Global Sourcing and Distressed Companies
A recent scenario involves a midwestern company with two product lines—one that had achieved record sales in 2000 but was tied to a quickly-dying technology, the other facing stiff price competition around the world. Over the past several years, the company watched its competitors take millions of dollars worth of market share while its outmoded products went unsold. Finally, liquidity became an issue as the rate of cash outflow accelerated and the company tripped covenants from operating losses and asset writedowns.
The course taken by the company was to severely reduce headcount, consolidate operations and focus capital resources on the product line with long-term potential. Unfortunately, it did this several years after the initiative would have had positive impact. Even after these draconian measures, the company remained unable to generate sufficient cash flow to meet its debts. With no plan for a turnaround, bankruptcy loomed. The company finally called on external sources that advised them to close domestic production and design facilities and outsource production to Asia. After studying this recommendation, the company discarded it as too risky, believing that it would take too long to take effect and would require capital they did not have.
Now the company is caught in a vortex—it has no cash to restructure and is unable to generate cash due to unprofitable operations. Furthermore, as the company searches desperately for solutions, stakeholders are growing increasingly impatient. Bank workout officers are not interested in a two-year turnaround plan and are becoming insistent.
Can This Business Be Saved? And Quickly?
The company can revisit its decision to discard the outsourcing idea. Based on our experience, these arrangements can be implemented inexpensively and quickly and show immediate results—even in crisis situations.
Why Cross International Borders?
Sourcing products globally can help manage cash, improve asset efficiency and increase profits with minimal set-up time. Overseas manufacturers can produce products at prices 30-50 percent below the cost of manufacturing like items in the United States. Lower wages, overhead expenses and exchange rates result in savings delivered directly and immediately to the company's bottom line.
While there is no single master approach for all business situations, the bottom line is that enterprises across the globe are becoming increasingly interconnected, and are experiencing excellent initial results with global sourcing.
Steps to Success
When implementing a global sourcing strategy, a key success factor is to minimize as many of the hindrances as possible. This shrinks the cost of and greatly reduces the time of implementation. External consultants with demonstrated experience can be particularly valuable in setting up a company's global sourcing operation quickly and for the lowest cost. The following are step-by-step strategies that generate the greatest level of success.
Understand and Evaluate Risks
According to "The Global Sourcing Benchmark Report" by Aberdeen, six key considerations need to be on a company's global sourcing checklist to help it balance cost, performance and risk:
- Manufacturing cost savings: includes raw material pricing, setup, tooling, transaction and other costs related to the actual product or service delivered.
- Transportation costs: make sure all transportation, drayage, fuel surcharges and other fees are included in the freight rate.
- Inventory: increased warehousing, handling, taxes, insurance, depreciation, shrinkage, obsolescence and other costs associated with maintaining inventories over a larger supply chain.
- Cross-border taxes, tariffs and duty: landed costs (the sum of duties, shipping, insurance and other fees and taxes for door-to-door delivery). Expect increased staff costs for managing this new expense.
- Supply and operational performance: Costs of noncompliance or under-performance from missing delivery dates or quality problems with customers can more than offset any price variance gains.
- Supply and operational risks: these include labor difficulties (e.g., longshoreman strike in Port of Los Angeles), geopolitical factors, tariff and policy changes, instability due to war and/or terrorism, natural disasters, even disease—as experienced earlier this year with the SARS outbreak.
Complete an Initial Analysis of Commodities, Countries and Companies
Target the commodity groups that fit well with the company's initiative. While such commodities generally have high labor content and low shipping costs, we are seeing higher-value products and services being successfully sourced from abroad.
The second step is to focus on the right countries from which to select the supplier. There is a great variation in infrastructure, local laws, customs and attitudes toward business from country to country. Additionally, wide regional variety exists within many countries. Make sure that the company adequately assesses all costs and risks as discussed above.
Structure Your Supplier Relationship
In the simple matrix below, it is clear that companies have several choices when sourcing globally. But these choices involve tradeoffs as represented in the graph.
The arrangement best suited to a distressed situation (fastest lowest initial cash outlay) is to source the product from an established contract manufacturer. The factory has been built, available labor is in place, and local management is ready to get going. Unfortunately, these businesses want to make a profit from the company and will charge it for their services. Additionally, as mentioned in the risk factors above, the distressed company may not command sufficient attention from these established companies to protect its valuable customers from "hiccups" in the supply chain. In a distressed situation, however, this is probably the best bet in the short term.
The success or failure of its sourcing initiative hinges on the suppliers' capabilities and the quality of your relationship with them. The company must closely assess and continually reassess the suppliers' viability and reliability—as closely as if it owned the suppliers' business itself. This requires that the prospective supplier agree to be open and transparent. Information transparency allows the company to perform total cost analysis and to effectively evaluate suppliers. Any unwillingness by a supplier is a red flag: Either the company is not important enough, or it is a warning of potential operating problems to come. Treat resistance or unwillingness to provide the company with the information it needs as a "no," and move on.
As the turnaround takes hold, the company can consider alternative approaches with the additional benefit of greater liquidity, additional time flexibility and the benefit of its newly acquired global sourcing experience. If it does have cash available to invest, a recommended approach is to enter into a joint venture. A joint venture gives it greater real-time visibility to financial and operational data that allows it to control the true cost of the product being manufactured. Typically, a joint venture also provides the advantage of pre-established manufacturing operations and processes, resulting in lower costs. In our experience, a joint venture can be activated more quickly than acquiring or starting up a supplier.
Acquiring an existing supplier will provide similar benefits to a joint-venture arrangement in that the company can take advantage of pre-established operations. However, it is not recommended in a turnaround situation because the due diligence, acquisition and integration effort consumes significant management attention. Management time in a turnaround is typically in short supply and is probably best spent on ensuring a seamless initiation and implementation of the foreign sourcing operation.
With relatively ample time and cash available to invest, an acquisition is actually the preferred method for the long term. The reason for this is that in addition to the cost savings for goods formerly produced in the United States, the overseas business provides an ideal platform for penetration into new, previously untapped markets and opportunities for top-line growth.
Global sourcing requires companies to coordinate sourcing requirements, activities and decisions across functions and divisions, international borders and time zones and potentially across a range of suppliers. Make sure the company synchronizes information and material flows throughout its operations and among its suppliers in real time.
Optimization—Generating Maximum Value in the Sourcing Process
To ensure that your global sourcing efforts generate significant value, the following activities must be optimized:
- Physical. Actual movements and flows within and between firms: transportation, storage and inventories, delivery, services. Key tactics: streamline transport costs, reduce inventories, identify fall back strategies in the event of disruptions to guarantee supply.
- Financial. Flows of cash between organizations, expenses, investments. Key tactics: Improve accounting and billing procedures, leverage financing, use IT.
- Informational. Processes, access to key information, benchmarking, market intelligence. Key tactics: Develop performance metrics and benchmarking based on your strategic goals, know the supplier and product markets, demand total cost-transparency from the supplier.
- Relational. Appropriate linkage between the company, its suppliers and its own customers for maximum benefit. Key tactics: Align the supplier's incentives, spell out the company's needs and requirements, provide its suppliers with accurate forecasts of demand, ensure early supplier involvement in any changes, clarify cultural differences, ensure good communication despite possible language differences.
- Product. Design, production cycle, quality. Key tactics: Reduce design-to-production cycle length, optimize operations and costs, develop quality monitoring and benchmarking.
The offshore outsourcing market is predicted to grow by 40 percent this year, with 75 percent of large and medium-sized firms considering such initiatives by 2004. While there is no single master approach for all business situations, the bottom line is that enterprises across the globe are becoming increasingly interconnected, and are experiencing excellent initial results with global sourcing. These results can be obtained quickly, even in distressed situations.