Adidas shoe production in China (DPA).jpgAs thousands of Chinese factories close their gates and western economies slump, it might seem that the Made in China tag has lost much of its attraction to western manufacturers. Don't you believe it.

The Boston Consulting Group admits that some western companies are indeed cutting back on low-cost sourcing from China and other Asian countries. But others are steaming ahead and expanding their supplier base in Asia, convinced of the significant cost advantages that sourcing from low-cost countries (LCC) can bring.

At the beginning of the year, western media were full of stories about Chinese factory closures and the consequences for western manufacturers and retailers that had grown to be heavily dependent on Chinese products. According to the more alarmist reports, 100,000 factories in China closed during 2008, putting unpaid workers on the streets and leaving western buyers without stock.

But BCG argues the effect of this closures has been overplayed. The closings represent a small percentage of total factory capacity, and the slowdown has merely picked off the weakest players, while the larger, more efficient factories continue to operate.

In the toy sector, which was hard hit by a drop western demand, most of the factories that have closed were smaller, cheaper plants producing toys to lower safety standards — and creating so much consternation among parents in the west.

So, the downturn has produced a much-needed shake-out in China's manufacturing base and the benefits of sourcing from China are intact.

In a sector like apparel, for example, sourcing in Asia can produce an advantage of 30 to 50 percent in the so-called landed price — the price companies pay once the product is delivered to their home country). David Lee, a coauthor of the report and a partner in BCG's Shanghai office, says:

With the huge price gaps between low-cost countries and developed markets, there is still a significant cost saving to be found even in the face of increased complexity, uncertainty and costs.”

Yet effective and efficient LCC sourcing is by no means a given. The economic crisis and declining demand for many products will lead to the collapse of numerous suppliers, in both high and low-cost countries. To prevent a disruption in supply, therefore, companies must assess the risks in their supply base as well as their options for alternative sources.

As well as the risk of a supplier going bust, LCC sourcing also requires business to take on a number of other risks, including currency risk and supply chain disruption.

A critical consideration when deciding where to source is the total cost of the product being sourced. Major cost components are the supplier's price in the local currency, which is driven by labour costs, raw material prices, and required operating margins; the conversion of that cost into the buyer's home currency; and total costs in the supply chain, including transportation costs.

BCG argues that although port congestion in the west might affect the length and variability of supply chains when sourcing from distant countries, ocean freight actually constitutes only a small part of the total cost of goods.


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