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Smaller companies are increasingly using offshore suppliers. Here are some notable risks to watch out for.
Alix Stuart, CFO Magazine
March 1, 2012
For the past two decades, Tennessee-based Storm Copper Components has sourced the raw copper bars and sheets that go into its products solely from U.S. suppliers. That strategy has worked well, says CFO Vince Schreiber, because the heavy materials are expensive and slow to transport, and customers want their orders fast.
About two years ago, however, it became clear that the fast-growing private company (150 employees) needed to diversify its supply base to work around the problem of sporadic domestic shortages and slowdowns. The solution: two additional suppliers on two different continents.
"Our preference is generally to do business with U.S. suppliers," says Schreiber, "but, ultimately, this is a customer-service decision."
That sentiment is increasingly being echoed at companies both large and small. Looking beyond U.S. borders for supply "is becoming much more mainstream, primarily due to competitive forces," says Bob Ferrari, a supply chain analyst. In some cases, firms are simply being proactive; in others, they feel pressured to explore such options because they fear competitors will undercut prices by making the move first.
But managing global suppliers isn't easy. Even a company as sophisticated as Apple has trouble keeping its offshore suppliers in line, as the consumer-electronics giant disclosed in a recent groundbreaking report. Environmental and ethical violations abounded, such as using underage labor and underpaying workers.
"You obviously can find cheaper-made goods" outside the United States, says Gene Tyndall, executive vice president of global supply-chain services at consultancy Tompkins International. But the real question for a CFO, he adds, is whether the so-called total delivery cost — the one that takes into account operational risks and potentially disastrous financial-statement effects — outweighs the cost-savings.
Companies that want to extend their supply chains overseas should keep the following considerations in mind, say experts:
• Longer order cycles. The most immediate difference with a global supplier is that everything is likely to take longer, at least initially. For Chinese suppliers, a midsize company should plan on a 12-week cycle from ordering goods to receiving them, says Tyndall. The smaller the volume, the longer the cycle is likely to be.
Longer order cycles can have an impact on a company's finances. New suppliers may expect payment upon shipment, potentially tying up cash for long periods. "You go from dealing with suppliers you know, who give you normal payment terms, to a situation where they're expecting you to pay before you have product," says Schreiber.
There are ways to avoid sending cash into the ether immediately. One of Schreiber's new suppliers has credit insurance, which effectively covers the seller's receivable until the product arrives and the buyer pays the invoice. Schreiber says he negotiated directly with the credit insurance company to get a line of credit sufficient to cover the full value of Storm Copper's first order with the supplier. Over time, the terms have improved as both parties have become more comfortable with each other.
• Myriad costs. It's important to have a cash cushion for the myriad smaller, often unexpected costs associated with foreign suppliers, experts say, costs that include customs duties, insurance, letters of credit, and even payment-processing fees. One surprise for many firms is that "the first time your company brings a container from anywhere else, customs opens it up and then sends you a bill for as much as $2,000," says Shawn Casemore, president of Casemore & Co., a supply chain consultancy.
• Tax and tariff policies. It's also essential to think about how a supplier country's tax and tariff policies are likely to evolve. If a country is experiencing a manufacturing downturn, for example, the government might try to protect the industry by slapping export tariffs on unfinished goods rather than finished, packaged goods. "Chances are you're not going to be in and out in a year, so you need to try to get a handle on the volatility in the environment," says Gary Lynch, global leader of Marsh's supply chain risk-management group.
• Balance-sheet issues. Schreiber, who is now receiving copper from Europe and Latin America, says that since Storm Copper technically owns the material as soon as it ships, he must carry it on the books as inventory for the entire eight-week journey (something he doesn't have to worry about when the copper comes from New York). That leads to an "artificial inflation" of the balance sheet, he says, which can affect debt agreements. "You have to test debt compliance ahead of time to make sure you don't violate any covenants by adding a bunch of inventory and payables."
• Foreign exchange. Foreign exchange is another potentially thorny issue that comes along with buying global. At oral-care product maker Dr. Fresh, CFO Duane Horne says 85% of its products are sourced from China and have been since the company's 1998 inception.
For simplicity's sake, the company still pays for the product in dollars, although it is moving toward paying in Chinese renminbi. Meanwhile, Horne is using 30-day nondeliverable forward contracts to help hedge part of the company's exposure that is baked into its current prices. (In general, prices will be slightly higher in dollars to compensate the supplier for the exchange risk it takes on.) The forwards "have been successful to date, but you do have to watch them very closely," warns Horne.
The best approach, then, is often to start slow, and make sure not to neglect existing suppliers in the U.S. "Pick one commodity that you know is available in China and do a pilot test with one or two suppliers there," counsels Tyndall. "Meanwhile, manage your supply base in the U.S., because if they get upset, that can affect everything."
Over time, there are a variety of best practices for vetting and managing foreign suppliers. For one, with sufficient volume, a company may want to establish a representative office in the suppliers' country. That's an approach Dr. Fresh has taken in China; about seven employees "coordinate with the factories on our behalf and are in contact with them on a daily basis," says Horne, adding that it's also beneficial to have staff members in the U.S. who are fluent in the suppliers' language. Brokers and other middlemen can also be helpful as volumes grow.
Above all, it's important to act with speed when an opportunity with a global supplier comes up — or it may soon be gone. Given the unpredictability of factors like labor costs, oil prices, taxes, tariffs, and natural disasters, cost advantages shift quickly, often to surprising places. "You've got to be flexible and agile," Ferrari says. "Today, supply chain sourcing is a very active process."
Alix Stuart is a Boston-based business writer.