Focus on global sourcing: Strategies for success

February 28, 2007

Across virtually all industries and geographic regions, manufacturers share one common goal: to increase profitability by decreasing costs. A growing number of manufacturers, both in the United States and around the world, have embraced global sourcing as a fast-track method for achieving that goal.

 Global sourcing first took off in the 1980s and has increased steadily over the last decade, culminating in its current position as a common business practice. However, when it comes to the effectiveness of most companies' global sourcing initiatives, there is plenty of room for improvement, finds a new study from CAPS Research, a nonprofit supply chain research organization jointly sponsored by the Institute for Supply Management and the W. P. Carey School of Business.

 The relentless focus on using global suppliers primarily to reduce labor costs has blinded many companies to global sourcing's other benefits, finds the study, which analyzed information from field research as well as an e-survey of 167 sourcing and supply executives across a variety of industries in the United States, Western Europe, Canada, Mainland China, and South America. These benefits, which may include lower total cost and improvements in overall supply chain performance, inventory management and sourcing processes, are brought about by investing in an integrated, centrally-led global sourcing program -- something most firms still lack.

 "Firms have achieved only a low level of maturity when it comes to integrated global sourcing and supply," explains Robert M. Monczka, co-author of the study, entitled "Effective Global Sourcing and Supply for Superior Results." Monczka is a research professor at the W. P. Carey School of Business and director of sourcing and supply chain strategy research at CAPS Research.

 Moving beyond cost

 It's not hard to see why firms have focused on the cost aspect -- one need only look at the dearth of manufacturers still producing the bulk of their goods in domestic locations to find proof of global sourcing's effectiveness. Indeed, study participants achieved average cost reductions of 19 percent, and average total cost of ownership reductions of 12 percent, as a result of their global sourcing initiatives.

 However, "companies need to think beyond merely using reactive international purchasing to reduce labor costs and make a concerted effort to develop and implement detailed global sourcing and supply strategies," says Monczka.

 "The first reason many companies adopt global sourcing is because their competition is going to emerging regions for labor cost arbitrage," he adds. "But as companies want to compete beyond that, they need the capability to ensure that these suppliers will be satisfactory over time, that they'll be able to grow them, and be able to add new suppliers for additional goods and services."

 For a variety of reasons, including limited time and budget resources, many companies are still stuck in the beginning stages of developing their global sourcing strategies.

 "Firms are still refining their global information systems, and figuring out how to work together across functions and across locations," Monczka explains. "They are also not fully evaluating the total cost and total value of their global sourcing decisions." Most firms surveyed also lag behind global sourcing leaders in finding personnel with the required worldwide knowledge and skills, increasing available sourcing data, enhancing their knowledge of available global suppliers, and implementing effective logistics planning and execution.

 By contrast, companies at the top of the global sourcing game "leverage their ability to combine requirements across business units, and consider what products are needed from a goods or service design standpoint to ensure standardization and common use of sourced products," notes Monczka.

 Taking this approach allows companies to make global sourcing not a silo effort, but an effective part of overall company operations. Procurement professionals working closely with engineering, for instance, can evaluate supplier capability as it relates to product design to determine whether a supplier has the capacity and capability to produce their goods. And coordinating sourcing decisions with finance allows businesses to determine if the financial picture of the firm will improve by going to worldwide suppliers, Monczka points out.

 Overall, companies that have the correct people, teams, processes, and executive support are the ones most likely to achieve superior global sourcing results. In addition, they are likely to leverage global sourcing from a central perspective.

 "By establishing common processes and information systems, employees have visibility to what is being purchased where, from whom, and for what price. This, in turn, makes them better able to decide who to source from globally," says Monczka.

 Also gaining favor as a global sourcing best practice is the use of International Purchasing Offices (IPOs), deemed "extremely important to global sourcing success" by more than 85 percent of surveyed firms that have them. As companies embrace higher-level sourcing, they are realizing the need to have operations closer to their supply base; IPOs provide that capability by supplementing corporate procurement employees with local knowledge. Many firms rely on their IPOs to provide operational support during the development of global agreements as well as throughout the life of the supplier relationship.

 "IPOs are absolutely critical. They give firms feet on the ground and eyes and ears in the area where sourcing may take place," says Monczka." Having company leaders located in these areas helps to establish a presence in the local community that says that you are serious about sourcing in the region." That local presence also comes in handy when and if a company decides to market its products to the area's population -- another competitive advantage of global sourcing done right.

 Risky business?

 Of course, even the most effective global sourcing initiatives do not come without risks, including lengthened supply lines, increased transportation and logistics costs, and supplier delivery and quality concerns, among others. For companies sourcing in emerging global regions, such as China, India, and Eastern Europe, the risks are greater yet. Survey respondents cite language/cultural barriers and the threat of intellectual property theft as concerns in China; logistical movement and lead time stability issues in India; and a lack of supplier responsiveness and flexibility when dealing with suppliers in Eastern Europe.

 Interestingly, the firms report only minimal concern about these risks compared with the inherent benefits achieved through global sourcing. The risks are manageable with time and resources, they indicate.

 "Firms are addressing these concerns by working closely with their global suppliers and putting in place risk-mitigation strategies," explains Monczka. "Companies might, for instance, source 80 percent of business with one firm but have a second supplier as well; or use a supplier in a low-cost region but also use another supplier in a more established region."

 In addition, he explains, the type of goods a company sources makes a huge difference in the risk/reward equation. Industries that bear high labor costs for assembly work and machining -- such as electronics, automotive, and appliances -- have more to gain from utilizing foreign suppliers. "For low labor-cost products, where labor comprises 10 percent rather than 40 percent of the total cost, the equation is different," Monczka notes. In these cases, global suppliers' decreased labor costs may not be enough to offset the risks and additional costs associated with lengthened supply lines.

 Transportation costs also factor into this formula. A company shipping heavy goods via ocean is likely to have a different perspective on the cost vs. risk argument than one using air transport to move small products.

 No pain, no gain

 Ultimately, the message for manufacturers is this: reaping the full benefits of global sourcing requires an integrated, highly structured, cross-functional sourcing initiative that receives proper executive support and human capital. Short-sighted companies that flock to foreign suppliers to save a quick buck may achieve interim success, but a fully fleshed-out program is the best bet for long-term operational success.

 "Firms will have to conduct a more careful evaluation to determine which countries it makes best business sense to source from," Monczka says. "They will have to investigate the true cost and true value they can gain from their sourcing initiatives, taking into account how suppliers impact cost, technology, business presence, and ability to compete globally."

 This is no easy task for companies that may have maxed-out budgets and stressed-out purchasing staffs, Monczka admits. "Firms will have to work hard to understand their supply base and their worldwide supplier capabilities so they make the best decisions. They will also need the ability to work with suppliers in distant places by having people on the ground," he notes.

 The Bottom Line:

  • Global sourcing is increasing as a result of intense worldwide competition in the manufacturing industry. New CAPS Research shows firms sourced between 31 percent and 40 percent of their total annual expenditures on a worldwide basis in 2005, compared with 21 percent to 30 percent in 2000. 
  • The majority of manufacturers utilizing global sourcing today do so primarily to reduce labor costs. Because of this narrow focus, they often have poorly implemented global sourcing programs and may be missing out on other benefits.
  • Companies that excel at global purchasing are those that have: a defined global sourcing process; centrally coordinated/centrally led decision-making; site-based control of operational activities; information sharing with suppliers; real-time communication tools; availability of critical resources; global sourcing and contracting systems; and international purchasing office support.
  • To reap the full rewards of an effective global sourcing initiative, companies must invest in people, technology, and processes.