The American Chamber of Commerce in China released it’s annual white paper on the state of American business in China and it seems to back up a lot of what we’ve all been hearing lately; the cost of doing business in China is increasing. With 2/3 of US businesses claiming rising labor costs and other inputs are chipping away at China’s competitiveness, it’s no wonder so many companies are reevaluating their low cost country sourcing (LCCS) strategies. For example at the recent Spend Management Town Hall, Whirlpool’s SVP of Global Strategic Sourcing, Mark Brown, said “it’s a jump ball between Mexico [and China] to service the US market” (mp3 available here).

Lower labor costs, followed by access to alternative suppliers and localization strategies for local overseas manufacturing, are the main sources of motivation behind LCCS strategies. However currency fluctuations, extended supply chains, supplier capacity and product quality concerns are critical risk factors that must be managed in any LCCS strategy.

Best in class companies are approaching up to 40% of their direct material spend being sourced in LCCs with an average cost savings near 20%. So there’s certainly still savings to be had, but not without clearly defined goals and strategies. In my experience, these 10 components are critical to ensure your LCCS strategy keeps both your costs and risk low:

• Have a LCCS strategy - Seems obvious…but you’d be surprised. Invest in an analysis of your spend to determine the best country fit by category, realistic cost savings targets and organization requirements to manage your program.
• Total Cost of Ownership - Thoroughly test your savings assumptions based on a TCO framework that includes currency changes, all logistics costs including emergency freight requirements, extended working capital requirements, etc.
• Supplier qualification - Thoroughly prequalify new LCC suppliers, including site visits, and ask yourself what type of supplier you are willing to work with.
• Invest in supplier implementation resources - On the ground, technical sourcing teams will work with suppliers to make sure your identified sourcing savings really stick to your bottom line.
• Low cost may be close to home - Not all categories should be sourced overseas - think near shore (Mexico, CEE)
• Supplier development programs - Work with your suppliers overseas to explore mutually beneficial ways tot take waste out of their production process. These suppliers are typically very receptive to your expertise.
• In country audit and testing - Don’t discover quality surprises at your loading dock. Test your shipments in the LCC country of origin.
• Leverage 3rd parties overseas - Don’t try this all yourself. 3rd party specialists exist to assist you with LCC strategies as well as supplier research, qualification, implementation and development.
• IP - Protect your intellectual property by sourcing sensitive components and assemblies from different suppliers. Don’t rely on the rule of law to protect against potential IP theft.
• Be realistic - LCCS is a journey and it takes time to do it right. There are few quick wins that truly stick to the bottom line, however a diligent approach will permanently restructure your cost base.

David Morgenstern is a Managing Director in Ariba’s Spend Management Services group with extensive experience in establishing strategic sourcing and low cost country sourcing programs. Since joining the company in 1999, David has developed Ariba’s global sourcing practices in Europe, Asia and Canada, and has served the private equity, manufacturing, automotive, consumer and public sectors. David has spent over 11 years working overseas, primarily in Asia, and holds a MBA from INSEAD. David currently leads Ariba’s global private equity and diversified manufacturing practices.

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