Mitigating China Supply Chain Risk: Should I Stay or Should I Go, Part 2

This is Part 2 in the series Mitigating China Supply Chain Risk: Should I Stay or Should I Go? by David Alexander* This part gets into the nitty-gritty of what it takes to find new suppliers.

We have an American client who has approached us several times over the past 5-7 years with questions or concerns over protocols and processes regarding their manufacturing base in China. This company has strong brand name with retail customers and an active sales force experienced at navigating big box channels and it has grown every year since inception.

Despite their size and their growth, they have continued to rely on their Chinese brokers who essentially have sole control over the factory relationships and manage all supplier issues. Nobody from the U.S. side of this company has ever visited China or set foot in any of their factories. Though this company has engaged in very little R&D, it has sizable investments in new tooling and packaging. This company has a 100% buy-sell strategy, meaning it does not produce or assemble any of the products it brings to market. This situation is less a strategy and more of the all too common model of “if it isn’t broken why fix it?”

Trade tensions with China have caused this company’s board to raise concerns about its dependence on China and some of its larger customers have begun pressuring it to present a tangible mitigation plan in the event things go entirely South with China. Their products are in a category that generates respectful top line sales to their retail customers. This client’s buyers and category management also have heightened concerns on impact of continuing trade wars.  2020 margins are already diluted and neither the brand nor its retailers can pass along any additional cost increases due to tariffs.

My company was brought on board earlier this year to assist in reviewing their current China strategy and to help them expand their reach with other potential S.E. Asian manufacturers. Though this project may seem cut and dry, experienced procurement professionals understand the substantial time and resources required to essentially duplicate in another country (or countries) an established supply base that was years in the making while at the same time having to contend with retailers that will not accept backorders, price increases or other disruptions.

Finding the Right Suppliers: Identify, Verify, Qualify

A proper factory sourcing process usually starts with a deep dive into a universe of prospective suppliers which can often be found in geographical clusters depending on the country. There can be hundreds (if not thousands) of potential suppliers, depending on the product, volume and expertise required.  What begins as a thorough research project should lead to a sourcing funnel that produces a much more limited subset of prospective contract manufacturers.

The next step is to prepare a professional deck of information regarding the products for factory visits and audits. There is no substitute for in-person operations verification, negotiating costs, and preparation for production.

A well-designed Request for Pricing (RFP) and Product Deck should contain technical (3D) drawings, material specifications, certification requirements, testing details and annual volumes. A company ideally should have a complete set of these criteria for every SKU in their brand portfolio.

 Spoiler Alert: This is quite commonly the “GO- NO GO” point for brands that have let critical operational details fall to the wayside and taken for granted that their suppliers would consistently support their goals, new product development and growth targets.

Custom versus Catalogue Suppliers

There are basically two types of suppliers or contract manufacturing options—Custom or Catalogue.

With Custom, a specific manufacturing discipline is involved such as Plastics—injection molding, roto-molding, additive, blow molding; Metal works—castings, machining, welding, bending; Cut and sew, Electromechanical—PCBAs, SMT, to name some general disciplines. Any and all of these combined can generally be considered “assembly”.

Catalogue (aka “Off the shelf”) is a supplier that produces a finished product, perhaps for existing customers or the China market, and offers private label versions with logo and other aesthetic changes. In some cases, custom variations to fit, form or function are made.

The below are the usual pros and cons to custom versus catalogue:

New Product Introductions

In identifying a good manufacturing partner, one key criteria we consider is that our clients do not want to see their suppliers competing with them by selling the same products in the same markets.

The more a manufacturer invests in developing and launching the products you will be buying from them, the less likely they will acknowledge you own the final design. The following are some questions to consider in determining WHAT? [how likely it is your manufacturer will claim to own the final design?]:

1. Did you use your own employees or an in-country industrial design firm to create the product?
2. Who specified the materials? Were these vendor specific, i.e. DuPont ?
3. Were there any specific certifications such as CE or UL (for products) ISO (for Mfg compliance) required in selecting suppliers? Who paid for these certifications? Does the supplier have existing certifications?
4. Has there been specific documentation created around the fit, form and function of the product?

Next comes the Engineering Change Management Process, which is when timelines and milestones tend to get fuzzy. Considerations here often include the following:

1. Is the process ad hoc or strict? Are revision numbers clearly recorded?
2. The number and frequency of changes made up to the final product.
3. Testing protocols for pass/fail (often called Accepted Quality Level testing)

It all comes down to clear, upfront and documented expectations and assumptions. It is critical this be laid out in a working agreement with your manufacturer from the get-go. More importantly who is footing the bill?  The frequency, complexity and contributions from the supplier in time and dollars will impact the degree to which it lays claim to your IP.

Even when selecting a supplier producing off the shelf products, it is critical to understand and establish the degree of exclusivity you as the brand are able to negotiate regarding the product and the territory or markets where the products are sold.

As you map out and plan a strategy of identifying a new supplier outside China, considerations should be given to :

• Research into new supplier base—time and expense
• Future Inventory requirements (safety stock and minimum order quantities
• Financial analysis of dual sourcing or moving production
• Have good records been maintained for assets (tooling)
• Carrying cost of capital for inevitable run-up of duplicate product inventory from new supplier
• New vendor set-up
• Time for your personnel to manage
• Travel and start-up costs

There are no short cuts.

* This post is the second in what will be a series of posts by David Alexander. I asked David to write these posts because our law firm and David’s company have worked together on various international projects and I felt David would provide a good and practical perspective on what is happening with international supply chains today. David and his company, Baysource Global  have been leading contract manufacturing and supply chain projects in Asia since 2005, working with leading brands on strategic sourcing, vendor management, QA/QC, and overall Asia supply chain strategies.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.