Big Savings, But Lots of Risk
Low-cost country sourcing (LCCS) promises big benefits. But before they adopt a LCCS strategy, companies need to understand the related risks and how to mitigate them.
By Kevin R. Fitzgerald -- Supply Chain Management Review, 12/1/2005
Businesses of all sizes now face shifting mega-forces that affect the basic way business must be conducted. Leading companies are changing their global supply chain strategies accordingly. To be profitable and grow, enterprises must adapt to rapidly changing business economics produced by these mega-forces. Included among these new strategies is sourcing goods and services from suppliers located in low-cost countries, a practice termed “low-cost country sourcing,” or LCCS. These mega-forces that are pushing companies to consider LCCS include:
Pricing. The pricing rules of the past no longer apply. For a long time, rising costs simply were passed downstream in the supply chain and ultimately were borne by the end user. Today, end users expect prices to decline each year—even if energy costs and other basic costs rise. Businesses in nearly all industry sectors are experiencing this new pricing dynamic: one that has been present in the automotive industry for decades. Simply put, businesses must reduce costs, year after year, or profitability will decline.
Globalization. As time passes, business competition becomes more and more global. Technology advances combined with a general breaking down of trade barriers and political barriers between global trading regions have moved business toward one dynamic global market. The potential rewards for winners are huge as undeveloped countries are integrated into the global market that continuously grows and changes. Companies that don’t expand into new markets will see their market share and profitability erode.
Supply chain competition. Competition is becoming more and more defined by supply chain capability. In particular, the upstream supply chain—which has been relatively ignored in some industries—is being recognized for its cost-saving potential.
Aberdeen research reveals that cost savings up to 35 percent or more can be achieved by buying from suppliers in low-cost countries. And, while still immature compared to suppliers in more-developed global regions, suppliers in key low-cost countries such as China have become much more technically competent and business-wise over the past 10 years or so. However, Aberdeen research results also show that most enterprises are ill-equipped to take on a supply management initiative as ambitious and complex as low-cost country sourcing. LCCS presents inherent risks that must be minimized, and the challenges of governing the global supply chain that is created by LCCS are huge. Nonetheless, enterprises of all sizes are plunging into this sourcing strategy for a very basic reason: to remain competitive in the global marketplace.
Enterprises plan to double their spending with offshore suppliers by 2008, as can be seen in Exhibit 1. The prime reason for this is clear: cost savings. Total costs for goods and services procured in low-cost countries are 10 to 35 percent lower than in more mature economies.
Though cost savings are clearly the principal driver for LCCS, enterprises realize other benefits. Supply executives report that this approach is vital for expanding into new markets and improving service levels and delivery performance to global customers. Exhibit 2 shows the leading reasons that enterprises deploy LCCS programs.Many companies initially source in low-cost countries to support local operations, as evidenced by several of the benefits shown in Exhibit 2—namely, inventory reduction, increased customer service, reduced cycle time, and logistics cost reduction. However, research results also showed that today the vast majority (80 percent) of goods and services sourced from low-cost countries are exported to the U.S. or other countries. Continued...
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