Global sourcing: What you need to know to make it work

Tim Minahan, special to

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Global sourcing can help U.S. companies reduce their costs by 10% to 35%. But sourcing decisions require companies to balance the tradeoffs of cost, performance and risk, many of which are hidden.

There is no disputing that global sourcing is on the rise; the U.S. alone imported more than $1.3 trillion worth of goods and services in 2001. It is similarly obvious why offshore sourcing is so attractive: most companies report a 10% to 35% cost savings by sourcing from low-cost-country suppliers.

But what exactly does global sourcing entail? Just how should U.S. companies identify, qualify and negotiate with offshore suppliers? And how do they ensure that price savings identified with offshore sources actually translate into lower total costs without disrupting quality or performance requirements?

Global sourcing entails identifying, evaluating, negotiating and configuring supply across multiple geographies to reduce costs, maximize performance and mitigate risks. Sourcing is also a cornerstone of total cost management (TCM), a technological and process framework for the optimal alignment, management and control of the total cost of ownership (TCO) of supply relationships.

Every sourcing decision requires companies to balance the tradeoffs of cost, performance, and risk. However, these factors are heightened when sourcing globally because of the variability of non-price or "hidden" cost factors such as cross-border freight and handling fees, complex inventory stocking and handling requirements, and a multitude of documentation and regulatory compliance requirements.

As a result, global sourcing is best defined as the process of identifying, evaluating, negotiating and configuring supply across multiple geographies in order to reduce costs, maximize performance and mitigate risks. Global sourcing factors that must be understood and balanced can be segmented into six categories:

  1. Material costs -- price, setup, tooling, transaction and other costs related to the actual product or service delivered

  2. Transportation costs -- transportation, drayage, fuel surcharges and other fees included in a freight rate

  3. Inventory carrying costs -- warehousing, handling, taxes, insurance, depreciation, shrinkage, obsolescence, and other costs associated with maintaining inventories, including the cost of money or opportunity costs

  4. Cross-border taxes, tariffs, and duty costs -- often referred to as landed costs, which are the sum of duties, shipping, insurance and other fees and taxes for door-to-door delivery

  5. Supply and operational performance -- the cost of noncompliance or underperformance, which, if not managed properly, can offset any price variance gains attained by shifting to an offshore source

  6. Supply and operational risks -- including geopolitical factors, such as changes in country leadership; tariff and policy changes; and instability caused by war and/or terrorism or natural disasters (e.g., typhoons, earthquakes) and disease, as in Severe Acute Respiratory Syndrome (SARS), all of which may disrupt supply lines

To understand and manage these factors, supply managers must stay abreast of tariffs, trade regulations and geopolitical landscapes that are constantly in flux. Understanding and optimizing the total cost of offshore sources also requires supply managers to have a solid understanding of the Harmonized System (HS) Code and International Commerce Terms (Incoterms).

An HS Code is a globally accepted six- to 10-digit number used to dictate the fees and restrictions associated with goods crossing a border. Globally, there are hundreds of thousands of HS codes, each representing a different tariff or potential trade restriction. International trade requires that these codes be assigned (i.e., "harmonized") prior to any goods crossing a country border.

There are 13 standard International Commerce Terms (Incoterms) that define the roles and responsibilities of buyers and suppliers for cross-border shipping. Each Incoterm assigns a different set of responsibilities, costs and liabilities to the buyer and the seller.

Such variables and uncertainties give global sourcing attributes that are similar to financial management, requiring companies to determine near- and long-term goals and to develop a balanced supply portfolio that includes the appropriate and comfortable mix of cost, risk and performance. In this scenario, sourcing managers function much like portfolio managers for the supply chain, identifying and evaluating new supply opportunities and constantly adjusting their companies' supply mix in an effort to derive optimal performance.

Just as the best financial portfolio managers rely on market intelligence and tools for analyzing financial vehicles, supply managers must have access to current information on global supply markets, as well as the proper methodologies and analytical tools to make sense of such information.

Tim Minahan is vice president of supply chain research at Aberdeen Group, a Boston-based IT market research and consulting firm.

To read more articles like this one, visit Aberdeen Group and register for free online access to Aberdeen's IT market research and analysis, and to subscribe to technology-specific e-newsletters.

© 2003 Aberdeen Group Inc.

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