The Gain and Pain of Global Retail Sourcing

Situational Analysis

For anyone who has not spent the last several years hibernating or stranded on a remote island, it has become apparent that supply-side control is more important than ever for overall business success. This is due to globalization (meaning new potential markets, but at the price of growing competition too), low-cost country sourcing (and even outsourcing of some, if not most, manufacturing or service operations), continuous cost pressures (shrinking margins), and other driving forces which have combined into a "perfect storm." Global sourcing (the process of identifying appropriate domestic and far- or near-shore suppliers of goods and services—preferably from countries with significantly lower cost bases—and then ordering the goods and arranging for payment and delivery) has thus become a way to go for many. In fact, this has lately become an increasingly important corporate strategy (and often an executive mandate for buying departments) that is rapidly becoming a survival strategy too, in sharp contrast to the stepchild and "ugly duckling" perception of supply-side control in previous decades.

Part One of the series The Gain and Pain of Global Retail Sourcing.

In fact, there is today a growing imperative within organizations to source directly from an ever-expanding global universe of prospective vendors. Indeed, according to the World Trade Organization (WTO), about 55 percent of all raw materials for American manufacturing are now being sourced outside the US, which compares to about only 12 percent in the 1980s. As another example, the Wall Street Journal last year reported huge volume increases of Far East imports through the port of Savannah, Georgia (US), where the cargo container volume of 1.7 million per year has tripled over a decade ago, as an US east coast alternative to the clogged and constrained (in terms of labor and capacity) west coast ports (which are the logical, shortest-path destination for Far East goods).

Potential Global Sourcing Gains

In a nutshell, companies source globally to differentiate their products, gain competitive advantage with reduced price points, and realize margin improvements. On average, many contemporary analyst studies, surveys, benchmarking reports, and so on, have concluded that a well-devised and well-executed sourcing strategy can produce margin improvements up to 2 percent (through a more efficient trading partner collaboration); reduced cycle times by up to 30 percent; up to 5 percent in reduction to the cost of goods sold (COGS); and up to a 15 percent increase in gross margin (through increased international sourcing on low labor and supply costs from East and Southeast Asia, Eastern Europe, and South America). Sure, expectations are usually much higher than these figures, since initial savings may provide false gains. And with many costs and risks being hidden (such as logistics complexity and increased lead time ramifications), one should always take a long-term view and analysis. For more information, see Understanding the True Cost of Sourcing.

What also contributes to the popularity of global sourcing today might be the fact that for years, only larger companies had the wherewithal to operate complex and pricey import/export software systems. Today's technology, conversely, has leveled the playing field for international trade, given that inexpensive Web-based systems—designed for simplicity and more easily deployed—can now enable much smaller companies to engage in global sourcing with a wide range of suppliers. The unstoppable march of the Internet and the growth of online shopping and other transactions mean that we are all operating in a new electronic real-time world (the global village), with inherent visibility into important events. These new systems make it possible for a small retail company to engage even just once—opportunistically if needed (as in a "one and done" manner)—with a supplier, to still record a profitable and efficient transaction. This has brought about what some experts call the "great leap" in global sourcing: it is no longer the privilege of only a few humongous and mighty companies, but is becoming a viable strategy for almost any company.

In addition, trading quotas and other barriers have been disappearing (or are being reduced) globally, while the expansion of the European Union (EU) eastwards opens up potential new sourcing countries along with new potential markets. With the end of apparel import quotas, this sector is growing rapidly in India and the Far East, while the passage of the Central American Free Trade Agreement (CAFTA) promises to bring additional activity into Central America as well. Today, on average, retailers are consequently following the top executive mandates to increase imports (of both raw materials and finished goods), even up to a quarter of total purchases (from a current level of 5 to 12 percent).

There is also a growing trend towards offering private labels or brands, and a consequent fundamental reassessment of the structure of global sourcing. In other words, the question now is whether to use agents or other middlemen at all, if via Internet trading exchanges (and the like) companies can now increasingly work directly with manufacturers. Therefore, given some reported examples of success with lower-priced house brands, retailers in several segments, including fast-moving consumer goods (FMCG), consumer electronics, and apparel, are increasing their focus on private-label merchandise to take advantage of margin improvements, improved quality consistency, and brand loyalty. For more information, see The Fragile Consumer Packaged Goods Market and Private Label Products and A Unique Product Lifecycle Management Tool for Private Label Retail.

Come with Some Inevitable Pains

Yet, the savings from global sourcing come with possible steep expenses elsewhere, since a company must find qualified factories, solicit bids, place purchase orders, inspect the factories, monitor quality, handle logistics, customs, and duties, and so on, all on its own, which is not a small feat. Any merchant nowadays has to manage numerous details on how private label brands are sourced, produced, and delivered, which can be quite daunting to deal with, especially when trading partners are scattered all over the world. The momentum of private labels in the retail industry (from grocery stores to major apparel stores) is driving even more opportunistic contracting with small and unknown suppliers in remote countries, which requires buyers to really take a chance when ordering from unfamiliar suppliers in the hopes of keeping total landed costs to a minimum.

This requires a timing mindset change, given that most issues with domestic suppliers can be resolved right away (or at least within a week, in the worst case scenario). Internationally, though, even for bordering countries, it might take a more particular purchase order even several weeks to be confirmed, let alone processed and delivered over oceans and through customs and duties. With global sourcing, the challenge has become how to communicate from a swanky domestic office in a Group of Eight (G8) country with a factory as far away as Africa or the Far East. The challenge is also how to assimilate and communicate multiple data points effectively into a unified operation on a single screen. After all, in the manufacturing process, communication necessarily takes place among retailers, manufacturers, brand managers, contractors, agents, brokers, and logistics providers. Many still share product information over the phone, or via email and faxes, or through physical communication, and the difficulty is thus to consolidate all these diverse data points.

In a more sophisticated scenario, though, all the members of the supply chain communicate through a Web-based system, which means that when a vendor makes a change in the status of a product, for example, everyone in the supply chain will see the change too. The key in global sourcing today is to minimize the overall cycle and disruptions, and the most important way to do that is to have live, accurate, immediate information. New Internet-native sourcing software applications should give users visibility throughout the world of current product or order status at any point in time, and eliminate almost all duplication of information, thereby allowing all trading parties to collaborate on more rewarding issues, rather than constantly fighting fires.

For instance, prior to implementing a contemporary Web-based automated solution, contacting multiple vendors at once for pricing would be a tedious and pedestrian manual process for the sourcing group. On the other hand, by using a Web-enabled infrastructure, user enterprises should be able to better integrate globally with their supply base, and broaden the scope of vendors they can locate. Such technology has lately streamlined the ability of many retail firms to get estimated pricing from several vendors simultaneously. Also, when the design team comes up with a new fashion concept and wants to get a sample of that concept, such a system allows the information that they have designed to flow into the sourcing organization, which then allows the sourcing team to start getting estimated costs, as well as time-and-action (meaning normalized or synchronized calendars within the entire production cycle) information. Then the team can better determine where it wants to place the production, depending on volume—possibly also integrating with the merchant organization to give them a feel for how much product the firm will be sourcing of a given style, so that they can look at capacity constraints. The next step could be to use the software tools to break style data down by more variables, in preparation for placing the purchase or production order. For instance, this might provide suppliers with answers to several questions: How much does the retailer want to order by color and by size? What is the final pricing? What is the final time-and-action calendar?

Increasingly, the standard order confirmation and customary advance ship notice (ASN) procurement practices cannot provide sufficient guarantee that everything is going smoothly with any placed order. This is particularly the case for the internationally sourced, custom-made purchases that are common in the consumer goods manufacturing and distribution industries. Here, the difficulty of communicating across time zones, along with long lead times, make for lengthy recuperation periods (if it is even possible to recover) when problems occur. That is why buyers should benefit from visibility and event management systems that would inform (or alert) them that, say, their orders were (not) started on time, or were (not) placed on the boat on schedule; or whether the design team has meanwhile (yet again) changed specs on color or fabric for a particular planned merchandise; or that the order was (not) properly documented to clear customs without a glitch.

The current (mainly manual) systems still typically require information to flow via scattered spreadsheets, phones, faxes, mail, and e-mails within the retailer's different groups, and when it is the time to place the order, the data is usually no longer timely or accurate. The information then has to be revised during the ordering phase, which leads to the possibility that the vendor may respond incorrectly—and one then has to go through the vicious cycle again.

Determining the true costs of these activities can also be complex, since in addition to a nominal purchase price, one has to add freight, tax, duties, cost of inventory, inevitable quality issues, and the buyers' time. Landed costs also vary tremendously, depending on how the merchandise is shipped. For all the above reasons, the issue of achieving more transparent and cohesive sourcing processes has become a frontline concern for many retailers, driven by boardroom directives to boost margins through direct sourcing of international products.

Unfortunately, the fact is that few information technology (IT) systems fully support the complexities and unique requirements of global trade. Many outmoded sourcing programs (some of which are part of traditional enterprise resource planning [ERP] and accounting systems) have not been designed to factor in currency fluctuations, customs duties, or additional bank processing fees, with the result that much of the accounting for those items is still being performed manually. It is thus no small wonder that, within only a few years of deployment, less than 15 percent of available software functionality is being used (see Application Erosion: Eating Away at Your Hard Earned Value).

Still, the benefits of private-label merchandise can be so large as to become crucial to retailers' strategies. Until fairly recently, the Internet medium has been neither reliable nor ubiquitous enough to support such broad supply network or the resolution of likely issues. Recently though, it has reached a much higher level of security, bandwidth, and connectivity, which coincides with emerging applications designed to run over the Internet and offer near real-time data and events for managing and analyzing the variables of global sourcing. For instance, Web-based supply chain visibility tools have reportedly helped these companies improve their production lead times, better manage their inventory movements, and track the production and delivery of products in near real time. Moreover, Web-based sourcing tools can help them with the identification of suppliers, negotiation of contracts, shipping manifests, streamlining of sourcing (through event management, and collaborating and planning with their trading partners), and ultimately increase their on-time deliveries.

Some importers might have big-ticket, expensive items, along with high stock-keeping unit (SKU) counts of low-cost accessories sourced directly from Asia, which imposes an integrated approach to supply chain management (SCM), and more accurate visibility. Collaboration between suppliers, logistics providers, buyers, and product managers is critical throughout the entire product lifecycle. An astute sourcing software suite should enable product managers and buyers to quickly develop comprehensive requests for quotes (RFQ) for their global sourcing efforts. It should also be able to normalize disparate currencies, languages, and lead times, and automatically calculate the estimated landed costs for a clear understanding and comparison of all submitted offers by multiple contesting suppliers. For these suppliers located around the globe, the suite should seamlessly unite and coordinate such details as product specifications, RFQ, quality control, packing lists, and all the invoices and customs paperwork, eliminating redundant data entry errors and speeding up production. Such a solution should also enable buyers and trading partners to more quickly collaborate on accommodating change orders to respond to any fluctuations in market conditions.

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