Top Managers’ Choice in Global Sourcing: Everybody’s Business or Failure

by Marc Staudenmayer,  Senior Partner,  Advancy

After more than 300 global sourcing projects, we have seen five companies out of six fail to reach their savings objectives. We have seen Asian suppliers which look highly performing and whose products never pass a French quality department. We have seen Eastern European suppliers who deliver the right quality for two years and then suddenly fail. We have seen German technical departments that are unable to communicate product specifications to a Chinese supplier because of missing standards and language. We have seen many more failures – and we have derived key success factors from companies succeeding better in global sourcing than their competitors. The following article explains what makes some companies more successful in Global Sourcing than others and provides a structured approach to manage successfully Global Sourcing activities.

Global Sourcing has been put on top of Chief Procurement Officer’s (CPO) agenda in most industries in the late 1990s. During that decade, growing globalization with simplified currencies, tax and customs rules, access to suppliers from so called best cost countries and generally sinking logistics costs have pushed the global sourcing share in corporate procurement volumes. However, modern Global Sourcing had started much earlier but was limited to a small number of countries like Japan, Taiwan & Korea (1980s) and to very few industries like textile for example.

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Source: Dennis Arnold: Textile & Apparel Sourcing, Advancy project experience and analysis

Looking at Global Sourcing development, one notices that its success does neither depend on the Chief Procurement Officers’ focus or energy nor on the curiosity to enter an emerging market. It is in fact depending on the consequent strategic focus of the whole corporate organization as it implies much more than a perfect/state-of-the-art procurement department to succeed.

Global Sourcing is not a necessity in itself and is addressed, most of the time, under competitive cost pressure. While at the beginning of global sourcing activities, pressure is mostly put by high-cost competitors having started earlier with global sourcing, in more mature markets this cost pressure is mainly put by competitors from developing countries. Competitive advantage is thus generated not by the fact of doing global sourcing but by the fact of being first and fast – and our experience shows that being first and fast in Global Sourcing means mastering three key issues:

  • Sourcing maturity stages: know the current development stage of your organization and manage the process in order to reach the next level
  • Sourcing content: identify which countries are interesting right now and in the near future and which ones need to be left aside
  • Sourcing mobilization: activate all necessary internal and external resources

 

Mirror Mirror on the Wall – Chose your Sourcing Maturity Stage of them all

The Advancy Global Sourcing project experience has lead to identify five subsequent maturity stages in corporate global sourcing. Working with small specialized industrial players as well as with large scale international corporations has shown break-through successes possible at every maturity stage: Sustainably introducing the first Chinese supplier into a production process of a SME is as trendsetting for the corporate organization as implementing a global shared service center in a best cost country for a highly mature company. Nevertheless, every improvement in Global Sourcing is at high risk of failure and it is of utmost importance to manage the process carefully – whatever maturity stage an organization is in.

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Typical corporate behaviors for the different stages are:

  • Stage 1: suppliers are met in home countries on trade fairs, intermediates act in-between supplying and procuring organizations
  • Stage 2: all direct procurement categories and main known sourcing countries are scanned for global sourcing potential. Competitors’ sourcing processes are analyzed.
  • Stage 3: own IPO (international procurement offices) have been set-up with supplier development capabilities, emerging markets take growing importance also in sales
  • Stage 4: production sites in emerging markets have been set-up, global sourcing is performed in one single local organization
  • Stage 5: global network of production sites and sourcing activities exists. Own product manufacturing and supplier sourcing decisions taken with global cost analysis including customs and tax considerations

It is quintessential to know your organization’s sourcing maturity stage and to be candid about it to yourself: None of the above mentioned maturity stages must be left out/skipped in corporate development as organizations learn in each one of them to prepare for the following. So: Take an ingenious look at the mirror. Assuming the willingness to determine objectively an organization’s maturity stage is therefore crucial. So is knowing exactly where an organization stands today and what stage comes next in order to manage the maturity process transparently. It is only through this process an organization gains time and process security.

Once an organization has clear transparency what maturity stage to go for, the next challenge is to know which countries to target at in order to create a competitive advantage.

 

Sourcing Content: Be a pioneer!

Whatever the maturity stage your organization is in, sourcing content is king. While a joke says most people would answer “China” to every question concerning global sourcing, there is deep economical insight necessary to take the right sourcing decision if it shall create competitive advantage. “China” might have been true for a couple of years but there are many more opportunities depending on which industry and maturity stage a company is in.

An easy way to identify a new sourcing market is to look what competitors do – and most of the time what top-management are reading in the news. Unfortunately, the truth in Global Sourcing is most of the time less brilliant than the stories told and creating a competitive advantage through global sourcing is not about imitating others but about being a pioneer.

Our project experience shows the best way to go is gathering all data and running your own economic analysis until you come to a conclusion. There is much information available, the tables show as an example industry specific information about Asia and Eastern Europe.

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The identification of economic trends per industry and the reflection about the industry’s local supply bases provide an insight into the country and regional development perspectives and thus allows to chose the right countries for corporate sourcing activities.

Knowing the Global Sourcing maturity stage to go for and the countries to address subsequently, the risk of failure is almost reduced to the capability of mobilizing the whole organization behind the project.

 

Sourcing mobilization: Yes, it is everybody’s business!

The main corporate error in Global Sourcing is to consider it is a procurement only task. The procurement department being able to tackle with a global supplier base is no more than a conditio sine qua non. Whether in stage 1 or in stage 5, the procurement department relies heavily on other departments when it comes to introducing new Global Sourcing solutions.

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Here are some examples for the involvement of other departments into the Global Sourcing Process:

  • Introducing a new best cost country supplier only works if the quality department is able to qualify products and systems according to foreign (and sometimes exotic) standards
  • R&D must contribute when specifying products and keep technical specifications open to foreign standards
  • Logistics department needs to be able to evaluate supply risks associated to best cost country suppliers
  • Tax and customs considerations must be assessed by the finance department
  • HR needs to integrate capability needs for global sourcing activities into the corporate HR development plan

Moreover, the even more important challenge is to open up the employees’ mindset for Global Sourcing. There are justified apprehensions in high cost country organizations about delocalization which need to be addressed transparently. People in high cost countries may face so-called loss aversion and react illogically when it comes to Global Sourcing. The main implication of the sheer number of departments and the transformational aspects make Global Sourcing an issue which cannot be handled by the procurement department only. It needs a bigger bracket and therefore is of executive board importance.

Chief Procurement Officers confirm the necessity of the executive board attention by stating in a survey at 95% that the main driver for global sourcing success is the corporate strategy – ahead of pure procurement drivers like cost reduction, supplier portfolio reduction, low cost production site development, tax advantages or raw material access.

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Sourcing Results

Most companies running Global Sourcing activities focus on cost reduction only. Upfront savings expectations range generally between 10 and 20% of direct purchasing costs which in real life – and under real total cost of ownership calculation – are very difficult to reach. Nevertheless, the impact of cross-functional Global Sourcing activities is much higher then just cost reduction as it provides access to new markets, to local market intelligence, a higher resilience against volatile sourcing markets and even access to know-how in the later maturity stages of the emerging countries for instance.

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Considering these cross-functional benefits and the competitive advantage they provide, it is the responsibility of a top-manager to run Global Sourcing as a cross-functional and all encompassing activity which cannot be handled by the procurement department only. Experience shows only one out of six leads its organization to success in Global Sourcing. The path to get there is mastering the sourcing maturity process, the sourcing content and, last but not least, the ability to mobilize a corporate organization behind Global Sourcing objectives.

Marc Staudenmayer,  Senior Partner,  Advancy

Further information at www.advancy.de

How to tax-optimize your procurement

Optimization of procurement costs has been a great savings generator since the early 90s. On their way to maturity in procurement excellence, organizations have optimized what to buy, where to buy and how to buy. However, we have noticed that even with mature clients the procurement savings through tax optimization remain mostly untapped. This is all the more interesting as for instance effective tax rates (ETR) differentials between highly industrialized and low-tax countries amount to more than 20%. The objective of this paper is to explain the reasons for this and to show a way to optimize the situation thoroughly.

 

Procurement tax component not optimized today 

With the professionalization of the procurement function main efforts are to optimize cost components and many organizations have done so successfully – with the remarkable exception of the tax component. Our experience shows four good reasons for that:

  • Tax costs are not only product related but depend also on the country, the selling and procuring organization are registered
  • Tax costs depend on the chosen legal and tax scheme from one single entrepreneur on the one side to multi-entrepreneur schemes on the other extreme
  • Operational business units do not have tax targets as optimization levers are bigger on corporate level
  • Tax is a major compliance issue for globally acting organizations and thus under direct control of the executive board, mainly the CFO

 

Complex savings potential calculation

Tax optimization in procurement is easy to imagine: if your supplier currently manufactures a finished good in China, your procurement organization operates in Germany and you sell it to France, the benefits will be generated in Germany with an ETR of around 30%. Moving your procurement department’s operations closer to China, for instance to Hong-Kong, will allow your organization to generate the benefits there and profit form an ETR of 16,5%.

The immediate conclusion would be to transfer all procurement orders to a tax optimized country. The apparent savings potential then sums up to 20% as the effective taxation rate in highly industrialized European countries is close to 30% and main interesting international locations offer importantly lower taxation rates.

In reality savings potentials are lower as transforming a procurement organization for tax reasons is very challenging and risky:

  • the cross-functional aspect (procurement, logistics and finance/tax) implies high organizational complexity
  • compliance risks are high, for instance with corporate tax, internal transfer pricing and function shifting: Highly industrialized countries’ tax authorities have put a major effort in controlling transfer pricing systems with the effect of lowering the benefits drastically. On top of that, these countries have also installed a “function shifting” taxation system which allows the authorities to tax the delocalization of a corporate function to a low-tax country.
  • tax advantages can only be realized on selected product categories and not the whole procurement volume
  • the future operating costs of building up a procurement function in a new location can be important and balance initial savings: Tomorrows salary levels, infrastructural costs and cost of living in location selected might be higher than today.

Knowing the different challenges and based on our operational expertise, we recommend strongly to first run a business case analysis, align executive and supervisory boards and then only start execution.

 

Structured approach leads to sustainable savings 

Pre-requisite 1: As the complexity of this cross-functional optimization approach is high, we strongly recommend to run such a project on executive board level. Pre-requisite 2: You will have to adapt your company’s legal/tax organization and should definitely build a cross-functional team with finance/tax, procurement, logistics, external legal advisors and external consultants: only the alignment of all involved corporate functions plus the challenge trough the external expertise from the very beginning will lead to a sustainable success.

The main tasks to be executed in the business case are the following:

  • tax1Analyze thoroughly your procured goods physical flows with the objective to build procurement category risk-classes for transferable procurement volumes. Focus especially on the value creation chain of your final products in order to illustrate your own organizational value add
  • tax2Analyze your current operating procurement model for the addressable categories: current supplier footprints, current purchaser locations, current associated procurement functions (supplier quality management, etc.), procurement IT-systems availability
  • tax3Assess your organizations current tax scheme between one single entrepreneur and multi-entrepreneur, integrate the current transfer price model used. Also integrate historical evolutions of this schema in order to address change risks with local authorities
  • tax4Run a location selection process in order to identify the best fitting country. Focus first on operational levers (proximity to supply base, availability of work-force, cost of operations, etc.) and then address potential tax advantages
  • tax5Build scenarios based on cost advantages and associated operational and tax risks in order to find best fitting solution for your organization

As a conclusion, our project experience shows tax-optimized procurement leads to a saving up to 10% on addressable scope. It is definitely a board task and requires a high excellence in project execution.

Marc Staudenmayer, Senior Partner, Advancy

Further information at www.advancy.de