Dr. Michael Watson, one of the industry’s foremost experts on supply chain network design and advanced analytics, is a columnist and subject matter expert (SME) for Supply Chain Digest.
Dr. Watson, of Northwestern University, was the lead author of the just released book Supply Chain Network Design, co-authored with Sara Lewis, Peter Cacioppi, and Jay Jayaraman, all of IBM. (See Supply Chain Network Design – the Book.)
Prior to his current role at Northwestern, Watson was a key manager in IBM's network optimization group. In addition to his roles at IBM and now at Northwestern, Watson is director of The Optimization and Analytics Group.
By Dr. Michael Watson
December 11, 2012
Should You Source from China or the US? Why Not Both?
Inventory Formulas Help You Determine the Total Landed Cost of Making in the US vs China, Shipping Air vs Sea, or Determining the Correct Dual Sourcing Strategy
Recently we’ve heard more stories about companies moving production back to the US—Apple and GE are the two big examples. This is on top of the coverage of chemical plants being built in the US to take advantage of cheap natural gas.
Dr. Watson Says:
A dual sourcing strategy gives you the low cost benefits of a China plant and the safety stock benefits of a US plant.
The stories are often presented as an either-or decision. And, often, when supply chain managers do an analysis, it is an either-or decision.
As a quick reminder, a good analysis includes the total cost of making the item at both locations. The easy (but not trivial) part of the total cost includes raw material, labor, energy, transportation, management costs, and duties and tariffs. In general, these costs tend to favor China.
A good analysis also includes the cost of inventory. Inventory cost tends to favor the US. To calculate inventory costs, you feed standard inventory formulas such factors as the excepted demand, demand variability, average lead time, lead time variability, minimum order sizes, and service levels. For some products, you may be able to reduce lead time from China by shipping with air services. So, this would give you two options in China- air and sea.
Now you have the total cost of producing in the US vs China. This is often referred to as the total landed cost.
To implement, you typically don’t just pick the lowest cost option. You also want to consider other factors such as risks, management overhead, marketing image, intellectual property, ease of product design and so on. If China is cheaper by $10,000, these other factors could sway the decision in favor of the US. If China is cheaper by $10 million, you would probably find a way to mitigate these other factors.
Up to this point, we’ve described the “either-or” analysis. Either you make in the US or you make in China.
But, it doesn’t have to be either-or. Some firms use another strategy—dual sourcing. This can be better than the “either-or” strategy. Professors Allon and Van Mieghem from Northwestern’s Kellogg School of Management have formalized this strategy in several papers and projects. The main idea
of this strategy is that you source a steady and consistent base amount (75% to 90%) from China and then use the US plant for the rest of demand and for any unexpected rises in demand or delays from China. By dual sourcing, you get the cost advantage of China and the safety stock advantage from the US plant. This strategy also mitigates risk by having two sources of production but comes with the extra cost of having to produce in two places.
Final Thoughts
When deciding where to make products, there is no single correct answer that applies to all products. Since you have data on every product and the inventory calculations are readily available, you can develop a unique sourcing strategy tailored to each product.
Recent Feedback
Good information. What about Mexico playing a role in this dual role of supply chain strategy? Mexico currently has the number 1 landed cost for US markets.
Gary Batt
Owner
ASAH
Dec, 15 2012
This article explains a common dilemma faced in practice today. It is important to remember that when deciding upon a sourcing option, it does not have to result in a sole sourcing decision. Numerous benefits are attainable with multiple suppliers in alternative locations. Careful analysis must be made when determining sourcing locations, but it is usually more favorable to dual source due to cost advantages of overseas sourcing options, and safety stock advantages of local sourcing options. In closing, I found this article made an excellent point in stating that every product is different, and unique strategies should be determined in designing sourcing options for individual products.
Jena
Student
University
Apr, 25 2013
When trying to decided to take advantage of the cheap labor costs of China or the more domestic friendly shipping costs of America, most companies fail to realize that they can have the best of both worlds. Enabling alternative locations for sourcing creates favorable strategic options for any company. Dual sourcing gives cost advantages with labor and shipping when dual sourcing from overseas locations, while also sourcing from a domestic site. Also there are competitive advantages instilled in the multiple suppliers who have to keep quality up or risk losing possible business to another supplier. However, this article does a good job at stating that ever product is unique and that unique strategies should be considered before deciding on where to source and how many suppliers to source from.
