Thursday, October 20, 2011

Sourcing in low cost geographies

When you have been involved in procurement for as many years as I have, you’ve seen the migration of low cost sourcing continue to move to different countries and new suppliers. For the industry I was in, I saw movement from Taiwan and Hong Kong to Singapore, then to Mexico then Korea along with a number of countries and currently with China and India. In certain industries there have been migrations to other low cost locations.

Other than governmental rules and regulations,the problems you face each time are pretty much the same. How do you know the supplier is real? Do they have the capability? Is there product high quality? Will they ship on time? Do they have the financial assets to perform? Are they doing the work or are they sub-contracting to the back-alleys? Do they have the legal right to manufacture the product, etc.?

In a recent post on LinkedIN there was a simple question raised: "Being a sourcing manager how to verify your supplier without an on-site visit". There were a large number of responses that fell into four categories. One was you need to do much more than just an on-site visit. A second was that buyers absolutely needed to do a site visit. The third group was individuals providing suggestions on how to do it. The last group was responses from companies that wanted to function as your purchaser or sell you a service. Those responses were from individuals and companies that want to sell their buying services or sell inspection and on-site audit services for both qualification and management. It’s this last group I want to discuss first.

There was a store I would go to on occasion that had a sign I remember “In God we trust, all others pay cash”. That sums up my attitude that unless the person is from my company or from another company or supplier where I know and trust their opinion because they have earned it, I don’t just trust what people say. To purchase products or services from a third party you really need to do due diligence on that company as much as or even more than the Supplier itself. While there are reputable companies that perform these services, there frequently are also a large number that may not be reputable or have the capability they promise. In addition to their fees they may also be working kickbacks from the suppliers for either giving them the business if you were to have them do buying or kickbacks for looking the other way and not providing you with the service you need.

The other problem with having someone purchase materials is none of these companies are authorized channels of the supplier like an authorized distributor would be. What this means is you have no privity of contract with the supplier in the event of a problem. Most suppliers don’t allow third parties to pass on the terms they received in the purchase to their customer so any warranty wouldn’t come from the supplier, it would come from the buying company. When you buy through these types of companies its like buying a product on an as-is basis with no warranties or indemnities.

As to the other groups, my own opinion is that what you need to do in qualifying suppliers is clearly dependent upon the risks you would have if they failed to perform. For anything but very low risk, low cost and low volume situations I would always recommend both significant due diligence of the suppler, product samples and on-site visits.

I have written a number of posts that I would recommend reading

Supplier financial analysis – January 26, 2011

Supplier risk - pre-qualification of the supplier risk – January 26, 2011

Supplier surveys – common questions to ask and why August 12, 2011

Lastly I would strongly suggest reading "supplier qualification or vendor validation use in negotiation" dated August 8, 2011. On-site visits allow you to add two additional dimensions to the qualification process that you can use in both making sourcing decisions and in negotiations. The first additional dimension is “what is the cost impact of what I see in their operations”. You use that in both negotiating cost but also identifying whether the Supplier will be capable of delivering future price reductions and that is something you would want to know if you planned to use the supplier for the long term. The second additional dimension is what problems do I see form the site visit. Get a tour of their entire operation from raw material incoming to final shipment. You use the information about problems to potentially eliminate them as a source. You can use it to get commitments negotiated into your contract to make sure you don’t have those problems or you have appropriate controls and remedies if you do. You can also use it as leverage to get a better price versus their competition. If you don’t have the skills to understand and evaluate what you see, bring someone along who does and learn from them what you need to look for.

If you learned from this post, think about how much more you could learn from the book.
The book is only US$24.95 plus shipping. The hot-link to is above the date.

How do you deal with a situation where the other side insists their standard terms must apply?

That question was posed on a LinkedIN site so I decided that I would discuss it here. There are a number of ways to push back. My favorites are:
1. Legitimacy / competitive benchmark
2. Risk and control.
3. Cost Impact.
4. Problems it creates that need to be solved.
5. Behavior it will drive and
6. Competitive benchmark.

My first approach is legitimacy linked to competitive benchmark. This isn’t a price benchmark it’s a benchmark terms and their competition. In this you explain that for all other suppliers you use your terms showing legitimacy to your terms. If they still insist on using their terms I would make it clear that any differences will need to be offset. I would further make it clear that any differences will also impact sourcing from them each and every time there are competitive products. This sends the message that while we may use your agreement to start from, where we are going to wind up in the negotiation is going to be no different than if you used your terms or they simply will not get business.

Any time you deal with the other party’s standard agreement there are two things you need to do to start. The obvious one is to review it for what it says. The other is to review it against your standard terms to see what is missing and identify what you need to add to the other party’s standard agreement.

When I look at a supplier’s terms the first thing I look at is risk. What risks are their terms the looking for me to assume. If they want me to assume a risk, I want to make sure that I can manage that risk. Most of the time managing the risk will require that you have control over what actions the supplier can take that could create the risk. When you insist on control as part of assuming the risk, most suppliers don’t want that control. So you link those two issues together. If they want you to accept the risk, you must have the control. If they don’t want to give the control to you, its then a risk you can’t manage. I always insist that the party that has the greatest ability to control the risk should be the one responsible for managing it. If that doesn’t get you what you need then you next link it to cost.

Most terms in the agreement will either have a cost or will drive a cost. Risks, if they materialize, create costs. If the Supplier wants me to assume a cost, they are providing me with less value, so I put a price tag on it and want to pay them that much less for their product or service. That’s negotiating terms from a total cost perspective. If they reduce their price to offset the increase in cost I may agree to accept it. If they don’t I will always use that to explain what the impact of that is from a competitive benchmark perspective. In another post I wrote about value equivalence, I used that to show that other suppliers offer better value and what they are selling and any unique features they have is simply not worth the difference in the total cost of doing business with them,

Some terms will clearly create problems for you, so the next thing I would do is explain the problem that their term(s) is creating and look to them to solve my problem as a condition of getting my business. If the supplier provides an alternative that works for both of us I will agree as long as I get the same value. If they can’t or won’t, once again I highlight the cost or risk that their position is creating which means that they either need to solve my problem or I want to pay less because they are adding a cost to me in dealing with the problem. If I can’t live with the problem it will create, I will walk away from the deal.

Many times Supplier terms really aren’t well thought out of in terms of the behavior they will drive. For example if a supplier doesn’t want to give me a firm commitment where I know that I can count on them to deliver product in a high quality manner, on-time, every time, I ask them what type of behavior do they expect that will drive. I then tell them the cold hard facts that 1) I will never single source them. 2. I will never consider them for being a primary source for an item because I simply cannot depend upon them. I want to make it clear than with those terms all they will ever be is a low volume second source at best and the number of times I would use them will be very limited. This is not a message their sales people want to hear. You use the sales person view of the negative impact it will have on their meeting their sales goals and their commissions to have them help drive change.

My next approach is competitive benchmark. This isn’t a price benchmark, it’s a benchmark of both terms and value. You can explain how their terms aren’t simply aren’t competitive with the ones you have from other suppliers, especially their competition.. You can highlight that with their terms they provide less value than the competition. You can them highlight that whatever unique feature they may have that differentiates themselves from the competition is simply not worth the difference in value/cost. This sends the key message that you are prepared to buy another supplier’s product without those features because from a cost/value perspective another product will better meet your needs.

If none of these work and you need the supplier, make the smallest possible commitment you can make. Then develop plans to migrate to another supplier or another solution as soon as possible. If you don’t need the supplier, walk away and make it clear why you are walking away.

If you learned from this post, think about how much more you could learn from the book.
The cost is only US$24.95 plus shipping. The hot-link to is above the date.