Miss Hilary

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Global sourcing and supply

Alan Braithwaite, LCP Consulting Ltd

Background

Global sourcing and supply is now a central part of many companies’ business strategies. It has proved essential to sustaining marketplace competi- tiveness and maintaining net margins. Indeed, global sourcing and supply is probably both the biggest economic trend of the last 20 years and a key ingre- dient for corporate survival; it takes advantage of low-cost and available labour, cheap international logistics, and less regulated operating environ- ments than in mature economies.

The adoption of low-cost sourcing and supply areas has displayed an expo- nential trend, which is forecast to continue. However, the dynamics of this new way of operating are only just being understood and have not been documented extensively. Global sourcing implies long-distance supply chains, multiple hand-offs and extended lead times. As companies move to increase their share of global sourcing beyond the current entry levels, there will be major implications for how these extended chains are managed; security of supply, demand responsiveness and product life cycle management all take on greater significance.

This chapter describes the landscape of global sourcing and supply and the dimensions that companies need to address to ensure a stable operational and business base. Global sourcing is an established geopolitical and economic fact of life. It is now a market-driven trend. But the challenge for every individual

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C o p y r i g h t 2 0 0 7 . K o g a n P a g e .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

EBSCO Publishing : eBook Collection (EBSCOhost) - printed on 6/19/2020 2:10 PM via AMERICAN PUBLIC UNIV SYSTEM AN: 189238 ; Waters, C. D. J., Chartered Institute of Logistics and Transport in the UK.; Global Logistics : New Directions in Supply Chain Management Account: s7348467.main.ehost

corporation is to implement it in a way that secures a sustainable advantage. This means organizing to manage risk alongside commercial and competitive advantage. All of the principles of supply chain management still apply; the specifics of global sustainability have many additional dimensions that are not experienced in more conventional local chains.

Growth in global trade

The expansion of global trade in manufactured goods has been one of the most pronounced and remarkable economic trends of the last 40 years. It has both fuelled and enabled the growth in the GDP of most developed countries, exporting jobs to countries with large pools of increasingly skilled and low- cost labour. The capacity of the labour pool in developed countries is being released to higher-value or essentially local activities and the service sector. The scale of this shift is shown in Figure 20.1.

This growth shows no sign of abating. It has been reinforced by the reduction in tariff barriers and the expansion of low-cost international logistics in the form of container freight. The importance of global trade is illustrated in Figure 20.2, which shows the strong correlation between import

Global sourcing and supply � 331

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Figure 20.1 Growth in global trade in manufactures

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and export growth. This also demonstrates that there is no correlation with growth and the absolute scale of imports and exports. This means that the opportunity of global trade is an economic benefit to both mature and emerging economies. If we set aside the natural tensions of self-interest that have been evident in recent world trade negotiations, it is clear that there are enormous benefits for buyers and sellers alike.

China has been posting GDP growth of 8 to 9 per cent a year and this has recently been described as an underestimate. It refers to itself with pride as the ‘factory to the world’. No one can ignore this trade potential, and global sourcing is now a matter of board strategy for all businesses in developed economies.

Statements in relation to planned increases in this trend are a regular feature of annual reports and analyst briefings. Wal-Mart, the world’s largest retailer, made the trend to direct international sourcing a key feature of its 2002 annual report, saying:

We also are making exciting strides in… global procurement. Last year we assumed responsibility of global procurement from a third party. This allowed us to better co- ordinate the entire global supply chain from product development to delivery. In addition, our global procurement program allows us to share our buying power and merchandise network with all our operations throughout the world.

332 � Global logistics E

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Figure 20.2 Correlation of import and export growth showing the country scale of activity

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Dyson closed its entire manufacturing in the UK and moved to Asia as a key element of its entry strategy for the US market. New origins for the garment trade are Turkey and Morocco, where companies can still leverage low-cost labour, but without full Far East sacrifices on lead time and flexibility.

Figure 20.3 shows the critical contribution of the automotive industry, engi- neering and electronics to globalization. In reality, companies like Wal-Mart are only catching up and this will probably be at the expense of both importers and local manufacturers.

The WTO (2005) predicts that global supply is the future. Indeed, it is an irreversible trend, since capacity is leaving developed markets because it cannot compete with low-cost imports. This global sourcing dimension of strategy is now a cornerstone of companies’ plans to generate value for customers and shareholders alike. Few can envisage a sustainable future without an increasing level of global supply.

Given this landscape of major change, this chapter brings together some key dimensions of the practice of global sourcing. It reviews the ‘layer and pillar ’ model (Figure 20.4), which proved useful as a means to describe the multifaceted nature of global supply chain management (Liang, 2005). Supply chain management in global sourcing must address all of the layers. Best practice is bound together by a requirement to understand and manage through a structured approach to risk and through the total Cost-to-Serve®.

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World trade – selected industries by value

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Figure 20.3 Global trade growth by product category

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Cost-to-Serve, which is a registered mark of LCP Consulting, is a supply chain costing methodology that can quickly capture the true logistics cost drivers, and identify activities that are intrinsically uneconomic.

Global sourcing as a way to change business strategy The central role of global sourcing in transforming business strategies can be understood by comparing the relative wage rates in regions of the world. Because of difficulties with exact comparisons, these figures are indicative rather than definitive. For skilled labour per hour in Germany the cost is $18 to $25; in the Czech Republic it is $3 to $5; in the United States it is $9 to $15; in Asia and India it is often less than $1. The cost of support services, construction, capital investment and management are in proportion, which means that the cost of an equivalent article made in an emerging economy can be as little as half of that sourced locally.

Traders have been taking advantage of this arbitrage potential for many years and have used their local relationships, buying skills and logistics know- how to make a margin. That margin was their return for taking risk, including quality, financing and marketing. The ultimate price differentials were reduced to 10 to 20 per cent to the end customer.

The surge in growth of global trade is the result of more companies going into markets to deal direct – cutting out the middleman. The effect of this has been to increase margins and also to increase the buyer ’s risk. The business strategy has been to plough back the margin benefit into lower prices, which

334 � Global logistics

Cost-to-Serve®

Risk management

Commercial and contractual

Logistics network

Supply chain processes

Information systems

Skills, capabilities and relationships

© LCP Consulting 2005

Figure 20.4 The layers and pillars of global sourcing best practice

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in turn has increased volumes and market share. The trick has been – and will be – to exploit the elasticity of demand by just enough to get more volume than the margin that has been conceded. Getting this right makes both sales and profits grow.

Across industry as a whole, the trend has been for lower real prices as value is passed on to customers. The open question is the extent to which this trend is now played out. The next step in global sourcing will involve another doubling of activity levels and this will require improved levels of control and integration. The skills of supply chain management will become increasingly central.

Identifying and selecting sources The practice of sourcing depends on the commodity and product. For example, chemicals display different supply characteristics from clothing, which in turn is different from microelectronics. Entering a new sourcing arrangement is a moment of risk and there are many factors to be considered. These include the following:

� Quality is a key issue. Vendors are increasingly able to deliver to quality – but this ability cannot be taken for granted. The implications of a long-distance quality failure are much greater than a local one, as the problem may not be discovered soon enough to avoid serious disruption. Increasingly, companies are insisting on more comprehensive quality control at vendors, alongside detailed specification and engineering integration.

� Ethical supply. The marketing and PR impacts of the use of child labour and the environmental conditions surrounding production are now important for consumers. Media disclosures can damage a brand with consumers and shake investor confidence. Increasingly, companies are conducting regular audits and inspections of their sources to make sure that they do not get surprises that damage their reputation.

� Patent protection. The leaking of design and technology advantage has become a common experience. Companies have outsourced to places where respect for patents and know-how is rather less than the standard they would expect. Often designs, ideas and products reappear through different channels and can erode markets and price levels. This risk requires a very careful approach to ensure that key differentiators are protected and that contractual guarantees are obtained that can be enforced.

� Operational excellence. Vendors’ capabilities can vary widely and it is crucial to understand the extent to which they will be able to perform to expec- tation. For example, late new product introductions can significantly affect the buying and marketing organization, and there is evidence of share price erosion when international chains fail.

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These points require a higher level of due diligence and ongoing management than many might expect. Dealing across cultural boundaries is a major part of this challenge – and the word ‘yes’ in many languages cannot be taken as an unequivocal agreement.

Commercial models Global trade is by definition more remote than buying locally. A problem with local supply can prompt a whole range of quite simple actions, including refusing to pay and taking legal action. With global sourcing and supply these actions are more difficult, since the goods may already have been paid for, and legal action is less likely to be successful. Commercial models are, therefore, a key part of supply chain design. These are about the point of payment for the various activities along the chain, where the risk is taken, and the margin that is taken or conceded for that risk and credit period. These terms can vary enor- mously by both sector and companies’ preferences. Traditionally traders took title to the goods at the side of the ship and paid with a currency instrument (letter of credit) that was guaranteed by a bank and cross-guaranteed by the buyer. Then they organized their own freight and paid any duties and tariffs at the destination. This model is often called FOB (free on board) and has been adopted by retailers, which are progressively replacing their traders and agents.

Another common option is CIF (cost of goods plus insurance and freight), where the vendor charges for the cost of goods plus the insurance and freight to get them to the final destination. Any duties and taxes in this model are for the buyer to arrange to pay when the goods arrive in the country. DDP is the most equivalent option to local supply. It stands for delivered duty paid and it is where the vendor takes total responsibility for all costs until the product is delivered. Financing is invariably part of this package.

These are the most common of many models that are referred to as IncoTerms. The precise selection of the right Incoterm is a critical decision for the specific trade on extended supply chains with many hidden risks and the requirement for extended financing. It will be influenced by a whole range of factors, including the buyer ’s balance sheet, the vendor ’s financial capacity, the risk in the trade, and the relative cost of financing and operating the chain under the different models.

International logistics The importance of international logistics cannot be overemphasized. The flexibility of container freight to make efficient, shared capacity available to many users has been a huge driver of global trade. But with scale in global trade have come new issues that require new approaches.

Even with container freight, traditional methods of managing inter- national logistics can involve as many as 10 to 12 hand-offs in movement and

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documents. If just one or two of these fail, with no effective way of putting them right, the unreliability of global logistics becomes the reality that is often a subject of comment and complaint.

With scale and growth, inbound management at the destination now requires central coordination. Correspondingly, management at the origin also needs to be controlled to ensure the right flow at the destination and to enable the buyer to take advantage of the scale of its activities. The management of documentation, customs clearance and compliance can also benefit from a single centralized administrative and forwarding set-up.

Finally, the question of security against terrorism is now a major concern in international trade. There are onerous requirements for certification of cargoes, especially into the United States, under the C–TPAT (Customs–Trade Partnership against Terrorism) scheme. Failure to comply can lead to cargoes being refused carriage or blocked for lengthy inspection and clearance.

The result of these factors is that major buyers are tending to appoint a global ‘lead logistics service provider ’ (LLP). These are often offshoots of the container shipping lines or international freight forwarders that have extended their services, and are especially appropriate where a buyer is main- taining many trading relationships. In companies where there are a smaller number of very large trading relationships, the tendency is to adopt an in- house forwarder.

In all circumstances, the operational need is for integrated management of many remote origins, providing information visibility, certification, and the capability to respond to factors in the supply chain.

Flow management Flow management and control is often executed, but seldom planned, by the LLP. Someone, generally the buyer, has to make the planning, forecasting and ordering decisions. The key feature of global sourcing is that chains become extended, with longer lead times and less agility to respond to changes in the actual marketplace. This needs improved forecast accuracy and more inte- grated supply chain planning. The consequences of poor planning are a combination of service failures and increased cost from emergency deliveries and associated expediting.

Global best practice is to introduce a sales and operations planning process, part of which is to identify the products whose demand characteristics make them particularly vulnerable during extended lead times. With these products there is generally the potential to implement supply chain strategy options such as postponement, capacity booking or switch sourcing:

� Postponement is where the product is made and shipped in a generic form so that it can go into a number of different final products. The generic parts are then localized in the final market to meet real customer orders (HP and

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Dell are renowned for using this approach). � Capacity booking is where a vendor is ‘booked’ to provide capacity on a

fixed cycle; the exact mix of product to be made is decided at the last minute. This reduces lead times and ensures that the product made is the one that is most needed.

� Switch sourcing is where the initial quantity is made in the lowest-cost source and, if demand forecasts are exceeded, any patterns or moulds are transferred to higher-cost sources where the product can be made and shipped with a much shorter lead time.

Organization design The organization of global sourcing is a major issue, with companies that use global sourcing creating organizations in their main origins that now seem disconnected from the core organization at the destination. The dilemma seems to be whether the offices in the origins are buying functions, logistics functions, technical functions – or some combination of these. Each of these relates to different functions in the parent organization – and ownership and control appear to become an issue. Furthermore, the relationship of the origin offices and capabilities with the main organization is inevitably challenged by distance, communications, systems issues and – most of all – goals and KPIs.

It is clear that the next stage of maturity in global sourcing and supply will require a greater definition of the organizational lines and responsibilities than exists in many businesses today. This will most likely be based on team- based structures working on categories, technologies and product life cycle projects as appropriate; it will be fully integrated with the core business at the right points and work actively to overcome the barriers of geography and culture.

Information technology Extended chains require information technology that can manage the long- distance ‘purchase-to-pay ’ cycle and all the steps along the way. The key is to make available a single version of the order and its status to every point along the chain. It must allow the appropriate people and organizations to make amendments, update status and provide a history of events. This is beyond ERP, as the various players along the chain (such as vendors, service providers and Customs and Excise) all have many relationships with other parties. They also have particular information needs that will not fit with the customers’ ERP systems – and the attributes of the data are rather different from those in conventional ERP systems. The data architecture needs to be able to handle consignments, waybills, containers, tariffs, providers, VAT and duty as well as orders, SKUs, vendors and locations.

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Data interchange between systems is essential to provide the visibility needed for flow control. Internet technology has provided the ideal platform on which many-to-many relationships can be maintained. It is low-cost and provides widely based connectivity. However, every major shipper then needs a single reference point for its international trade, and this is unlikely to be the main ERP system. Some of the major shippers and forwarders have invested heavily in such event management systems and the associated connectivity. The early versions of these systems have added considerable value, and the new generation is expected to provide another step change.

However, the systems world is full of tensions as providers compete to promote their systems and lock in their clients. It is unwise to expect that the IT world of global trade is an open and transparent one. There are many barriers, including the operational excellence (or lack of it) with which the technology is fed.

Operational excellence With as many as 12 operational hand-offs in the extended international supply chain, there is much that can go wrong – so operational excellence is critical to a smooth supply chain. Typical issues that must be done with excel- lence are:

� product labelling and bar-coding – right code, right box, right quantity; � invoicing – right product, right cost, right consignee; � customs – right classifications; � advanced shipping notices for right product; � schedule and date required compliance; � container packing accuracy; � handling quality.

Surveys have shown very high levels of non-compliance and operational vari- ability in global supply. Quite simply, the origin participants do not under- stand the requirements for supply chain management by their customers and, therefore, often do not comply. The use of an LLP can be combined with more proactive vendor management to make sure that due dates and data quality are achieved – and to impose charges when standards are missed. Case material has demonstrated the downstream value of upstream excellence. The cost is tiny in relation to the value, and the barriers to excellence are more about culture and understanding than deliberate obstruction.

Risk management Risk management should be continuous for buyers. There is much to be concerned about, for example:

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� the basics of vendor viability; � sudden and unadvised changes in priorities by vendors and service providers; � quality and timeliness issues; � introduction of unauthorized materials or child labour; � loss/leakage of technical know-how and patents; � sudden and unexpected duty and quota constraints as a result of political

and economic pressures; � currency variations; � sudden and unforecast changes in customer demand.

A lot of these would apply to local supply as well, but their scale and impacts would generally be less. The combination of culture, language, distance and complexity conspire to make a formal risk management process with regular checks essential. This requirement will expand further as global sourcing moves into its next phase of growth.

Critical success factors The measures to manage global chains and mitigate risk require six capabil- ities. These capabilities form the critical success factors:

1. Total acquisition cost management: the ability to analyse and predict the total cost-to-serve from the source of supply to its final point of sale. The cap- ability in this analysis is not simply to build up the logistics costs from freight, inventory holding, duty, applicable customs regimes and so on. It is more important to analyse and build into the costing the risk of markdown and lost sales through a market–risk–cost profile. This analysis identifies products that should never be traded on a long lead time or that should be the subject of a postponement strategy. It is also likely to show that there are some products where actions to reduce lead time and increase flexibility will justify a higher initial purchasing cost.

2. One-touch information flow: to avoid double entry, duplication, mistakes and inconsistency as the same transaction moves through the many points of contact in the chain. Accuracy of information is a precondition of proactive management. This capability is systems-enabled – and it is critical to have the widest view of the total chain on one information platform with the ability to recognize inconsistencies.

3. Total product identification and compliance: to ensure fast, accurate product and handling unit identification that feeds the ‘one-touch information’ requirement. The use of bar codes and RFID to the correct standards is the enabling technology.

4. Real-time routeing through dynamic visibility: the capability to see through the chain, know what is coming and test for events that have not happened as planned, and to interpret the implications of failures in a

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proactive way and make decisions to minimize their impact. This is the ‘traffic control’ of a global supply chain, and it must be managed transpar- ently and with the cooperation of all the parties in the chain.

5. Vendor development: the capability to understand and improve the long- term performance of vendors in terms of cycle times, timeliness, quality and accuracy. Based on the historical performance of the chain, it is possible to identify improvement programmes to develop supplier reli- ability. The ultimate goal is to issue orders and schedules on shorter lead times, reflecting real demand or more accurate forecasts. Understanding the underlying performance of vendors and their category of products in the marketplace is the starting point for this.

6. Information platform to provide consistent and timely information: the cap- ability to put in place, operate and maintain a full supply chain visibility solution. All of the above capabilities are anchored by the operational skill to secure and maintain the information backbone, with the diverse data structures that are needed by each supply chain function.

Global sourcing – sustaining the trend It is clear that first movers to global sourcing have gained a competitive advantage. Often these were traders that had an intimate knowledge of a supply market in terms of the vendors and their capabilities – as well as the logistics to get the product to the market. They committed to stock risk and knew where to dispose of product if the original channel did not work. For this they earned a respectable margin for the risks they took.

In the context of the explosion of global sourcing and the further potential, the conclusion is that the ‘land grab’ is over. Figure 20.5 suggests that we are

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Maturity of GS

Time

Global sourcing entry

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Companies are here today, the land

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the next surge is under way

Figure 20.5 Maturity development of global sourcing

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moving from initial exploitation to putting in place stable structures that can handle the next phase of growth. This will be essential as companies become more dependent on long-distance supply chains with all the risks and issues that we have identified.

The increased penetration of global sourcing will make its management a core skill and capability. This chapter has attempted to provide an initial view of the emerging landscape and issues.

References

Liang, JX (2005) Best practice in global sourcing, Unpublished MSc thesis, Cranfield School of Management, Cranfield

World Trade Organization (WTO) (2005) International Trade Statistics, WTO, Geneva

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