VideoGenerally speaking, office-supply retailer Staples is not known for selling its own merchandise. Instead, the company has built a nice business selling such well-known brands as 3M, Avery, and Panasonic. So what are managers at the $14.4 billion (in revenues) company doing overseeing a network of far-flung factories that churn out pens, paper, and a host of other products?
Eliminating the middleman, as it happens.
As part of the Framingham, Massachusetts-based company's strategy of building its own line of products, the retailer is now purchasing goods directly from cross-border suppliers and manufacturers. Toward that, the company has employees flying in to such remote locales as Indonesia and Vietnam. Those workers haggle with local producers, audit quality and labor practices, and figure out how to ship merchandise to the company's 1,600 stores. Says Paul Gaffney, Staples's executive vice president of supply chain: "What started as a fledgling purchasing operation mostly handled by others has matured into a true Asian-based sourcing organization."
Direct sourcing is not new. Multinational giants like Chrysler and Colgate-Palmolive have been doing it for decades. But now the urge to purge go-betweens is catching on with retailers and smaller manufacturers. In the past, such companies relied almost exclusively on agents to procure products.
Indeed, many retailers, ranging from Target to Federated Stores, are looking to buy more without agents. Even companies that have been sourcing direct for years are pushing the direct approach to new levels. Hewlett-Packard, for one, not only purchases computers and monitors directly from its contract manufacturers, but it also sources parts and materials on behalf of those manufacturers.
Big Savings on Moldy Sneakers
Not surprisingly, cost is driving the switch to direct sourcing. This is particularly true in the retail sector, where cutthroat pricing from the competition (aka Wal-Mart) is forcing rivals to focus on high-margin, private-label goods and wring new savings out of procurement. By sourcing goods directly, Gaffney says, Staples is shaving about 10 percent off the net average cost of its house-brand products. "Whenever you can eliminate folks who along the way have to make their own profit," he says, "you can save money."
You can also save some aggravation. Shipping goods from China to North America by boat takes three-and-a-half weeks (air cargo is faster, but prohibitively expensive). Hence, there's no time for corrections if problems with a product aren't discovered until delivery. Notes Paula Rosenblum, director of retail research with Aberdeen Group: "With direct sourcing, you don't want to wait for your shipment to get here to discover that the canvas sneakers you ordered are moldy."
The desire for greater control is behind the sourcing strategy at Pacific Alliance Manufacturing Group, which makes such brands as Nicole Miller and Gloria Vanderbilt Knits. CFO Jake Pleeter says that while the company still uses buying agents, it now works more closely and consistently with a smaller number of factories. "We have worked hard to take factories, teach them best practices, and then give them enough volume so they're captive to us instead of handling work for 10 other manufacturers."
The approach helps speed up turnaround, too. Pleeter recalls one case in which Pacific Alliance contracted with a factory, only to find that the factory owner set aside Pacific Alliance's goods when he received a better price from a rival. "A lot of these guys are transactional," says the CFO. "It's much better if you have a long-term partnership."
The gains from direct sourcing come at a price, however. A company must find qualified factories, solicit bids, place orders, inspect the factories, monitor quality, and handle logistics, customs, and duties—no small checklist. Determining the true cost of those activities can also prove tricky. "Even experienced buyers like automotive companies still struggle to quantify the total cost of sourcing directly," says Pierre Mitchell of the Hackett Group. While the purchase price of an item may look great, Mitchell warns that the true cost may be much higher. "You have to add freight, tax, duties, cost-of-inventory, quality issues, and executives' time."
Where's the Patio Furniture
Many companies are finding that their existing technology does not account for these hidden costs. Foreign sourcing is often managed with ERP (enterprise resource planning) systems that are better suited to domestic procurement than cross-border orders. In fact, many older sourcing programs were never designed to factor in currency fluctuations, customs duties, or additional bank processing fees. Hence, much of the accounting for those items gets done manually.
That was the case at Ocean State Job Lot (OSJ), a privately held deep-discounter operating in New England. Recently, the company doubled its imports but found that its IT systems couldn't handle several aspects of the import process. For one thing, the software had no container track-and-trace function, making it difficult to determine whether an order of patio furniture was still in a warehouse in China or steaming across the Pacific.
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