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This piece was produced in collaboration with CIPS, the Chartered Institute of Purchasing and Supply
Food scandals are shaking confidence in food supply chains around the world. While food safety was once assumed to be paramount in the minds of food retailers and buyers, it has become clear that consumers have been deceived into consuming foods strikingly different from what their religion, preference or cultural values allow.
Both McDonald’s Corporation and KFC parent Yum recently suffered brand damage when Chinese authorities closed down a local meat supplier after evidence of old and contaminated meat was found in their products. More recently, a Taiwanese company, Chang Guann, has been fined for selling old oil, unfit for human consumption, as food-grade cooking oil.
McDonald's and Yum Foods have stopped using the maligned supplier, Shanghai Husi Food Co Ltd, found new suppliers and publicly apologised to consumers.
China is the third largest market for McDonald’s with Yum close behind. With competition offering increasingly attractive domestically and locally-sourced foods, this scandal occurred at a time for McDonald’s and Yum Foods.
CIPS believes that part of the solution to food scandals like this lies in a licence for the procurement profession. Employers seeking procurement professionals for their business can rest assured that MCIPS holders are the best professionals in the procurement field.
MCIPS-qualified professionals operate under the key concepts behind ethical and sustainable procurement and supply management thereby reducing instances of fraud and corruption. Supply chains are becoming increasingly global and complex in nature, and MCIPS training provides the skills to keep up with these changes.’
Stay tuned for our next piece on ethical and sustainable procurement.
Photo: Agence France-Presse
This piece was originally produced for the ChinAfrica Econometer
As costs increase in China and other Asian manufacturing countries, the "African Tigers" are competing to absorb displaced manufacturing capacity and become the next leaders of low-cost manufacturing. Recognizing the success of export-led manufacturing growth in bringing the Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan) out of poverty, African business and political leaders are seeking to mimic this success at home. The leading East African economies of Ethiopia, Kenya and Rwanda provide competitive manufacturing environments with unique strengths.
In addition to low labor prices, low-cost African economies benefit from key duty-free and quota-free trade agreements, such as the United States' African Growth and Opportunity Act and the EU's Everything but Arms pact. However, these East African nations face a host of challenges in absorbing Asian manufacturing capacity. For example, many are unable to provide a stable supply of electricity, and thus local enterprises face a costly reliance on generators for electricity.
Ethiopia, Africa's second-most populous country, has been successful in attracting investment from China through the nation's Chinese-constructed special economic zones, such as the Ethio-China Light Manufacturing Special Economic Zone, 30 km outside of Addis Ababa. In this zone, one of China's largest shoe manufacturers, the Huajian Group, began operations in January 2012. Even when their lower productivity is accounted for, Ethiopian workers present a dramatic cost reduction to manufacturers. Ethiopian workers at the Huajian factory receive a monthly wage of $40 per month, whereas the average manufacturing wage in China was $625 per month in 2013.
Manufacturers in these economic zones also benefit from relatively low property and utility costs, in part due to the government's interventions to attract foreign investment. Huajian stated that it achieved profitability within a year of operation, and that its profitability prospects will improve as landlocked Ethiopia improves its underdeveloped transportation system. Currently, the cost to transport a container from Addis Ababa to the nearest port of Djibouti is roughly equal to the cost of shipping from Guangzhou, China to Djibouti. The government seeks to decrease these costs through a 10-year, $4 billion infrastructure development program.
Kenya represents one of the most open and progressive states in Sub-Saharan Africa, and the government has recently approved three special economic zones, one of which will be implemented jointly with the Dongo Kundu Transshipment Freeport. The recent increase in Chinese investment in Kenya means that China is now Kenya's largest source of foreign direct investment.
With the second-highest ranking in the World Bank's Ease of Doing Business index in Sub-Saharan Africa (behind Mauritius), Rwanda presents a uniquely stable business environment. Chinese C&H Garments Co., for instance, recently announced plans to establish a 200-employee factory, which, if successful, will be used as a "proof of concept" to attract other manufacturers to Rwanda.
Global purchasing managers sourcing from China face a myriad of options on setting up their Chinese procurement operations. Whether it be a direct structure such as a rep office, offshore structure, joint-venture, and WOFE; or to completely outsource operations to a trading company or third-party service providers, each option has its own pros and cons. Understanding the Purchase Positioning Matrix can help companies determine the most suitable procurement structure to set up in China.
The Purchase Positioning Matrix: A Tale of Two Axes
Based on ‘The Portfolio Instrument’ developed by Dirk-Jan F. Kamann (which is itself based on Kraljic’s 1983 purchasing model), the Purchase Positioning Matrix is a framework for buyers to develop their supplier relations strategy by examining their sourcing needs in terms of sourcing value and sourcing complexity. The Matrix can be represented by the following illustration:
The matrix has two axes, an x-axis that measures the complexity of the procurement needs (low complexity would be sourcing simple commodities such as pumps; high either complexity would be missile systems), and a y-axis that measures the procurement value (which can be high because the purchase item is expensive, e.g. an aircraft, or because the purchase volume is large, e.g. USD 100 million’s worth of pumps). A procurement need is considered complex if there are no more than four suppliers that can meet the manufacturing requirements, otherwise it is regarded as simple. A procurement need is considered high value if the procurement value for a product group or from a country is more than 3% of the total procurement value.
Based on these two axes, the matrix can be divided into four quadrants with corresponding values of sourcing complexity and value: Bottleneck (high, low); Routine (low, low); Leverage (low, high); and Strategic (high, high).
The Bottleneck Position: Stuck in No Man’s Land
(Lower right quadrant – Low value, high complexity)
Procurement in this quadrant tends to focus on specialised products from unique suppliers that are not very expensive. Typically, OEM products belong to this quadrant. Avoid this position if possible. The best strategy is to look for standard substitutes that are widely available. International buyers in the Bottleneck position, however, do not have readily available and economically sensible options available to them in selecting a procurement structure in China. The complex procurement requires a more formal business structure in order to establish partnerships with suppliers. This makes establishing a rep office or outsourcing not the most suitable options, yet the low procurement values also do not justify the expense of a JV or WOFE structure.
To make matters worse, the supplier has all the power in this position as their product is of high complexity or rare, while the buyer cannot effectively leverage economies of scale. The lack of appealing options in establishing a procurement structure, combined with low buyer power means that buyers should avoid being placed in this position as much as possible and try to seek out substitute products. If, however, foreigner buyers find themselves unable to extract themselves from this position, perhaps the best way is to adopt a fly-in fly-out approach until they find a substitute product.
China example: China’s rare earth metals industry
Currently China has a near monopoly on the rare metals industry, supplying around 95% of global exports. However, due to the industry’s damaging impact on the environment, the Chinese government is consolidating the industry. A single government-controlled monopoly, Bao Gang Rare Earth, has been created to mine and process ore in northern China, the region that accounts for two-thirds of China’s output, while production from southern China will be consolidated into three companies in the near future. The government has already ordered 31 mostly private rare earth processing companies to shut down and is forcing four others to merge with Bao Gang. Along with industry consolidation, China is also tightening export quotas, which has sent the price of rare earth metals soaring, impacting a long list of industries. For example, the average price for fluorescent bulbs (using the rare element europium oxide), rose by 37% in 2011.
The Routine Position: Lather, Rinse and Repeat
(Lower left quadrant – Low value, low complexity)
Procurement in this quadrant usually focuses on more routine products which are easily available and cheap. Here, organisational costs can be more important than the invoiced costs. Suppliers should be selected on their ability and willingness to reduce the costs of logistics.
International buyers in the Routine position have the most options when choosing a procurement structure in China. If the procurement values are very low (less than 1% of the total input value) and the complexity is simple, it makes more economic sense to just outsource the entire procurement operation to a qualified service provider, such as a PSP or trading company. If the procurement value is closer to the 3% threshold, establishing a rep office (whether from headquarters or off shore) should be considered, since with higher procurement values, more extensive use of service providers will be needed. Thus, it makes sense to establish a permanent office to ensure the quality of service providers. WOFE or JV structures are not economically justifiable.
China example: Alibaba
As the ‘factory of the world’, its no surprise that China is home to the world’s largest online business-to-business trading platform for small businesses, Alibaba. Claiming to have more than 65 million registered users, Alibaba is a transaction-based wholesale platform that brings together importers and exporters from more than 240 countries and regions. For buyers with limited procurement needs in China, Alibaba provides another channel for them to source small quantities of goods at wholesale prices from China.
The Leverage Position: Maximising Economies of Scale
(Upper left quadrant – High value, low complexity)
Procurement needs in this quadrant are characterised by high volumes in monetary terms and the availability of ample suppliers for the same product. Because of the volume, various discounts become available. This further reduces other organisational costs, such as ease of ordering, lead-time, flexibility, and payment terms, among others. In this position, buyers have substantial power over suppliers.
A rep office structure, whether from headquarters or off shore, is the most suitable one for international buyers in China in the Leverage position. The high value of procurement from China makes it economically worthwhile for the company to set up a rep office in China. The key to making this work is the frequent use of service providers. Although branch offices cannot directly import/export, it can chose from plenty of service providers in China that can provide this function. From a savings-to-cost ratio, this makes the branch office highly scalable since it is much easier to use or not use service providers than to hire or fire direct employees. Furthermore, since the purchase complexity is low, companies can comfortably outsource procurement operations in China without having to send their own personnel, leaving the branch office to take care of routine supervision duties.
China example: Walmart
Walmart is the world’s largest retailer and grocery chain by sales. In 2011, Walmart reported USD 422 billion’s worth of revenue, which is more than its five closest competitors combined, including Target and Tesco. Because of its mammoth size and buying power, Walmart can leverage economies of scale to pressure suppliers to accept lower margins in exchange for high purchase volumes. Many suppliers give in to Walmart’s pressure because they depend on the discount retailer for a majority of their sales. To keep its prices even lower, Walmart sources extensively from China, and has established its Global Merchandising Centre in Shenzhen. Walmart’s purchase volumes from China are so substantial that if Walmart were a country it would be China’s sixth largest export country.
The Strategic Position: Towards a Win-Win Relationship
(Upper right quadrant – High value, high complexity)
Procurement needs in this quadrant are characterised by high costs and unique suppliers. Here, co-operation and long-term relations that gradually grow deeper are typical features. Relations rather than contracts are an issue; usually, in regards to contracts, they last five years or the total production life cycle of a particular product.
International buyers in the Strategic position have complex procurement needs and high procurement values, which makes it worthwhile to set up a more formal business structure, such as a WOFE, in order to form strategic relationships with the limited number of suppliers. A company may even consider partnering with an existing supplier in China by forming a joint venture in order to obtain exclusive distribution rights or to be able to better manage the design/production process for the products produced by that supplier. Due to the highly strategic and sensitive nature of the buyer-supplier relationship in the Strategic position, relying on agents and trading houses for procurement needs is no longer suitable.
China example: Commercial Aircraft Corporation of China (COMAC)
COMAC, a Chinese state-owned corporation, is a new entrant in the larger passenger aircraft industry and has the potential to break the Boeing/Airbus duopoly. COMAC has already signed an agreement with Irish airline Ryanair, Europe’s largest discount airline, to cooperate in the development of China’s large passenger aircraft, the C919. According to the deal, the two companies will work together in research and development, airworthiness and customer services on the C919 project. The C919’s first test flight is planned for 2014.
Putting the pieces together
With an understanding of the Purchase Positioning Matrix, global procurement mangers can now identify where they belong on the matrix and hopefully avoid some costly mistakes, such as setting up a WOFE structure or expensive JV when they are in the Bottleneck or Routine position. As a general rule, starting from the ‘Bottleneck’ position, buyers should strive to move in a clockwise direction with the goal of ultimately ending up in the ‘Strategic’ quadrant. This will be a natural transition for international buyers in China to move towards anyway, especially as China moves further up the value chain, away from labour-intensive, low value-added
manufacturing into high-tech, R&D-intensive industries currently largely dominated by developed countries.
This article originally appeared in the April 2012 edition of The China Analyst. To download the entire issue, please click here.