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strategy and business
 / Spring 2005 / Issue 38(originally published by Booz & Company)


The China Syndrome

2. Transportation Efficiency. Procurement from China naturally increases transportation cost over more local sourcing arrangements. In China, a product must go from the factory to the port, onto a ship, and then to the U.S. or another major market, where it is unloaded and trucked to its destination. The cost of ocean transport alone from China to the U.S. is $2,500 to $3,000 per container. For a $12 casting, the total incremental transportation cost is $1.10, compared with $0.30 for a typical Mexican supplier shipping to the U.S.

Financial assessment of China sourcing should be made on the total landed cost of a product, which includes the manufacturing cost differential as well as the full logistics cost — hence two major considerations when assessing transportation costs:

• Measure the ratio of transport cost to total product cost. Since ocean transportation costs are essentially a fixed cost per volume shipped, economics favor China when smaller, higher-value items are involved. For instance, thousands of small electric motors can be packed in one container, spreading the fixed costs over numerous units. Conversely, plastics and stamping assemblies for auto interiors require protective packaging that results in low packing density and fewer parts to share the burden.

• If airfreight is required — for instance, to meet lead time requirements shorter than ocean freight allows — the savings generated by lower-wage-rate manufacturing in China are usually eliminated. Airfreight costs about $1.51 per pound; ocean transport, $0.06 per pound. Only products with very high packing density and high value per unit (for example, printed circuit boards) can support the costs associated with airfreight.

3. Lead Time and Scheduling Stability. Ocean freight adds four to six weeks to the delivery time from China to Western markets. The risk of this extended supply chain to the core business needs to be incorporated into any assessment of whether China is the right place from which to procure. The time delay generated by the longer supply chain significantly increases the chances of both stock-outs in the near term, and excess and obsolete inventory in the long term. So procurement executives must carefully weigh several factors to ensure that their lead times and scheduling remain stable:

• Because Chinese providers typically include large volumes of a product in each shipment, buyers face inventory and defect risk. Purchasing in large volumes means more of the buyer’s dollars are tied up in massive inventory investments, a source of inventory carrying costs and, potentially, obsolescence. Moreover, if manufactured defects are spread throughout a shipment, that could mean thousands of useless components.

• For some product categories, ocean freight lead time can make a Chinese procurement effort unwise. For instance, a manufacturer of telecom infrastructure seemed to be a perfect fit for China because its wiring panels required labor-intensive assembly. However, this benefit was canceled out because the manufacturer’s customers often demanded a high degree of late-stage product customization and expected a rapid lead time. The manufacturer was able to charge more for these customized products and, thus, pay the slightly higher wages in Mexico and Eastern Europe for a quicker turnaround on components delivered to U.S. and Western Europe operations.

4. Product Design. Engineering changes can introduce instability even into mature supply chains. Because the items most frequently sourced are components made up of other components, when an old version of a product becomes obsolete, a change can create a cascade of incompatibility. What’s more, manufacturing operations require time to digest new products and processes; subpar quality frequently corrupts operations during a transition period.

The long lead time and large order quantities required to do business cheaply in China exacerbate both these problems, because the arrival of old-version components can continue for weeks after an engineering change. And it can require an equally long time to take corrective action on lower-quality parts — thus, the central product-design considerations when sourcing from China:

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