Procurement Management and Global Sourcing

Topic 7 – Global Sourcing

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Topic 7 – Global Sourcing i

Contents

Contents ii

Introduction 1
Learning objectives 1

International Purchasing and Global Sourcing 1

Challenges to Global Sourcing 3

Barriers to Global Sourcing 4

Progressing To Global Sourcing 4

Risks in Global Sourcing 6

International Commercial Terms (or INCOTERMS) 6

Summary 7

ii Procurement Management and Global Sourcing

Introduction
Global sourcing in simple terms means buying goods or services from
overseas. Global sourcing is important for a firm even if they may not buy
any overseas originated product directly by them. Therefore, knowledge
and skills to deal with global sourcing is also important for any procurement
professional.

Learning objectives
At the conclusion of this topic you should be able to understand:
• Assess international purchasing and global sourcing
• Examine the reasons for worldwide sourcing
• Identify the challenges of global sourcing
• Assess the barriers to global sourcing
• Examine the risks in international transaction and relevant mitigation
approaches

Reading
Prescribed Text: Monczka, R.M., Handfield, R.B., Giunipero, L.C. and
Patterson, James L. (2014), Purchasing and Supply Chain
Management, South-Western, Cengage Learning. 6th Edition. Chapter
10

International Purchasing and Global Sourcing

International purchasing relates to a commercial transaction between a
buyer and a supplier in different countries. Global sourcing, on the other
hand, involves proactively integrating and coordinating common items and
materials, processes, designs, technologies, and suppliers across worldwide
purchasing, engineering, and operating locations.

Topic 7 – Global Sourcing 1

 Figure 1: International Purchasing and Global Sourcing Levels

Source: Reproduced from: Monczka, Handfield, Giunipero, and Patterson, 2011

As shown in Figure 1, a firm starts its international buying from level II

when it engages worldwide buying as needed. When it adopts worldwide
buying as part of its purchasing strategy (level III), it starts gravitating
toward global sourcing. Its global sourcing begins with regional and global
coordination of worldwide purchasing strategies (Level IV). In next step
companies integrate global purchasing strategies with other functional
groups and processes. There are several reasons a company may adopt
global sourcing strategies. These includes cost/price benefits, access to
Technology, quality, access to only source available, introduce competition
to domestic suppliers, react to buying patterns of competitors and establish
a presence in a foreign market. Petersen, Frayer, David, Scannell and
Thomas (2000) argue, as shown in Figure 2, effectiveness of global sourcing
is dependent on a number of factors.

Figure 2: Model for Global Sourcing Effectiveness

Source: Reproduced from Petersen, Frayer, David, Scannell and Thomas (2000)

Two of the primary factors are global sourcing business capabilities and top
management commitment to global sourcing. Global sourcing business
capability of a firm is dependent on global sourcing structures and process,
international language capabilities. Global sourcing structure of a firm is
2 Procurement Management and Global Sourcing
 dependent on top management commitment to global sourcing.

Challenges to Global Sourcing

There are several global sourcing challenges. These are briefly described
below:
i. Low supply chain responsiveness: A low level of supply chain
responsiveness is often observed when goods and services are
purchased from remote countries. Supply chain executives need to
analyse opportunities from a skills, experience, organisation and
cultural perspective, to determine what process, procedure and
systems are to be put in place to deploy an agile supply chain.
ii. Increasing logistics cost: High logistics costs often reduce the benefit
from low cost procurement: Costly global transportation and
excessive global inventory (static inventory and pipeline inventory)
often cripple the company’s confidence in sourcing from remote
countries. The good old theory of “total cost of ownership” should
always prevail.
iii. Unstable supply: Many of us have experienced supply disruption as
the result of increased buying competition and increasing material
and energy cost in the common low procurement cost supply
markets? Developing supply alternatives should be a continuous task
to procurement managers.
iv. Quality and environmental concerns: We, as buying companies,
often overlook the importance of introducing stringent control and
audit mechanisms at remote supply sites to ensure high quality and
environmentally sound products and services are being purchased.
v. System deployment dilemma: Failure in providing supply chain
visibility can detrimentally affect your procurement program.
Today’s supply chain planning and execution tends to be heavily IT
driven. We often ask ourselves if we are driving the system or the
system is driving us? We can deploy a perfect ERP or Advanced
Planning system today, but we can never guarantee that it solves
the supply chain coordination issues tomorrow. While we are
designing an IT platform, let’s not forget the basics - today’s supply
chain issues are still largely people and process issues.
vi. Insufficient supply chain coordination: How should we coordinate
along the supply chain? Internally, the interaction across your
demand planning, procurement, purchasing, R&D, manufacturing
operations, warehousing, distribution and other logistics functions,
determines the systemic health of your supply chain. Externally, the
connectivity to your suppliers and your customers to a certain
degree, determines your company’s supply chain efficiency and
effectiveness.
vii. Lack of genuine partnership: Cross-enterprise collaboration between
you and your suppliers is going to be vitally important to your
success on a global scale. A true partnership comes with honesty,
integrity, understanding and transparency. It’s often easy to say,
but hard to do.

Topic 7 – Global Sourcing 3

 viii. Need for consistent performance measurement: Companies can
often be overwhelmed by the number of performance measurement
matrices that external consultants give them. But selecting a set of
KPIs that make sense to key supply chain stakeholders is not an easy
task. Consistently measuring a suitable and balanced set of KPIs is
going to give long-term and sustainable benefits to your
organisation.
Proper management of all these challenges will help a company to contain
not only the procurement costs, but improve your total supply chain cost.
(Reproduced from [Link]
Contemporary-Procurement-Challenges-4338953.S.99220485 accessed 25
November, 2014).

Barriers to Global Sourcing

There are several barriers to global sourcing. These include, lack of
understanding of international procedures, lack of knowledge of
documentation, resistance to change, domestic market nationalism, longer
lead times and material pipelines, logistical, political, financial risks, lack
of knowledge of foreign business practices, language and cultural
differences, negotiations can be difficult and engineering changes,
difficulties in changes in general. These barriers can be overcome by
education and training of related staff, publicizing success stories,
establishing globally linked systems (including information systems), foreign
suppliers with domestic-based support personnel, measurement and reward
systems that encourage worldwide sourcing and use of third-party agents or
intermediaries.

Progressing To Global Sourcing

When a firm progresses towards global sourcing it faces a host of issues.
Some of the important issues are, obtaining information about worldwide
sources, supplier selection issues, cultural understanding, language and
communication differences, logistical issues, legal issues, organisational
issues, countertrade requirements, costs associated with worldwide
sourcing.
• Obtaining information about worldwide sources:
• International Industrial Directories
• Trade shows
• Trading companies
• Third-party support
• Trade consulates
• Supplier selection issues: Companies should never assume that all foreign
suppliers can meet its requirements. It should evaluate foreign companies
as it would do for domestic suppliers. Trial orders may help establish a

4 Procurement Management and Global Sourcing

 performance record.
• Cultural understanding: Culture is the sum of the understandings that
govern human interaction in a society. These understandings result in two
broad areas of differences across countries; values (the way people think)
and behaviour (the way people act). Knowing where and how cultural
differences will appear improves a buyer’s comfort and effectiveness.
• Language and communication differences: If a supplier is using English as a
second language, the buyer should be responsible for preventing
communication problems. Adjust your speaking style, don’t speak too fast,
use extra presentation graphics helps. Write down big numbers, watch your
language (profanity, jargon, acronyms), watch your body language, 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.
• Logistical issues: Many foreign countries have less developed
infrastructures than the developed world. This can result in a higher total
landed cost for foreign goods.
• Legal issues: There are a number of ways laws can be applied to your
global sourcing. Common law, continental-base law and Islamic law or
local traditions – which want to use? Many foreign countries do not like to
deal with complicated laws. English common law is much preferred.
Bribery (facilitating or speed payments) and reciprocity, while illegal some
countries are an accepted practice in other countries. Have a written and
signed document that describes the expectations of the buyer and seller.
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 exist if they follow the convention on the
International Laws – Uniform Custom Practice, International Chamber of
Commerce.
• Organisational issues: What do International Procurement 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.
• Countertrade Requirements: Countertrade refers to international trade
where buyer and seller have at least a partial exchange of goods for goods.
Reasons countertrade evolves; lack of hard currency to purchase imported
goods, provides a means to sell products in markets in which a country may
have otherwise lacked access. Some governments now take a more
pragmatic view of countertrade.
• Costs associated with worldwide sourcing: Total cost in international
purchasing is also called landed cost. International purchasing may include
many additional cost components compared with domestic procurement.
Some of these are unit price, tooling, packaging, transportation,
duties/tariffs/taxes, insurance premiums, payment terms, fees and
commissions, port terminal and handling fees, customs broker fees,
communication costs, payment and currency fees, inventory holding costs.

Topic 7 – Global Sourcing 5

Risks in Global Sourcing
Global sourcing involves high risk because geographical distance,
differences in regulatory or statutory requirements to accomplish the
movement of goods, differentials in the currency values, greater difficulties
in reversing flow of goods or money, longer credit period and political
disturbances. For an international trade transaction, the risks involved may
be classified as credit risk, transport risk, exchange risk, transfer risk.
These are briefly described along with possible mitigation strategy below.
• Credit risks are risks related to non-payment (seller’s risk), non-delivery or
delivery of incorrect goods (buyer’s risk), delayed payment or delayed
delivery (seller’s/buyer’s). This risk can be mitigated by (i) assessing
reliability of overseas parties {(importer/exporter/bank(s)} or (ii) by
deploying adequate methods of payment.
• Exchange risk are risk that are associated with fluctuation of values
between buying country’s currency in terms of selling country’s currency
or a third currency if the payment is intended to settle by using a third
currency. This risk can be mitigated by (i) setting price in local currency,
(ii) maintaining foreign currency account to pay import bill and receive
export proceeds, (iii) enter into forward exchange contract (A contract
with bank to sell or buy a specified amount of foreign exchange at a future
date applying the current exchange rate).
• Transport risks are risks related unforeseen damages or loss of cargo during
the transportation, especially international transportation. There a variety
of insurance products available to mitigate transport risk.
• Transfer risks are risks related to transfer of money or goods between two
countries due to disturbances caused by parties other than the parties
involved in transaction (buyer, seller, transport company or financial
institutions). Often this risk is associated with political disturbance or
disagreements between buying and selling countries. Mitigation strategy
for transfer risk include assessing economic situation of overseas countries
involved in selling or transportation, assessing the trend of overseas
country’s political relationship with buying country, assessing the stability
of foreign exchange policies of the overseas countries related to the
contract (third country may involve in transportation of goods especially
for land-locked country). Exporter may also cover their contract by taking
export credit insurance cover.
There are also some other risks in global sourcing such as risk of non-
compliance, biosafety protocol, security, government effectiveness, legal
and regulatory, macroeconomic, foreign trade and payment and tax policy.

International Commercial Terms (or INCOTERMS)

The Incoterms® rules are an internationally recognized standard and are
used worldwide in international and domestic contracts for the sale of
goods. First published in 1936, Incoterms® rules provide internationally
accepted definitions and rules of interpretation for most common
commercial terms.
The rules have been developed and maintained by experts and practitioners
brought together by ICC (International Chamber of Commerce) and have
6 Procurement Management and Global Sourcing
 become the standard in international business rules setting. Launched in
mid-September 2010, Incoterms® 2010 came into effect on 1 January
2011. They help traders avoid costly misunderstandings by clarifying the
tasks, costs and risks involved in the delivery of goods from sellers to
buyers. Incoterms® rules are recognized by UNCITRAL as the global
standard for the interpretation of the most common terms in foreign trade.
Please note that all contracts made under INCOTERMS® 2000 remain valid
even after 2011. Moreover, although we recommend using Incoterms® 2010
after 2011, parties to a contract for the sale of goods can agree to choose
any version of the Incoterms rules after 2011. It is important however to
clearly specify the chosen version INCOTERMS® 2010, INCOTERMS® 2000 or
any earlier version. There are The 11 Incoterms® 2010 rules are presented
in two distinct classes:
• Rules For Any Mode Or Modes Of Transport
EXW EX WORKS
FCA FREE CARRIER
CPT CARRIAGE PAID TO
CIP CARRIAGE AND INSURANCE PAID TO
DAT DELIVERED AT TERMINAL
DAP DELIVERED AT PLACE
DDP DELIVERED DUTY PAID
• Rules For Sea And Inland Waterway Transport
FAS FREE ALONGSIDE SHIP
FOB FREE ON BOARD
CFR COST AND FREIGHT
CIF COST INSURANCE AND FREIGHT
(Extracted from [Link]
facilitation/incoterms-2010/ accessed on 1 December 2014)

Summary
Global sourcing although has large number of challenges and barriers, in a
globalised business environment companies cannot afford to avoid this.
Procurement professionals with adequate knowledge and skills are able to
use this in enhancing competiveness of their organisations.
The next topic addresses purchasing and commodity strategy development.
The topic mainly addresses how can we use procurement as a strategic tool
and make our businesses more sustainable.

Topic 7 – Global Sourcing 7

 References
Handfield, R. B., Monczka, R. M., Giunipero, L. C and Patterson,
James L. (2011), Sourcing and Supply Chain Management, Cengage
Learning, Fifth Edition (International Version).
Monczka, R M., Handfield, R. B., Giunipero, L. C and Patterson, James
L. (2011), Purchasing and Supply Chain Management, South-Western,
Cengage Leaming, Fifth Edition.
Trent, R. J., & Monczka, R. M. (2003). International Purchasing and
Global Sourcing - What are the differences? Journal of Supply Chain
Management, 39(4), 26-37.
[Link]
[Link]/doi/10.1111/j.1745-493X.2003.tb00162.x/pdf
Petersen, Kenneth J; Frayer, David J; Scannell, Thomas V (2000). An
empirical investigation of global sourcing strategy effectiveness.
Journal of Supply Chain Management 36. 2, pp.: 29-
38. [Link]
[Link]/docview/235220386?accountid=13552
Kotabe , Masaaki (1998), Efficiency vs effectiveness orientation of
global sourcing strategy: A Comparison of US and Japanese
multinational companies. The Academy of Management Executive;
Nov 1998; 12, 4.
[Link]
[Link]/docview/210517666?accountid=13552

Web resources
[Link]
facilitation/incoterms-2010/

[Link]
Procurement-Challenges-4338953.S.99220485

8 Procurement Management and Global Sourcing

Online Discussion Activity
Study the enclosed case on world leader of specialty industrial
lubricants and answer other two questions. Follow the “Case
Analysis Guide” (refer to Topic 2 notes) in studying the case and
writing your answers.

Case on world leader of specialty industrial lubricants

Company A is a world renowned leader in the field of specialty
industrial lubricants. It is owned by one of the largest oil companies in
the world. It has a very wide product range that covers almost every
need by industries. Company A is extremely customer focused and
responsive to their needs; Marketing works very closely with the
customers and R&D to develop new products even though sometimes
the customer demand is not very high. With more than 1,000 different
product offerings worldwide and anywhere from 5 to 20 raw materials
required for each product, the total number of raw materials required
in inventory was mind blowing.
The business model was very decentralized. Each country ( and there
are more than 80) had the authority to develop new products or
formulations to cater quickly to customers’ demands. R&D would look
for suitable raw materials & instruct Supply Chian to procure them.
Procurement was relegated to being simply an operator without any
strategic input. R&D would often fix the raw material prices without
much negotiation. What was worse was that sometimes these new
products only lasted less than a year and supply chain would be stuck
with obsolete raw material inventories.
Although Company A was very innovative in product design & could
cater to customers’ demands quickly, it fared very badly in terms of
product cost. Every year, millions of dollars were required to write
down obsolete raw materials, many of which were bought at above
market rates simply because there was no negotiating mechanism
with the suppliers.
John, who was newly appointed the regional supply chain manager of
Asia Pacific after a worldwide re-organization, was tasked
immediately to save $1million within a year. This was really a tall
order and John didn’t know whether he could achieve so much within
a short amount of time. After attending a regional meeting, He was
beginning to sense that R&D together with Marketing really called the
shots with regards to new product development. There was no input
from supply chain.
What John did next and showed the regional management team
shocked everyone in the room. All he did was to take the top 20 raw
materials used widely in Asia Pacific and compared the landed prices
by country. There was a very wide disparity in prices of the same
material by country which was difficult to explain even when taking
into account quantity discounts or import duties. In many cases, the
disparity was greater than 100%. John proposed a strategic change in
their procurement approach.

Topic 7 – Global Sourcing 9

 Online Discussion Activity
John did not stop here. He wanted to truly go global with some of the
raw materials that were used worldwide. Before long, with John’s
recommendation, the Australian procurement executive was made the
Global Lead Buyer for a particular raw material that was used in large
quantities throughout the world. From this alone, the cost savings per
year was more than $1million. Its no wonder that the suppliers are
not smiling as they used to.
Henceforth, procurement would play a lead role in regional buying.
The procurement executive of each country will become the lead
buyer for Asia Pacific for the raw materials if his country was the
major consumer of. In this way, all materials will be covered by
regional contracts which gave control and also great economies of
scale. Procurement was able to drive a hard bargain. By doing this
John also elevated the position of procurement within the
organization. No longer were the suppliers able to dictate prices to
each country at will.

1. Write an overview of the case

2. In the old business model, discuss and state what were some of
the inefficiencies that led to high product cost. What can you say
about integration within and outside of the organization?
3. What are the advantages and efficiencies of the new business
model?

10 Procurement Management and Global Sourcing