"Sourcing in China started with low-tech products but it has evolved beyond that," says Jim Hemerling, a senior vice president in The Boston Consulting Group's Shanghai office. "Now, in addition to traditional products, another huge area is consumer electronics. I believe the next big wave will be industrial goods, with companies like ITT, Siemens, Honeywell and ABB leading the way."
When hearing this statement, we realized how important it could be for Foxtel to source from China. After receiving some bids from 3 different suppliers, Legend, Great Wall and Panda, we compared them with our current supplier prices. We challenged our current supplier bid with the total cost of ownership (TCO) of the Chinese suppliers. The TCO not only matters with purchasing price, but also take into account all the associated costs of dealing with such a supplier.
After comparing weighted, world-wide costs per kit across suppliers, we found that Legend Supplier has the greatest potential for cost savings. We therefore recommend sourcing through Legend. We believe that Foxtel can achieve a 38% cost savings after all relevant and material cost are accounted for. This translates into a savings of $1,781 per kit or, in other words, a total annual savings of over $13 million.
While it was obvious from the very beginning that there would be a substantial material cost savings if Foxtel used a Chinese supplier, it was less obvious how additional costs, such as freight and inventory costs, would affect the Chinese suppliers' total cost. In order to assess the total cost of sourcing from different suppliers we identified twelve relevant costs categories and estimated their impact on each sourcing option. These relevant cost categories included: import costs, ocean freight, transportation from the port to the facility, safety stock, increases in inventory holding cost, quality/warranty claims, disposal, obsolescence, EDI, extra warehouse capacity, supplier development, and increases to Foxtel's cash-to-cash cycle. By totaling up these relevant costs per kit and then adding them to the material cost per kit, we arrived at a TCO cost per kit with which to make meaningful comparison between sourcing options. (The U.S. and Brazil costs were combined using total units manufactured at each location as a weight.)
A sensitivity analysis of the key cost driver still yielded Legend as the clearly preferred supplier, even when all cost drivers where combined into a worst case scenario. We found that changes in key cost drivers such as crude oil prices, transpiration cost, and inventory had little effect on the final outcome.
China is inherently more risky than sourcing from our current local suppliers. In fact, we estimated that sourcing from China is roughly four times as risky as sourcing locally. We believe that the risks associated with supplier reliability and intellectual property rights account for most of China's risk. We also believe that both of these can be controlled for. First, the fluctuation in supplier reliability can be addressed by increasing Foxtel's safety stock which, according to our sensitivity analysis, does not change the final sourcing recommendation. Second, we believe that the intellectual property risk can be mitigated by continuing to have final assembly of the finished goods outside of China. Additionally, we suggest 5 steps that can be taken to mitigate the risk of intellectual property piracy.
[...] The U. S. and others had said that China undervalued the Yuan by up to 40 percent, giving Chinese exporters an unfair price advantage. Chinese leaders have said for years that they eventually would let the Yuan trade freely on world markets. But they said any decision would be based on China's economic needs, not foreign pressure The new system puts tight daily limits on changes in the Yuan's value but could allow it to change substantially over time. From now on, the Yuan will be limited to moving each day within a 0.3 percent band against a collection of foreign currencies. [...]
[...] We did not include the in-transit inventory for holding cost analysis as the opportunity cost associated with that is already captured in Financing required for increase in Cash-to-Cash cycle. Like the cost of maintaining safety stock, inventory holding cost is different among suppliers and the Legend suppliers could offer least inventory holding costs 32.43 Quality/Warranty cost Current Legend Great Panda Relevant Cost Supplier Supplier Wall Supplier (Shenzhen Supplier (Guangzhou , China) (Shanghai , China) , China) Warranty cost is the function of sale price, probability of failure and the customer claim rates. [...]
[...] We believe that Foxtel can achieve a 38% cost savings after all relevant and material cost are accounted for. This translates into a savings of $1,776 per kit and a total annual savings of over $13 million. Incorporating Risk Factors/Soft Costs However, before making a final recommendation we need to also consider the additional negative impacts of the risks and soft costs associated with sourcing from China. From our risk assessment above, it is evident that China is inherently more risky. [...]
[...] We did not include the in-transit inventory for holding cost analysis as the opportunity cost associated with that is already captured in Financing required for increase in Cash-to-Cash cycle. Quality/Warranty Cost Warranty cost is the function of sale price, probability of failure and the customer claim rates. Because the warranty duration is five years and the probability of warranty claim swifts by time, we calculate the present value of five-year warranty cost for each kit to evaluate the change of true warranty cost after outsourcing. [...]
[...] As stated in the case, the prices of the Chinese suppliers are prices FOB and assuming that Foxtel keeps same payment terms as they have with the present supplier, the cash-to-cash cycle for kits would increase by the increase in transportation lead time (assuming the payment terms remain same between different options). We took the cost of debt (assumed same as industry average) as the cost of extra financing required in order to finance in-transit inventory for the increased transportation time. [...]
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