A Shift in Sourcing Strategies
Mary Siegfried is a senior writer for Inside Supply Management®
March 2013, Inside Supply Management® Vol. 24, No. 2, page 26
Supply management organizations are moving from a low-cost-country strategy to a best sourcing plan that focuses on value, total cost of ownership and a changing world.
Years ago, supply management professionals turned to low-cost countries to manufacture products, establish services operations and source materials in an effort to improve the bottom line for their companies. They found that inexpensive labor in India, China and emerging Asian countries made this new low-cost-country strategy successful — despite requiring the management of lengthy, complex supply chains.
Then the world began to change. Energy prices skyrocketed, risks from unforeseen natural disasters and political upheavals soared, and intellectual property protection posed greater challenges than first thought. Suddenly the quest for cheap labor was not always translating into cost savings.
Supply management professionals agree that a low-cost-country sourcing strategy has lost some of its luster. While low labor costs and prices will always be part of a sourcing strategy, they no longer are the centerpiece. Today's best-practice supply management leaders are developing sourcing strategies built on a foundation of value creation, total cost of ownership (TCO), landed cost analysis and risk management. Many call it a best-sourcing strategy.
A Wake-Up Call
Low-cost-country sourcing became popular decades ago, but many supply managers found it to be a short-term strategy, says Thomas L. Tanel, C.P.M., president and CEO of CATTAN Services Group, Inc. in College Station, Texas. Now supply management professionals are turning to best sourcing, which Tanel says also is referred to as best-country sourcing or value-country sourcing.
The change came about as supply management organizations began to consider the hidden costs associated with sourcing around the globe. As all the factors that make up a TCO analysis were considered, supply chain leaders "received a wake-up call," Tanel notes. Those factors include intellectual property protection, quality, intermodal freight costs, shipping costs, custom and brokerage fees, and inventory investment costs, to name a few.
Best sourcing is an evolving concept without a specific definition because it is multifaceted. However, supply management professionals point to several aspects that comprise best sourcing:
- It requires a supply management organization to be responsive and flexible to respond to changes in its supply chain and in the world.
- It requires a supply management organization to be a core function in the company.
- Its goal is to create value for the company, stepping back from a low-price focus for goods or services.
- It is rooted in TCO, landed cost analyses and a robust risk management program.
- It is not a one-time event. It's an evolutionary process that currently is taking hold in many organizations and will continue to grow and change in the future.
Responsive and Flexible
For a best-sourcing strategy to work, a supply management organization needs to be responsive and flexible, says Brian Schulties, C.P.M., vice president of procurement for Prysmian Group in Lexington, South Carolina. "What it comes down to is constantly reviewing our supply strategy because of shifting global dynamics," he says. "At one point, we had to decide if we were going to place our future in low-cost countries, and the answer was no."
That doesn't mean low-cost countries are not part of Prysmian's sourcing strategy; it means the organization searches the world for the best place to manufacture and source — and that means making adjustments to meet the demands of a changing world. Based in Milan, Italy, Prysmian is a leader in energy and telecommunications cables and systems, with 97 plants worldwide, including 11 in North America. The company uses many petroleum-based products for its wire and cable production, and Schulties only has to look at recent changes in the energy market to demonstrate the importance of responsiveness in best sourcing.
The marketplace and supply base are shifting for PVC, polyethylene and other compounds used in the production of wire and cable, he explains. "The North American market has become the second most competitive place in the world outside of the Middle East," Schulties says. "We are seeing major investments from our suppliers in North America, which are building plants to manufacture polyethylene products, using resources here because natural gas is inexpensive. There is real opportunity now in the domestic energy market."
Because of his organization's emphasis on best sourcing, Schulties says it is able to seize that opportunity by adjusting its sourcing strategy. He says a sourcing shift for petroleum-based products is occurring now and will continue over the next couple of years as the North American energy market matures.
"We can make those strategy changes and decisions quickly because we have the latitude to do so," he explains. Procurement at Prysmian is organizing uniformly throughout the world, whether it's in Russia, Spain, France, North America or any of the other Prysmian plant locations. He says that allows for a flow of information and visibility around the globe that makes supply management "fast and flexible."
Designing a Core Function
Best-sourcing practices are driven by top-line revenue growth, bottom-line earnings and a company's short-term and long-term business plans, says Mark Berlin, vice president of global procurement and supply chain for OSI-Rapiscan in Torrance, California, a global supplier of security inspection systems. But before a supply management organization can develop a best-sourcing strategy, Berlin says it must be viewed as a core function.
"For best sourcing to work, supply management leaders must assess their own organization, identify spend that is not under procurement's control, understand marketing and manufacturing strategies, and then make the argument that supply chain is not merely a support organization," he explains.
"For procurement and supply chain to be effective, input from cross-functional groups is critical for speed to market, cost control, earnings and top-line growth," Berlin adds. "Supply management teams need to meet with cross-functional partners to understand the business requirements, as well as understand supplier objectives before developing and implementing a supply strategy. Seek to understand, focus on process, cost and revenue. Communication is constant and frequent."
Focus on Value Creation
A key element of best sourcing is creating value for the company. As low-cost-country sourcing comes under greater scrutiny, supply management professionals began looking at sourcing from a more strategic viewpoint.
"An organization might have manufacturing operations in Asia because the company needs to be closer to the Asian marketplace. That creates value," Tanel says. He adds that there are many ways a best-sourcing strategy creates value, such as shorter lead times and fewer quality problems. "For example, having inspectors at your receiving dock doesn't create value," he points out. "Having inspectors at your shipping dock — where they can do some good — creates value."
Schulties agrees, saying as Prysmian has grown, his organization has centered more on productivity, process ability in its plants and product innovation. "These are all part of our value chain and are elements you don't get in a low-cost-country strategy. I talk about value all the time because that is what we pride ourselves in, not just purchase price."
Tanel recalls working with a company that had moved some manufacturing to India but ran into logistics problems. "The vice president of logistics had to tell the CEO that all the gains the company made in its low-cost-country strategy in the first five months had been wiped out because they had to ship parts to India by air to keep the plants running." He asks, "So what value had they really created?"
While many companies considered certain aspects of TCO, often it wasn't until a problem arose that they realized many factors, such as value creation, were being overlooked.
TCO, Landed Cost Analysis
To develop a best-sourcing strategy, supply management professionals say organizations must be able to understand all the costs that make up a product or service. And most admit it's not easy to do. "It takes time and can be costly itself to really capture all the data that needs to be captured. Some companies don't have the ability to plug in those numbers or the accounting software to evaluate them," Tanel says.
Most supply management organizations are aware of the need to evaluate costs such as transportation and customs fees, but other key cost factors can be harder to pin down, says Berlin. "However, you need to consider the cost of quality; the cost of servicing warranties; travel involved in the engineering, design and development of a product; the product launch; and the quality challenges throughout," he says. "A TCO analysis is important whether operations are domestic or overseas."
Schulties looks back on his years in the automotive industry during the time when low-cost-country sourcing was taking hold. He saw issues with quality, increased lead times and inventory costs. "Those hidden costs were not initially understood," he notes. "I might have saved 20 percent to 25 percent on production costs but the 'unknowns' turned out to be 15 percent of that 25 percent."
Berlin points to a situation from a previous employer where the organization was involved with evaluating a best-sourcing decision. He explains the company had a product originally manufactured and designed for the overseas market. The product was then sold in the U.S. and a domestic build strategy was developed because of an increase in orders within the United States.
"When we had production capability in the U.S. and volumes were lower abroad, we looked at whether we could be more competitive producing the product in the U.S. and shipping it overseas," he explains. Key components of the evaluation were the cost of custom packaging, less-than-carload (shipments less than the amount required to be eligible for carload rates) and premium costs for freight on oversized product. A total landed costs savings of 15 percent was achieved by bringing manufacturing back to the U.S. "Those are just of some of the elements we had to evaluate. It's why TCO and landed cost modeling are critical when making a best- sourcing decision," he says.
An Evolving Strategy
Best-sourcing decisions, of course, also have to take into consideration risk throughout the supply chain, Tanel says. "There are too many hot spots around the world, and it doesn't take much to disrupt your supply chain," he says. "Supply management professionals must understand the costs and impacts of risk in their supply chain. It involves sitting down and going through scenarios by questioning, 'If X happens, what do we do and how can we handle it?'"
Schulties says the evaluation of risk in a best-sourcing strategy is proof that it's a strategy that is constantly evolving. "Global dynamics continue to change and that could change your strategy," he explains. A strategy that fits today might not fit two years from now.
"I've been doing this (supply management) for 26 years," he says. "I probably have another 15 years to go, and I will probably change strategies seven times, as global market dynamics require."
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