Live Event - China +1 Sourcing Strategy: Challenges and Opportunities
In the evolving landscape of global trade and manufacturing, the ‘China plus one’ strategy is emerging as a pivotal approach for companies aiming to diversify their supply chains. This strategy is rooted in the acknowledgment of China’s unparalleled manufacturing prowess, but it also recognizes the imperative need for companies to mitigate risks associated with geopolitical tensions, location-specific disruptions, and other unforeseen challenges.
In this webinar organized by Beroe for the benefit of the Procurement community, Dr. Rob Handfield, Distinguished Professor of Supply Chain Management at North Carolina State University and Valekumar Krishnan, Head of Digital Procurement Program at Beroe Inc elucidate the complexities and considerations inherent in implementing this strategy, exploring the nuances of identifying reliable suppliers, assessing technological advancements, and understanding the multifaceted nature of costs in potential ‘plus one’ countries like India, Thailand, and Mexico. They emphasize the importance of cultural understanding, demand volatility assessment, and the meticulous evaluation of suppliers' capabilities to ensure a seamless integration of new supply bases.
Below are edited excerpts from the webinar, with speaker quotes refined for clarity and conciseness:
Sakthi Prasad: Professor Handfield and Vale, could you shed light on the practical challenges companies face when diversifying operations from China to other countries? Given China's production prowess, companies are exploring a "China plus one" strategy for risk diversification and to mitigate trade tariffs imposed by the U.S. How do these challenges vary across industries, and what are your thoughts on this based on your experience?
(Dr. Rob Handfield)
Dr. Rob Handfield: Certainly. The recent anti-China sentiment, fueled by disruptions in manufacturing due to zero-COVID policies, has prompted industries to contemplate alternative sourcing. However, China remains a compelling choice due to its competitive Free On Board (FOB) costs and quality execution, especially in industries like electronics. For instance, an auto parts distributor mentioned that three manufacturers in China produce 80 to 95% of wheels, brake pads, and shifting production elsewhere would be challenging due to their efficiency and mastery over manufacturing technologies. A Chief Procurement Officer (CPO) also highlighted the impracticality of moving operations out of China, emphasizing the risk of doubling costs and losing market share.
Valekumar Krishnan: I'll briefly add that the motivations for nearshoring are multifaceted, involving regulations, geopolitical issues, supply chain diversification, rising costs, tariffs, trade wars, zero COVID policy, and economic incentives in certain geographies. It's crucial to distinguish between industry shifts and category shifts when considering nearshoring. It's an organizational decision, impacting procurement strategies as supply bases change with industry shifts. The implications of nearshoring are profound, affecting both tier two and tier three supplier perspectives, necessitating a meticulous approach to track these changes.
Sakthi: China is globally recognized for its excellent infrastructure. When considering potential “plus one” countries like India, Vietnam, Thailand, or Mexico, are there any nations that stand out for making substantial advancements in infrastructure?
Rob: Absolutely. I recall visiting China around 2000, and the infrastructure was not as developed. However, in the subsequent 23 years, China has invested trillions in infrastructure, enhancing highways, rail, and ports, both within its borders and globally, like in Africa. This investment has given them a preference in utilizing these ports when they choose to do so. In comparison, other countries are somewhat lagging. India, for instance, has logistical infrastructure that needs significant improvement, but there are ongoing initiatives, led by leaders like Modi, to enhance it. Companies like Walmart have faced logistical challenges in India due to inconsistencies in rail lines and other logistical aspects. However, Vietnam and Thailand have commendable logistics in port cities, and Mexico is also showing rapid improvements, especially in cities with a substantial manufacturing base. The investments in roads in Mexico have been particularly noteworthy, facilitating the transportation of automotive parts efficiently.
Vale: In my observation, there are four distinct clusters emerging. First, the Latin American cluster, with Mexico specializing in automobiles, aerospace, medical devices, and e-commerce. Then, in Southeast Asia, we have Vietnam focusing on electronics, apparels, renewable energy, and toys, and Malaysia, Indonesia, and Thailand specializing in consumer electronics, electric vehicles, and solar panels. The Indian subcontinent sees India specializing in automobiles and electronics, and Bangladesh in textiles. Lastly, Eastern Europe, particularly Poland and Slovakia, are focusing on automobile parts and electric vehicles. It’s crucial to note that one in four conversations I have with clients revolve around adopting a nearshoring strategy. There’s a discernible shift in trend from offshoring in the '80s, led by China, to nearshoring now. Interestingly, even China is adopting a nearshoring strategy, moving their production centers and R&D centers to other markets like Mexico, Vietnam, and India. This shift by China itself indicates a transformative change in global manufacturing strategies.
Sakthi: Professor, you touched upon aspects like lead times, cultural similarities, and timezone alignment in our pre-interview discussion. We’ve repeatedly discussed countries like Mexico, Thailand, and India. When considering industries that are ripe for a China plus one strategy, which country, in your opinion, is best positioned to capitalize on this?
Rob: Indeed, nearshoring offers substantial benefits, particularly in terms of flexibility, agility, and lead time, which are crucial for heavy industries. I often cite the example of Japanese auto companies like Honda and Toyota. They have always adopted a sourcing strategy that emphasizes proximity; they buy where they sell and sell where they buy. This approach of having suppliers close to manufacturing and assembly sites is pivotal for just-in-time or lean manufacturing. It allows for multiple deliveries per day and promotes a more responsive and flexible local supplier network. This proximity is crucial for addressing problems collaboratively and promptly, fostering multi-level collaboration and relationship-building that drive innovation and cost efficiency. While the per-unit price and labor costs might be higher in such setups, the overarching benefits in terms of responsiveness, problem resolution, and innovation are substantial.
Vale: Adding to this, observing the trends in Foreign Direct Investment (FDI) is crucial. China’s global share of Greenfield FDI has seen a significant reduction since the mid-2000s. However, it continues to be an optimal location for certain commodities. The strategy here is to discern which categories and industries are suitable for nearshoring. Companies are diversifying their investments, exploring other countries to source the same products, adopting a China plus one strategy. For example, Poland is exhibiting rapid growth in exporting EV batteries, but the sourcing of raw material, artificial graphite, traces back to China. So, it’s about understanding which are your tier one and tier two categories and having a category strategy very specific to the products which are critical for you. It’s about understanding which regions make sense to nearshore and which don’t, and then aligning your strategies accordingly.
Rob: Absolutely, I was intending to elaborate on the multifaceted nature of costs associated with managing geopolitical and location risks, and government restrictions, especially evident during the COVID period. We recently collaborated on a project with an apparel company where we identified four pivotal, often unquantified, factors that significantly impact industries and companies.
Firstly, there’s the cost associated with demand volatility. It’s crucial to assess the confidence level in demand predictions and how deviations in these can pose risks, particularly when dealing with offshore sourcing. This volatility in demand can significantly impact inventory turns and lead times, escalating the overall costs.
Secondly, there’s the ‘cost of being wrong.’ This is particularly prevalent in consumer goods industries where predictions about consumer preferences can be erroneous. When consumer preferences diverge from predictions, it results in excess inventory which often has to be sold at a discount, sent to landfills, or, in cases like pharmaceuticals or food, expires. This misalignment can lead to substantial losses through discounts and can even lead to the cannibalization of your own product if competitors seize the opportunity.
Thirdly, inventory carrying costs are a significant consideration. In today’s market, these costs range between 18% to 25%. The cost of deadstock, or stock that is left over at the end of a season or that can’t be utilized, is a substantial factor in this.
Lastly, understanding and quantifying the risks associated with disruptions is crucial. This includes scenarios like factory shutdowns or ethical sourcing issues that can tarnish the brand. Assessing the potential damage to the brand and understanding these various costs is vital.
Most companies often overlook the quantification of these costs, failing to assess how much of their margin is consumed by these unforeseen expenditures. It’s imperative for companies to delve deeper into understanding and quantifying these costs to safeguard their operations and margins effectively.
Sakthi: When considering potential plus one countries, what are the best practices and tools for identifying reliable suppliers? Are there specific platforms or networks that have proven effective in this regard?
Rob: Identifying reliable suppliers necessitates having individuals who understand the language and culture and are adept at evaluating factories in places like Thailand, India, and Indonesia. It's crucial to have someone with deep industry expertise, possibly with experience in conducting supplier audits, to validate the capabilities, relationships, and financial stability of new supply bases. Before entering into any contracts, a profound understanding and validation of all these variables are essential. We discuss these aspects in our textbook and our new book, "Flow: How Best Supply Chains Thrive," emphasizing the importance of a comprehensive knowledge of the supplier.
Sakthi: How should one assess capabilities, capacities, and technological advancements in these new regions? What benchmarks or standards should procurement professionals use for comparison?
Rob: Evaluating capacities and standards involves considering various aspects. We are working on the Ethical Apparel Index, and there are several third-party audits and assessments available, like WRAP, Sedex, SA8000, etc. However, having your engineers and professionals visit the facilities to understand their capabilities is equally important. It’s crucial to know whether the supplier has experience working with Western firms and to address the complexities related to transportation and currency issues, possibly engaging brokers or consultants to navigate these aspects. Assessing whether their equipment is up-to-date and understanding the extent of manual labor involved are also vital components of the evaluation process.
Large OEM firms like Nike and Adidas have established systems for vetting and auditing, but smaller brands may find it challenging due to resource constraints. Therefore, utilizing third parties is advisable. We are developing a digital platform as part of our Ethical Apparel Index, targeting smaller brands to bridge the gap and provide a trustworthy platform for evaluating suppliers.
Sakthi: We have delved into the trends and current situations in various countries, focusing on the procurement perspective. The question arises, how does one discover and vet new suppliers in ‘plus one’ regions when companies mandate exploring new supplies in alternate regions? Vale, could you share your thoughts on this?
Vale: Certainly. (Showcasing the “Nearshoring Solution prototype” developed by Beroe) Let’s consider a scenario where I am exploring nearshoring options for agro commodities. The prototype allows users to input the HS code, choose the commodity and category, input the destination country, and the country of origin, for instance, China, to explore alternatives. The tool operates on the logic of trade data, analyzing customs data and reorder patterns between different nations, identifying top exporters by value and volume, and considering countries outside of China. It also factors in countries that are reliant on China, the impact of ocean freight, price deviations, tariff charges, anti-dumping, most favored nation status, landed costs, and potential embargoes between nations. Compliance with various international acts and supply chain laws is also integrated into the analysis.
The tool provides a comprehensive overview, allowing users to deep dive into each country, understanding price forecasts, identifying top suppliers, and learning who’s buying from whom. This is crucial as it gives an idea of who has already tested the market. One approach is to deploy cost engineers, auditors, and workforce to gather this data, or one can learn from the industry peers and competitors about their buying patterns, volumes, suppliers, and ports they are buying from.
The tool amalgamates datasets from compliance, BP, adverse events, supply chain disruptions, trade data, and Bill of Material based data, allowing AI to assist in decision-making. For instance, a GPT-enabled version of Beroe data allows users to query data using AI technologies, asking questions about top exporters into the US other than China for a particular commodity over the last five years, and understanding the tariff and logistics impact.
In summary, the tool integrates various datasets, applies logic, and lets AI assist in decision-making, providing a comprehensive, straightforward, and powerful approach for procurement professionals to make strategic decisions without delving into the role of a trade analyst.
Sakthi: That’s insightful. So, I’m assuming this comprehensive tool encompasses nearly all commodities that need to be addressed?
Vale: Absolutely, it covers anything that traverses via air, rail, road, or sea routes. Essentially, while your indirects or services might not be included, anything that has a physical presence and can be visually verified will indeed be covered by this tool.
Audience Q&A: Below are edited excerpts from the Q&A section, with speaker quotes refined for clarity and conciseness.
Sakthi: Moving on to the Q&A, it seems to be related to the tool you demonstrated, Vale. Can this tool also be utilized based on CAS numbers, especially for specialty chemicals in pharma?
Vale: Absolutely, the short answer is yes. The tool can indeed work with CAS numbers. Essentially, we extract the equivalent HS code from the material masters and match it. So, whether it’s CAS numbers, SIC codes, NAICS codes, or UNSPSC codes, the tool will translate it into the right taxonomy and extract the necessary data.
Sakthi: Given that companies have been operating in conjunction with Chinese suppliers or services for decades, how adept, in your experience, are companies at constructing a mature or sufficient organizational structure, organizing skills, and strategy to align with the nearshoring direction? Essentially, if a company has collaborated with a Chinese supplier for decades, is such a partnership replicable in other regions?
Rob: Well, the succinct answer is, it depends. Having profound experience in one region or country is undoubtedly advantageous when transitioning to others. However, one must consider the significant cultural differences. For instance, comparing China, Vietnam, and India is like comparing apples, oranges, and grapes—three entirely different cultures, norms, learning methods, and organizational governance approaches. It’s crucial to have someone with local presence who understands these cultural norms because, at its core, supply chain management is about relationship building. Starting relationships on the right foot and adapting to the working methods of suppliers in different regions is pivotal. Local knowledge is indispensable when initiating collaborations with suppliers in these diverse regions.
Sakthi: Here’s another interesting question. What is the most effective method to verify that a supplier is procuring their raw material from outside of China, delving into tier two and tier three?
Rob: Indeed, it is a challenging aspect. Perhaps some of Beroe’s analytics can delve into that. Understanding the intricacies of tier two and tier three suppliers is notoriously difficult. The most reliable method is to engage directly with their procurement teams, review their purchase orders, and investigate the origins of their inputs by visiting the receiving docks to see where the materials are coming from. This hands-on approach provides the most tangible evidence. Relying on suppliers to disclose this information can be tricky as they might lack transparency or may wish to conceal certain details to avoid complications. This lack of transparency is something I’ve observed frequently in various countries overseas.
Sakthi: This question is related to the demo you've presented. How does your AI tool differ from tools like Panjiva?
Vale: Absolutely. Panjiva, an S&P product, is indeed a remarkable product, focusing primarily on generating data based on trade data from the World Customs database. However, it doesn’t incorporate market intelligence around alternate suppliers, their capacities, innovations, technology, ESG scores, supply chain disruptions, susceptibilities to risks like cyber attacks, and financial risks associated with working with different suppliers. Our tool amalgamates Panjiva’s capabilities with additional layers of intelligence, offering insights into supply chain financials, adverse media, ESG scores, and more. It provides an enhanced output, including price projections, fitting into not just nearshoring but also into budgeting strategies.
Sakthi: When discussing the China plus one strategy, does this imply that, in the long term, China remains the main supplier base? If so, what should be the percentage allocation?
Rob: From the studies we’ve conducted, China remains a viable strategy for categories characterized by stable demand, lead times, and prices—what we term as ‘low and slow’. For such categories, maintaining a significant base in China is logical. However, for fast-moving categories with high demand volatility and supply chain risks, a blended strategy, perhaps 80% China and 20% domestic or nearshore, seems prudent. Domestic or nearshore suppliers, although potentially higher in cost, offer adaptability and can meet sudden shifts in demand more efficiently than a supplier with a long lead time, like those typically found in China.
Vale: To provide a benchmark, organizations often set goals to start with an 85-15 mix, with 85% from China and 15% from a nearshoring market. This is considered a good starting point and aligns closely with Dr. Handfield’s suggestion of an 80-20 mix, offering a balanced approach to mitigate risks and adapt to market demands swiftly.
Sakthi: Okay, and regarding the percentage cost increase for a plus one supplier, do we have any benchmark?
Vale: It could actually be a decrease. I think it largely depends on the category you're considering. For example, in agro commodities, specifically cyclical ones like edible oils, you're likely to see a sizable reduction. However, in categories like metals, reductions are not as apparent. So, it's crucial to evaluate each category individually.
Rob: It's worth noting that labor costs in Mexico are now lower than they are in China. Chinese labor costs have experienced significant increases, rising by 20%, 30%, even 40% in some instances.
Sakthi: The next question revolves around geopolitics. How would the supply chain in the pharma industry be affected in the event of tension between China and Taiwan? Additionally, how can companies prepare for such geopolitical risks?
Rob: My personal observation on this matter involves numerous discussions about the potential of China invading Taiwan. Personally, I don’t believe that such an event is likely to transpire. There are several reasons for this perspective. Firstly, the repercussions on the global economy would be catastrophic, causing widespread shutdowns. Specifically, Taiwan stands as the world’s leading manufacturer of semiconductors, with Taiwan Semiconductor holding approximately a 40% market share. If an invasion were to occur, it’s improbable that Taiwan would maintain its current production levels, leading to substantial shortages of chips.
Regarding the pharmaceutical sector, I am not well-acquainted with the extent of pharmaceutical production in Taiwan, but the implications would presumably be parallel. A significant portion of Taiwanese citizens harbor anti-China sentiments, and it’s unlikely that they would willingly cooperate to sustain production levels under such circumstances. Especially considering China’s substantial reliance on Taiwan, particularly for chips, disrupting the equilibrium would not be in their best interest. It’s akin to not wanting to jeopardize the source of one’s prosperity, the “golden goose” that yields the golden eggs, so to speak.
Sakthi: As we delve into the planning perspective required for potential plus one countries to replace China, it is crucial to understand how to plan effectively to replace China sourcing.
Rob: Indeed, we have covered numerous elements essential for this transition. Conducting an in-depth supplier assessment is pivotal, along with understanding alternative logistics channels, tariffs, and other costs that might come into play. Grasping currency issues and regulatory requirements is crucial to ensure no violations occur when sourcing from these countries. This transition requires meticulous preparedness; it’s not a swift process but necessitates extensive work and consideration.
Vale: To add a quick point, depending on the industry, one initial step many clients take is to check the U.S. Treasury Department's Specially Designated Nationals and Blocked Persons List, known as the SDN list. This is especially common when considering nearshoring from China to locations like the Philippines, the islands, and Vietnam. This check is a fundamental step in ensuring any regulatory flags are addressed right from the start, particularly for businesses operating from the US.
Sakthi: We received a comment stating that reshoring manufacturing requires more skilled workers and will not easily occur without major policy changes. However, the positive impact on job creation in the home country would be significant. This is indeed a thoughtful comment.
Rob: I’d like to follow up on that. This situation presents a golden opportunity for countries like India, which has the potential to become the next global manufacturer. With substantial investments and necessary changes in governance and regulatory policies, India could seize this opportunity. It’s a challenge but also a monumental opportunity, and I am hopeful that the government in India will implement measures to facilitate manufacturing and export from the country.
Sakthi: Absolutely, Professor. This is a once-in-a-generation opportunity not just for India but also for other countries like Indonesia, Thailand, and Vietnam. It’s crucial that they leverage this chance effectively.
Sakthi: Moving on to the final question, it pertains to the chemical constraints in China. Can you elaborate on the constraints that chemical manufacturers are currently experiencing in China?
Vale: Certainly. The predominant constraint is related to carbon emissions. The government has implemented stringent regulations, causing many tier two and tier three suppliers to cease operations due to non-compliance. We have extensive reading material on this topic that we can share shortly.
Sakthi: Unfortunately, we have run out of time. I extend my heartfelt thanks to Professor Handfield and Vale for their insightful exposition of the China plus one sourcing strategy. We have received numerous intriguing questions, and we will endeavor to reply by email to those that remain unanswered. We will also be sharing the recording of this session. A big thank you to all the participants for joining today. If you have any additional questions, please do reach out to the email address provided in the Q&A box. Have a good day, and to those in Asia, good night.
Rob: Thank you very much. For those interested in exploring more about my ideas, I have a blog available for reading.
Vale: Thank you so much for taking the time to discuss this crucial topic. Have a great day, everyone!
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