CNET también está disponible en español.

Ir a español

Don't show this again


Sourcing in China not a sure bet

A five-dimension analytical model for deciding when--and when not--to purchase from the East.

Sourcing in China not a sure bet
By strategy+business
Special to CNET
February 7, 2005, 10:00 AM PST

For one U.S. automotive supplier a few years ago, it seemed that purchasing components from China was the right thing to do--and quickly. Manufacturers in virtually every industry were setting up shop in China; to read about it in the business press, every venture paid off. The industrial manufacturer, though, discovered to its dismay that success in China was not a sure thing.


With Western companies rushing to China to fill gaps or strengthen links across their supply chains, one particular part of their operations--procurement --deserves special scrutiny. If approached with a rigorous evaluation of product characteristics, Chinese component purchasing can be the right answer for optimal management of the supply chain. When not well planned and carefully analyzed, sourcing in China can be the source of woe.

Gold rush
The China "gold rush" grew out of a dilemma. In recent years, when companies examined their profits and losses, most found that purchased material was the largest line item--typically 40 percent to 70 percent of the total cost of goods. In the face of relentless market pressure to keep prices down, procurement often became a prime target for cost reductions. But that well, for many companies, has begun to run dry. Thus, businesses are increasingly looking to nondomestic sources to meet cost-reduction demands.

Asia, especially China, is the most apparent solution. It has the cheapest labor, a pro-business environment, a productive work force, and strong government support for keeping domestic manufacturing operations as inexpensive as possible--a direct path to easy cost cutting.





Each of five critical dimensions must be examined for every prospective purchase of components and materials for a company to determine whether purchasing from China is the best decision.

Manufacturing cost




  The total labor content (direct and indirect) of a product is the primary driver for China procurement savings. For a product with a large labor component (i.e., 25 percent or more of the product cost structure), low Chinese wages represent a meaningful benefit. In these cases, the labor savings--applied labor hours multiplied by the difference in the labor rate--can be significant. But for some products, such as shoot-and-ship injection-molded plastics, for which one operator manages several high-speed machines, the labor requirements are too low for China sourcing to be the best option.



  Savings on raw materials in China are possible when these materials are locally sourced from competitive suppliers. Electronic components and some lower-end steel grades are areas where local competition can lead to raw-material savings. However, when Chinese suppliers have to import materials--such as high-quality steel alloys--there can be a significant cost penalty in a procurement agreement.


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 United States is $2,500 to $3,000 per container. For a $12 casting, the total incremental transportation cost is $1.10, compared with 30 cents for a typical Mexican supplier shipping to the United States.

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:


  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, 6 cents 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.

Lead time and scheduling stability

  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.


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.
China may still be a lucrative gold mine for some companies. Others, though, should be careful: The ore could be a fool?s blend.

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:


  China is probably not a good option when a high degree of skill is required to implement design changes. Chinese supply chains are challenged by the language gap, a lack of local technical capability for implementing changes correctly, and the complexities of suppliers' processes for managing launches of new products.

Technical capabilities

By contrast, almost all suppliers can handle commoditized processes such as stamping, casting and manual electronics assembly. Companies buying from Chinese sources must weigh two issues relating to the supplier's capabilities:


  The evolving sophistication of Chinese suppliers means careful buyers can gain some important, albeit temporary, advantages. Although products made with the least complicated, most mature technologies are the best choices to source from China, the nation's suppliers continue to develop increasingly sophisticated skills. As a result, more companies are sourcing process-sensitive products, such as rubber and machined parts, from China. That can be a good decision when other critical procurement dimensions, such as lead time, engineering changes, and labor and transportation costs, favor China. It also can give a purchaser a boost over competitors who haven?t figured out where to go to combine China?s cost advantage with its emerging capabilities.


To read more articles like this one, visit

Copyright © 2005 Booz Allen Hamilton Inc.

Reprinted with permission from strategy+business, a quarterly management magazine published by Booz Allen Hamilton.

Interested in more research studies like these? If so, sign up for strategy+business enews, a service of Booz Allen Hamilton's strategy+business magazine.