Return to Gunpowder
This Issue—Volume 5, 2007

As the summer winds down, there has been lots of China talk of late. It’s a subject we can’t afford to ignore, so we’ve given the China topic to our trusty European correspondent, Stuart Burns, who has decided to dish up his version of Apocalypse Now. Back on this side of the pond, US Correspondent Tony Poshek talks with a Chief Mechanical Officer from a Fortune 10 rail company on strategies for effectively sourcing in a duopoly or oligopoly supply market. Last, if your company sources metals, take our free MetalMiner quiz to see how well you are sourcing.

Disagree with us or got an idea for an article? Let us know:


Is this the beginning of the end or the end of the beginning?

Amongst the overwhelming flood of “China’s products are not safe” headlines there have been a number of articles of late about the rising cost of
doing business in China and the number of large corporations who are quietly
re-thinking their low cost country strategies.

Just this week, floor products and power tool maker TTI, Techtronic Industries, the Hong Kong-based owner of such great western brands as Hoover, announced they have re-focused their expansion plans on Mexico and Eastern Europe, sighting a combination of rising raw material costs, wage inflation and increased tax burdens in China. TTI said it was sensible to shift their new investments toward production closer to their core markets as China’s competitive advantage became less significant.

How do TTI’s arguments stack up? Raw material costs have been rising everywhere so China is not alone in that. The problem with China is it’s a distorted market—distorted by centralized control which has the effect of pushing domestic prices out of sync with the rest of the world by the use of rebates and subsidies on imports and exports. From our own project work, we have seen recent cases of Ferro Chrome, Steel and Aluminium to name but three products where domestic China prices are below world prices. By the same token there are other commodities which are higher and China continues to suck in imports in large volumes. We will give TTI the benefit of the doubt then on raw materials.

How about wage inflation? It is true to say China is suffering with the Asian disease—rapid growth fuelling demand for qualified engineers and managers from a talent pool that is not able to deliver. China is not unique here. Thailand, Malaysia, India all suffer from an acute shortage of qualified engineers, accountants, doctors, and lawyers (perhaps we could all deal without the last ;-). In fact, every profession faces a shortfall as the education system has failed to keep up with demand in terms of numbers and in terms of skills, particularly for working in foreign owned companies where middle and higher staff members require good linguistic and communication skills. A recent McKinsey study estimated China will need 75,000 business leaders over the next 10 yrs versus the current stock, which is estimated at 3–5,000. Of more importance to a company like TTI it was estimated that the available pool of engineering talent in China was comparable to that of Britain, which now has a mostly service economy. What’s the problem, you ask? The universities are turning out engineers but without language skills and deep in theory with no practical skill. This scarcity of skills able to operate in foreign owned companies is driving up wage rates and pushing skill shortages to the top of most companies list of woes according to an EU Corporate Network Survey this year. This then would support TTI’s decision.

So how complex is the tax system in China? Well the system is complicated by having both tax and reporting requirements (licenses, permits, approvals etc,) at the city, state and federal (province) level. In addition there are 13 types of Chinese taxes applicable to foreign investors and their establishments in China. Customs Duty, Value-Added Tax (VAT), Consumption Tax (CT), Business Tax (BT), Foreign Enterprise Income Tax, Individual Income Tax, Deed Tax, Land Appreciation Tax, Resources Tax, Slaughter Tax, Stamp Duty, Urban Real Estate Tax and Vehicles and Vessels Usage License Tax. Not all of them are applicable to all business and it’s true to say I have not seen a tax system anywhere in the world that can be said to be simple. But clearly manufacturing in China does require a large investment in legal, accountancy and management time for foreign companies.

So is this the beginning of the end for China as the world’s manufacturing base of choice in general? No, probably not. But it could be the end of the beginning for some organizations which will soon base new investment decisions on a range of issues—not just labour rates or ex factory piece part prices. As the financial advantage of manufacturing in China reduces other factors like proximity to market, managerial control and stability, other regions will certainly benefit. And not just other low cost supply markets like Eastern Europe and Mexico, but even suppliers in the USA and Western Europe that have narrowed the gap by productivity, gained from automation and lean manufacturing.

Stuart Burns is Managing Director of Aptium Global where he leads the firm's practice
in Europe and Asia.

Q&A with Dan Welch—Dealing with Duopoly/Oligopoly Supply Bases

Based in Chicago, Dan Welch is Chief Mechanical Officer for a rail division of a Fortune 10 corporation. Dan oversees all sourcing activities. He has over 15 years experience in sourcing in the rail industry, working previously for industrial heavy-weights such as GE, and Union Tank Car. We caught up with Dan to get his perspective on what it takes to manage duopoly/oligopoly supply-bases. Perhaps more important, Dan offered a few suggestions for all sourcing managers.

Please give our readers some background as to why the rail industry has so many oligopoly supply bases, and how this may differ from other industrial supply bases.
Rail cars carry large heavy loads traveling at high speeds across many different railroads in every state; carrying everything from toxic chemicals to automobiles to dirt. To assure safety and smooth operations (including interchangeability) rail traffic is heavily regulated by the Department of Transportation, the Federal Railroad Administration, and the Association of American Railroads among many others.

While some of the regulations limit the number of suppliers simply due to the fact that they create difficult and very specialized hurdles to clear for design and testing, others specifically require that only approved products/suppliers be used. For many of these, the design, production and quality control processes, and even each individual production facility must be approved on a regular basis. This means that a casting that may appear to be rather simple might have 5–10 years of product development, service trials, and approval submission prior to its approval for interchange use. If you then consider the fact that product demand for rail equipment is very volatile (orders can go from 15,000 cars per year to 75,000 in a matter of 1–2 years), it is not surprising that we have seen continual consolidation of the supply base.

Not surprisingly, there are rarely more than 2–3 suppliers for a given part, and at several times during my career, there have been many occasions when the entire rail community must rely on a single approved supplier for a component that is required on every car on the continent. The material side is slightly better, but even there, only a very few steel mills can produce some of the material required to build rail cars.

So it sounds like this is a “true” duopoly/oligopoly situation, as opposed to a self-imposed one?
That is absolutely correct. These are restrictions that are external to our business. It is not a choice based on our business concerns with pricing and/or design. It is not a situation where you internally reduced the supply base because of issues such as a preferred engineering specification. This is purely a situation where these are the only suppliers we have to choose from.

Can you give an example of how having a ‘true’ oligopoly supply base can affect the negotiation power a buyer may or may not have with his suppliers?
This gets to be difficult for buying organizations that are perceived as "little guys" who don't have large purchasing volume. The suppliers know that you don’t have the volume to necessarily make the business attractive to them. They also know exactly who their competition is, and in most cases what their pricing and capacity is. Therefore as opposed to the traditional buyer-supplier relationship, in a true duopoly situation, the supplier has far more leverage in a negotiation.

Over the last several years in the sourcing world, there have been many new technologies and processes that have been introduced (e-auctions, eProcurement systems, etc.) In a duopoly/oligopoly, how effective have they been?
Even in the railroad industry there are some opportunities to use these new processes for the more commodity-type categories, and they can work great. However, for most of the railroad specific components that are a duopoly/oligopoly they are just not that effective. Simply put, there is very shallow competition, and without competition it is very difficult to negotiate pricing as a buyer.

What are some best-practices you would recommend to buyers that have to deal with a true duopoly/oligopoly supply base?
If the components are critical to your business, you need to establish a good relationship with the supplier in a duopoly/oligopoly situation, as they have more leverage. You have to learn about your supplier, and know what’s important to them. You need to intimately understand how they manufacture the equipment, how they prefer to handle deliveries, and how they prefer to handle invoicing/payments. You want to find ways to become easier to do business with, in their eyes. In effect, you almost have a role-reversal where the buyer behaves more like a salesperson.

Then you can decide what you can “offer” them. Flexibility is a key here. Can you find a way internally to “mirror” the suppliers’ capabilities and strengths? This may mean changing the way you handle payables and invoicing. Demonstrating greater flexibility in your specification requirements for alternate sub-components and helping the supplier achieve better efficiencies and economies of scale in their production process is also key. It is more attractive to the supplier to make a product that is more “mainstream”. Can you offer volume? If not, can you offer a steady, consistent stream of business? Do you pay on time, or in a shorter term than your competition? Can you sit on inventory to better fit into the supplier’s manufacturing capacity/availability? In summary, you want to differentiate yourself positively and eliminate the things that differentiate you negatively.

It is important to identify the categories that will put you in a duopoly situation early on. You want to plan well in advance, and have a long-term strategy. Ideally, you want to have long-term agreements with the suppliers that you set in place off-cycle. In other words, if your business is seasonal or cyclical, try to negotiate at the low-point of that cycle when the demand is low, with a long enough contract length to protect your business for the next high-point in the cycle.

All of these ideas can help to achieve ‘wins’ for your company. They may not always be based on better pricing (although that is possible), but they can produce ‘wins’ in areas such as delivery lead-times and quality.

Any last words of advice, for those buyers that find themselves having to manage a true Duopoly/Oligopoly supply base?
When you find yourself in this situation, you are living in a very small world. It is exceptionally important that you maintain your integrity and reputation, because you will be dealing with the same people again and again.

Tony Poshek is Director of Aptium Global where he leads multiple engagements
for the firm's practice in North America.



Does metals pricing volatility keep you awake at night? If your company—
or a company you work with—is struggling with metals price volatility,
we’ve got a solution to make you rest easier. As a first step, take our free
MetalMiner Best Practice Quiz to find out how you might be able to
take advantage of cost savings and cost avoidance opportunities within
your metals and metals services spend categories.



This newsletter is published by Aptium Global Inc a direct material advisory firm based in Chicago, IL. With offices in the UK, China, India and a network of global associates, Aptium Global works with small and medium sized manufacturing companies to save money on direct material purchases. Smaller companies face the same cost pressures as the Fortune 500, yet often lack budgets for cost reduction services. Aptium Global works with organizations on a pay-as-you-save™ basis, minimizing impact on cash flow and maximizing impact on the bottom line. We aim to publish this newsletter on a monthly basis but reserve the right to miss a few deadlines here and there.

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