Sourcing Strategies in International Purchasing notes

TOPIC 3 :

SOURCING STRATEGIES IN  INTERNATIONAL PURCHASING

Definition of sourcing

Sourcing is the process of identifying, selecting and developing suppliers.

The definition of sourcing can be simple or much more complex, the simple definition is “the process involved in identifying potential vendors, conducting negotiations with them to and then signing purchasing agreements with them to provide goods/or services that meet your company’s needs”

Sourcing generally refers to those decisions determining how components will be supplied for production and which production units will serve which particular markets. Multinational firms have been pursuing integrated sourcing to a greater extent than before because such an operation allows them to exploit their competitive advantages (Kotabe and Murray, 1990). Sourcing can, next to the above, be defined as ‘the reorganization of tasks, functions and services of an organization, wherethe more effective managing of organizational and operational processes is the main issue (Huibers and Schut, 2006).

Huibers and Schut (2006) also state that ‘with sourcing, organizations can manage their

operational and organizational processes more effectively’. This can be done internally,

externally, national or international. Sourcing can be done concentration of activities, transferring the execution of services or processes to an external party or the transferring business activities abroad. In other words sourcing can have many forms depending on the organization it is applied to.

A. Counter trade:

This is a form of international cashless trade in which an order is placed a purchaser to a supplier in another country on condition that goods of equal proportions will be sold in the opposite directions. The types of counter trade entail:

  1. Barter or Swap: This is a one off, direct, simultaneous exchange of goods or services between trading partners without a cash transaction. The term ‘’swap” is used when goods are exchanged to save transportation costs.
  2. Counter purchase: A country sells to a foreign country on the understanding that a set percentage of the sale’s proceeds will be spent on importing goods produced in the country to which goods are exported.
  3. Buy back or compensation: This occurs when the exporter agrees to accept, as full or partial payment, products manufacturer the original exported product.
  4. Switch trade: This refers to the transfer of unused or unusable credit balances in one country to overcome an imbalance of money a trading partner in another country.
  5. Offset trade: This is similar to counter purchase, except that the supplier can fulfil the undertaking to import goods or services for a certain percentage value dealing with any company in the country to which the original goods were supplied.

 

Advantages of counter trade:

  • Acceptance of goods or services as payment can avoid exchange controls,
  • promote trade with countries with nonconvertible currencies and
  • reduce risks associated with unstable currencies
  • It facilitates enterprise to enter into new or formerly closed markets;
  • expand business and sales volume and reduce the impact of foreign protectionism on overseas business
  • Countertrade has enabled participants to make fuller use of plant capacity, have longer production runs, reduce unit expenses due to greater sales volume and find valuable outlets of declining products.

 

Disadvantages of counter trade:

  • Negotiations tend to be longer and more complicated than conventional sales negotiations and must sometimes be conducted with powerful government procurement agencies.
  • Additional expenses, such as brokerage fees and other transaction costs, reduce the profitability of countertrade
  • Countertrade may give rise to pricing problems associated with the assignment of values to products/commodities received in exchange
  • Offset customer can, later become competitors
  • Commodity prices can vary widely during the lengthy periods of counter trade negotiation and delivery.

 

B. Reciprocal trading:

This is a mutual exchange of buyer’s and supplier’s products of advantages/privileges in commercial relations. It is selling through the order book when a policy is adopted of giving preferences to those suppliers who are also customers of the buying company. In order to perfect this form of transaction, many countries across the globe agreed to form international reciprocal trade association (IRTA). This is the global trade association for the modern trade and barter industry. IRTA promotes proper accountability rules, equitable standards, ethics and governmental relations.

 

C. Currency management

Deration when buying abroad. This is because there is always a risk that currencies will fluctuate and the buyer will end up paying more than the original expectation. The degree of involvement of the buyer in the management of currency will vary between one organization and another. Large organizations e.g. multinational usually have a cooperate treasury department that manages currency transactions.

Techniques of managing currency available to the buyer include:

  1. Pay in own currency: A seller in foreign country may accept payment in the currency of the buyer. This is possibly owing to the fact that the currency of the buyer is attractive at that market. The disadvantage is that the seller may increase the price to protect the unfavorable involvement.
  2. Paying in a mutually agreed currency that is not the currency of the country of the buyer nor the seller
  3. Inserting a clause in the contract e.g. this contract is subject to an exchange rate. If the exchange rate exceeds this parameter, then the contract is re negotiated.
  4. Inserting a clause in the contract that averages the sum of exchange rate at the time of signing the contract and the time delivery.
  5. Buying the currency and holding it until the time it is required.

 

D. Direct procurement:

A procuring entity may use direct procurement as allowed under subsection (2), (3) or (3) as long as the purpose is not to avoid competition.

A procuring entity may use direct procurement if the following are satisfied:

  • There is only one person who can supply the goods, works or services being procured
  • There is no reasonable alternative or substitute for the goods, works or services
  • There is an urgent need for the goods, works or services being procured
  • Because of the urgency the other available methods are impractical
  • The circumstances that gave rise to the urgency were not foreseeable and were not the result of dilatory conduct on the part of the procuring entity

 

The following procedure in line with direct procurement shall apply:

  1. Need assessment
  2. Sourcing supplier
  3. The procuring entity may negotiate with a person for the supply of goods, works or services being procured
  4. Section 47 shall not apply to an amendment to a pre-existing contract if the amendment is for the purpose of carrying out a direct procurement allowed under section 74(4)
  5. The procuring entity shall not use direct procurement in a discriminatory manner
  6. The resulting contract must be in writing and signed both parties

 

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E. Use of intermediaries

In in ternational business relationships there is often one more party, some kind of intermediary, directly involved. Examples of intermediaries involved in international business relationships are the manufacturer’s sales forte, distributors, agents and wholesalers (see e.g. Keegan, 1989, p. 443). The usual way to explain the existence of an intermediary is to say that the intermediary is needed to bridge over the gap between the seller and the buyer. The gap can tonsist of both place- and time related factors, such as geographical distance and separation of production and consumption in time, and of technological differences between the seller and 3

Thus, the fact that at least three parties are more or less involved in the same business relationship increases the complexity.

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Effects of globalization in international purchasing

Definition: The worldwide movement geared toward integrating  economic, financial, trade, technological, environmental, political, ecological and communications integration in order to streamline global supply chain. .  Globalization implies the opening of local , nationalistic and international  perspectives to a broader outlook of an interconnected and interdependent world with free transfer of capital, goods  and services across national frontiers. However, it does not include unhindered movement of labor and, as suggested some economists, may hurt smaller or fragile economies if applied indiscriminately.

forces and political and macroeconomic forces.

a) Global Market Forces

There is tremendous growth potential in the foreign developing markets which has resulted in  intensified foreign competition in local markets which forces the small – and medium-sized companies to upgrade their operations and even consider expanding internationally. There has also been growth in foreign demand which necessitates the development of a global network of manufacturing bases and markets. When the markets are global, the production-planning task of the manager becomes difficult on one hand and allows more efficient utilization of resources on the other. Few industries remain today in which the international product life-cycle theory still applies. Product markets, particularly in technologically intensive industries, are changing rapidly. Product -cycles are shrinking as customers demand new products faster. In addition, the advances in communication and transportation technology give customers around the world immediate access to the latest available products and technologies. Thus, manufacturers hoping to capture global demand must introduce their new products simultaneously to all major markets. Furthermore, the integration of product design and the development of related manufacturing processes have become the key success factors in many high-technology industries, where fast product introduction and extensive customization determine market success. As a result, companies must maintain production facilities, pilot production plants, engineering resources and even Research and Development (R & D) facilities all over the world. Apple Computer, for example, has built a global manufacturing and engineering infrastructure with facilities in California, Ireland and Singapore. This network allows Apple to introduce new products simultaneously in the American, European and Asian markets. Companies use the state-of-the-art markets as learning grounds for product development and effective production management, and then transfer this knowledge to their other production facilities worldwide. This rationale explains why Mercedes-Benz decided recently to locate a huge manufacturing plant in Vance, Alabama. The company recognizes that the United States is the state-of-the-art market for sport utility vehicles. It plans to produce those vehicles at the Vance plant and introduce them worldwide 1997.

b) Technological Forces

A peculiar trend which was prevalent in the last decade, besides globalization, was a limited number of producers which emerged due to diversity among products and uniformity across national markets. Product diversity has increased as products have grown more complex and differentiated and product life cycles have shortened. The share of the US market for high-technology goods supplied imports from foreign-based companies rose from a negligible 5 per cent to more than 20 percent with the last decade. Moreover, the sources of such imports expanded beyond Europe to include Japan and the newly industrialized countries of Hong Kong, Singapore, South Korea and Taiwan. There has been diffusion of technological knowledge and global low-cost manufacturing locations have emerged. In response to this diffusion of technological capability, multinational firms need to improve their ability to tap multiple sources of technology located in various countries. They also must be able to absorb quickly, and commercialize effectively, new technologies that, in many cases, were invented outside the firm thus overcoming the destructive and pervasive ‘not-invented-here’ attitude and resulting inertia. There has been technology sharing and inter firm collaborations. The well-known joint ventures in the auto industry between US and Japanese firms (GM-Toyota, Chrysler-Mitsubishi, Ford-Mazda) followed a similar pattern. US firms needed to obtain first-hand knowledge of Japanese production methods and accelerated product development cycles, while the Japanese producers were seeking ways to overcome US trade barriers and gain access to the vast American auto market. As competitive priorities in global products markets shift more towards product customization and fast new product development, firms are realizing the importance of co-location of manufacturing and product design facilities abroad. In certain product categories, such as Application Specific Integrated Circuits (ASICs), this was the main motivation for establishing design centres in foreign  countries. Other industries such as pharmaceuticals and consumer electronics also have taken this approach.

c) Global Cost Forces

New competitive priorities in manufacturing industries, that is product and process conformance quality, delivery reliability and speed, customization and responsiveness to customers, have forced companies to reprioritize the cost factors that drive their global operations strategies. The Total Quality Management (TQM) revolution brought with it a focus on total quality costs, rather than just direct labour costs. Companies realized that early activities such as product design and worker training substantially impact production costs. They began to emphasize prevention rather than inspection. In addition, they quantified the costs of poor design, low input quality and poor workmanship calculating internal and external failure costs. All these realizations placed access to skilled workers and quality suppliers high on the priority list for firms competing on quality. Similarly, Just-in-time (JIT) manufacturing methods, which companies widely adopted for the management of mass production systems, emphasized the importance of frequent deliveries nearsuppliers. A number of high-technology industries have experienced dramatic growth in the capital intensity of production facilities. A state-of-the-art semiconductor factory, for instance, costs close to half a billion dollars. When R & D costs are included, the cost of production facilities for a new generation of electronic products can easily exceed $ 1 billion. Similarly, huge numbers apply for the development and production of new drugs in the pharmaceutical industry. Such high costs drive firms to adopt an economies-of-scale strategy that concentrates production in a single location, typically in a country that has the required labour and supplier infrastructures. They then achieve high-capacity utilization of the capital-intensive facility aggressively pursuing the global market. Besides this the host government subsidies also become an important consideration.

d) Political and Macroeconomic Forces

Getting hit with unexpected or unreasonable currency devaluations in the foreign countries in which they operate is a nightmare for global operations managers. Managing exposure to changes in nominal and real exchange rates is a task which the global operations manager must master. If the economics are favourable, the firm may even go so far as to establish a supplier in a foreign country where one does not yet exist. For example, if the local currency is chronically undervalued, it is to the firm’s advantage to shift most of its sourcing to local vendors. In any case, the firm may still want to source a limited amount of its inputs from less favourable suppliers in other countries if it feels that maintaining an ongoing relationship may help in the future when strategies need to be reversed. Becton Dickinson has built a global manufacturing network for its disposable syringe business, with production facilities in the United States, Ireland, Mexico and Brazil. When the Mexican peso was devalued, the company quickly shifted its production to the Mexican plant, theregaining a cost advantage over its competitors’ US factories. The emergence of trading blocks in Europe (Europe 1992), North America (NAFTA), and the Pacific Rim has serious implications for the way firms A? structure or rationalize their global manufacturing/sourcing networks. These trends are clearly apparent in many industries. For instance, before 1992, 3M’s European plants turned out different versions of the same product for the various European countries. Today, 3M manufacturing plants produce goods for all of Europe and, in the process, realize significant cost savings. Similarly, Philips, Thomson, Electrolux and Ford are in the process of creating pan-European networks of factories (producing both components and finished goods). The trade protection mechanisms which exist in the form of tariff and non-tariff barriers effect the global operation strategy; but these are readily losing importance in the new borderless trade regime.

Effect of a Global Integrated Economy on Global Operations

Operations and logistics are forced to adapt to environment. The logistic framework is forced to integrate its activities to meet the challenges of an integrated economy.

a) Geographical Integration

Geographical boundaries are losing their importance. Companies view their network of worldwide facilities as a single entity. Implementing worldwide sourcing, establishing production sites on each continent and selling in multiple markets all imply the existence of an operations and logistics approach designed with more than national considerations in mind. This geographical integration has been exploited the regional economic integration, a very good example being the European Union. After the integration process was triggered off on 1 January 1 1993. At that time, customs duties between European Economic Community countries were abolished. This elimination of borders caused companies to rethink their physical flow structures for Europe as a whole. The usual practice of setting up sales subsidiaries in each country and creating country-specific logistics support and production systems was no longer appropriate. For companies the production and marketing is not restricted to one country but is global. Geographical integration becomes possible not only because of data processing and communication technologies, but also thanks to an excellent worldwide new means of transport. Express delivery services such as Federal Express, DHL, UPS and TNT, with their planes, hubs, systems of collection, tracking and final delivery, allow companies to send articles long distances, in the shortest time possible, and at a much lower cost compared to the cost of carrying inventory.

b) Functional Integration

The world is moving at such a fast pace that the various functional activities are no longer sequential and compartmentalized. The responsibilities of the global logistics and operations manager is not limited to coordinating the physical flows relating to production distribution, or after sales service; they are also responsible for functions such as research, development and marketing. This functional integration improves flow management considerably. When setting up projects for developing new models, automobile manufacturers such as Renault in Europe have two teams working together: one from the R&D department and the other from the logistics group. The teams’ assignment is to simulate the flows required in the procurement and manufacturing stages according to the elements prepared the research unit. The logistics department, for instance, can affect the automobile design stage recommending modifications in order to create savings in logistics.

c) Sectorial Integration

In traditional supply chains, suppliers, manufacturers, distributors and customers each work to optimize their own logistics and operations. They acted in isolation concerned only with their part of the flow system which resulted in creating problems and inefficiencies for other players in the channel hampering the smooth flow all of which add cost to the total system. Leading firms, realizing this situation, are beginning to extend their view beyond their corporate boundaries and work cooperatively with all channel parties in an effort to optimize the entire system. This cross-boundary cooperation is referred to as Sectorial Integration.

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