Sourcing Unique Components in the Electro-Mechanical Engineering Industry from Chinese Suppliers

A Multiple-Case Study

Diploma Thesis, 2007

103 Pages, Grade: 1,0



List of Figures

List of Tables

List of Acronyms

1 Introduction
1.1 Motivation
1.2 Objective and Scope
1.3 Thesis Structure

2 Basics and Definitions
2.1 Mechanical and Electro-Mechanical Engineering Industry
2.2 Supply Segmentation
2.3 Sourcing Strategies
2.3.1 Regional Sourcing
2.3.2 International Purchasing
2.3.3 Global Sourcing
2.3.4 Buyer-Supplier Relationships
2.4 Total Cost of Ownership
2.5 Outsourcing

3 State of Research on Sourcing in China
3.1 Evolution of China Sourcing
3.2 Sourcing Strategies in the Chinese Market
3.2.1 Mediated Sourcing
3.2.2 Direct Sourcing
3.3 Difficulties of Sourcing from Chinese Suppliers
3.4 Key Elements for Negotiations in China
3.5 Suitable Items for Sourcing from Chinese suppliers
3.6 Staffing in China

4 Research Methodology

5 Case Studies
5.1 Company A
5.1.1 Overview
5.1.2 Sourcing
5.1.3 Design and Engineering
5.1.4 Production Management
5.1.5 Quality Control
5.2 Company B
5.2.1 Overview
5.2.2 Sourcing
5.2.3 Design and Engineering
5.2.4 Production Management
5.2.5 Quality Control
5.3 Company C
5.3.1 Overview
5.3.2 Sourcing
5.3.3 Design and Engineering
5.3.4 Production Management
5.3.5 Quality Control
5.4 Company D
5.4.1 Overview
5.4.2 Sourcing
5.4.3 Design and Engineering
5.4.4 Production Management
5.4.5 Quality Control

6 Cross-Case Comparison
6.1 Sourcing
6.2 Design & Engineering
6.3 Production Management
6.4 Quality Control
6.4.1 Internal Control
6.5 Comparison Across Customer Segments
6.5.1 Customer Dimension
6.5.2 Supplier Dimension
6.5.3 Staff Dimension

7 Proposed Approaches

8 Summary

9 Outlook

10 Bibliography

Appendix A: Contact Details

Appendix B: Interview Questions

List of Figures

Figure 2-1 : Functional Purchasing Policy, (Monczka, et al., 2002)

Figure 2-2 : Material Cost Reduction Strategies Focusing on Technical Complexities, (Cavinato, et al., 2006)

Figure 2-3 : Material Reduction Cost Focusing on Market Complexity, (Cavinato, et al., 2006)

Figure 2-4 : Supply Segmentation and Strategies, Critical Factors and Metrics for Material Cost Reduction, (Monczka, et al., 2002)

Figure 2-5 : Segmentation of International Sourcing Strategies and Possible Movement Paths, (Chadwick, et al., 1995)

Figure 2-6 : Segmentation of International Sourcing Strategies, (Kaufmann, et al., 2005)

Figure 2-7 : International Sourcing Entry Strategies, (Chadwick, et al., 1995)

Figure 2-8 : Key Elements of a Supply Relationship; in (Cavinato, et al., 2006)

Figure 2-9 : A Simple Relationship Model, (Leenders, et al., 2002)

Figure 2-10 : Outsourcing Model According to (Quinn, et al., 1994)

Figure 2-11 : Outsourcing Model According to (Olsen, et al., 1997)

Figure 2-12 : Reaching the Outsourcing Decision; (Power, et al., 2006)

Figure 3-1 : Evolution of China Sourcing, in (Hemerling, et al., 2007)

Figure 4-1 : Market Share of Leading Producers, (Deneen, et al., 2006)

Figure 4-2 : World Market Share 2006, Sources: Annual Reports 2006 and (Datamonitor, September 2006)

Figure 4-3: Schematic Illustration of a Product of the Examined Electro-Mechanical Engineering Industry

Figure 5-1 : Task of World Wide Sourcing (WWS), (Deneen, et al., 2006)

Figure 5-2 : Sourcing Process Company A

Figure 5-3 : Selection of Brands in Relation to Customer Segment

Figure 5-4 : Sourcing Process Company B

Figure 5-5 : Sourcing Process Company C

Figure 5-6 : Sourcing Process Company D

Figure 6-1 : Customer Segments vs. Product Price and Product Quality

Figure 6-2 : Customer Segments vs. Engineering Lead Time and Product Quality

Figure 6-3 : Customer Dimension

Figure 6-4 : Customer Segments vs. Supplier Cost and Technological Capabilities of a Supplier

Figure 6-5 : Customer Segment vs. Supplier Empowerment and Monitoring

Figure 6-6 : Customer Segment vs. Supplier Empowerment and Quality of Feedback

Figure 6-7 : Supplier Dimension

Figure 6-8 : Customer Segment vs. Staff Expertise and Number of Staff

Figure 6-9 : Customer Segment vs. Staff Retention Rate and Staff Responsibilities

Figure 6-10 : Staff Dimension

Figure 7-1 : Customer, Supplier and Staff Dimensions and the Implications for a Best Practice Solution

Figure 7-2 : Sourcing Guideline for Cost-Oriented Customer Segments

Figure 7-3 : Sourcing Guideline for Quality-Oriented Customer Segments

List of Tables

Table 2-1 : Demands in Product Development and Manufacturing, Source: Fraunhofer-ISI Survey Innovationen in der Produktion 1999, in (Vieweg, et al., 2002)

Table 2-2 : Overview Commodity-Like Items vs. Unique Components

Table 2-3 : Obstacles to International Purchasing and Root Causes

Table 3-1 : Examples of Solutions for Sourcing in China

Table 4-1 : Relative World Sales of Industry Sector by Regions, (Deneen, et al. 2006)

Table 4-2 : Purchasing Decision Criteria for Products of Selected Industry Sector, (Deneen, et. al. 2006)

Table 4-3 : Research Database for Case Companies

Table 5-1 : Case Companies' Overview

Table 6-1 : Business Scope of Case Companies

Table 6-2 : Customer Orientation of the Case Companies

Table 6-3 : Coordination of Sourcing and Aspects of Human Resources

Table 6-4 : Ordered Supplies and Feedback Mechanism

Table 6-5 : Diverging Supplier Selection Criteria

Table 6-6 : Supplier Involvement, Engineering-to-Supplier, and Contact Channel for the Supplier

Table 6-7 : Lead Times and Engineering Loops

Table 6-8 : Forecast and Forecast Deviation

Table 6-9 : Quality Inspections at the Supplier Site and at the Buying Company Site

List of Acronyms

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1 Introduction

1.1 Motivation

Sourcing from Chinese suppliers is probably one of the most challenging purchasing tasks facing Western corporations. Already relatively simple commodity-like items, despite the low supply risk involved, pose considerable challenges to the purchasing function. These commodity-like items have a low product complexity and their technical specifications are mostly stable and standardized. The demand for them is continuous and is of a relatively large order volume. But methodologies and best-practice guidelines exist to identify Chinese suppliers, e.g. (Wagner, 2006), to develop them, e.g. (Burt, et al., 2003), chapter 22, or (Vodicka, 2006), and to establish a global supply chain, e.g. (Burt, et al., 2003), chapter 16, and particularly (Tabrizi, et al., 2007).

However, the case of sourcing unique components from Chinese suppliers is currently not widely published in the academic and industry literature. Many industries require more complex items which are ordered only in small numbers. The order process is not solely handled by the purchasing department, but the involvement of the engineering function and others is needed to varying degrees, for example because of customization, legal issues and so on. These order items are referred to as “unique components”. Currently, these unique components are mainly manufactured in-house or sourced from regional suppliers, (Kinkel, et al., 2003), although considerable price advantages from low cost country (LCC) suppliers, particularly from China, may be expected. Given China’s rapid industrialization, (Granier, 2004), and sharply rising investment in R&D, (Organisation for Economic Co-operation and Development (OECD), 2006), it is according to (Hemerling, et al., 2007), (Kaufmann, et al., 2005) and (Lieberthal, et al., 2004), only a matter of time before technologically advanced products will be developed by Chinese companies as well.

1.2 Objective and Scope

The objective of this thesis is to develop a guideline which helps companies to coordinate its efforts in sourcing unique components from Chinese suppliers. Chinese suppliers have been chosen as representative of any low cost countries. One reason is the wide array of business literature on China-related topics; another is the opportunity for the author of this thesis to study “first-hand” the key issues during a visiting internship at the Advanced Manufacturing Institute of the Hong Kong University of Science & Technology.

This thesis discusses the sourcing process between the main parties involved, that is, the buying company, possibly a local subsidiary, and the supplier. The guideline of the sourcing process will show when the major parties will be involved, how they interact, and what their specific tasks are. Along with the tasks of the guideline it will be explained which are the most critical issues and how possible problems can be resolved. The focus is the sourcing and engineering process of unique components.

Together with some generalizations this guideline should be applicable to low cost country (LCC) supplier in general as well.

1.3 Thesis Structure

The next chapter, Chapter 2 (Basics and Definitions), will give a short overview of the most important aspects of the problem under discussion. This will provide a brief description of the ME industry, different approaches of supply segmentation, and different sourcing strategies. For subsequent discussion, characteristics of buyer-supplier relationships, the total cost of ownership (TCO) approach and outsourcing will be presented.

Chapter 3 (State of Research on Sourcing in China) will provide an overview of the current state of research on which the author’s proposed approach is based. This will include the evolution path of sourcing in China, the particular sourcing strategies, difficulties of sourcing from Chinese suppliers, the key difficulties of negotiating in China and a characterization of items suitable for sourcing from Chinese suppliers is given.

In chapter 4 (Methodology) the examined industry sector will be described in more detail, and the chosen research methodology explained.

The results of the case study research conducted in the electromechanical engineering industry will be presented case by case in chapter 5 (Case Studies). After a brief overview of each company, the findings are organized in the functional areas of sourcing, engineering, production management and quality control, respectively. Because of the open discussions and critical information the representatives gave of their respective companies, their identities had to be disguised as much as possible.

The findings of the case studies are compared in Chapter 6 (Cross Case Comparison). First the comparison follows along the same aspects as the case study research. But then the results are compared along the emerging segmentation along the customer segments of household and industrial users.

Based on the findings of the cross-case comparison, the critical issues will be further discussed in chapter 7 (Proposed Approaches). The different approaches of each interviewed company will provide additional insights into the workings of the best-practice sourcing guidelines. The reader shall thus be able to understand, the factors of which a buying company must be aware when sourcing unique components from Chinese suppliers.

Chapter 8 (Summary) eventually summarizes the results of this thesis. Chapter 9 (Outlook) will provide some issues for further research that promise to deepen the understanding of the rationale behind the guidelines.

2 Basics and Definitions

2.1 Mechanical and Electro-Mechanical Engineering Industry

The mechanical engineering (ME) industry is a very important sector in the German economy. The ME industry consist of mainly small and medium-sized enterprises (SME). A large portion of these manufacture highly complex and customized components and products. (Vieweg, et al., 2001)

The study (Vieweg, et al., 2002), chapter 1, argues that the current definition of the German federal statistics bureaus is too narrow and should be broadened to include areas that are classified by the current statistics as manufactures of steam generators (28.3), tools (28.62), and electrical and optical equipment (31.1, 31.2, 33.2). Reasons for this are given in Chapter 4 (Research Methodology) as the increasing interdisciplinary approach for customer satisfaction and the introduction of electric, electromechanical and information technology into the products. Electromechanical devices are those that combine electrical and mechanical parts. These include electric motors, loudspeakers, some fire alarms, and mechanical devices powered by them, such as calculators and adding machines, switches, solenoids, relays, crossbar switches and stepping switches.[1] This notion of the ME industry in the broader sense includes parts of the electro-mechanical engineering industry as well and will be used in this thesis.

The findings of the empirical study of (Vieweg, et al., 2002), chapter 4, describe the mechanical engineering (ME) industry as particularly heterogeneous in terms of products, production volume and company size. See also Table 2-1 : Demands in Product Development and Manufacturing,
Source: Fraunhofer-ISI Survey Innovationen in der Produktion 1999,
in (Vieweg, et al., 2002). He points out that this is not a particular trait of the ME industry of Germany, but of the industry worldwide. The empirical finding of the production volume is that in 1999 more than 72% of all (German) ME companies produced unique copies or small series[2]. According to (Kinkel, et al., 2003), these are mostly customized and highly complex products. The percentage share of the entire industry’s turn-over in 1998 was around 37%.

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Table 2-1 : Demands in Product Development and Manufacturing,
Source: Fraunhofer-ISI Survey Innovationen in der Produktion 1999,
in (Vieweg, et al., 2002)

In the survey (Vieweg, et al., 2002), chapter 4, it is also pointed out that these figures were relatively stable in the years before, and that slight decreases in the overall share of unique copies is due to the business cycles not to modularization[3]. The latest survey of the VDMA[4] in early 2007, (VDMA, 2007), still states the above observations as characteristics of the ME industry. Therefore it can be assumed that the industry’s structure today (in 2007) is still comparable.

Because of the predominantly small production volume in combination with the decreasing manufacturing depth, see (Kinkel, et al., 2003) for details, the ME industry needs at least some components only in small quantities. But, currently, sourcing from Chinese suppliers is focusing on large order volumes and continuous demand. The results of this high volume approach are not per se transferable to low-volume sourcing, i.e. sourcing unique components from Chinese suppliers.

The insights gained through studying the EME industry can provide insights for the ME industry as well.

2.2 Supply Segmentation

The previously mentioned supply segments “commodity-like items” and “unique components” are not established expressions and shall be defined more detailed in this chapter. But the segmentation is essential to distinguish different strategies, tactics and management approaches for sourcing.

The starting points for the characterization are the seven general supply classes identified by (Leenders, et al., 2002), chapter 9. The four most important classes are:

(1) Raw materials in commodities
(2) Special items that are particular to the product line and therefore custom ordered
(3) Standard product items which are quoted on the basis of relatively stable list prices
(4) Items of small value like MRO supplies

However, this list is rather simplified and thus requires a more thorough analysis in terms of general characteristics.

The supply segmentation of (Monczka, et al., 2002), chapter 6, defines the importance of the purchase requirement in more detail based on the number of capable suppliers and the value to the buyer. As will be explained in detail in chapter 3 (State of Research on Sourcing from Chinese Suppliers), the number of capable suppliers in China is in general low.

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Figure 2-1 : Functional Purchasing Policy, (Monczka, et al., 2002)

In the Acquisition quadrant there are few capable supplier and the items have low value to the buyer. Because of the complexity of the market, the cost of searching and comparing the (few) capable suppliers usually outweighs the value of the item. The items often have standardized quality and technology requirements. The cost for switching suppliers is low.

The technology characterizing the items situated in the Multiple quadrant is relatively standard and widely available. Because of the large number of capable suppliers the focus shifts to price comparison when contracting a supplier.

The Leverage quadrant is constituted of supplies which are often needed across the entire company. The notion of the items’ value shifts to a relationship of quality and price.

When the value to the buyer is high and the number of capable suppliers is low, as is the case in the Strategic quadrant, the items are unique or customized. According to (Monczka, et al., 2002), these items include critical technology, but as will become clear in chapter 3 (State of Research on Sourcing from Chinese Suppliers) this does not need to be the case in the context of sourcing from Chinese supplier.

Strategies to reduce the material cost of supply items can be based on the level of technical complexity and the market complexity. Overview of strategies for each supply segment given by (Cavinato, et al., 2006), chapter 5, are shown in Figure 2-2 : Material Cost Reduction Strategies Focusing on Technical Complexities, (Cavinato, et al., 2006) and Figure 2-3 : Material Reduction Cost Focusing on Market Complexity, (Cavinato, et al., 2006).

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Figure 2-2 : Material Cost Reduction Strategies Focusing on Technical Complexities, (Cavinato, et al., 2006)

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Figure 2-3 : Material Reduction Cost Focusing on Market Complexity, (Cavinato, et al., 2006)

In chapter 13 of (Monczka, et al., 2002), as in (Cavinato, et al., 2006), chapter 5, the focus is on the items themselves, which are distinguished according to value (i.e. cost, service, or required administrative effort) and risk, or cost[5] per unit and risk, respectively. Risk is the extent to which the company will incur bad quality, prices hikes or other supply interruptions. See Figure 2-4 : Supply Segmentation and Strategies, Critical Factors and Metrics for Material Cost Reduction, (Monczka, et al., 2002).

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Figure 2-4 : Supply Segmentation and Strategies, Critical Factors and Metrics for Material Cost Reduction, (Monczka, et al., 2002)

Based on the above supply segmentations and characterizations, unique components and commodity-like items have the characteristics given in Table 2-2 : Overview Commodity-Like Items vs. Unique Components.

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Table 2-2 : Overview Commodity-Like Items vs. Unique Components

It should be noted that unique components are not necessarily ordered as a single copy but rather in relatively “small” order volume. Depending on the company size and the volume of the final products, the actual order volume can lie between a single copy per month, several dozen per month or up to several thousand per month.

For this thesis the term commodity-like items is used to describe products with high demand volume on a continuous basis. The technical complexity of these products is low and the requirements towards product quality are limited. The supply risk in general is low and particular products are easy to substitute.

2.3 Sourcing Strategies

The German ME industry currently, to a large extent, sources unique components regionally. (Kinkel, et al., 2003). At least in the case of the ME industry, the term “regionally” is used to include Central and Eastern European countries (CEEC) as well. (Vieweg, et al., 2002). Finding ways to open new alternatives for sourcing unique components through international sourcing is one of the main goals of this thesis.

2.3.1 Regional Sourcing

The author proposes the introduction of the term “regional sourcing” for this thesis. It describes an amalgamation of local, national and, to a certain degree, international sourcing.

The terms local sourcing, and national or domestic sourcing (as well as international and global purchasing) are defined in (Burt, et al., 2003), chapter 15, and (Leenders, et al., 2002), chapter 14.

According to (Vieweg, et al., 2001), a “local supplier” is situated within a distance of not more than 50 km from the buying company. However, this could mean that local suppliers are situated in different countries, too. One of the main reasons to call these suppliers locals is the possibility to easily, quickly and frequently interact with their representatives on a personal, face-to-face basis. Since, for example, in Germany ME companies are concentrated in Baden-Württemberg and Western Bavaria[6] (Statistische Ämter des Bundes und der Länder, 2005) “local suppliers” could be situated (at least for Bavarian ME companies) in Central and Eastern European Countries (CEECs). See also (Vieweg, et al., 2002). Although the neighboring CEECs are now part of the European Union of 25 member states (EU), academic literature would define this case as international sourcing. Despite this definition, the author proposes to include this case in an umbrella term of “regional sourcing”

The main advantages according to (Burt, et al., 2003), chapter 15, are the following. Because of the small geographic distance a closer cooperation between the buying company and the supplier is facilitated. This is particularly important for early supplier integration (ESI). For the sourcing of unique components, there is a superior technical assistance desired, which can often be better provided by regional suppliers. Because delivery time and distance is only a fraction of the ones in international sourcing, delivery dates tend to be more certain. In combination with the resulting shorter lead times, this increases flexibility. Although the price of a regional supplier tends to be higher, the total costs tend to be lower. This is a result of consolidated transportation for several purchasing companies in the same tour and lower insurance charges. The closer cultural proximity usually results in easier resolution of disputes before these escalate into legal conflicts. Finally, the fulfillment of implied social responsibility shall be mentioned. But this last point apparently is less important for ME companies because they are sourcing from CEECs as well.

2.3.2 International Purchasing

For several reasons given by (Heinritz, et al., 1991), chapter 11, a purchasing company may be driven to source its demand from an international supplier. The buying company can realize price benefits which can be large enough to lead to cost reductions. Depending on the product to be procured it may be a simple necessity to source internationally, since supplies are not available domestically/regionally. This is at least partially due to high-quality technological know-how of production, although this tends to be limited in LCCs. From the purchasing point of view, it makes plain business sense to maintain a certain level of competition among active suppliers to maintain the best balance of cost/quality. The relative ease of communication has further improved the environment for international sourcing. However, problems – to be discussed later – do remain. Finally, the desire to enter a foreign market may increase the need to source internationally. It may make good economic and political sense to source from within the market to be entered. It may be part of the responsibility for the economic development of other countries that most multinationals accept, or it may be the political demand for local content. While (Kaufmann, et al., 2005) adds higher quality this will at least for the short tem not be the case for China.

But, according to (Heinritz, et al., 1991), chapter 11, international sourcing may involve serious difficulties which must be considered before a supplier is selected. First of all political issues are to be addressed and historical evaluation of the supplier’s country or region should be undertaken. Legal issues can jeopardize the outcome of an otherwise successful project, especially in LCCs with a frequently underdeveloped rule of law. During cooperation, cultural and language differences may cause friction. In translation, words and expressions may gain a different interpretation in the target language, something which also applies to specifications and requirements. To ensure the success of an international sourcing project, currency fluctuations need to be kept in check. The buying company possibly needs to consider that lead time, due to transportation and the above problems, may be longer. And, depending on weight and measures of the procured item, international sourcing may simply be impossible.

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Table 2-3 : Obstacles to International Purchasing and Root Causes

Here, the author defines international sourcing as the opposite of regional sourcing. Personal company visits (including returns) take longer than one day. If a close cooperation between buying and selling company is desired, this leads to the dependence on telecommunications media. Otherwise representatives of the company need to be dispatched for a considerable amount of time leading to a lock-in of the employee on this particular project. Depending on the function and hierarchical level of the employee and the human resources of the dispatching company, this may cause considerable problems for other projects.

2.3.3 Global Sourcing

As (Chadwick, et al., 1995), chapter 10, and (Monczka, et al., 2002), chapter 11, point out, international sourcing is not global sourcing. Global sourcing would require a more universal approach to the buying company’s needs and markets, demand co-ordination of product ranges and the location of production, and communication over the entire buying company with its factories worldwide. Such an integrated approach is not applied in basic international sourcing.

A basic segmentation of different international sourcing strategies which a multinational company may pursue distinguishes between the degree of geographic concentration of a company’s activities and its degree of coordination of these activities. It was proposed in (Chadwick, et al., 1995) and is shown in Figure 2-5 : Segmentation of International Sourcing Strategies and Possible Movement Paths, (Chadwick, et al., 1995).

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Figure 2-5 : Segmentation of International Sourcing Strategies and Possible Movement Paths, (Chadwick, et al., 1995)

The three sets of arrows indicate potential strategic development paths for companies to move from an import-based strategy to another.

In order to identify an umbrella term for international purchasing and global sourcing, (Kaufmann, et al., 2002) proposes International Supply Management Systems (ISMS). An ISMS would cover international purchasing as well as global sourcing. International purchasing, as it is described in (Monczka, et al., 2002), is then equivalent to a low level of an organization’s ISMS. If the level is high the organization pursues global sourcing.

This model proposed by (Kaufmann, et al., 2005) is more focused on the sourcing aspects than the model proposed by (Chadwick, et al., 1995). The benefits and barriers of the different international sourcing approaches are displayed in Figure 2-6 : Segmentation of International Sourcing Strategies, (Kaufmann, et al., 2005).

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Figure 2-6 : Segmentation of International Sourcing Strategies, (Kaufmann, et al., 2005)

The expected benefits of global sourcing are a higher leverage of its own unique competencies and taking advantage of the local benefits from operating in various countries. These benefits cover the supply side, the production operations and the demand side of the company; in (Chadwick, et al., 1995), (Kaufmann, et al., 2005). The same benefits were put more simply by (Ghemawat, 2004) as increasing economies of scale and exploiting “arbitrage”. He means profiting from different environments. The aspects of the environmental advantages range from cultural issues over administrative and geographical to economic ones.

The different alternatives to actually enter the international markets are presented in (Chadwick, et al., 1995) based on the model presented by (Rugman, et al., 1985). Figure 2-7 : International Sourcing Entry Strategies, (Chadwick, et al., 1995) shows how these different approaches vary in the dimensions of time and depth of involvement in the foreign supply market.

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Figure 2-7 : International Sourcing Entry Strategies, (Chadwick, et al., 1995)

For example import via agents or distributors is (here) the simplest and least risky option. But it can be very costly because of the high fees involved, and communication with the actual supplier is usually not possible.

When importing direct via subsidiaries or own representatives, these act as agents. The knowledge of local suppliers and customs is provided by the subsidiary. This offers more proximity to foreign sources, deeper knowledge of foreign business practices, and better communication skills. Difficulties may arise if the subsidiary receives only a low degree of responsiveness from the domestic company, and with increasing international procurements this approach becomes less and less effective.

A deeper involvement is achieved by establishing international procurement offices (IPOs). These IPOs are focused in function (i.e. purchasing) and region.

In order to be able to fully integrate and co-ordinate global sourcing, direct investment is considered essential. Such a commitment is intended to last for decades. The objective is to maximize the buying leverage. A company can still use IPOs but joint production or co-production involving the sharing of manufacturing facilities, is now possible. By increasing the economies of scale, production cost savings can be realized. The consequences, however, are that a high amount of management’s time and attention is required, and a lot of resources are committed. The typical features of agreements are increased sole sourcing between the partners, deeper technological interchanges involving process technology (in addition to access to parts themselves), and joint development of emerging technology. In the context of coordinating with a Chinese supplier, increased interchanges involve rather access to know-how (for the supplier) than to technology (for the buyer).

2.3.4 Buyer-Supplier Relationships

In order to achieve the high degree of integration required for global sourcing it is necessary to understand the differences between transactional, collaborative and alliance relationships; in (Burt, et al., 2003), chapter 5. Transactional relationships are basically tactical relationships; the opposite is a supply alliance aiming at strategic synergies. For sourcing unique components long-term relationships, such as collaborative relationships or supply alliances, appear to be more promising.

An overview of the key elements of a buyer-supplier relationship (i.e. communication, length of contract, supplier involvement), and the characteristics of the supply segments most suitable for these relationship strategies is shown in Figure 2-8 : Key Elements of a Supply Relationship; in (Cavinato, et al., 2006)

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Figure 2-8 : Key Elements of a Supply Relationship; in (Cavinato, et al., 2006)

Obstacles preventing close buyer-supplier relationships are supplier-related and buyer-related issues, and regulatory barriers. For example, the supplier doesn’t want to share all the required corporate information, or, more often encountered in China[7], the supplier has only a limited interest in the relationship. The supplier-related difficulties are a still persisting “arm’s length” approach, and the focus on finding suppliers which are already technology or product leaders. (Monczka, et al., 2002), chapter 5

However, a relationship is dynamic and can have different degrees of buyer and supplier satisfaction. In order to evaluate the mutual satisfaction in buyer-supplier relations, and to be able to visualize one’s current situation, (Leenders, et al., 2002), chapter 8, introduce a simple buyer-supplier satisfaction model. See Figure 2-9 : A Simple Relationship Model, (Leenders, et al., 2002).

The diagonal line can be interpreted as the fairness and stability line. On this line it is assumed neither buyer nor supplier have a reason to terminate the relationship. Any deviation from the fairness line indicates that one party is disadvantaged. The ideal state is the upper right-hand corner; the middle position should be understood as the minimum acceptable level.

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Figure 2-9 : A Simple Relationship Model, (Leenders, et al., 2002)

For buyer-supplier relationships concerned with sourcing unique components, the aim should be to be above the minimum acceptable level in the upper right-hand quadrant (A). This A-quadrant is the basis for long-term relationships and supplier partnerships.

A stable relationship is likely neither in the lower right-hand quadrant (B) nor in the upper left-hand quadrant (C). In each quadrant one side is worse off and will try to improve its situation. Whether these actions will move the mutual satisfaction level to quadrant A or D is not always certain.

If the relationship is mapped into quadrant (D) it is not certain that the relationship will break down, but both sides will try to improve at least their own degree of satisfaction quickly.

This simple model can be the basis to develop improvement plans. For details on crunch tools and stroking techniques please refer to (Leenders, et al., 2002).

2.4 Total Cost of Ownership

In order to capture all of the cost components involved in obtaining a good the TCO approach has been developed. According to (Chadwick, et al., 1995), chapters 9, the costs of a good are, besides the price and other acquisition costs, the pre-acquisition costs. In the case of capital goods operating costs, downtime costs, maintenance costs and disposal costs are added. Each of the cost factors is calculated at present value. (Cavinato, et al., 2006), chapter 23, understands the TCO as analogous to cost from the buyer’s perspective[8]. He lists four main cost factors (inventory levels (transformed into a monetary unit), transportation costs, quality costs and reliability costs). For a more detailed list of the components of the TCO please refer to (Burt, et al., 2003), chapter 8. There the increased cost factors of acquisition costs, ownership costs and post-ownership costs are divided into 15 single cost factors.

A five step[9] approach to conducting a TCO analysis can be found in (Cavinato, et al., 2006), chapter 23. Because the analysis process is complex and time consuming, the same source advises to select a project that actually promises to outweigh the process costs.

A different TCO approach in (Ellram, 1995) seeks to link Activity Based Costing (ABC) to TCO. ABC is focused exclusively on company-internal costs, and assigns these costs to the activities that generate them. In this context the focus is on the administrative costs of the purchasing department, while the current TCO approach distributes costs across the products. Linking ABC and TCO promises to properly assign the true costs of purchasing to a particular supplier. The result would segment the supplier pool in low-cost-suppliers and low-price-suppliers. The major obstacle is, however, that ABC is not the standard accounting principle for the majority of companies.

2.5 Outsourcing

This chapter provides a brief introduction to the complex field of outsourcing.

The motivations as well as the drawbacks of outsourcing can be divided in strategic and operational aspects. The main pursued strategic goals are increased flexibility, long-term capacity adjustments, access to key-technology or market entry. The operational motivations are input cost reduction, operational capacity adjustment, higher process competency and higher product quality. (Quinn, et al., 1994). The drawbacks are the resulting consequences. Strategically this is the high risk in case of failure, undesired know-how transfers and a loss of the own skills and know-how. Operationally the major undesired consequences can be potentially higher costs, uncertainties in quality and performance, a decreased flexibility. In (Kinkel, et al., 2003) and (Kinkel, et al., 2004) some of these issues are being revealed in studies on the German mechanical engineering (ME) industry.

The outsourcing model described by (Quinn, et al., 1994) categorizes the situations for a company willing to outsource according to the potential for competitive edge and the degree of strategic vulnerability. The result is control option or the contract relationship.

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Figure 2-10 : Outsourcing Model According to (Quinn, et al., 1994)

The different control needs can be low for simple off-the-shelf products. For moderate control needs a special venture or contract should be arranged. And for high needs of control (“strategic control”) in-house production should then be the choice. This case relates to products that employ key-technologies or require know-how that is not available to the company’s competitors.

Under a given outsourcing decision, (Olsen, et al., 1997) described the intermediate situation of the outsourcing model described by (Quinn, et al., 1994) in more detail. The result is to implement an action plan that best suits the existing supplier relationship.

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Figure 2-11 : Outsourcing Model According to (Olsen, et al., 1997)

In addition to (Quinn, et al., 1994), who characterized only three of nine theoretical situations, (Nellore, et al., 2000) demonstrated the existence of the remaining six and characterized them.

A major concern for all companies deciding on whether to outsource or not, is how to avoid that the outsourcing provider becomes a competitor.

A practical view on outsourcing as a business process itself is given in (Greaver, 1999).

A detailed approach on deciding whether to outsource any business is provided by (Power, et al., 2006). One of the two equally important basic threads is the strategic assessment of the necessity to outsource. After the four assessments of the business value, the operational and financial implications and a risk assessment, the case for (or against) outsourcing business is made and a recommendation to the top-management is reached. During or subsequent to this first thread the actual needs are defined. To assess the detailed requirements an in-depth operational assessment and, simultaneously, the outsourcing strategy is defined. The results are the Statement of Work (SOW) and the Request for Proposal (RFP).

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Figure 2-12 : Reaching the Outsourcing Decision; (Power, et al., 2006)

Additionally, (Bragg, 2006) focuses in detail on the outsourcing of specific business functions such as manufacturing, engineering, and so on.

In the PhD thesis (Wasner, 1999), the factors influencing the outsourcing decision and the involved risks are examined in terms of their operational and strategic scope.

(Momme, 2002) developed a framework linking the outsourcing process to strategic planning, including a logical sequence of key activities with built-in performance measures.

For practical perspectives and real-life solutions refer to (Burkholder, 2006), who offers a rich collection of cases.


[1], last visited: 08.09.2007

[2] The remaining companies manufacture to 22% mid-sized series, and only to 6.5% actually large series.

[3] (Vieweg-2002) states that instead of one copy there were two copies ordered.

[4] The Verband Deutscher Maschinen- und Anlagenbauer e.V. (engl.: German Engineering Federation) is the biggest industrial association of the German mechanical engineering and plant engineering industry.

[5] In (Cavinato, et al., 2006), chapter 5, “cost” is considered to the “value” added to the final product by the part.

[6] Other centers of the ME industry in Germany are the state of North Rhine-Westphalia and the administrative district Leipzig in Saxony. However, both centers are in terms of enterprises outnumbered against Baden-Württemberg and Western Bavaria. (Statistische Ämter des Bundes und der Länder, 2005).

[7] See (Ammann, 2004) for details.

[8] For the seller, “cost is the monetary measure of resources consumed to provide the good”, (Oliver, 2000), chapter 2.

[9] The five steps are: (1) Choosing a Project, (2) Team, (3) Cost and Data, (4) Fine Tuning and Sensitivity Analysis, (5) Recommend and Implement. For more details, see (Cavinato, et al., 2006), chapter 23.

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Sourcing Unique Components in the Electro-Mechanical Engineering Industry from Chinese Suppliers
A Multiple-Case Study
University Karlsruhe (TH)  (Institut für Produktionstechnik - wbk)
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Sourcing, Unique, Components, Electro-Mechanical, Engineering, Industry, Chinese, Suppliers
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Dipl. Wi.-Ing. Andreas Martin Radke (Author), 2007, Sourcing Unique Components in the Electro-Mechanical Engineering Industry from Chinese Suppliers, Munich, GRIN Verlag,


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