www.scemagazine.com ISSN 1742-447XJuly/August 2008
GettinG Back to Your rootsHow to Manufacture a Better Future
Make it … Store it … Ship it … Make it … Store it … Ship it … Make it … Store it … Ship it
GloBal sourcinGA changing role for China
supplY chain FraudThe unacceptable face of globalization
e-solutionsGet closer to your customers
short-sea shippinGMaking sea-freight simple
www.scemagazine.com July/august 200830
global sourcing
T he gap between Chinese
manufacturing costs and overseas
price points is closing. With
increasing input material and labour
costs, companies around the globe are
losing competitive advantage. Asia Pacific
Directors are feeling the squeeze as P&L
statements reflect declining margins.
Currency exchange rates are one external
factor increasing costs. Between May 2007
and May 2008, the Chinese RMB (CNY)
appreciated by 9.69% to Sterling, 9% to the
US Dollar, and depreciated against the Euro
by -4.1%, so only in the EU did products
from China gain profit margin as a result.
As currencies fluctuate, every global supply
chain is affected.
Other internal upstream processes in the
China supply chain create costs. Consider
localized transportation and inventory
management. With increasing fuel prices
and inefficient logistics, such as routing
and material handling, further profits are
sacrificed. The positioning of inventory
throughout the global supply chain greatly
affects material flow costs as well.
With a limited knowledge of the realities
in the China supply chain, few companies
have been able to adjust their global models
to protect profit margins. Alternatively,
companies are beginning to consider
substitute manufacturing locations.
In developing a long-term sustainable
advantage, productivity and efficiency
throughout the global supply chain will
remain critical.
Face the RealitiesIn 2006, Hewitt Associates and the US
China Business Council estimated that
average salaries increased by 7–9% in tier
one Chinese cities. Similarly, raw material
prices have risen by 10–30%. In 2007,
VAT refunds were reduced or eliminated,
influencing export oriented businesses.
This profit erosion has contributed to the
closure of more than 10,000 manufacturers
in Guangdong province. To establish
advantages in the next wave of China’s
development, greater focus will be placed
specifically on the upstream China supply
chain. Where do we start? One area is
inventory management.
When considering China’s inventory
management, including raw materials,
work-in-process, finished goods and
in-transit, opportunities for improvement
are apparent. For instance, the IBM
Global Business Services 2007 Mainland
China Value Chain Study (IBM Institute
for Business Values, October 2007)
reports 66% of local Chinese companies
have cash-to-cash cycles of greater than
30 days. This is compared with 60% in
Europe and 59% in North America. Cash
flow velocity is important for inventory
management, capacity and to strengthen
productivity, all of which can reduce costs.
Cash flow velocity is important for inventory
management and to strengthen productivity,
each of which can reduce costs.
Raw material prices are rising. In some
industries, the annual increase is in excess
of 50%. In China, inventory management
polices are commonly the responsibility
of the manufacturer; however, procedural
knowledge may be underdeveloped.
Stock-outs and delays are frequent. This is
compounded by rising prices and limited
cash flow. Improved processes are needed
to manage supplier selection, material
handling, storage optimization, inventory
accuracy, re-order point policies, and cycle
and lead time considerations.
Work-in-process inventory is viewed in
a similar manner. Rarely are operational
procedures audited to identify process
efficiency or continuous improvement
opportunities. Assembly lines, for example,
are commonly designed without quantitative
analytics including functionality and time
optimization for material flows.
The IBM Study provides further key
indicators related to finished goods inventory
as well. For China’s local companies, 97%
report finished goods inventory turnover of
the rise oF GloBal ManuFacturinG coMpetition
‘East cheap, West dear’ is too simplistic a view of global sourcing, argues Bradley A. Feuling, CEO, Kong and Allan.
2008 July/august www.scemagazine.com 31
four turns or higher. This figure compares
with companies in Europe at 78% or North
America at 68%. Some may initially identify
this as a strong metric. What we see are
potential inefficiencies.
The key piece is the denominator —
inventory. Many survey respondents were
export-oriented. This means finished goods
inventory will naturally be low. Considering lead
times, this may reaffirm an ability to maintain
a high supply chain service level, yet at a
significant cost. By not holding finished goods
in China, there is a lost opportunity of inventory
balancing between a manufacturer, in-transit
and a customer’s distribution location.
SynchronizationConnected to the discussion of lead times
and inventory management are three further
areas of consideration. These are logistics,
capacity management and demand-
production synchronization.
The Chinese market is highly fragmented.
Some estimate more than 700,000 registered
third-party logistics (3PL) providers exist
with an average fleet size of three trucks.
According to the JLJ Group, China: Logistics
and Distribution Industry (March 2007),
20% of local Chinese companies utilize 3PL
outsourcing and logistics costs are 20% of
China’s total GDP. This compares with, for
example, 9% in the United States.
Here, it is clear, local logistics costs can
be reduced. Areas such as consolidation,
route optimization, cross-docking and
in-transit merging are developing, yet the
knowledge for effectively building these
models is limited. Stronger warehousing and
distribution networks continue to expand
as second and third-tier city investment
increases. Hub and spoke designs are only
starting to become defined.
Capacity management in China is
another important consideration: differing
perspectives exist; on one side, competition
in many industries has created low capacity
utilization for individual manufacturers;
in other cases, foreign suppliers may
be at near full capacity with high quality
production and demand. In this case,
initial capacity audits are essential for both
operations and supply chain throughput.
Capacity goes beyond production when
taking into account inventory and logistics
management. Production planning, new
product ramp up, and expansion will face
delays if capacity is not properly managed.
By assessing the end-to-end supply
chain, companies can mitigate the risk of
capacity bottlenecks.
Demand-production synchronization is
more commonly an afterthought in low cost
sourcing. For a manufacturer to accurately
maintain inventory, prepare an accurate
production schedule and deliver in a
required time frame, demand accuracy is
critical. In most cases, overseas orders are
placed or demand forecasts are adjusted
without taking into account production
and delivery lead times. Problems arise,
costs increase, quality variability grows and
product shipment is delayed.
To create a competitive advantage,
suppliers and buyers can no longer operate
in isolation. Co-ordination is becoming
increasingly essential, bringing the world
closer together.
If You Know a Better Hole ... ?With the realities of the China supply chain,
both local Chinese and Western companies
are considering alternative low cost
manufacturing countries. Locations such as
Laos, India and Vietnam, in order of export
growth from 2002–2006, are becoming
influential destinations. As in China 15 years
ago, labour, overhead costs and production
volumes are critical. When analysing
substitute manufacturing locations, which
direct and indirect costs may create cost
prohibitive operations?
Local logistics influence direct and indirect
costs. Laos, a landlocked country, is a
clear example. Although export from Laos
increased by 50% year-over-year in 2006,
according to the Asian Development Outlook
www.scemagazine.com July/august 200832
global sourcing
2007, transportation to the
nearest port will traverse
multiple countries. The
complexities and costs
undoubtedly increase. In
general, inventory holding
costs may be lower based
on overhead and labour, yet the
question again becomes lead time.
Here in-transit inventory based on
shipping volumes paired with lead time
will influence total supply chain costs.
Infrastructure is a key factor impacting
logistics. Roads, rail, ports and airfreight
capabilities must all be considered. When
compared with China, many alternative
sourcing locations have invested little to date
in developing freight capacity.
Likewise, material handling is a concern. A
basic understanding of packing and physical
handling will be lower where investment in
training has been minimal. This can influence
product quality and potentially upstream
production. Consider India, where multiple
provincial borders may be crossed in-transit
to reach a port. Each border check adds
potential risk for product damage.
Building on these
foundations, inventory
management may add costs to
the supply chain. Raw material
procurement is importantly different.
For substitute sourcing locations, raw
materials will often be imported, increasing
costs and upstream lead times. This
regularly leads to decreased in-transit
inventory operational efficiency. Demand-
production synchronization again becomes
a key through calculated planning, yet even
greater knowledge gaps in manufacturing
systems may exist.
Technology and training investments
are also important factors. What type of
manufacturing capabilities do existing
suppliers utilize? In China, much of the
manufacturing technology may already be
present, but is the same true in Vietnam?
Integrated software is growing in China,
although from a low base. In other
destinations, the reality is an even lower
acceptance of systems such as EDI/INT,
with the exception of India. Investing in
people is important to develop leadership
and managerial talent. China in most cases
is farther along the project management
and manufacturing operations talent
development cycle.
Last, capacity management and utilization
in alternative sourcing locations should be
a focal point. China continues to invest
in significant manufacturing, storage
and transportation resources. Although
challenges do exist, in many cases the
capacity is available — although potentially
constrained by inefficiencies as noted. Laos,
India and Vietnam, however, are in earlier
stages of development and infrastructure
investment. Smaller geographic and
industry sizes will influence capacity, as will
increasing competition. This will specifically
impact all four types of available inventory
capacity. Logistics capacity for example
faces similar potential problems. How does
the size of the transportation capacity differ
and affect batch size optimization? If not
properly analysed, the complexities multiply,
as do the costs.
As China’s supply chain infrastructure
and knowledge base continues to develop,
efficiencies in process, inventory, logistics
and supply chain management will evolve.
Competition and declining profit margins
have brought this reality to a few select
industries such as apparel and electronics.
The day is approaching when many
industries will be more concerned with
productivity and efficiency than market
share. The signs of change are apparent.
At the same time, many countries will
look to challenge China’s manufacturing
foundation. Cost incentives are the
initial driver. Sustainability and industry
diversification will be the keys as
companies migrate up the value chain.
Although opinions greatly differ, Chinese
manufacturing is realizing the value added
mentality. What still remains to be seen are
two critical and emerging components,
namely service and innovation. By bringing
together low cost, service and innovation we
may just witness an intriguing new chapter
in the China growth story. •
More InformationBradley A. Feuling, CEO, Kong and Allan, is based in Shanghai, China. Kong and Allan is a consulting firm specializing in supply chain operations and global expansion. www.kongandallan.com
as china’s supply chain infrastructure and knowledge base continues to develop, efficiencies in process, inventory, logistics and supply chain management will evolve. competition and declining profit margins have brought this reality to a few select industries such as apparel and electronics.