Pacific Rim Logistics: Proceed with Caution

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The road to successful Pacific Rim outsourcing has more than its share of bumps. Here are some turn-by-turn directions to the path of least resistance.

We've all heard the worst tales about manufacturing in Asia—pet food tainted with deadly chemicals, toys coated in lead-based paint.

But plenty of other obstacles await U.S. firms that produce goods in the Pacific Rim. They might not spark headlines, but they sure do cause headaches.

Consider what happened to Tassi LLC, a small startup based in Mesa, Ariz. Last February, Tassi hit the market with a line of colorful terrycloth bands a woman can use to keep the hair off her face while she cares for her skin or puts on makeup. The launch went well, but a subsequent order with Tassi's factory in China hit a snag.

"In February, China shuts down for Chinese New Year," says Paul Ellsworth, Tassi's chief executive officer and general counsel. "Many people quit their jobs, take the month off, and go home to their families."

Ellsworth and his wife, company founder Shawna Ellsworth, ordered more hair bands, not realizing that the holiday would stall production. "Now we know to plan around it," he says.

Or take the entrepreneur who contracted with a Chinese factory to make bags for scrapbook hobbyists. The factory's samples looked great, so she placed her first order and paid for it. But when her container load of products arrived, they didn't match the bags she had ordered.

"The bags were not saleable," recalls Jim Norris, Jr., president of One World Sourcing, a strategic sourcing and product development specialist in Brooklyn Heights, Ohio. "Whenever the entrepreneur tried to contact the supplier, she either received no answer, or was told that no one at the factory speaks English. She lost her investment."

For U.S. companies with supply chains stretching into the Pacific Rim, taking charge of relationships with overseas partners is key to business success.

"Having control over supplier relationships provides standardization, process management, visibility, and some assurance that deliveries will be made," says Tony Zasimovich, vice president, international logistics for APL Logistics, a third-party logistics provider based in Oakland, Calif.

Companies get in trouble when executives assume they can place orders and trust overseas suppliers to manage the manufacturing process, says John Tracy, principal at Tracy-Hayden Associates, a logistics and operations consultancy in South Orange, N.J.

Tracy points to the example of Baxter Healthcare Corp., which sold a blood thinner called heparin that was made with tainted materials. Baxter's U.S. supplier obtained the materials in China.

"No one paid attention to the fact that the primary subcontractors in China would subcontract, and their subcontractors would subcontract," Tracy says. "As a result, no one knew where the materials came from."

No matter how long the supply chain, a company must maintain control from end to end. "If you can't determine the right process, don't pass the problem along to a third party and hope they'll figure it out for you," Tracy advises.

Years of experience sourcing in the United States might not provide the necessary know-how to deal with the numerous and complex challenges involved in managing relationships with Pacific Rim partners. Here's a roadmap to some of those challenges.

What Language Are We Speaking?

The difficulty of communicating across thousands of miles and one dozen time zones is obvious. Less obvious is the difficulty working together across languages and cultures.

"We faced a great communication barrier," recalls Heidi McCormack, co-owner of Mimimack in Brookfield, Wisc. McCormack and her partner spent about six months looking for a factory in China and India to manufacture their Spec-tickles—beaded accessories for decorating the stems of children's eyeglasses.

"For example, I was describing a round object to a potential partner, and he said, 'I don't know round,'" McCormack says. She tried "circle" and "like the earth," before the man hit upon "sphere" and they were able to continue the conversation.

English might be the international language of business, but even when you and your overseas partner both speak it, you might not be talking the same language.

As an example, "The Japanese always say 'Yes,' but they mean 'I understand,' not 'I agree,'" says Don Dickey, supply chain senior manager at WiLife, a Draper, Utah-based manufacturer of digital video surveillance systems that was acquired by Logitech last November.

Physical distance, along with differences in culture, mentality, and business practices, pose major challenges for partners trying to build trusting, long-term relationships.

"Such relationships could become weak and fragile, unless the partners work hard to bridge the gaps between them," says Steven Kuo, general manager, U.S. eastern district, in the New York office of Dimerco Express, a third-party logistics company specializing in China.

U.S. companies that source from Asia also must learn the ins and outs of taxation and import/export regulations in the countries where they do business. "Regulations can seriously affect the business and lead to misunderstandings or disputes with vendors, suppliers, or partners in the area," Kuo says.

Mastering the nuances of transportation in another country is difficult as well. "In many parts of the world, transportation security is not assured," Tracy notes. "The fact that you load products on a vehicle and they ship does not mean the same material arrives at the destination."

Choose Your Partners

Long before they have to start dealing with transportation or tax laws in the Pacific Rim, U.S. companies first must determine which vendors or manufacturers can reliably supply the products they need.

"Over time, they build trust with certain factories," says Zasimovich. But it might take a while.

A company needs a partner that can not only do high-quality work, but also meet its particular needs. Tassi, for example, looked for a factory that could support its product launch by producing in small quantities.

"Our hair bands come in 12 colors, and we wanted to produce a few thousand in each color," Ellsworth says. "It was difficult to find a factory in China that would produce such a small volume."

As a startup, WiLife sought out small to medium-sized contract manufacturers in China. Company officials wanted WiLife to represent a big enough chunk of each factory's business to gain leverage in managing the relationship.

"As a small company, we weren't looking for top-tier suppliers; we looked at lower tiers," Dickey says.

While working with a lower-tier factory offers cost advantages, less-established suppliers may pose challenges when it comes to quality, production capacity, and punctual delivery.

"In the past year, quality control has become our number-one concern," says Charles Woo, chief executive officer of Megatoys, a Los Angeles toy wholesaler that sources from China.

Become an Expert, or Hire One?

There are two major schools of thought on how to stay in charge of relationships with PacRim partners:

1. Do it yourself. Fly over there, get to know the people and the processes, set up an office, and hire employees in the country where you manufacture. Such employees provide priceless expertise because they understand the culture and the business environment.

2. Let someone else do it. Don't try to learn and do everything necessary to manage partners overseas. Instead, hire a third-party service provider with offices and a network of contacts in the region to represent you.

Dickey belongs to the do-it-yourself camp. For a previous job with Iomega Corp., he lived in Malaysia, helping to kick a new company-owned factory into gear. When developing rapport and trust with overseas partners, communicating via phone and e-mail isn't enough, he says. Some degree of face time is essential.

"Somebody from the home office needs to go over there; it's best to send people who understand and are comfortable in the culture," Dickey says. "They know your company's perspective, and can work seamlessly with their counterparts."

WiLife uses third parties to handle transportation and clear products through customs, but not to manage relationships with suppliers.

As a startup, WiLife sent employees to China to keep an eye on operations and work through quality issues. Today, as a business unit of Logitech, WiLife benefits from the larger company's quality engineers and supplier management groups based in China.

"It helps to have people on the ground in the area, speaking the same language," Dickey says.

The supplier portals included in some enterprise resource planning systems can be helpful for managing day-to-day activities, Dickey says.

Compared with e-mail, the portals provide a more structured and efficient way to share forecasts, purchase order commitments, advance shipping notices, and other information across long distances.

"These tools keep everybody on the same page," he says.

From an office in Hong Kong, Megatoys employees keep tabs on the company's manufacturers in southern China.

"When they promise delivery, our employees monitor daily production," Woo says. "If it's not enough, we have them hire more labor and add extra shifts."

Those local employees also perform quality inspections and take random samples to an independent lab in Hong Kong to test for lead. "Sometimes testing once is not enough," Woo says.

For example, if the factory runs out of paint, the new supply it buys might not match the sample that was tested. And the tests sometimes do reveal problems.

"That's why we test regularly," he adds. "Last year we tested one product eight times. We want to make sure quality is consistent from batch to batch."

Companies trying to identify suitable suppliers in the Pacific Rim might get references from chambers of commerce in the countries they're targeting, or from 3PLs. Legal consultants also can help, Kuo says.

In addition, companies might check Internet-based trading platforms and business directories. Kuo recommends two sites based in China: Alibaba.com and Baidu.com.

And here's another simple strategy: "Pay a visit. Seeing is believing," Kuo says.

Sourcing Firms

For some companies, hiring a trusted third party to manage the relationship with Pacific Rim suppliers makes more sense than trying to develop the expertise in-house.

That's especially true for small startups such as Mimimack and Tassi, which both used sourcing firms to locate manufacturers, work out the details of producing their goods, and monitor the work.

After failing to find a factory on its own, Mimimack contracted with One World Sourcing, which chose a manufacturer and now manages the company's orders.

One World operates offices in Shanghai, Donggvan, Hong Kong, and Bangkok. Local employees eliminate headaches for U.S. firms by catching problems at the factory level, Norris says. Companies don't need to waste 30 days or more while bad product crosses the ocean before they discover any flaws.

Also, "if a project gets bogged down, or things don't seem to be going the way the company likes, I jump on a plane and head over there," Norris says.

When a customer needs a new product made, One World solicits quotes, proposed timetables, and samples to determine which factory should do the job. As production begins, One World staffers inspect the raw materials to make sure they're correct.

"Then we do a mid-point inspection to make sure the product is actually being manufactured," Norris says. "When the product is done, before it ships, we make sure it looks like what it's supposed to look like."

One World doesn't handle transportation, but it can connect customers with freight forwarders, Norris adds.

Tassi works with Silk Road Asian Sourcing, an international procurement and project management company headquartered in Shenzen, China, with additional offices in Hong Kong, Thailand, and the United States. The company's chief executive officer, David Dayton, is an American living in Shenzen who is fluent in Thai and Mandarin.

Dayton helped the Ellsworths choose a factory and work out the details of Tassi's product design and packaging.

"At first we had to work through some issues with the fabric, sizing, and sewing," Ellsworth says. Now Silk Road helps monitor production.

The company also handles quality control. "When we're in production, Dayton has someone on site most of the time, checking the product as it's being manufactured," Ellsworth says.

At first, for an extra fee, Dayton oversaw shipping for Tassi as well.

"But then he hooked us up with a shipping company," Ellsworth says. "When an order is ready to be shipped from Shenzen, we make arrangements with the carrier, which coordinates the shipment with Dayton."

The Role of 3PLs

Although they usually don't manage entire relationships between U.S. companies and their Asian suppliers, 3PLs do offer many services to help shippers keep an eye on production on the other side of the world.

APL, for example, provides vendor management for many companies. "We act as the eyes and ears of companies that place orders overseas," says Zasimovich.

The process starts when APL receives an electronic copy of the purchase order that the customer sends to the factory. APL makes sure the supplier delivers the order as promised—"that it's shipped in time, and that it's exactly the number of units that are supposed to be shipped," Zasimovich explains.

In some cases, APL tracks the production cycle, making sure the manufacturer hits milestones at the right points in the schedule to make the ship date.

In the case of apparel, for instance, it might start by making sure raw materials arrive on time, then follow through on the production process.

"Twenty-one days out, we'll check if the manufacturer began the cutting. Sixteen days out, did it begin the sewing? Then seven days out, we'll check the final stitching and packaging," Zasimovich says.

APL doesn't conduct inspections during production, but it might provide quality assurance on a shipment of finished goods. "We may, for instance, be asked to do a random inspection," Zasimovich says.

APL also plays a role when a company first brings an overseas vendor onboard. "We'll go out and meet them, or we'll host vendor seminars in the countries," Zasimovich says.

Along with its many other logistics and supply chain services, Dimerco also provides some quality assurance.

For example, the company recently moved the inventory of one customer, a U.S. pen manufacturer, into a Dimerco-owned warehouse in Hong Kong. During the move, Dimerco's employees inspected the product and discovered some manufacturing errors.

"The customer went back to the supplier, and they were able to address the errors before the items were shipped globally," says Greg Spudic, Dimerco's regional vice president, marketing and sales.

Since then, quality inspections have joined the list of standard operating procedures for handling customer products in that warehouse.

Besides monitoring production and inspecting finished goods—keeping an eye on what is happening—U.S. companies and their service providers have to prepare for events that might happen.

Unexpected challenges may arise due to tight capacity during peak shipping seasons, congestion caused by a port strike, production delays, or quality issues. "Contingency plans become crucial," Kuo says.

APL has worked out contingency plans for some customers that involve quickly switching production to Country B if major problems arise in Country A. APL's teams throughout Asia synchronize their logistics procedures, making it simple to move an operation.

"If purchase orders suddenly shift from Taiwan to the Philippines, for example, companies can pick up and execute orders using the same process, without any special arrangements," says Zasimovich.

Norris points to the Chinese government's move to shut down manufacturing within 75 miles of Beijing to reduce pollution for the summer Olympics. That caused big problems for companies relying on factories in the area.

One way to protect against sudden problems in one region is to contract with two factories in two different parts of the country.

That strategy might raise concerns about product inconsistencies, Norris concedes. "But, what's a bigger problem: products on the store shelf in remotely different colors, or not being able to ship products at all?" he asks.

Mitigating Risk

Using multiple factories, keeping buffer inventories, and toggling between ocean and air freight depending on demand all help mitigate risk, Dickey says.

One risk management strategy Logitech employs is to operate its own factory in Suzhou while also using several contract manufacturers.

"Large companies can do that; for smaller companies, it's a much bigger challenge," he says.

But it's the sort of challenge that more and more U.S. firms have to grapple with as they work to keep control over operations on the far side of the world.

Cracking the Market

Many U.S. firms that manufacture in Asia have not yet started selling there. But as new markets open, companies will need to learn the ins and outs of distributing in the Pacific Rim.

One major challenge for foreign companies that want to sell into China is the country's 17 percent value-added tax (VAT), says Steven Kuo, general manager, U.S. eastern district, for third-party logistics firm Dimerco Express.

Many firms used to ship their products from the mainland to Hong Kong, then back again—sometimes the same day—to avoid paying the VAT.

Foreign companies can achieve the same end more conveniently now that China has set up several free-trade facilities. When a company ships goods from its Chinese factory to one of these bonded logistics parks, that's considered an export. It then can ship from the park to customers in China.

"That can be considered an import, and no VAT applies," Kuo says.

Another piece of good news is that a company's Asian contract manufacturers may be able to introduce local distribution and sales channels.

That's what happened to video surveillance firm WiLife's parent company, Logitech, and to Iomega, says Don Dickey, WiLife's supply chain senior manager.

"Chinese conglomerates—government-owned businesses—sometimes have a family tree of sister companies, so you can network among your suppliers, people they know and work with, to gain introductions."

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