In our last column (November 2004), we launched a discussion of global sourcing: acquiring materials from lower-cost countries to reduce costs and to support the considerations of complex, global business models. Today U.S. companies do business in myriad lower-cost areas, including Central and Eastern Europe, Mexico, and Brazil. However, the center of global sourcing currently is China because it offers—for the time being at least—low labor costs, an educated workforce, large domestic and export markets, and a commitment to reduced tariffs.

Every discussion of global sourcing must attempt to answer two questions: Which products or categories of products are best suited to global sourcing? And what approaches exist for structuring global sourcing activities? This column will discuss both of these questions and also highlight the global sourcing strategies that companies can adopt to help them improve their supply chain performance.

Labor-intensive products—items geared to leveraging a country's abundance of lower-cost labor—used to represent the bulk of products sourced from lower-cost countries. In China, for example, consumer goods, clothing, and textiles were long the largest export categories. Today China increasingly exports products with higher technology content as the country's manufacturing industry matures and as a growing number of companies begin sourcing directly from China. At the same time, there is momentum away from exports of natural resources as China's swift economic growth places greater internal-demand pressures on those resources. (See chart, below.) This is the direction that most lower-cost countries will likely take: ramping up with labor-intensive manufacturing, then slowly migrating toward more skilled production of higher-value products and services.

Multinationals generally use one of three business models to source products internationally:

• Trading agents. These entities help identify local suppliers, negotiate prices, and follow up on order fulfillment and logistics. In effect, they operate as third-party service providers, which means less operational complexity and smaller local investments for their clients. As a result, companies must be particularly concerned about their own level of control and about the technical knowledge and potential responsiveness of the trading agent.
• Local joint ventures and wholly owned foreign enterprises. In return for somewhat greater efforts and investments, companies typically gain a better understanding of their suppliers; tighter control over quality; and more opportunities to form long-term, direct relationships with suppliers. These benefits are accompanied by greater challenges, such as coordinating sourcing programs across different countries and continents, and managing associated fulfillment, transportation, and distribution activities.
• International procurement offices (IPOs). This approach involves specialized sourcing teams performing dedicated logistics and order management functions. Sponsorship from all affected business units and the ability to manage in-house or outsourced logistics functions are particularly important.

Of the three options, establishing an IPO tends to be the most widely practiced and most successful approach. In addition to benefits related to specialization and centralization, IPOs generally offer the best chance to reduce sourcing costs and limit sourcing cycle times. The presence of such an office also helps ensure that all forms of procurement information are properly communicated worldwide. Overall, they are considered to be the best way to incorporate a new sourcing region or country into an established global supply chain. Typical capabilities include:

• Local supplier identification, screening, and negotiation
• Purchase order management
• Sampling, design, and engineering support
• Logistics coordination and management, and
• Quality assurance and control.

Some companies have successfully begun their sourcing journey by establishing a joint venture to ramp up local production and serve the local market. A year or so later, they open an international procurement office that serves both global and local markets, and increases overall value by accessing a broader range of sourced materials. This approach will continue to make sense for many companies in the future because it limits initial investments, identifies small problems before they become big ones, and resolves issues before regulatory approvals and licenses are obtained.

There is no universal approach to managing sourcing operations in China or in any other market. Nevertheless, all global sourcing initiatives should begin with an approach that is business-case driven—identifying and quantifying the need, and then developing a strategy for sourcing in lower-cost countries.

Most companies will then need to conduct ongoing strategic sourcing exercises to identify the widest range and mix of suppliers, map sourcing processes, rationalize their supplier base, negotiate or renegotiate contracts to improve efficiency, and tighten relationships with key suppliers. Each of these achievements can help businesses implement successful global sourcing initiatives and ultimately improve their overall performance.