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(originally published by Booz & Company)


Knowledge-based Sourcing in China

It’s a different game entirely for companies interested in long-term, innovation-based relationships and for retailers seeking to improve product design and quality or to secure access to unique capabilities. If top Western executives need to change their product designs in response to new tastes or market demands anywhere in the world, to what extent can they count on Chinese suppliers to understand those realities and to accommodate them if they do not have a close partnership?

Moreover, consider the costs that companies can incur if they fail to pay close attention to their suppliers. Mattel Inc., for instance, was forced to recall more than 20 million toys — mostly because of lead paint — that had been sold from November 2006 through August 2007. What Mattel and other companies learned from this experience was the importance of having the right people and processes in place from the outset. In other words, a greater up-front investment in supplier relationships reduces the risk of having to pay far more to clear up a problem after it has erupted.

Putting Theory into Practice
When companies decide that a knowledge-based sourcing approach in China (or another low-cost country) is right for them, three imperatives are essential to successful implementation:

1. Know your suppliers inside out. This includes understanding the true cost positions of current and potential suppliers. We have heard of many cases in which a supplier in China did not understand its own costs. It won work from major manufacturers and retailers only to discover that it was losing money by fulfilling its contracts. Not surprisingly, these relationships fell into crisis. Visit suppliers and see their technical capabilities and capacity with your own eyes — their machinery and equipment, their process technologies, the number and qualifications of their employees, and the like. A bid is no guarantee of a supplier’s willingness and ability to meet current volume and quality requirements or its future competitiveness.

Assess supplier performance against major cost drivers (including wages and benefits, productivity, facility and process/equipment scale and utilization, logistics, and access to raw materials). Low labor costs and the ability to obtain cheap raw materials and components are just two possible elements of cost structure. To gain a true advantage, it is important to establish the ideal combination of world-class performance with location, scale, process technologies and automation, and success in execution. It will then be possible to rate potential suppliers against that ideal and determine how close a supplier from a low-cost country can come to meeting it. In some cases, it might be more advantageous to select a supplier closer to home.

2. Develop strong relationships with a small number of suppliers. Identify the suppliers that are willing to commit to a long-term relationship and to jointly creating a competitive advantage. Offer an enduring and profitable business relationship to each supplier and, in turn, demand its commitment to meeting cost, delivery, quality, and, if applicable, innovation targets. This will likely require local resources dedicated to supplier development, which means working with the supplier to achieve ambitious jointly established targets.

To avoid fragmentation of the supply base, stop bidding out each part and dropping suppliers any time another company offers a better deal. It is difficult for suppliers to develop the right capabilities, make customer-specific investments, and work together well if they’re not confident of continuity.

Beware of the risks of a large supply base into which you have little insight and over which you have little control. The dangers include divisive conflicts within the supplier’s leadership team, financial problems, shifts in the supplier’s strategy or customer base, and deteriorating performance. These problems could go unnoticed until crucial shipments are missed, costs mysteriously escalate, or quality suddenly nose-dives.

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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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