Domestic Costs of Foreign Sourcing

Domestic Costs of Foreign Sourcing

By Mike Jones
St. Onge Co.

Give or take, it goes something like this: How much would we save if we sourced the product we are manufacturing (or sourcing domestically) from China, Southeast Asia or elsewhere?

Then, the sourcing or manufacturing group gets some prices and adds in the costs of international transportation, tariffs, taxes and one-time investments, etc. And, if they’re more thorough than most, they remember to include an allowance for increased in-transit inventory. After they add up all the numbers, if international trumps domestic sourcing by more than 20%, they may pull trigger and go overseas.

Before we get back to the story, and the punch line, I need to make three caveats: First, I am by no means an international sourcing expert. I’m well aware that I have just oversimplified the decision making process—I hope. Second, while St. Onge Co. does plenty of work for manufacturing folks, personally, I work more with distribution and supply chain personnel and am therefore perhaps overly sympathetic to their cause. Third, I am by no means suggesting companies that decide to source internationally have made the wrong decision. Sometimes, they have, but most times, they have not. The problem is, no matter how sound the decision, more times than not, managers fail to take into account the implications to the downstream domestic supply chain.

In too many instances, no one consults U.S. distribution personnel—except perhaps to help with a transportation rate or two. Sourcing, of course, is not their area of expertise. They know little about the international playing field and, in some manufacturing-centric companies, they’re viewed as little more than a necessary evil.

Tangential side note number one: Regardless of how the Council of Supply Chain Management Professionals, American Production and Inventory Control Society, or anyone else may choose to define it, for most manufacturers, “supply chain management” does not include manufacturing or sourcing.

In my experience, the major item many fail to account for is an increase in domestic inventory and reduction in domestic service levels—almost always the result of a move to foreign sourcing.

Secondarily, those who move offshore rarely consider the implications to the domestic distribution network itself. When major sourcing changes occur, addressing these issues almost always occurs in a reactive manner and almost always by domestic supply chain personnel responding to a decision rather than collaborating with their sourcing counterparts. This is unfortunate. Both network and inventory optimization tools exist to provide valuable insights and cost estimates to the decision making process.

Tangential side note number two: Other, less quantifiable considerations that are frequently downplayed or disregarded include sales benefits of the 'Made In USA' label, supplier reliability, intellectual capital considerations and valuation changes in the Chinese yuan. And, don’t forget the risk of product flow disruption due to work stoppages, natural disaster, political turmoil, or God forbid, another terrorist attack. Heaven help us if anything happens to the Port of Long Beach. Luckily, hurricanes don’t hit the West Coast, but how quickly we forget Sept. 11, longshoremen strikes and the fact that China is a communist country.

Now, back to the lighter and more mundane topics of networks and inventory. First, let’s look at the domestic distribution network. I’ll keep it simple. If one day, I’m sourcing most of my product from the Northeast, and the next day, I’m sourcing it from the West Coast (i.e., China) or south Texas (i.e., Mexico), I might come to realize that my distribution centers are in the wrong place or are now the wrong size due to inbound freight and other considerations. Long story short, it would sure be nice to know about any sourcing decision before I sign a five-year lease renewal on my Ohio distribution center, decide to downsize my West Coast distribution center or commit 60% of my outbound shipment volume to a Northeast-centric carrier. With the aid of internal distribution experts and perhaps a little network modeling, you can make better sourcing decisions, avoid overflow warehouse space and minimize customer-service disruptions.

Finally, the punch line: inventory. Almost without exception, when I ask domestic supply chain managers if the inventory impact of foreign sourcing was properly anticipated and planned for, the answer is “no.” As mentioned earlier, that’s because it does not make the strategic-sourcing radar screen. It’s also because it’s difficult to quantify without the use of more sophisticated analytical tools.

Fortunately, those tools now exist. Unfortunately, few people are aware of them. Even fewer use them.

Generally speaking, here’s what happens. In addition to in-transit inventory, which is easy to quantify, domestic safety stock must increase if you expect to maintain current service levels. This is because, with few exceptions, foreign sourcing brings with it less favorable replenishment parameters, such as longer lead times, larger order minimums and, most importantly, greater lead-time variability. St. Onge Co. has done significant analysis to show that the latter—lead-time variability—is the biggest culprit.

If a domestic supplier is having a bad day, the usual seven-day lead time turns into eight or nine days. If the foreign supplier, or more likely, the foreign supply chain, is having a bad “day” (missed sailings, port congestion, customs holds, etc.), the usual 90-day lead time turns into 120 or 180 days. This brings with it cost, which can rear its ugly head in a number of areas: increased inventory, diminished fill rates, expedited shipping, outside warehousing, double handling of product and more.

For most companies, the lesser of these evils is increased inventory carrying cost, which brings with it increased warehousing cost. While less than an exact science, it is possible to estimate and anticipate these costs legitimately as part of the sourcing decision and planning process. Just remember, when planning the foreign, don’t forget the domestic.

Mike Jones is president of the St. Onge Co. (, 717- 840-8181, [email protected]), a supply chain and engineering consulting firm headquartered in York, Pa. He has spent most of his 14 years in the industry at St. Onge, managing the firm’s supply chain practice, which has performed hundreds of domestic and international network and inventory deployment strategy projects.

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