Best cost country sourcing
By Jamie Loder, Director (4C Associates)
The last year and a half has shown us that change is the only constant in global affairs. This is true of geo-politics, tariffs, trade fluctuations, shifting costs and capacity and of course … the global pandemic. These factors have brought supply chain resilience sharply back into focus as a priority for businesses placing as much emphasis on continuity of supply as on the cost of it.
Organizations that had taken advantage of low cost country sourcing and in particular heavy dependence on China, often purchasing raw materials, products or components from single sources, learned the hard way about the significant risk this introduces to their business. The proximity of supply to the end user also came sharply into focus with huge disruption to global freight transport and spiralling prices.
Foxconn, the $178BN Taiwanese company which makes the iPhone and just about every other tech gadget and which has a workforce of close to 1M in China, says it expects manufacturing to fragment into a China supply chain and several others for the rest of the world. The cost of a container from China to Northern Europe has increased from $2.5K in June 2020 to $11K in June 2021. This has led to fundamental erosion of margins on imported goods as for the most part these rates cannot be passed on to the consumer. Lack of availability of containers and shipping is driving this price increase and forcing companies to seriously consider often long established trade relationships.
The assessment that companies need to make is more challenging and complex than in the past with a lack of predictability in costs representing a major uncertainty but this is just one of a number of factors that need to be considered when assessing best cost countries for sourcing.
What are Best Cost Countries?
Best cost countries are often erroneously equated with low cost countries, but while the latter may offer the lower price, underlying factors associated with doing business in and with these countries can collectively produce an unfavourable total cost to the company.
Evaluating low cost countries based on labour, materials, logistics, inventory, payment terms, trade considerations and others, helps companies determine the location or locations where their total cost of ownership is optimized – their best cost countries.
There are four key drivers that companies can use to execute best cost country sourcing:
1.Factor Cost Advantages
This not only describes the process of optimizing costs for labour, energy and raw materials but also assessing the controllability or predictability of those costs over time. Subsidies may be a significant factor in the overall assessment of factor cost advantage and this is certainly the case in the world of fashion retail where GSP+ certification (to import tariff free with the EU) is a significant factor when assessing overall cost of production in countries such as Pakistan or Sri Lanka.
2.Supplier Market Proximity.
This is where options are evaluated based on market proximity to materials, capabilities, technology and capacity. We may also evaluate the propensity for future innovation based on the ecosystem of materials and production processes. There are risk factors associated with supplier proximity. For example the University of Michigan in a recent study observed that “at first, suppliers are naturally attracted to geographic clusters because there’s demand. But after a while, the proximity enables suppliers to induce demand that’s unrelated to customer needs. It produces no noticeable gain for the customer firms and, in fact, limits the growth possibilities of a region because it increases economic and transaction costs”.
3.Customer & Market Proximity.
Here we consider customer demand and preferences including “made in X” requirements and premiums for understanding and utilizing local talent markets. There are obvious advantages of being close to one’s customers, for example in the case of Tier 2 or Tier 3 suppliers to the aerospace or automotive industries but these can also be disadvantages by increasing dependence on one customer or geography at the expense of all others.
4.Supply Chain Flexibility & Resilience.
By evaluating countries according to supply chain flexibility and resilience criteria we mitigate the risk of disruption through global network diversification and robust contingency planning. This factor has been significantly underemphasised in the past and it is only really with the advent of the global pandemic that this has been brought back into sharp relief. Creating a comprehensive view of the supply chain through detailed tier-by-tier mapping is a critical step to identifying hidden relationships that invite vulnerability. Today most large firms have only a murky view beyond their tier-one and perhaps some large tier-two suppliers.
Whichever approach is taken – and by far the best approach is to utilise all four – the conclusion as to the Best Cost Country may not be the obvious one and the safest rout in many cases is likely to be the adoption of a range of options to properly address risk considerations.
If the global pandemic has taught us anything it is that the traditional lower cost alternatives conceal far higher risks than many companies ever anticipated and which have exacted a very high price indeed in terms of disruption, shortage and delay.
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