Moving closer to home

The rush to control costs by moving production to low cost countries (LCCs) has led many American companies to establish manufacturing or sourcing arrangements in China and South East Asia. But where the products or their markets demand shorter lead times or a company's marketing strategy centers on rapid replenishment, the discussion turns to near-sourcing.

A narrow, procurement-focused philosophy has created quality and reliability problems in some supply chains, says Jaume Ferrer, senior executive for the supply chain management practice of Accenture (www.accenture.com). The rush to find cheaper suppliers did not take an end-to-end, total-cost-of-ownership approach and this precludes adequate supplier development and supplier integration, he believes.

A report on German industry highlights some cases where companies shifted production back to Germany after poor results from outsourcing to LCCs, Ferrer notes. You can't make a trend out of some exceptions, he cautions, but industry experts agree there is some movement in bringing certain manufacturing closer to home.

Using the example of his native Spain, Ferrer says Spain continues to be less expensive than Germany, but German companies are only going to invest in Spain if the labor cost factor is not the dominant one. Other factors will drive the decision to near source, including proximity to market and time to market. Access to technology, knowledge and skills can also come into play, continues Ferrer.

Part of Spain's evolution into the world's eighth largest industrial power comes from its role as an LCC in the 1970s and 1980s. It now boasts more than 100 multinational global companies, including Telefonica, one of the world's leading global communications operators. Also on the list are innovative fashion companies such as Zara (www.zara.com) and Mango (www.mango.com), who depend on rapid replenishment and the responsiveness of their supply chains for their success.-Spain shifts from year to year between the fourth and fifth rank globally for automotive production, adds Ferrer.

What countries stand ready to repeat Spain's success? Clearly, the Eastern European countries that joined the European Union (EU) in 2004 have received a lot of attention. Other Eastern European countries that are not yet members of the EU also show promise. Ferrer and others are also quick to add Turkey to the list.

As a Muslim country, Turkey has an image problem in Europe, but, Ferrer points out, the skill level is very high. And while some of the Balkan and Eastern European countries get started with lower technology industries such as fashion, Turkey's Vestel (www.vestel.com) is one of Europe's leading manufacturers of televisions. It is both a private label manufacturer for a number of major retailers and an original design manufacturer. Having its design and production so near the Western European market also means Vestel can respond quickly to demand.

Tom Hickey, vice president of fashion and retail for DHL Express (www.dhl.com), also includes Turkey on his list of countries where European companies are near-sourcing. He adds Israel and Egypt from the Middle East as well.

Hickey's view is similar to Ferrer's. Companies practicing near-sourcing are trying to keep costs low by manufacturing close to their consuming market. This allows them to keep inventory levels in line and link forecasting and production more effectively while also providing lower cost manufacturing. Ron Roest, general manager of logistics for the Holland International Distribution Council (www.hidc.nl), adds that technical factors can drive near-sourcing. In a diverse market like Europe, product standards can vary. Computer keyboards vary by language (the European Parliament operates in 20 languages). Power systems are also country-or region-specific. And some non-technical issues like country-specific packaging may enter into the decision.

But mostly, says Roest, the combination of the value of the product, where it is in its lifecycle, dynamic demand and the subsequent difficulty in accurate demand forecasting chafe against multiple stock keeping units (SKUs) and the long lead times associated with sourcing in distant LCCs. Six, seven or eight weeks for order handling, transportation and final delivery puts pressure on forecasting to be accurate, Roest points out.

If products can benefit from lower-cost labor and low cost components, they are candidates for production in an LCC and final configuration closer to the end market, says Roest. But when it comes to post-sale service and repair, those functions generally have to be near the consuming market.

Gaining proximity to market by moving to low-cost Eastern European countries can carry a price in productivity, Roest adds. In other LCCs, manufacturers have complained about quality problems and logistics executives express concerns for reliability of both the infrastructure and service providers. All of these issues are valid concerns in Eastern Europe and some of the other near-sourcing options. But, notes Ferrer, pointing to Turkey again, the deficits in logistics in Turkey and its connections with Europe are being addressed. A beneficiary of the effort is the Balkan region, another lowcost source for near-sourcing.

The road from Europe to Turkey essentially goes through the Balkan states, says Ferrer, and because of the high volume of traffic between the Middle East and Europe, the European Union has some major projects underway to widen the highway and build up new rail links. Additional developments in "sea highways," or short sea shipping, will help reduce congestion and provide additional transportation alternatives in the region. The EU effort, says Ferrer, is not limited to current EU member states. The infrastructure upgrades are being extended into future EU member states in the region. It's being paid for with EU funds and, says Ferrer, "They have no reason to say no and a million reasons to say yes."

While Ferrer speaks in macro terms about developments, he brings matters back down to a company level and says that success with outsourcing to LCCs needs an end-to-end view that includes strategic planning of supplier capacity as well as close cooperation in upgrading supplier relationships and supplier capacity. When a mismatch occurs as a result of a procurement strategy instead of a sourcing strategy, it can be devastating.

Ferrer offers the example of a European retailer whose opportunistic procurement-driven sourcing strategy drove purchases of cheap products in Asia. As a result, the company ended up with large warehouses to handle the Asian imports and, because procurement wasn't demand driven, the goods had to be heavily discounted to sell.

Developed countries in Europe are also benefiting from labor coming in from the low-cost countries of Eastern Europe. Roest says, for instance, that Polish workers can be seen in Dutch distribution centers. Wage laws don't allow employers to pay below-market wages to those workers, but the workers bring a flexibility and motivation that is helping to change attitudes in the Western European countries as well. The productivity levels in their home countries may be two or three times lower than in Western European countries, but for the opportunity to earn higher wages paid by Western European employers, these workers respond to Western management. It seems to be a good fit, says Roest.

It is sheer speculation whether the workers will carry these lessons back to their home countries and raise productivity levels there, but it is clear that over the next decade, wage levels in these nearby low-cost countries will edge upward and, if manufacturing growth is to continue, productivity will have to rise as well. It remains to be seen whether these LCCs will duplicate Spain's success and become industrial powerhouses in their own right, but for the moment, they are getting attention for the dual benefits of cost and proximity.

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