China Moves From Number 1 to Plus 1

Nov. 1, 2008
The ripples from the US banking crisis have spread far and fast, reaching China's key production areas as US and European consumers slow purchases and

The ripples from the US banking crisis have spread far and fast, reaching China's key production areas as US and European consumers slow purchases and retailers cut back on orders. Steve Trussell, VP Global Sourcing & Procurement for Applica Inc., commented during a presentation at the Council of Supply Chain Management Professionals (CSCMP) annual conference that he had heard that as many as 20,000 businesses in China had closed. “Bleak is a strong word,” he added, saying that there were still plenty of opportunities in China.

Aware that there is more talk now of companies pulling some or all of their sourcing out of China and moving it closer to home markets (Eastern Europe for the European Union and Latin America for the US), Trussell and his fellow panelists supported an approach described as China Plus One where some sourcing may be shifted to another market to take advantage of some cost savings.

There is too much already invested in China for it to disappear as a sourcing center, says Mike Ksiazek, an independent sourcing consultant. There's too much infrastructure and too many products outsourced there for it to disappear. The reality is, says Ksiazek, “Five years ago, I had 17 factories, and today I have three. Those 14 factories, the buildings are gone, the equipment is gone, the people are gone, and the technology is gone. It's all over in an Asian supplier somewhere.”

It's not a choice where you can say, “China's not viable bring it back,“ he continues. China's going to be there. Where there are opportunities, start looking at other countries, he suggests. One of the countries getting a lot of attention is Vietnam. Ksiazek notes he has been able to take a fair amount of commodity products from China into Vietnam. In his case, it wasn't driven by cost as much as it was by dumping duties on the imports into the US. “You have to be cognizant of the market conditions. Be focused on what's changing in your environment. And have your strategy in place and your means in place to determine what you need to go off and do to be successful,” he says.

One solution for Ksiazek was to revisit a former sourcing location, Egypt. Earlier, he had used Egypt for some products, but the currency value went up and costs rose, and so he had shifted sourcing elsewhere. Now, he's looking at Egypt again, but he points out that it isn't always easy to move around. Commodity products can shift pretty easily when a lower-cost opportunity presents itself, but more highly engineered or value-add products are harder to move. That's where each of the sourcing professionals stresses relationships. It's an opportunity to work with your current supplier to help them improve efficiency, productivity and their own profitability to strengthen the bond.

There's no one-stop shop that can pick up all of China's manufacturing, says Ksiazek. India may be put forward as an option, but it has infrastructure problems. Vietnam can take some of the work, but it has a limited workforce and no deepwater ports. The reality in Vietnam, says Mike Matteo, SVP, ThreeSixty Sourcing, is that it has a workforce population of 22 or 23 million people, about the size of a province in China. Some key industries have already staked a claim on much of that working population, including the apparel industry and the furniture industry. Finding qualified workers can be a challenge. But in a China Plus One strategy, where you are looking for a way to mitigate some risk, it is one means to balance the supply chain by moving some of the less highly engineered products to a sourcing country like Vietnam.

In fact, says Matteo, there are no deepwater ports in Vietnam so goods moving from there will transit to Hong Kong or Taiwan on feeder vessels before being shifted to larger ships for the bulk of the journey to the US market. That can add cost, so you need to look at the best total-cost decisions. That comes back to knowing your suppliers and their strengths and weaknesses.

For those value-added products, says Ksiazek, it may be harder to shift to a new source, so you need to focus on working with some core suppliers to increase their productivity. “Focus on their success because you just can't find another $150 million cost of goods appliance maker out there. They're just not there.”

An alternative for some of those commodity goods can be within China but outside the current highly developed regions. As with India, though, one of the issues is infrastructure. But China does have the ability to mobilize quickly and it will develop the infrastructure to support development in target areas like Western China.

“We think of it as almost sourcing from another country,” says Ksiazek. “Five years ago 80% of my factories were in the south of China, today 50% are in the south.” The center of gravity may still be largely in the south, but there is a strong draw to the North and West.

Finding resources can be a complex process, and the procurement experts agree that while many companies get started by working with brokers or trading companies, the transparency is important along with the relationship with the supplier. Matteo says even when he's using a broker or trading company, he likes to be able to go to the factory and see it, touch it, feel it, kick the tires and have a relationship with the factory owner. It's often beneficial to have a third party involved for sourcing because you don't have the “feet on the ground” he continues.

Trussell sees an advantage to using a broker or trading company when the sourcing arrangement is a “small spend” where there isn't the justification for putting people in place. Or, he says, a broker can be valuable if you're new to the environment or country. He points out that he'd rather control his own destiny in his sourcing and even when using a broker, he wants to see the factory and have that transparency.

Ksiazek adds that everyone starts with brokers and trading companies because that's how they gain experience and knowledge in different markets, but factories in low-cost countries like China are more sophisticated now and the actually want to work directly with the customer, they want that relationship themselves, they don't want a middleman between them and the customer.

Relationships are very important, not only to achieve the goals of the contract, but for resolving disputes. Often the contracts will state what recourse is available in a dispute, says Matteo. Arbitration is often the vehicle specified, but the reality is that enforcement may be difficult. Most suppliers will sign documents and agree to the terms and conditions of the purchase order, but part of the reason they will sign is because they know the enforcement will be extremely difficult, continues Matteo. “It comes back to the leverage you have with that supplier either through your relationship or through financial means.”

In China, everything is negotiable, says Ksiazek, even something you negotiated yesterday. He includes arbitration clauses in contracts, but agrees that actual experience indicates the resolution will come down to the relationship. Trussell points out that while you're arbitrating an issue with your supplier, you can run into serious customer service issues. You back yourself up by being dual sourced, by having back-up choices. That creates competitive tension, adds Ksiazek and your supplier is less likely to “hold you hostage” because they know you have the ability to move that product. At the same time, you have your unpaid bills as financial leverage to get the issue resolved.

Dual sourcing does come back to the China Plus One strategy in that the alternative source can be outside China, but the three procurement professionals agree that it also works to have a second source inside China.

Safety and security have become an ever-larger issue for products originating in China. On the procurement side, as new safety regulations come into force, they are added to product testing and quality control procedures. But on the issue of security, one of the ongoing arguments, says Matteo, is who should be responsible for input of all of the information that is required by US Customs and Border Protection (CBP). The customs brokers are saying it should be the forwarders, the forwarders say it should be the steamship lines, and the steamship lines are saying “No, not us,” says Matteo. The truth is, the importer is ultimately responsible, he points out.

New regulations such as the 10+2 rule won't add much if you have already been complying with the regulations that were in place, continues Matteo. Ultimately, he says, the importer will end up entering the information or the importer's logistics agent will have that responsibility.

In addition to the safety and security compliance issues, says Ksiazek, you have social compliance issues like child labor laws, working rules, health conditions and hazardous materials. There's a very different level of trust you need to have with your Asian suppliers, he continues. There can be trust, but there also needs to be verification. “Every container I ship out of China is 100% inspected,” he points out. “This is just another reason to say I have to have transparency throughout that supply chain.”

Offering the example of trying to get “green” certification for a line of products, Ksiazek notes that requirements can extend back to knowing where the power came from that powered the plant that made the product. If you're working with a broker, you don't even know where the plant is, he says. “It comes back to having a supply chain in China that is transparent, that is visible, that you understand and know how it works.”

A major challenge operating in China is the need to have people in place and finding the right people. Not only is it difficult to assess experience and skills (what's on the resume may not resemble actual experience) but also competition is heavy to recruit similar skills from one talent pool.

The manager you hire may be lured away by a 5% salary increase at a plant across the street. And the problem can be even more dramatic in a China Plus One context where the wage inflation can run much higher. If you don't provide it, the worker can get it at the plant across the street. So, if the first problem is recruiting, the second is staying ahead of the wage inflation to retain good workers and managers.

As current economic trends play out, China and other Asian sourcing sites continue to be a significant part of many supply chains and will remain so. Flexible strategies that supplement China sourcing with back up sources and suppliers in Asia or closer to the consuming market and strong relationships with suppliers are critical to maintaining quality and a smooth flow through extended supply chains. And, say the experts, there is no substitute for visibility, regardless of how many layers exist in that supply chain.