Is your organization ready for the next generation of business challenges?

by Tapan Pandya, Rob Hills, and Jerry O’Dwyer

If you blindfolded a global sourcing executive in 2005 and transported him or her forward three years to 2008, they would find themselves in an unfamiliar place. Within this time, the dollar would have depreciated nearly 20 percent against the RMB (Renminbi). Stories about the Chinese economic miracle would have been replaced with features about tainted raw materials and dangerous environmental practices. Headlines involving India, Inc. would have shifted from describing services process excellence (e.g., CMM Level 5) to instead showing pictures of out-of-control salary inflation and unprecedented levels of white-collar turnover.

But it’s not just regional country changes that have caused such a shift. Executive perception about the benefits of global sourcing would have also changed greatly from that of near-term, 20-percent-plus savings opportunities to long-term, harder-fought battles for total cost margin points.  
If the impact of these changes was not enough to cause executives to realize how much the market has evolved, then a number of other factors certainly would make them believe that a new era of global sourcing is upon us. For example, changes in local tax, tariffs and duties (import and export) have changed the total cost equation for many companies, rendering past global sourcing decisions either cost neutral or worse. In addition, public policy and debate has shifted from one of open borders, encouraging free trade, to a protectionist mindset that seeks to question past trade deals such as NAFTA, as well as North America’s relationships with its major trading Asian trading partners.

Add to these economic and political shifts the rising cost of raw materials and transportation, thanks in large part to oil prices that have more than doubled since 2005, and it becomes all the more clear that we are not on the same global sourcing stage that we were just a few years back.

Together, the sum of these factors has created what is quickly becoming an entirely new era for global sourcing. We call this new environment Global Sourcing 2.0. But regardless of the name, companies must learn to navigate these new global sourcing waters if they are to save rather than lose money, while proactively managing and mitigating all of the risk factors that can damage brands and wipe billions from market capitalizations in a single day. Indeed, Global Sourcing 2.0 comes with an entirely new set of rules and opportunities. For those procurement organizations that want to survive and thrive in this new environment, it is crucial to understand both the basic rules of the game and the more advanced nuances of what is already separating out leaders from laggards as Global Sourcing 2.0 begins in earnest.

Global Sourcing 2.0 Defined
Sometimes it is easiest to define a subject by what it is not. In the initial global sourcing boom, companies often referred to their efforts as falling under “low-cost country sourcing” initiatives or LCCS for short. Under Global Sourcing 2.0, we need to strike the notion of LCCS from the vocabulary for good, as the era of low-cost country sourcing is rapidly disappearing. Instead, we are left with an environment where labor costs, the primary driver of the LCCS concept, are rising throughout the developing world and countries are beginning to compete on a range of factors rather than simple unit cost metrics. These factors include infrastructure, access to local markets, raw material pricing and availability, overall quality and performance levels (and certifications), and environmental and socially responsibility practices. The sum of these factors is setting the standard for new cost models that transcend the simple concept of low-cost labor—which becomes only a single contributing factor in the overall Global Sourcing 2.0 equation.

Global Sourcing 2.0 is not a black or white world. Instead, it is filled with shades of gray. Take the case of China: While it’s easy to say that the total cost equation for China is not working for companies anymore, this greatly oversimplifies the current paradigm. Consider China’s emerging geographies, and, for example, how the Chinese government is subsidizing transportation costs from the inner provinces to encourage manufacturing in less developed areas. Previously, companies would only consider suppliers close to port cities. In addition, despite the market noise about “new” countries such as Vietnam stealing the limelight from China, these smaller, developing countries often lack the infrastructure and scale to meet global expectations despite lower labor costs. In Vietnam, for example, unless they are trucking goods into the Chinese market, Western procurement organizations face transshipment requirements since no Vietnamese ports can fit the largest container ships. These requirements create additional costs and lead times for any goods a company plans to export from the region not using airfreight.

This new global sourcing era also brings with it the prioritization of risk management, including traditional supply risks such as country currency/political risk and supplier financial viability, on-time performance, quality/PPM (parts per million), etc., as well as new risks that suppliers might pose to an organization’s brand based on labor practices, corporate/social responsibility, and environmental concerns.

Perhaps most important, Global Sourcing 2.0 not only surfaces the need to consider risk management as part of core sourcing strategies; it also helps companies identify the logical owners of risk (e.g., buyers, suppliers, or third parties) in each transaction. In short, Global Sourcing 2.0 has brought with it a shift in thinking away from mere negotiation and savings—even a total landed cost savings perspective—to a mindset that requires companies to think about new ways of creating value while controlling risks in the overall globalization process.

Profiting From Change
Given the shifting priorities from the initial world of global sourcing to the 2.0 environments in which companies are operating today, should procurement organizations attempt to unlearn or undo their earlier strategies? No, not exactly. Perhaps the concept of revisiting earlier approaches is a better way to look at the situation. For example, while creating an international procurement office (IPO) might still be the right strategy in certain circumstances, perhaps it makes sense to shift to more of a shared services model than a geographically centered one, especially considering the role of multiple geographies in the new sourcing environment. At the same time, it is probably worth evaluating whether existing supply agreements are creating new liabilities (e.g., did initial agreements not factor in clauses for commodity volatility and availability that reduce the risk of rising prices and/or possible supply disruptions or delays?).

Profiting from Global Sourcing 2.0 requires companies to consider alternative strategies and skill sets not only around supplier identification, negotiation and implementation, but also in broader business areas. In this regard, building transparency around a supplier’s complete cost structure is critical, and well beyond the “total cost” on a landed unit level that many companies already consider today. These new total cost approaches can help an organization to work with its suppliers to develop multi-tier sourcing strategies that might involve a supplier working with other suppliers or setting up its own operations in lower-cost labor markets like Vietnam or Sri Lanka, weighing the relative cost advantages and risks that greater supply chain complexity brings.

Or companies might opt instead to consider the cost of quality in new ways and to work with suppliers to reduce their dependence on low-cost labor by streamlining their processes through lean and Six Sigma programs, as well as making new capital investments in equipment and facilities. Many companies are starting to realize in countries like China, that improvements in process and automation can reduce variability in manufacturing, not only enhancing quality, but also lowering the total cost of working with a particular supplier. These types of initiatives can also help companies to build tighter linkages with suppliers, enabling them to move upstream in the relationship as well. In this regard, companies in the A&D and automotive industries, for example, are working with Indian and Chinese suppliers in the R&D phase to engineer out cost in the design phase and also to create products with specialized appeal for localized markets.

Global Sourcing 2.0 also provides an opportunity for organizations to better manage costs in areas that are outside of a supplier’s direct control but often have a material impact on total cost, such as logistics and tax/tariff/export policy.

Consider this: As fuel prices continue to escalate while oil comfortably stays in territory well over $100/barrel, companies must better manage freight forwarding and consolidation strategies, either through taking back greater ownership of the global logistics function from suppliers or working with 3PLs in new ways. In this regard, rather than simply working with a supplier to provide goods FOB Shanghai, why not explore and cost-out other options?

In addition, given the decreased export incentives in a number of developing markets in Asia such as the reduced China VAT rebate for suppliers, companies should also get creative about new ways of structuring supplier relationships. For example, there are approaches that enable companies to avoid the supplier VAT charges by structuring certain classes of relationships and joint ventures as export processing facilities rather than simply buyer/seller transactions in the traditional sense.

All of these approaches require companies to adopt a Global Sourcing 2.0 mindset that encourages depth, creativity and flexibility in structuring supplier relationships. Indeed, the same old “sourcing bag of tricks” will no longer get the job done in this new era. Instead, companies need to focus on building out the right structure, skills and expertise internally. They must also define effective ways for third parties, ranging from sourcing/supply chain consultants to logistics providers to transfer pricing specialists, to cost-effectively and efficiently transform their global sourcing operations to thrive in this new environment. Virtually all of these efforts require moving beyond a negotiation and cost orientation towards a broader approach that considers value, risk, and the overall role of international trade—of goods, services, and ideas—as part of a core global sourcing approach.

Is your organization ready for Global Sourcing 2.0? If it isn’t, the time is running out to start evolving your thinking and strategies before it’s too late to capitalize on the opportunities and avoid writing down the benefits that are expected from previous global sourcing investments.   
 

    Jerry O’Dwyer is a principal with Deloitte Consulting LLP and is the Sourcing & Procurement National Practice Leader. Rob Hills is a principal with Deloitte Consulting and is the National Practice Leader for Direct Materials Supply Management. Tapan Pandya is a senior manager with Deloitte Consulting in the Sourcing and Procurement practice