Taming the Beast

International logistics for direct-to-customer businesses – boosted by the popularity of the Internet – adds many variables and serious risks to inter-country distribution and sourcing. The good news is that with careful risk management and preparation, any company can navigate these turbulent waters and offer tremendous value to shareholders and customers alike.

Going global safely and effectively brings with it significant benefits. Perhaps most important, it opens up new markets. Although the United States is the largest single market (estimated at over $8 trillion in 1997), it is only a fraction of the total worldwide market (estimated at over $38 trillion in the same period.) Some countries will open markets to a company if certain components are sourced or built in the country.

Sourcing and distribution overseas can save time and money, opening up new options to reduce cycle times by sourcing closer to global locations, and reducing costs by selecting the best of competing channels. In my experience, companies that effectively employ global sourcing and distribution techniques can reduce landed cost by 15% to 50%.

In many industries, the opportunity still exists to use global distribution and sourcing to create advantages relative to the competition. These advantages can come in the form of reduced repair and return cycle times, faster delivery times, credit for value created in the country, reduced freight costs, favorable labor rates, and many more. Rest assured, however, that the types of benefits available to the early adopters (such as Liz Claiborne and Motorola) are steadily declining. Soon these techniques will have to be employed just to keep up. We are no longer debating the benefits of global sourcing and distribution, but looking for ways to implement them effectively.

The Beast lives there In the Disney movie Beauty and the Beast, some townsfolk gather to march on a castle and kill the Beast that lives there. The Beast has lived in the castle for years without incident, but when the townsfolk become aware of him, they panic. In an unlikely fit of self-awareness they sing, “We don’t like what we don’t understand – in fact, it scares us; and this monster is mysterious at least.” This insight often applies to managers whose international experience has been limited to family vacations and eating at ethnic restaurants. Although it’s a common reaction, fearing the unknown is unfortunate because it tends to prevent us from taking a sober and considered path into the new territory.

Our goal as managers in terms of globalization, however, is to avoid two possible extremes, avoidance of global distribution and blind confidence in its use. While we add strong advantages to our company by enabling it to sell globally, we do take on significant risks and costs as well. For years the news has been replete with companies and celebrities that failed to do proper homework on their global suppliers and were then exposed for the use of prison or child labor, only one of a myriad possible problems.

We can, however, walk the fine line between avoidance and blind confidence. The first step is to break down global distribution into manageable pieces that we can analyze and mitigate. To begin, we can define international distribution as domestic distribution with some additional variables. In other words, shipping to Sao Paulo, Brazil, is the same as shipping to Des Moines, IA – with some additional considerations.

Risky business Let’s start with familiar ground and build our understanding one variable at a time. Eight major variables, their risks, and ways to mitigate them are discussed below:

1. Culture and language influence business behavior and communications. Risks include failure to understand cultural issues that are important and motivating to another party. One such problem is the failure to anticipate how a message will be received because of different linguistic/gesture meanings. To avoid this, you must consciously prepare for your audience. This is a common step for any negotiation that takes on new importance in global relationships.

2. The distance to remote service providers makes it more expensive to perform site visits and more difficult to manage international suppliers and carriers.

The risks that surface if we do not develop relationships abroad and verify capability and approach with international suppliers are legion, especially when you consider the added complexity of various cultures in terms of languages, acceptable behaviors, and standards.

To reduce these risks, prioritize your visits. Although you may not have the time and resources to visit every supplier every year, identify the critical service providers and focus your energies there.

Use trusted resources in the various regions of the world to act as your eyes and ears. Possible examples might be your freight forwarder, the Chamber of Commerce, and other suppliers. Use the Internet to gather financial information and as the backbone for meticulous measurement tracking with key suppliers.

3. Infrastructure varies wildly by region, even within an individual country. Examples of possible variations are airlift capacity, roads, utilities, security, use of child and prison labor, modal options, and accepted business practices.

Making a decision assuming an infrastructure common in your home area may lead to unanticipated quality, service, or timing problems. Using a foreign service provider whose business practices are inconsistent with company policy, local laws, or public sentimentalities can lead to legal and public relations disasters.

If you design a comprehensive approach and discuss infrastructure inconsistencies with resources familiar with the remote location, you are more likely to prevent “time bombs.” On a more detailed level, sufficient inspection and certification in the sourcing process can eliminate the need to repeat the procedure for every shipment.

4. In addition to basic language and cultural differences, alternative standards can cause significant exceptions. Consider NASA’s mission to Mars that failed, costing taxpayers over $125 million. The cause of the failure was linked to inconsistent standards between two teams, one using the metric system and the other the English system. Applying different standards for “service,” packaging requirements, units of measure, or labeling, or using the metric system will cause a problem with specifications and lead to the wrong product being built or delivered.

The remedy? Update all specifications to address these potential ambiguities. Use test runs to evaluate end product early in the life cycle. Observe – or have someone else observe – the design/production process. Review local standards with the Chamber of Commerce or some other expert in the region.

5. An unstable or unfamiliar political environment can affect your supply chain, your ability to repatriate profits, and how you can manage your workforce.

Political instability may result in service interruptions or pose a danger to the personal safety of people who work for you. A corollary is the constant potential for a government to change the rules, making it harder to manage a workforce, clear customs, pay duties, or work with suppliers.

The best way to mitigate this kind of risk is to gather intelligence up front. Do research and collect information from such sources as the U.S. Department of State, the Central Intelligence Agency, The Economist magazine country reports, security consulting firms, international insurance firms, and the Internet.

Don’t neglect to talk to others with direct experience – freight forwarders and customs brokers invariably have first-hand experience that can be extremely helpful.

6. Financial transactions and multiple currencies multiply the complexities of any international relationship.

Currency fluctuations can change the economics of any transaction or contract.

The letter of credit (LOC) is commonly international legal tender. This document can seriously constrain a company’s ability to service a contract. Never accept another party’s LOC without a detailed review, and take the responsibility for writing it yourself whenever possible.

Right at the start, you must make a considered decision about which currency to use in the relationship. Then, just in case, you should always develop a hedging strategy for managing currency risk. There are many methods that do not involve unnecessary speculation.

7. Distribution costs and cycle times are significantly different in international relationships than they are in domestic ones. In many cases the cost of the product becomes secondary to the freight, duty, inventory, installation, packaging, and other costs. Decisions made without considering all costs can lead to financial disaster.

Ballooning inventory is a particular risk of international fulfillment. Often, when cycle times are high, decreasing inventory is the first reaction to solve the problem. A poor decision can explode cycle times. (One client had a 105-day repair-and-return cycle time when another with similar cost options offered fewer than six days.)

Use the total cost of ownership method to evaluate your options. One common mistake is to ignore the cost of inventory. Look aggressively for options to minimize inventory, including local sourcing, pull systems, spot markets, supplier resources, and so on.

8. In intra-country agreements, the legal authority deferred to in case of significant disagreements or breach of contract is not in question. Under the U.S. Foreign Corrupt Practices Act, U.S. companies are bound by U.S. law even when doing business abroad. But when working in multiple countries, you must also adhere to the law in each land.

If the legal authority that binds the contract is not identified, significant misunderstandings may occur. You can help avoid these by developing and promulgating personal and service provider conduct policies. Identify the legal authority in all contracts, whether that authority is the U.S. UCC law, the United Nations Court of Arbitration, or the law of the host country.

Like any powerful tool, global distribution can provide tremendous benefits and ominous dangers. This article highlights these benefits and risks. Future columns will explore each of these areas of risk and describe practical ways in which you can safely maximize your use of the global market.