Sourcing in China is already big, but much bigger days are ahead.

There is an urgent need to build real procurement capabilities in China, particularly in setting higher sourcing aspirations, overcoming the organizational barriers that are getting in the way of achieving more, and adapting global standard sourcing practices and tools to source more goods at better prices.

The first principle for becoming world-class at execution in China is to set aspirations high. Multinational companies (MNCs) are falling short against this aspiration. That may seem to be an odd assertion on the face of it. After all, there can’t be a person left in Europe or America who does not know that China is a key supplier to retailers and businesses in developed markets.

But what the man or woman on the street in Boise, Bremen, and Beijing probably doesn’t know is this: global companies could source substantially more from China than they now do. We recently completed an assessment of procurement operations across ten different industries, including auto parts manufacturing, high tech, and retailing. We found that MNCs who are typically sourcing for global use only about one-third of the goods they believe they could potentially source in China, and are getting only about one-quarter of the potential savings. This is because they know they’re getting better prices than at home, but don’t yet know just how low prices in China can be.

Global companies are leaving tremendous value on the table. They simply aren’t setting their aspirations high enough for what their sourcing operations can achieve for the corporation, both in China and globally. Certainly there are numerous procurement and supply management challenges to face, such as identifying good suppliers; overcoming language and cultural barriers; boosting suppliers’ quality; ensuring reliable deliveries; managing supply chain inventory; communicating with engineering, design, and procurement managers in corporate headquarters; and overcoming logistics hurdles.

Executives of MNCs in China know that the local sourcing challenges aren’t the real reason why their company’s sourcing levels are just a trickle of what they could be. The real reason is that aspirations aren’t set high enough, from global headquarters on down, and consequently the company isn’t putting in the focus or the resources to be successful.

With few exceptions, global retailers could lift their aspirations for putting Chinese goods on global store shelves. Retailers frequently are sourcing volumes at the low end of what is possible for them. Moreover, many retailers source too many categories through agents. By our estimates, retail chains in the United States and Europe save an average of 15 to 35 percent across categories by purchasing goods sourced in China through intermediary buyers (called agents). The few retailers that do some of their own buying in China directly from the manufacturers (thereby dis-intermediating the middle market) save at least an additional 10 to 15 percent above what agents get there, and often more than that.

One Fortune 500 company that sells wholesale and retail goods does a limited amount of sourcing in China. We looked closely at a representative sample of more than two dozen of the company’s SKUs (which the company’s executives helped to identify), and found that sourcing these SKUs in China could produce savings of over 20 percent on a total landed cost basis (even factoring in increased shipping, insurance, and inventory costs). Extrapolating these findings, the company realized that if it systematically sourced from China the relevant product categories involved, the company’s net income could increase by 50 percent. Similarly, a large American retailer estimates that if it direct sourced “clean wins” in China, saving a conservative 10 percent on the cost of these goods, it could boost the company’s net income by at least 30 percent.

A global industrial company that does some manufacturing in China recently estimated that its China sourcing roughly amounted to nearly 10 percent of global cost of goods sold. If it tripled the amount of sourcing it did in China, figuring an average savings of 20 percent on what is sourced here, the company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) could rise from 9 to 14 percent. That was eye-opening for executives.

A handful of MNCs are lifting their aspirations, and over the next few years will serve as models to the others. General Electric, for instance, set its sights in 2002 on doubling sales from its various businesses in China to $5 billion by 2005 and to sourcing $5 billion in components and goods from China by the same target date—a very aggressive target. The company hit its sales target, but achieved only three-fifths of its sourcing target at that time. Today, GE has shifted much of its decision-making responsibilities regarding sourcing to China, greatly improving its ability to make sourcing decisions quickly.

IBM has also raised the bar significantly on its sourcing aspirations in China. In 2006, IBM moved its global procurement headquarters to Shenzhen—the first time an IBM enterprise function has ever been located outside the United States. At the time of the move, IBM already had over eighteen hundred procurement employees in China, and was sourcing about one-third of its $45 billion annual procurement spending from suppliers in Asia.

Competitive advantage

Over the longer term there are even greater advantages—competitive advantages—to be gained by setting (and achieving) high aspirations for sourcing in China for global as well as local markets. For instance, a few companies intend to shift design approval and ordering decisions from corporate offices in the home country to China. They also would like to integrate design and manufacturing functions and co-locate them in China.

These broader organizational changes won’t happen overnight. But when they do happen, we think the impact could be enormous. Companies that get it right will be in a position to establish a long-term source of competitive advantage by taking the operations they build in China today to the next level.

One way would be to cut cycle times. By locating sample and specification approvals in China for products in industries ranging from casting to machined parts to clothing to consumer electronics, the turnaround time for getting a product or component into mass production can be dramatically shortened. Pushing this further and allowing the China office to handle prototype approval and final product ordering would add even more value. Currently, most procurement offices in China still rely on headquarters for these decisions.

Bringing China-made products to market more quickly would have a radical impact on a company’s economics by improving its understanding of consumers, increasing the accuracy of forecasts, and reducing stock-outs and markdowns.

The executives we’ve talked with who are considering these moves do not underestimate the difficulties involved. We frequently hear executives in China say that the hardest part of sourcing in China is headquarters. Aspirations to increase China sourcing frequently are undermined in the home office by middle managers who believe they are acting in their function’s best interests but actually are impeding the interests of the company overall.

Supply managers measured in inventory turns, for example, might worry that distant and uncertain supply lines will require them to hold larger inventories, thereby driving up costs and reducing turns. Similarly, logistics managers, who are evaluated on their ability to economize, warn that far-flung suppliers will push up costs.

One manufacturing company helped its managers at home to “get over it” by using its existing processes to select, approve, negotiate with, and manage new Chinese suppliers, instead of setting up a special initiative staffed by employees whose powers usurped the authority of current sourcing and product managers. Processes and sourcing roles changed only after the company became comfortable working with Chinese suppliers.

Headquarters isn’t the only hurdle to cross, however. Increasing procurement requires the company to build a staff of people in China capable of making the right decisions for the company. Talented engineers and designers must be moved from headquarters or recruited and trained on the ground in China.

Sourcing in China complicates product development decision-making when these functions are half a world apart. A few MNCs  are planning to integrate design and manufacturing functions and co-locate them in China to reduce design-to-order cycle times. Executives at these MNCs have taken to heart lessons from the notebook computer industry, which has blazed this trail to good effect.

“China sourcing must be managed from China—not from the U.S., and not even from Hong Kong buying offices, which are too far from the Chinese factories and the information they need,” says Diane Long, head of adidas’s China sourcing. Long has been sourcing in China for twenty years. Before joining adidas, she was head of the Shanghai-based sourcing office of Liz Claiborne.

“If a designer is here, they will be more likely to pick a material or an accessory that is here in China and that the vendor already has.” In the apparel sector, there are frequent tales of designers in New York or Paris who pick a button or a ribbon from a Japanese vendor that is two or three times (sometimes even five to ten times) more costly than a comparable product of equal quality from a local vendor. Buying from the Japanese vendor also adds six weeks for delivery.

“In apparel, higher-end garments designed and made in China can take thirty-six to forty-two weeks to get from concept to store, down from about a year. Some of the time saved is through better sourcing, like buying fabric in China instead of importing it, but having designers there can shorten lead times by at least 30 percent.”

Adapting global standards

For companies to crack new markets with new products in China, they need to get their procurement and sourcing operations into world-class shape.

Multinational companies in China need to do a lot of work to boost the capabilities of suppliers. To improve their own manufacturing productivity in China—to do lean right—they need to bring suppliers up to global standards. For instance, Chinese suppliers’ component failure rates are higher than global standards, their deliveries are not sufficiently reliable, and their costs could be squeezed through more attention to efficiency and reduction of waste. (Rejected parts of incoming components run as high as 7 percent in some industries; 1 percent is the norm in established supply chains in developed markets.)

Linear performance pricing is another common procurement technique that works well in China. It is an analysis that builds on comparing price to performance rather than on a supplier’s intrinsic economics. The chosen performance factor of the various products on the market is plotted against their price. If the supplier’s price falls high above the revealed trend line, negotiation can ensue on why that gap exists and the possible ways to reduce it. If other products fall well below the trend line, they may be studied for production or supply innovations that allow their lower price. The technique is also ready-made to negotiate future price points when the supplier is able to lift its product to a higher performance level.

Execution is in the details

Sourcing well in China is about paying attention to the details. What surprises executives about sourcing in China is the number of details that can go wrong and the effort required to hold a program together. Companies find that they have to pay much more attention than expected to monitoring their suppliers’ processes—working back from expected delivery dates to check that suppliers receive raw materials on time and meet every subsequent milestone until the products ship.

Diane Long advises American Chamber of Commerce members in China to pay “unrelenting attention to detail.” It is one of the factors that separates good-enough from world-class sourcing practice here. “Understand the exact process used to make the product, from beginning to end, and never be satisfied that it will be done well without watching every step. Do not accept general explanations.”

“And, do not accept ‘meiyou wen ti’ (no problem) as an answer, because when a vendor in China says meiyou wen ti, you can count on there being a small problem that is growing into a big one! If a mistake happens, it is usually because someone failed to follow the disciplined process that has been mapped out for them. We use a ‘five whys’ dialogue to find out what went wrong—literally asking ‘Why?’ five times until you get to the bottom of it.”  wt



Reprinted by permission of Harvard Business School Press.  Excerpted from Operation China: From Strategy to Execution. © 2007 McKinsey & Company, Inc.; All Rights Reserved.



Jimmy Hexter is a director of McKinsey & Company and leads the firm’s Operations Practice in Asia. Jonathan Woetzel is McKinsey director and co-founder of the firm’s China office.

The State of Logistics in China

As China occupies an increasingly larger space in the global economy, questions about in-country logistics—both for outbound exports and internal distribution—face foreign shippers and manufacturers. 

Two leading U.S. transportation companies—Werner Enterprises and Schneider Logistics—have staked out beach-heads in China and we decided to see what they think about the state of logistics there.

Derek J. Leathers, President of Werner Global Logistics, which has been in China since 2005, notes that logistics costs are proportionately three times higher than in developed countries (“in the U.S. or Japan distribution costs are between 6% to 9%, in China the low-side estimates are 20%, but many claim it’s north of 30%”).

Why? The answer is a combination of infrastructure and scale.

“China is very similar to early 1990s pre-NAFTA Mexico,” notes Leathers, who was there. “You’ve got tons and tons of players, the average fleet size is less than five trucks, there is no national player.”

The big thing missing, thinks Leathers, is “the logistics analysis piece.” That’s Werner’s business strategy in China, to offer better designed networks to move goods (“there’s not a lot of mode analysis around”). But with all those tiny fleets, he admits optimization is tough: “We do it with people on the street, capacity managers whose job is to spend all day calling on trucking companies and to build alliances with transportation providers.”

Compared to the capacity piece, finding customers is relatively easy.

Tom Escott, President of Schneider Logistics, is undertaking a different mission. “Our main strategic thrust is serving the domestic Chinese market for the same customers we have in North America (e.g. Wal-Mart, Kimberly-Clark).” Of late, though, service has broadened to some Chinese national companies (“there’s an interest in elevating the way they look at their supply chains”).

Schneider’s focus is on transportation, warehousing and distribution (working primarily with independent operators and leased facilities, “We’re asset light”).  

Escott sees the physical infrastructure improving. “It continues moving forward at a rapid pace, there are better and better highways, especially along the developed coastal area, but also inland.”

Next on Schnedier Logistics’ strategic agenda is to further extend its network into the center of the country, while further expanding its domestic footprint. “We’re in the process of acquiring freight forwarding license,” says Escott. “By year’s end, we’ll be offering door-to-door service from the U.S. to China.”

— Neil Shister