What’s all this talk about risk?

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Editor’s Note: Today’s post is from Dick Locke, Sourcing Innovation’s resident expert on International Sourcing and Procurement. (His previous guest posts are still archived.)

The issue of global supply chain risk gets a lot of attention nowdays, and it certainly should. However, I’ve seen a few silly statements. One is that global sourcing is sooo over. Another is that nobody should buy in China. (OK, I exaggerate, but just slightly.)

Here’s my perspective:

First, we need to clarify what “sourcing” is. Wikipedia says “In business, the term word sourcing refers to a number of procurement practices, aimed at finding, evaluating and engaging suppliers of goods and services“. That’s the definition I’ve always used, too. It doesn’t mean actually buying, it means looking around. Global sourcing just means looking around globally.

With that definition, you can see what sourcing globally gets you. It gets you intelligence on the prices, costs, and viability of potential sources all over the world. In other words, it gets you a potential reward in the form of the lowest supply costs. Rewards in purchasing, as in investing, go hand in hand with risks. You can’t evaluate the risks without knowing the rewards. Fortunately, in purchasing higher rewards don’t always mean higher risks.

Let’s suppose a global sourcing program shows that the lowest landed cost suppliers are in some place various gurus find risky and you can save a tremendous amount by your company standards if you actually buy there. Would you walk away from a deal just because it’s risky? I hope not. That’s not the road to success. The computer industry ships about $30 billion dollars annually from China to the US. Quality and intellectual property problems are rare. What are some of the steps computer companies take? I can name four: Include quality experts in sourcing evaluations right from the start, buy only from foreign invested companies in China, have not just feet on the ground in China but trained brains too, and carefully reference-check for intellectual property issues before proceeding. It helps, too, that products such as laptop computers are “economically dense” in terms of cost per kilogram so that air freight makes sense.

Philosophically, when you evaluate risk during a sourcing process, you are not comparing the risk of one choice to a mythical risk-free world. You are comparing the risks of choosing one supplier to the risks of choosing (or staying with) another supplier.

Some risks are digital or binary. They are go no-go tests that should be applied before a potential source is even allowed to quote. A propensity to steal intellectual property is one such test. Lack of adequate quality standards and practices is another. But please don’t claim that no supplier in a country can meet those standards.

Other risks are more like analog. You can measure their severity. The best way is to see how often or how much or how often a situation would have to happen before what looks to be the lowest cost supplier is no longer lowest. Exactly how much would a supplier’s currency have to appreciate before it becomes (in hindsight) the wrong choice? Exactly how often would you have to ship by a premium method at your expense before your lowest cost supplier is no longer lowest? While you’re doing this remember that the second and third lowest cost suppliers have their own risks too. If volatile fuel prices (or cap and trade programs) cause one supplier’s cost to go up, they will also affect other suppliers’ costs.

I have a concern is that every company has strong momentum to stay with their existing supply base. If consideration of risk is not done well, it becomes just another excuse to keep on doing what the company has been doing all along. I saw it at HP when I was developing its global sourcing program. It took a few years to overcome.

Dick Locke, Global Procurement Group.