaports (Le Havre, Antwerp, Rotterdam, Amsterdam, Hamburg) will always prove to be the best way to customers.

Furthermore, what impact does the change in production location have on your lead times? Business cases from the high-tech industry show that companies sometimes struggle to find the optimal sourcing policy when faced with a choice between shipping the goods in by sea or by air. The optimal sourcing policy also depends very much on your inventory and time-to-market strategy.

Inventory
The inventory strategy may stress either costs or reliability. If you have high-value goods with long lead times, you will opt for a centralized distribution structure to minimize inventory in the supply chain and hence reduce invested capital. If this is not the case and you instead need to supply your customers quickly (with spare parts, for example), you will need to focus on the agility of your supply chain and therefore have multiple warehouses throughout Europe.

Having one location or having multiple locations influences the sourcing policy to a large extent. Airfreighting goods into a central hub in Europe can prove to be cost-effective by combining volumes for the various European countries. Shipping FCL (full container loads) to various ports is a cost-neutral operation and the number of locations is therefore less of an issue.

The level of inventory also depends on the re-order strategy. Can individual countries re-order separately or is the re-order process truly aligned at an European level? A policy of allowing countries to re-order separately can mean that the order frequency goes up and that subsequent inventory levels will rise when goods are stored at various stocking points.

If the sourcing strategy focuses on shipping containers in from Asia then consideration must be given to maintaining extra stock in Europe. Having lead times of 4 weeks can be a showstopper if products cannot be delivered within the required time frame to the clients. In order to avoid stockouts, more inventory should be stored in Europe. An option to avoid buffer stock is to fly in urgent orders to the customers.

If we look, for example, at the apparel industry with short product life cycles and long lead times, the solution can also be found in postponing part of the production process and by keeping certain value-added production facilities in Europe. This means producing the commodity products in Asia and adding value closer to the customer. For this industry this means creating flexibility in the process. This type of strategy can be the key to surviving in a very competitive business environment.

The amount of obsolete stock, an extremely critical issue for the electronics industry, must be closely monitored when discussing the various options since it influences the bottom line of your revenues. When there are conditions for high risk of obsolete stock, the supply chain cannot have products in the pipeline out of Asia for six to eight weeks.

The inventory levels also have a close relation with the customer service levels. The changes that are occurring on this side also need to be incorporated in the optimization of the supply chains.

Customer Distribution
With more products being sold in the Eastern European countries, the distribution structure will be affected. At the moment, sales to Eastern Europe are often made on an Ex-Works (EXW) or Free Carrier (FCA) basis. This means in practice that trucks arrive at the main distribution center without proper pre-notification. With an increase in the number of trucks that come irregularly to the warehouse, the efficiency of the warehouse operation is put under pressure.

Companies may therefore elect to increase the number of sales based on a Delivered Duty Unpaid (DDU) basis. This means that the outbound flow of goods is now under their own control. Two elements that need to be considered during this analysis are transportation costs (including documentation) and lead times.

Assuming control of the outbound supply chain can also be very useful in cases where short lead times are required. By offering these services you can tie your customers to your company by assuring replenishment when the customer is in highest demand of this service.

In addition to taking responsibility for more of this outbound flow, companies may need to consider increasing their storage capacity in close proximity to their customers in Eastern Europe. The regional satellite warehouse(s) in Eastern Europe could therefore grow into larger facilities. The quality and flexibility of the warehouse solution should not be neglected at this stage. Is the current facility still the right facility for the coming 10 years?

Future Vision
The changes in the key elements of the supply chain mean that the footprint (the location and number of warehouses) is adapting as well. Old and new hot spots are competing to get the business from the multinationals.

It is not likely that in the coming 5 to 10 years Western European countries can be served in full from an Eastern European country due to the long lead times.

We expect that the European supply chains of multinationals will develop towards differentiated supply chains. That means that the products that are sourced in Asia or Eastern Europe will find their way to the markets through different gateways and different distribution channels. This will rearrange footprints and also rearrange the optimal solution where new trade-offs have to be made in the structure: will it be most effective to have a centralized, regionalized or hybrid structure?

Conclusion
Unfortunately, it is our experience that many companies do not adapt their supply chain strategies at a pace that remains abreast with the changes going on within the marketplace. All too often, supply chain decisions are based on the singular aspect of lower labor costs in distant countries. They do not take into account the impact that this strategy will have on the other factors that influence overall supply chain costs and processes. Instead of a confluence of cost reductions, one witnesses a divergent strategy resulting in either higher total supply chain costs and/or lower customer service levels.

After analyzing numerous case studies for projects that we performed for companies in various industry sectors, the conclusion can be drawn that the strict focus on labor costs has regrettably been the most significant contributing factor for disruptions in the supply chain for many of these companies.

Advance knowledge for resolving and dealing with the above-mentioned changes can provide you the tools to truly create effective and efficient supply chains.

If you are about to re-analyze your supply chain, it may be wise to sit down with an expert and identify some quick wins that can be made in the short term.


Peter ten Broek is senior consultant, supply chain management, for Groenewout. Visit www.groenewout.com for more on the engineering and consultancy firm specializing in logistics and supply chain management.

Many companies have elected to offshore their purchasing business competencies and capacity to regions with low labor costs in order to save money and free up organizations' assets. Obviously, the Far East, especially China, is hot at the moment, but countries in Eastern Europe also remain a frequent choice for multinationals to locate production facilities.

In parallel, the customer base is changing for many international companies. Heretofore, most European consumers have been concentrated in a banana-shaped region extending from the northwest of London through Germany to Milan. Approximately 350 million Europeans with very high buying power live in this region.

Yet today, the customer base is being enriched by the customers located in the Eastern European countries (75 million people, GDP growth rate 4.5 percent). Consequently, the so-called banana will now take the shape more or less of a boomerang. The respective areas within Eastern Europe in which consumers have particularly high buying power are more geographically dispersed than in Western Europe.

As a supply chain manager witnessing these changes you have to answer the following key questions concerning your supply chain:

• What is the future optimal sourcing strategy?

• What is the future optimal inventory strategy?

• What is the future optimal distribution structure?

Sourcing
A strategy of sourcing from different origins compels companies to thoroughly analyze which gateways would be optimal for shipping through when bringing goods into Europe. Does it make sense to ship goods from Asia to a central European distribution center in, for example, Rotterdam or Antwerp, and then redistribute these goods to regional warehouses?

It may make more sense to ship goods from Asia directly to regional warehouses through other European ports such as Hull, Giao Tauro, St. Petersburg, Constanza or even Koper in Slovenia. It is not a given that the traditional northern seaports (Le Havre, Antwerp, Rotterdam, Amsterdam, Hamburg) will always prove to be the best way to customers.

Furthermore, what impact does the change in production location have on your lead times? Business cases from the high-tech industry show that companies sometimes struggle to find the optimal sourcing policy when faced with a choice between shipping the goods in by sea or by air. The optimal sourcing policy also depends very much on your inventory and time-to-market strategy.

Inventory
The inventory strategy may stress either costs or reliability. If you have high-value goods with long lead times, you will opt for a centralized distribution structure to minimize inventory in the supply chain and hence reduce invested capital. If this is not the case and you instead need to supply your customers quickly (with spare parts, for example), you will need to focus on the agility of your supply chain and therefore have multiple warehouses throughout Europe.

Having one location or having multiple locations influences the sourcing policy to a large extent. Airfreighting goods into a central hub in Europe can prove to be cost-effective by combining volumes for the various European countries. Shipping FCL (full container loads) to various ports is a cost-neutral operation and the number of locations is therefore less of an issue.

The level of inventory also depends on the re-order strategy. Can individual countries re-order separately or is the re-order process truly aligned at an European level? A policy of allowing countries to re-order separately can mean that the order frequency goes up and that subsequent inventory levels will rise when goods are stored at various stocking points.

If the sourcing strategy focuses on shipping containers in from Asia then consideration must be given to maintaining extra stock in Europe. Having lead times of 4 weeks can be a showstopper if products cannot be delivered within the required time frame to the clients. In order to avoid stockouts, more inventory should be stored in Europe. An option to avoid buffer stock is to fly in urgent orders to the customers.

If we look, for example, at the apparel industry with short product life cycles and long lead times, the solution can also be found in postponing part of the production process and by keeping certain value-added production facilities in Europe. This means producing the commodity products in Asia and adding value closer to the customer. For this industry this means creating flexibility in the process. This type of strategy can be the key to surviving in a very competitive business environment.

The amount of obsolete stock, an extremely critical issue for the electronics industry, must be closely monitored when discussing the various options since it influences the bottom line of your revenues. When there are conditions for high risk of obsolete stock, the supply chain cannot have products in the pipeline out of Asia for six to eight weeks.

The inventory levels also have a close relation with the customer service levels. The changes that are occurring on this side also need to be incorporated in the optimization of the supply chains.

Customer Distribution
With more products being sold in the Eastern European countries, the distribution structure will be affected. At the moment, sales to Eastern Europe are often made on an Ex-Works (EXW) or Free Carrier (FCA) basis. This means in practice that trucks arrive at the main distribution center without proper pre-notification. With an increase in the number of trucks that come irregularly to the warehouse, the efficiency of the warehouse operation is put under pressure.

Companies may therefore elect to increase the number of sales based on a Delivered Duty Unpaid (DDU) basis. This means that the outbound flow of goods is now under their own control. Two elements that need to be considered during this analysis are transportation costs (including documentation) and lead times.

Assuming control of the outbound supply chain can also be very useful in cases where short lead times are required. By offering these services you can tie your customers to your company by assuring replenishment when the customer is in highest demand of this service.

In addition to taking responsibility for more of this outbound flow, companies may need to consider increasing their storage capacity in close proximity to their customers in Eastern Europe. The regional satellite warehouse(s) in Eastern Europe could therefore grow into larger facilities. The quality and flexibility of the warehouse solution should not be neglected at this stage. Is the current facility still the right facility for the coming 10 years?

Future Vision
The changes in the key elements of the supply chain mean that the footprint (the location and number of warehouses) is adapting as well. Old and new hot spots are competing to get the business from the multinationals.

It is not likely that in the coming 5 to 10 years Western European countries can be served in full from an Eastern European country due to the long lead times.

We expect that the European supply chains of multinationals will develop towards differentiated supply chains. That means that the products that are sourced in Asia or Eastern Europe will find their way to the markets through different gateways and different distribution channels. This will rearrange footprints and also rearrange the optimal solution where new trade-offs have to be made in the structure: will it be most effective to have a centralized, regionalized or hybrid structure?

Conclusion
Unfortunately, it is our experience that many companies do not adapt their supply chain strategies at a pace that remains abreast with the changes going on within the marketplace. All too often, supply chain decisions are based on the singular aspect of lower labor costs in distant countries. They do not take into account the impact that this strategy will have on the other factors that influence overall supply chain costs and processes. Instead of a confluence of cost reductions, one witnesses a divergent strategy resulting in either higher total supply chain costs and/or lower customer service levels.

After analyzing numerous case studies for projects that we performed for companies in various industry sectors, the conclusion can be drawn that the strict focus on labor costs has regrettably been the most significant contributing factor for disruptions in the supply chain for many of these companies.

Advance knowledge for resolving and dealing with the above-mentioned changes can provide you the tools to truly create effective and efficient supply chains.

If you are about to re-analyze your supply chain, it may be wise to sit down with an expert and identify some quick wins that can be made in the short term.


Peter ten Broek is senior consultant, supply chain management, for Groenewout. Visit www.groenewout.com for more on the engineering and consultancy firm specializing in logistics and supply chain management.