Approaches to International Sourcing

By Robi Bendorf, C.P.M.

(The following is the basis of the feature article in September 1998 issue of Purchasing Today)

With ever increasing global competition and demands for continuous cost improvement, today's purchasing management is being challenged with the question, "Are we buying from the best place in the world?" Depending on your company's internal resources, skill sets, and long term strategies there are many ways to obtain the answer. In this article we will discuss the advantages and disadvantages of the following five most common methods that US companies use to approach international sourcing:

US Sales Contacts of Foreign Suppliers

US Sales Contacts of Foreign Suppliers abound in the U. S. and exist in all traditional Supplier forms including Sales Representatives, Agents, Distributors, Importers, Direct Sales Offices, Trading Companies, Brokers etc. We distinguish them from other global sourcing approaches in that they are undisputedly working on behalf of the Supplier. Our approach to them is essentially the same as traditional US Supplier relationships and this of course is their greatest advantage, since they generally make buying from overseas extremely simple. They generally handle all communications, logistics, import, contractual, and pricing issues on behalf of the foreign Supplier to the point that the US Purchaser may not even know the name of the foreign Supplier.

Sparing the Purchaser from dealing with the many issues we will discuss later in the Direct Approach, is of course a great advantage, particularly if the Purchaser is limited in resources and skill sets, however we should point out the disadvantages. Based on their knowledge of the US market, Sales Contacts of Foreign Suppliers will base prices, not so much on the overseas production cost, but on what the US market will bare thereby often depriving the you of significant savings opportunities. There is of course the added cost of the US sales operation that must be included in the price and rarely will the Purchaser be notified of the positive impact of currency exchange rates on the cost. This is a particularly important issue presently since the Dollar has strengthened significantly against most major currencies in the last 12 months. One Purchaser was extremely upset to find out that their US Distributor for pipefittings coming from Italy had not passed on the 11% savings resulting from the more favorable US Dollar to Lira exchange rate which had occurred in 1997. And finally, although in some cases the Purchaser can insist on dealing directly with the foreign Supplier, usually the Supplier will require the Purchaser to place orders and communicate through the US Sales Contact.

US Global Sourcing Companies

Purchasers can take advantage of the capabilities and experience of US Global Sourcing Companies. As in the case of many areas in international business, this segment is not well defined so that Purchasers can find these Sourcing Companies having numerous classifications. Whether they are called Trading Companies, Third Party Sourcing, Importers, Brokers, Global Search or Sourcing Companies, they are distinguished from US Sales Contacts of Foreign Suppliers by the fact that they represent the Purchaser and not the Supplier.

The advantages of using the US Global Sourcing Company approach can be summarized by stating that they can makes buying internationally as simple as buying form the Supplier across the street. Usually they provide the following services:

Because US Global Sourcing Companies have "been there, done that" many times, utilizing them for international sourcing can frequently speed-up the global sourcing process, improve the potential for success, reduce the amount of internal sources required, and eliminate the need for the development of internal global sourcing capabilities. This would apply not only to the initial global sourcing effort, but also to the ongoing global procurement activities. The Purchaser also has the advantage that most, if not all, of the initial search cost is borne by the Sourcing Company and if insufficient savings are obtained, then the Purchaser has no further exposure.

The major disadvantages of using US Global Sourcing Companies for global sourcing fall under the categories of increased price, reduced control, and the failure to develop internal capabilities that may be essential to maintaining competitiveness. Increases in price vary widely depending on the type of Sourcing Companies utilized, their relationship with the Supplier, the relationship with the Purchaser, annual volume from the Purchaser, and the services required. Generally, Sourcing Companies who supply all the above services for made to print items, will charge between 7 to 20% over their direct costs (goods, freight, duties, insurance, broker, etc.), not including inventory carrying cost. Although this can appear high, for many Purchasers the Sourcing Companies fee is a good investment when compared to the cost of developing in-house expertise, lost or delayed savings opportunities because of lack of expertise, or the cost of moving through the learning curve.

Reduced control must be taken into consideration when using a US Global Sourcing Company. Most Sourcing Companies will have formal agreements with both the Purchaser and the Supplier to insure their continued involvement for, if not the life of the project, at least a 3 to 5 year period. This makes it extremely difficult to remove the Sourcing Company if they do not perform or if the Purchaser wants to go direct to the Supplier on additional items. Although Sourcing Companies do not usually restrict direct communication between Purchaser and Supplier, as a practical matter, most communications flow through the Sourcing Company. As a result, the beneficial exchanges between Purchaser and Supplier personnel who have specific product knowledge may not occur, and product or process improvements may be missed.

US Global Sourcing Companies are generally used to obtain the advantages already noted and as a result the Purchaser will most likely continue or increase their dependency on Sourcing Companies since there will be little or no impetus to develop global sourcing capabilities in-house. The Sourcing Company basically becomes the Purchaserís international purchasing department and as a result the Purchaser is limited to the basic country, product, and Supplier focus of the Sourcing Company. As noted by Donald L. Wineman, C.P.M., president of Marston Group in Asheville, NC, US Global Sourcing Companies tend to be pretty specialized so the Purchaser has to make sure that there is a good "fit" in product knowledge. Another issue presented by Ken Gallier, President of WTC Services in Pittsburgh, Pa, is that since Sourcing Companies are usually focus on just one or a few countries, opportunities in other parts of the world are not explored; nor are products considered by the Sourcing Company that cannot easily bare the Company's price adder and still offer savings to the Purchaser.

Overseas Sourcing Representatives

Overseas Sourcing Representatives (OSR) can be a valuable resource in the Purchaser's efforts to determine the best value in the World. They are based in and usually are citizens of the target country who have extensive knowledge in purchasing, the capabilities of the local Supplier base, and acting as buying representatives for Foreign Purchasers. They range in size from one-person operations to companies with large staff's with numerous departments specializing in specific commodities. They routinely provide the following services:

Just like US Global Sourcing Companies, OSRs can greatly speed-up and improve the success rate of international buying projects. Although it is not like buying across the street, since the Purchaser must communicate internationally and usually handles all import details, the OSR does give the Purchaser what amounts to an experienced purchasing department in that country. Since most OSRs work on commission paid by the Purchaser, the Purchaser does not incur a cost unless the OSR comes up with a good Supplier used by the Purchaser. This is both good and bad news, since the OSR will not continue to support the Purchaser's Global Sourcing efforts unless there are financial successes for the OSR along the way.

Finding the best Supplier in a country is usually made easier by using an OSR since they know the reputations of the Suppliers and are more likely to find the small obscure Suppliers who often offer the greatest values. Another advantage confirmed by many veteran international Purchasers is that OSRs can be invaluable in negotiations since they know the customs, culture, and the objectives of the Supplier in ways not known or easily understood by the Purchaser. OSRs also have the ability to make in country visits by the Purchaser much more productive since they handle the logistics and have reduced the potential Suppliers to only those that they know have a chance to be qualified. And a final advantage is the ability of many OSR's to provide technical expertise and perform or arrange for quality inspection.

The major disadvantage in using an OSR is that they will add 5 to 20 % to the direct material cost. As in the case of the US Global Sourcing Company, often this may be money well spent. Most OSRs will agree to a sliding scale of commission depending on the annual activity with the Purchaser and the number of services being performed. Although there are many potential OSRs in each country, their capabilities and performance vary widely so that Purchasers have to exercise a great deal of due diligence in the selecting process. Additionally OSRs are usually good in just one country or in some cases good in only one major city, so that if an area such as Asia is targeted, the Purchaser will have to select OSRs for each targeted country. Since OSRs may also be limited in product expertise, specializing in stamping, castings, or electronics for example, Purchasers having varied product categories to source may to do well to have multiple OSRs.

The same control issues noted above for the US Global Sourcing Companies applies to OSRs as well. Purchasers most also be concerned that the Supplier may be paying a finders fee or sales commission to the OSR. Formal agreements between Purchaser and OSR usually specifically prohibit this, but veteran international Purchasers admit that it is difficult to confirm compliance with this provision. For Purchasers who are not committed to long term global sourcing strategies, or have limited resources to devote to global sourcing activities, the OSR approach should be considered.

Direct

With today's improved communications and the availability of high quality Suppliers all over the World, many Purchasers deal directly with the Supplier in the foreign location without the use of any third party. According to a survey reported in Purchasing (April 97), 62% of those who source overseas, use the Direct approach. When considering whether or not to use the Direct Approach, Purchasers most first understand that all the services identified above as being provided by US Global Sourcing Companies and OSRs, will have to be provided by the Purchaser in the Direct Approach. This means that the following skill sets will have to exist or be developed by the Purchaser for maximum success in International Sourcing:

In addition to the above skill sets, the Purchaser most also have available the financial and human resources to carry out the Global Sourcing Process (see "Implementing Global Sourcing", 83rd Annual International Purchasing Conference Proceedings). These resources often involve the need for additional people and considerable monies for travel, research, training, qualification and approval.

For most Purchasers, the decision to go Direct should be based on the expected volume of international purchases, the commitment to long-term international sourcing strategies and the internal resources available. These were the criteria used by a Midwest manufacturer, where both a long-term international strategy was wanted and sufficient resources to develop in-house capabilities were available. Based on an initial analysis, 174 ďA" parts with annual activity of $56 million were selected for global sourcing consideration. Preliminary savings analysis suggested that savings of 28% of the total parts cost might be available. This savings estimate was based on the lower labor and overhead costs found overseas and did not include the additional costs that would be added by using a 3rd party. As stated above a third party could be expected to add 5 to 20 % to the overseas purchased price or an annual cost of between $4 million to $11 million if all items where purchased overseas and through a third party. Assuming that approximately 1/4 of the potential items where purchased overseas and through a 3rd party, would still result in added cost of $1 million to $2.8 million for the 3rd party involvement. This amount is far in excess of the $300,000 to $400.000 estimated for the Company to perform global sourcing directly. Based on this analysis, the Purchaser decided to use the Direct approach in order to gain the advantages of greater control, development of internal capabilities, avoiding the country preferences of 3rd parties, and obtaining lower total material cost.

IPO

Having an International Procurement Office (IPO) is "actually" having the Purchaser's own Procurement Operation located overseas. An IPO is owned and operated by the Purchaser, staffed with the Purchaser's employees and does sourcing only for the Purchaser. According to the survey referenced above, 8% of those that do source overseas, do so through an IPO.. The best IPOs have not only experienced buyers, but engineers, quality and production personnel as well. IPOs while providing all of the services defined above for the OSR, also gives the following advantages to the Purchaser over the OSR:

With all the valuable services provided by IPOs and the above advantages, why do not all international Purchasers use them? The major reasons are that they are costly and challenging to operate, usually difficult to staff, and add to the Purchaser's head count. Although expenses vary from country to country, office space, travel, and communications cost are usually much higher overseas than in the US. According to Dick Lock, Principal of Global Procurement Group, successful IPO expense rates are about 5% at the $10 to $15 million per year of IPO volume and 1 to 2 % at over $100 million. Since Dick and other IPO experts strongly recommend that IPOs be staffed by local people, finding and retaining the 4 to 5 high quality loyal employees is a major challenge for IPOs and sending over expatriates is usually too expensive. Another issue is how the IPO is to be funded; Purchaser's general business expense, markups on IPO volume to the Purchaser, or variations of both? Even with an IPO, the Purchaser must still develop import capabilities. These issues notwithstanding and because of their many advantages, IPOs should be considered when there is sufficient annual volume to cover expenses, a long-term commitment to the country or region, and the Direct Approach is not providing the expected results.


By Robi Bendorf, C.P.M., principle of Bendorf & Associates Consulting in Pittsburgh, Pennsylvania (click here for a bio).

http://www.bendorf.com