Worldwide Sourcing IDIS 424 Spring 2004

1. Chapter 11 Worldwide Sourcing • IDIS 424 • Spring 2004

2. International versus Global Sourcing What is the difference between international purchasing and global sourcing? International purchasing is the process of buying goods and services from suppliers outside your firm or business unit’s country of operation Global sourcing refers to the proactive integration and coordination of material and service requirements across worldwide business units, looking at common items, processes, technologies, designs, sourcing practices, and suppliers

3. International Purchasing Why do we source internationally?

4. International Purchasing What makes international purchasing more complex than domestic purchasing?

5. Key International Purchasing Issues • International purchasing topics… • Culture • Language and communication • Law • Total or landed cost • Organization • Risk management, including currency risk management • Countertrade • Sources of international information

6. Culture • A system of shared beliefs (the way things are done around here) • Values (the way people think) • Behavior (the way people act) • Major complaint about Americans is their ignorance of other cultures

7. Culture • Differences in manners are usually not problems unless taboos are violated • Example: It is totally incorrect to hand something using your left hand in the Middle East • Example: Wearing a white shirt signifies death and mourning in the Philippines • Value Differences • harmony • Buyer-Seller rank • Orientation toward guilt or shame • use of first-names

8. Language and Communication • If a supplier is using English as a second language, the buyer should be responsible for preventing communication problems • Adjust your speaking style • Slow down • Use extra presentation graphics • Write down big numbers • Watch your language (profanity, jargon, acronyms) • Watch your grammar • Watch your body language

9. Language and Communication • The two largest differences in communication styles across countries are message speed and level of content • Americans generally give fast messages with the conclusions expressed first. This style is inappropriate in many countries, particularly Europe • High-context communication assumes the receiver already understands a great deal of background information

10. Language and Communication • Bring an interpreter to all but the most informal meetings. Allow an extra day to educate interpreters on your issues and vocabulary • Document, in writing, the conclusions and decisions made in a meeting prior to leaving • Remember that many words do not translate well

11. Law • The U.S. uses common or case law, which leads to lengthier and more detailed contracts than are found in countries that use code or civil law • Many foreign countries do not like to deal with U.S. law and long contracts • Bribery (facilitating payments) and reciprocity, while illegal in the U.S., are often not illegal oversees • Have a written and signed document that describes the expectations of the buyer and seller. It does not have to look like a U.S. contract

12. Law • Advanced, industrial countries have legal systems that can be trusted to treat foreign companies fairly. Developing countries may not • There is no effective legal protection in many countries against intellectual property piracy. Perform a thorough reference check of prospective suppliers • True international contracts exists if they follow the Convention on the International Sale of Goods (CISG). The U.S. has signed this convention

13. Total Cost • Total cost in international purchasing is also called landed cost • International purchasing may include many additional cost components compared with domestic purchasing… • Unit price • Tooling • Packaging • Transportation • Duties/tariffs • Insurance premiums

14. Total Cost • International purchasing may include many additional cost components compared with domestic purchasing… • Payment terms • Fees and commissions • Port terminal and handling fees • Customs broker fees • Taxes • Communication costs • Payment and currency fees • Inventory carrying costs

15. Organization • International purchasing offices • Worldwide commodity teams • Third-party support • Worldwide strategy review and coordination sessions • Executive steering committee support and guidance • Lead buyers or site experts • Global matrix structures • Information technology systems Organizational Support Mechanisms

16. Organization International Purchasing Offices • What do International Purchasing Offices (IPOs) do to support international purchasing? • Identify foreign suppliers • Solicit quotes • Expedite and trace shipments • Negotiate supply contracts • Obtain product samples • Manage technical problems • Represent the buying firm to the suppliers • Manage countertrade • Perform site visits

17. Currency Risk Management Currency Risk Management • Approaches for managing currency risk… • Purchase in U.S. dollars • Sharing currency risk • Currency renegotiation or adjustment clauses • Currency hedging • Finance department expertise • Currency forecasting • Escape clauses

18. Currency Risk Management Currency Adjustment Clauses • Two major types of adjustment or renegotiation clauses: • Delivery-triggered adjustment clause • Time-triggered adjustment clause

19. Currency Risk Management Delivery-Triggered Adjustment Clauses A contract for 3000 castings with Nippon Steel is issued on June 1, with delivery of 1000 castings to be on June 30, July, 30 and August 30. A currency adjustment clause is written into the contract establishing a base exchange rate of 100 yen per dollar +/- 4%. Upper Boundary 104 Yen/$ 100 Yen/$ base Currency Range 96 Yen/$ Lower Boundary June 30: Yen appreciates to 90 yen per dollar. What should happen? July 30: Yen is 97 yen per dollar. What should happen? August 30: Yen moves to 100 yen per dollar. What should happen?

20. Currency Risk Management Time-Triggered Adjustment Clauses An annual contract for castings is agreed to with Nippon Steel. A time triggered currency clause is agreed to with reviews to be made quarterly. The base exchange rate is 100 yen per dollar +/- 4%. Adjustment review dates are April 1, July 1, and October 1. Upper Boundary 104 Yen/$ 100 Yen/$ Base Currency Range 96 Yen/$ Lower Boundary April 1: Yen appreciates to to 95 yen per dollar. What should happen? July 1: Yen moves to 99 yen per dollar. What should happen? July 30: Yen depreciates to 106 yen per dollar. What should happen?

21. Currency Risk Management Currency Hedging • Hedging involves the purchase and sale of currency contracts • Motivation for hedging is risk aversion and not monetary gain • Two primary kinds of hedging • Futures exchange contracts • Trade on currency spot market exchanges • Forward exchange contracts • Issued by banks and traded among institutions

22. Currency Risk Management Currency Hedging - Forward Exchange Contract A buying firm purchases 300,000 French motors on September 1 at a cost of 4 francs each. Delivery and payment will occur on December 1. Total contract requires payment of 1,200,000 francs Buyer takes no steps to protect contract from currency fluctuation Exchange rate on September 1: 1 franc = $.1530 Expected total cost of contract on September 1 = (300,000 x 4 x .1530) = $183,600 Exchange rate on December 1: 1 franc = $.1820 Expected total cost of contract on December 1 = (300,000 x 4 x .1680) = $201,600 Contract price increased 10% due to currency changes

23. Currency Risk Management Currency Hedging - Forward Exchange Contract A buying firm purchases 300,000 French motors on September 1 at a cost of 4 francs each. Delivery and payment will occur on December 1. Total contract requires payment of 1,200,000 francs Buyer purchases a 90 day forward exchange contract Exchange rate on September 1: 1 franc = $.1530 90 day forward rate is 1 franc = $ .1545 Expected total cost of contract with 90-day forward rate lock-in: (300,000 x 4 x .1545) = $185,400 plus bank fees

24. Countertrade • Countertrade refers to international trade where buyer and seller have at least a partial exchange of goods for goods • U.S. government now takes a more pragmatic view of countertrade • More common with military or high dollar contracts • Purchasing is often a reactive part of countertrade (to support marketing and sales)

25. Countertrade • Forms of countertrade... Barter --- Counterpurchase --- Offset --- Buy-Back --- Switch Trading ---

26. Sources of Information Where do we find information about worldwide suppliers? • International industrial directories • Trade shows • Trading companies • Internet • External agents • Trade consulates • Internal sources • Sales brochures and catalogs

27. Global Sourcing Benefits Purchase Price • Purchase price decreased 15% on average • 87.6% of firms report that purchase price declined • 9.9% report no change • 2.5% report that purchase price increased • Total cost of ownership improved 11% on average • 72.7% of firms report that total cost of ownership declined • 24% report no change • 3.3% report that total cost of ownership increased Total Cost of Ownership

28. Global Sourcing Benefits Supplier Quality • Supplier quality improved 6% on average • 42.6% of firms report that supplier quality improved • 54.1% report no change • 3.3% report that supplier quality decreased • Delivery cycle time lengthened 5% on average • 23.3% report that delivery cycle time shortened • 34.2% report no change • 42.5% report that delivery cycle time lengthened Delivery Cycle Time

29. Global Sourcing Benefits • On-time delivery performance improved 3% on average • 32.3% of firms report that on-time delivery performance improved • 46.7% report no change • 21% report that delivery performance worsened On-Time Delivery Performance

30. Key Differentiates of A Successful Global Sourcing Progarm • Develop a well defined process • Involve the “right” individuals as participants

31. Major Problems in Global Sourcing Progarm • Lack of qualified people to support the program • Lengthened lead times • Cultural Differences • Transportation • Evaluation of the participants