The Perils of Global Sourcing

How to Overcome Them (Part II)


By Jon Maxim


In the first part of this article (Accelerate Issue 13) I reviewed the challenges of Global Sourcing from an organizational point of view. Let’s assume that your organization is now well positioned in terms of structure, communications and culture. Do we simply gather up all of our skilled negotiators and send them out to do deals? You may want to consider a few things first.

Is the global supplier a myth?

An executive in one global corporation once told me of their experience with a major supplier (let’s call them XYZ Co.), also a major global corporation. The client wanted a set of standardized products, services and maintenance for all of their subsidiaries, branch offices, etc. around the world. They wanted it delivered by one global supplier.

“We thought we had match made in heaven. XYZ has a great reputation for quality, service and management. They advertise themselves as offering global solutions. The reality is very different. It’s almost impossible to get a meaningful global agreement with XYZ. Their standards of service vary widely among the countries. The local people don’t take direction well from head office. Our Global Account Manager has very little influence. If you go to their senior management, problems get resolved – but we can’t continue doing that on a regular operational basis.”

My own experience is that “global suppliers” vary widely. Some are well organized to deliver products services and support. Others are global “wannabes” who may work hard at trying to be global but do not have sufficient experience or organization to handle global supply challenges.

I have had the pleasure of dealing with the former. A good example is one of the large computer product and services companies. It has a well organized global sales and support structure. They can give you clear indications of which of their products are available in which country with detailed specifications. They can tell you in detail the pricing for their products in each country including FOB, transportation, duties, taxes, local markup, etc. You can order online from them anywhere in the world and get direct shipment to your remote offices.

However, many suppliers do not yet meet these levels. The consequence is that your staff has to understand all of these details.

Just how do you manage your supplier?

Managing your suppliers globally is more than negotiating a deal and then tracking and managing its results. Salespeople are extremely adept at “divide and conquer” tactics. They will find people sympathetic to their cause to promote their interests.

When you also add international distances and organizational complexity, there is far more opportunity for salespeople to use these tactics. I commonly run into situations where the price that is charged to a global client in different countries varies widely. The price differences have no rhyme or reason even when you take into account different tariffs, taxes, exchange rates, transportation costs, etc.

Another surprise that people new to global sourcing experience is that dealing with a supplier in one country does not mean goods will be manufactured and shipped from that country. This will lead to a large number of factors that need to be considered before making the sourcing decision. The accumulation of costs that you will face include packaging, freight, origin local transportation, destination local transportation, duties, VAT, sales & use taxes, country modifiers, export licenses, port fees, brokerage fees, Letter of Credit fees and much more. Complicating this is which currency or currencies will be used. Exchange rates fluctuate making it difficult to negotiate “fixed” prices. This leads to another peril of global sourcing.

In an effort to use the right expertise when conducting trans-border transactions, organizations will often use local agents. This is generally a smart thing to do. But, people also hear that agents are skilled at navigating the complexities of local bureaucracies include dealing with corrupt officials. They believe that the agent can insulate them from the “dirty work”. However, in the USA and other jurisdictions, there are laws that make you responsible for corrupt practices in other countries even if you were not directly involved.

Are you ready to practice international trade law?

Most Sourcing organizations focus their effort on achieving the ultimate expression of the deal they have made – The Contract. It is true that a contract is the best way to ensure that all parties understand exactly what was agreed. It also offers protection in the event that any of the parties default on their obligations or if liability issues arise. In the Global Sourcing arena, a lot of the skills and concepts with which we have become comfortable are used very differently when dealing with a different country.

Consider choice of law. Most people would recognize that using another country’s laws could introduce unexpected problems. But many people do not realize that they may be subject to both the foreign country’s laws and US laws. Examples are the Foreign Corrupt Practices Act, Anti-Boycotts Legislation, Export Administration Act, etc.

Choice of language is another consideration. Often contracts are written in one language and then translated into another. Translations are not always perfect. Remember that the language of international commerce is broken English! I once was evaluating proposals from several Chinese bidders that had been translated from Mandarin to English. The RFP had asked for a service that we needed as a mandatory requirement. The answer in one of the proposals was translated in such a way that it was impossible for us to discern whether the bidder was committing to offering the service or whether they would not offer it under any circumstance. When the vendor was questioned as to their true intent, they replied that they found it impossible to understand from the translated RFP whether we needed the service or not!

Even when we are using the same language such as English, different regional usage can give different meanings to commonly used phrases and terms. For instance, does a bi-monthly payment mean twice a month or once every two months? It can actually mean either one!

Some of these problems arise when both parties assume they know the meanings of the terms and they actually do not. One of the most common problems that I come across is use and misuse of the delivery terms FOB origin, FOB destination, CIF, etc. These definitions are spelled out in the International Contracting Terms known as INCOTERMS. I thoroughly recommend that anyone involved in international sourcing keep a copy of the INCOTERMS near at hand at work. A handy reference guide to the terms is available at http://www.iccwbo.org/incoterms/wallchart/wallchart.pdf. But remember, they are not law and the proper way to use them is to incorporate a direct reference to them in your contract.

And what if the choice of law is not specifically contained in the agreement? Many people are unaware that there is the United Nations Convention for International Sale of Goods (CISG). The CISG has been adopted by over 60 countries (including the US). It is in many ways similar to the US Uniform Commercial Code (UCC) and generally favors the buyer.

Lastly there are many pitfalls that occur in global sourcing that you may not anticipate. Such as – if you source goods from a supplier to be delivered to several of your international locations, it can sometimes result in unintentional export. Now you have to become an expert on export as well as import regulations. And do watch out for date formats – different countries use mm/dd/yyyy, dd/mm/yyyy and yyyy/mm/dd respectively (and some even use a different calendar). I have found one of the safest ways to express the dates in international trade is like this: 06 September 2006.

I have not even begun to scratch the surface of international legal and contractual complexities. People may assume that all they need is the help of an international lawyer. They definitely do help but you will also need to make sure that your Sourcing professionals are trained and gain experience in international issues before you can be truly effective in Global Sourcing.

Are your logistics globally logical?

Many Sourcing professionals pride themselves on their knowledge of logistics. These skills are transportable to Global Sourcing but, just as with legal and contracting, there are special issues to contend with. Apart from the physical challenges that accompany the movement of goods and services, there are many others that affect one of the most sensitive factors - cost.

When goods and services cross borders, a multitude of tariffs such as duty, manufacturing tax, sales and use tax, etc. can be applied. Some have become ubiquitous in international trade. The “value added tax” has been made famous by the European Union’s VAT or Canada’s GST and has spread to many other countries. But watch out. Although the principle of input credits applied to output taxes is fairly common, the detail of how the tax is calculated varies by country.

Even when the taxes are fairly clear, where they apply may be more obscure. Brazil is famous for tripping up the unwary importer. A product when shipped fully assembled can attract vastly different duties to the same product shipped partially assembled. The definition of what is partially assembled can be more of an art than a science.

Freight used in transportation of international goods can often be more than the cost of goods. This is not just because of greater distances. Typically an international shipment involves many handoffs from factory to local carrier to freight forwarder to ocean carrier to customs broker to local transport company before it get to the ultimate client.  Understanding how to use the various agents and brokers is an important skill.

And no discussion of Global logistics would be complete without considering the risks. Many a distributor has gone under because of their poor understanding of how to handle RMAs. RMA (Returned Material Authorization) is the agreement on how defective goods will be treated. Will they be repaired on-site by the manufacturer or their agent? Will you have to return them to a local depot for service or replacement? Will you have to return them to the factory overseas? Who bears the cost of the return? This often overlooked area can make costs skyrocket.

Another risk is payment. In international transactions this commonly accomplished through a Letter of Credit (L/C). Many people are familiar with L/Cs where a bank will guarantee the payment to the supplier in the event of default by the buyer. What some people are not so familiar with is that you have to write a L/C with the same care as a contract. The terms and conditions under which the funds can be released have to be specified with great care or you may find suppliers will get paid even when they are not yet entitled to payment.

And lastly let’s not forget risk of loss and title. This once again is the territory of INCOTERMS. Be sure that you use the right INCOTERMS classification which reflects what was agreed between the parties.

Conclusion

Clearly there are several challenges to Global Sourcing. There are also many advantages to Global Sourcing. To make sure that the advantages are achieved be prepared to:

• Research and obtain references on your suppliers to make sure you understand what are their true global capabilities

• Train your Sourcing professionals and give them the opportunities to increase their skills in international trade. Become familiar with the CISG, INCOTERMS and laws affecting international trade

• Use agents, consultants, brokers and other third parties wherever appropriate

• Be flexible in accepting language barriers, different trade customs and cultural differences

Also, be prepared to adjust your concept of the workload associated with Global Sourcing. The amount of work to complete a deal may be more influenced by the number and types of countries involved than by the size or complexity of the acquisition. You will want to spend most of your effort on procurement that has the greatest impact globally. You don’t have to try to have every procurement managed globally.

Lastly, as I mentioned in my previous article be prepared to communicate your strategy and progress clearly and often to all your local and global stakeholders. I have every confidence that if you apply the principles in this article and my first one you will have a successful Global Sourcing implementation.
 

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