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1International Federation of Purchasing and Supply Management

Global Sourcing: Challenges and Constraints

Giovanni Atti

Past President ADACI Member of Board e Chairman of the Education Committee

of the International Federation of Purchasing & Supply Management

Procurement & Supply Chain Directorate AgustaWestland

Buenos Aires October 5th 2007


In the last five years ‘Global Sourcing’ policies have

entered in the Buyer’s strategic agenda and many professionals have launched global sourcing campaigns to reduce costs

Global sourcing: it is not an option

it implies adequate skills and organisation, risk management and top management support


if the overall company culture is mainly focused on

domestic supplies and

does not enjoy flexibility, supply chain

collaboration, long term vision, capability to face

uncertainties and to evaluate potential risks

global sourcing initiatives could fail


Whithin a global environment, where most products

are made almost everywhere, the competitive edge

belongs to companies that:

are properly organised (lean operations)

enjoy low labour rates

manage big quantities


Average hourly rates in China:

$ 0,59 2000 $ 0,69 2001$ 0,80 2002 $ 0,92 2003$ 1,03 2004 $ 1,12 2005

labour cost is rising and labour intensive organisations move to less developed provinces or to Vietnam/Bangladesh

Economist 10.2006

2006 : Renminbi devaluated by 6% Productivity increased by 15-20%

Financial Times 8.3.2007


Except for niche markets, survival depends on the capability to reduce costs

USA experts say: ’ if you cannot reduce them by 25%-30% it is better you close down’

Taking into account the difficulty to reduce fixed costs

lowering sales prices by 25%-30% means to reduce the

overall product cost by 35%-50%


To do it, companies have to recover efficiency and effectiveness through:

lean management approaches

global sourcing initiatives

outsourcing plans of goods & services in low- cost countries


Global Sourcing includes:

Spot Buy directly or through dealers/tradings

It does not imply changes in the supply chain

Repetitive Purchase of standard goods

IPR owned by supplier

re-engineering of the supply chain


Global Sourcing includes:

Repetitive Purchase of customised goods IPR owned by buyer

raw mat & finished components bought by supplierre-engineering of supply chain

Outsourcing of Manufacturing Processes

PR owned by buyer raw mat. / finished components bought by supplier

re-engineering of operations and supply chain

Four buying processes with growing difficulties


Global Sourcing: a medium-long term company decision:

to generate a ‘second source’ or to outsource non core processes/services

based upon adequate market analysis & business plan

shared and continuously supported by Top Management


implying supply management and supplier development capabilities in countries with different laws, culture and practices

subject to risks independent variables unstable performances interpretation of requirements different applicable standards

subject to learning curves and high initial costs

ROI in medium-long term


Benefits of global sourcing / outsourcing:

can reduce costs by 25%- 60%

fosters competitiveness

can avoid new investments

makes the company: lean, international and more focused on market trends

creates a ‘second source’ (additional capacity)


Benefits of global sourcing / outsourcing:

Favours penetration of local markets

McKinsey: 87% of offshore investments made to penetrate local markets

Meets offset / industrial compensation reqts.


It can also allow:

access to new technologies

transformation of fixed into variables costs

access to skills not available on domestic market

higher flexibility and reduced time-to-market


Barriers / Problems to consider:

Diverse political and industrial environment

Diverse business practices

Culture/ language / law differences

People concern

Volatile exchange rates

Logistic support

Qualitative and JIT sourcing requirements


1. Diverse political and industrial environment

political interference (China),

bureaucracy (India )

managers take tactical decisions, strategy made by politicians (China)


1. Diverse political and industrial environment

State Owned Enterprises insufficiently customer oriented (China)

logistic Infrastructure: inefficient e fragmented

frequent energy black-out (China: 14 summer 2005 - India: 6-12 every month - World Bank 2005)


India

Trucks: 80% has more than 5 years, UK: 48% Singapore: 47%

50%-80% are overloaded (EU 0%-5%)

Average speed on motorways: 45km/h

Trains: dangerously overloaded

Airports & Ports: old, crowded, and poorly connected


China

sourcing of std products: relatively easyselection of most reliable supplier: very difficult

too many players in most industrial sectors

professional directories do not exist

information through official channels: scarcely reliable

confusion between manufacturers and dealers

50% of enterprises cannot export directly


2. Diverse Business Practices (mainly China)

poor planning, budgeting, monitoring and reporting capabilities

capable to reproduce, but need a coach telling them how to work

unstable quality performances

scarce knowledge of cost analysis – they accept target prices but often ask for price increases after delivery

of initial production


no measurement of performances

basic principle of international commerce: ‘pacta sunt servanda’ not always respected

The buying company needs specialists:

- trained for the purpose,

- capable to listen, understand and accept the partner’s organisation

- capable to work with local management and to promote supplier improvement plans


3. Cultural Differences China

Organisation, procedures and working methods mean beaurocracy and management constraints

They never say ‘no’ and tend to skip questions they do not want to answer

Customer loyalty does not exist, they favour who pays more


4. Different language and laws

Very few people speak English (China)

Professional interpreters not always available They do not translate nasty comments/remarks (China)

Check appropriate intepretation of drawings, technical specifications and contractual clauses

technical documentation not immediately understandable to people not familiar with

Standard of reference can be different


risks associated to the existence of unknown compulsory laws that prevail over any agreement

Suggested clause: subject to the provisions of the termination Clause ….,

the Supplier confirm that each article of the Agreement per se,

and the entire Agreement as a whole, do not infringe any imperative

or mandatory national, regional or local law and/or administrative

norm existing in his Country, and undertakes to keep the Buyer

informed about the entry into force of laws and/or norms that impact

the terms of the Agreement. Should any new law and/or norm limit

or impact the execution of the Agreement or impose the Buyer

additional costs, the latter could decide to terminate the same,

as per the provisions of Clause …


Governing Law and Jurisdiction: neutral country

Limited down payments possibly covered by international bank guarantee

Transport costs quoted aside (they could double the cost of material bought)


5. Exchange rates fluctuation / inflation

Avoid use of local currency and national price indicators

6. Supply Chain Constraints

In some regions it is difficult to find raw materials dealers and/or MRO suppliers

Supply of spares, customer support and repair activities could represent a problem


7. Qualitative and JIT Constraints

Total Quality Management approach almost unknown

Quality Requirements often under-evaluated

Buyer or service provider appointed by buyer, should make the acceptance test before shipment

Return of material rejected often very difficult (bureaucracy, import licences, etc.)


Global Sourcing

Direct relationship without intermediaries more difficult but more profitable,

Taking into account risks and selection, qualification and learning costs, relationship must be based on big quantities and span in medium-long term

Implies progressive implementation, constant monitoring and supplier improvement plans


Outsourcing offshore:

strategic decision that changes structure and organisation of the supply chain

process that provides opportunities and enhance competitiveness

a source of problems and possible failure


a tool of creative destruction

- savings obtained used to reduce selling price and fund R&D

- lower selling prices increase market demand

- R&D generates new advanced products (competitive edge)

- when old products replaced by new ones outsourcing no more necessary

(outsourcing: ‘destruction’ of old organisation progressively replaced by a new one)


Diana Farrel, Head of McKinsey Global institute

Saving obtainable with the outsourcing: 30%-70%*

* Textile industry


Outsourcing of complex supplies (high value)

Where the share outsourced exceeds 50%-60% of the need, it could be useful to establish a joint-venture (capital shared initiative)

the costs of such operation are relatively low at the beginning of the relationship and raise in parallel with the learning and integration process

Potential strategy of our competitors: acquisition of our best partner (anticipate competitors move!)


Global Sourcing / Outsourcing Process

1. Preparation of Sourcing / Outsourcing Plan

2. Contract Arrangement

3. Implementation & Contract Management

4. Supplier Development & Continuous Improvement Plans


1. Sourcing Plan Preparation

a. Which are the commodities to start with?

Not many ( 1- 2 )

Where volumes and local capability exist

b. Sourcing activity

Market intelligenge to find potential opportunities


c. Sourcing Plan

Analysis of Costs vs. Benefits

Risk Analysis (assessment, evaluation, mitigation)

Planning

Approval

2. Contract Arrangement

Definition of Procurement Spec. & Statement of Work

RFQ, negotiation

Contract preparation and signature


3. Implementation & Contract Management

Appointment of Programme Managers

Progressive implementation of activities (SOW)

Contract Management ( monitoring, reporting, measurement of performances,

change and rejection management, etc.)

4. Supplier Development & Continuous Improvement Plans

To increase efficiency, effectiveness of relationshipTo promote product innovation


Key Points to consider for Outsourcing Plans

a. Do the parts/processes to be outsourced contain:

New company proprietary technologies?Technologies existing in public domain?

Core competencies (fresh solutions) kept inside, not recent findings can be transferred to partners

Even if covered by confidentiality agreements risk of disclosure exists!

Task of buying company is to innovate, not to protect obsolete solutions!


b. Technical configuration frozen?

if not, do not outsource!

c. A few months delay is within the norm!

Do not outsource parts whose delivery date is mandatory!

Second source is always recommended

If you delocate single source, double the inventory and carefully monitor major

vendor activities


d. Real saving always lower than expectations

e. Benefits of Partnerships strongly reduced after 8-12 year time of collaboration


Outsourcing Risks / Obstacles Research CAPS ATKEARNEY 2004

loss of control 72%

protection of intellectual property 68%

company policy/philosophy 53%

inadequate business case 42%

dependency on supplier (concern) 38%

labor/community reaction (concern) 36%

loss of critical capability 32%

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