Sourcing From China, It Is Not About The Deal
For many companies, the art of doing business in China is finding the “right” supplier. A local office is set up to identify good prospects, meetings are arranged, the price looks good, a cursory check on the facilities is made, and then a contract is signed. So far, so good.
But getting the contract signed is the least of a company’s concerns: a company may hammer out a deal that looks great on paper but then lose much more in its fulfillment. To managers reading this article we pose these questions: What are your stockouts, and how much money do you spend on airfreight from China? If both are negligible, read no further. If, however, you have back orders and airfreight is a significant proportion of your transport bill, then this article may help.
Why Things Go Wrong
In our experience, there are a number of reasons why certain Western companies that have purchased goods from China over a number of years have suffered from stockouts and high airfreight bills.
Companies Don’t Calculate Total Costs
The company may not understand the total cost of acquiring the goods. When it looks at costs from suppliers, it may look solely at the quoted figure (that is, the cost of the goods plus delivery costs). Because that figure is so low, the company will be tempted to source whole ranges from China. Companies with more experience know that one must take into account local expense + late delivery+ extra stock + handling + quality + and so on in estimating the total cost.
Contracts May Be Too Vague
The company may not realize that just because its purchasing department has a relationship with the agent, it doesn’t necessarily follow that customer scheduling, sales order processing, and manufacturing planning will work out smoothly. Unfortunately, not many contracts detail how the operation will work when it is up and running—and without those details spelled out, the contractual relationship will often fail when real schedules are placed with real factories.
Chinese Suppliers Hate to Say No
Many Chinese suppliers are reluctant to say no, even when it might be better for all concerned if they did. Too many Western buyers identify a good small supplier in China—one with competitive prices—and subsequently overwhelm it with work. The supplier, seeing the opportunity, is never going to say no, and will commit well over its capacity to deliver. Within months, it becomes the nightmare supplier. Contributing to the problem is the fact that suppliers in China are desperate sell their products to overseas markets, and they will promise anything to secure contracts with Western customers. When company representatives visit a potential supplier in China, the supplier is likely to answer 80 percent of their questions with, “Yes, we have,” or “Yes, we can.”
Chinese Suppliers May Not Consider Supply Chain Risks Many
Chinese suppliers appear to give little thought to supply chain management and supply chain risk. If asked about their inventory level, they may answer that they don’t know, or they may estimate in terms of months or weeks of usage.“ Very few of them take forecasted demand, lead time, or good customer service levels into consideration in setting up safety stock. This is in part because they don’t calculate forecasted demand and in part because many are not sure about lead times at the product level. Their lack of awareness of supply chain risk often has negative consequences for themselves as well as the Western contracting company. A Chinese supplier may increase its capacity in order to satisfy the contracting company’s demand. Bit by bit, it may come to rely on the contracting company because the company is buying up the majority of its output. Then, if the contracting company suddenly should cut the size of its orders, for whatever reason, the supplier, having become so dependent, may end up out of business—and if that happens often, it can greatly reduce the base of suppliers available later, when demand has picked up again.
Complications with Guanxi
Western companies may have trouble understanding how to build up guanxi (deep relationship) ties, which are the key to doing business in China. In some cases, building up guanxi can seem—or actually be—disconcertingly like corruption, though that certainly does not have to be the case. If a Western company finds itself spending significant amount of money on one or two suppliers, that may be the signal that the guanxi it’s building isn’t the best sort.
How to Make Things Right
That’s the bad news. Fortunately, there are a number of things that Western companies can do to make their experience in China more successful.
Companies Must Understand Their Needs
Companies must work backward from demand, and they must have a strong procurement policy. Having a strong procurement policy, as outlined by Peter Kraljic in his September-October 1983 Harvard Business Review article “Purchasing Must Become Supply Management,” is critical. A well-developed spend analysis (analysis of what the company spends, and where), coupled with a strong transaction cost analysis (TCA) model makes it possible for companies to make the right decisions on what is really worth outsourcing to China and what isn’t.
Companies Must Make Contracts Explicit
Rather than making assumptions, companies must understand the real relationships between customer scheduling, supplier sales order processing, and manufacturing planning, and then document those relationships and the rights and responsibilities of all parties in the contract.
Companies Must Look Beyond a Supplier’s “Yes”
Companies must research the detailed capacity of the supplier before awarding any business. This can be difficult in China, but as a rule of thumb, company managers should ask what level of business increase the company could cope with without huge disruption, and then ensure that they never put one of the company’s suppliers in a similar position. In addition, companies shouldn’t let “yes” answers be the only basis for choosing a supplier. Instead, company representatives should spend time at the supplier to understand its processes. Company representatives should ask managers at the supplier to show them how the system works. For example, if managers at the supplier says, “Yes, we have an enterprise resource planning (ERP) system,” the company’s representatives can ask how the supplier uses the ERP system to do its production planning, and its manufacturing resource planning. They can ask to see how the processes get linked in the system. Similarly, if the supplier’s managers say that the supplier has a measurement system, the company representatives can ask to see previous data and charts of the measures. The company will benefit tremendously by asking fewer yes-no questions and more questions about how things are done.
Companies Must Not Feed Their Suppliers to Death
Companies should rationalize their supply network by building up a balanced supply chain; they must not give too much work to any one supplier. They must send clear demand information to their suppliers and must recognize that the suppliers will not be able to perform well if the schedule is unstable. Chinese suppliers will normally do reasonably well on consistent and accurate schedule, but most of them cannot cope with any significant changes in demand, and once a supplier is behind schedule, it is not easy for it to recover, as its own supply chain is too weak to respond.
Companies Must Use Guanxi Wisely
China is a very tempting place for anyone, but Western companies must be careful not to put too much on any one buyer’s plate. A shared supplier information database, clear and open supplier audit and evaluation standards, and cross checks within the team will reduce the negative impact of the shadier side of guanxi. By all means companies should make good use of guanxi, but they must not get trapped by guanxi.
In This Case, Assume the Glass Is Half Empty
Most people seem to assume that sourcing in China should work, but it is wiser to start out by assuming that without a lot of cultivation, the relationship will not work. The partners typically have competing objectives and little true understanding of how each other’s business operates. Thus companies should expect that from time to time there will be breakdowns in the supply chain in China; the real art is not setting up a new relationship, but healing bad ones and making them good. Supply chains in China are, at heart, personal, and with personal effort, they can be made to work.
