Sourcing and Outsourcing in China
Challenges in the Interchange between Danish Companies Sourcing in China and their Chinese Counterparts
Name: Camilla Stendevad Christensen Date of birth: August 20, 1976
Supervisor: Kim Sundtoft Hald Date: May 7, 2012
Copenhagen Business School HD Suppy Chain Management
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Indhold
1. Executive summary ... 3
2. Introduction ... 4
2.1. Motivation ... 4
2.2. Problem statement and research questions ... 6
2.3. Delimitations ... 6
2.4. Structure of the text ... 7
3. Methodology ... 8
3.1. Research philosophy and approach ... 9
3.2. Choice of research method ... 9
3.3. The survey ...11
3.4. Selecting the samples ...13
3.5. The interviews ...14
3.6. Choosing the case companies ...15
3.7. Reflections on the methodology ...15
3.8. The survey companies ...16
3.9. The case companies...16
3.9.1. Company A ...17
3.9.2. Company B ...18
3.9.3. Company C ...18
3.9.4. Company D ...19
4. Theory ...19
4.1. Sourcing and outsourcing ...19
4.1.1. Reasons for sourcing in China ...21
4.1.2. Risks when sourcing in China ...21
4.2. Agency theory ...23
4.3. Risk Management ...26
4.3.1. Supply Chain Risk Management ...27
4.3.2. Risks in connection with global sourcing ...29
4.3.3. Relational Risk ...30
4.3.4. Performance Risk ...33
4.3.5. Product Quality Risk and Visibility in the Supply Chain ...34
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4.4. The cultural dimension ...37
Denmark and China – Hofstede’s cultural dimensions ...37
4.4.1. Face and ‘guanxi’ ...40
4.4.2. Communication ...42
4.4.3. Trust ...42
4.5. Selecting the right supplier in China ...42
4.6. Interaction among supply chain partners ...44
5. Analysis ...44
5.1. Supplier Selection ...45
5.1.1. Using ‘guanxi’ to find new suppliers ...46
5.1.2. Face to face contact ...48
5.1.3. Criteria for selecting suppliers ...48
5.2. Working with the chosen suppliers ...52
5.2.1. Price ...54
5.2.2. Communication and relations ...55
5.3. Main challenges in connection with sourcing in China ...57
5.4. Mitigation and Control Strategies ...59
5.5. Outcome ...63
6. Conclusion ...64
7. Possible further study ...67
8. Bibliography ...68
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1. Executive summary
Flere of flere danske firmaer vælger at flytte dele af deres produktion til Kina for at kunne optimere deres supply chain og drage fordel af den rigelige og billige arbejdskraft i det store land i Østen. At source eller outsource i Kina er dog ikke altid uden udfordringer, og denne opgaver søger derfor at se på nogle af de største udfordringer, der kan opstå i udvekslingen og samarbejdet mellem danske og kinesiske firmaer.
Opgaven identificerer i den henseende først og fremmest valget af leverandør som en af de først og vigtigste skridt på vejen mod at opbygge en god og solid leverandørbase i Kina og samtidig forebygge nogle af de mest graverende risikomomenter i forbindelse med outsourcing og sourcing fra Riget i Midten. For at sikre et så succesfuldt valg af leverandør som muligt, peger opgaven på fordelene ved at bruge kinesiske medarbejderes netværk og at møde potentielle leverandører ansigt til ansigt så tidligt som muligt i samarbejdsprocessen. Det er desuden vigtigt at de danske firmaer, der ønsker at finde leverandører i Kina fra starten af gør sig klart, hvilke kriterier og parametre, der er vigtige og så finde leverandører, der
matcher disse kriterier så tæt som muligt. Når leverandører vælges ud fra bestemte kriterier er det samtidig vigtigt at tydeligt at kommunikere alle sådanne kriterier til de kinesiske leverandører for så vidt muligt at undgå misforståelser, der kan lede til potentielle risikosituationer.
Når valget af leverandør først er foretaget ser opgaven på potentielle udfordringer i forbindelse med samarbejdet med de kinesiske leverandører. Især udfordringerne omkring sikring af kvalitet og leveringstid bliver diskuteret og forsætter med en diskussion af vigtigheden af at skabe et godt forhold til de kinesiske leverandører gennem for eksempel besøg i Kina. Besøgene bør ifølge opgavens anbefalinger samtidig ses som en mulighed for at indsamle information om leverandørerne og afgøre hvilket niveau af kontrol, der skal opretholdes for at sikre samarbejdet og leveringerne.
En overordnet og gennemgående udfordring for de danske virksomheder, der sourcer og outsourcer i Kina er sikring af kvaliteten af leveringer. For at forsøge at minimere udfordringerne i forbindelse med dette aspekt ser opgaven på strategien omkring delvist at skabe en tæt og langvarig relation med de vigtigste kinesiske leverandører, men også at have så højt et niveau af kontrol, som de giver mening at have i forhold til produktets vigtighed og pris. Tillid mellem de danske og kinesiske samarbejdspartnere bliver naturligvis set som vigtig, men kontrol evalueres også at være nødvendigt. Rigtigt mange af de benyttede strategier til at minimere risiko i forbindelse med indkøb og outsourcing til Kina bliver set som værende forskellige kontrolstrategier.
Opgaven afsluttes med en kort diskussion af, om hvorvidt der er en fremtid for produktion og indkøb i Kina.
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2. Introduction
It should be fairly well known that China over the last three decades increasingly has become a leading manufacturing centre for a wide range of products destined for the Western Market (Jia, Rutherford 2010).
Just between 1990 and 2001, the Foreign Direct Investment in China rose by 1269 % (Helbo, Jakobsen &
Gammelgaard 2007). The economy in China is not only distinguished by its rapid growth, but just as importantly by its size. More and more Danish companies are consequently looking to boost their performance by restructuring their supply chain and looking for ways to source manufacturing and service activities from the enormous low-cost country in the East. Many companies have managed moving part of their business to China, but just as many businesses have failed because of the many barriers between Scandinavia and China. When a Danish company decides to source parts of its production or service activities from China the decision can have unintended consequences, exposing the companies and their supply chains to hidden costs and new, and at times unforeseen risks (Jia, Rutherford 2010). There are of course some generic risks, which exist in the process of sourcing from all foreign countries, such as language obstacles, quality control, culture gap and contractual risks, and these risks are more than prominent when sourcing from China.
To many companies, China is an appealing market where the potential of saving or making a lot of money in a relatively short period of time can be very compelling, but looking at the RAPEX list of recalled products1, it is clear that quality risks in connection with sourcing or outsourcing to China is no small risk. Going through the list for the first 3 months of 2012, we find that more than half of all the recalled products on the European market are originating from China, and this does not even include the products, which have Chinese brand names, but where the origin has not been firmly established. In connection with the sourcing from China, it is therefore important to consider the total cost of the sourcing and on how to reduce some of the uncertainty and risk, which can lead to a higher total cost than first anticipated.
Otherwise, the cost saving through sourcing from China may not be as great as first expected. The focus of the paper is therefore which kind of challenges the Danish companies most commonly encounters and how they solve or avoid problematic outsourcing and sourcing experiences.
2.1. Motivation
Having graduated from the University of Copenhagen with a major in Chinese, and presently working with purchasing from China, the subject of supply chain risk management in connection with sourcing from China was very interesting and relevant to me personally. As the company I work for has relatively short time span for each procurement project and constantly have to find new suppliers, an incredible amount of
1 Source: http://ec.europa.eu/consumers/safety/rapex/index_en.htm visited on May 4, 2012
5 fire fighting and travelling is often required to get the business relationships in China to work. Knowing that personal relationship and the more long term aspects traditionally can be very important in a Chinese setting, I was interested in finding out how other Danish companies fared with their Chinese suppliers, what they saw as the greatest challenges when sourcing from China, how they selected suppliers, made the relationship work and how they mitigated supply chain risks.
In their article “Leveraging knowledge in China: the experience of a foreign entrepreneur”, Lightfoot and Almeida (2007) build on the experience of the Italian expatriate C. Saro, who had been doing business in China for 16 years. During an interview, Saro says:
“Negotiating with the Chinese can also be a real challenge, as they keep changing the rules to try to gain additional benefit; if things do not tilt in your favour, switch partners until you are in the better position. Negotiating is not a win-win proposition but a win-wear out one. It is hard to develop a trust based relationship under circumstances like these”. (Lightfoot, Almeida 2007)
Working with Chinese suppliers on an almost daily basis, I have experienced the constant changing of rules, which Saro mentions, even though I, as Saro, speak Mandarin Chinese and am often fairly quick to get on a friendly basis with the suppliers. The approach to Chinese suppliers that they would often change the rules and one should therefore often change supply partners did however not seem like a particular viable solution to me, so I were interested in trying to understand what kind of supply chain challenges other Danish companies had, and how best to mitigate and minimise these challenges.
It is clear that many Danish companies are gaining more and more experience in global sourcing and there are many who have ventured to China to both have access to the abundant and cheap labour and the enormous Chinese market. For many companies, sourcing or outsourcing to China does give access to a competitive advantage or at least to lower manufacturing costs, but the challenges to be overcome in the great Chinese market are also fairly considerable judging from the amount of research literature treating the subject (see for example (Jia, Rutherford 2010, Lightfoot, Almeida 2007, K.W. Platts, Song 2010, Millington, Eberhardt & Wilkinson 2006, Olson, Wu 2011, ROTH et al. 2008)). As the supply chains are being globalised and thereby significantly longer, the issue of supply chain risk management is getting an increasingly important topic. The leaner and more integrated the supply chains for the Danish companies get, the more uncertainties, dynamics and challenges in one link can affect the other links in the chain (Norrman, Jansson 2004). That it is necessary to look at other costs than just the simple cost of purchasing a product or a component when sourcing from China should therefore be fairly well-known by now.
Before starting this paper, I had the notion that even though it still makes sense for many Danish companies to manufacture in China, then it is not without difficulties and often a high degree of
6 uncertainty from the various challenges arising in the interchange between the Danish companies and their Chinese counterparts. In order to make decisions regarding supply chain risk management at the Chinese market, it is of course important first and foremost to identify or estimate the risk, which is what this paper is trying to do with a particular focus on the risks arising from the interaction between the Danish organisations and their Chinese partners.
2.2. Problem statement and research questions
The problem statement for this paper is being formulated as follows:
What kind of Supply Chain Risk Management challenges in the interchange between focal companies and suppliers are Danish companies outsourcing and sourcing in China most commonly encountering and how can risks related to these challenges be minimised/ mitigated?
Related research questions:
- What should the Danish companies be aware of when first choosing supply partners in China?
- What are some of the main cultural barriers between Danes and Chinese and how can they influence the supply chain?
- Why is it important to build a relationship with the Chinese counterparts and how can this best be done?
2.3. Delimitations
Within the field of global Supply Chain Risk Management a very long list of uncertainties and risk parameters can be mentioned, but most will not be discussed in this study as the scope of the paper is too limited and it would not be possible to discuss all of the risk factors in depth. The paper is for this reason first of all focussing on risks internal to the supply chain and in the interchange between the Danish buyers and the Chinese suppliers. It does not deal with risks related to for example currency fluctuations, volatility of customer demand, natural disasters, political risks etc. Moreover, to further limit and focus the discussion, the study is centred on the uncertainties evaluated as being most important by the respondents of the survey and the informants from the interviews. The perspective of the paper is for this reason the challenges in the interchange between Danish companies and their Chinese suppliers seen from the point of view of the Danish companies sourcing and outsourcing in China only, it does not take the point of view of the Chinese suppliers nor does it compare to sourcing in any other country.
The paper looks solely at SCRM challenges in connection with the actual ongoing sourcing and outsourcing to China. It does not enter into a discussion on whether the sourcing or outsourcing in China is in fact
7 relevant for the companies as opposed to sourcing from another country or insourcing. Moreover, the paper is focused on the risk and challenges, which may arise in the interchange between the Danish companies and the Chinese suppliers and therefore does not treat all of the risks related to the actual logistical issues also central to a supply chain.
2.4. Structure of the text
In order to be able to answer the research question, the text is divided into 9 chapters:
Chapter 1 introduces some of the reasons why Danish companies are increasingly sourcing and outsourcing to China, but also introduces that many challenges can be connected to working in the large country in the East. The chapter also looks at why it at all may be interesting to treat the subject of this paper and introduces the problem statement and delimitations for the paper.
Chapter 2 explains the research approach to the paper and discusses some of the considerations in connection with the empirical study and the research philosophy. The chapter also looks more closely at the practical considerations behind the survey and the interviews and introduces the survey and case companies.
Chapter 3 is both a literary review and a more general introduction to some of the theories which are relevant in order to answer the problem statement. The chapter discusses the concepts of sourcing and outsourcing and why it may make sense to source from China to begin with. Moreover, the chapter goes into a discussion of agency theory, risk management and supply chain risk management as well as examining some of the cultural aspects which may influence sourcing in China.
Chapter 4 is the core of the text, where the answers from the respondent companies and the case companies are analysed in the context of some of the theoretical perspectives from the previous chapter.
The chapter starts out by discussing the challenges in connection with finding the right supplier in China at what the Danish companies may be focussing on in order to mitigate any supply chain risk management challenges already from the start. Secondly the chapter looks at the cooperation with the chosen suppliers and moves on to look at the main challenges perceived by the survey and case companies when working with Chinese suppliers. In order to address the problem statement, the chapter also addresses some of the possible mitigation and control strategies of the Danish companies and ends up by shortly discussing the more long term implications in connection with sourcing in China.
Chapter 5 is the conclusion, which wraps up the discussions based on the theory and the findings of the text and the paper ends with a short discussion in chapter 6 of some possible further study.
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3. Methodology
The research approach mainly used in this paper is the inductive approach where the theory is developed as a result of the observation of the empirical data. The choice of using the inductive approach is most likely due to the author’s background in the social sciences and humanities, where the tradition is to try to understand the way in which humans interpret their social world and then analyse the collected data in order to formulate a theory(Lewis, Thornhill & Saunders 2009). Due to the fairly short time span of this paper, some elements of the deductive method did however have to be added, as the inductive approach often requires a longer period of data collection and analysis in order for the ideas and thereby the theory to emerge gradually. The two research approaches are however not mutually exclusive, but it may in fact lead to some advantages in the research process to draw in both approaches in the process. An overview of some of the major differences between the two approaches can be found in Tabel 1:
Deduction emphasises Induction emphasises
Scientific principles
Moving from theory to data
The need to explain causal relationships between variables
The collection of quantitative data
The application of controls to ensure validity of data
The operationalisation of concepts to ensure clarity of definition
A highly structured approach
Researcher independence of what is being researched
The necessity to select samples of sufficient size in order to generalise conclusions
Gaining an understanding of the meanings humans attach to events
A close understanding of the research context
The collection of qualitative data
A more flexible structure to permit changes of research emphasis as the research progresses
A realisation that the researcher is part of the research process
Less concern with the need to generalise
Tabel 1 Major differences between deductive and inductive approaches to research (Lewis, Thornhill & Saunders 2009)
The traditional inductive approach may be designed through first collecting qualitative data through interviews and then when an analysis and theory is formed go back through the deductive method to collect quantitative data. The present study was however designed through first gathering a general quantitative idea of steps and risks in connection with sourcing from China through a survey based on the author’s understanding on the research topic, followed up by 4 interviews to gather a qualitative data upon
9 which an analysis and theory could be formed. As the paper may be a cross-disciplinary study spanning both business and social research, the described method was chosen partly because it allowed more flexibility in the research, permitting changes underway and partly because the method was seen as a more thorough and less rigid approach to the subject.
3.1. Research philosophy and approach
Choosing the survey method and the quantitative research as a point of departure for this study might in principle point towards the positivistic research strategy, but due to various factors described below, the research approach is more pragmatic, meaning that more than one philosophy was adopted as supplements. The positivistic approach is originally from the natural sciences and the understanding is that the researcher’s role is neutral and that (1) the sciences confirm the senses; (2) facts are collected with the purpose of formulating regularities; (3) the role of the theory is to create hypothesises, which can be tested and that will thereby allow explanations of laws to be assessed; (4) data collection and data analysis must and can be conducted in a way that is objective and value free; (5) statements must be scientific – meaning that they should not contain any evaluations or estimations(Bell, Bryman 2007, Watt Boolsen 2008b). As the surveys for this study however were supplemented with interviews and as the writer of this paper moreover not only has a background in the humanities, but also has studied and worked with China for many years, a strictly positivistic and objective approach would most likely be close to impossible. The research philosophy is for this reason also strongly influenced by the hermeneutic approach, which emphasises that it is important to interpret to be able to understand (Bell, Bryman 2007, Watt Boolsen 2008b). Through the hermeneutic objective, it is important to understand situations through the eyes of the social actor and understand the meaningful phenomena in its context.
The role of the researcher in this tradition is ambiguous as it is necessary to relate to the informants’
interpretations at the same time as the researcher will try to convert the informants’ conceptions into science (Watt Boolsen 2008b).
Because of this double-sided approach, the word ‘respondent’ will be used throughout the study when any findings from the survey are presented (the positivistic approach) and ‘informant’ or ‘interviewee’
will be used when presenting information from the interviews (the hermeneutic approach).
3.2. Choice of research method
The tradition when writing the final paper to obtain the Diploma of Business Administration at Copenhagen Business School seems to be either conducting surveys or making a case study, but this in itself is of course not a sufficient rationale for doing the same for the present paper. Yin (2009) points to three conditions or
10 situations, which have to be considered when choosing research method, which is summarised in below matrix:
METHOD (1)
Form of Research Question
(2)
Requires Control of Behavioural Events
(3)
Focuses on
Contemporary Events
Experiment How, why? Yes Yes
Survey Who, what, where, how
many, how much?
No Yes
Archival Analysis Who, what, where, how many, how much?
No Yes/ No
History How, why? No No
Case Study How, why? No Yes
Tabel 2 Relevant Situations for Different Research Methods (Yin 2009)
According to above matrix, then both Survey and Case Study are adequate research methods when focusing on contemporary events, which the research question could definitely be said to do. Looking at the research question, then “what” questions can be exploratory and is a justifiable rationale for conducting an exploratory study such as a survey, where the goal is to develop pertinent hypotheses or proposition for further study (Yin 2009). In the case of this study, it could moreover be a form of “how many”, as the study is trying to identify the various ways in which Danish companies can encounter problems when doing business in China, and therefore the survey method does make sense for this study.
As second part of the research question for this study looks at “how” risks can be minimised, I did on the other hand also find it relevant to supplement the survey with a few interviews drawing on the case study. The “how” question are explanatory and according to Yin likely to lead to the use of case studies as the preferred method, when the focus is on contemporary events, and when we do not have control over behavioural events (Yin 2009). As this paper is asking the question of how risks can be minimised, it is not only focussing on what kind of challenges can arise in the sourcing process, but also on the contemporary event of sourcing from China without being able to control the behavioural occurrences.
The supplementing case study is by this definition a possibility to understand a real-life phenomenon more in depths.
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3.3. The survey
Once we have established that a survey is indeed part of the appropriate research method for answering the research questions for this study, it is relevant to define what is meant by a survey.
According to Merete Watt Boolsen, the scientific requirements for a survey are as follows (Watt Boolsen 2008b):
(1) Relevance: Are the questions centred on the topics of the survey?
(2) Precision: How small variations can be measured?
(3) Validity: Does the survey measure, what it is supposed to measure?
(4) Reliability: If the survey is repeated, will it reach the same conclusions?() Moreover, Merete Watt Boolsen distinguishes between the following forms of validity:
- Measurement validity (the degree of congruity between the concept and the measurement of the concept)
- Internal validity (the degree to which the analysis make sense, are convincing, reliable and reflect the problem statement)
- External validity (the degree to which contexts and processes are described in order to make it possible to compare to other surveys)
- Ecological validity (the degree to which the result makes sense in the concrete connection, and whether the scientific research can be used in the concrete context) (Watt Boolsen 2008b)
I chose the electronic questionnaire for collecting data, as this clearly was the fastest way of getting my questions to as many companies as possible. Moreover, by using the program SurveyMonkey, I would get easy access to analyse the survey results through the summarised data, which the program gave access to.
The downside to the electronic questionnaires is of course that response rate is usually very low and the section might not be representative (Watt Boolsen 2008b)(Watt Boolsen 2008a).
To get an idea of who to send my questionnaire to, I contacted the Danish Embassy in Beijing, who sent me a company list from the Trade Council of Denmark, China naming all the Danish companies having representation in China. In March 2012, I therefore sent e-mails addressed to the procurement department in each of the companies asking them to take 10 minutes to complete my survey. Moreover, I made a brainstorm of companies, which might likely be sourcing from China and sent an e-mail to each of these companies too. Finally I used my personal network to get my survey to as many procurement departments
12 in as many companies as possible. All in all, by this method, I sent out 237 e-mails and got 67 answers back, which was a response rate of about 27 %, or one fourth of the contacted companies answering the survey.
The program I used for the survey, SurveyMonkey, has functions, where I can track, who answers my survey and send a reminder to the ones, who did not answer. This function did however not allow that e- mails were forwarded, so if I had chosen to use this function, I would have had to call each of the companies to get the mail address of a relevant person. This was neither possible nor practical as most calls would have to be placed during my own working hours and I did therefore not use this function. Moreover, I had the feeling that many companies see their purchasing practices as central to their business strategy and they might therefore not answer the questionnaire unless it was anonymous. This assumption was later confirmed by several e-mails from the respondent companies saying that they would be happy to reply to my questionnaire, but they needed to make sure that the survey was indeed anonymous.
Having Danish companies as the focus of this study, it made sense to make the survey in Danish instead of English, even though the paper itself is written in English. By making the questionnaire in Danish, I would make sure that Danes were answering the questionnaire, as very different answers may have been obtained from for example Chinese nationals being employed in the procurement departments of the Danish companies. This angle could of course also have been very interesting to investigate, but was not the focus of this paper.
As most of the Danish companies having representation in China are of a certain size, it is not surprising that I mostly got answers back from larger companies. 35 respondents, or 53 %, answered that they were working in companies with 250 or more employees. Most of these companies already had a fairly long experience of sourcing from China, seeing that 39.4 % of the respondents from large companies answered that they had worked with their most important suppliers for 2 to 5 years, 45.5 % answered they had worked with them for 5 to 10 years and 12.1 % that they had been working with their most important suppliers for more than 10 years. For this reason it may be assumed that many problems and challenges had already been overcome in these large companies through many years of trial and error and because they would have resources to mitigate potential identified risks.
It might most likely have been an advantage to first have written the whole theory section of this paper prior to sending out the questionnaires, as this would have allowed me to more precisely target the issues discussed in the theory section. As I preferred to use the iterative approach, I did however start by first of all sending out the questionnaires. One of the reasons were moreover, that it seem important to get as many responses back as possible, which was also one of the reasons why I decided to send out the
13 questionnaires as early in the process as possible. I therefore based the survey questions on the basis of a few articles and on my personal experience with Chinese suppliers and consequently had to base the main parts of the theory section on the findings from the questionnaires and not the other way around. In order to make up for some of the short comings of the questionnaire, and to try and get a more nuanced view of some of the questions from the survey, I did however follow up the questionnaire with four short interviews.
3.4. Selecting the samples
There are many arguments supporting the impracticability of collecting data from the entire population of Danish companies sourcing or outsourcing to China, one of which of course is the lack of time and funding.
Moreover, no census seems to be available as to exactly how many Danish companies either source or outsource to China, which means that it is not possible to know how many companies are in the full population for this study. For this reason it was instead necessary to select a sample.
In order to delimit the population, it might in hindsight have been expedient to only include the Danish companies in the survey, which had representation in China, and thereby were represented on the list, which the Royal Danish Embassy in Beijing publishes every year. Thereby there would have been a sampling frame and the possibility to generalise about the population based on the sample would have been stronger. The problem with the list was however that some of the companies represented there in fact seemed to be Chinese companies with Danish people being employed, and some of the companies on the list turned out to not have representation in China after all. Finally, only using the companies represented in China may have meant that some interesting risk aspects in connection with Supply Chain Risk Management would not have been included in the paper, as it must be assumed that the companies represented in China are the ones being most successful in the Middle Country and some important challenges may thereby have been overlooked. It may however be argued that the fact that the total population size is unknown is a weakness in this research as it makes it less possibility to generalise based on the findings, but this was first of all a choice of the author and secondly, less concern with the need to generalise is as mentioned a feature inherent to the inductive approach (Lewis, Thornhill & Saunders 2009).
The findings from the respondent companies may consequently not be used as saying anything in general about Danish companies sourcing in China, but it may give an idea of some interesting trends and concerns.
The non-probability sampling provides a range of alternative techniques to select samples based on subjective judgement (Lewis, Thornhill & Saunders 2009). The sampling techniques used were a mix of convenience sampling by sending out e-mails to all the companies on the list from the Royal Danish Embassy in Beijing; snowball sampling by asking friends working in or with companies sourcing from China
14 to help me get the questionnaires answered; and self-selection sampling where the individuals, who heard about the survey themselves identified their desire to take part in the research (Lewis, Thornhill & Saunders 2009, Bell, Bryman 2007). These sampling techniques did most likely create some bias and resulting in some level of homogeneity in the sample.
For all non-probability sampling techniques, the best sample size is according to Saunders et al. (2009) ambiguous and there are no fixed rules. Even though it is clear that the bigger the sample, the more representative it is, regardless of the size of the population from which it is drawn(Bell, Bryman 2007), then the sample size was dependent on what was possible to gather within the time frame given for this paper.
With this sampling approach, the sample is to some degree biased and may as already mentioned not represent the whole population, as a non-probability sampling is mostly likely affected by human judgement. It may have been desirable to remove the bias from the sample, but this will in any case mostly be close to impossible to do all together, even when the sample has been selected using probability sampling. Moreover, then any findings can only be generalised to the population from which that sample was taken (Bell, Bryman 2007). We should therefore be aware that the sample for this research is to some extent a biased non-probability sampling, which should not be used to generalise for the whole population of Danish companies sourcing in China, but it can still provide some valuable insights.
3.5. The interviews
Complementing the survey with qualitative interviews was evaluated to be advantageous to supplement the exploratory and explanatory element of the study. This can in a sense be seen as a multiple case design, but as the method for this paper is seen as a mix between the survey method and the case study, the various case studies are not as thoroughly described as they might have been in a study solely focussing on the case studies as the empirical approach.
In order to collect information from the case organisations, interviews of between 30 and 45 minutes were carried out with four individuals from four different companies. Each of the individuals was managers or owners in the companies and therefore well placed to have a thorough knowledge of the strategies and processes of the sourcing process. According to Steinar Kvale (2008), then an interview is a conversation with a structure and a purpose between two or more people; it is an inquisitive method with the aim of bringing about thoroughly examined knowledge. The interview method used for this study was the semi- structured interview, which is defined as an interview with the objective of collecting descriptions of the outlook of the interviewee with a view to interpret the meaning of the described phenomena (Brinkmann, Kvale 2009). A semi-structured interview is by definition and interview where the researcher may have a list
15 of themes and questions to be covered, but the order of the questions may be varied, and questions may be changed or omitted, depending on the specific organisational context and the flow of the conversation (Lewis, Thornhill & Saunders 2009).
The interviews were all conducted in Danish and face to face, but the citations of the interviews are translated into English in this paper. A complete transcript o the original Danish interviews can be found in Appendix A.
It should finally be mentioned that the interview with company A was an interview conducted within the company where the author of this paper work, meaning that there already was a relation between the interviewer and the interviewee, which may have influenced the interview. The author did not know the informants of Company B, C and D beforehand.
3.6. Choosing the case companies
The choice of the case companies were made purely based on accessibility. When I sent out survey-mails, I at the same time asked if the respondents might be interested in following the survey up with an interview.
In this connection, only one person from a company based in the Copenhagen area reverted with an invitation for a more thorough interview. Five persons from companies in Jutland were also open for an interview, but due to the impracticability of going to Jutland in the period of writing this paper, and due to a preference for meeting face to face, these were not used. It should be noted that the findings of this paper might have been strengthened considerably if these interviews had in fact been conducted. Two other case companies presented themselves through the personal connections used to get respondents to the survey and the final case company was, as mentioned, the company where the author works herself.
3.7. Reflections on the methodology
Looking back, it might have strengthened the empirical data, if I had in fact first conducted some or all of the interviews with the case companies and then later formulated and sent out the questionnaires. The reason why this might have made more sense is that the questionnaire first of all was formulated based on my own knowledge of sourcing in China, and conducting some or all of the interviews before formulating the questionnaire might have added some aspects to the questions asked. Alternatively, I might also have increased the quality of the survey, if I had first sent out some test surveys and got feedback on these before sending out to all of the possible respondent companies, but time did again not permit this. Another strengthening of this paper could also have been made by actually travelling to Jutland to interview a broader range of companies and by this make sure that more interviews were conducted at larger companies with more experience in sourcing from China.
16 A weak point of this paper might also be that I may have had a blinkered view by looking at the Supply Chain Risk challenges as if they are specific for China, where many of the challenges may in fact be applicable to sourcing and outsourcing to other countries or even Denmark as well. A better understanding of general sourcing challenges and a comparison with other countries, in order to pinpoint which challenges were specific for China and which more general, could probably have strengthened the paper, but due to the time limit, I chose not to take this focus.
3.8. The survey companies
As most of the respondents companies were found by contacting the companies, who were listed as having representation in China, it may not be surprising that the largest part of the response companies, namely 53.1 % were large companies with more than 250 employees. 21.9 % of the respondents were from middle sized companies, 14.1 % from small companies and 10.9 % from micro companies. Out of the 65 respondents, 80 % had representation in China through mostly sourcing – and/or sales offices, but also with own manufacturing facilities and even research departments. All the respondents had been sourcing or outsourcing to China for at least one year and about 85 percent of the companies had more than 5 years experience in China out of which 45.3 % even had more than 10 years’ experience in the large country in the East. The fact that such a large percentage of the companies had long experience in China may also mean that many strategies had already been tried and tested and many challenges with the Chinese suppliers might therefore by now have been solved or risk mitigation practices put in place.
Traditionally, mostly simple, cheap components are sourced from China, and more than half, namely 50.8 % of the respondents still sourced these kinds of components or material from China, but it is at the same time worth noting that 42.4 % also sourced simple, but high value components, 49.2 % sourced complex, but cheap components and 39 % in fact sourced complex and high value components from China. One respondent answered: “The trend is clearly that we are aiming towards more complex products with a higher value than for instance 5 years ago” (Survey, Mar. 11, 2012, 11:50 PM)
3.9. The case companies
In order to get a more thorough understanding of what kind of Supply Chain Risk Management (SCRM) challenges Danish companies are encountering when sourcing in China, the surveys were supplemented by interviews in four different companies all sourcing from China. This section is aimed at giving an idea of some of the background information of the case companies. As one of the case companies preferred to stay anonymous, it was decided to keep all four companies anonymous and they are for this reason called Company A, B, C and D.
17 3.9.1. Company A
Is the company where the writer of the paper works herself and therefore has some extra insight into processes and challenges in connection with Company A’s sourcing in China.
Company A is a small Danish company with 15 employees. The company is a tender based trading company doing offers for organizations such as United Nations, the World Bank, EuropeAid and Japan International Cooperation System and has been sourcing in Asia and mainly China for about 25 years. Apart from a few long term contracts, the company is mainly finding new suppliers for each project, which means that all collaboration with Chinese suppliers is on a one-time or very short term basis. Company staff is often travelling to China to meet with Chinese suppliers before contracts for larger projects are placed and when complications have arisen underway.
Company A is chiefly focused on sourcing construction and electrical equipment from China, which in most cases are fairly simple products with many possible suppliers. All the technical specifications are received from Company As customers and passed on to the Chinese suppliers, who are not allowed to change anything in the design.
Suppliers are mainly found through the Internet and first point of contact is a telephone call from a staff member followed up by an e-mail. Usually a broad field of potential suppliers is contacted for a specific project and the final choice is done based on prices, quality certificates, ability to document and meet specifications and the general communication with the supplier. When possible, Company A prefers to always have 2-3 potential suppliers for each project.
Company A does usually not know anything about their suppliers’ sub-suppliers.
When new suppliers are used, Company A is almost always making sure to arrange inspection by an external company before the finished goods are shipped directly to the customers. When larger and more important orders, a staff member of Company A would moreover travel out to visit the suppliers either before or during the production to supervise and control the production process. In contrast with Company B and D, then Company A does not have anyone employed in the company, who were technicians or specialised in the products, which Company A was sourcing in China. This means that Company A must either engage third party inspection companies to check the products, or they must rely on the logical sense of the non-specialised employees travelling out to supervise and control the process.
The interview was carried out with a project manager, who had been working with sourcing from China for about 10 years and is involved in most supplier decisions.
18 Company A is using many resources both on preventing problems in connection with sourcing from China and on fire fighting once complications arise.
3.9.2. Company B
Company B is a large Danish company with around 1050 employees worldwide. The company is both sourcing and outsourcing to China and has done so for about 5 years. The company is producing very sophisticated sound and vibration measurement equipment and is both sourcing simple components and critical parts from China.
Suppliers for Company A are selected through a fairly sophisticated process. Because Company A is part of a larger group of companies, they have a setup, where dedicated people in Shanghai and China on behalf of 14 different companies are doing supplier selection, evaluation and approval before any suppliers are presented to the individual company managers and further selection can be carried out.
Company B had a control system installed by their Chinese suppliers, where they could monitor the quality of the produced products online every month. Moreover then all finished products were inspected and tested before leaving the factory.
When the equipment produced is critical, Company B would usually know about their suppliers’ sub- suppliers. They would not know anything, when the components were not critical.
In Company B, the interview was conducted with the Group Sourcing Manager, which means that the interviewee was responsible for all the suppliers used by the company group. The interviewee was in China about once a year to visit some or all of the Chinese suppliers.
3.9.3. Company C
Company C is a small Danish company with 5-6 employees having sourced in China for 12 years. The company is doing merchandise and textile branding, which ranges from very simple products like ball pens to more complicated products used for foods and therefore subject to strict food safety demands.
Chinese suppliers were mainly found through trade fairs, where the first point of contact was through personal exchange.
For larger orders, an inspection on random samples would be carried out by an external company at the factory before the finished products were shipped off to Denmark. For smaller or simpler orders this would not be done, as it would make the product too expensive.
19 Company C put emphasis on cooperating as long time as possible with their Chinese suppliers and would make sure to travel to China to meet suppliers and cultivate contacts about once a year. The interviewee said in this connection: “We very seldom change suppliers. For better or worse. For worse because we may not always get the very best prices, but on the other hand then we can really trust the ones, who deliver to us. So there is not so much flow in the suppliers” (Appendix A, p. XXV).
Company C does not know anything about their suppliers’ sub-suppliers.
In Company C, the interview was carried out with the owner of the company, who had started sourcing form China about 12 years ago.
3.9.4. Company D
Company D has 1 to 3 employees depending on the work load and had been sourcing from China through contacts in Hong Kong for around 15 years. The products are fairly complicated watches, where many sub- suppliers usually are necessary.
The suppliers were mainly found through trade fairs in Hong Kong and thereby through a personal contact.
No inspection is ever carried out at the factory, but everything is inspected meticulously once it arrives at the offices in Denmark. Any items with errors are sorted out and sold as second quality, but everything is paid for at Company D always pays in advance. If the errors are grave, Company D would inform the suppliers and hope that the errors would be corrected by next shipment. Small errors would not be reported.
Focus would be on long term cooperation, but communication would only go through the contacts in Hong Kong. No effort was made to directly find suppliers in Mainland China.
4. Theory
Multinational companies can greatly benefit from being able to exploit the advantages of being in regions with different capital and labour markets. China has in great deal gained from this with the growth of its productivity and the diffusion of knowledge from the foreign companies entering the Chinese market and building relationships with the local Chinese firms.
4.1. Sourcing and outsourcing
Partnerships in supply chains can vary from everything from spot purchases, where the relationship is purely transactional to relationships characterised by a kind of virtual integration, where the other supply
20 chain member almost is a member of the focal company (Lyles, Flynn & Frohlich 2008). Most literature seems to concentrate on outsourcing rather than just sourcing from China. A distinction should of course be made, as there can be differences in for example the time perspectives and the degree of integration between businesses. This paper does however consider that some of the core issues to be discussed in connection with security issues in China can be applied to both sourcing and outsourcing, which is why the paper at times deals with the two concepts interchangeably.
Outsourcing can be defined as subcontracting a process to a third-party company. It is ‘the operation of shifting a transaction previously governed internally to an external supplier through a long-term contract, and involving the transfer to the vendor (Freytag, Clarke & Evald 2012). While sourcing or purchasing can just be a simple financial or purchasing decision, outsourcing has a more long term aspect.
Sourcing and outsourcing can be very important in connection with making a supply chain cost-effective, but it does also involve a number of inherent risks (Olson, Wu 2011). In the sourcing or outsourcing process, organisations can adopt various strategies, some of which involve more risk than others.
Sourcing products and services across the global marketplace is an increasing trend in the constant search for optimising supply chains. As the Internet makes communication globally possible in real time, there is a rapid development of the international and global business. It has developed over time from mainly being manufacturing activities to now including all possible activities such as product development, market intelligence, logistics, administration, sales, IT and business process services(Lyles, Flynn & Frohlich 2008, Freytag, Clarke & Evald 2012).
Outsourcing can not only save labour costs, but it can also reduce many risks to the core organisation such as financial exposure, overcoming limits of productive capacity and easier compliance with local regulations.
Other benefits of outsourcing include more flexibility of the focal company, converting fixed costs to variables, opportunity to focus resources on core activities, and the possibility of improving time to market (Olson, Wu 2011, Freytag, Clarke & Evald 2012). While outsourcing can provide a wide range of advantages, it is just as often related to difficulties and unfulfilled expectations, and more and more firms seem to have to re-evaluate their sourcing decisions underway (Freytag, Clarke & Evald 2012). About 20 % of outsourcing agreements are terminated after two years and 50 % terminated after four years according to an international survey by Dun and Bradstreet (Freytag, Clarke & Evald 2012). Another survey by Deloitte Consulting (2005) found that 70 % of respondents had negative experience with outsourcing because the outsourcing objectives were not fulfilled and 25% of the respondents brought originally outsourced services back in-house again (Freytag, Clarke & Evald 2012). The act of bringing originally outsourced business in-
21 house again can also be called backsourcing. There are of course many reasons for backsourcing, but some major reasons seem to be problems, which cannot be solved, new opportunities arising or wanting to rebuild internal capabilities (Freytag, Clarke & Evald 2012). The problems with outsourcing can also be many and varied, some of the most common ones being loss of core competences; being leveraged by suppliers; the loss of strategic flexibility, suffering interruptions to supply, receiving poor quality of supply, fall in employee morale; loss of internal coherence; confidentiality leaks and loss of intellectual property rights(Freytag, Clarke & Evald 2012). Other problems also often mentioned are in the relationship between the firms, where the cultural differences, lack of sufficient project specification or difficulties in knowledge transfer could influence the success of the outsourcing or sourcing.
All these issues make it clear, that sourcing is strategic, and managers must make sure to look at it strategically.
Changes in sourcing solutions are often not easily made, as the consequences of reconsidering and changing an arrangement may be difficult to oversee and calculate. The different issues in connection with the changes in sourcing solutions may point in different directions and careful attention should be made to as many factors as possible without paralysing the organisation. Taking a new supplier may seem attractive due to for example lower costs, but switching costs, control costs and the level of risk connected to another supplier may be high.
4.1.1. Reasons for sourcing in China
There is a fierce competition for the North American and European market between the traditional outsourcing destination countries such as India, Ireland, Israel and China (Olson, Wu 2011). China has over the last decades become very attractive to Western companies seeking to source or outsource products and services due to the abundant low wage and efficient labour resources. According to Olson and Wu, China’s trade is now around 10 percent of the total trade in the world and is the number one destination for foreign direct investments (FDI) from OECD nations (Olson, Wu 2011). Already in 2004, China became the number one exporter of technology products in the world.
As the possibility of communicating in real time through the Internet and phone improves, the risks of sourcing from China are somewhat reduced. Moreover, the increasing use of international product standards reduce the risks of non-compliance (Olson, Wu 2011).
4.1.2. Risks when sourcing in China
While outsourcing to China reduces some business risks, it does however also expose the core organisation to other risks. The list of risks to supply chains in connection with sourcing from China is long and the
22 question is of course always whether it is outweighed by the advantages of sourcing from the low cost country.
One of the larger problems when sourcing from China is the quality of the products getting produced there (Lyles, Flynn & Frohlich 2008) and companies should be aware of the challenges in connection with the lack of technological expertise, quality fluctuations, poor delivery performance, inconsistent raw material quality, poor process control, undisciplined quality systems, low machinery capacity and inadequate inspection equipment, to mention some of the major quality problems when sourcing in China. The problems in connection with having to recall products may be caused by problems such as purposeful counterfeiting, improper manufacturing techniques or poor design – the latter however not necessarily the fault of the Chinese supplier. According to RAPEX (Rapid Alert System for Non-Food Products), the number of cases where products had to be recalled due to quality problems within the European countries have doubled during the period 2005-20102 (Ying et al. 2011)). In 2009, more than half of these cases involved products originating from China. As a result of the many recalls, the popular attitude towards products from China has been deteriorating and lowering the level of trust in Chinese supply chains (Lyles, Flynn &
Frohlich 2008). Recalling products due to quality issues is of course also very problematic and harming on many levels for the company outsourcing or sourcing products in China in the first place. Not only is it costly for a company to recall a product, the scandals can also seriously harm the reputation and brand of the company at the end of the supply chain (Ying et al. 2011).
Product recalls most often are caused by either manufacture defects in which the products do not conform to specifications or design defects, where products do not meet safety standards (Lyles, Flynn & Frohlich 2008). A major problem is that the quality of a company’s products often not only depends on the company’s own quality, but also of the quality of the supplier’s and the supplier’s suppliers. The increase in the Chinese product harm incidents may of course be due to the increased complexity of products, closer scrutiny by manufacturers and policy makers, and higher customer demands (Ying et al. 2011), but it is without a doubt also due to the lack of visibility and traceability in the Chinese supply chains. Traceability means that there is documentation that proves that supplier has followed the procedures throughout the whole process from the origin to the point of sale (Lyles, Flynn & Frohlich 2008) and this is often very difficult to obtain in the Chinese supply chains. Lyles et al moreover list miscommunication, betrayal of trust, cross-cultural differences in values, relationships, and rules of reciprocal exchanges as origins for quality issues in the supply chain (Lyles, Flynn & Frohlich 2008).
2 Source: http://ec.europa.eu/consumers/safety/rapex/index_en.htm, visited on May 4, 2012
23 In China, longer supply chains may occur due to ‘cheng bao’ (承包- subcontracting) sometimes being used as a way to fulfil favours and ‘guanxi3’ (关系) obligations. The supply chains may in this respect be less efficient due to cultural expectations (Lyles, Flynn & Frohlich 2008). Longer supply chains do of course not only make traceability and visibility within the supply chain even more difficult, but it also aggravates any Bullwhip effect, which may arise in the chain. The Bullwhip is the experience that any problems or issues appearing down-stream in the supply chain will grow in effect and may end up having devastating effects on the upstream supply chain partners (Lyles, Flynn & Frohlich 2008). Since the Bullwhip threatens to make everyone across the supply chain lose money, upstream suppliers are just as dependent on their downstream partners as upstream companies are on their upstream sources. For this reason, it may make sense to choose the suppliers based on past relationships and actual performance over the previous months or years (Lyles, Flynn & Frohlich 2008). Because of the interdependence, up-and downstream partners in China are often looking to build relationships where suppliers have little to worry about in terms of demand, and buyers are sure of their supply in order for all partners to obtain greater stability and resulting profitability (Lyles, Flynn & Frohlich 2008).
In order to ensure quality of the supply from China, many companies use third party assessment of suppliers, but it may still be difficult to monitor and check all levels in the supply chain, as the third-party assessors typically can only visit each of the many suppliers once or twice a year. Moreover, if all links in the supply chain should be continuously monitored, it may increase the price of the various components and products so much that it defeats the whole point of relocating the production to China in the first place in order to take advantage of the lower cost labour (Lyles, Flynn & Frohlich 2008).
4.2. Agency theory
Risk absorbtion and risk sharing between buyers and suppliers can be studied through the lens of “agency theory” (Tse, Tan 2011). This theory deals with the risk sharing problem when cooperating parties have different standpoints towards risk and when the cooperating parties have different objectives and division of labour (agency problem). Especially, agency theory is concerned with the omnipresent agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work (Eisenhardt 1989). The theory is mainly concerned with two problems, which arise in agency relationships. The first is the agency problem that arises when (a) The desires and objectives of the principal and agent conflict, and (b) it is difficult or expensive for the principal to verify what the agent is actually doing. The second is the problem of risk sharing that occur when the principal and the agent have different attitudes toward risk, where the principal and the agent may prefer different actions because of
3 For further discussion on ’guanxi’, see “The Cultural Dimension” below
24 the different risk preferences (Eisenhardt 1989). The unit of analysis is the contract governing the relationship between the principal and the agent and the focus of the theory is on determining the most efficient contract governing the principal-agent relationship (Eisenhardt 1989).
Agency theory has developed along two lines: the positivist and principal-agent. The two streams are however complementary as the positivist theory identifies various contract alternatives, while the principal-agent theory indicates which contract is most efficient under varying levels of outcome uncertainty, risk aversion, information and other variables (Eisenhardt 1989).
In the positivist theory, the first proposition is that when the contract between the principal and the agent is outcome based, then the agent is more likely to behave in the interest of the principal, as the preferences of the agent thereby is aligned with those of the principal because the rewards for both depends on the same actions. The second proposition is that information systems can reduce agent opportunism, since the information system would inform the principal about what the agent is in fact doing whereby the agent will realise that he or she cannot mislead the principal. The theory is thereby that when the principal has information to verify the agent behaviour, then the agent is more likely to behave in the interest of the principal (Eisenhardt 1989).
The focal point of the principal-agency theory is determining the optimal contract, behaviour versus outcome, between the principal and the agent (Eisenhardt 1989). The simple model in this theory presumes a goal conflict between the principal and the agent, that the outcome can be easily measured, and that the agent is more risk averse than the principal. If the principal in fact had complete information of what the agent was doing, then a contract based on behaviour would be most efficient. If the principal, as is most often the case, however does not have complete information of what the agent is doing, then, given the self-interest of the agent, the agent may or may not behave as agreed. The agency problem then arises when the principal and the agent have different goals and the principal cannot determine if the agent is in fact behaving appropriately (Eisenhardt 1989). In this aspect two problems are cited:
- Moral hazard, which refers to a lack of effort by the agent. Meaning that the agent may not put forth the agreed-upon effort.
- Adverse selection, which refers to the misrepresentation of ability by the agent. Meaning that the agent may claim to have certain skills or abilities, which the principal cannot completely verify (Eisenhardt 1989).
In the case of unobservable behaviour due to moral hazard or adverse action, the principal can either try to discover the agent’s behaviour through investing in information systems or the principal can contract on
25 the outcomes of the agent’s behaviour. With an outcome-based contract the preferences of the agent is co-aligned with those of the principal, but at the price of transferring the risk to the agent, as outcomes are only partly a function of the agent’s behaviour (Eisenhardt 1989). In this case, when outcome uncertainty is low, then the cost of shifting risk to the agent should be low and outcome based contracts is therefore the more attractive choice. When uncertainty however is high, it will more expensive to shift risk despite the motivational benefits of outcome-based contracts (Eisenhardt 1989).
The main point of this simple model within the principal-agent theory is consequently the trade-off between the cost of measuring behaviour and the cost of measuring outcomes and transferring risk to the agent (Eisenhardt 1989). Eisenhardt draws up a number of additions to the simple model though; one is in the case where the agent might not be as risk-averse and it therefore becomes more attractive to pass risk to the agent using an outcome-based contract and conversely the more risk averse the agent becomes, the more expensive it becomes to pass on the risk. Another extension is to relax the assumption of the goal conflict between the principal and the agent, in which case the agent will behave as the principal would like whether his or her behaviour is monitored or not. As goal conflict decreases, the less it makes sense to use the behaviour-based contract. Yet another set of extensions pertain to the task performed by the agent, where one assumption is that the more the appropriate behaviour of the agent can be specified in advance, the more it makes sense to use the behaviour-based contract, and the more measurable the outcome is, the better to use the outcome-based contract (Eisenhardt 1989). Finally, Eisenhardt propose that when principals and agents engage in a long-term relationship, the principal will probably learn about the agent and will by this be more able to assess behaviour. In opposition, in short-term agency relationships, the information asymmetry between principal and agent is likely to be larger and therefore the outcome-based contracts would be the better option.
In summary, then the underlying assumptions of the agency theory are that suppliers in general are risk averse, but large suppliers are less risk averse. According to the agency theory, the buyer is the principal, who entrusts to suppliers, the agent, the task of producing different parts or components. The principal then decides whether and how to share the risk arising from unpredictable fluctuations in the supplier’s product quality. The Principal does however often not know the source of the agent’s quality fluctuations (information asymmetry) as the agent should have a better idea of the product quality (the source of defect) than the principal. Because of this information asymmetry, the principal may not always take the proper action in risk management and may decide to shift or absorb risk, unduly favour or penalise a supplier, or take other action, which may not be to the advantage of the supplier either. For this reason, a better supply
