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Sourcing from offshore suppliers in China, India, Eastern Europe, Latin America and other low-cost regions is so widespread that few manufacturers and retailers can be competitive unless they join in this trend. In fact, the U.S. Federal Reserve Board attributes much of the recent economic growth and low inflation to this offshore outsourcing "best practice."
However, the downside of offshore sourcing receives far less attention at the Fed or in any boardroom-at least until something goes wrong.
The more a company sources from distant, low-cost lands where financial transparency, operating visibility and reliable logistics are practically unknown, the risk of serious supply chain disruptions increases geometrically.
In a recent supply chain risk assessment study, Aberdeen Group, a Boston-based research firm, said that more than 80 percent of supply management executives reported that their companies experienced disruptions within the past two years serious enough to negatively impact their companies' customer relations, earnings, time-to-market cycles, sales, and overall brand perceptions.
Among the chief causes of these disruptions are the same best supply chain practices that companies strive for: low-cost country sourcing, lean inventory and supplier rationalization. While these strategies can improve efficiency, they can also remove buffer inventory and backup suppliers from the supply chain, amplifying the impact of unanticipated events such as supplier bankruptcies, quality failures, missed shipments and natural disasters.
Tim Minahan, Aberdeen Group's senior vice president of global supply management research and the author of the study, says, "The most surprising thing was that while 80 percent saw supply risk increasing, few companies [had] put emphasis on managing that risk."
More than three-quarters of companies in the study, called The Supply Risk Benchmark Report, expect supply risks to increase over the next three years due to supply market instability, new regulatory requirements, natural disasters and terrorist attacks. Aberdeen predicts that supply risk management will emerge as a major business discipline and measure of competitiveness within the next five years.
"More than 60 percent of companies without formal procedures for assessing and measuring supply risks plan to initiate supply risk management programs within the next year," says Minahan.
One place these newly risk-aware companies are starting is with strategic sourcing studies to gain a balanced look at cost and risk factors involved with offshore sourcing, manufacturing and distribution.
"Too many global companies just look at unit costs to make their sourcing decisions," says John Brockwell, head of JPMorgan Chase Vastera's supply chain management consulting practice. "They do not adequately analyze total landed costs, and they certainly do not weigh risk factors that can increase inventory requirements and working capital as well as disrupt production, sales and customer services."
Strategic Sourcing Studies
JPMorgan Chase Vastera, which is best known for its global trade management services and technology, also does strategic sourcing studies for clients that look beyond typical unit-cost or landed-cost comparisons. Analyzing the causes and impacts of physical supply chain risk is critical to good decision-making. Creating different "what-if" scenarios that model real-world variability allows the business to understand a range of potential costs versus a single perfect-world estimate. Among the risk factors considered are:
• Supplier stability
• Quality and impact of poor quality on cost and service
• Logistics capability in supplying product
• Total landed costs (freight, duty, brokerage, inventory carrying costs, etc.)
• Impact of variability on inventory/working capital
• Political and economic stability
Most companies conduct such studies when they are about to develop a new product, rationalize locations or move to a low cost environment for a mature product. The studies are strategic in that they form the basis for a go/no-go decision.
For companies focused on the lowest supplier costs for competitive reasons, the decision has already been made to be in China or even lower-cost countries such as Vietnam. The strategic study must look at how to deal with risk.
"If cost is their primary driver, we help them achieve the lowest costs with the least risk," says Brockwell. "We help them understand the risk, so they can plan for contingencies where possible."
Besides looking at the financial health of potential suppliers, JPMorgan Chase Vastera considers the overall working capital requirements in the entire supply chain.
"We analyze which entity has the most financial leverage in this supply chain and how that's to be optimized," says Brockwell. "The idea is to minimize risk for every trading partner. Suppliers, especially smaller ones, need to get cash faster. Manufacturers need to keep inventory off their books."
Much of Vastera's experience is in the high-tech, telecommunications and automotive industries where companies have no choice but to manufacture in low-cost countries to support their customers.
For example, one risk-adverse, high-tech supplier that JP Morgan Chase Vastera worked with preferred to maintain its maquiladora assembly operation in Mexico rather than move to a lower-cost country because of the good quality, solid operations and low overall risk it had enjoyed. But when one of the company's major customers set up operations in China and insisted that this company move some of its operations there to support them, the supplier had no choice.
"We helped them understand all of their costs, increased working capital requirements and other risks, so they could mitigate the risks of operating in the Chinese market," says Brockwell.
For companies that are not driven by customer pressure or lowest possible labor costs, JP Morgan Chase Vastera helps companies consider locations that present less risk and faster time-to-market.
"We are again seeing companies looking at Mexico and Central America because they are closer," says Brockwell. "There are very favorable trade agreements in the Western Hemisphere that minimize duties and present fewer trade conflicts. The shorter lead times provide a big advantage in terms of inventory and working capital."
The strategic studies also provide clients with a long-term view of operating in a particular part of the world. For example, China has tried the patience of both the U.S. and the European Union with aggressive pricing on commodities such as garments, shoes, children's furniture and other items to the point that successful anti-dumping actions through the World Trade Organization are a definite possibility.
"Our strategic studies consider the impact of such trade actions on supply costs," says Brockwell. "Whatever cost advantage originally assumed would quickly disappear if high tariffs or quotas were suddenly applied. We help our clients look at what might be happening over a time horizon appropriate for them."
Once a company is operating in a low-cost country, the focus shifts from purely a strategic view to an operational one that requires constant vigilance and ongoing monitoring.
"Companies sourcing in low-cost countries quickly learn that their supply chains are more fragile and need close attention," says Jim Lawton, vice president of marketing for Open Ratings, Waltham, Mass., a company that provides supply risk management services and technology. "Just one key supplier can cause a disruption that cascades throughout the supply chain to the point your ability to meet customer commitments and investor expectations are impacted."
|"Early access to information is important. No one wants to read about your supplier's problem on Yahoo or in the newspaper."|
- Dennis R. Lemon of BlueRiver-Consulting
|Tips for Working with Suppliers in Low-Cost Countries|
|Dennis R. Lemon, president of BlueRiver-Consulting in Tempe, Ariz., learned about working with offshore suppliers when he was Honeywell International's director of corporate supplier quality and health. His job was to determine if a supplier was financially and operationally capable of performing as expected over the life of the contract. Lemon offers several rules of thumb for working with suppliers in low-cost countries.|
• In China, suppliers on the East Coast have the greatest amount of experience working with U.S. and European companies, so they understand how to provide foreign companies with the information they need. But to gain better prices, many foreign companies are looking to suppliers in the interior of China, and they are far more difficult to work with and rarely provide the transparency that Western companies want.
• Many Western companies want to be the dominant customer with their offshore suppliers to gain clout. But many suppliers are so thinly financed that any slowdown in the dominant OEM's business can sink the supplier and then leave the OEM without a source of supply. "No OEM should take more than 25 percent of that supplier's capacity to help the supplier spread its risk," says Lemon.
• Maintaining multiple sources for critical parts is important, even if it increases total costs. In certain industries, however, spreading this risk is very difficult. In aerospace, for example, production volume is low, but quality must be very high. There just are not enough suppliers with the quality and expertise to spread around the risk.
• When a manufacturer first outsources to a low-cost country, the focus is entirely on tier-one suppliers that the company deals with directly. As the outsourcing matures and expands, companies need visibility into the tier-two and tier-three suppliers because their quality and capability become critical risk factors as well. OEMs must convince their tier-ones of the need for input into the selection of their suppliers. "Gaining enough trust to work with the suppliers' suppliers is not easy to do, because it goes against the way they are used to operating," says Lemon.
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