- China's sourcing wave

Date:  July 18, 2007 Author:  China Trade Gateway

Has your company been caught up by the sourcing wave that is heading for the mighty Middle Kingdom? If not, you are fast becoming a minority as your competitors and peers all take advantage of the sourcing opportunities presented by the Chinese Manufacturing Behemoth.  In boardrooms across the globe, the question that is asked is not “should we source from China?” but “when do we start sourcing from China?”. If your company has never looked at China or has looked at it in the past and not taken action, it is probably time to look again as China’s manufacturing capability is growing dynamically.

International fiants such as Wal-mart, General Electrical, Ford, Carrefour and others have already made the move and are already taking advantage of the cost savings that exist. McKinsey & Company reports that US retail giant Wal-mart bought about $15 billion worth of goods in 2003 and hopes to double that amount by 2007. 

Mid-size and small companies can also take advantage of the cost savings offered by China, and many are already beating their path to China. Even countries such as Mexico and Brazil, traditionally sources of low cost labor and production are themselves looking at China as a means to help them remain competitive as their currencies revalue.

China has rapidly become the sourcing destination of choice for companies globally and not just for low cost, low value, low technology goods but also for high-tech products for industries such as telecom, biotechnology, pharmaceuticals and electronics.  Whilst it is clear China needs to be at the forefront of one's sourcing strategy, many hurdles still remain and so a systematic and prudent sourcing strategy needs to be employed.

China sourcing – The positives
China globally has a reputation as a cheap manufacturing hub, and so for many companies entering China, cost advantages are still the primary motivator. Other factors such as product quality, capital avoidance and inexpensive R&D are all becoming increasingly important.

• Lower labor costs: China’s advantages relate to its access to the world’s largest labor pool with average hourly wages significantly lower than developed countries. A 2004 study by the US Bureau of Statistics reported that on average a factory worker in China earns a paltry 64 cents an hour - 20 times less than what a company would pay to the same worker in a Western country. Average hourly wages are even lower than Mexico’s and whilst labor rates are increasing they are certainly lower than those in developed countries.
  
  
• Large manufacturing capacity: China has abundant manufacturing capacity. With the government actively supporting State Owned Enterprise factories there has been plenty of capacity to meet the increasing demands from the Western world without consequential increases in price, at least until recently. The lower set up, land and factory costs also mean there are fewer overheads that are passed on to the end buyer.
  
  
• Lower capital costs: Foreign companies with a long-term interest in the Chinese market are also taking advantage of this ‘capital avoidance’ by buying land and setting up factories in the interior provinces of China at a fraction of what one would spend in their home country. The use of local components also helps to minimize input costs.
  
  
• Improvements in quality: While China’s low manufacturing standards are still a cause of complaint, there has been a noticeable improvement in production quality in recent years.   The increasing number of foreign companies moving production to China has applied pressures on factories to improve the levels of production sophistication and so quality with many factories now meeting international standards.
  
  
• Low-cost product design and R&D: China is the world’s third largest spender on research and development (R&D) facilities, and this has had lead to a consequential minimization of production costs and improvements in product development. These cost benefits and improved product development capability are further compounded by the fact that China produces an estimated two million engineering graduates a year who on average can cost one-tenth of an American engineer’s salary.
  
  

China Sourcing – The negatives
Sourcing from China is obviously compelling. However, it still comes with its challenges such as the following:

• Communication with suppliers remains a problem and whilst the level of English language proficiency is growing, it still continues to be a barrier especially in inland provinces.
  
  
• Product quality still remains a concern although improving. China has traditionally been a volume producer of goods with no focus on quality and quality control is still a prerequisite to ensure you get what you have ordered.
  
  
• Initial start up time for identifying a quality supplier or setting up your sourcing operation often takes longer than anticipated and involves ongoing management to ensure it succeeds.
  
  
• Intellectual property theft is still a vexed issue and foreign companies looking to OEM their products in China will find IPR protection will continue to be a major concern for the foreseeable future.
  
  
• Increased management complexity through the need to manage new supplier relationships or an overseas office in a different geography, time zone and place with cultural and language differences.
  
  
• Operation and supply chain challenges in trying to manage on time delivery of your goods from a geographically remote location which has different holidays and environmental factors out of your control that may impinge on delivery times (i.e. earthquakes, power shortages etc).
  
  

Sourcing success requires a plan & process
For those who have balanced the positives against the negatives and made the decision to source from China, the key to success lies in being clear on your objectives and expectations and in planning your approach. There are no short cuts in sourcing from China, you must do your due diligence and closely evaluate all suppliers. You must follow a systematic process.

Sourcing from China will typically involve the following steps:

• Firstly, you must understand and clearly define your needs, the product and technical specifications you require and the quality standards that must be met and be able to communicate them.
  
  
• Secondly, directly or through a representative, you will need to identify and evaluate suppliers to find one who can meet your requirements. This will entail factory visits and audits of multiple suppliers to establish their track record, manufacturing, capability, quality control procedures, performance capabilities, their financial situation, production capacity, quality of goods, client references, export history, IPR performance and their level of experience with Western companies and lastly their price competitiveness. Further, evaluations of the products you require will need to be undertaken to make sure they meet your technical and quality requirements.
  
  
• Thirdly, based on the above evaluation you will select the supplier(s) you will work with and enter into commercial negotiations to finalize pricing, payment terms, warranties and delivery requirements. The conclusion of this process will see you place purchase orders so that production commence.
  
  
• Fourthly, on the completion of production you will need to organize for the goods to be inspected prior to shipment by a third party inspection company or your representative in China to ensure that you are getting the quantity and quality of goods you have ordered.
  
  
• Finally upon passing inspection, the goods are shipped to the destination port of your choice.
  
  

The important thing to remember with China is that once you have secured your new supplier relationship, your work does not end there. You cannot sit back and expect your goods to be delivered on time as ordered and with no complications. Ongoing management of the supplier relationship is key to your sourcing success. Be sure you visit your supplier regularly and that you inspect the quality of all shipments. Sourcing from China is an ongoing process.

Choosing the right sourcing path
If you’re a company interested in sourcing from China, what are your options? 

Sourcing remotely
If you wish to source goods from China directly, there is no escaping the fact that you will have to go to China and meet with potential suppliers in person. Trade shows and online B2B marketplaces like Alibaba and Global Sources are good places to start your exploration for possible suppliers from the Chinese market. However, be sure to do your due diligence and visit their facilities as many companies represented through these mediums are not who they seem to be. Whilst many may say they are a factory, many are in fact trading houses or middlemen. Having gone to China and found your supplier it is possible to manage them remotely given the well-established communication channels that now exist. But managing remotely will mean if you have problems with communication, time and distance differences will exacerbate the problems. To successfully manage remotely it helps to have staff in your home office who speak and write Chinese. Furthermore it is important that you have been very clear on your requirements, and you should always ask for samples and digital photos before shipment and also have an independent third party undertake quality control.  However, you will never fully know if the product you have ordered meets your requirements until it is shipped and often it is difficult to get recourse from a new supplier whom you have not established relationship with. Furthermore, even if you are able to negotiate recourse you still will have missed orders.

Sourcing agents or representatives
For smaller companies, sourcing agents or representatives are a cost-effective means to manage your sourcing program from China. These agents will help you identify suppliers, manage the day to day relationship with the factory, provide quality assurance and perform logistic tasks and overall ensure you get what you ordered. They can be paid on a monthly retainer basis which will be based on the volume of work required or paid on a commission basis on top of the price quoted to you by the factory.

A presence of your own
Having your own team and office in China is probably the most effective way to develop and manage suppliers but it is also the costliest. A simple representative office with 3-4 employees can cost you anywhere from $10,000 to $25,000 per month. Each of the above approaches has merits but overall the decision on how you source from China is unique to each company and will depend on the volume and value of the goods you intend to source and the available resources both in dollars and management time to manage this. 

Conclusion
At the end of the day, we are all forced to live with the decisions we make but it is clear that if your sourcing strategy does not include China then you are at risk, as your competitors are either already there or are planning to go there. The hurdles of sourcing from China, however daunting they may be, can be overcome and those who have succeeded have demonstrated that the benefits far outweigh the challenges. China is going to be the sourcing destination of choice for some time. The question is clearly not if you should go but when. After all can you afford to miss the boat by not jumping on the current sourcing wave?

(Source - "Getting Sourcing Right in China" published in The McKinsey Quarterly, www.mckinsey.com; Doing Business in China, Enterprise Ireland, www.enterprise-ireland.com) Management of Quality Control & Compliance - ensuring products are free from defects and comply with the required standards

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