Right-cost, not low-cost sourcing

A range of potential risks, from the reputational to the regulatory, await firms that don't consider the full costs of what they're sourcing. Investing in deeper supplier relationships can ensure a positive outcome.


By Thomas Clouse

Source: from Expand› DKSH’s magazine for Market Expansion Services, Issue 01 May 2011

The global world of sourcing - Creating the right relationships

Stories about sourcing in low-cost countries tend toward the extreme. Some tell of tremendous savings while others complain about poor-quality products and dishonest local partners. In most cases, a company’s success in sourcing depends upon its priorities and its preparation. Often the companies that boast of savings initially become the same companies that later suffer from unexpected cost and quality issues.

Chris Runckel, President of US-based Runckel and Associates, a consulting firm, explains: “The most common mistake companies make is to chase low prices. If you focus only on price, you often miss other potential costs.”  Many of these other potential costs stem from quality issues, says Runckel. While companies can save money initially by using lower-cost suppliers, they must often pay more to remedy problems when those suppliers are unable to meet quality requirements. In such situations, companies not only face the direct costs associated with replacing faulty products but also the potential damage to their reputations if the products reach their customers. In one example, US toymaker Mattel had to recall almost a million toys in 2007 after it was discovered that one of its suppliers has used lead paint.

Clearly communicate your expectations

Communication is an important element in ensuring quality. Companies must be clear about their product specifications and business expectations, a task which is complicated by differences in culture and language. “Companies should put out a package of requirements to suppliers that explains in easily understood terms what is expected and how the whole process will take place,” says Runckel. And poor quality is not the only issue that can damage a company’s reputation, he adds.

Companies should also make sure the suppliers they work with have ethical business practices. “More companies want to know that their suppliers treat their workers decently, follow business standards and legal procedures, and know how to treat the environment properly.”

Mario Preissler, Head Business Unit Performance Materials at DKSH, explains: “The most important factor is really making sure the suppliers you identify are professional companies that will follow the standards that you expect and will still be around in the future.”

Visiting the supplier companies can serve as a first step in determining their level of professionalism. It also gives companies a chance to evaluate the logistical costs of a company’s location. As Runckel mentions, lower-cost producers are often located further from ports and railroad lines, which can translate into higher shipping costs and longer travel times. This also increases companies’ exposure to price shocks when oil prices rise.

Handling regulatory risks

The location of the company not only matters for transportation costs but for regulatory risks as well. Tariffs, which can vary greatly from country to country, add significantly to product costs and can increase quickly when trade tensions surface. In the first half of 2010, for example, more than 32 WTO members implemented anti-dumping measures to slow the inflow of imports.

Regulatory risks can take place on a smaller scale, too, such as when local authorities increase minimum wages as they have in recent months in Shanghai, Jiangsu, and other parts of China. They may also be less direct. For example, weak enforcement of intellectual property rights can endanger companies’ technological assets.

Evaluating potential suppliers
  • Check that potential suppliers have the experience, capacity, and financial resources to meet your quality requirements
  • Ensure potential suppliers fully understand your quality requirements. Common practices vary from country to country, so be aware of your assumptions
  • Investigate potential suppliers’ business practices to ensure they’re in line with your company’s standards and expectations
  • Evaluate the costs of transporting your products from your potential supplier to your final market
  • Factor tariffs into your costs and potential trade friction into your risks
  • Understand the legal environment. Pay particular attention to transparency and enforcement

A changing economic backdrop

Properly incorporating all these factors price, quality, communication, ethical business practices, logistics, and regulatory environment – is made increasingly complicated by the rapidly changing global economic backdrop. Higher wages are increasing production costs but are also boosting domestic consumption. The traditional model in which companies produced in low-cost countries and exported to developed countries is changing, especially as many suppliers in low- cost countries are improving in quality and expanding their capabilities. “The gap is closing,” says Mario Preissler of DKSH.

That closing gap makes supplying decisions more difficult, argues Yogesh Malik of consulting firm McKinsey & Company. “As companies in developing markets become increasingly credible suppliers, deciding which low-cost market to source from becomes more difficult,” he notes in a January 2011 report1    about building the supply chain of the future. That report cites a McKinsey survey, in which 68% of respondents expected supply chain risk to increase in the next five years.

In response to such risk, companies must not only research the many factors mentioned above but also invest in their supplier relationships to gain the most from their supply chains. “It is very important that the source you buy from makes enough money to have an interest in maintaining a long-term relationship with you,” says Preissler. “The longer the relationship lasts, the more secure you are.”

But while supply chain risks are increasing, so are the potential benefits. Strong supplier relationships help companies realize those benefits. Many firms are already adjusting their strategies. In a survey of manufacturing executives conducted in September 2010 by KPMG, a tax and audit firm, more than half of the respondents planned to collaborate more closely with or give full responsibility to suppliers for issues ranging from product development to cost reduction.

While such suppliers are less likely to offer the absolute lowest price, they are more likely to work together with companies to address the increasingly complex challenges of the global economy. Furthermore, when suppliers begin taking on more responsibility, companies can focus more clearly on product development as well as marketing and business strategies and are thus more likely to have happy endings to their sourcing stories.
1 Building the supply chain of the future, McKinsey Quarterly, January 2011 2 Global manufacturing outlook, KPMG, September 2010

Thomas Clouse is a freelance journalist based in San Francisco and Beijing. He writes about a wide range of economic, political, and social issues for magazines in the USA, the UK, China, and India. He was educated at Stanford University.

About Chris Runckel

Christopher W. Runckel, a former senior US diplomat who served in many counties in Asia, is a graduate of the University of Oregon and Lewis and Clark Law School. He served as Deputy General Counsel of President Gerald Ford’s Presidential Clemency Board. Mr. Runckel is the principal and founder of Runckel & Associates, a Portland, Oregon based consulting company that assists businesses expand business opportunities in Asia. (www.business-in-asia.com)

Until April of 1999, Mr. Runckel was Minister-Counselor of the US Embassy in Beijing, China. Mr. Runckel lived and worked in Thailand for over six years. He was the first permanently assigned U.S. diplomat to return to Vietnam after the Vietnam War. In 1997, he was awarded the U.S. Department of States highest award for service, the Distinguished Honor Award, for his contribution to improving U.S.-Vietnam relations.


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