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(originally published by Booz & Company)


Knowledge-based Sourcing in China

Structural shifts in the Asian giant’s economy are forcing companies to adopt deeper and more personal strategies for supplier relationships.

The experience of a top U.S. retailer tells a lot about what it is like to do business in China now. Over the years, this company had built a broad supply base in China involving hundreds of firms — and inch by inch its rivals were doing the same. To seize an advantage over its competitors, the retailer decided to significantly narrow this supply base and create deeper relationships with a relative handful of trusted suppliers. It was a wise move: Benefiting from supplier expertise and collaborative partnerships, the retailer gained a 33 to 50 percent advantage over its competitors in terms of the time needed to introduce new products to the American market.

Although the retailer can claim success, few companies have followed its lead. The myth still persists in some quarters that smart analysts in a back room can understand bids from Chinese suppliers a continent away, despite having little contact with the companies that are being asked to produce and ship critical components and products. Indeed, many U.S. and European manufacturers send an RFP (a Request for Proposal, asking suppliers to bid on a job) to Chinese companies without ever setting foot on the mainland.

Such practices will no longer work, partly because of important structural shifts under way in China’s economy, including commodity and wage inflation, the rising value of the Chinese currency, high real costs of talent due to low employee retention, and the failure of many manufacturers to implement efficient and lean operational systems in their plants. Because of these factors, some 50 percent of multinational companies doing business in China think the nation’s competitiveness in low-cost manufacturing is eroding, according to a new survey by Booz & Company and the American Chamber of Commerce in Shanghai. Almost a fifth, or 17 percent, are considering — and in some cases already pursuing — a shift of operations to even lower-cost countries such as India, Vietnam, and Thailand. Nonetheless, the vast majority of these companies find China to be highly attractive as a growth market, thanks to its expanding economy and a middle class that continues to grow by tens of millions of people every year.

Faced with these conditions, companies will find it increasingly necessary to pursue a dual strategy of using the Chinese platform to make more sophisticated product components for export and simultaneously seeking to penetrate the domestic market. This means taking a more holistic view of how sourcing fits into a company’s overall activities in China, and it requires a deeper level of management engagement. Consequently, we believe that multinationals should consider adopting the new approach to working with Chinese suppliers that we call knowledge-based sourcing, which significantly increases insight into the supply base through a deeper understanding of — and two-way discussions about — production costs, manufacturing and transportation economics, lead-time requirements, schedule stability, the likely degree of product design changes, and the technical skills of the suppliers.

The use of knowledge-based sourcing in China is a controversial idea for some Western executives. In their minds, an investment of this magnitude, which can require maintaining a staff of dozens or hundreds of people in the country, could offset any possible gains from sourcing there. Wal-Mart seems to adhere to this view. It requires its suppliers to participate in an annual bidding process that consistently awards contracts to the lowest bidder (even as, critics allege, the quality of its products declines). This process serves the purpose of driving the price down with each passing year, which is Wal-Mart’s primary motivation. But it does little to develop strategic supplier relationships, decidedly a low priority for the retailer.

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  1. Christoph Alexander Bliss, Ronald Haddock, and Kaj Grichnik, “China’s Shifting Competitive Equation,” s+b Leading Ideas Online, 03/18/08: Discusses the findings of the China Manufacturing Competitiveness 2007–2008 study, conducted with the American Chamber of Commerce in Shanghai.
  2. Ronald Haddock, “Integrating China into Your Global Supply Chain: Lessons Learned from Global Supply Chain Integrators” (PDF), Booz & Company white paper, August 2008: An overview of how successful companies need to understand China as both a low-cost manufacturing destination and a growing market. 
  3. Bill Jackson and Michael Pfitzmann, “Win-Win Sourcing,” s+b, Summer 2007: Argues that the most effective procurement model fosters knowledge sharing, not mistrust.
  4. Bill Jackson and Conrad Winkler, “Building the Advantaged Supply Network,” s+b Resilience Report, 09/15/04: Collaborative strategies with examples from aircraft, consumer products, and auto manufacturers, plus advice for step-change planners. 
  5. Edward Tse, “Context and Complexity,” s+b, Autumn 2007: Asserts that success in China requires a flexible approach for a diverse market.
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