Strategy

A Holistic Manufacturing Sourcing Location Strategy Beyond Labour Cost

by Peter Hopper, Partner, Managing Director, Strategic Decisions Group

With factory wages rising, brands that previously had the majority of sourced production in China are shifting abroad to countries with lower wage rates, such as Indonesia, Vietnam and Bangladesh, to maintain their traditional low-cost advantage.

According to the 2016 Fashion Industry Benchmarking Study released by the US Fashion Industry Association, 77 per cent say “Made in China” accounts for less than 50 per cent of their companies’ total sourcing value or volume. Results confirm that US fashion companies are not “putting all eggs in one basket” and “China Plus Many” has become a commonly adopted sourcing strategy. This trend is also seen in the technology sector, with the investment from Foxconn and Samsung Electronics in India and Vietnam respectively.

Brands till now have been satisfied with the comparative advantages from labour cost arbitrage. As the business environment changes, can the decision-making process on sourcing locations remain so simple? Should there be additional factors other than wage cost trends that have to be taken into consideration?

Decision-making in a complex & uncertain world

Across every sector of society, decision-makers are struggling to manage the heightened complexity and uncertainty in the business environment. What should be done to ensure that organisations’ strategies are optimal and no value is left on the table?

To achieve that, we must have a rational and systematic decision-making process that always involves the right people. Such a process should focus on the six elements that define high-quality decisions: setting the right frame, considering alternatives, gathering meaningful information, clarifying values and trade-offs, using logical reasoning, and commitment to action.

Following this approach can prevent us from falling into some of the most commonly known decision-making biases, such as prudence, overconfidence and reductive fallacy, which would lead us to false decisions, missed opportunities and huge costs to organisations.

Therefore, in deciding new sourcing locations, it is important to fully understand the sources and the real impact of the uncertainties faced by manufacturers in each alternative. In this way, they can determine the most optimal strategy and focus on what really affects value and what can be done to mitigate the downside risks.

Risk profiling

Risk heat maps and risk rankings are commonly-used tools by brands to assess the risk profile of sourcing countries. However, they are highly subjective, reflect only a static view and tend to deemphasise high–impact, low-probability events. Beyond the traditional quantitative metrics and analytics, it is essential to use advanced analytics which also takes into account the probability of risks and the shifting dynamics.

Risk factors faced by brands when determining their sourcing location strategy can be categorised into four areas – economic and trade, supply chain, geopolitical and brand.

1. Economic and trade risks, which include uncertainties in material and wage inflation, exchange rate, protectionism policies and trade agreements, are factors that can impact the landed cost of products directly. Brazil, for instance, imposed new anti-dumping duties against China and a few other countries after an economic downturn, making production in China and exporting to Brazil less desirable.

Donald Trump’s recent election in US has also significantly change the global economic and trade risk profile. Showing enthusiasm for trade protectionism, and the reversal of previously secured trade agreements has the potential to change the landscape again.

Should the Trans-Pacific Partnership (TPP) not be ratified, which now seems likely, the impact on Vietnam will be significant. Sourcing strategies based on an assumption that Vietnam would become a partner in an existing or newly setup trade agreement will need to be revised.

2. Supply Chain risks refer to the unpredictable disruptions in production and distribution that can be caused by various reasons, such as raw materials delays, factory fires, transportation breakdowns, labour disruptions and natural disasters. Unexpected ramp-up delays when expanding into a new country or region, or government intervention in land acquisition, may also cause insufficient capacity and thus business delays.

3. Geopolitical risks can lead to temporary shutdowns of factories, delays in production and/or direct losses. The simmering territorial disputes in the South China Sea and the uncertainty of the democratic reform in Myanmar are some of the geopolitical concerns in Asia among brands.

4. Brand risks refer to the risk to reputation caused by major labour and HSE (Health, Safety & Environment) related controversies for the brands. With the rising growth of social media usage, the world is increasingly interconnected. Information flows instantly around the globe. Brands have become more fragile. This is particularly a concern for those with high brand value. If such an event happens, the brand is likely to face reparation costs and a period of slower or negative sales growth.

Due to a lack of experience, it is expected that compliance risk will be higher when vendors are expanding into new countries or regions. Factory additions or closures and a stretched ramp-up schedule will also likely increase the chance of noncompliance with policies and standards, and thus increase brand risk.

The chase for cheap labour is over

For years, brands have been moving their production location from country to country, chasing the cheapest labour source. With advancements in robotics and other manufacturing technologies, as well as the increasing importance of local market proximity, brands need no longer to simply focus on labour wage to decide where to open and expand factories. A systematic decision-making process which involves an appropriate frame in place, a broad set of alternatives and a good understanding of the sources of values and impact of risks are paramount to good sourcing location decisions.

About the Author

Peter Hopper is a Partner and Managing Director of Strategic Decisions Group (SDG) with responsibility for the Asia Pacific region. With over 30 years of operating experience in a wide range of technology and manufacturing-based industries, Peter has hands-on experience managing complex portfolios and working with large and medium-sized companies in periods of fast growth and industry restructuring. He also leads the firm’s Hong Kong office, which supports all of SDG’s global operations in sourcing, energy, oil & gas, life sciences and education in Greater China and the region as a whole.

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