Global Sourcing Strategies: Pacific Rim Playbook

Sourcing components and raw materials from the Pacific Rim is no longer a cutting-edge logistics strategy; it has become commonplace. But that doesn’t make it any less complicated.

“The cost efficiencies gained by sourcing in Asia and India lured many companies into overseas trade,” explains Jon Routledge, vice president international sales-express, DHL. “And they face a completely different set of challenges than they encounter when sourcing domestically.”

Companies that venture to the Pacific Rim must deal with culture, language, and currency differences, as well as regulations, tariff codes, terms, restrictions, and quota levels, among other issues.

“Small and mid-sized businesses have to conquer a laundry list of new issues if they want to compete in global sourcing. Often, they are not equipped to handle these challenges on a global scale,” notes Routledge.

To complicate matters, sourcing in the Pacific Rim today isn’t simply a matter of moving goods from China to the United States. A company may source raw materials in China, for instance, ship goods to Taiwan for assembly, handle trade finance in Hong Kong, and outsource tech support to India—all for a customer in North America.

“We tend to forget that Asia comprises 42 countries,” says Routledge.

The question then becomes: how can companies link all these activities to flow as seamlessly as if they are sourcing from, say, Texas? The answer: Very carefully.

The Big Picture

Fundamentally, sourcing in Asia is about far more than reducing manufacturing unit production costs.

“Unit production costs are only one part of a very complex global sourcing picture,” says George Stalk, senior vice president, The Boston Consulting Group, Toronto.

“As supply chains lengthen, they incur direct, indirect, and hidden costs. Direct costs include shipping, nesting, and de-nesting of containers at both ends of the ocean pipeline, as well as inventory, procurement, handling, storage, insurance, and financing.

“The indirect, hidden costs are more difficult to identify and quantify,” Stalk continues. “These costs arise from variable supply chain dynamics.”

Time considerations are one indirect cost. The longer it takes to move a product from Point A to Point B, the more difficult it is to manage the supply chain without fluctuations that drive up costs.

“Fluctuations arise as demand changes at Point B ripple back through the chain,” Stalk explains.

Other hidden costs include:

• Overtime premiums on factory capacity.
• Expedited materials handling.
• Buffer inventory throughout the supply chain.
• Price discounts.
• Lost sales.
• Flushing defective inventory from the supply chain.
• Congestion-related costs at ports.

“In the aggregate, the cost impact of offshoring is felt most heavily in the supply chain: parts and materials procurement, transportation, inventory management, distribution, and customer and aftermarket service,” says Erich Gampenrieder, senior manager in Accenture’s Supply Chain Management practice.

The supply chain cost categories most heavily affected by offshoring decisions rank as follows, says Gampenrieder:

1. Aligning logistics, manufacturing, and assembly.
2. Redesigning and maintaining an operations network over time.
3. The impact of long lead times, high levels of raw materials inventory, and the intermediate cost of products and finished goods.
4. Transportation/distribution network restructuring and optimization.
5. Exception handling.
6. Ensuring supply chain flexibility to accommodate demand shifts.
7. Establishing and maintaining external partnerships.

To achieve high performance through offshoring, global sourcers need to conduct a total cost of ownership analysis. This analysis should consider how labor intensive the new operation is versus the old operation; total inbound and outbound volumes shipped; total value of inventory carried; and other metrics.

Analysis is one thing; implementation is quite another. Many companies find it difficult to hurdle two main obstacles: their organizational structure and performance management/reward system.

“Many companies are organized functionally and measured on how well they control costs,” explains Stalk. “Within this framework, they focus an enormous amount of attention on containing shipping costs.”

But consider this: the cost of shipping one container via ocean transport may comprise less than one percent of the transported item’s sale price.

“In contrast,” Stalk says, “the cost of a stockout is 40 percent to 60 percent of the item’s sale price—depending on gross margin. And the cost of an overstock is 20 percent to 40 percent. Those percentages overwhelm shipping costs.”

Using a total-cost approach, air freight becomes an interesting option. Although it can be four to eight times more expensive to ship via air than ocean, companies transporting products with high gross margin and high demand variability still pay only a 4-percent to 8-percent premium on one percent of the product cost.

“That sure beats a 40 percent to 60 percent markdown,” Stalk says.

While some large companies do their homework and identify indirect costs, analyze the impact of offshoring, and perform total cost of ownership analyses before diving into Pacific Rim sourcing, small to mid-sized companies with little or no global sourcing experience can become overwhelmed.

Recognizing their need for guidance, many global forwarders and integrators have designed programs specifically for small companies. UPS Supply Chain Solutions, for example, offers a Supplier Management Program that consolidates purchase orders and manages vendors for U.S. companies sourcing in the Pacific Rim and elsewhere.

“Shippers send us their purchase orders as if they were sending them directly to manufacturers,” explains Mark Millar, director, strategic business development, Asia Pacific, for UPS Supply Chain Solutions.

Managing the Details

“We help retailers, for instance, set vendor cut-off dates at Chinese ports so their products meet in-store delivery dates,” says Millar, who is based in Hong Kong. “We manage shippers’ suppliers to ensure they fill orders properly and on time, and use our supplier management system to track this information so shippers can determine—by exception—which products are falling behind schedule.”

UPS SCS also develops forecasts in concert with ocean and air carriers to improve rates and service; consolidate multiple vendor shipments into full containerloads; and provide visibility upstream through its purchase order management system so shippers can monitor events and progress.

Many global logistics providers also handle documentation for Pacific Rim sourcers. Proper documents are crucial to ensuring that shipments can be loaded onto vessels and unloaded smoothly at the U.S. destination point.

Some companies new to sourcing in the Pacific Rim choose not to use global forwarders, but turn instead to their suppliers for logistics expertise.

For companies opting to take this approach, logistics capabilities rank at the top of supplier selection criteria. Companies need to ask several questions concerning a potential suppliers’ abilities, such as: How willing and capable is the supplier to act as an exporter on your behalf? Can the supplier meet export regulations?

In addition, John Mascaritolo, commodity director, transportation and logistics, corporate global procurement, for NCR Corp. recommends solving the following cost riddle: Is it fair for suppliers to bundle the cost of logistics into their manufacturing price because they assume the burden of getting the goods out of their country?

Or, should you partially unbundle the logistics costs, negotiate the transportation portion separately, and tell your supplier to call your carrier when a shipment is ready?

“If you choose the latter approach,” Mascaritolo explains, “the supplier is still responsible for preparing goods to leave the country, but you retain control over your transportation costs.”

Integrators also can play a key role in Asia Pacific sourcing strategies. “Global companies must be able to rely on and trust the abilities of their freight forwarders; they are the lifeline that makes international sourcing work,” Mascaritolo says. “Weak freight forwarder networks complicate global sourcing.”

What should global sourcers look for when choosing a freight forwarder? Door-to-door delivery is key; your forwarder should understand how to act on behalf of your suppliers to get goods out of the origin country, and get material into the destination country.

Coming to Terms with INCOTERMS

When negotiating with Asian suppliers, using International Commerce Terms, or “Incoterms,” can simplify sourcing. Incoterms are internationally accepted commercial terms that define the respective roles buyers and sellers play in the arrangement of transportation and other responsibilities. Incoterms are used in conjunction with a sales agreement.

Incoterms identify risk and burden between buyer and seller, but do not stipulate when the title of merchandise passes. Title of merchandise is covered in the supplier contract, and should be handled separately from Incoterms. Importers should use Incoterms that fit their specific needs.

One flexible Incoterm Mascaritolo recommends is “Free Carriage Allowed” (FCA). Under FCA, risk and burden—including transportation and insurance costs—pass to the buyer once the seller delivers the goods to the buyer’s carrier. The seller is obligated to load the goods on the selected carrier’s vehicle, and becomes the exporter of record.

This way, the buyer controls the shipment by using its own carrier, but doesn’t need a legal presence in the country to be considered exporter of record.

“Put the Incoterms burden on your supplier to be the exporter,” Mascaritolo suggests. “This makes the seller responsible for getting the shipment, with proper documentation, to your carrier. The seller manages the export documentation process and agrees to meet the regulatory requirements of moving goods out of the country.”

Connecting your freight forwarder with your supplier is also a wise move. “This creates a collaborative relationship that sets your shipment in motion,” Mascaritolo says. “Your specified transport mode—ocean or air—is indicated on your purchase order, with specific instructions and delivery due dates.”

Under this type of arrangement, a shipper’s freight forwarder reserves airfreight or ocean cargo space and picks up the shipment from its supplier in Country A.

“The forwarder knows from your instructions whether it is to act as a customs broker and clear the shipment on your behalf into Country B, or to deliver the goods to your point of consumption,” Mascaritolo explains. The forwarder manages the shipment process, and notifies the shipper only when it needs to handle an exception.

“You can make Pacific Rim sourcing work by bringing a mega freight forwarder in to work with your global suppliers,” he notes.

Mega freight forwarders—those with a huge global footprint and thousands of customers—can be invaluable to international sourcers because they provide intricate shipping services across the globe. A niche forwarder, by contrast, may have expertise only in certain parts of the world, leaving shippers at risk in some areas.

Though sourcing in the Pacific Rim provides manufacturers and retailers many benefits, they run a higher risk of encountering supply chain problems and disruptions than companies with a simple domestic supply chain.

“A port strike, capacity shortage, missed sailing—all these problems can occur,” Mascaritolo says.

What can you do to protect against these risks? Mascaritolo advises discussing these events, before they occur, with your freight forwarder.

“If your shipment gets bumped off a plane, for instance, you’ll know you can rely on your freight forwarders to fix the problem because they have a relationship with the carrier,” he explains.

Not only is this kind of communication with forwarders helpful, it’s critical with your global 3PLs and Pacific Rim suppliers.

But not every company allows its logistics managers to communicate directly with Pacific Rim suppliers.

“You have to create a triangle of internal-external communication with your logistics department in the middle,” Mascaritolo says. “Logisticians should deal with the contract manager who owns the supplier relationship, and with other internal contacts. You need to know what to expect from each supplier.”

Ideally, a company’s logistics division will be included in sourcing decisions, preferably early in the process. “Ask your procurement people if they are contemplating sourcing in any new countries so you can devise a carrier network in advance,” Mascaritolo suggests.

Also, clue in your 3PL because it can help in the decision-making process.

“Logistics providers need to know early on what countries are being considered for sourcing,” Mascaritolo notes. “They can offer reasons why one country may be a better choice than another, review sourcing contracts to make sure the new suppliers can meet shipping requirements, and determine whether Incoterms can be changed to make the sourcing arrangement more favorable.”

Best Practices at Work

High-tech firms such as NCR Corp. and IBM are big proponents of Pacific Rim sourcing.

NCR Corp., the Duluth, Ga.-based multinational company known for its ATMs and retail technology systems, for example, sources parts and componentry from China, Taiwan, Singapore, and other Asia Pacific countries.

“NCR’s sourcing practices are similar to other companies in the high-tech industry,” says Mascaritolo. “We’re always looking to improve price configurations for parts and componentry. We want to maintain a necessary level of quality at the best price, so we seek out suppliers that meet those criteria.”

NCR uses an extensive bid process to drive procurement choices; it does not simply shop for the lowest price.

“We look at the total cost of the entire sourcing process,” Mascaritolo explains. “We consider supply chain factors—time; distance; logistics costs; regulatory concerns; import/export process issues; and political concerns or instability; among others.”

Joseph Gianatassio, general manager of production procurement in Asia Pacific, heads IBM’s China Procurement Center, which procures production hardware in Asia Pacific for use throughout the world.

“In 2006,” reports Gianatassio, “IBM sourced $3 billion worth of commodities in China alone. We procure roughly $16 billion in hardware goods globally; we source 80 percent of that in Asia Pacific.”

IBM, which operates small procurement centers in Singapore and Malaysia, began sourcing materials from China in 1994. The company set up a wholly owned procurement subsidiary there in 1996 to support its manufacturing entity in Shenzhen. The center, with a staff of 130 people, provides procurement for internal brands as well as procurement consulting.

IBM has developed a core of global suppliers that serve the IT industry. “We’ve helped them grow and establish processes to meet our requirements,” Gianatassio says.

“Issues such as legal licensing requirements, cultural differences, and quality and intellectual property concerns must be precisely addressed and controlled as part of the procurement process,” he explains.

The legal and supply chain requirements for sourcing in Asia are particularly rigorous. Customs requirements, for example, are challenging, so companies need good working relationships with Chinese customs officials.

These relationships can help at month’s end or quarter’s end, when shipment volumes increase and Asian ports can become congested. Shippers that have cultivated a strong relationship with Customs and maintain documentable, controlled processes, are less likely to have their shipments held up.

“IBM has spent a lot of time with Chinese customs officials to build their trust,” Gianatassio says. “When we tell them a shipment weighs 200 kilos, they know we are telling the truth. If you say a shipment weighs 200 kilos but it weighs in at 250 kilos, you lose their trust.”

IBM’s corporate logistics council is responsible for establishing cohesive worldwide logistics strategies and processes. The council negotiates global contracts with logistics service companies.

“In addition,” Gianatassio says, “we use a small base of local transportation providers. This is an effective strategy because we can leverage our volume.”

Ultimately, ensuring success in Pacific Rim sourcing boils down to developing an established, replicable business process.

“Once shippers have this process in place, they need to follow it. They need to establish controls around the process and execute. Don’t deviate,” stresses Gianatassio. “If IBM moves a significant amount of sourcing to India, for example, we’ll replicate the process there. That’s our formula for success.”

“Asia will continue to be a major sourcing location for many years to come,” predicts DHL’s Routledge.

But it won’t be the only game in town. “As Asian countries become more affluent, costs will increase, and companies no doubt will go in search of the next low-cost production area,” he says.