Global Sourcing In Procurement

In 1776, Adam Smith in his book “The Wealth of Nations” suggested that some countries of the world produce certain goods and services more efficiently than other countries. The country that produces goods and services more efficiently is said to have an absolute advantage in its production.

Smith emphasised that countries should produce and export those goods and services in which they have an absolute advantage.

In contrast, the country should import goods and services which it cannot produce itself efficiently from those countries, which have an absolute advantage in the production of those goods and services. This was the beginning of the concept of ‘free trade’.

Today, the world is highly interconnected through the use of technology and the easing of cross-border trade restrictions. Global trade has also increased because countries now realize the importance of staying competitive in the international market and deriving maximum benefits. With the emergence of global trade, various concepts, such as global supply, global sourcing, and global supply chain management have come into the picture. In this chapter, we will discuss the concept of global sourcing.

Global sourcing refers to the practice of procuring the required products and services from the international/global market. When a buyer buys goods or services that are not produced in the country of the buyer (or are produced in a minimum quantity or produced inefficiently), the products/services are said to be procured globally.

In the global market, several suppliers provide similar products/services. Therefore, when a buyer ‘A’ belonging to country X wants to purchase some goods or services (say G), he/she should search for sellers that sell G in the domestic and international markets both. He/ she should carefully analyze the final prices that would have to be paid for G from different suppliers. In addition, he should lay emphasis on the total time in which G can be made available after verifying the quality of G. After analyzing these factors, buyer ‘A’ should shortlist one seller with whom it can place a purchase order.

Stages of Worldwide Sourcing

According to Joseph Carter, the Associate Director General of the Thunderbird School of Global Management at Arizona State University, there are three stages of worldwide sourcing, which are:

International Purchasing

At this stage, organizations focus on leveraging volumes, minimizing prices and managing inventory costs. Organizations that are new to global purchasing are at this stage.

Global sourcing

Organisations that want to derive advantages from the international market must shift their focus on segmenting and improving their supplier capabilities, supporting production strategies, and serving customer markets. Organizations that have some amount of experience in global sourcing are at this stage.

Global supply management

Organisations that are able to optimize supply networks by using effective logistics and capacity management and minimize risks in offshore sourcing are at this stage of worldwide sourcing.

Reasons for Global Sourcing

It is fairly simple to procure goods and services from the domestic market as compared to sourcing them from the global market. This is because there are many factors associated with global sourcing, such as customs clearance, shipping, care of products in transit, etc.

It can be said that sourcing from a global market requires more effort in comparison to domestic sourcing. However, organizations go for global sourcing because of various reasons. Some of them are:

Superior Quality

Some countries import certain goods simply because they cannot produce those goods having the required quality characteristics. For example, Egypt produces and exports Giza 45, which is the best variety of cotton in the world and it commands the maximum price. Organizations that want to use the best cotton can import this variety.

Better Timeliness

It is possible that products or services required by a buyer may be provided to it in a shorter time if procured from a global supplier as against the time taken by a domestic producer.

Lower Cost

When a buyer compares the prices offered by various national and international sellers, he/she adds miscellaneous costs, such as the cost of communication, transportation cost, and import duties to the final cost of goods in case of international procurement.

A comparison of the price quotes offered by national and international suppliers may reveal that one or more international suppliers are offering lower costs than domestic suppliers. Therefore, it is in the interest of the buyer to procure goods/services from an international supplier.

This type of sourcing strategy in which an organization sources materials from other countries that offer labor at less cost with an aim to reduce the operational costs is called as Low-Cost Country Sourcing (LCCS).

Better Technology

Different countries specialize in different products and process technologies. Countries that specialize in technology should export it to those countries that do not have that given technological capability.

For example, India imports missiles and other defense equipment from various countries, such as Israel, the US, and Russia. India has recently enhanced its internal manufacturing abilities for producing defense equipment. However, the country has still not reached the required level of technology in defense production. Therefore, the technology that India does not possess is brought through import.

Broader supply base

While purchasing from the global market, a buyer may choose a seller from a large number of suppliers.

Expanded Customer Base

While a buyer may choose a seller from a large number of suppliers, it is also true that the customer base of a supplier is no longer limited to his/her home country. He/she can offer his goods and services to any individual or organization in the world.

Access to Raw Materials

Sometimes, a country may have a product or process technology and capacity but may not have raw materials required for producing a product using that technology. For example, India has developed technology to produce nuclear power.

However, it does not have sufficient amounts of radioactive material, such as uranium to produce nuclear power. India imports uranium from Russia, Kazakhstan, France, Canada, and Australia.

However, India is also working on plans to utilize its thorium reserves for using it as raw material in nuclear power plants instead of uranium.

Access to Cheaper Wages

This benefit is applicable to the buyers of services. International organizations can source human resources from countries having low wage rates. For example, many countries of the world, such as the US, the UK, Australia, Ireland, etc. fulfill their skilled labor needs from countries, such as China, the Philippines, India, etc.

Middle-eastern countries, such as the UAE, Turkey, Qatar, Iran, Israel, Saudi Arabia, etc. hire low-skill labor (like construction workers and domestic help) from underdeveloped and developing countries, such as Pakistan, India, Bangladesh, Egypt, Yemen, Palestine, Sudan, and Syria.

Increase in Competition Among Domestic Companies

When certain products are available to customers at cheaper costs from global suppliers and when existing customers are also shifting their loyalty, domestic companies feel the need to implement strategic changes to their production in order to decrease production costs.

In the absence of these changes, the domestic organizations’ market share and customer base will continue to decrease and eventually cease to exist.

Methods of Global Sourcing

Organizations can enter and access the global market (for the purpose of global sourcing) using various methods such as:

Low-Cost Country Sourcing (LCCS)

In this type of global sourcing, organizations procure their materials in countries that offer low labor and production costs. It helps in reducing the overall operational costs of production.

Examples of LCCS include the import of labor-intensive manufactured products from China, outsourcing of various business processes to countries like India that offer low-cost English-speaking workers, and outsourcing of IT functions, such as development and testing in countries like India that offer highly skilled workers at much less cost.

Outsourcing

Organizations mainly focus on their major business functions or core capabilities. All other functions in which they do not have capabilities are outsourced to other organizations. Usually, the functions that are outsourced include business processes, legal processes, knowledge processes, and recruitment processes.

For example, several IT companies in US/UK outsource there not critical functions to India. Organizations also outsource their knowledge processes (KPO business) to India as there are a large English-speaking population.

Imports

Organizations can procure goods and services from the international market. They can place orders with the concerned seller and receive them by paying the required customs duty.

Offshoring

When organizations set up offices in a foreign country to take advantage of less expensive raw materials and/or low-cost workers, the environment conducive for the conduct of business, etc. it is said that the business of the organization has been offshored.

Internet and E-commerce Portals

There are international e-commerce portals such as Amazon.com and Alibaba.com from which an organization may buy the required products. These e-commerce platforms have a network of sellers offering various products. The buyer may choose the required product and place an order for it.

International Procurement Offices (IPOs)

When organizations want to procure various goods or any good in large quantity from a particular country, it usually sets up an office called International Procurement Office or International Purchasing Office, which is abbreviated as IPO. An IPO is owned and operated by its parent organization.

The parent organization may also create one IPO for sourcing from multiple nearby countries in the region. For example, a US-based company may establish its IPO in India for global sourcing from the South-East Asian region.

Evaluation of International Suppliers

Organizations usually have their own criteria for evaluating international suppliers. For example, some organizations may give importance to lead times taken by the supplier, whereas other organizations may give importance to the quality of material provided by the supplier.

However, there are certain criteria that are used by organizations all over the world while evaluating international suppliers. These criteria are considered to be best practices in evaluating international suppliers and are described as follows:

Checking for References and Referrals

Before an organization fixes and contracts with a particular supplier, it should search for and read reviews (or may even contact) all the previous customers of the supplier. This information can be critical and can help save the organization from unscrupulous suppliers.

Clearly Defined Clauses

The buyer organization must remember that while sending the Request for Quotations (RFQ) to the suppliers, all the important conditions or clauses must be stated clearly. For example, clauses such as those related to Liquidated Damages (LD) must be stated clearly in the RFQ as well as the contract.

Establishing Performance Indicators

The buyer organization determines key performance indicators on the basis of its needs and the type of product that is being sourced. Performance indicators vary depending on the nature of the products.

For example, if an organization is sourcing fresh fish from some country, it should have key performance indicators such as time to deliver, required approvals, conditions of delivery, and mode of transportation.

On the other hand, if an organization is sourcing precious and semi-precious stones, it should have key performance indicators, such as certification of gems from an international or national organization, conditions of delivery, etc.

Creating an Evaluation Method

An organization after selecting a supplier must keep a close watch and audit the supplier on a timely basis to ensure that the suppliers are meeting the required performance levels.

The evaluation method can be developed by attaching weights to different performance criteria and calculating the performance score for different suppliers. However, the organization may also create a unique structured evaluation method depending on its needs.

Involving Multiple People and Resources

While seeking review and feedback with respect to a particular supplier or at the time of collecting material information, it is important for the organization to take inputs from miscellaneous individuals and information technology resources.

The larger the number of sources of information, the more valid the results of the data analysis would be.

Ignoring Price in the Beginning

At the beginning of supplier evaluation, the price factor should be ignored totally and more emphasis should be given to factors, such as quality, trust, track record of the supplier, lead time, swiftness in replacing faulty products, after-sales service, etc.

Although price is a big factor, it should be considered only after the above-mentioned criteria are met. More often than not, the organization’s first criterion for evaluating international suppliers remains the price of goods to be procured.

Issuing Timely Appreciation and Warnings

It is essential to issue verbal or formal written appreciation to suppliers who exceed the organization’s expectations in order to further consolidate the organization’s relationship with the supplier.

On the contrary, if a supplier is constantly compromising on quality or is defaulting on one or more performance indicators, the organization should issue a strict warning to the supplier.

Landed Cost of Global Sourcing

Sometimes, new traders and importers may make a major mistake in calculating the real price or cost that they need to pay for the required import. Most beginners usually visit international e-commerce portals such as Alibaba and view the minimum order quantity and the unit cost of the required product.

They simply calculate the total cost by multiplying their product quantity with the unit cost. They forget to include a number of ancillary costs such as customs duty, insurance, etc. This is because they are unaware of the concept of Total Landed Cost (TLC).

TLC refers to the total cost of acquiring certain goods from abroad, which includes various charges. The major components of the total landed cost are the actual price paid for the goods, cost of freight and insurance, taxes and duties as applicable, plus the brokerage and handling fees, warehousing costs, etc.

TLC is to be paid at the time of ordering or receiving the product. Apart from these costs, some other costs, such as inventory carrying costs, corporate income tax, risk/ quality/service related costs, the financial impact of carbon footprint, currency exchange rates, etc. may also be applicable in specific cases of import and export.

Usually, the seller pays transportation and loading costs, whereas the buyer pays for marine freight transport, insurance, unloading, and transportation of goods from the receiving point (port) to the final destination. It is important to calculate TLC because it helps in analyzing the visible and hidden costs within the supply chain. When the actual cost of products is known with certainty, it becomes easier to devise methods for pricing and delivering the product to end users in the most efficient manner.

Knowing the actual cost of the product makes it easier for the importing organization to make various decisions. It is not possible to make product sourcing and profitability decisions without knowing TLC.

Risks in Global Sourcing

Most organizations now understand the need for sourcing globally and achieving greater competitiveness. Global sourcing usually involves advantages, such as better quality, better quantity, lower prices, and sourcing products that are not produced domestically but are demanded by the people.

In spite of all these advantages, there are certain types of disadvantages associated with global sourcing. These disadvantages emerge as a result of risks that are not planned for or are not mitigated. Various risks associated with global sourcing are mentioned below:

Time Risk

In global sourcing, lead times for technology development, staffing, customer testing, quality issues, investments and customs clearance time can vary considerably. All these factors may affect the profits and reputation of the organization that is sourcing the goods.

Financial Risk

While sourcing from the overseas market, there is always confusion about whether the savings anticipated as a result of sourcing from the global market would happen or not. The reason is organizations, especially novice organizations do not fully understand the components of the total landed cost. Major financial risks associated with global sourcing include currency fluctuations, cancellation, and delay costs, supplier solvency risks, etc.

Supply/operations Risk

Certain risks are associated with an organization’s supplier. These include the supplier’s financial position, quality of goods provided by the supplier, service issues, etc.

Organizations also need to consider other factors, such as: ‘Is the supplier the only source of procuring goods’; assessment of the volume that a supplier can provide, right of the first refusal for extra capacity, inventory levels, logistics arrangements, etc.

Regulatory Risk

Regulatory risk refers to the risk that arises due to changes in the laws and regulations that affect the organization, industry, or the entire sector. Regulatory risks may arise in various forms, such as compliance risk, legal risk, reputation risk, etc.

Trade regulations such as those relating to dumping, customs duties, embargoes, etc. are a major type of regulatory risk. In addition, there may be some technical regulations, such as the integration of IT infrastructure and building permits.

Demand/Market Risk

This risk is associated with the timing of product marketing. An organization that sources globally would sell goods or some products that require these sourced goods as inputs.

However, the organization needs to keep track of customer demands and the competitor’s strategy so as to ensure that its goods are sellable in the market.

Intellectual Property (IP) Risk

There is a possibility that proprietary knowledge related to design, engineering, materials, assembly, etc. can be easily copied. If an organization’s supplier or buyer organizations start copying such intellectual property and introduce similar goods with minor modifications, it poses a major IP risk.

Steps in Managing Risks in Global Sourcing

Managing risks related to global sourcing involves a number of steps, which are mentioned below:

Understand Risks

Organizations must list out all the possible risks and their interdependence with each other along with the probability of their occurrence. In addition, the impact that risk may create should also be evaluated and documented.

Quantify Risks

All the risks should be quantified (in terms of their probability of occurrence) in financial terms (i.e. loss due to the occurrence of risks).

Plan

After understanding and quantifying the risks, the organization needs to create a mitigation and contingency plan. A contingency plan is made to provide strategies for dealing with the technical, physical, financial, and communication implications of these risks. A contingency plan lays out what should be done if a risk happens, who will do it, and how it will be done.

Syndicate

It means that the risk shared by the procuring organization and the supplier should be spread to multiple parties.

Own

Organizations must manage their supplier’s investments as if they were their own. This is important because if any problem occurs at the supplier’s end, it may ultimately affect the organization.

Apart from the above-mentioned steps, it is also recommended that an organization should follow a risk management framework for managing procurement-related risks. This framework comprises three steps, namely risk anticipation, risk monitoring, and risk mitigation.

Risk anticipation involves the creation of strategies to avoid or minimize risk exposure. Risk monitoring involves tracking all risks on a continuous basis and alerting stakeholders if it is felt that a risk would soon occur.

Risk mitigation involves taking appropriate steps to minimize the impact of risks that have occurred. An organization must also allocate each risk to specific persons or departments so that they can be managed effectively. One important method of mitigating supply risk is insurance.

The buyer and the seller can both mitigate the risks associated with global sourcing in the ways mentioned in the Table as follows:

Buyer	Seller
Select suppliers have a good track record and reputation in the market.	Agree to supply goods to a buyer having a good track record and reputation in the market.
Use performance guarantee bond.	Ensure that the buyer is not insolvent.
Use secure methods of making payments to the supplier such as documentary credit.	Use secure methods of making payments to the supplier such as documentary credit and advance payments.
Acknowledge and respect the culture of the supplier.	Do not give very high credit limits and credit periods to the buyers.
Agree to use only one particular currency for transactions so that forex risk can be minimized.	Ensure that the sales contract does not contain any clauses that can be subject to dispute at a later stage in the trade deal.
Hedge the forex risk by entering into forwards or options contracts with the bank.	Ensure that there are no document risks.
Mitigate the interest rate risk by using fixed interest rate loans or interest rate swap agreements.	Acknowledge and respect the culture of the buyer.
Insurance coverage for goods	Hedge the forex risk by entering into forwards or options contracts with the bank.
Create contingency plans	Rope in an individual or an organization in the buyer’s country to settle any disputes related to the non-payment or delayed payment.

Article Source

Burt, D., Dobler, D., & Starling, S. (2004). World Class Supply Management (7th ed.). Boston, Mass.: McGraw-Hill.

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