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Be aware of hidden costs in Chinese supply chain

From Gasgoo.com| November 22 , 2007

Raimund Diederichs
Director, McKinsey&Company

Gasgoo.com: Could you give us a general picture of the management efficiency gap in auto parts supply chain between China and Europe, and that between China and the United States?

Raimund Diederichs: It's certainly not an easy question. Let me evaluate. First of all, there is one thing where china is certainly ahead, which is managing this huge growth. We all know that the demand and sales in the china car market is tremendous, and outperforms more than every other market in the world. So on one hand, I pay my respect to the Chinese OEMs and suppliers to manage that impressive growth, building factories to deliver to this growth. On the other hand, first, about the whole inbound supply chain, I think the level of interactions between the European OEMs with their local suppliers (most of them are local), there are very close tie between them. The inventory between OEM and parts supplier is in many cases very minimal, for example, they may just ask for a 24 or 48 hour delivery, so the whole rules are set to deliver almost with very low inventory between suppliers and OEMs. That is one advantage where I would say we are not yet at that level here. I think the inbound supply chain is not as perfect. I don't have exact figures, but the inbound inventory is much higher here. Then the second one is about R&D management which is not supply chain related. I think what you see in Europe and in the U.S. that the interaction with the suppliers is not only on supplying parts and components; it's also in the area of R&D. I know in Europe, a lot of suppliers bring the innovation to the OEMs, so the OEMs don't have to do themselves. I think here the capabilities of the Chinese suppliers have to increase because while the volume is very high, you could still say innovation is not at the level, where be it in Japan, Europe or U.S. I would say that's partially because suppliers can not contribute as much as they do in Europe to the innovation of their components, and in the final stage, the innovational cost. In a summary, first, the supply chain is not as perfect as managed, you go there they are just buffers the inventory and the connectivity is not at the level which could be; the second one I think is R&D, the innovation part where I could imagine that could need more work done.

Gasgoo.com: In terms of management efficiency, in which aspect do you think the Chinese homegrown OEMs should improve themselves?

Raimund Diederichs: That's difficult. First if you look at the OEM landscape, there are certainly keen winners, be it the MNCs, who have joint ventures, who are very successful, but also the companies like Chery and Geely and etc that have over time grown to a domestic impressive market share. I'm convincing that this growth will go on for several years. On the other hand, I would say, given all the debate about fuel consumption, environmental safety standards, the demand is there to beef up the products, it also goes into the direction of innovation, that means the EU four and five consumption norms are getting in a certain stage implemented here in China, so that means a lot of fine tunes on the engine, transmission part and etc. I think this is something where all the OEMs in China are challenged, and this is one of the biggest challenges next to managing the growth and etc., but this is more coming by demand, but how to manage the innovation in that direction.

Gasgoo.com: Let's talk about the management of supply chain and sourcing. In automotive industry, there are different types of cooperative relations between OEM and auto parts suppliers. Compared to their counterparts in North America, the OEMs have close relations with auto parts suppliers in Japan, Korea and European countries. So what do you think of the relations between the OEMs in China and their auto parts suppliers?

Raimund Diederichs: To start with what happened over the many years of cooperation between the Japanese, European or U.S. OEMs with their suppliers, I think what you see, there is a history of very close cooperation, education, training of each other, so that means at least (for example in Europe), the OEMs and the key suppliers are almost on the same level of knowledge, technology, etc. My impression is that this is not yet here the case, so I would say the biggest challenges are how can we educate the suppliers from the OEM perspective in terms of lean, smooth supply chain, on time deliveries, etc., so I think here the challenge will be from the OEMs to invest in that training efforts, I know there is a lot of going on, how much effort Toyota put in educating with teams, their suppliers are heavily investing in their supply skills. I think that's a major challenge to train these suppliers, and frankly a lot trainings have to come from the OEM towards their suppliers.

Gasgoo.com: Auto parts buyers worldwide are now very enthusiastic about sourcing in China, does this mean that OEMs world wide will re-adjust their supply chain? What challenges do you think this readjustment would bring to the management of auto parts suppliers?

Raimund Diederichs: I think there are several challenges. There is one case that china will be more and more leveraged in supplying OEMs outside china, that means you deliver your parts into U.S. and into Europe won't happen to a degree of 50%-60%, because still in Europe and in U.S., they will have a lot of local suppliers. But I think the percentage of parts sourced from china will be much higher over time. So the Chinese suppliers have to build up a global supply chain, have to learn how to manage, not just delivering into Chinese OEM final assembly factories, but how to manage the flow, probably the containers would take three or four weeks from shanghai to LA or three or four weeks from shanghai to work to them, so that means you have to manage such a long supply chain, and this is not an easy one to do, so you have to stock, maybe in warehouses in Europe and in the U.S., so you have to have the systems and transparency on these inventory in place, once you want to source from China into these markets. The second one, as the international OEMs are already here in China, and I think they have the special demand, they come with the history of supplying in direction from Europe and from the U.S. So I think also in this side, as I said before, the need for supply development in the lean, high quality, being flexible towards product changes in the OEM final assembly, will increase over time.

Gasgoo.com: Global sourcing will definitely bring challenges to the logistics sector. What are these challenges? And how could global buyers overcome these challenges?

Raimund Diederichs: I think the challenges are certainly given first of all by the lead time, what I said, if you ship by containers, and I think most auto parts will be too expensive to ship by air10:08, so you have the three to four weeks on the sea, adding the land transport to the ports, and the same on the side in Europe or U.S., so you have another one to two weeks, it means that you have to manage the supply chain for five weeks, which is pretty long, compared with when you source locally, you have normally two or three days, certainly not for all components but for many components. So this is something where you have to be prepared as a Chinese supplier. How to overcome that? I think you have to start pilot, as a Chinese supplier, you have to start maybe looking into an European OEM, and trying to start delivering into that, and learn by doing it what you have to do, you have to track your goods over this process of five to six weeks, you may have to get to know how to finish a goods ware house, close to the OEM facility in Europe or U.S., these are the things you have to do. Frankly I think not everybody is ready to do that, because it is quite different if you're just connected by distance of two, three four hundred kilometers, having your OEMs close to here versus having this which is 12 or 24 hour transport distance versus a five to six weeks transport distance, and that is certainly put a high demand on what I said already, tracking of the parts, inventory management, and managing whatever customers requires, etc. so these are the challenges, but they are given the longest transport time.

Gasgoo.com: In china, what is the average percentage of logistics cost in OEM's overall revenue?

Raimund Diederichs: To be frank, I don't have a number, and I'll be very careful in putting you a number. There are the classic costs: inventory carrying cost, warehouse cost, and transport cost, these are the typical ones which people see as supply chain cost. In Europe, there often is between whatever six, eight, to ten percent, but you have a lot of these hidden supply chain cost, when you have bad quality, you have to send them back; if you have production schedule changes, since the supplier couldn't deliver on time, you have to change your product schedule, these are the hidden cost. I think they are much more important in the growth environment like we have today in China, because on the classic logistics, I think the freight cost, which is trucking and transport, you cannot do a lot on the inventory cost, given how close you are to interact. I would not say this percentage is the most important one, I would more look at the overall picture, what's the impact of the supply chain for the OEM in terms of candidate makers' production schedule, candidate seller's products, candidate doesn't have a support for the next product generation, to be on time with these new products, and there I would say this is much more important, than just measuring on a standard fact on transport or inventory cost which sum up to a certain percentage.

Gasgoo.com: China now has very efficient logistics infrastructure, such as highways, railways, and airports, why are their logistics and transportation cost for china's auto parts sector are still so high?

Raimund Diederichs: Yes, as a foreigner coming here and living in the impressive country for three years, I'm really impressed by the infrastructure put into the country, be it on railway, be it on street, be it on ports. To be frank, If you say we have high logistics cost, (I take that now as a classic logistics cost, which is transport), I don't think there are that high. My understanding is the transport cost in China is relatively low.

Gasgoo.com: Than European countries?

Raimund Diederichs: Yes, because you have certainly a kind of overcapacity of trucking, truck drivers, etc. with own truck school, would drive wherever you want to go. I think this will stay for sometime. We certainly have a problem of overloading, etc. that most of these trucks are whatever fact, 2 to 3, overload in some areas, I think this will go over time, go away, since this will be curbed by government, and all the governments is trying hard to diminishing that; That may increase a little bit of the transport cost, because the overloading would be reduced, but I wouldn't say this transport cost is a big issue, even they are a little bit more expensive in Europe. I think this is not a very big issue, in more having the parts on time, in a decent flexibility once the product changes at the OEM assembly factory.

Gasgoo.com: Could you give us some recommendation to the logistics providers of China's automotive industry?

Raimund Diederichs: Yes, looking at the logistics providers in the industry, I think compare that with Europe, what you have seen in Europe, that logistics really grow from pure trucking into warehouse management and quality management, etc. I would say that this will sooner or later come onto china, because as an automotive OEM, my business is assembling a car, innovating the car and assembling the car, but not running a warehouse, so this is I think an ideal field for logistics providers, that it means they don't just deliver by truck the parts from a supplier warehouse to an OEM warehouse, but start managing maybe the incoming goods warehouse from an OEM, by managing the whole inventories, managing the final distribution into the assembly plant, and managing even an optimum safety stocks and working stock levels for the OEM for this various supplier parts. So I think this pure logistics task will expand over time, but the challenges on behalf of the transportation companies to invest in this kind of challenges, to invest in this kind of knowledge, to make the OEMs a good offer of what can we do more than just trucking from one place to another.

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