The secrets of successful low-costcountry

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2 Supply Chain Management The secrets of successful low-costcountry sourcing By Kris Timmermans For many industries, the proportion of overall procurement needs sourced from low-cost countries will double within five years. But it s a complex technique, demanding great flexibility and a careful balancing of often competing interests within a company. Here are some successful strategies. Valeo, a leading French automotive equipment supplier, recently announced plans to source a whopping 70 percent of its procurement expenditures in low-cost countries by 0. And although that percentage may be exceptional, an Accenture survey, conducted in August 004, suggests that during the next three years, the proportion of overall procurement spending that is sourced from low-cost countries will double for some industries, including auto, communications and high tech, and retail and consumer goods (see sidebar, page ). The accelerating trend toward increased sourcing of materials and components from outside home markets is being fueled chiefly by the relentless competitive pressures that are driving companies in a wide range of industries to figure out ways to continue to reduce costs. Since most manufacturing companies spend much more than half of their revenues on purchases of parts and materials, low-cost-country sourcing or LCCS plainly makes sense. But successful LCCS is not a straightforward proposition. It involves a careful balancing of often competing interests within a company and demands great flexibility. The experience of one global heavy-equipment maker is instructive. Although saving money was clearly the company s primary objective, quality of product and reliability of supply were also key considerations. And in the years or so since the company embraced low-cost-country sourcing, it has managed to find all three. Sourcing from lowcost countries has cut expenses by about percent on most procurement projects that take the LCCS approach. LCCS now accounts for some 8 percent of the company s procurement expenditures this is expected to rise to between 0 percent and 30 percent by 008. This ambitious goal, moreover, reflects a vote of confidence in low-cost countries as future manufacturing hubs. Explains the company s European sourcing manager: We believe that over time, as markets develop, we should be serving low-cost countries from low-cost countries. We want both to lower costs and to develop a local procurement base from which we can source locally. A decade of experience has taught this company a critical lesson: It s absolutely essential that LCCS be made a core part of the overall corporate strategy. An opportunistic approach might be sufficient,

3 Supply Chain Management Avoid overselling the capabilities of any one country to the buying teams at headquarters. according to the sourcing manager, but a structured approach will deliver more sustainable results. Once a company has decided which parts of its business are best suited to low-cost-country sourcing, it needs to choose either a near-shore or a far-shore supplier a choice dependent on the careful consideration of cost, logistics and quality. In general, a company will not find everything it needs in one place. For example, suppliers in Eastern Europe now send highquality components to the equipment maker s plants in several locations on an almost daily basis. It s a similar story with machine parts from China. The company sources most of its steel from Russia. Flexibility is also important. You might be looking for a supplier for component X but turn up a better one for component Y, continues the sourcing chief. But don t do industrial tourism you can search forever if you don t know what you re looking for. A structured, strategic approach should probably also involve existing suppliers. For example, say a company buys motors from a multinational with a manufacturing base in India. That company might ask the manufacturer to source its products from there, which could reduce costs for both parties as well as divide the burden of developing sources. It would also save the company from having to go to India to look for a new supplier of its own. Not that a company doing LCCS shouldn t do plenty of its own spadework. For instance, the equipment maker in our example has a 40-strong, largely Chinese procurement team in China. What s more, the sourcing manager is a strong believer in working with local staff. It s not just a question of culture and language, he explains: These are people with a strong local network who are in tune with local market conditions. In these kinds of relationships, there is the potential for conflicts between local employees, who want materials and components to be purchased from local suppliers, and the buyers back at headquarters, who may have other priorities when making purchasing decisions. Indeed, such conflicting objectives can be one of the biggest problems associated with LCCS. In fact, the total alignment of objectives probably isn t possible. But the European sourcing chief is relatively sanguine: By setting high targets and ambitious goals, there s less disappointment overall when some of them aren t met. And if a company takes care not to oversell the capabilities of any particular country to buying teams at headquarters, that, too, can help. The key factor, though, is to preserve what this executive calls the reactivity of your supply chain. To achieve the best overall supply chain performance, his company constantly monitors the critical balance between cost, logistics and quality. That balance may change, altering the relationship between commodities sourced from near-shore and far-shore suppliers, for instance. It s critical to be clear upfront with suppliers about your expectations. And although the manager admits 4

4 The Accenture LCC Prioritization Tool The graphic below charts the sourcing experiences of the global equipment manufacturer mentioned in the main story. The matrix helped the company prioritize what categories of spending or segments it should source from a low-cost country by asking two questions: What benefit will I get if I move this to a low-cost country? and What risks will be involved? Any segment in the upper right quadrant has high benefit potential and low risk. To create the matrix, each segment is scored based on both its potential benefits and risks. For example, the overall benefit number for one specific segment is the weighted average of this segment against five criteria, such as the total spent in high-cost countries or the total cost per kilogram. The segments that were already sourced from a low-cost country are represented in yellow. The bigger the segment, the bigger the circle. Parameters selection Benefit potential Risks Criteria Criteria Complexity of parts Total spent with HCC % Total cost per KG % Factory cost content Labor costs Energy Complexity of parts 3% Risk with current suppliers 1% Raw material specs Quality criticality Technical issues Factor cost content 3% Supplier switching costs 1% Raw material Transport Coefficient of variation % Total cost of ownership 30% Total cost of ownership Type of local Current LCC suppliers 1% Supplier switching costs Supplier qualification Part lifecycle status 1% logistics process Number of lead time receiving facilities Tooling costs Demand fluctuation High HCC supplier segment LCC supplier segment Segment 4 Segment 3 Segment 1 Segment 13 Benefit potential Segment 18 Segment 11 Segment Segment 7 Segment 1 Segment Segment 17 Segment 8 Segment 1 Segment Segment Segment Low 0 Segment 9 High 0 Low Risk Outlook 00, Number

5 Supply Chain Management Where East Meets West The title of Accenture s August 004 survey of low-cost-country sourcing (LCCS) Where East Meets West is no accident. For most of the 38 senior global procurement executives in countries who were surveyed, Asia especially China is regarded as the primary source market. China s pride of place is scarcely surprising, considering the country s astonishingly low labor costs and the fact that these days you can source just about anything from the People s Republic. However, European and American companies differ in their choice of secondary supply markets, and for compelling reasons. Both follow a strategy of sourcing from near-shore, low-cost countries, ideally within the same economic zone. Thus, Europeans prefer Eastern European countries like the Czech Republic, Poland and Hungary, from which they source mainly components and raw materials. Americans favor Central and South America as secondary supply markets for a broad range of goods. The exception is India, which, despite its distance from the United States, is one of the three most important LCCS options for percent of American respondents. This may reflect India s considerable reputation for delivering high-quality technology and commercial services although it s noteworthy that respondents still rate India below China in terms of cost, product quality and delivery reliability. The survey also revealed that companies expect the savings they achieve from low-cost-country sourcing to increase by 37 percent during the next three years, as the auto, communications and high-tech, retail and consumer products, and resources industries roughly double their LCCS spending a ringing endorsement of the practice. Successful LCCS, however, is a tricky business. The range of goods sourced from low-cost countries is wide, but survey respondents indicated a constant trade-off between price, logistics and risk. Most respondents expressed concern about the risks associated with reliability of supply, product quality and the caliber of day-to-day management in low-cost countries. And concerns about security risks ranked high, especially in Russia, Argentina, Ukraine and Africa. The more LCCS experience companies had, however, the more optimistic they were about managing these risks. that the company hasn t always done so successfully the equipment maker has experienced disappointments and frustrations with some of its low-cost suppliers maintaining supply chain flexibility has nonetheless proved to be essential. In practical terms, supply chain flexibility can also mean keeping sufficient stock in warehouses close to manufacturing facilities so that the company can react to the vagaries of demand even if, ideally, you want no more than a week of inventory. The equipment maker does this in China, for instance, where it has a large manufacturing facility and dozens of local suppliers. LCCS may sometimes actually seem to be adding to costs rather than reducing them. So the support and understanding of top management is clearly crucial. LCCS can bring huge rewards, but as this supply chain executive cautions, It s a long journey. About the author Kris Timmermans, a partner in the Accenture Supply Chain Management service line, leads the company s European Sourcing and Procurement practice. With more than years experience, Mr. Timmermans has worked with clients on a large number of supply chain transformation projects across a broad range of industry groups. He is based in Brussels. kris.timmermans@accenture.com

6 Supply Chain Management II Low-cost-country sourcing by the numbers The charts below are based on research Accenture conducted in August 004 a survey of 38 senior procurement executives from Europe and the United States in a wide range of industries. Respondents were asked about what they sourced from low-cost countries, where the sourcing took place, what risks were involved and how low-cost-country sourcing influenced the procurement process. Cost reduction is the strongest motivation for low-cost-country sourcing. What are the drivers for launching a low-cost-country sourcing initiative? (1 = very low; = very high) Level of importance To lower costs 4.7 To comply with local content rules 3.4 To gain access to alternate/ backup sources of supply 3.4 To meet our company's capacity requirements 3.4 To respond to a customer's demand to locate close to its manufacturing facilities 3.3 Access to higher-quality goods and services.9 Outlook 00, Number 7

7 Supply Chain Management II All industry sectors expect to increase the level of spending within low-cost countries. The communications and high tech sector should see the greatest increase in savings. Low-cost-country spending as a percentage of total procurement spending Automotive 18% 3% Automotive 1% 19% Communications and high tech Communications and high tech 4 Retail and consumer products 1 7 Retail and consumer products 17 3 Industrial 8 0 Industrial 18 Resources 4 Resources 1 19 Government and public sector 13 Government and public sector 13 0 Transportation and travel services 13 Transportation and travel services 1 18 Finance and insurance 3 Finance and insurance 0 1 Pharmaceuticals and health services Pharmaceuticals and health services 1 19 Spending today Spending in three years Savings today Savings in three years Components and parts are the most frequently sourced commodities from low-cost countries. Most important goods by category Percent of total responses for top three most important goods Nonferrous, semi-manufactures 0% Commercial services Industrial machinery and equipment Raw materials, fuels Technology 11 Consumer durables 9 Metals and mining Automobiles and components Electrical equipment Chemicals and pharmaceuticals

8 European and American companies exhibit different preferences in what they source from low-cost countries. Most important goods by category and geography Percentage of total responses for top most important goods Nonferrous, semi-manufactures % 0% North America EU Industrial machinery and equipment Raw materials, fuels Commercial services Technology 11 1 Consumer durables 8 9 Automobiles and components Metals and mining 8 Chemicals and pharmaceuticals 3 Electrical equipment 7 Successful companies use multiple buying channels. China is the preferred low-cost country source, with nearshore locations currently forming a significant second tier. Percent of companies executing low-cost-country sourcing strategy Direct purchase 8% Weighted preferences of top three low-cost countries* (Percentage of respondents in top three low-cost countries) Local agents 3 Brazil, 8% Local sales office 3 Own international procurement office Third-party international procurement office Other 4 1 Argentina, 9 Mexico, India, China, 3 Hungary, % Poland, Czech Republic, China, 19 USA EU * Weighting based on first-, second- and third-choice selection where second and third choices had half and one-third ratings, respectively.

9 Supply Chain Management II China and Eastern Europe are the growth hot spots for low-cost-country sourcing. Percentage of respondents sourcing in low-cost countries today and planning to source there in three years Total procurement spending by region (in percent) Eastern Europe China % 33% National/home country Africa and Middle East North America 8 3% 4% Latin America 1 South and Central America 4 South and Central Asia Western Europe 0 18 Eastern Asia Africa and Middle East 7 Eastern Europe South and Central Asia Eastern Asia Other Today In three years Japan 4 4 Total today In three years The United States buys primarily consumer durables, technology and services from China; the European Union buys raw materials and fuel, which are more old economy items. China, India and Eastern Europe are best performing in terms of quality and delivery reliability. Percentage of respondents ranking countries their best and worst three low-cost countries by quality, cost and delivery reliability (weighted) Percentage of participants sourcing their top three product categories from China -1.3% Russia Consumer durables 13% 8% -9.3 Argentina Technology Commercial services Nonferrous, semi-manufactures Chemicals and pharmaceuticals Raw materials, fuels Industrial machinery and equipment Metals and mining India Poland Hungary Czech Republic Ukraine North African countries South Africa Automobiles and components Electrical equipment 1 United States European Union China %

10 Low-cost-country sourcing delivers reductions in total costs, though sometimes at the expense of other factors, particularly lead time and innovation. Satisfaction with results of low-cost-country sourcing program Share of respondents by percent (neutral positions not shown) Total cost 1 8% Satisfaction Dissatisfaction Quality 9 40 Delivery reliability 33 Lead time 4 1 Product innovation 48 Low-cost-country sourcing is not without risks, but these are reduced with experience; companies that do low-cost-country sourcing have much lower concerns about a range of issues. Key concerns about low-cost-country sourcing Security and safety Do LCC sourcing Plan to do LCC sourcing Will not do LCC sourcing Cultural differences Geopolitical risk Local proximity to suppliers Internal resistance to change sources of supply Increasing transition costs Day-to-day management Reliability of supply Quality of sourced products Identification of suitable vendors Level of concern