Revisiting LCCS in a Demand-Driven World

Low-cost country sourcing (LCCS) may not always be the right answer when supplier development, risk, lead times, and other factors are brought into the equation.

By Mickey North Rizza -- Supply Chain Management Review, 4/1/2007

• LCCS: Business as Usual?
• Technology and Organization Structure
• What is the "Right" Shore?

Low-cost country sourcing (LCCS) has become synonymous with global sourcing. But they're not necessarily the same. Exactly where you source overseas can make a significant difference on the bottom line. For buyers to be effective and provide the right sourcing answer at the lowest total true cost, they need to understand the complete picture, including risks and supplier development. They need to carefully weigh the options to make the right decision based on the entire value chain for the products being brought to market. They need to understand LCCS within the context of a demand-driven supply network. Here are some thoughts on how this can be accomplished.

Most companies are sourcing from low-cost countries to achieve lower product costs. But for the commodity, sourcing, and buying personnel involved, it's no longer business as usual. By purchasing a product outside of the country in which it had traditionally been purchased, the buying firm faces a number of challenges. The taxes, duties, customs, banking requirements, transportation, overhead of an international procurement office (IPO), inventory buffers, and long lead times from the point of shipment to the point of use can add up quickly in terms of costs. Add in language, culture, currency exchange rates, and timing factors... and the sourcing process can become a daunting task. But the largest hurdle for companies to overcome is institutionalizing a sourcing process that encompasses all elements of the buy—regardless of where purchased—and to make the process standard and routine. Traditionally, a company starts with a single project to test or pilot an LCCS process. Some of the most successful companies we've studied have realized great results in their pilot programs. For example, a metals manufacturer gained a 40 percent net cost reduction by re-sourcing a production consumable to India. Similarly, a major oil company found a 25 percent cost reduction by re-sourcing specialty production chemicals to China. After a successful pilot program, companies find that sourcing agents, supplier-development engineers, and “in-country” expertise is required to cut costs and ensure continued reliable supply.

The big Fortune 500 to Global 2000 companies build that expertise in multiple ways. They establish IPOs in the low-cost countries or regions either by building these operations internally or engaging the services of firms such Accenture, IBM, and Ariba to do so. Once the IPO is developed, companies then fill any gaps with internal category expertise, supplier-development engineers, and risk-mitigation techniques.

Unlike their larger counterparts, the smaller companies ($2 billion and below) are not spending the money on IPOs but instead are working with the services arms of firms such as Accenture, Ariba, A.T. Kearney, IBM, and others. These services providers identify spend categories, supply markets in various geographies, and sourcing opportunities in low-cost economies.

It remains up to the buying company, however, to build out the supplier-development and quality-control infrastructure. AMR Research finds that building out this final step to reliable supply is a change-management challenge. But how well a company understands the need for close-proximity supplier development and quality personnel can really make a difference in the availability of supply, total costs, and warranty claims.

Technology and Organization Structure

Technology applications can enhance the LCCS value proposition by streamlining work flows and providing collaborative opportunities among the network of buyers, services providers, and suppliers. e-Sourcing tools from Ariba, Emptoris, Ketera, Oracle, Procuri, SAP, and Verticalnet are critical when distributing multilingual RFXs and qualifying suppliers. Global trade management companies such as Tradebeam and Tradecard make a difference in the financial management of the trade including letters of credit and inventory management. And collaboration technology providers such as Clear Orbit, E2Open, i2, Oracle, SAP, and Wesupply offer opportunities to close the gap on forecasts, purchase orders, specifications, and advanced shipping notices.

While technology may close the gap across the elements, a cross-functional team to manage supply and quality is another critical factor in sourcing success. One automotive company tightly coupled its sourcing and a supplier performance management technology with a cross-functional team of commodity specialists, sourcing agents, buyer planners, design engineering, supplier development engineers, and quality personnel. The results of this highly collaborative environment were amazing.

What is the "Right" Shore?

While typical LCCS strategies, such as those involving China, have proven to potentially lower production costs, many companies are now looking into near-shore sourcing. This might involve sourcing in Mexico for goods destined for the U.S. and Canadian markets or in Eastern Europe for products headed to Western Europe. David Morgenstein, Ariba's managing director of sourcing, has noted that near-shore manufacturing can cost as much as 20 percent more than manufacturing in China, but it can still be competitive on a total cost basis.

Buyers need to become savvier, incorporating risk, supplier development, and soft- and hard-dollar costs in the total-cost-of-ownership equation. By doing this, they will gain a better understanding of the true costs in the sourcing equation. One consumer products company found that its forecast China savings were not living up to expectations. Upon analyzing the situation, the company found that a few unanticipated air shipments, along with an initial miscalculation in the total landed-cost structure, were to blame for that particular product line missing its profit mark. This scenario is repeated across many industries. As a result, smart buyers are now doing two things: (1) focusing on total delivered profit analysis vs. total landed or “true” costs and (2) exploring “right shoring.”

A delivered profit analysis can provide a holistic view tied to a demand-driven value chain. While it is important to understand the delivered profit from LCCS, it is even more critical to weigh that profit within the context of the entire demand-driven value stream. An LCCS initiative may bring value on its own, but it may still be a drain on the entire value stream. To illustrate, an item coming from one Eastern European country into another Eastern European country may be low cost when compared to other countries. But when the particular country's taxes, economics, and socio-political risks are brought into play, the value may be diminished.

Near shoring is gaining momentum overall for one main reason: Companies are now reviewing the total value provided by near shoring as compared to offshoring in China and other traditional LCCS locales. While offshoring provides clear reductions in the product cost, the associated overhead and processes required don't always sustain the value. Near shoring may not yield production costs as low as the offshoring sites, but it can provide less cost and process fluctuation in the value chain.

Companies with variable demand or those that require a flexible supply chain may benefit from a near-shore strategy. In particular, companies that have products with variable demand, require low inventory, have bulky but labor-intensive products, and require significant buyer-led supplier development or engineering support are good candidates for the near-shoring option. Recognizing this, suppliers in Mexico, for example, are marketing their services to U.S.-based companies with these characteristics. It is clear that companies are at various stages of maturity in their LCCS strategies. They vary from those that have just put a toe in the water to those that have proven track records of repeatable success. At every level of maturity, however, the mistakes are many and sometimes costly. The challenge for all companies today is to understand the value provided by LCCS and then enhance that value to provide greater profit margins in the future.