China: Ready For the Next Sourcing Wave?

Boston Consulting Group's Jim Hemerling says China is emerging as a global R&D and innovation hub in its own right. Sourcing execs take note

One critical dimension of business operations that is both driving, and being driven by, globalization is the sourcing of components and products from China and other rapidly developing economies (RDEs)—and this mega-trend is entering a new era.

For some companies, global competitiveness will depend on their willingness and ability to anticipate and shape the coming changes. This may involve rethinking sourcing strategies, devoting far more resources to recruiting and grooming sourcing executives, and reorganizing and even relocating procurement organizations.

This continuing rapid change comes at a time when many Western companies are starting to feel comfortable with their existing sourcing arrangements. They have gone through a series of wrenching organizational and strategy shifts and have survived both the culture shock and growing pains associated with moving major portions of their sourcing thousands of miles from home. While many would like more time to fine tune or streamline these operations, or just to take a well-deserved breather, they can't afford to get too comfortable, because global sourcing is evolving rapidly.

Wave 1.0: China for low cost

The first wave of Chinese sourcing was driven by Western companies' competitive search for low cost components and finished goods, both for Chinese and home markets.

Numerous U.S., Japanese, and European companies established corporate beachheads in China to implement their low-cost strategies. Stand-alone sourcing offices sprang up in Shenzhen, then Shanghai and other locations, and anyone with even a few years of sourcing experience became a hot commodity. During this initial phase, Western multinationals looking to source from China faced two significant hurdles: a dearth of qualified suppliers and a dearth of qualified sourcing people.

Wave One sourcing from China and other RDEs took off when manufacturers in these countries demonstrated they could produce quality products for less money, more often than not using the buyers' own designs. During this initial stage, companies were able to recruit, train, and retain enough qualified sourcing specialists to tap into China's supplier networks.

Wave 2.0: China participates in innovation

As sourcing matured, so did the suppliers. In a wide range of industries, from consumer electronics and IT equipment to automotive manufacturing, many Chinese suppliers moved far beyond being arm's length suppliers. They started to innovate and collaborate with their customers on component and product design, marking the transition to sourcing 2.0. Today, many of these same Chinese suppliers are designing new products for global markets as part of supply chains that are integrated into global procurement processes.

The expanded role that Chinese sourcing offices—and their suppliers—are playing in the conceptualization and design of new products and processes shouldn't be seen in isolation. Like India, China is moving fast forward in the research and development (R&D) arena.

The 2005 World Investment Report from the United Nations Conference on Trade and Development (UNCTAD) indicated that Western multinationals already had established more than 700 research and development facilities in China. The number continues to increase with each passing day. Hewlett-Packard (HPQ) opened its HP Labs China this past November. Other U.S. companies with major R&D facilities in China include DuPont, General Electric (GE), General Motors (GM), IBM (IBM), Intel (INTC), Lucent Technologies (LUTHP), Microsoft (MSFT), Motorola (MOT), and Rohm & Haas (ROH).

Though exact numbers are not easy to pin down, the Organization for Economic Cooperation and Development (OECD) estimated last year that China in 2006 would become the world's second-highest investor in R&D after the U.S. Using purchasing power parity as its measure, OECD estimated that the U.S. would spend $330 billion on R&D, China $136 billion, Japan $130 billion, and the EU-15 a combined $230 billion.

Wave 3.0: China as global center for procurement

Today's China is the center of an economic maelstrom that grows larger and more powerful (and increasingly complex) every day. R&D centers originally set up to support product localization for the Chinese market are now going full force in developing new products for the global market.

These rapid changes, which will continue to accelerate, mean that many Western companies have to rethink their global procurement operations. The announcement that IBM is moving its global procurement headquarters to Shenzhen is the most visible sign that sourcing wave 3.0 is underway—with China becoming the global center for procurement.

This is especially true for electronics, where the combination of low cost R&D capabilities, and deep multi-layer networks of electronic suppliers clustered together, has turned China into the dominant global electronics hub. IBM is not an isolated case. In the automotive industry, for example, General Motors has relocated its power-train electronics procurement offices to China. Other companies and industries will follow suit.

As part of our ongoing work, The Boston Consulting Group recently benchmarked the China sourcing operations of leading multinationals. We found that most companies continue to realize significant savings by sourcing in China. However, we also found wide variations in performance among the companies. While some companies excel, most have significant room to improve. Many are still struggling with sourcing 2.0; only a few have started to come to grips with wave 3.0.

China will not, and should not, become the center of global procurement for every company. China may not be the best location for some goods as other countries, such as Vietnam, take their place in the global supplier food chain. Not every company has to ride wave 3.0 in China. However, given the continued evolution of China sourcing and the wide range of performance we observe among China sourcing offices today, a prudent step for most companies would be to ensure that their sourcing operations are where they should be, to fully leverage China and other RDEs for global advantage.

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