Hidden links in Asian supply chains

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Supply chain visibility is a critical issue in the development of trade between the Far East and Europe but industrial fragmentation can hide the true source of a product. Jiim Ridgwick, who leads Deolitte’s Sourcing practice for China provides some illumination.

Suppliers that subcontract or trade without notifying the buyer, or having trading companies that protect their commercial position by hiding the identity of the suppliers, are both accepted business practices in many industries in Asia. Manufacturers in Asian emerging markets often meet the supply requirements of their international customers through an interlinked network of sister operations, business partners, subcontractors or even the sub-contractors of their subcontractors. In many cases the buyer is not even aware that this trading relationship is happening. This is particularly commonplace when buyers seek a one-stop source of supply outside of the limits of their chosen supplier’s capacity or competence.

Trading companies that make global sources accessible to companies who are buying abroad also add uncertainty to supply chains. If they were to share information about the manufacturer, it opens doors for buyers to purchase directly, thereby removing their role and margin from the transaction.

Suppliers that subcontract or trade without notifying the buyer, or having trading companies that protect their commercial position by hiding the identity of the suppliers, are both accepted business practices in many industries in Asia. Many industries are so fragmented that, to meet the product range, volume or lead-time requirements, there may be no single supplier that can produce the complete order. Furthermore, even with rigorous supplier identification and screening processes the most capable manufacturer may still be overlooked due to the lack of public domain information about them or due to extreme market fragmentation (for example, there are 10,000 electronics and telecommunications equipment manufacturers in China with revenues over $800,000).

In many buying relationships the true source manufacturer is unknown by the buyer. From whichever channel a product is sourced, it is therefore critical in low cost locales to know where and by whom the product is being made. Increasing the visibility of the supply chain not only mitigates some key global sourcing risks, it also allows capture of further benefits from a company’s Asian supply base.

Benefits of illuminating hidden links

Open and transparent relationships with the trader helps ensure that quality requirements have been met. Quality managers in the buying organisation can speak directly with those responsible for production, thereby building accountability. They can also see firsthand evidence by visiting the factories to be reassured that production workers and their managers understand, respect and adhere to the buyer’s quality and social responsibility requirements.

The importance of nurturing direct relationships with Asian suppliers should not be underestimated. It is impossible to build trust if the buyer and the manufacturer never actually meet and spend time together to understand one another. By communicating through the trading entity, messages can be mis-communicated or, at worst, manipulated to meet the objectives of the trading entity.

Building direct relationships can also provide the foundation for service improvement, joint product development, and cost and price reduction through value engineering. Suppliers in emerging economies are entrepreneurial and innovative; they are hungry to explore such opportunities.

While managing social and environmental compliance is possible with suppliers that buyers know, it fails for those that are hidden. In relying on the trading entity to conduct this due diligence the risk increases exponentially. In a world with powerful global brands, consumer expectations do not differentiate between products produced domestically or overseas; to them the entire supply chain is all one brand.

Recently, a US industrial supplies company that has sourced from China through a Taiwanese trading company for many years, made the wise decision to visit one of the trading company’s manufacturers. Initially the trading company was extremely evasive in providing the details and setting up the visit. It was not until they visited the supplier that they realised that the company was, in fact, a prison factory that uses Chinese prisoners to manufacture the product under forced labour. In the US it is a criminal offence to knowingly import goods made by a convict or through prison labour.

This further demonstrates that the only way to have total confidence is to see the supplier’s conditions first hand or to use an independent trusted audit firm. To accomplish this, each part of the supply chain must be known and visible.

How to illuminate hidden links

Even if the trader is trusted to manage the source manufacturer to the right standards and in the buyer’s best interests, the case for illuminating these hidden links is still equally valid to control risk and to realise longer-term benefit.

While many Asian manufacturers are willing to share the fact they are using a network of partners to meet the requirement, often they will not volunteer this information. So during the supplier qualification, it is important to ask probing questions. Thorough due diligence is required before any effort-intensive on-site evaluations to start to establish the facts on how they intend to fulfil the order.

For example, it is good practice to request photographs of the production floor to gain a sense of the scale of operations and to understand which stages of production they subcontract. In these supplier requests, ensure they provide photographs of the lines where this exact product is currently produced or if the supplier were to win the business, the production lines on which the product will be manufactured. Furthermore, re-iterate the expectation that a sourcing manager will visit the line in the next round of qualification.

In a similar manner, buyers should make it clear to trading companies that they will visit all production sites as part of their global risk policies. This is easier to mandate at the start of the relationship and does not have to be adversarial or focused on penalties.

Deloitte’s Global Manufacturing Industry Group recently published its annual ‘Innovation in Emerging Markets’ study which this year focused on managing product sourcing risks in emerging markets. It surveyed more than 650 executives from both developed market and emerging market companies to learn how manufacturers are responding to the intense scrutiny of product safety, quality, and environmental issues.

This survey showed that most executives said they do at least some monitoring of their suppliers’ subcontractors, but only one-third said that such monitoring was extensive.

The survey showed that roughly 90 per cent of executives said they visit supplier facilities in emerging markets, with half saying these visits occur more than once a year. Nearly all said that these inspections looked at quality control processes, followed by facilities/equipment, raw materials, and the skills of quality control personnel. Companies that are more successful with emerging market sourcing were more likely than others to assess the skills of managerial employees and working conditions in their inspections, as well.

In all such site visit audits, it is important to cross-reference each answer from the supplier by requesting and observing supporting evidence. Evaluate their true capacity. Seek evidence that the target product is actually being manufactured and that production covers the elements of the manufacturing process critical to quality and not just assembly, finished goods testing or packaging.

Finally, traders must understand the importance of buyer visibility to all nodes in their supply chain, and therefore when they wish to change the source manufacturer, they should notify the buyer and gain their approval before any transition.

This should be documented into the supplier agreements and should be monitored by plant visits through the contract term.

Even in supply relationships where the buyer works directly with the source manufacturer, the role of the trading entity may not necessarily become obsolete. As buyers aim for transparent trade relationships, the traders must continue to demonstrate and improve their value proposition to earn their share of each transaction.

At one extreme their role could be to introduce the buyer to the manufacturer then to step back. At the other extreme, day-to-day communication is through them, they receive all payment and are ultimately accountable for product quality and delivery. Buyers should carefully consider the role of the trading company in their Asian sourcing. Having the trader as a point of escalation or as an intermediary can be invaluable to reach a particular outcome, for example, to overcome the source manufacturer’s resistance to a low minimum order quantity or to a new, unknown customer. The trading entity may have more influence as it is likely to be trading with the manufacturer on behalf of other buying companies. Alternatively, the trader could gain concessions leveraging personal connections (or “guanxi” in China) through drawing on the trust gained through their entire business relationship. This may have a greater effect than the influence a foreign buyer could apply even with local sourcing staff.

Exit strategy

It is also wise to develop an exit strategy that aims to remove the intermediary trader from the transaction after a period as the direct relationship grows. This should also be discussed with all three parties present under the auspices of keeping the three-way business relationship lean and competitive.

Based on the recent phenomenal growth of exports from Asian sources, if a trader with a sustainable value proposition is removed from one buying chain there are many other opportunities for them to capture. In this fashion a trading company partner can become an element of continuous improvement in a global sourcing programme.

In summary, an accepted practice among Asian suppliers is that manufacturers will trade or subcontract to fulfil orders – in some cases without the buyer’s knowledge – and trading companies will protect their role in the transaction by concealing their manufacturing sources. This leads to concealed nodes in global supply chains that represent lost opportunity at best, and at worst a significant risk to product quality and corporate brand equity. Through understanding the importance of full supply chain visibility and by addressing this point of exposure directly, tactics can be employed to shine light on the hidden parts of Asian supply chains.

As global companies press for transparency, trading companies will have to step up their offering to remain competitive. Looking forward, this evolution will greatly benefit the buying companies.

Jim Ridgwick is part of Deloitte’s Supply Chain practice, leading their Sourcing practice for China; he advises leading European and US companies on the design and successful implementation of their global sourcing programmes.

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