If you’re thinking that “low cost country” sourcing cuts costs, you’re not thinking big enough.

In today’s “global factories” – extended manufacturing enterprises made up of internal and external resources – sourcing can be laden with opportunities and fraught with risk. If you’re thinking that “low cost country” sourcing cuts costs, you’re not thinking big enough.
Yes, sourcing really is “strategic”
Twenty years ago, when large U.S. manufacturers started to source simple parts and components from low cost countries (LCC), their rationale was cost: the cheap labor easily offset the transportation and associated fees, making the end product more cost-competitive in domestic markets. Now, those “developing” countries are “emerging” economies, and that has made a significant difference. Suppliers in LCCs are becoming more sophisticated every day; and their governments are welcoming foreign investment, not just for the wages but for the inevitable transfer of production and design knowledge.

In our work, we’re seeing that countries which were sources – of raw materials or cheap labor – are morphing into markets. Many domestic manufacturers are thinking about selling goods in emerging countries or they’re following their own domestic customers that are doing so.

Having a supply base in an emerging economy can put a manufacturing company on the ground for selling products. In some cases, governments are making the use of local suppliers a prerequisite to market access; selling in these markets is permissible only if you buy from or partner with local sources. So, if global sourcing was once primarily about cutting costs, now it’s also about growing revenue.

Ask new questions; get new answers
In our experience, it’s relatively uncommon for a U.S. manufacturer to have complementary, integrated strategies at the top. If the world is your factory, you should consider asking these strategic questions about sourcing:

• What type of an organization, business processes, and technology are required to capture the benefits and mitigate the risks from emerging market sourcing?

• What parts or components could be – and should be – sourced from emerging markets?

• Among all the low cost countries in the world, which are most suitable for each part or component?

• When, where, and why should you set up a local production facility?

Costs: Get the big picture
While cost savings aren’t the whole picture anymore, they’re still a powerful incentive for LCC sourcing, and for many companies cutting costs is still the primary objective in the business case.

Of course, most U.S. manufacturers focus on reducing labor costs. In emerging countries, wages and benefits can be a small fraction of those of the domestic workforce. For products with large labor content, those savings speak for themselves. But labor should not be the whole focus. What about the costs of transportation, lead times, inventory, taxes and fees, as well as the risk of missed delivery dates, poor quality, or disruption in the supply chain? And on top of those, an LCC sourcing strategy can trigger “soft” costs, such as all the time and talent required for supplier identification, assessment, development, launch, and certification.

Supplier management: Suppliers need to be identified, developed, launched, and certified. Finding the supplier with the necessary capabilities is challenging enough. Once you have found a “capable” supplier, is the company financially sound? Will the company open its books to demonstrate financial viability? Then, you should determine whether the company has the appropriate processes, systems, and controls in place.

Supplier support: Of course, the relationship works both ways. In the short term, the U.S. manufacturer has to provide good product specs/drawings to the supplier. In the long term, it will likely have to share a lot of knowledge in order for the supplier to meet its expectations. Obtaining the first article sample may require engineering staff on site to help the supplier start up.

Sourcing Organization: Some “people” issues are internal (“Do we have the capabilities? Do we have the insights? Do we have the “right” talent in the “right” place? Are we structured to collaborate strategically?”); others are external (“How do we manage a remote supply base? How do we bring low cost country suppliers up to our quality standards?”). For a company serious about emerging market opportunities, creating the appropriate organization is paramount; this can mean having skills, knowledge, and experience in procurement, quality, engineering, and product development. The “cultural composition” of the sourcing organization should be a mix of expatriates to serve as liaisons to the domestic facilities and indigenous staff to facilitate solid collaboration with the supplier.

Additional Lead Time and Inventory: Many organizations are reluctant participants in low cost country sourcing. The additional inventory, resulting from longer transit times, is contrary to “lean organizations” and their drive towards minimal inventory and one-piece flow; and it can materially impact cash flow, depending on the International Commercial Term employed. Companies also have to acknowledge the risk in having parts within the supply chain for an extended period of time – the risk of obsolescence and excess supply from a lack of control over demand fluctuations.

So does that mean LCC sourcing is not suitable for every item? The quick answer is yes.

Exceptions to the rule
When you start peeling back the onion, it’s clear that some parts and components are not good candidates for global sourcing. For example, slow-turning parts, made-to-order parts, or components requiring after-sale servicing are not good bets. Nor are products that are difficult to ship economically because of their size or configuration.

On the other hand, high-volume, standardized parts are generally more suitable; additionally, they tend to be attractive to emerging markets suppliers that want well defined and simple production processes. The key is to understand the market supply capabilities and match potential sourcing candidates accordingly.

Quick ROI
Coincidently, if a company moves down the path to building a local production site, low cost labor can be – again – an important part of the cost/benefit equation, not just in forming the site’s labor pool, but in building the plant itself. Large facilities can be constructed quickly and cheaply because of the large supply of semi-skilled labor willing to work 24/7.

Consequently, a smaller amount of capital investment may be required to bring a large facility into operation; as a result, the time required to realize positive cash flows can also be shorter. The same concept can be applied when tooling up the facility – many machine tools are now available locally at a discount when compared to domestic sources.

First things first
Input from all functions – production, design, marketing, finance, logistics, procurement – is very important in selecting an appropriate low cost geography or country. Each region has its own strengths, such as specific manufacturing prowess, natural resources, English-speaking labor, a growing consumer base, a strong supplier network, or tax incentives.

In other words, from the beginning, low cost country sourcing requires careful planning and rigorous execution. LCC sourcing is a potentially powerful way to reduce costs, but in actuality it’s also much more than that; it’s a key capability for companies undergoing the fundamental shift suggested in the move to selling in emerging markets.

Is low cost country sourcing “right” for your business? That depends on your “global factory” strategy – a big, and for many manufacturers new, world view.

Tim Hanley is Vice Chairman, U.S. Process & Industrial Products Sector, Deloitte & Touche LLP. Reach him at THanley@deloitte.com

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