Hands-on sourcing: pay more to make more profit

Supplier ManagementMany inexperienced importers think they don’t need any on-the-ground support when they buy directly from factories in developing countries with immature legal systems like China. After a few bad experiences, they are usually confused as to what they ought to do.

It should come as no surprise that the more closely you monitor production, the more likely you are to receive satisfying products on time. In short, this is my answer.

Finding a nice sample, negotiating a good price, and issuing a PO is only the beginning of the work. If you go back to your office and wait for the shipment, you are taking maximum risks.

If you want to reduce your risks, the solution is hands-on sourcing.

What does hands-on sourcing mean?

  • Do serious due diligence (accounting & customer checks) on potential suppliers;
  • Visit every factory (or order third-party audits) before you issue POs;
  • Either top management has an eye on your orders, or the supplier is too large;
  • Show the technicians what you want to receive and what you cannot tolerate;
  • Keep in close contact with the supplier during production;
  • Perform inspections before shipment (the earlier, the better), with no exception;
  • Set up regular meetings, or at least have regular discussions, with suppliers;

The opposite attidude (hands-off sourcing) includes very little spending in prevention, but does it really ensure that your overall costs will be lower?

Is it worth the investment?

Most importers do not fully understand the relationship between lower sourcing risks and higher profits. So I did a little case study:

Example 1 with hands-off sourcing:

  • Total cost is 20,000 USD (FOB price) + 7,000 USD of unavoidable costs (sea freight + import duties + domestic freight + miscellaneous fees…);
  • There is a 15% chance of serious quality/timing problem: that risk is “worth” 15% x 27,000 USD = 4,050 USD.

Example 2 with hands-on sourcing:

  • 22,000 USD (FOB price–let’s say you go with a better factory and their prices are 10% higher) + 9,000 USD of unavoidable costs (because of you spend more in monitoring services and 10% more in import duties);
  • There is an 8% chance of serious quality/timing problem: that risk is “worth” 8% x 31,000 USD = 2,480 USD.

Difference: over the long run, the buyer of example 1 saves 1,570 USD per order, compared to the buyer of example 2.

Of course, it is difficult to estimate the exact risks. And the numbers vary from one situation to the other. But my feeling is that the savings are underestimated (how about adding the favorable impact of delivering quality products in time to your customers?)

What do you think?