The Importance of Procurement in a Global Environment
Until recently, procurement was a necessary, but seldom celebrated, component of multinational corporations. But times have changed: These days, procurement organizations within companies are playing pivotal roles in the success of global firms in ways that old-fashioned purchasing managers could never have imagined. In this special report, Wharton faculty and procurement experts at The Boston Consulting Group discuss why the procurement function has risen to such prominence in a highly competitive global environment, and how, as supplies of critical commodities tighten and prices rise, companies can strategize to mitigate these and other risks.
Part 5: China Sourcing
Multinational corporations have been sourcing from China for years, but that doesn’t mean that all the questions have been answered about how to engage in procurement activities in the world’s fastest-growing economy. In this interview, David Lee, a partner and managing director at BCG, says that plenty of challenges remain. Among them: finding good suppliers that offer products at relatively low costs, and being willing and able to outsource a sufficient volume of one’s business to Chinese suppliers.
Knowledge at Wharton: We’d like to talk to you a little today about China sourcing. As you well know, that’s a very important and particular issue of interest to companies around the world. Can you begin by giving us an idea of how China sourcing differs from sourcing in other parts of the world?
Lee: I think China sourcing, to a certain extent, is very similar to a lot of the low-cost country sourcing or overseas sourcing. There are some things that are particularly different because China is still going through a lot of transitioning right now. So, there are a lot of issues that need to be addressed. For example, Chinese suppliers do not always have the same capabilities and the quality level can be highly uneven.
But on top of that, we have a very non-transparent supplier market. We don’t have, for example, a lot of the supplier databases that you would like to have in the Western world. When they first come to China, the first major problem a lot of companies face is: Where do you find a good supplier? There are definitely a lot of suppliers out there, but whether you can find a good one will be a big question.
And, of course, China is going through a lot of changes as we speak. Chinese culture, historically, is slightly different from the Western world in terms of language, in terms of culture, and in terms of the business norm because we are still going from a planned economy to a more open economy. All of these things are changing. I think one of the interesting things that a lot of Westerners will always say is, “When a supplier says yes, they don’t really mean yes. They are just very polite.”
Knowledge at Wharton: A moment ago, you said the lack of transparency can be a challenge for companies that want to source in China. How do organizations go about surmounting that challenge?
Lee: I’ve personally done a lot of sourcing in the West and also in China. In the West, things are relatively easy in terms of identifying the supplier market, so you can always go to some database and download a list of suppliers that are capable.
In China, there’s no such database. Everybody says they have some database, but our experience has been that most of the databases are about 50% wrong and then another 10% to 20% are outdated. So, you never really can find a very good supplier database.
Often, you need to do a lot of legwork before you can do the sourcing activities. This becomes very dangerous and very difficult for a lot of people who have no experience working in China. We have seen in a number of companies, when they do China sourcing, instead of casting a wide net to find the right supplier, they usually follow whoever your competitors are sourcing from and go find those suppliers.
So, we see that the good are getting better and the worst are still staying there without being developed. We see that quite often in the automotive sector. At the very beginning, five, six or seven years ago, when foreigners started coming to China to source, they all came to the same place. They all sourced the same parts.
Nowadays, with the supply base getting much more capable and the local demand getting higher, we see suppliers being developed to a certain level that some are actually supplying to Western companies for future models, which is a new thing in China.
Knowledge at Wharton: If an organization is dissatisfied or unhappy with the results of their China sourcing programs, what should they think about doing to improve their results? And secondly, is there any industry against which they can benchmark best practices, to try to find a good example to follow?
Lee: I think those are very interesting questions. First of all, when you say that a company is not doing well in China sourcing, there are usually two issues. Number one is they can’t find good suppliers that can supply them at a relatively low cost. Number two is they can’t move enough volume over to China. I think that these two things are usually interlinked, but they can also be separate.
What we have seen is that China has a lot of good suppliers that are capable. And in a recent survey with a number of China sourcing office directors, what we have seen is that the savings ranges from 10% to 60%. And on average usually it is about 20% to 30% on most commodities. If it is less than 20% then it usually doesn’t really make sense for you to source in China.
So, Chinese suppliers definitely do offer significant savings potential. But when we talk to these companies and ask, “Why don’t you source more from China?” the consensus is “because our headquarters is not willing to send more volume.” If you use baseball terminology, the catcher is always ready to catch but the pitcher is not ready to throw the ball. These are some of the issues that we see time and time again across all industries and across all companies.
We think that these are the major issues. Of course, if we talk to the R&D people, the engineering people, [and] the quality people at their headquarters, there are always reasons why they are not 100% willing to move their product over there. Extending the supply chains [and] the risk with changing suppliers — all of these are risks. But the question of how much risk each company is willing to take will determine how successful they are in the China sourcing arena.
Knowledge at Wharton: Despite the challenges that exist in China sourcing, I assume that you would say it’s still well worth it for companies to pursue China because they can really reduce their procurement costs. Is that accurate?
Lee: I think that would be right. But I would probably go a little further. If you don’t go to China and if you just stay with your incumbent suppliers, your competitors will not stay with you. Your competitors are going to move to China anyway. So, “What are you leaving on the table?” would be a question.
We already see that a lot of suppliers in China are getting to a kind of scale that is unheard of in the West. And they have the capability of eventually migrating to overseas markets and start attacking your home turf. So, having a China sourcing team over there, number one, can help you close that gap. Number two, it will also help you understand the supplier market dynamics so you can plan accordingly.
I think that recently BCG has worked with a number of clients that are expressing concern about “all of these Chinese [and] Indians” — or, in the old days, the “low-cost-country suppliers” — that are emerging very quickly and now they might be changing the dynamics of the markets.
Knowledge at Wharton: You mentioned a moment ago that of course you have a lot of experiences that you can discuss regarding BCG clients. I know that you’re probably reluctant to identify them. But can you think of an example of one of your clients which is doing procurement very well in China? And, perhaps you could give an illustration of why they are doing so well and what kind of steps they have taken in that area?
Lee: I can think of one very recent example. An automotive company came to China about five or six years ago to set up their China sourcing office. At the time, not that many people were thinking about China. But over the years they have increased their China sourcing volume substantially.
It’s still relatively small — around 5% to 10% of the global total spent. But it’s substantially higher than some of their competitors. How did they do it? When they came to China, instead of just looking at the supply base, they knew very well that in automotive, with the stringent requirements in the West — the PPAP, the APQP — all these things are pretty much a foreign language to a lot of the Chinese suppliers.
As a result, they’ve developed a huge supply development team focused on helping suppliers get up to the company’s standard and also up to the automotive standard. Through this process, they were able to develop suppliers that are much more loyal to them. Number two is that they are able to work with suppliers that are not locked in by their competitors because they were not the first one to move to China in terms of the automotive sector.
By doing so, they have created a supply base that over the years has blossomed quite substantially. And after five or six years, they are sourcing up to 5% to 10% of their volume from China. This is quite substantial for automotive companies, given the JIT requirements that you can’t source everything from overseas. So, I think that this company basically entered into this particular angle by leveraging supplier development.
Knowledge at Wharton: What sorts of benefits has this company particularly seen from its efforts in China? Can you tell us how much they’ve saved in terms of costs and other things that they’ve achieved?
Lee: Well, I think there have been substantial cost savings. And of course in the automotive area, what we have seen quite generally [is that] in most of the companies coming over to China to source automotive parts, in terms of casting toolings, they can save up to 40% to 60% from the cost that they would have paid if they were made in the U.S. or in Western Europe.
If you are talking about harnesses, if you are talking about aluminum wheels — some of these products range from the low teens to about 30%. So a wide range of products really depends on what kind of products you want to source and how well you’re sourcing.
Knowledge at Wharton: What are some of the misconceptions about sourcing in China that companies might have before they embark on that kind of an endeavor or when they are just getting into it?
Lee: I think that the one major misconception is: “Well, we need to go to China. Let’s build a China sourcing office and once you finish cutting the ribbon, that everything [will be] business as usual.” We have seen quite a number of cases in a lot of Western companies when they come to China that way.
Yes, of course you will always save money from China. You will always increase maybe 10% to 20% annually. We have seen a lot of the good companies doubling every two to three years in terms of their China sourcing volume. Given that you are starting from a very, very small percentage of turnover being sourced from China, unless you have quite a substantial increase in volume like this, you will not have a major impact in your organization.
I always work with our clients to give them an estimate. Usually it would take you years just to get 10% of your volume sourced from China. You are talking about, on average, saving about 20%. So that is probably about 2% impact on your EBIT. This is quite substantial, but it takes years for you to obtain.
The question for a lot of companies is, “How can I go beyond 10%? How can I go to 20% or 30%?” This will require a lot of commitment, not only from the CEO, but all the way to the operating-level people. A lot of the disconnect we have seen in the past is that the CEO will tell Wall Street about one thing, and then the operating-level people have no idea how he came up with all these targets. And as a result of this, they gave up. We have seen that happen all the time.
Knowledge at Wharton: Is there anything else that you would like to talk about to give our listeners an idea of what the current hot issues are in terms of sourcing and what the next couple of years are likely to look like in the area of procurement?
Lee: Well, I think the major issue that we have seen in the past — and probably will [see] in the near future — [is] convincing headquarters or convincing your technical team that China is a viable source. I think a lot of companies have found different ways to achieve that. Definitely, there are a lot of internal marketing tools that the China sourcing team leader is implementing in China, and [is] actually going back to the U.S. and to Europe to do a lot of marketing or a “road show” to tell everybody how great Chinese suppliers are.
We have seen some companies doing what they call “China Supply Day.” They fly a lot of their executives, including the quality people [and] the engineering people, to China to look at all these suppliers and have a sourcing conference in China.
One company has flown in about 70 people from all over the world to meet with 200 selected suppliers. And through this week of meetings, they have arranged about 400 face-to-face meetings, one on one, with some of these suppliers. As a result of these activities, they were able to increase the amount of sourcing.
I think given that I’m based in China right now, a lot of things don’t really surprise me anymore in China. But I remember when I was still working in the U.S. that a lot of the image of China was very backward – [that it was] not very automated, that machinery was rare, and that you basically have a lot of sweat-shop work. And I think this is far from the truth right now.
A lot of suppliers are extremely capable, highly automated, and as a result, by bringing a lot of the decision-makers to China to see for themselves, it actually opened their eyes and changed the perception. You cannot underestimate the impact of changing the nonbelievers [and] the impact of that on the entire organization. And by changing their attitude, the entire organization will start moving toward the right direction.