Supply Chain Enabled

Procurement – Sourcing and offshoring

Published: December 7, 2022
Author: Prashant Kumar

Sourcing and Shoring

Global supply chains have been strained by unprecedented demand and limited effective logistical capacity.  A global supply chain is core to the organisation’s competitiveness, and its success depends on the synchronisation of relations, activities, and agreements in order to be flexible, dynamic, high quality, and cost effective for customers. Firms are extremely conscious of volatility in the supply chain, and many manufacturers are reassessing their global sourcing strategies. Will multinationals retreat to a hemispheric, near-shoring model or opt for a hybrid that maintains an international component? This article highlights the risks and benefits as well as the total cost along the supply chain.

Multi-national companies (MNCs) adopt dynamic strategies for the global configuration of their activities, and, for this reason, divestment and new investments go hand in hand.

Offshoring: The process of transferring part or all of the value-added activities organised by a firm from its home country to another. This differs from offshore outsourcing, which involves purchasing products or services from another firm located overseas.

Reshoring: The process through which an MNC relocates all or part of value-added activities conducted abroad back to the home country of the company

Nearshoring: Positioning all or part of the value-added activities in a country that is geographically, economically, and culturally close to the country of origin of the company

Back-sourcing:  A firm brings back in-house the services that it previously outsourced to another company

Approaches for manufacturing internationally

  • Contract Manufacturing: When one company enters into an agreement with another company to manufacture goods over a set period of time, usually in a foreign country
  • Licensing: A business arrangement, in which a firm authorises another firm to use its IP (intellectual property) to manufacture products in exchange for a royalty
  • Franchise: In exchange for royalties, a company grants or licences another company a set of rights and authorities that allow the company to replicate its entire business model.
  • Joint Venture: Two or more companies enter into a business agreement to work together to set up a new firm to enter a new marketplace
  • Subsidiary: An independent company that is at least 50% owned by another firm (parent company). When a subsidiary is 100% owned by another company, it is referred to as a wholly owned subsidiary.

  Motivations and Challenges of Offshoring (Table 1)

Low labour costLong lead times
Huge labour poolSecurity risks
New infrastructureTime zone difference
Possibility of acquiring advanced technologiesLanguage barriers and cultural differences
Less restrictions on sustainability, working conditions, and qualityRequirement for higher inventory levels
Herd MentalityExtra freight security
Possibility of selling products in foreign marketsIntellectual property risk
Corporate profit motiveRepeated environmental and/or human rights violations

In the last few decades, there have been significant changes: China has grown to be the second largest country by GDP, strengthening of Chinese currency, labour costs have skyrocketed, energy prices have increased, significant increase in inflation, Covid – 19, increased political risks due to Russia – Ukraine War, emphasis on local sourcing, increased restrictions on quality, working conditions, safety and sustainability

 Where is manufacturing moving to (Table 2)

Achieve the lowest costApparel, mainly footwearMostly in China but slowly shifting to other countries like Bangladesh, Vietnam
Low cost, but closer to supplyAerospace parts, auto parts, footwearMoving more to Mexico and to Dominican Republic
Large supplier baseConsumer electronicsMostly in China but moving slowly to India
Fast responsive supply chain for high profit and low volumeHigh end consumer goodsGradually returning to the United States

Framework for Financial Assessment of Global Sourcing (Holweg, Reichhart and Hongand, 2011)  (Table 3)

Static CostDynamic CostHidden Cost
Purchase price ex-factory gateIncreased pipeline and safety stock due to the bullwhip effect and product varietyLabour cost inflation is due to rising standards of living and competition in the labour market
Transportation cost per unit, assuming no unexpected delays or quality issuesInventory obsolescence due to long lead timesCurrency fluctuations, in cases of artificially pegged currencies
Customs and duty to clear a shipment for exportCost of lost sales and stock-outsRise in transportation cost, e.g., due to higher oil price and carbon offset costs
Insurance and transaction costExpedited shipments, e.g., airfreight, to ensure uninterrupted supplyOverhead for managing the international supply base, including travel costs or costs for local personnel in the supplying markets
Cost of quality control and compliance with safety and environmental standardsN/AThe loss of intellectual property to contract manufacturers
Search cost and agency fees to identify and interact with local suppliersN/AThe risk of political and economic instability or change

In today’s world, it is extremely important for you to understand the business requirements and, based on them, make a strategic or tactical decision. We hope this article has given an interesting vision of the sourcing and offshoring phenomenon and given you insights on the risks and benefits associated with it.

Contact us at any stage if you are interested in a discussion on how offshoring and sourcing impacts your business. 

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