The secrets of value-added sourcing

Professor Christopher Jahns and Roger Moser highlight the challenges - and rewards - of low-cost country sourcing.

China is the new El Dorado for purchasing. More and more enterprises would like to increase their spend in China. Unfortunately, this often remains just wishful thinking, even though it is easy to find unrivalled low-cost suppliers in China. The key question is how can the goods get to Europe cheaply, quickly, and safely?

An Italian businessman shrugs his shoulders in resignation: "A year ago, we found an unbelievably inexpensive Chinese supplier of very good quality goods at a sourcing summit in Shanghai." This should have been a dream come true - but instead the businessman talks of constant aggravations. "A large portion of the last delivery was damaged and our supplier has been searching for the current delivery at the company's logistics provider's warehouse for two days."  The Italian businessman has concluded that although the Chinese are able to produce more inexpensively than their competitors, logistics lets them down.

He has hit on something which many enthusiastic buyers overlook on their purchasing tours through the Dragon Empire - the bottleneck in logistics. The prices are low, but transport, storage and handling costs often add considerably to the costs. The more enthusiastically the buyer raves about the price attractiveness in China, the more probable it is that he or she has only calculated the purchasing price - not the Total Costs of Ownership (TCO) including the supply chain risks.

Sourcing in China is only cheaper when the price advantage is not wasted by the costs and risks that go along with the logistics, intellectual property rights and Chinese bureaucracy. This figures will fluctuate depending on what is being bought and the geographical location of the supplier. Many managers who include the TCO in their calculations estimate that the price advantage should amount to at least 20 to 30 per cent in order to make procurement in China worthwhile.

It might come as a surprise to many people to hear that purchasing success in China is not guaranteed! China is not a low-cost country per se. When we discuss this with purchasing managers, many confirm that they are happy when they are able to achieve even half of their cost-saving goals in China. Nevertheless, their CEOs demand that ever more pieces of the pie are ordered from China - showing that there is a gap between perception and reality.

The market insights, which the recently founded BMW/SMI endowed chair for Purchasing and Supply Management at the Tongji University in Shanghai have gathered, show that companies achieve the best purchasing results in China when they combine purchasing and logistics.

The secret of low-cost country sourcing lies in so-called value-added sourcing. Mid-sized companies and large conglomerates often use the support of value-added-sourcing-providers, such as Triscol from DHL. Triscol not only handles the entire logistics management locally, but also offers support with sourcing, warehousing and finances.

A company which distributes natural food products throughout Europe is a good example of the problems buying in China can pose. A Chinese partner supplied excellent quality goods for six months then, suddenly, large portions of the deliveries arrived spoilt. Following an investigation, the customer discovered that it wasn't the supplier's fault, but the logistics provider - the goods weren't refrigerated. During the winter, this hadn't been revealed  as a problem but come summer and the goods spoiled.

The freight forwarder wasn't aware that they had done anything wrong, saying: "We have been transporting goods for this company for over 20 years and never had a problem!" He was correct - however, he was referring to goods which had only previously been delivered within China. For Europe, other regulations apply and neither the freight forwarder nor the European purchaser picked up on this point. Afterwards, the purchasing manager commented dryly: "Managing logistics processes from provincial China to Europe is indeed different than transporting goods from Manchester to Lyon."

The buyer happily purchased in China, but didn't properly coordinate the internal and external logistics. It was common knowledge that the internal logistics manager had already mentioned at the beginning of the deal "They purchase all over the world and couldn't care less how they deliver on time and how fresh the goods arrive!" This carelessness would have been eliminated by a professional provider with value added sourcing.

Many companies are learning a difficult lesson through embarrassing emergencies and large losses. A company requires skills on two fronts for low-cost country sourcing: purchasing and logistics. Both competencies either have to be developed and co-ordinated on their own or be integrated via a partnership. How necessary and meaningful this is, can be shown in the example of supply risk management.

The purchasing department of the above-mentioned natural foods company had investigated the production processes and structures, the management and employees of the Chinese supplier for quality risks, but equal attention wasn't given to the logistics. Why should European buyers know all aspects of Chinese logistics? Professionals who are knowledgeable in such matters have been saying for years: "What can drive for hundreds of kilometers and is only held together by rust? A Chinese lorry!"

Indeed, Chinese logistical risks are numerous and formidable - which should not be interpreted as an accusation. Anyone expecting eight-lane motorways in Chin, shouldn't complain about the Chinese infrastructure, but question their own delusions. Adequate infrastructure exists in and around the large cities, such as Shanghai or Bejiing, however, elsewhere the infrastructure is generally insufficient. Furthermore, the logistics market is extremely fragmented and the equipment of the local service providers can often seem to be "remnants of the Ming-Dynasty", as one exasperated French CPO exclaimed in a fit of desperation.

The CPO of a Belgian company has complained that "the Chinese logistics problems are gigantic, non-negotiable trade restraints."  The Chinese road network is vast - extending to almost two million kilometres -  but only one-third is paved with the remaining roads often little more than dusty gravel paths.  The huge distances in China are also constantly underestimated because in Europe, distances are not an issue and we are not used to low quality roads causing problems.  As Napoleon once said about his abortive Russian military campaign, "The longer the supply chain, the higher the risk."

Problems are not only due to the poor infrastructure and behind-the-times technology. It is also due to the Chinese, who consider logistics to be purely transportation, handling and storage, just as Europeans did in the past. Because of the competitive pressure of the fragmented logistics market, these basic logistics services are offered price-consciously, which is good. However, on the flip side, because these services are offered so competitively, the service providers have little money in their pockets with the result that many lorries are in a poor condition and many warehouses are inadequately equipped.

IT systems for planning and controlling the supply chain are rare, just like barcodes. Pallets are used by local forwarders for storage, but not for transporting - because pallet exchange systems do not exist. General cargo networks, common practice in Europe, do not exist in China, along with material flow control, IT systems, storage infrastructure and stock management. The length of the Chinese rail links doesn't even amount to one-third of the American network, although China's population is approximately four and a half times as large. And, China only has eight percent of the motorways of the US.

And these are just a few of the shortcomings in the Chinese logistics system. The result of these deficiencies are long transit times, transport damage, increased risk and higher logistics costs. According to an EC study by the Fraunhofer Institute, approximately seven per cent of the GDP in Germany can be attributed to logistics costs - in China, it is 17 per cent. According to corresponding estimates, transportation and storage costs account for 30 to 40 per cent of the total costs of goods produced, up to 60 per cent for food, and 80 per cent for chemicals - despite the extremely low transportation costs! The lean logistics offerings brake economic growth in China.

The Chinese nut can only be cracked if the disastrous separation of purchasing and procurement logistics on the one hand, and sales and distribution logistics on the other hand, is abolished. The integration of purchasing and logistics is not also called supply chain management for nothing. Since many Chinese companies are not ready for supply chain management, value added sourcing has become a whole new area of business.

What sounds so complicated is often easy in practice, although it can be quite expensive. A few years ago, Chinese BMW and Ford salesmen noticed that some new cars were delivered with damages to the paint finish caused during delivery. Chinese lorry drivers sideswiped trees and houses along the way as they tried to handle huge articulated lorries on small roads.

BMW decided the solution lay in abandoning the 18-wheelers and instead deliver cars from their factory in Shenyang to the 40 dealers throughout China using closed lorries. Ford decided on a different solution. Chinese delivery drivers were only allowed to drive the oversized lorries after passing a special safety driver training and each lorry is kept under surveillance during transportation.

These examples illustrate something new every time: those who merely buy (or sell) in China, inevitably do "bad" business. "Good" business is only possible when the supply chain is rigorously and excellently managed. Needless to say, many companies are overwhelmed by the task. Many average performing companies still complain about long delivery times from China, while best-practice companies, get around this in various ways, for example, by hot hatching - paying a surcharge for having their goods loaded on ship last and unloaded first at the port of arrival. Delivery times can be dramatically reduced by days, even weeks, by further optimisation of value added sourcing.

But nobody can achieve this overnight. The learning curve for low-cost country sourcing in China is relatively steep. Many CPOs assure us: "Sourcing in China is not a Quick Fix for short-term cost saving projects!" Others say, "In order to do successful business with a 7,000 year old culture on the other side of the world, more patience is required than most Europeans posses. Usually, it takes months, rather than weeks, until all the logistical bottlenecks have been resolved and the projected 100 per cent savings realised. As the Chinese say: "The grass doesn't grow faster even if you pull on it!"

Professor Christopher Jahns is executive director of the Supply Management Institute at the European Business School, International University, Frankfurt. Roger Moser is co-ordinator at the Supply Management Institute.