14 Apr 2023 FAILURE TO ADAPT RESULTS IN MAJOR SHIFTS TO SUPPLY CHAIN ECONOMICS
Products from China have increased in costs for many years due to increased labor costs. When combined with tariffs, as well as the Pandemic, it requires that companies nearshore. Failure to do so may result in the failure of the business and its liquidation. Here’s a case study to consider. Recently a 10-year-old furniture company collapsed financially. The challenges that it experienced with supply chain disruptions from China during the global pandemic resulted in months-long product delays and extraordinary logistics costs. As a result of the US-China trade dispute, the products were also subject to the highest tariff. The combination of these factors overwhelmed the company financially, even though it was digitally astute, custom furniture oriented, and delivered products directly to the customer’s residence.
Opportunity to Save (and Potentially Avoid Failure) Explored and Dimensioned
Following the imposition of Trump’s 301 tariffs on China, the cost of product increased dramatically as a result of the additional 25% import increase. In an effort to save money, a project to explore Mexico as an alternative was launched, which would have resulted in substantial ex-factory savings of 25%, but did not move forward. Possibly, this was from poor negotiations. Additional substantial savings could have also been gained by the lower cost of trucking from Mexico to the client’s customers. The combination of a 25% product cost savings, the elimination of the 25% 301 tariff, and lower logistical costs would have significantly improved profit margins. Additionally, from an inventory and cash flow standpoint, the 16-week lead time from factory order to arrival at the distribution center would have been reduced to less than 6 weeks.
The Pandemic Compounded the Financial Difficulties of the Company
The following year, the global pandemic brought horrendous disruptions to the Chinese supply chain for this unfortunate company’s product category. Factories were closed with zero notice, ocean transportation experienced closed ports and/or ships having to bypass an open port because the crew had contracted COVID-19. Even upon arrival off the West Coast port, there were continued major delays due to port congestion because of worker shortages, trucking shortages, as well as many other issues. Assuming that the container was then loaded on a train for an inland destination, there were frequently major issues with congestion at the railyards, resulting in additional weeks of delays.
The financial impact skyrocketed import costs as containers now cost up to 4 times pre-pandemic levels. The extreme shortages of product disappointed customers and revenues were negatively impacted, resulting in nearly $100 million in debt and the expenditure of approximately $10 million in assets, which was clearly not sustainable. Without the ability to generate funds, there was no cash to continue operations, leading to the company’s liquidation. Shareholders, lenders, vendors, and employees were all victims of poor decision-making and the strategic economic shift.
Deciding to Move Forward with Mexico Would Have Both Saved Millions of Dollars and Avoided Supply Chain Disruptions
There was a clear opportunity to save millions of dollars annually with little to no transition costs. No one could have seen the global pandemic coming, but the leadership of this particular company failed to make changes when there were drastic shifts in internal dynamics. This begs the question of why. The answer lies with a change in organizational responsibility for sourcing of products.
Originally, the company operated with a supply chain organization that sought to lower costs by competitively bidding products from several factories in China, as well as exploring Mexico as an alternative while shortening the supply chain. However, since the marketing organization leadership had previously sourced product from China, it was felt that going forward, there was no longer a benefit to a supply chain operation that would be focused on cost reduction and efficiency improvement because the marketing leadership could fulfill that function. This proved to be a serious mistake. In a stable environment with many factories willing to provide products based upon aesthetics and willingness to adapt styles, the strategy could work. The underlying (false) assumption is that the marketing department would not only select great products but would do so at a competitive cost. However, when sourcing is performed by marketing team members who fall in love with the product, any negotiating leverage disappears, and competition among various factories is rarely productive or even conducted. Further, marketing team members have not historically been involved in negotiating ocean freight, resulting in the mistaken assumption that the logistics cost of importing is a given and cannot be changed or negotiated.
Various Sourcing Strategies
Unlike the mistaken marketing team members from above, at Shoreview we are very aware that there are several distinct strategies for sourcing products. The first involves work at qualifying factories early on and developing set cost structures. The second and third assume that those involved in sourcing are selecting products from sources with well-established capabilities.
The first strategy, Strategic Sourcing, is the process of identifying the best factories based upon product capabilities and landed cost. It requires exploring various countries and logistics. In the case of furniture in China, this was done decades ago. Once qualified factories have been established, it is just a question of picking and choosing products and asking for minor updates. The difficult work of qualifying factories, establishing pricing parameters, and developing import processes has been completed and is no longer a consideration. Typically, strategic sourcing is accomplished by supply chain professionals, such as those at Shoreview, partnering with engineers. Subsequent choosing of product from a qualified source does not require the same skill set.
A second strategy for some companies is Ordinary Sourcing. This strategy is somewhat different. It is based upon many factories being available, and the objective is to locate the factory based upon attending trade shows or using internet services like Alibaba. In this case, the product has been designed in advance, and finding an existing source willing to manufacture this product at a competitive price is the objective. This is the simplest form of sourcing as it is a search among existing known possibilities and is somewhat like selecting from a catalogue.
A third strategy is Counter Sourcing. It is based largely on attending trade shows and/or visiting showrooms. This strategy requires matching product designs to those on display and modifying them to meet anticipated consumer tastes. Little attempt is made at understanding manufacturing or the logistics involved. Import costs are essentially thought of as being free and reliable. The focus is entirely on the aesthetics and the assumed desire for the products selected.
The Overwhelming Desire for Control
Most marketing organizations which cater to consumer tastes (such as clothing, jewelry, or furniture) are fully competent in selecting products or modifying existing products to meet or create consumer desires. These product lines, which are typically characterized by high margins and not having competitive costs, are not as important when securing the best product. Therefore, as long as the supply chain is mature and functioning well, the company can thrive with marketing-leading sourcing.
However, for those with less mature supply chains and smaller margins, involving a supply chain organization in the sourcing process with competitive bidding is oftentimes viewed as both unnecessary and an intrusion on control. While this can be true when every element of the supply chain is well-developed, and the latter can be viewed as a limitation on choice, marketing leading sourcing is absolutely a mistake if the company needs to pursue margin improvement through cost reduction. Marketing leaders have not been historically involved or trained in factory qualification and competitive bidding processes. However, the ability to yield a degree of control and shared decision-making is viewed as a loss of status and prestige for the marketing executives.
Executives also balk at the idea of re-sourcing or nearshoring because of the potential of moving away from traveling to exotic locations such as Hong Kong or Paris. While locations are a perk, having to travel from factory to factory throughout various countries is difficult and time-consuming. Manufacturing companies that have showrooms or attend trade shows with elaborate display booths eliminate those difficulties for sourcing executives who are really not interested in how the product is made or what factors influence product costs.
Maximizing the Possibility of Successful Re-Sourcing
Given the potential of future disruptions of global supply chains from such things as armed conflict between Russia and Ukraine or China and Taiwan, there is a compelling need to move away from China and to embrace re-shoring or nearshoring. Taking into consideration that global economics have changed, there may be an opportunity to lower costs. Being closer to the US market also results in shorter supply chains, which require less inventory investments, and enhances the ability to respond faster to changes in demand.
Had the furniture company decided to source from Mexico before the pandemic, they would have saved millions of dollars during the shifting global environment. Also, it would have avoided the worst effects of the major disruptions brought on by the global pandemic. Product costs would have been stable, and the supply of product assured. As it turned out, the desire for marketing to “control” the sourcing of product and ignore the potential savings had catastrophic results, and the company no longer exists. Whether or not there was a breach of fiduciary responsibility by the chief executive officer is a decision for the courts.
The United States has had many companies which failed to adapt to the previous major shifts in global economics or technology. The Rust Belt has many shuttered buildings where once thriving manufacturing companies did not react to the rise of China as a low-cost alternative for products. Many executives thought that they were protecting their workforces by not upgrading equipment or selectively importing components from a new supply chain to ensure their products remained globally cost-competitive. It is not difficult to develop a long list of Fortune 500 companies that have failed due to shifts in supply chain economics. The difference between those former times and now is that there is a very compelling alternative to China. This furniture company failed to grasp it. Its shareholders, debt holders, and former employees paid the price for the wrong decision by the executive team.
Re-Sourcing from China to another country is a strategic decision. It involves great effort, and there are difficulties to overcome. That being said, Re-Sourcing to another Southeast Asian country like Vietnam or Thailand is less complicated, as the Chinese culture extends into those countries, and oftentimes the factory in China will facilitate the change. The existing culture within the company should be successful in implementing these changes, as it does not threaten the cultural patterns which have been established over the years.
However, re-sourcing to the US (re-shoring) or to Mexico (nearshoring) is far more difficult and resource-consuming. Executive leadership will need to be more intimately involved to ensure that the change effort is appropriately staffed with those favorable to the potential of change rather than the existing managers and leaders who may resist the change because it will substantially change their roles, activities, or status within the company. Since it also requires far more effort, it may be necessary to add additional resources either internally or externally to accomplish the tasks required. If external resources are required, then the executive leadership should be diligent in selecting a consulting resource that has a demonstrated track record of results and hands-on experience with resources on the ground in the target country. Shoreview Management Advisors is such a company for Mexico. Contact us for more information on Re-Shoring or Near-Shoring.