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.