Low-Cost Country Sourcing: It's More Complex Than You May Think
The far- and near-shore sourcing of goods and services from countries with lower cost bases is clearly a hot topic - understandably so, with possible long-term savings of 10% to 15%. Expectations are usually much higher than this because initial savings provide misleading gains. But with many costs are hidden, it's important to take a long-term view.
The Bottom Line
Far- and near-shore sourcing is substantially more complex than sourcing locally. Don't attempt it without adequate technological support and process control.
What It Means
Companies in the UK, United States, and most other countries in the West are increasingly looking to outsource product and services to save costs and improve performance. LCCS, or Low-Cost Country Sourcing (not the Lotus Car Club of Sweden), is likely to be heard much in 2005 as companies seek to learn when, where, and how to capitalise on low labour and supply costs from East and Southeast Asia, Eastern Europe, and South America.
However, outsourcing to geographically distant countries has introduced some of the following difficulties:
- Communication problems, caused by radically different time zones, can reduce supply network visibility and the closeness of the working relationship, thus seriously hampering an effective Demand-Driven Supply Network (DDSN) approach.
- Clients, engineers, and project managers find it expensive and time consuming to travel the long distances to development centres outside Europe. The costs of doing so often negate the benefits of outsourcing.
- It's costly and time consuming to set up an international sourcing office, plus it takes three months to get new suppliers up and running effectively.
- Cultural and language differences are still a barrier to success. Misunderstandings can prove expensive, although cultural differences are generally less pronounced with near-shore locations.
- Political instability is a very real concern with some far- and near-shore locations, and alignment with local and European Union (EU) law can be complex. UK and EU law favours dealing with EU and EU accession countries, whilst U.S. law favours near-shore sourcing.
- Skills availability and consistency can also present problems with far- or near-shore sourcing.
Case Study No. 1: Best Buy
Like any solid marriage, sourcing ventures should not be taken in hand, unadvisedly, lightly, or wantonly, but rather reverently, discreetly, advisedly, soberly, and with adequate IT support-whilst not necessarily forsaking all other. Using sourcing systems can overcome or mitigate many of the risks associated with the issues mentioned above.
When Best Buy started dealing with offices in China (Shanghai), it was certainly hampered by a 13-hour time difference (7,000 miles), especially for its own label products. Here, a team of 30 acts as the vital link between Best Buy's merchandisers and buyers back in Minneapolis, Minnesota and dozens of outlying Chinese factories.
Using a system provided by Eqos, the Eqos Platform, Best Buy reports saving a full man-day, every day, through increased information visibility, plus several hours each week through the use of Eqos' bid analysis. The system took just 17 weeks to go live. Important to its success is the scalability that it affords. Best Buy is currently undergoing a 20-fold increase in activity, without a significant increase in head count. While Best Buy won't release the amount, the increase was significant and proves that this is no pilot. Just because a country offers low-cost labour, companies should still be prudent when it comes to the number they employ. Throwing bodies at a problem in order to handle scale is not the answer. Plus, excessive direct labour can decrease flexibility and increase risk. So, an important point to look for in any IT provider is its ability to prove scalability.
Case Study No. 2: United Technologies
Another issue is determining which products or services to right-source and to where. This is where companies need domain expertise and experience. The problem facing United Technologies (UTC) was a bit unusual:
A truly global business, UTC is a $31B company that provides products to the Aerospace and Building Systems industries worldwide through its many companies, including Carrier, Otis, and Sikorsky. The aim was to sustain lower operating costs by replacing the supply of motors and related parts from European suppliers to local Russian suppliers. However, its local teams were not trained in Western sourcing methods. As a result, the company was facing high costs from importing motors and related parts from Europe. UTC engaged Ariba to provide the strategy assistance and local support to find sourcing savings and train its own people to be expert negotiators. Ariba doesn't simply have a product: Following its acquisition of FreeMarkets, it also gained localized domain expertise, allowing it to support the strategic analysis as well as the execution.
China alone presents interesting challenges for those seeking savings
There are three company maturity levels in China:
- High - Highly developed, often large and international, these suppliers have strong manufacturing processes and communication abilities, but savings are the lowest.
- Medium - These companies tend to be nationally based within China and can offer better savings, but risks are higher because their infrastructure is not as mature.
- Low - The least developed companies offer the highest savings opportunity, but they tend to be locally run and lack good communication skills. They are also the most illiterate in terms of Western culture and sourcing styles. Therefore, risks are high. It's much like sourcing in the UK, but with much higher risk and challenges.
Conclusion
As companies begin the transition to sourcing more complex products and services from far- and near-shore locations, many Asian countries are starting to experience capacity constraints in the race to meet demand. In China especially, salaries for professionals are reported to be increasing by 10% every six months. So, sourcing from one location today does not mean that you can continue to do so later on. Another issue is that low-cost sourcing has not been owned within a company. Only now is there a glimmer that some companies are creating a new senior role responsible solely for offshore supply. This has got to help vendors such as Ariba and Eqos, which right now spend too much time educating customers. Eqos, meanwhile, is a relatively small company without the resources to market itself as loudly as other vendors. Nevertheless, customers such as Best Buy are a testament to the value that can be derived from such systems. Plus, reference selling is certainly the cheapest form of marketing.
Ariba, on the other hand, has another problem. The Ariba brand name is unquestionably the most well known in the sourcing field, but the company has previously been seen as a product company. Few customers would have approached Ariba for strategic and operational services assistance. It must alter this brand perception, possibly by creating another division under the Ariba brand name.
Despite all the questions, one thing is for sure: LCCS will linger for some time.
Thursday, 23 December 2004
