A Step-by-Step Approach to Low-Cost Sourcing

China is the hottest market in the world today. Companies of all sizes and in all industries are rushing to either establish or expand operations in this huge and rapidly developing market. While China offers significant savings to manufacturers and service companies, as well as large and rapidly expanding end markets, this same foreign market also presents major supply chain challenges that should not be overlooked.

There are different ways to establish business operations in China. One approach that has proven effective is to first enter the foreign market by purchasing goods there before establishing manufacturing and distributions operations. This approach has dual benefits: The company realizes immediate cost reductions while also gaining knowledge of doing business there and setting the stage for future expansion.

The Aberdeen Group Inc. recently conducted research about low-cost country sourcing (LCCS) among enterprises in all industries, including electronics. This research revealed:

Penetration of new markets is indeed a strong driver for companies that deploy an LCCS program, second only to cost savings (see Figure 1, below).

Many or most companies considering LCCS have little or no understanding of the major risks created by the extended global supply chain that is required to either source from or manufacture in low-cost countries such as China.

The latter research finding is disturbing, since problems with a global supply chain can quickly eliminate any cost savings generated by doing business in a low-cost country like China. In a worst-case scenario, global supply chain disruptions can affect sales, revenue and market share. The Aberdeen research underscores the critical need to place supply chain considerations at or near the forefront of any plan before penetrating new, low-cost markets.

A good example of a company that took such a supply-chain-focused approach is Kulicke & Soffa Industries Inc. (K&S), a manufacturer of semiconductor wire bonding assembly equipment, associated packaging materials and test interconnect products. Based in Willow Grove, PA, K&S began its entry into the Chinese market about 10 years ago. But K&S made a strategic business decision not to immediately jump into China directly, but, instead, first establish operations in Singapore.

"We knew it would be difficult to go to China first," says Alan Schindler, vice president of supply chain management for K&S. "As we make low-volume products that require a high mix of materials configurations, it can be difficult to find the right suppliers. We established operations in Singapore because it's much easier to implement business processes and systems there. Our underlying premise in going to Singapore was that if we could build a supply chain there, we also could build a factory there."

While K&S enjoyed immediate cost savings when it started outsourcing manufacturing to Singapore, Schindler and his team saw the company could gain an additional 20% to 25% commodity cost reduction by moving into China. However, K&S also accurately predicted that China presented greater risk than Singapore. The company, therefore, took steps to mitigate that risk.

"When we moved to China, the risks were very high because Chinese suppliers are not as far along the maturity curve as other countries," says Schindler. "So, we looked to take our current suppliers into Singapore along with us. When we asked them to establish operations in China, most of them did."

This supply-chain focus had additional advantages. "Because these suppliers moved to China with us, the transfer of information from our factories in Singapore to those in China all was executed within our existing supply base," says Schindler. "K&S did not have to be involved. The intensity of K&S' involvement was focused at the subsystem and factory certification level." The information transfer did not entail any effort or costs from K&S and was more efficient than transferring technical information from one supplier to a totally different supplier.

This approach of having existing suppliers expand operations into China automatically produced back-up suppliers. "We had built redundancy into our Asian supply base," says Schindler. "If a factory in China was not operating, we had a back up in Singapore."

Currently, K&S is in the process of shifting as much as possible of the company's total expenditure to Asian suppliers. "We want to leverage the supply base in China for all the rest of K&S Industries," says Schindler.

Schindler underscores two key points about doing business in China. First, logistics operations can make or break the extended supply chain that is created when sourcing from a low-cost country like China. "If you know logistics, you can save a lot of money," says Schindler, adding that supply chain mapping is key to mitigating risk.

The second point is that since China does not have the same level of intellectual property (IP) protection as more developed countries, critical information should be closely held. "For K&S, the end result of our supplier development efforts in Asia is our intellectual property. As supplier development is very difficult in China for the complex parts that we must source, we will not divulge the names of our suppliers. We consider this information to be the intellectual property of K&S."

Schindler also stresses the importance of establishing a full-time presence in China, and not managing suppliers from locations that are halfway around the world from home base. "We have an international purchasing office [IPO] in China, in which supplier quality engineers and procurement engineers interface with our Chinese suppliers. The IPO serves as a bridge between our suppliers in China and engineering groups in the U.S. and Singapore," explains Schindler. These engineers in the IPO enable K&S to have constant communication with the Chinese suppliers. "We also conduct quarterly business reviews with the Chinese suppliers in which we review their long-range business plans and how K&S fits into those plans," he adds.

K&S now plans to shift the sourcing of many high-labor-content subsystems to China to capitalize on the cost savings potential. "We're doing this in concert with our current China supply base," says Schindler.

Schindler also underscores the importance of top management support associated with any effort to enter a low-cost country. This point also was highlighted in Aberdeen's findings. "Senior management has to be fully committed or it can be a nightmare," he says. "We had that support at K&S."

(Click here access Aberdeen Group's research report, "Low-Cost Country Sourcing Success Strategies.")

Kevin Fitzgerald is vice president of supply management research at the Aberdeen Group Inc.