Monthly Archives: July 2007

Surviving China’s Rapidly Changing Sourcing Tides: Part II

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 (now of MetalMiner) 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 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.

* All posts prior to 2012 were removed in the Spend Matters site refresh in June, 2023.

JLP Responsible Sourcing Part V: Discipline

In our last post, we discussed the issues of health, safety, and hygiene and the hazards you need to look out for, corresponding to section D of the report.

In today’s post, we cover section E of The John Lewis Partnership‘s “Responsible Sourcing Supplier Workbook” which covers discipline.

Discipline refers to the treatment of workers and the issue here is whether or not they are treated fairly and with respect. Unacceptable discipline ranges from verbal abuse, shouting and threat of abuse through bullying and illegal fines all the way to sexual harassment and abuse, beatings, and humiliating punishments.

Why is this an issue? Research by the John Lewis Partnership has discovered the following facts:

  • a sexual harassment study in commercial agriculture and textile manufacturing in Kenya found that over 90% of respondents had experienced or observed sexual abuse and 95% of women who had suffered abuse were afraid to report the problem for fear of losing their jobs
  • workers in England and Wales experienced an estimated 849,000 incidents of violence in 2002/2003
  • workplace bullying contributes to an estimated loss of 18 million working days every year in the UK as victims of workplace bullying take an average of seven additional days off per year

In order to prevent discipline-related issues, as an employer, you need to ensure that:

  • no worker is subject to, or threatened with, physical, sexual, or verbal abuse
  • managers, supervisors, and line-leaders do not use any kind of harassment, bullying, or intimidation
  • fines are not used as a disciplinary measure
  • disciplinary policies and procedures are transparent, applied equally to all employers, and effectively communicated to all workers in their language
  • there is a formal grievance procedure in place
  • managers and supervisors understand the disciplinary procedures
  • records are kept on disciplinary and grievance actions
  • dismissals are only on legal grounds
  • positive incentives are in place to promote good behavior

In our next post, we’ll tackle the fifth major issue addressed by the workbook, freedom of association and employee representation. (You can access all of the posts in the series (to-date) by selecting the JLP category at any time.)

Supply Chain Humor This Week I

Extra! Extra! Read all about it! The Talent Crunch impacts Supply Quality Down Under!
Durex, hard on it’s luck, had to put out an open advertisement to find qualified product testers for its leading brands of condoms. I kinda thought that was a job every college guy wanted. Guess it’s just the North American college guy’s dream …

Hat Tip: Tony Poshek, aka The Cynical Sorcerer

What? Those Things Need Power?

The One-Laptop-Per-Child (OLPC) program screwed up big-time in its latest gift of 300 laptops to a Nigerian school – one per pupil – when they failed to investigate whether or not the school had any power to run, or even charge, them. And they say China has issues…

Hat Tip: Tony Poshek, aka The Cynical Sorcerer

Canada Loses Out On The Spice Trade Again

The Spice Girls are back and are performing at least 11 shows spread over five continents, but despite three US performances, there is not one performance in Canada – not even Toronto or Vancouver! When the spice trade is involved, we never win. But at least fellow blogger Doug Hudgeon of Vendor Management (renamed Contract Capital Management [WayBackMachine]) will get a chance to see them in Sydney on January 12, 2008. After all, according to Yahoo Music, they aren’t really much different than The Dandy Warhols.

Surviving China’s Rapidly Changing Sourcing Tides: Part I

About an hour ago, the webinar by the same name, hosted by MFG.com and Aptium Global, and moderated by none other than Spend Matters own Jason Busch, wrapped up. This webinar had some fascinating insights into the current state of China sourcing, which has many people in a frenzy due to the massive VAT rebate changes that went into affect on July 1.

The current hullabaloo is due to the fact that on July 1, China cancelled VAT rebates on approximately 553 products, reduce the VAT rebates on approximately 2,268 products, and only exempted VAT charges on about 10 products. In other words, about 37% of the total classifications have had the VAT rebates slashed or eliminated. The VAT rebates were created in the 90’s at a time when exports were low to support growth in the export economy. However, now that there is a huge trade surplus with many trading nations, especially with the US ( to the order of 14 B ) China apparently wants to rectify the situation. Typically, Chinese companies are supposed to pay 17% VAT when they sell a product. Until recently, the VAT rebates drastically reduced (or eliminated) this tax on exports – but now that they are being eliminated, some products could end up costing you 17% more.

According to James Jin, the head of the MFG.com Shanghai office, the purpose of the VAT Refund Change is to reduce the trade surplus, eliminate high energy consuming & resource intensive exports, avoid products triggering trade functions, and give China more spending power. As a result, there are will be increased export prices on lower value add products such as fasteners, extrusions, etc; serious financial pressures on Small and Medium enterprises in China with low margins, especially going through trading agents, and some of them will likely go out of business; and increased opportunities for imports into a growing, and opening, Chinese markets. In the short term, the rebates cause quite a panic among those suppliers being negatively impacted who caused major traffic jams during the last through days of June trying to get their products out of the country before the VAT changes came into affect.

However, according to a recent survey conducted by the MFG.com China team, it looks like things aren’t all that bad. The Shanghai office conducted a poll of IPO (International Purchasing Organization) buyers on July 6 and received the following answers to the six questions presented:

  • What is the impact of the VAT reduction on your purchasing?
    Significant: 16%; Some 37%; Insignificant: 21%;
  • How much is the overall estimated purchase price increase?
    >5%: 26%; 3-5%: 11%; 0-3%: 21%;
  • How does material cost increase impact your China sourcing?
    Significant: 26%; Some: 26%; Insignificant: 32%;
  • What is the estimated price increase due to China material cost increases?
    > 5%: 22%; 2-5%: 33%; 0-2%: 17%;
  • What is your solution to the risk of increasing cost?
    Share Risks with Suppliers: 33%; Re-source in China: 22%;
    Switch to other Low Cost Countries: 19%; Maintain Pricing: 15%;
    Other: 11%;
  • What is your predicted sourcing trend for China in the long run?
    Increase: 79%; Decrease 11%; Unchanged: 5%;

In other-words, despite the fact that 53% of IPO respondents expect the VAT reductions to have some (negative) pricing impacts, with 37% expecting those price increases to be at least 3%, and despite the fact that 52% of IPO respondents expect material cost increases to also have (negative) pricing impacts, with 55% expecting those pricing increases to be at least 3%, 79% of respondents still expect to increase their China sourcing, with 55% planning to do so either by sharing risks with suppliers or re-sourcing to other in-country supply sources.

The MFG.com Shanghai office also polled the Chinese suppliers and found the following:

  • How does the VAT refund reduction impact your exports?
    Significant: 6%; Some: 29%; Insignificant: 29%; Not at all: 36%
  • How much of a price increase is likely to result from the VAT refund reductions?
    >5%: 18%; 2-5%: 12%; 0-2%: 0%; Not Sure: 18%; 0% – 52%
  • How are China material costs impacting exports?
    Significant: 32%; Some: 18%; Insignificant: 28%; Not at all: 18%; Unsure: 4%
  • What price increases could result from material costs??
    >5%: 14%; 2-5%: 30%; 0-2%: 5% 0%: 41%; Not Sure: 10%
  • How do the export cost increases impact competitiveness for the North American / European markets?
    Significant: 26%; Some: 11%; Insignificant: 32%; Not at all: 26%; Unsure: 5%;
  • If impacted, what is the solution? ?
    Increase Price: 43%; New Customers: 19%; Reduce Costs: 15%;
    Change Products: 4%; Other: 19%

In summary, 35% of responding suppliers believe that the VAT will impact their exports, with 30% expecting at least a 2% increase, but I’d suspect they are still more worried about material costs with 50% expecting material costs to have a (negative) impact on exports and 44% expecting the associated price increase to be at least 2%. Fortunately, only 37% believe their competitiveness will be affected and 57% are going to look for solutions that do not involve increasing price.

But, as pointed out by James, what is really important to note is that, despite the recent smear campaign (and despite the fact that since 2005, 431 Chinese-made goods have been recalled in Canada alone), many China suppliers consistently perform well and to high quality standards. For instance, MFG.com tracks ratings of all its suppliers, and 92% of China suppliers receive high or perfect ratings on quality, 96% of China suppliers receive good or excellent ratings on responsiveness, and 90% consistently deliver early or on time, giving them a rating of very good or excellent 72% of the time, and good or better 92% of the time. In other words, the vast majority care about the products they make and will work with you to correct any issues – but you have to manage them as you would your own plant and make sure quality materials, processes, and systems are being used.

Furthermore, as Mitch Free, founder of MFG.com, pointed out, the recent changes, despite the fact that they are a big deal and will continue to be a big deal, are not all bad news. First of all, they present an interesting opportunity for American Suppliers to bet aggressive and start to bring business back home. They will need to employ advanced technologies and a great strategy to do this, but that’s not a bad thing. Furthermore, he also points out that this will force Chinese suppliers to elevate to a higher level of technology to compete, especially on lower value-add products, and this is good for everyone! Mitch, in responding to a listener question, also pointed out that a higher-value finished goods economy, like the one that matured in Japan and Korea is undeniably coming, but that the question is, as always, when. Due to China’s sheer size, it’s likely to take a long time. It’s also up to the government, who appears to be in total control of their market with their power to control exports, give and take VAT rebates, alter the value of their currency, etc.

This was a great webinar, and Lisa Reisman also had some great insights on how to properly assess and manage your China sourcing and low-cost country sourcing in general, but that’s the subject of my next post.

In the mean time, I’d like to point out, as re-iterated many times by moderator Jason Busch, that MFG.com is launching a learning center next week to address all of the issues with China sourcing at http://www.mfg.com/chinasourcing and that this 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.

Until the MFG.com learning center goes on-line, you can read and re-read the Spend Matter’s* series on the subject in these posts:

  • Full Spend Matters Coverage: The China Sourcing Controversy by Jason Busch on July 5
  • Paris Hilton’s Dog Dead Due to Pet Food From China!!!! by Tony Poshek on July 5
  • China Sourcing: The Future Ain’t What it Used to Be (Post 1) by Lisa Reisman on July 6
  • China Sourcing: You Got ‘VAT? by Jason Busch on July 6
  • China Sourcing: The Future Ain’t What it Used to Be (Post 2) by Stuart Burns on July 6
  • China Sourcing: The Future Ain’t What it Used to Be (Post 3) by AJ Sweatt on July 6
  • China Sourcing: The Future Ain’t What it Used to Be (Post 4) by James Jin on July 6
  • China Sourcing: The Future Ain’t What it Used to Be (Post 5) by Jason Busch, Pat Furey, and David Morgenstern on July 9
  • China Sourcing: The Future Ain’t What it Used to Be (Post 6) by Paul Martyn on July 17
  • Anti-China Propaganda Canada Style by Jason Busch on July 10
  • A Last Minute Webinar: What’s Really Going on in China by Jason Busch on July 11
  • MFGx — The China Debate by Jason Busch on July 12

* All posts prior to 2012 were removed in the Spend Matters site refresh in June, 2023.

Outsourcing Insights from PricewaterhouseCoopers

PricewaterhouseCoopers (PWC) recently released the results of their March/April 2007 survey of 226 customers and 66 outsourcing service providers on outsourcing in their “Outsourcing Comes of Age” report. Although quite lengthy (over 20 pages), it does contain a few good insights. Furthermore, given the complexity of outsourcing, and the conflicting claims we continually hear in the press, it’s important that studies of this sort be produced regularly, as its hard to form a justified opinion off of magazine articles that only tell us about the experiences of one particular company or outsource service provider.

This is a confusing topic because there is research that indicates many outsourcing deals collapse before the contract ends (and sometimes even before the contract is signed!), due to rising costs, lack of materialized savings, and mistrust. And they are right – most deals, especially in the early days (for the company doing the outsourcing or the service providers), do at least partially fail. Some analysts are going so far as to suggest that outsourcing is in a death spiral and that organizations will soon become disillusioned with outsourcing. Then you have the group of influencers and media pundits tirelessly heralding lucrative outsourcing deals, impressive benefits, and uncapped growth projections, often with 30% to 40% growth. And they are right – some companies do achieve that level of success. And the truth obviously lies somewhere in between. But where? And where does it lie for you?

What did PWC find? It found that outsourcing is growing in complexity, and that sophisticated leaders don’t fear that complexity – as the complexities of innovative partnering translate into the benefits of growth and performance. It found that outsourcing is as diverse as business itself, differing by country, sector, and even company – characterized by smarter suppliers, improved automation, and better-informed buyers driving toward long-term, sustainable, outsourcing arrangements. And it found that firms that effectively master the new complexities stand to reap the benefits.

PWC found that outsourcing is high on most companies agendas and that the major attractors are cost savings (76%), access to capabilities and talent (70%), and strategic benefit (63%). Sometimes a provider can do it better than you – and good firms use the best resources available, whether they be in house or not. PWC found that the most widely outsourced activity is IT services (57%), but that production or delivery is a close second (55%), and logistics a close third (51%). HR Services (35%), sales & marketing (33%), and innovation/R&D (32%), and procurement (30%) make up the middle tier. Call centers (25%) and finances and accounting (24%) round-out the bottom. It found that 27% to 55% of respondents (depending on the business function) plan to expand their outsourcing over the next five years and that there are three growth hot spots, finance & accounting (44%), customer call centers (45%), and procurement (53%).

The survey found evidence that customers need to rely increasingly on multi-sourcing and joint ventures and that successful customers are those that collaborate effectively with their service providers. To this end, the report presents two possible approaches to multi-sourcing, a lead supplier model, where one service provider functions as a general contractor who orchestrates other suppliers, and a collaborative partnering model, a collection of master partners governs the relationship, but more approaches exist.

They also found that although nearly half the service providers see employee opposition as a barrier to outsourcing, two thirds of the customers don’t see it that way. The report suggests two possible reasons: (1) vendors could be blaming employee opposition when the real issue is the business case and (2) customers are insensitive to the issue. I’d have to go with the second. Outsourcing is a significant change to the way you do your business, and requires sophisticated change management. You can’t just sign a deal and say “It’s the service provider’s problem now.”, because it’s not. It’s your problem – after all, it’s your business. It’s critical to get buy-in before you even start the negotiations with a provider, and have a transition plan in place – preferably one that results in as few layoffs as possible, with zero being the optimal number. (It can be done, Hallmark did it.)

Good outsourcing, especially in procurement, starts with the tactical and keeps the strategic in-house, at least at a high level. (For example, allowing your specialist serviced provider to strategically source your indirect materials is often a good idea, but giving up control of your critical direct materials is usually not.) This will significantly reduce the number of employees required to handle purchase orders, but that does not mean that it will significantly reduce the number of employees you need to effectively manage, and grow, your business or that getting rid of them is the best way to save money. If you’re an average company, with most of your spend not under management, the best way to save money is to train them to do proper sourcing and redeploy them on spend management projects to double or triple the spend you have under management and double or triple your savings (which should far exceed the cost of the retained resources).

One statistic that is particularly positive is the number of customers, 66%, who say that social and environmental issues will have a significant impact on their offshoring decisions. As long as they are not just giving lip service to the importance of corporate social responsibility, this is good news indeed. On the negative side, 52% of service providers believe that these issues are not important for their clients. I hope they get the message to “shape up, or ship out” before its too late. (Maybe PWC should arrange for them to get a visit from the Governator. )

PWC also found, not surprisingly, that there is a payoff for those that Collaborate, Collaborate, Collaborate, Collaborate. Emerging open business models are allowing firms to engage networks of partners and customers to generate higher value at lower costs and collaboration is yielding best practices in the capabilities and processes itself. Unfortunately, they also found that at this time, only 40% of joint governance structures are working effectively, indicating that many organizations and service providers still need to shape up and take a best practices approach both to collaboration and candour. PWC concluded by noting that a collaborative model of outsourcing is required to support buyers increasingly seeking to outsource core products to suppliers who want to rise to the challenge.