This last Wednesday, Global Sourcing Specialists partner, Ashton Udall, gave a talk to a Bay Area group of CEOs that are part of the International Housewares Association group CORE.

The talk was a lot of fun and it was interesting to hear the anecdotes from both small and mid-size housewares companies’ execs.  To recap, below are two points from the presentation and discussion which I thought solid takeaways:

How Badly do we Really Want Manufacturing to Return to the US? It was not surprising to hear complaints about many of the standard issues that have challenged foreign businesses manufacturing products in China: quality, IP protection, sourcing reliable factories, etc.  As with most discussions like this, there are always a few funny stories of the absurd (by US practices) things that have taken place when operating overseas (e.g. factories using customer owned molds as collateral for bank loans, the bribing structure which Chinese factories must play in, etc.)  There was also quite a bit of talk and concern amongst executives about the price increases being experienced in China manufacturing, particularly in the last 6 months.  No question…a lot of companies are feeling the pressure.

However, an interesting sentiment from many execs in the group was that US manufacturers made it difficult to do business here.  Will the trend of a Renaissance in US manufacturing, as predicted by the recent BCG report, include SMEs?  I heard many experiences in which they had a hard time getting call-backs from US factories, US factories were not interested in anything but very high volumes, and it just plain seemed like US manufacturers didn’t care to earn business.  Some said they loved the can-do attitude of the Chinese and found that, for all the challenges, Chinese sources were generally more eager to please and win business.  A few of the executives had substantial manufacturing operations in the States and, despite enjoying the control they obtained by being much closer to their sources, they concurred with the difficult attitude found in many US organizations.  Will this continue to be a problem for SMEs as things shift towards 2015?

The Sourcing Landscape is Changing–Which Means Analysis and Tough Decisions Lie Ahead: I began my presentation with the observation that most companies do not consider how they design and optimize their supply chain to support their corporate strategy.  Stepping back to look at how this could be done can give a great deal of insight on making decisions to balance cost and risk in selecting suppliers, and regions to source from.  I think most executives of SMEs are content to battle the tactical challenges of manufacturing in China, so long as costs are low.  Rising wages, a shrinking labor pool, and the fact that the Chinese govt. is purposefully enacting policies to shut down many manufacturing industries in the coastal regions and redeploy them inland, is now giving many pause as to how long the cost advantages will exist.

It’s clear that costs will continue to increase in China in the next few years and companies should be far more critical of who their suppliers are and whether they will be able to evolve, survive, and continue to offer value-added services.  There are great organizations in the coastal areas of China that provide tremendous value-add in the way of expertise, service, and engineering.  For those working with the dirt floor factories and in industries where low cost pricing pressure makes it difficult to work with factories that offer more than the bare minimum, it is high-time to begin thinking about sourcing suppliers from other regions (inland China) or countries if you aren’t already.  Either way, in the short term, it’s going to be ever-more critical to assess the suppliers you are working with and to source suppliers that can support you as the China landscape continues to change.  Paying a little more in unit cost is better than waking up one morning to find out your factory has shut down and your money, molds, and product have disappeared.

In the coming years, your company will face tougher decisions.  To stay?  To go?  If we go elsewhere–where and why?  Do we follow the herd?   If one has to make tough decisions and think about overhauling a substantial portion of your supply chain, you might as well step back and assess the bigger picture of how your customers would like to be served and which regions and factories are best able to support you in doing this.  I’ve never heard of a scenario in which following the herd offered a competitive advantage.  Take a look at this business model canvas:

What will be your market segments in 5 years?  What will be the value proposition that can set you ahead of your competitors?  And will following the herd allow you to deliver it in a way no one else can?

In 2010, the Dept. of Education funded a study by Dr. Donald Leu, which turned out a report claiming that school children were facing a learning crisis spawned by the internet.  The study highlighted an experiment of Dr. Leu’s, in which he asked his students to write a report on the Tree Octopus, “an allegedly endangered species roaming the treetops of the Pacific Northwest”.  The story goes:

Researchers on Leu’s team asked a group of students to hunt down information on the critter, which of course does not exist. But the same researchers pulled a bit of trickery on the students — they directed them to a website dedicated to saving the mythical tree octopus from extinction. And presto: the kids taking part in the study fell for the hoax and even continued to believe in the tree octopus after the study’s leaders explained that there was no such thing.

Here’s a sampling of the tree octopus factoids featured on the site:

Tree octopuses have eyesight comparable to humans. Besides allowing them to see their prey and environment, it helps them in inter-octopus relations. Although they are not social animals like us, they display to one-another their emotions through their ability to change the color of their skin: red indicates anger, white fear, while they normally maintain a mottled brown tone to blend in with the background.

According to Leu, the founder and director of the New Literacies Research Lab at the University of Connecticut, the moral of the exercise is simple: “anyone can publish anything on the Internet and today’s students are not prepared to critically evaluate the information they find there.”

The Yahoo article I read about this in points out that the root cause of the problem may lie less on the shoulders of the internet, and more on the ability of children to think critically.  It also seems to apply to some users of manufacturer directory websites like Alibaba as well.  Dan Harris of ChinaLawBlog, has written yet another post about the perils of Alibaba, prompted this time by a Time Magazine article which has uncovered fraud within Alibaba itself.  I often remark in my presentations, as well as previous blog posts, that Alibaba and similar websites have ONLY helped us with the tip of the iceberg in the sourcing and manufacturing process.  These listings of manufacturers are powerful in that they have made it far easier to connect with companies overseas.  However, I agree with Dan when he says that this has gotten a lot of SMEs into trouble because they don’t yet know that the connection is just the tip of the iceberg in sourcing and managing a good manufacturer, particularly in a low cost country like China.

When I lay out a sourcing and manufacturing schedule for a client, it quickly becomes apparent that finding the contact information for several potential suppliers and opening communications with them is…I don’t know, generally 1%-5% of the entire process!  There is quite a bit in the way of stages, decisions, negotiations, and analyses that has to take place before a company has product coming off the line.  Part of this is getting to know who you’re going to select as a supplier, and this surely can’t be gleaned from a website, even if Alibaba has awarded them a “gold” rating.  The scandal reported by Time Magazine in relation to these ratings being manipulated, just goes to show that even a 3rd party website and their purported audit, does not offer any assurance.  The article states:

An internal investigation by independent board member Savio Kwan revealed that beginning in late 2009, Alibaba had noticed an increase in fraud claims against sellers designated as “gold suppliers,” which means they had been vetted by an independent party as legitimate merchants. The investigation revealed that about 100 Alibaba sales people, out of a staff of 5,000, were responsible for letting fraudulent entities evade regular verification measures and establish online storefronts.

The company said it uncovered fraudulent transactions by 1,219 of the “gold suppliers” registered in 2009 and 1,107 of those in 2010, accounting for about 1% of the total number of gold suppliers during those years. It further said that “the vast majority of these storefronts were set up to intentionally defraud global buyers” by advertising consumer electronics at cheap prices with low minimum-order requirements. The average claim against fraudulent suppliers was less than $1,200.

I think the Times’ report of the fraud going on inside Alibaba is 1) not surprising given the fraud that has taken place in the factory audit industry itself, and 2) just another example of the Tree Octopus phenomenon.

Sourcing and managing a manufacturer, particularly one in China, is not something done well without leaving your chair.  You’ve got to do your due diligence and use common sense, no matter what on the internet implies that you don’t.  Oh, and if you’re intrigued by the Tree Octopus and disappointed it doesn’t exist, check out the Magnetic Octopus which can be domesticated and lives on refrigerators.  It’s awesome.  An Alibaba supplier swears it:

http://www.alibaba.com/product-gs/292165505/Plush_octopus_with_magnet_plush_octopus.html

I saw an article in Business Week last week about Sony bringing in Executive Deputy President Yutaka Nakagawa, a proven cost-cutter, to reduce Sony's supply chain costs.  Over the next two years, the company is aiming to halve the number of its parts and materials manufacturers and reduce purchasing costs by 20% this fiscal year.  Sony is hoping to achieve lower costs by buying larger volumes from fewer suppliers.  If the cuts can return the company from what is expected to be its second consecutive year of losses, newly created working capital can be dedicated towards new innovation and product launches.  However, as the Businessweek article points out, if the cuts result in being single sourced when/if demand spikes or quality defects arise, Sony could find itself in a precarious position.  

This reminds me of an article in Purchasing.com, found via Sourcing Innovation, explaining that Cost Reduction Efforts Require More Focus than Sacrifice.  The article's gist harks back to some of my rantings on the importance of strategy in sourcing and long term success.  The article cites a recent survey of private companies by PricewaterhouseCoopers which notes that companies are focusing on reducing costs in discretionary spending such as travel and entertainment, as well as streamlining operations, workforce reductions, and employee compensation.  In many ways, these might be regarded as short-term cost reductions that help financial statements quickly, and in the sphere of public companies, make Wall Street step back from the ledge and decide to live.  The article goes on to point out:

Another piece of research from the Corporate Executive Board, supports this thinking, saying companies need to focus more on reducing cost of goods sold and less on SG&A. "While most CFOs are quick to cut overhead (SG&A) to achieve cost-reduction goals, the companies that are able to maintain cost reductions over the long term spend more on SG&A as a leveraged way to help the business drive operational efficiency and reduce cost of goods sold," the CEB report says. In fact, it says on average, the better cost-cutting companies report cost of goods sold being about 49% of sales vs. 62.8% for average companies. However, the best cost-cutters have slightly higher SG&A.

You see, when you cut travel, you cut the ability for your people to make, and maintain, relationships. When you cut entertainment, which is typically a very small budget to begin with, you increase stress, which decreases productivity. When you streamline operations, things start to slip through the cracks. Then when you cut workforce, you cut capability, key processes get skipped entirely, critical sourcing events just don't happen, and you keep sourcing off of expensive ever-green contracts and spot-buying at high prices. When you cut training, your staff's skills get even more outdated and your cost reduction efforts miss the mark. And when you cut compensation, your best employees feel unappreciated and trampled on, stop giving 100%, and start looking for their next job.

As the article says, you have much better opportunities, including:

    * transaction processing
    * supplier management
    * health care benefits
    * IT assets (hardware and software)
    * logistics 

Investing in your people to implement good cost controls and look for ways to achieve operational efficiencies, rather than simply going after the quick and easy slashing of fixed costs, results in your people finding ways to lower the cost of goods for the long term.  This is one major method that smart companies use to destroy the competition over the long haul.

Related blog posts:

• Developing Mass Market Products: The "Good Enough" Revolution
• To Manufacture in China or the United States: Get Beyond Cost to Strategic Sourcing and Manufacturing of Products
• Swimming Naked in the Supply Chain: Getting to Know Factories and Sourcing

When to source manufacturing offshore in a country like China, India, or Mexico?  When to keep manufacturing at home in the U.S.?  Don't start with cost:  start with strategy.

Lowering costs has been the most common and highly publicized impetus for companies to source and establish manufacturing operations offshore in a low-cost country like China.  But there are myriad reasons why a company might expand operations to an offshore country, or on the flipside, choose to maintain manufacturing at home.  Many of them have nothing to do with cost, but can be far more significant to a company's health than the cost of goods.

For many consumer product industries, seeking the cost-savings is a given.  To be competitive on the retail shelf, offshore manufacturing operations in low cost country sources is necessary.  But the strategic planning for sourcing and manufacturing often does not go beyond this perspective of thinking, a practice which often lands companies in trouble by sacrificing the most valuable aspects of their organization, or results in them missing a chance to maximize the value of their supply chain.  

First, consider a company's competitive advantage.  What aspects of the company are most important to the company's competitive position in the market?  Innovation and launch of new products?  Delivery of a consistent, high-quality customer experience with the company's products and services?  Lowest prices on the market?  There are many ways a company can differentiate itself and flourish in the market.  The question is–how will sourcing an offshore supplier in a country like China detract from or augment this competitive niche? 

Business case studies have shown that companies which have sought offshore suppliers to lower costs, at the expense of other important aspects of their company (such expenses were not clearly understood at the time), have ended up losing market share and value.  For example, companies which are leaders in innovation and technology often become so because they have nurtured a culture of strong, horizontal communication within.  Ideas, knowledge, and relationships are built across functional boudaries (meaning engineers eat lunch with marketing folk) which all contribute to the cross pollination of ideas  and the development of new, innovative products.  However, when a VP of operations decides to begin contracting out manufacturing an ocean away, without paying specific attention to developing the proper communication channels, the core strength of the company is sacrificed over time in the pursuit of short-term cost reductions.

A way in which the above technology company may have gone about this in a better way?  Keeping manufacturing operations at home may or may not have been the answer.  But they clearly could have prepared for their move offshore more effectively.  They could have sourced lower cost manufacturing suppliers and developed close partnerships to foster open dialogue.  Perhaps the company makes sure its design team goes over to visit their suppliers several times per year to visit manufacturing facilities, and vice versa.  A company seeking to optimize its supply chain in this fashion, by attaining a lower cost of goods, IN ADDITION to investing the resources to support its competitive advantages with outsourced service providers, can truly maximize value.  Apple computer could be considered a company that has done this very effectively.  Apple knows where to spend and where to save.  For more insight into how Apple does this on a product basis, check out Manufacturing the Ipod Shuffle: How Apple Produces Great Products at Great Prices.

As Dan Harris of ChinaLawBlog points out in his post Manufacturing in China.  Because There Are 1.3 Billion People There, gaining access to China's consumer market is now becoming a significant reason cited by companies for expansion of operations in China.  Following customers to support them in foreign countries might be another reason.  The fact is, there are numerous ways to drive value beyond lower cost goods.

Why keep manufacturing at home?  Some companies may find it more valuable in the long term to keep manufacturing operations at home, despite the opportunities for cost reduction elsewhere.  These companies know that paying more in the short-term to maintain whatever edge their domestic operations gives them, offers greater rewards in the long-term.  An example of this may be a fashion oriented company that creates new product lines several times annually, and has difficulty accurately forecasting which items will sell.  Thus, they may find that the cost of holding inventory for long periods of time and not being able to respond quickly to market trends is more expensive over the long haul than manufacturing their products domestically and gaining very short lead times.  An analysis of the supply chain at the product level may motivate a company like this to choose a hybrid model in which some of its products are manufactured abroad and some at home.  A fashion company like Zara, which can go from product concept to market in 18 days, is a great example of this.  It starts with strategy.

The bottomline is that companies, particularly smaller companies, that are now sourcing contract manufacturers in places like China, India, Vietnam, and elsewhere because of cost pressures, should consider how else manufacturing in these areas will impact their business.  They have the opportunity to advance to a higher level of strategic planning.  In a country like China, they may gain greater access to materials suppliers, they may be able to take advantage of low cost engineering and design talent, they may find an opportunity to sell into China as well.  If their competitive advantage rests upon delivering high quality product, or innovating products on the cutting-edge, they would do well to ensure that they source suppliers that can support these functions and invest the necessary level of resources to optimize them.  Some may find that not outsourcing, and staying at home, serves their purposes better in the long run.  Companies may find that smaller minimum quantities and faster turnaround are the key drivers in their business.  The point is to assess the strategic sourcing circumstances, make an educated decision, and execute it accordingly.

Is this your factory?

An article by Andrew Reich from ChinaSuccessStories (h/t Dan Harris of Chinalawblog) highlights five straightforward but oft missed steps in assuring the quality of product from your China manufacturer.  Dan Harris, added a sixth point, and Global Sourcing Specialists is chiming in to add a seventh key to quality when when working with chinese factories: Source a quality manufacturer

First, it should be noted that these steps need to be taken together.  Accomplishing one or a few of them will not suffice to assure your product quality, and will likely only delude you into a false a security about what is coming off the production line and potentially making its way into the hands of your customers. 

ChinaSuccessStories's first five points:

1. Detailed documents: The number one key to quality when working with factories in China
   is documentation. Having bi-lingual, detailed, factory agreed upon
   checklists in place that document an item’s specifications and the
   criteria for inspecting the product before shipment, is essential to
   controlling product quality. One can not say for sure, but I would be
   willing to bet that the factories responsible for products recently
   recalled for lead paint did not have bi-lingual documentation on hand
   from their customer stating the type of paints that could and could not
   be used. Sure, this type of documentation takes time and hard work to
   create, but putting such processes in place is the first and most
   important step in avoiding quality issues. QC Checklists should describe in detail:

   a)     Item Packaging

   b)    Item Defect Classification (what is considered an defect and at what 
           severity)

   c)    Item Size and Other Specifications

   d)    Item Functionality and How it is Checked

2. Factory Presence:  Having a presence at the factory ensures that both factory staff and
   management really know who you are. Either through a 3rd party QC
   company or your own staff, ensure that you are being represented at the
   factory in person on a regular basis, and that the factory clearly
   connects your presence there with your production. Success in China is
   all about relationship (Guanxi), and dealing with quality is no
   different. Work towards a state where the factory has a personal
   commitment to you and your products.
3. Inspection:  Perform regular product inspections (either with your staff or a via
   3rd party), not only on the final product shipment, but also during
   production (otherwise knows as DUPRO). Ensure these inspections are
   consistent and based on clear inspection criteria. Always review the
   inspection results with factory management and their own QC team.
4. Keep Approved Samples:  Some say that a picture is worth a thousand words. I say that a sample
   is worth a thousand headaches! Items often get revised and modified
   several times in the sourcing process, and then again after production
   begins. Keeping an approved sample in your office, and also one in the
   factory that can be used to verify the production product by the QC
   team, is essential in seeing eye to eye with your Chinese suppliers.

5. Take Responsibility:  Nothing will alienate your Chinese suppliers more than a mistake on
   your side for which you take no responsibility, and blame their
   misunderstanding. I’ve seen hard-headed buyers make this mistake more
   than once, to the demise of their hard earned factory relationships.
   So, make sure you have all the facts before you start to blame.
   Recognize when it’s possible that a mistake or production issue may
   have been caused by your own fault, or your own team’s
   mis-communication. Take responsibility when this happens, even if it
   means a financial loss. If you are working with the factory on a long
   term basis, the credibility you will gain will outweigh what you have
   given up.

   The message here is don’t take anything for granted. You and your
   suppliers most likely come from two vastly different cultures, have
   different values, and see quality differently. By making sure quality
   standards and procedures are in place and clear to all parties you will
   definitely avoid costly production issues.

Dan Harris' 6th Point: Legal Contracts

Our 7th Point:  Sourcing of Quality China Manufacturers

Really, this point might be placed first, only because the sourcing process takes place before any of these other steps are taken, AND, if you work with the wrong China factory, or any factory for that matter, these other steps may be very difficult to accomplish and/or ineffective.  It's similar to following all of the cooking instructions with great meticulousness to bake a world-class cake, and then baking your cake in the Easy Bake Oven.

Thus, to ensure supplier sourcing sets the other 6 steps up for success, one would do well to locate several potential sources, receive manufacturing and cost feedback from each of them, and select one or two that seem best able to support the project's and company's needs based on qualifications, engineering and QC support, product lines, and customer service.  Assessing a supplier for these qualities will likely, and should, involve auditing the factory production line, as well as meeting with management and key personnel.  Do this–and the rest will be much easier.

I attended Stanford University's third annual conference on socially and environmentally responsible (SER) supply chains last Thursday, May 21.  The conference has doubled in size every year since 2006 and promises to be larger next year.  A full day of presentations and panels from executives at leading companies such as Cisco, Intel, Safeway, Disney, HP, Verite, and more made for a multitude of perspectives and approaches to the topic of sustainability in supply chains. 

A few general observations from the conference:

• The realm of social and environmental responsibility in supply chains is still very nascent.  It seems each company, industry, and the business world as a whole is still establishing definitions for what it means to be socially and environmentally responsible.  This dialogue, of course, is very important and will likely set the stage for a future platform to act from. 
• It seems greater success can be had when companies address issues of social and environmental responsibility in their supply chains from an industry approach.  This leads to a greater probability of standardization and leverage in the supply chain, which in turn, based upon presenters' comments, seems to foster faster and more widespread change in the supply chain as a whole.  Some critical factors for success gleaned from many of the presentations, despite the industry of a given company, are the following:
  • The involvement and commitment of top, C-level, management
  • The combination of efforts across companies within a given company
  • Honest and free communication within companies and with competitors (a very scary and challenging proposition for many companies)
  • A sharing of best practices and communication amongst shared suppliers within the industry (meaning–get your suppliers to talk and share with each other to benefit everyone as a whole)
  • Outside and independent verification to create transparency and accountability

A few other interesting takeaways:

• Cooperation amongst several companies within an industry to acheive industrywide social and environmental responsibility seemed to be easier to accomplish in B2B industries, and industries that did not generally "face" consumers or receive consumer and/or watchdog scrutiny.  Those companies that had more of a B2C orientation viewed supply chain SER as more of a competitive differentiator, and thus were less inclined to share information and resources with others. 
• I expect the conference will double in size and notoriety next year.  This is an issue the business world has only begun to explore.  I found myself wanting more nitty gritty dialogue from the conference, but as companies move down the path from the general questions of definition and the surface levels of implementation, I am sure the dialogue and topic will become much more comprehensive, heated, and fruitful.

 By Ashton Udall

We're preparing to sit down with a new potential client and the management of the factory which we've sourced for their project tomorrow afternoon.  Every time we work on a sourcing project, we're faced with the question of how close do we bring the vendors to the customers.  Many outsourcing service providers fear they'll be left out in the cold in a situation like this.  But we've found it to be very helpful, in fact, necessary to always allow our customers the opportunity to meet the manufacturer that will be producing their products.  The value to us in keeping everyone arms length from each other is smaller than one might think (the value essentially being mitigating the risk of being cut out of the process prematurely), and it costs us, and raises risk levels, in several ways.

• Honesty and straight-dealing: It may be impossible to quantify the value, but bringing everyone into the communication loop may be one of the most important aspects of all parties knowing each other.  It sets a tone.  Communication and information can flow more freely.  Less time and energy is spent on Prisoner's Dilemma thinking–trying to figure out how to come out ahead of the other guy in all situations, and more time is spent collaborating to figure out how to resolve problems and innovate. 

I recently had an interesting conversation with a former senior exec of sourcing and manufacturing at Nike and Disney about transparency in their supply chains and working with vendors to improve their labor and environmental practices.  At a time when these companies faced serious risk in consumer backlash because of the exposure of poor working conditions at factories, Nike, for example, took a hard look at their manufacturing base and changed course to focus on working more intimately with fewer suppliers.  According to this gentleman, everyone opened their books, saw what each other was making, understood that everyone needed to make money for the system to work, and collaborated on resolving issues that challenged any party in the supply chain, because they could all be honest about the causes and effects of what was taking place.  Nike is now known to be well out in front of the 8 ball when it comes to dealing with corporate social responsibility issues in its supply chain.  Issues do and will continue to come up for them, but they are in a much better place to resolve these problems at factories.  The same cannot be said for many other companies out there. 

• Understanding the manufacturing process: When sourcing a new manufacturer for a product, particularly when a new product is being developed, it's always helpful when a client has toured the manufacturing facility where the product is going to be made.  Understanding the engineering of the production plan, seeing the machines that are used, how materials are stored, how quality control is accomplished, all offer a client the opportunity to better understand why certain issues are coming up and what can be done to resolve them.  This is particularly helpful in the product design and new product development process, when the ability of a manufacturer to include certain product features, use specific materials, or provide these things at a specific cost, is challenged by what is actually feasible in the manufacturing and sourcing process.  An understanding of the manufacturing process and capabilities allows all parties involved to quickly move beyond trying to understand why something is an issue, to resolving the issue. 

• Knowing the key players: In any organization, you will find that there are some people that really move things forward, and some that don't.  Whether this is because they wield formal authority or soft power in the organization, they get up and get to work earlier than the next guy, or they aren't afraid to pick up the phone and talk to people, you want to know who are the people that really drive progress and solutions for your project in the organization.  When the S hits the fan–you want to be able to reach these people.

Not all customers have the opportunity to travel to the factory location, particularly if it's overseas.  It's our job to be the feet on the street, whether in China, Vietnam, Mexico, the Midwest, or southern California.  But, we encourage customers to come see the manufacturing plant and meet key players in the contract manufacturing organization if they have the opportunity and motivation.  Organizations relying on keeping people, and parties in the process, at arms length when designing or developing new products, sourcing new manufacturers, and managing the supply chain as a whole, do so because they lack the ability to provide strong value in other capacities.  There are many ways to add value to the sourcing process.  This is one simple way to make a big impact.