In my first post, I summarized some of the fascinating insights to come out of MFG.com‘s James Jin and Mitch Free on the current hullaballoo about China, and the recent VAT rebate reductions and cancellations in particular. In this post, I’m going to discuss some of the great tips that were provided by Lisa Reisman of Aptium Global on how to properly assess and manage not only your China Sourcing, but low cost country sourcing projects in general.
Lisa Reisman started by explaining that a number of different factors impacted your China price. These factors, most of which are common to most Low-Cost Country Sourcing Destinations, include:
- raw material costs
- value-add services
- currency fluctuations and exchange rates
- export tariffs
- VAT and rebate rates
- packaging costs
- inland freight costs
- outbound ocean freight and air freight costs
The current situation with China is that multiple cost elements are increasing at the same time: raw material costs are consistently rising (as China consumes more and more raw materials for its own uses), exchange rates are falling with the weakening US dollar, China is under pressure to increase the value of its currency – further decreasing the favorable exchange US business are used to, and the VAT has been slashed or removed on over 37% of the total classifications.
The degree to which you are impacted ultimately depends on what savings percentage you are currently getting on the products you are sourcing, whether it’s in the low 10% range, the medium 10% to 20% range, or the high 20% + range, and whether or not the products you are buying are value-add. If you’re in the high savings range, chances are you’re not going to be impacted much, if at all, by the recent VAT rebate reductions and eliminations and don’t have much to worry about. The same holds true if you are in the medium savings range and are sourcing value-add products, which were not impacted by the recent cuts since China is trying to push those exports. But if you were in the low-savings range (which made sourcing to China a questionable decision in the first place), and especially if you were buying products with little or no value-add, chances are that you have been impacted by the recent VAT rebate reductions and eliminations, since those products with minimal value-add and those products very near to a raw material state have been hardest hit and, recently, have provided low savings opportunities.
What should you do? The first thing you should do is assess the impact of the recent changes (VAT rebate reductions and eliminations, rising material prices, weakened exchange rate) on your total landed cost, and, if necessary, your total cost of ownership. If the impact is significant, or significant enough to reduce your savings to the low end of the spectrum, then you need to consider reducing your risk by identifying other alternate sources of supply, including domestic sources and nearby sources. If global is the way to go, start thinking about Vietnam and India. It might also be time to start considering Mexico and Latin American sources of supply again.
If you’ve been moderately hit, for example, instead of saving over 20%, you’re now saving only 10% to 15%, then, if you’re buying from a trading company or importer, and your volume is significant enough, it might be time to consider a direct relationship or a new source of supply in China that would allow you to take advantage of a direct relationship.
Basically, if you’re sourcing those products that are a good fit for LCCS, you might be okay, but you should still review your landed cost model. In general, a product is a “good fit” for LCCS if there is significant volume, the product can be made with (a mix of) unskilled and / or semi-skilled labor, production is regular and repetitive, technology sophistication can be leveraged, there are infrequent design and tool changes, the IP is not highly sensitive, the content is mostly (available) raw materials, JIT delivery is not required, and quality requirements are not unduly high.
And when you’re considering sourcing from China in particular, you need to take the following considerations into account:
- China public policy is a form of political risk (tariffs, duties, rebates, etc.)
- Currency risks need to be considered (weakening US dollar, increasing pressure on China to raise the value of the Yuan)
- Security risk
- Supplier Capabilities (especially on the quality side – some are great, but as the recent recall scares in North America have proven, some are not)
- Shipping & Logistics Costs (especially from inland suppliers)
- Supplier Stability & Volatility (some suppliers are hit hard by the recent VAT rebate reductions and eliminations)
Lisa’s analysis and advice concluded with the following:
- If you don’t have a detailed TCO (Total Cost of Ownership) model, which includes a detailed landed cost model, develop one.
- Consider dual-source vs. sole source strategies – especially for low(er) cost categories.
- Near-shoring (e.g. Mexico) is another viable option and can help ensure steady supply.
- Supplier identification and qualification remain key activities – consider this carefully when looking at new countries.
- Don’t let the hullabaloo get to you and rush to leave China. If your parts are (high) value add, you could still be doing quite well. Update your total cost model and price alternatives first before making hasty decisions. Remember the findings of the MFG.com survey we summarized in our last post, only 26% of IPO’s (International Purchasing Organizations) are expecting purchase prices to increase by over 5% and only 18% of suppliers are expecting to need to increase purchase prices by over 5% as a result of the current VAT rebate reductions and eliminations.
Note that Lisa also participated in Spend Matters‘ The China Sourcing Controversy series with her post Has the China Balloon Popped?, wrote a guest post on Maximizing the Savings Potential of Global Sourcing Strategies back in April here on Sourcing Innovation, and also wrote a post on Quantifying Quality in Lean Sourcing Initiatives back in January here on Sourcing Innovation that also has some relevance.
Finally, as I mentioned in my last post, MFG.com is launching a learning center on the issue this week at http://www.mfg.com/chinasourcing that will include an archived version of the webinar, additional information on the recent MFG.com poll, questions and answers to all webinar questions (including the many that they didn’t get to), and a slew of executive briefs on the relative issues with more to come as time goes on.