Twenty-five years ago, leveraging low-cost labor in Asia as a means to save sourcing-related costs, was a no brainer. That was then, this is now.
Fast forward 25 years and the ROI calculations have changed significantly. Some of these changes are born from a macro-economic landscape that has disrupted labor arbitrage. Some are born from the lessons learned from a quarter century of Asia-dependent sourcing success stories and some are learned, more critically, from its failures.
The changing calculations:
- The price of labor: In 1999, US labor costs were 20X the costs of Chinese labor. Now, the disparity is significantly smaller at only 4X.
- Escalating sourcing costs: Tariffs and duties, transportation costs, and interest rates on cash tied to inventory in-transit have all increased, which means the overall costs of an Asia-dependent sourcing process has also increased, substantially, beyond labor.
- Intellectual capital: Beyond costs, there are the complexities associated with protecting intellectual capital (IC), including the difficulty of enforcing IC protections in the case of breaches.
The four factors:
Should companies continue to outsource to Asia? Our guidance at Accordion is… it depends. We have identified four factors that should be considered when calculating the ROI of an Asia-dependent sourcing strategy.
1. The Supply Chain:
- Variability and uncertainty in delivery times are a given. But the question for your company is: do we have (or does it make sense to invest in) advanced supply chain planning tools and processes that can continuously balance demand and supply in order to inform additional inventory needs in response to unexpected geo-political events/natural disasters?
- Beyond added inventory and ensuring domestic capabilities to leverage advance planning tools, companies need to determine whether they have cost-efficient access to in-region warehouses, located near export ports, that will stock inventory on a just-in-time basis. This can help reduce variability and consolidate shipments.
- Finally, ROI calculations should include significant variability for in-bound transportation costs, given their instability over the last four years.
2. Product and Process Development:
- If the Asia-based supply chain calculations still promise meaningful ROI, the company must next tackle IC concerns. Can the company ensure that product and process engineering design are controlled by the parent organization? Similarly, proprietary manufacturing machines, dies, and processes should be owned by the parent company in the US and the equipment should be destroyed at end-of-life.
- Additionally, the company must file patents and IC trademark ownership documentation with local (e.g. China) governments and work with local law firms to prosecute infringement on patents, trademarks, etc. (There is precedent in certain countries, like China, for successful prosecution and enforcement of patent infringement).
3. Sales and Marketing:
- There are brand value considerations at play as well. Can the company effectively manage how local producers sell its non-export-quality products to ensure there is no dilution to the brand or its premium pricing capability?
- The company must have a thoughtful approach to weighing brand value risks against the short-term revenue from selling end-of-life (or other non-export-quality) products at reduced price points within local Asia markets.
4. Finance and Accounting:
- The next critical consideration is cash flow. Can the company negotiate favorable payment terms and manage accounts payable to those terms? This is a critical part of the overall calculation given the long lead times for cash conversion for products manufactured in China and marketed/distributed in North America. (Note: The Chinese government provides incentives for Chinese exporters to minimize interest rates on exported products and AR associated with exports.)
- And of course, there are accounting variables to take into consideration. Can the company’s tax department manage the location of the parent entity so that it can take advantage of setting up a Principal Office in countries with special tax advantages? Even with ever-changing US regulations impacting overseas taxation, there are still significant advantages to be had by leveraging tax incentives from governments of select Asian countries.
The bottom line:
Leveraging Asia for sourcing and contract manufacturing is not as lucrative as it once was. In addition, a host of IC-related concerns have made Asian-dependent sourcing more complex. That doesn’t mean there’s no longer any meaningful benefit – it’s just not as straightforward. Accordion can help companies use the four factors above to better calculate whether the ROI of an Asia-based sourcing program warrants its additional risks and management burdens.