China Sourcing: Cold Thinking behind Hot Marketing

The First Edition of China Sourcing Series

GAS: Mr. Li, thank you for your accepting to do this interview with Gasgoo.com. You have many years of experience in China sourcing for multi-national companies (MNC’s). So what are the main challenges they are facing today?

Li Peng:  So far, more than 95% of the Top 500 international companies in the world have set up their Chinese sourcing centers in Shanghai. The main problem they are facing is how to get to know and assess Chinese suppliers appropriately. Due to the differences between Chinese and foreign cultures, Chinese suppliers understand drawings and technologies differently from foreign customers during their communication. So, they usually have problems in providing a proper quotation based on the understanding of the customer’s equipments. The foreign customers also want to improve the efficiency in communication.

Another challenge is not only to develop new products but also steadily supply qualified products in mass-supply. This is a huge problem that the international purchasing staffs are facing. First of all, a general assessment of the whole quality system should be done, and then some guidance and suggestions should be given to the suppliers from the OEM’s point of view. For example, let’s take STA of Ford and SQE of GM. There are high requirements for engineering ability in their purchasing staffs. They should not only have the management experience in quality control systems and cost but also provide the solutions for the common problems based on the cultural background of Chinese suppliers. The solutions and practical suggestions are from the experience of purchasing engineers. With this experience, the engineers could give guidance to suppliers and show the key points which are most needed. However, such talents are rare. It is difficult for foreigners in MNC’s to know China well, while local workers can scarcely reach such a professional level. So these kinds of talents are deeply needed.

GAS: Generally speaking, the shortage of highly experienced engineers is a challenge.

Li Peng:  Yes.

GAS:  Nowadays it’s very popular for international companies to purchase in China. Many MNC’s have established sourcing centers in China with high expectations of finding good purchasing prospects. It seems that anything could be sourced in China. Actually it is not true. Presently there are not so many suitable auto parts to be sourced in China. Which kinds of parts do you think are right ones to be sourced in China?

Li Peng:   I will answer this question indirectly. If you want to do sourcing well, you should have a clear idea of the target products and their cost structure. Take raw materials, for instance. Which kinds of products are competitive as far as raw material costs in China? Foundry, non-ferrous, iron, finish machining, etc. Patterns and processing techniques are mature in China and all the materials used are available without importing. In addition, the cost for labor, management, processing, and pattern and product design are comparatively low. As a result, these items are competitive if sourced in China.

The second kind is labor-intensive products but with some exceptions. Take wire sets, for example. Some of the connectors are patented, which accounts for 80% of the total cost. Such kinds of wire sets are not suitable for China sourcing like those for assembled vehicles and short engine wire sets. But other common kinds such as ordinary wires and connectors are good for purchasing in China.

The third concern is transportation cost, which should account for a small portion of the overall purchasing cost. Some simple products such as meter assembly and patterns could be made in China. But with the high transportation cost accounting for more than 30% of the total cost, they might not be competitive. However, some other products, like inner board with low production cost as well as a low portion of transportation cost, these kinds of products are suitable for China sourcing. So are some chemical products and leather because of the rich raw materials, matured processing, and labor demand. Some of the joint ventures have already started production in China. These labor-intensive products may be automated abroad, while in China, they are half-automated or hand made. These products are suitable for export as long as the quality can be guaranteed. In conclusion, we must analyze the cost structure. From this point of view, the Chinese purchasing list can be decided on.

GAS: You mean the products which have a high percentage of labor involved are suitable to be sourced in China?

Li Peng:  Yes. As I mentioned, we should be concerned with the costs of labor, transportation, and other relevant factors. If all the factors including raw materials are available in China, these products should be more competitive in the global market. The quality consistency of Vietnam, Malaysia, and Thailand are not as good as that of China, while the cost structure of Japan and South Korea is far more than that of China, which gives China the purchasing advantage. So it is reasonable for so many MNC’s to source in China.

GAS: Chinese price is a hot topic now. For those products suitable for China sourcing, how much can be saved compared to sourcing abroad?

Li Peng:  Generally 20% to 30%. It is riskier to change suppliers such as logistics, inventories and new product development. I don’t think someone would like to do so if there is not a huge price gap. Take export logistics, for example - supplier factory to local port to destination port to customers’ factory - there are a lot of intangible added-costs. According to our former experience in China sourcing, we would only do the business if there were more than 30% of price depreciation in cost.

GAS: Only above 30% will you consider changing suppliers?

Li Peng:   Not change immediately. It depends on the importance of the parts being sourced. It takes a long process to change key parts suppliers. Maybe at the beginning 20% of production will be purchased from the new suppliers, then 50%, 80%, up to 100%. The more important the parts are, the slower this changing process is.

GAS: According to your sourcing experience, are the prices of suitable products in China good enough?

Li Peng:  It’s possible. For example, an iron casting priced in RMB in China and in Euro abroad is relatively cheaper in raw material cost. Another point, developed countries have tough regulations for manufacturing factories in order to protect the environment and higher requirements in accuracy, which leads to higher cost and more expensive facilities. But in China, we can make rough finished castings with cheap machinery first. Some big factories even amortize machinery cost to zero. The only thing they need to do is to buy some better facilities and keep good control of quality. In that way, the cost would be at a very low level, which could be lower by 40%-50% compared to the cost abroad.

GAS: What are your thoughts on the quality of Chinese suppliers?

There are two aspects to supplier quality: one is product quality and the other relates to the quality of the suppliers’ communication with its foreign customers. Let me focus on the latter first. If you cook a steak in the western style, it would be welcomed by the foreign customers. However, if you cook it in the Chinese spicy flavor, with the same materials and almost the same cost, the foreign customers may not like it. That means in doing business with foreign customers, the suppliers should adopt the style which the customers are familiar with. The communication style of some Chinese state-owned enterprises are not very acceptable to foreign customers even if the quality of their products is good.

Regarding product quality, the lack of stability and consistency in product quality is the main problem for Chinese local suppliers, as well as for other Asian countries except Japan (even South Korea is not as good as Japan). There are few Chinese vehicle manufacturing companies with sales volume of over 100,000 units. However, the lowest production capacity of foreign OEM production platforms is 300,000 units, with some even over 1 million. This requires high compatibility in most casting parts. The management of 10,000 units of production is totally different from that of 1 million units of production. You could produce 10,000 qualified products, but you cannot guarantee the good quality at 6-sigma level when you produce 1 million units. The OEM and sourcing companies should give some reasonable and practical suggestions to suppliers to let them realize the importance of quality consistency. And then both parties should work together to find acceptable solutions. Meanwhile, we could also learn lessons from mistakes made by some foreign suppliers.

GAS: I have heard that Chinese suppliers can provide quality products in small quantity, but usually fail in mass production.

Li Peng:  Yes, this is the problem I just mentioned. Actually, when you supply in mass quantity, the current management system cannot meet the future demand. So adjustments are necessary. For example, there is an automated production line for the safety belt adjustor whose output volume is 800,000 units. After being introduced in China, the output was 80,000 units due to the limitation of the OEM. So we assembled them by hand to reduce cost. The Chinese suppliers could extend working hours to guarantee the quality for small quantity orders. However, when the demand increased up to 280,000 units, it was difficult to guarantee the quality by hand. So how do you adjust? One of the methods is to check the products with a comprehensive test device before they leave the factories. Another choice is to control the production process using the foreign automated production line. However, where are the facilities located? Is the process mature? The customers would not make big orders at the beginning, because it would be disastrous to run a high-cost production line without any output. As a result, how to deal with this dilemma is also a problem.

Some of the domestic suppliers did not understand this point and followed conventional processes. There used to be 10 workers before and now there are 100 workers. However, when the number of workers reached 1,000, the suppliers also reached the limits of manual labor. When they cannot increase scale to meet the required quality, consistency becomes a problem. When the problems appeared, some foreign engineers were invited to come solve the problems, but usually failed to find the key points in 2 or 3 days because there were so many problems involved in the different steps. So it is necessary to make long term follow-up and research work in the factory to provide effective solutions.
 
GAS: If we make the benchmark of 100 for mature American and European suppliers, what’s the mark for Chinese suppliers?

Li Peng:  It may vary greatly depending on products and areas. The marks of Jiangsu and Zhejiang provinces is relatively higher, about 80, while inland it is lower.

GAS: Below 50?

Li Peng:  There are some below 50.

The mark is not the most important part. Factories are similar to people as far as differences in capacity and potential. Some people have the capability of 10 but with 100 potential; while some have the capacity of 20 with 0 potential. The first ones are what we are looking for. Under certain guidance, the potential would be increased up to 110, the international level. However, its cost structure should be reasonably low and what we would need to do is just improve its management system. Actually, foreign customers often make the mistake to track and find the best suppliers and ask them to supply. The phenomenon is that good suppliers have more orders than their production capability.  It is impossible for these suppliers with good quality, advanced technology, excellent service, and competitive cost structure to produce 50% more for some uncertain foreign customers. And it is also impossible for these suppliers to establish new factories to expand their production capability and reach the same management level within a short period. So if you plan to do long-term sourcing in China and you want to do it well, you have to set up a team with excellent ability for developing good local suppliers, and that will be rewarding.

GAS: You just mentioned some problems that Chinese suppliers have. What’s the bottleneck? Equipment, processes, or raw material purchasing?

Li Peng:  Actually, all of them. Let’s start with raw material. The quality of raw materials are not consistent, such as steel and casting iron. The contents of chemical elements may vary in different raw materials.
Regarding patterns, a plastic pattern costs 300,000 RMB in China but US$ 200,000 in Europe. But there is a huge difference in the pattern lives. The Chinese pattern could be used only 80,000 times with two repairs, while the foreign pattern might be used at least 300,000 to 500,000 times, using a conservative estimate, without any problems. That means 3 Chinese patterns equals one foreign pattern. So there is little advantage in cost for Chinese patterns.

Another problem is equipment accuracy. Maybe at the beginning, the accuracy of Chinese machines is reliable. But after a period of depreciation, the accuracy goes out, which leads to quality problems in some products. If we fail to change the inspection method after production, these unqualified products will go to the market, which will affect the reputation of the company and even the supply chain.
In addition, processes are also a factor. The suppliers should have the right system to control product quality based on a good understanding of raw materials and equipment. This means you should know when your machine could probably go down and what kinds of measures you should take in advance to control product quality to tolerance.  

GAS: New product development by Chinese suppliers is usually considered as a weakness. What’s your opinion?

Li Peng:  In my opinion, the understanding of new product development by local Chinese suppliers is not very precise. The real development is to create or invent something which does not exist on Earth. Take an engine cylinder, for example. It should be created from the beginning, from drawing design, standardization, and verification to the final finished product. However, so-called Chinese development is actually introducing a mature product design, translating the drawings into Chinese, and producing the product. These two developments are totally different. The latter is just the process of production. So the Chinese suppliers only have production ability but no design ability.

Nowadays, multi-national customers want their suppliers to take part in the development of new products because the competition amongst OEM’s is the competition between systems produced by “OEM + suppliers” rather than the OEM alone. If both the suppliers and customers have the ability to develop new products jointly and communicate effectively, new products would be developed quickly to lead the market. This is what we want. In other words, Chinese suppliers should accept the idea that they should become the potential suppliers in the future by developing new products of their own after copying other mature products. We could cooperate with those suppliers who could take the place of foreign institutions with development ability but without production ability. 

GAS: That is our expectation. But currently most of the Chinese suppliers are on the first level you have mentioned above – producing foreign mature products without design ability.

Li Peng:  About 95-98% of suppliers belong to this first level and only 1-2% of the suppliers are able to design and develop new products of their own. High quality product development should be encouraged and supported by the government. The present achievements of Japan and Korea have proven this point. 

GAS: The Chinese suppliers’ weak development ability is the reason why only those mature products have been substituted by Chinese ones, without new development.

Li Peng:  The products are those in international standardization and with few patents, for example, casting machining. Some high-tech casting products such as transmission housings are not competitive because of the high defect rate, sometimes 50% even up to 80%. Now China produces low-tech products such as synchronizing gears. Few products made of complicated materials and of high accuracy are produced in China. We are trying to find such suppliers but with no results.

GAS: In the supply chain, is the logistic system also a weakness for Chinese suppliers, the ability of managing tier-2 suppliers and the ability of integrating the supply chain? 

Li Peng:  They have improved over the past two years. However, when compared to American and European suppliers they are immature. If the Americans and Europeans are at the 100 mark, then at most we are at 50. Take transportation, for example. There are three means of transportation in China: air transportation, railway transportation and road transportation. The cost of air transportation is more expensive than that abroad. Missing parcels and delays often happen in railway transportation. More problems exist in road transportation such as overload, traffic jam and weather conditions etc., which may lead to delivery delays. There are many uncertain factors in logistics that cannot be solved by any department. It depends on the whole country. However, the circumstances have been improving lately. So the purchasing staff needs to understand the current situation and then find the best solutions for logistics.

GAS:  It’s been said that the sales volume of most Chinese suppliers is between 100 million and 1 billion. Few of them have logistics warehouses in Europe and North America, and even fewer have a service system overseas. Presently it is the OEM’s or sourcing customers that manage logistics due to the weak logistics system of the suppliers. Is it true? 

Li Peng:  Yes. Top OEM’s are doing this since they have logistics partners and even their own logistics companies. It is a safe way to do so. Looking at total cost, we should consider factory price as well as logistics costs and some other composite costs. It is also a good idea to recruit domestic suppliers into the supply chain of top international OEM’s.
 
GAS: I’ve heard of a case where an international corporation placed an order with a Chinese supplier but it failed in mass production. The buyer had to transport a certain quantity from Germany by air, resulting in a huge loss. For mass production, the weak ability of managing upper suppliers is the cause of this phenomenon.

Li Peng:  It does happen commonly. I believe that around 30% of purchasing staffs have had cases like this. One reason is that the OEM purchasing staffs lacked international sourcing experience and did not consider all the factors. Another reason is that the suppliers also did not consider all the factors for supplying internationally. Such a case happened to us before. We paid more attention to the quality control system, material source and equipment. Before mass production, how many inventories should be stored in China? How many should be close to the customers and how many should be on the way? If all these factors are considered, then there won’t be any problem. However, many purchasing staffs rush for success to make orders to suppliers as soon as they see the 40% price depreciation. Some even stop previous projects. Of course, the suppliers are working hard. But if the management of the supply chain is not perfect, the chain will break down and customers will have to allocate goods from other places all over the world. We’ve had experiences where the cost of goods was US$ 300,000 while the cost of air transportation was US$ 600,000. Under such circumstances, not only should the suppliers take responsibility but also should the buyers. The coordinators should be the OEM’s or buyers in the supply chain. An overall effective coordination in international procurement is critical.  

GAS: Could you please give some suggestions as many companies intend to set up sourcing centers in China?

Li Peng:  First of all, it is better to plan and prepare carefully and have a general knowledge of China sourcing. The first two years will be the investment period with a high monetary investment and little return. However, there is an old saying in Chinese that goes “sharpening your knife is not a waste of time for cutting your ?”; you can profit in the third year if all the preparation work has been well done globally, including personnel, public relations, etc. Secondly, suppliers with different focuses should be sorted differently according to different products and requirements - even different areas. Therefore, buyers can find the right suppliers based on the sorted sequences and different focuses.

GAS: Thank you for your time.

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