Low Cost Country Sourcing

Low-cost countries. A dream for some and a nightmare for other others. What are typical supply chain risks in low-cost countries and how can they be managed? That is the topic of the PhD dissertation by Holger Köhler, now available as a book: Supply Chain Risiken im Low Cost Country Sourcing: Reduktion von Lieferrisiken in China und der Türkei. In the book, which is a more or less unabridged version of his dissertation, Holger Köhler not only presents a (new) system for the systematization of supply chain risks, he also develops a model for the factors that influence supplier risk and he exemplifies the cause and effect of supplier risks in China and in Turkey.

For my German readers

I am multi-lingual, and that is very fortunate, because it gives me access to a wide range of literature otherwise only available and known to those who speak the language. German is perhaps not the most widely spoken language in business, but Germany is definitely a – if not the – economic powerhouse in Europe and it is no surprise to find excellent German literature in logistics and supply chain management, including supply chain risks in Germany.

This book is no exception, and while my German readers undoubtedly will benefit most from this review, I hope that my other readers will find it equally interesting and inspiring for their own research.



Three-In-One

The book has three main parts

  • a review of the current state of supply chain risk management theories and how they pertain to low-cost country sourcing
  • a model for explaining how certain supplier attributes influence certain supplier risks
  • a case study based on the model that quantifies cause and effect of supplier risks in China and in Turkey

This review will focus primarily on the first bullet point, which is the most interesting to me, along with the second part which I will spend some words on, and I will not delve to deeply into a review of the third part, besides summarizing the results and managerial implications.

What is risk?

One very interesting figures in the book is the definition of risk. Here, risk is divided into pure risk (Reines Risiko) and speculative risk (Spekulatives Risiko), with the former having damage potential as the only possible outcome, while the latter has potential for both negative as well as positive outcomes.

Speculative risk can be further dived into risk in a strict sense (Risiko im engeren Sinne) and risk in a wider sense (Risiko in weiteren Sinne), where strict risk has a potential for loss only, and wide risk has a potential for both loss and profit (chance).

I’ve never seen this comparison before. More often than not, in everyday and popular understanding, risk is the potential for loss, as in Harland et al. (2003), although the ISO standard defines risk in terms of uncertainty. This is a figure I will most certainly use in my future deliberations on risk.

How to mange risk?

Another figure I will start using instead of what I am using so far is a figure describing the various ways of managing and reducing risk. It follows the traditional line of Avoid-Reduce-Transfer-Retain but not fully.

On the left is the overall risk (Gesamtrisiko), which through  avoiding (Vermeiden), reducing (Vermindern), limiting or containing (Begrenzen) and insuring or transferring (Versichern) is reduced to the leftover risk (Restrisiko) that is retained (Selbsttragen) by the company.

Note that avoiding and reducing are aimed at the causes of risks (Ursachenbezogen), while reducing, limiting, insuring and retaining are aimed at the effects of risks (Wirkungsbezogen). The two latter are seen as passive risk management (Passiv), while the three former are seen as active risk management (Aktiv).

While this figure uses the 4 classic approaches to risk management, it does not use a risk matrix approach and displays them differently. I think this way is better in illustrating how larger risks are turned into smaller risks.

The notion of active and cause-related versus passive and effect-related is very similar to what I wrote in my post on contingent versus mitigative risk management, and I am glad to see that I am not the only one viewing risk management in this perspective.

What types of supply chain risks exist?

Supply chain risks exist on different levels throughout the supply chain, some within the chain, some outside, but still within the network, and some entirely outside of the network, as illustrated by Martin Christopher in his book chapter on supply chain risk. Köhler’s division of levels is similar, but at the same time very different and perhaps more complete:

The innermost are risks that are endogenous to the supply chain (Supply-chain-endogene Risiken) and pertain to supplier (Lieferant) and customer (Abnehmer), i.e. information risks (Informationsrisiken), legal or contractual risks (Rechtsrisiken), financial risks (Finanzrisiken) and supply risks (Lieferisiken).

Outside of this are risks that are exogenous to the supply chain, but specific to the sourcing market (Supply-chain-exogene beschaffungsmarktspezifische Risiken), i.e. social and cultural risks (Sozio-kulturelle Risiken), legal risks (Rechtliche Risiken), technological risks (Technologische Risiken), political risks (Politische Risiken) and economical risks (Wirtschaftliche Risiken).

On the very outside are risks that are exogenous to the supply chain and independent of the sourcing market, that is every else and unrelated that can go wrong.

I like this figure. It is compact, and it manages to convey the big picture while not leaving out (m)any details. In a way it is reminiscent of Helen Peck and her four levels of supply chain risk, interestingly not referenced by Köhler.

Another not-referenced article that lists many of the same risks is Ghoshal’s organizing framework for going global from 1987, later picked up in an article on global supply chain risk management by Manuj and Mentzer in 2008 (also not referenced).

Don’t get me wrong here: I cannot hold against Köhler that he has missed or omitted some articles that I know of and that I would have mentioned; his reference list is more than sufficient by any standard, and it even contains references dating back to 1932, clearly showing that he has done his homework and done it well.

And while Köhler uses this framework as specific to low-cost country sourcing, I would say that it applies to any kind of international purchasing or global sourcing.

Risk drivers and moderators in low-cost country sourcing

This is where it gets tricky and this is where Köhler builds his model and puts forwards his hypotheses, no less than 27 in total, which I will refrain from listing, although in most of my reviews I do. Essentially, he divides his model into

  • supplier-related factors (Lieferantenbedingte Einflussfaktoren),
  • the impact these factors have on the sourcing company (Risikowirkung auf beschaffendes Unternehmen), and
  • contextual moderating factors (Moderierende Kontextfaktoren).

How these work together is described in the figure below:

Supplier-related factors
are divided into three main groups: export readiness (Exportbereitschaft), export competence (Exportkompetenz) and export relationship (Exportbeziehung).

Export readiness
is determined by top management commitment (obviously no German word for that), strategic relevance (Strategische Relevanz), strategic value (Strategische Bewertung) and readiness to change (Änderungsbereitschaft).

In other words, these are the prerequisites for a supplier before engaging in exporting. These prerequisites determines whether the supplier actively seeks exporting opportunities and sees them as valuable or whether the supplier is perhaps not that much interested in exporting.

Export competence
is determined by financial skills (Finanzielle Fähigkeiten), operational skills (Operationelle Fähigkeiten), team skills (Mitarbeiterfähigkeiten) and technological skills (Technologische Fähigkeiten).

In other words, these are the day-to-day working skills necessary to ensure the smooth operation of the export supply chain. Obviously, exporting requires a different set of financial skills and a different kind of financial backing than if operating domestically. Team skills can be hampered by frequent staff turnover, while operational skills relate to efficient production processes, backed up by adequate technology, in particular for exchanging vital and timely information.

Export relationship
is made up of trust (Vertrauen), bonding (Verbundenheit), empathy (Empathie), shared values (Gemeinsame Werte), and communication (Kommunikation). In other words, this is what makes the relationship tick (or not).

Trust relates to the extent to which the partners perceive either other as credible and benevolent. Bonding express the degree of unison behavior towards reaching a common goal. Empathy, the ability of the supplier to understand, foresee and meet the company’s needs is crucial to the success of an export relationship. Shared values is the extent to which the partners have beliefs in common about what matters most or not; without it misunderstandings and culture shocks may develop. Communication forms the base and relates to the formal and informal exchange of information.

FYI, Göran Svensson has written a very good article on the gap between trust and dependence in business relationships, and Stephan Wagner looks at how buyer-supplier relationships evolve over time.

Contextual moderating factors
are either seen as either external or internal.

External moderating factors
are the export market complexity (Marktkomplexität), the environmental dynamics or pace of change (Umweltdynamik), and the performance of the logistics provider or 3PL (LDL Performance).

Export market complexity
is determined using 5 indices, and an export market is seen as complex if every year it is necessary to (1) significantly decrease costs, (2) and increase quality, (3) make considerable changes (leaps) in technology, (4) cut down product development times and (5) make more timely deliveries.

Environmental dynamics
expresses (1) how fast laws, regulations and standards change, in particular relating to customs and trade, and (2) how extensive the scope of change is. For more on this, see Catherine Truel’s book on customs risk and Pekka and Hameri’s paper on cross-border supply chains.

Logistics provider performance
consists of (1) delivery lead time (on time), (2) delivery reliability (as agreed upon), (3) delivery accuracy (no items missing, not too many), (4) delivery quality (no damaged items) and (4) delivery flexibility (ability to comply with a change of plans). In fact,  logistics providers play a major role in orchestrating not only the supply chain, but also the risks in the supply chain.

Internal moderating factors
are the ownership of the exporting company (Eigentumsverhältnisse), in particular whether it is (1) a privately held company or (2) a government-owned facility.

Moderating factors do not directly influence the outcome, but they influence the direction of the other variables.

Impacts on sourcing companies
are divided into two categories, supply failure risks (Liefermängelrisiken) and supply outage risks (Lieferausfallrisiken).

Supply failure risks
are defined by deviations in (1) delivery volume (more or less than asked for), (2) delivery place (not delivered to where it was supposed to), (3) delivery price (not as agreed), (4) delivery quality (not according to contract specifications), and (5) delivery time or lead time (not on time, too early or too late).

Supply outage risks
are defined differently from what I would expect, and are classified as (1) supplier defaults on contract because other customers are seen as more important, (2) supplier defaults because his product portfolio changes and he no longer can supply the desired product, (3) supplier aborts the contract because realizes that he cannot meet the high standards set by customer, and (4) supplier has contingency plans in place to ensure that the contract is met should his own suppliers default.

This is quite a complex model, and I am impressed with how simple it looks like from the outside, and how complex it must be to work with in detail. I am perhaps even more impressed with the statistical analyses and comparisons undertaken on the basis of this model, where each and every hypothesis is tested and evaluated. It is completely outside the scope of this blog post to go into any details here, but it is highly valuable and highly recommendable reading. Hopefully my description of the parts of the model, albeit a bit tedious maybe, can inspire others to follow in Holger’s footsteps or apply his thinking to other areas of supply chain risk.

Risk management in low-cost country sourcing

In the end, Köhler links up his model and his findings with the supply chain risk management cycle, thus illustrating the managerial implications for addressing risks in low-cost country sourcing. The risk management cycle has 4 iterative steps, (1) Risk identification, (2) Risk evaluation, (3) Risk management, and (4) Risk audit. Note here that the risk evaluation has two directions, effects (Wirkungsbezogen) and causes (Ursachenbezogen), as already outlined above.

Supply risk management has two perspectives, passive and reactive (Passives, reaktives Management von Lieferrisiken) on one side, and three active management approaches on the other side:

  • (1) Relationship-oriented (Aktives beziehungsorientiertes Management), aimed at the export relationship of the supplier.
  • (2) Competence-oriented (Aktives kompetenzorientiertes Management), aimed at the export competence of the supplier
  • (3) Potential-oriented (Aktives kompetenzorientiertes Management), aimed at the export readiness of the supplier.

The “sliding triangle” on the left signifies the relevance that each subfactor has within the 3 main factors, and I am quite amazed how Holger managed to squeeze his whole PhD (almost) into this single figure.

Conclusion

This book, or PhD dissertation if you so wish, is solid work. That much I can say. It is not a book you can read like you would read a novel; it does take time, but it is definitely worth the time – for those who can read German. Even if you don’t the language many of the figures are nonetheless almost self-explanatory if you know a little bit of supply chain (risk) management.

I wish I could have this post longer, because this book is full of intriguing concepts, valuable insights and clear-cut easy to read illustrations, it’s that good, but I have to stop somewhere.

It really is too bad that this book is available in German only, and in my opinion it constitutes by far one of the better publications that have come across my desk in recent time. I do hope that Holger will think about publishing some of his work in English journals, because his work deserves recognition beyond the German-speaking realm.

Holger struck a nerve with me and I am sure he will do the same with many of my followers, and I definitelylook forward to referencing his future works on this blog.

Reference

Köhler, H. (2011) Supply Chain Risiken im Low Cost Country Sourcing: Reduktion von Lieferrisiken in China und der Türkei. Berlin: Erich Schmidt Verlag.

Publisher link

Author link

  • tu-darmstadt.de: Holger Köhler

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