Logistics of Low Cost Country Sourcing

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Logistics of low cost country sourcingNaveen Kumar a; Dan Andersson b;Jakob Rehme c

a Department of Management and Engineering, Division of Logistics Management, LinköpingsUniversity, Linköping, Sweden b Department of Technology Management and Economics, Division ofLogistics and Transportation, Chalmers University of Technology, Göteborg, Sweden c Department ofManagement and Engineering, Division of Industrial Marketing, Linköpings University, Linköping, SE,Sweden

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To cite this Article Kumar, Naveen , Andersson, Dan andRehme, Jakob(2010) 'Logistics of low cost country sourcing',International Journal of Logistics Research and Applications, 13: 2, 143 — 160To link to this Article: DOI: 10.1080/13675560903557841URL: http://dx.doi.org/10.1080/13675560903557841

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International Journal of Logistics: Research and ApplicationsVol. 13, No. 2, April 2010, 143–160

Logistics of low cost country sourcing

Naveen Kumara*, Dan Anderssonb and Jakob Rehmec

aDepartment of Management and Engineering, Division of Logistics Management, Linköpings University,SE-581 83 Linköping, Sweden; bDepartment of Technology Management and Economics, Division of

Logistics and Transportation, Chalmers University of Technology, SE-412 96 Göteborg, Sweden;cDepartment of Management and Engineering, Division of Industrial Marketing, Linköpings University,

SE 581 83 Linköping, Sweden

(Received 15 October 2007; final version received 15 December 2009 )

Increasing globalisation creates new possibilities for sourcing from low cost countries (LCC), but alsocomes with a range of logistics challenges and issues to be dealt with. The purpose of this paper is toinvestigate how logistics and its impacts are considered in LCC sourcing decisions.An exploratory multiplecase study of industrial product companies engaged in distant LCC sourcing serves as an empirical base.Findings reveal that firms do not explicitly take logistics into account during LCC sourcing decisions. Evenif logistics is considered, it is generally in a reactive way and takes a transactional cost focus. Instead, wepropose a framework to proactively consider logistics factors in the early stages of LCC sourcing. This isdone through identifying product and supplier related logistics factors and their impact on pre-transaction,transaction and post-transaction elements in the Total Cost of Ownership model.

Keywords: global sourcing; international logistics; low cost country; sourcing decision; total cost ofownership; industrial products

1. Introduction

In recent years globalisation has had a significant impact on supply-chains. Instead of procuringfrom nearby suppliers, Western corporations are increasingly buying from companies in low costcountries (LCC) (Rehme et al. 2006). Sourcing from suppliers in the same or nearby countrieshas many differences when compared to sourcing from Asian countries such as China and India(Schary and Skjøtt-Larsen 1995). The principles of lean supply chain management, close relation-ship with suppliers and flexible manufacturing are considered to be in conflict with long supplychains from distant suppliers (Levy, 1997). Apart from the obvious purchasing challenges in LCCsourcing, there are also a number of logistical challenges in terms of distance, time, inventoryrequirement, demand volatility, documentation and customs barriers (Babbar and Prasad 1998,Handfield 1994, Levy 1997, Murphy and Daley 1994, Schary and Skjøtt-Larsen 1995). How-ever, general purchasing literature and international purchasing literature seem to be focused on

*Corresponding author. Email: [email protected]

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144 N. Kumar et al.

the purchasing aspects of LCC sourcing, such as determining product specifications, finding andselecting suppliers and negotiating with them (Carter and Narasimhan 1990, Motwani et al. 1999,Kumar and Rehme 2008), and neglecting the logistics perspective during the LCC sourcing deci-sion. Logistics factors such as on-time delivery and cost are considered only when the actualsourcing begins (Van Weele 2002).

The increased volume and value of products with a longer lead time in the distant supplychain compels for good logistics planning capability in the early stages of LCC sourcing decisionmaking (Fawcett et al. 1997). An LCC is generally characterised with low logistics maturity(Arvis et al. 2007), making logistics issues important in LCC sourcing decisions. It is also arguedthat international logistics and purchasing strategies must complement each other, and that theyare critical for success in LCC sourcing (Babbar and Prasad 1998, Trent and Monczka 2005).Babbar and Prasad (1998) note that there are very few firms engaged in international businessthat have well defined or integrated strategies for international purchasing and logistics. Althoughprevious research has addressed some logistics issues in international purchasing (see, e.g., Zengand Rosetti, 2003, Fawcett et al., 1997, and Fraering and Prasad, 1999), such research is stillfairly limited and does not explicitly deal with logistics in relation to LCC sourcing (Kumar andRehme 2008). Given these challenges, the question must be posed as to what extent logistics isconsidered when LCC sourcing decisions are made.

The purpose of this paper is to investigate how logistics issues and their impacts are consideredin LCC sourcing decisions. The scope of this paper will deal with the first two steps of thepurchasing process, i.e., determination of specification and selecting supplier in the sourcingstage as defined by Van Weele (2002), and the interplay with logistics factors influencing thesetwo steps in LCC sourcing.

There are many similar terms used to depict the situation when companies start to buy productsfrom other countries. Different definitions are used in varying contexts and are termed in variousways such as international purchasing, global sourcing, import sourcing and offshore sourcing(Arnold 1989, Trent and Monczka 2005, Swamidass 1993, Farrell 2004). Cost benefit emergesas a common motive in many studies about international purchasing (Birou and Fawcett 1993,Handfield, 1994, Frear et al. 1992, Trent and Monczka 2005). From a purchasing literature per-spective, sourcing is a part of the purchasing process that deals with the planning phase ratherthan the implementation phase (Van Weele 2005). LCC sourcing is a specific case of internationalpurchasing and needs a different approach to understanding and decision making. An LCC is acountry where some factor prices (often labour) are lower than the international average. An LCCof today may not stay low-cost in the future, making the search for LCCs a constantly moving tar-get. In this constant search for cost reductions and relocation of suppliers or production facilities,companies will face a variety of logistics challenges.

The next sections cover a theoretical frame of reference followed by the methodology of datacollection. Case companies are illustrated followed by analysis and discussion. A summary of theresults and the conclusion is presented in the final section.

2. Theoretical frame of reference

There are a number of decisions and analyses that must be made in sourcing from LCC. Decisionstages include need definition, product identification, supplier evaluation and management ofoperations (Carter and Narasimhan 1990, Motwani et al. 1999, Zeng 2003). These stages aresimilar to those in the general purchasing process.

The first three steps in the purchasing process are labelled sourcing and the subsequent stepslabelled supply (Van Weele 2005, p. 13). Quantity and on time delivery reliability are the logistics


International Journal of Logistics: Research and Applications 145

factors involved in the sourcing phase of the purchasing process and other logistics factors suchas ordering policy, inventory control, order expedition and follow up and monitoring deliveryreliability are included in the supply phase (Van Weele 2005). In the sourcing stage there is aneed to analyse which products are suitable for LCC sourcing (Christopher et al. 2006, Fraeringand Prasad 1999, Smith 1999, Lee 2002, Nellore et al. 2001, Van Weele 2005). There is a clearneed to verify supplier availability, supplier selection and how logistics factors influence/affectthe supplier selection criteria (Min 1994, Motwani et al. 1999).

Given the significance of logistics in LCC sourcing, it is imperative to look at the two steps ofproduct selection and supplier selection with a logistics focus. Studies in international sourcingindicate that cost reduction is an important criterion in sourcing from LCCs (Birou and Fawcett1993, Trent and Monczka 2005, Handfield, 1994, Dornier et al. 1998). Since our focus is on thelogistics issues during sourcing stages, the interest is to look into various logistics factors thatinfluence landed cost. The total cost of ownership (TCO) approach is a good way to gain a clearunderstanding of the logistics costs and their impacts on the LCC sourcing decision. Moreover,TCO is a generic tool used in many purchasing decisions and also in international purchasingdecision making (Fraering and Prasad 1999). The TCO analysis of LCC sourcing is approachedfrom a logistics perspective.

The next sections will discuss three areas in the context of LCC sourcing;

(1) Product Selection(2) Supplier Selection(3) Logistics influence on TCO.

Figure 1 schematically represents the theoretical framework used in this paper.

2.1. Driving forces behind international purchasing

Previous studies point to three main drivers behind international sourcing: price, quality andavailability of goods and services (Trent and Monczka 2003, Birou and Fawcett 1993). Swamidass(1993) has two broad categories for the drivers of international purchasing: cost factors andnon cost factors. Cost factors, such as reduced material prices, labour cost, cost competition,exchange rates and cost of capital affect the amount of sourcing from LCC. Influential non costfactors include new market growth opportunities, product or process technology involved in theprocured product, better quality, better delivery performance, improved supplier relationship andflexibility (Birou and Fawcett 1993, Dornier et al. 1998, Swamidass 1993, Trent and Monczka2003, Handfield 1994).

Total Cost of Ownership

Product selection Supplier selection

Logistics FactorsInteraction

Figure 1. Logistics interplay with purchasing process.


146 N. Kumar et al.

2.2. Product characteristics and their influence on logistics

Smith (1999) has identified different criteria of product selection for international purchasing. Thelogistics parameters for item selection for LCC sourcing include demand volatility, cost of delivery,rate of change (in process, specification and product technology), complexity of the product andthe risk associated with failure. Fisher (1997) helps us to understand the relationship betweenproduct type based on demand characteristics and supply chain strategy. Product characteristics(standard or special), demand (stable or unstable) and replenishment lead time (short or long)parameters seem to critically influence the selection of the products for LCC sourcing and alsothe supply chain strategy (Christopher et al. 2006, Lee 2002).

Nellore et al. (2001) suggest that LCC sourcing is not preferred for complex products thatrequire early supplier involvement and intensive engineering collaboration. Levy (1997) suggeststhat components that need JIT delivery, low inventory levels, lower lead time and flexible manu-facturing are not ideal candidates for sourcing over long distances. Pope and Prasad (1998) pointout the importance of considering aspects that influence the inventory and logistics such as thedemand pattern of the product, shelf life and nature of the product. In summary, product charac-teristics that affect logistics in an LCC sourcing setting include volume sourced, the nature of theproduct (e.g., standard or specified), inventory and demand volatility.

2.3. Supplier characteristics and its influence on logistics

Previous research has a strong focus on multi-national sourcing through subsidiaries and the needfor appropriate supply chain configuration (Kumar and Rehme 2008). Literature suggests that on-time delivery, delivery reliability and lot size/batch quantity are the influential logistics criteriain supplier selection and that international supplier selection is different from domestic supplierselection (Motwani 1999, Min 1994). Logistics factors such as delivery reliability depend onsupplier country/region specific factors such as transportation infrastructure and availability oflogistics services (Murphy and Daley 1994). Country specific infrastructure has a great impact ondelivery lead time and uncertainty, hence influencing the logistics cost especially through increasedinventory (Pope and Prasad 1998). Pope and Prasad (1998) offer a very broad interpretation ofinfrastructure related parameters including roads and railroads, communication, availability ofsuitable transportation, industrialisation, and availability of employable labour and wage rates.The country in which the supplier is present also affects the supplier selection process in terms ofcultural closeness and the ability to understand the value of time and interpretation of information(Min 1994, Murphy and Daley 1994). In summary, supplier characteristics that influence logisticsinclude on-time delivery reliability, cultural closeness, batch size, country-specific factors andtransportation infrastructure.

2.4. Total cost of ownership

In order to analyse and evaluate logistics consequences of increased purchasing from LCCs,it is important to understand the basic economic underpinnings. According to Nelson and Sisk(2005), the term “low cost country” has been closely connected to countries with low labourcosts; however, they argue that when making this categorisation all costs need to be considered.Therefore, it is vital to include the total cost of ownership (TCO) in the decision making frameworkand understand logistics impact on TCO.

However, in addition to including a wider range of costs the focus of logistics has over the lastfew decades been on issues such as flexibility, better service, time, increasing revenue and partic-ularly on logistics as a way to compete. From a total cost of ownership and logistics perspective,the aim is to reduce the total logistics cost while achieving a given service level and TCO helps to



Figure 2. Proposed model for analysis.

show logistics performance (Lambert and Burduroglu 2000). TCO is suited for supplier selectionand supplier evaluation decisions (Ellram 1995). Even though the total cost systems approachhas been used in purchasing for a long time, very few companies have been successful in captur-ing the total cost in LCC sourcing (Trent and Monczka 2005). A TCO categorises the total costin three different areas based on the stage in which they occur: pre-transaction, transaction andpost-transaction.

• Pre-transaction elements include costs such as need identification, source verification, addingthe supplier to the internal system, educating the supplier and adding new competence to thefirm (Ellram 1993).

• Transaction elements include price, order placement or preparation, delivery/transportation,tariffs/duties, billing/payment, and inspection cost (Ellram 1993). Zeng (2003) has listed anumber of logistics related elements to be included: consolidation charges, cost of urgentshipment, transfer fee, inventory holding (pipeline inventory, safety stock and warehousingcost), handling and packaging.

• Post-transaction elements include defective finished goods, repair/replacement costs, loss ofcustomer goodwill and reputation. McGowan (1997) emphasises that the logistics cost and con-trol in international purchasing is dependant on the ownership of the goods. He also emphasisesthe importance of lost business and the cost associated with the risk in international logistics.

The proposed model in Figure 2 shows product characteristics and supplier characteristics thatinfluence logistics along with the total cost of ownership elements. Literature evidences oflogistics cost elements that affect total cost of ownership in each of the three stages i.e. (1)pre-transaction (2) transaction and (3) post-transaction are also depicted in the picture.

3. Methodology

International purchasing is considered a young research field requiring empirical in-depth explo-ration and theoretical borrowings from adjacent fields (Quintens et al. 2006). Given the specificresearch focus of how logistics issues are considered in LCC sourcing, exploratory research is


148 N. Kumar et al.

Table 1. Context variables of the case companies.

Firm A Firm B Firm C

Size of the company Small/medium scale Medium/large scale Large scaleDemand management Customer order based Assemble to order Forecast basedLCC sourcing from India, Taiwan and China China, Korea and

potentially IndiaIndia

Market presence Global corporate presence Global GlobalCustomers Tier 2 & Tier 1 End user Tier 1Sourcing organisation Agent based (International

purchasing office in thefuture)

International purchasingoffice and sourcingthrough subsidiaries inLCC

International purchasingoffice and sourcingthrough subsidiaries inLCC

Nature of product sourced(See Kraljic (1983) fortypology explanation)

Commodity type Bottleneck, commodity,leverage

Strategic, bottleneck,commodity, leverage

required. Case study based research using an explorative semi-structured questionnaire was used,focusing on LCC sourcing decision making. We have chosen to focus on Swedish industrial prod-uct companies engaged in LCC sourcing of semi manufactured goods from Asia, especially Chinaand India. Such industrial products, which have higher logistics and coordination complexity, area sector of rapid increase in LCC sourcing in Sweden from distant Asian economies (Rehme et al.2006). Three case companies in the sector sourcing from distant LCCs were selected. There arevariations in terms of the company size, demand dynamics and which stages of LCC sourcingthe case companies have reached. One case company has had a long evolution of sourcing fromLCC and could be considered very successful. The other two case companies are at differentstages of LCC sourcing (refer Table 1). The reasons behind choosing companies with varyingcharacteristics are that it helps to capture the different dynamics and the importance of logisticsin different stages of LCC sourcing, and also because it increases the generalisability of results.

Two individual in-depth interviews with Firm A and Firm B and two in-depth interviews withthe manager at Firm C’s purchasing office in India were conducted. Secondary sources of materialwere collected in order to understand the context of each company before conducting the inter-views. Respondents represented corporate purchasing and divisional purchasing and had beenassociated with the LCC sourcing decision making process since its initiation. The questionnairewas sent before the actual interview and the respondents’ supplemented secondary internal doc-uments during the interview. Each interview lasted for 1.5 to 2 hours and was recorded and thentranscribed into case descriptions. These descriptions of cases ranged from between 10 and 20pages each and were sent to the case companies for verification and correction. Such case descrip-tions help to increase the construct validity of such research (Yin 1989, Ellram 1996). Duringthe data validation the respondents supplied additional information and identified a few minorcorrections to the case descriptions. Open and axial coding techniques of breaking down the datafor analysis, conceptualisation, categorisation and creating connections across categories wereused during analysis (Ellram 1996). Within-case analysis and cross-case analysis was performediteratively and the results were compared with conflicting and similar literature according to therecommendations of Eisenhardt (1989).

4. The three firms and their experience in the logistics of LCC sourcing

4.1. Firm A – The multinational component supplier

Firm A is part of a large multinational company and is a second tier supplier of components forthe automotive and industrial products sector. There is a strong corporate directive to rationalise



purchasing and to source from LCC. LCC sourcing is used as a way to introduce competitioninto the existing supply base. Customers have also pressured the company into sourcing fromLCCs as a part of the continual improvement of cost competitiveness. Simple components withno design changes and standard specifications are sourced from LCCs. Most of the componentssourced are commodity products. The product selection is made internally, but supplier selectionand logistics coordination with suppliers is made through other corporate divisions present inthe LCCs themselves. Sometimes LCC sourcing was also done by agents, though there are plansto set up an international purchasing office in the future. Third party logistics companies helpin coordination of the goods and take part in transporting goods only to the factory in Sweden.The logistics cost is roughly calculated as 10–15% of the total cost as a rule of thumb and nodetailed analysis is being done. The transportation cost and the customs cost are the other logisticselements included in the TCO analysis. When demand planing is not done in close collaborationwith customers, Firm A has to have a huge amount of stocks. This increases the inventory andwarehousing requirements and also makes Firm A inflexible to demand fluctuations.

4.2. Firm B – Load handling solution manufacturer

Firm B offers load handling solutions with a wide product range and has a global market presence.LCC sourcing is considered because of cost reduction possibilities and future market developmentpotential in LCC. Purchasing is regarded as professional and global in nature. The LCC sourcingpractices of competitors havealso motivated an increased sourcing in LCC. Based on the productcharacteristics, a cost savings of about 15 to 40% is being targeted. Low volume, low demanduncertainty and simple products are sourced initially to test the supplier and then volumes areplanned to increase in the later stages. LCC sourcing is not used for bulk products with a lowvalue density or for complex products. Firm B evaluates on time delivery from suppliers on thebasis of purchasing Ex Works in LCC, as does Firm A. Other supplier logistics capabilities areseldom a qualifying criterion for supplier selection. The International Purchasing Office presentin the LCC takes care of the logistics of moving goods from the supplier’s factory in LCC to thefacilities in Europe. The focus at the time of the study was on finding and building supplier qualitycapability, and logistics will be considered explicitly in the near future as the volumes increase.Transportation and customs cost are the logistics costs included in the total cost analysis. Themajor challenges include the inflexibility to sudden customer order changes and the inability ofthe existing lean production system to handle large batches involved in LCC sourcing.

4.3. Firm C – The 1st tier OEM

Firm C is a first tier OEM manufacturer and has been a pioneer in sourcing from LCC. Thefirm has long-established procedures for managing sourcing and logistics activities and couldbe considered successful in LCC sourcing activities. Firm C is convinced of the potential costreduction in LCC sourcing for corporate global operations and is also motivated by the marketpresence perspective. The quality level available in LCCs further motivates Firm C. The com-pany has an international purchasing office in India, which has a clear understanding of thepurchasing and logistics requirements of their various global facilities through cross-functionaland cross-locational efforts in decision making. The first phase of sourcing starts with simpletime-insensitive, low volume, constant demand and less complex products, and later moves onto high volume constant demand products. These initial stages allow the company to understandthe supplier quality level and simultaneously set up logistics capabilities for sustainable LCCsourcing. Bulk low value products that are non stackable are avoided even if the unit cost is sub-stantially lower. Low volume products are also avoided because of increased logistics coordinationcosts. During the sourcing process Firm C understands the technical capability of the supplier and


150 N. Kumar et al.

the feasibility of the purchase. Firm C shares detailed volume plans both with the supplier andsimultaneously with Third Party Logistics (TPL) providers. Once the technical capability of thesupplier is proven and established, the TPL company coordinates the demand planning informationand material from the supplier to Firm C’s individual global factories. The TPL company ensurestimely delivery and logistics facilities such as warehousing, transportation, customs handling arealso taken care of. The TCO includes a sophisticated list of logistic cost elements. Challengesinclude reduced flexibility to demand fluctuations, cultural problems, inland transportation infras-tructure, handling, special packaging requirements and warehousing space requirements. Thereis a high internal resistance to sourcing from LCCs for the company since it is a tier 1 supplierand the logistics capabilities are perceived difficult to judge internally.

5. Analysis and discussion

There are a number of decisions and supporting analyses that have to be made before a companycan be supplied with goods from a low cost country. First, the company has to make a strategicdecision whether or not to get involved in LCC sourcing, and a series of decisions follows. In thethree case companies the final decision whether or not to source from LCC was not made untilthe actual supplier selection was made and a product was selected for testing the supplier. Allthe companies have changed some of their suppliers from a close location to suppliers locatedin a distant LCC. Except for Firm B, the case companies have previously purchased (rather thanmade in-house) the products and, hence, it was not a question of a make or buy decision thatthese companies were facing but a decision to source from locations nearby or from distant LCClocations.

5.1. Motives for low cost country sourcing

In all the cases it was shown that the move to low cost country sourcing was made in orderto achieve different strategic benefits. Primarily, it was to increase competitiveness by costreduction but also to gain access to LCC markets. Among the case companies the followingfactors influenced sourcing decisions from LCC:

• Cost reduction• Market opportunities to sell in LCC• Demands from different stakeholders

Literature suggests various motives underlying sourcing from other countries. Swamidass (1993)and Monczka and Trent (1991), for example, suggest both cost and non cost factors. Many ofthe motives listed by these authors are in line with the motives stated in the cases, with costbeing the dominant factor in sourcing from LCC. However, access to new processes or producttechnology—better material and quality—which may be a motive for international purchasing(Trent and Monczka 2005, Handfield 1994) are not the motives for the case companies, althoughall the companies want to maintain the quality level. Considering the potential cost benefits, allthe case firms revealed that purchasing from LCC was a clear directive from the corporate sideand also that there was a clear need to establish the companies in LCC markets for future marketgrowth. To some extent, introducing competition and also making suppliers more responsive (asmentioned by Monczka and Trent, 1991) is present in gaining. The most important driving forcesfor purchasing have been cost reduction (20–40%) and gaining access to new markets. These costreductions and sustained market attractiveness are the reasons to clearly move into LCC sourcing.



Drivers for LCC sourcing include owner or corporate manager directives to move into LCCsourcing, the fact that purchasing is becoming more global, professional and coordinated,competitor practices, and increasing pressures to source from LCCs from customers.

5.2. Product characteristics and its influence on logistics

The case companies categorise products based on value and complexity and not predominantlyon logistics factors. Firm C sources only commodity raw material based products and the othertwo firms have a wide range of potential products to source from LCCs. On a product levelcharacteristics such as value density, degree of customisation, demand volatility, readiness toassemble and shelf life affect logistics. The case companies believe that products with a highvalue to volume ratio, a low level of design changes, large volumes and regular demand patternsseem to drive LCC sourcing decisions. Each clearly company has distinct product characteristicsand experience in LCC sourcing. This can be clearly understood from Figure 3. Though there arevarious product characteristics involved, as illustrated in Figure 3, we will explain some of thecritical product characteristics and their influence on the logistics of LCC sourcing.

• Value density. The increase in value density proportionally reduces the logistics cost per unitand impacts LCC sourcing decisions. From Figure 3 it is evident that all the case companiessourced components that had a high value density. In the case studies the LCC price advantagewould be eroded through higher transport costs and warehousing costs if goods were bulky andof lower value density.

• Standardisation. The degree of standardisation affects both order lead time and delivery reliabil-ity. Customisation levels not only increase product variety but also increase process or productdesign changes on the supplier side, thereby increasing the lead time and causing logistic uncer-tainties. Firm B works in an assemble-to-order setting and their customer delivery lead time ismore than a month, but the company allows their customer to change the specifications untila week before the delivery of the product. When the transportation lead times are more than40 days (minimum) for the components to be moved from LCC in Asia, such a high degree ofcustomisation either increases inventory or necessitates rush orders to be sent by air freight, orelse it is necessary to reduce the customisation level for customers. Potential quality problemsincrease because of higher product/process changes and also because of improper communica-tion and understanding of these design changes. Firm C sources products with a high potential

Figure 3. Product characteristics influencing logistics friendliness.


152 N. Kumar et al.

for quality problems but has good logistics coordination to reduce uncertainties. Standard itemswith little customisation are easier to source from LCCs rather than non-standard items, whichinvolve product and process changes (Nellore et al. 2001).

• Demand stability. For large volumes with high demand stability it is possible to establishefficient logistics systems, and especially if the transport efforts are efficient due to high fillrates as in the case of Firm C. For Firm A and Firm B lower volumes will require less thanfull container loads, which will result in a higher cost per item and potential service reductions(and damages due to additional handling). Large volumes with high demand variations increasefinancial risk because of a stock out situation and therefore, additional safety stock must beadded, increasing the cost. Demand volatility increases logistics costs; therefore, products withlow demand uncertainty and high volume are preferred from LCCs. Products with high demanduncertainty increase risk through increased inventory and obsolescence. This was the case forFirm C where the initial LCC sourcing began without considering shelf life and it resulted inobsolescence.

• Order processing speed. In the cases there are two distinct order lead time elements: manufac-turing lead time and transportation lead time. Complex engineering products involve a numberof stages resulting in longer manufacturing lead times. Manufacturing lead time is increasedif there is increased customisation. Transportation lead time also affects the shelf life of thecomponent and increases finished product inventory. If the shelf life is not long after takinginto account the total lead time, then products run the risk of obsolescence.

• Packaging. Packaging should contribute to increased value density whilst maintaining the abilityto transport effectively with low risk. The use of pallets for packaging influences the containerfill rate, reducing transportation costs and risk of damage. But the case companies studiedhave not taken into account the influence of packaging after transport. When products likecastings and forgings are transported by sea they need additional operations such as unpacking,cleaning and sorting, which increase the logistics costs and leadtime and may cause delays.In this paper the process of unpacking, cleaning and sorting is referred to as the ‘ready toassemble’ character of the product. Both Firm B and Firm C have a higher need for performingthese ready to assemble operations involving additional logistics and increased lead time beforethe products can actually be used.

All three case companies exhibit similarities in having product characteristics of high value den-sity, product/process design standardisation and shelf life characteristics. This could be becausethey are all industrial product companies and are at least fairly experienced in sourcing. In Figure 3it can be seen that Firm A and Firm C have sourced products with characteristics that have higherlogistics friendliness than Firm B. Firm A has products that fit sourcing from LCCs but the volumeis rather low, hence the batch quantity and supplier selection choice becomes an issue in makingLCC sourcing viable. Firm B is in the situation where it is unsure of the product characteristicsand their influence on LCC sourcing decisions. For Firm B, aspects such as demand stability andpotential quality problems coupled with long lead time are issues of concern because Firm Boperates in an assemble-to-order environment and the volumes are not very high. We can see thatthe interacting effects of different elements determine the degree of logistics friendliness basedon product characteristics and that no single product characteristic alone can determine logisticsfriendliness.

5.3. Supplier characteristics and its influence on logistics

Matching supplier characteristics to the product needs is a natural next step in LCC sourcing afterproduct selection. The case companies started with simple commodities to test and understandthe supplier capability. If the consistency of supplier quality is assured, complex products are



sourced in the later stages as in the case of Firm C. Logistics friendliness in supplier selection isdependent on three broad areas, which include supplier capability, TPL company capability andthe logistics characteristics of the country in which the products are sourced from. These affecton-time delivery reliability and also the lead time of sourcing from LCC.

• Supplier characteristics. Suppliers for all firms are selected based on a technical capabilityevaluation and logistics is seldom taken into account. The logistic maturity of the suppliers interms of ability and awareness seems to be rather low in our case studies of LCC sourcing.Despite this, the firms are still dependent on the logistic capability of the supplier to deliver. Thesooner the firm takes control over the products the more control the company has in managinglogistics cost and service level (McGowan 1997). In our case, company factors such as culturaldifferences and order execution cycle time affect the logistics lead time. Firm C ensures thatthe suppliers have excess manufacturing capacity because this enhances their ability to handleemergency orders and cope with demand volatility. The suppliers undergo a stringent selectionprocess because of the stakes involved, but most of the evaluation is focused on the quality ofthe products and not on the logistics capability of the suppliers.

• TPL company.All case companies have used third party logistics (TPL) companies to handle thelogistics of their supplies and to have a predictable delivery schedule. The reason for using TPLcompanies is that they provide the required coordination with suppliers for delivery schedulesand information at cost effective levels (Fawcett et al. 1993). Firm A and Firm B argue thatsince the supplier has poor logistics awareness it is imperative to use a TPL company thathas a global reach. Moreover, the TPL companies have control over transportation operations,especially in the LCC, which is seen as critical by all the firms in the case study. This iscritical because knowledge about logistics in LCCs is limited at the case study companies. Allthe case companies bought TPL services, which include documentation, coordination/control,information services, consolidation, carrier selection, warehousing, customs clearance and anunderstanding of local regulations. However, Firm C is planning more closely with the TPLcompanies and the suppliers for future warehousing requirements, demand coordination withsuppliers and information transparency between all parties, which is considered to be criticalfor sustainable LCC sourcing.

• Macro characteristics. Macro level logistics factors are aspects to consider when choosingbetween supplier alternatives. The case companies face logistics challenges based on the coun-try they are sourcing from and also specific regions in that country. On a country level, broadestimates can guide sourcing decisions. Murphy and Daley (1994) use logistics friendlinessor unfriendliness from a country level perspective on logistics issues and discuss the impactof infrastructure on international sourcing. This aspect, though crucial, is not often used bycompanies in their LCC sourcing decision making. Transportation infrastructure affects logis-tics lead time, modes of transportation and uncertainty associated with them (Pope and Prasad1998). Customs lead time affects the total cycle time and also the warehousing time required inthe LCC. Understanding macro factors will help them design better logistics solutions takinginto account the challenges of infrastructure in LCCs. Some of the case firms have not takenmacro level logistics factors into account during sourcing. Logistics cost structures in LCCsdiffer substantially and the data was seldom readily available to perform adequate analysis ona macro level. Recent research by the World Bank (Arvis et al. 2007) has made it possible toaccess logistics information at a country level enabling macro level factors to be included insourcing decision making process. Measures such as customs clearance efficiency, informationinfrastructure for logistics, ease and affordability for international shipments, competence ofthe local logistics industry, domestic logistics cost, ability to track international shipments andtimeliness of shipments are used to arrive at a logistics performance index at a macro level,


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Figure 4. Supplier characteristics influencing logistics.

which can be used in making sourcing decisions. Firm C had detailed estimates and an under-standing of the macro level factors and hence, they were able to manage the sourcing in a betterplanned way.

Figure 4 on supplier characteristics and the influences on logistics illustrates that Firm C is betterpositioned than both FirmA and Firm B. One reason for this is that Firm C is more experienced andalso has focused on working closely with suppliers and TPL to develop the importance of logistics.When it comes to macro level factors such as transportation infrastructure, export procedure anddocumentation, all firms experience the same problems; however, Firm C interacts and worksclosely with its TPL company to have better control over logistics issues. Simultaneously, Firm Cchooses suppliers who are involved in supplying globally to reduce the differences that arisebecause of culture.

5.4. Total Cost of Ownership

Total Cost of Ownership (TCO) is a tool used by companies to evaluate LCC sourcing. However,Firm A and Firm B performed only a cost analysis rather than a comprehensive TCO. All casecompanies expect a cost saving ranging from 10 to 30% in line with previous research (Frear et al.1992). Logistics affects pre-transaction, transaction and post-transaction aspects of TCO, but thetransaction components are the most frequently cited by the case companies. In practice, the costsconsidered are mostly from product-related factors and not from supplier-related characteristics,even though both product- and supplier-related characteristics, influence the total cost. Logisticscosts are extremely dependent on product characteristics and volume and these logistics costs aredifficult to calculate using TCO. Moreover, companies find that it is hard to predict the volume ofbusiness before the sourcing operations begin and evolve over time. Table 2 shows an overviewof the logistics costs considered by the case study companies. Different companies have showndifferences in understanding and using the TCO model and its different steps (pre-transaction,transaction and post-transaction).

• Pre-transaction: Though all cases show that there are pre-transaction costs, they are not clearlydocumented. Most pre-transaction costs are related to the organisation of LCC sourcing activi-ties. For instance, setting up the international purchasing office, agent based sourcing systems,



Table 2. Logistics cost elements in total cost of ownership.

Firm A Firm B Firm C

Pre-transaction costStructural change in supply chain (international purchasing office, agent based

sourcing, subsidiary based sourcing etc..,)X

Supplier and TPL investigation and evaluation cost X XNew competence cost (purchasing and logistics skills with local LCC knowledge) X XTravel and communication cost X X XNew supplier switching cost (training and setting up of logistics planning activities

and procedure)X

Cost of LCC sourcing organisation (with cross functional and cross locationalteam for decision making)

X

Transaction costTransportation cost X X XWarehousing cost XInventory carrying cost XCustoms X X XPackaging cost X X XReady to assemble cost (unpacking, cleaning and sorting/sequencing for assembly) XRisk and damage cost (insurance etc.) X X XAdministrative cost X X XInspection and monitoring cost X X X

Post-transaction costLost sales and opportunity costObsolescence costCost of salvage/disposal (for defective goods) X X

the acquisition of new competencies, etc., but they are not documented. Moreover, these pre-transaction costs occur as a result of trying different alternatives of sourcing over a period oftime and the companies do not have a fixed strategy for LCC sourcing. For example, companiesstart with agent-based sourcing and subsidiary-based sourcing and gradually move towards theformation of an international purchasing office. Many firms, including the case companies stud-ied, believe they have had considerable costs during the set-up phase for travel, communicationand training and development of the suppliers. These costs are closely related to selecting theright supplier and the TPL company for handling logistics services. Set-up costs include inves-tigation costs for finding possible suppliers as well as analysing them and improving their levelof logistics operation. Further, the pre-transaction costs consist of negotiating costs as wellas the building of new competencies to be acquired in the international purchasing office. Allcase companies agree that local knowledge about logistics and operations in LCC is critical,hence the requirement of new competencies. Though there are many pre-transaction costs, onlyFirm C has considered them proactively. The pre-transaction costs that are considered here arein line with previous research as in the case of Firm C (Zeng 2003). We can see that mostpre-transaction costs are driven by supplier characteristics.

• Transaction: In our case studies, most of the total cost analysis focused on transactional costs.As long as a price advantage of 15–40% is maintained in the portfolio of purchased goods fromthe LCC, purchasers in the case companies believe it is not necessary to study the logisticscost in detail. Two case companies arrived at a conclusion that generally the logistics cost isabout 10–15% of the unit price. Hence, logistics costs seldom guide the decision making ofimport sourcing from LCCs. In the transaction costs, transportation costs and customs dutyand packaging costs are considered because they add directly to the purchasing price of thecomponent and they are generally readily available.

Since the value of the products initially sourced is low, the rise in inventory cost at a later stageis neglected. But when the sourcing of high value items begins, the inventory costs and handling


156 N. Kumar et al.

costs have to be taken into account, though purchasers find it hard to calculate the inventorycost in their long distance LCC supply chains. From the case studies we also understand thatit is critical to inspect the components both in the LCC and also in the country of destination.But case companies have not captured the inspection cost. The cost of inspection is related tosupplier characteristics in terms of maturity and capability. Firm C chooses the supplier whocan deliver high quality consistently to reduce the inspection cost.

Packaging is critical in international sourcing to reduce damage and, according to thepurchasers, needs careful attention. Packaging aspects – both unit packaging and the con-tainerisation of loads – influence the total cost. Firm C agreed that packaging costs dependon palletisability and containerisation and that it was very difficult to calculate the packagingcost before volumes really picked up. Most of the time such industrial product companies arereceiving packaged and coated products that need further processing such as cleaning beforethey can be finally used in assembly. This leads to added logistics costs and longer lead times.

An important element of transaction costs that all the companies either failed to includein TCO or underestimated was warehousing costs. Some companies are moving from a leanproduction mechanism (such as JIT, Two Bin System, Kanban) to full container supply, but thecompanies have not yet analysed the increase in warehousing cost in their approach to LCCsourcing. The lack of time to make through analysis, lack of information, and poor internalcoordination in the initial stages could lead companies to exclude warehousing costs in totalcost analysis. Warehousing is clearly a logistics activity and logistics are dealt only in theimplementation phase of LCC sourcing in a reactive fashion. The move from contemporarycost focused supply principles (e.g., lean, JIT) to consolidated full container shipment handlingaffects many cost and service parameters (warehousing, inventory cost, shelf life concerns,etc.).

• Post-transaction: It is clear that although the firms studied are very much aware that costscan arise during the post-transaction stage because of defective products or failed on-timedelivery, those cost elements seem not to have been explicitly considered. Post-transactioncosts are being mitigated through strict quality controls in supplier selection and developmentof suppliers; however, the costs that can occur have not been quantified. Longer lead-timeson the supply side, the need for an agile/short lead-time on the product side, and possi-bly shorter product life cycles could result in obsolescence. The opportunity costs of lostsales because of failed deliveries or defective products are seldom considered. These havenot been incorporated explicitly in the TCO analysis. This could be because the compa-nies that have been studied were from the industrial products category and these costs aremore important in industries such as the fashion industry, as suggested by previous research(Christopher et al. 2006).

At this juncture, it is important to relate to the product and supplier characteristics and theirinfluence on TCO. When sourcing functional products with low demand volatility and low vol-ume, the pre-transaction cost will reduce the potential LCC sourcing cost benefits. Therefore,functional products with very low volume offer no viable LCC sourcing solution though theycan be used to test supplier capability. Apart from the pre-transaction components, administra-tion costs and transport costs are also aspects that offset the sourcing price benefit. When afunctional product with a high volume is being sourced from LCC the focus is more on theefficiency of the system. An innovative product with high demand volatility bought in high vol-ume is associated with the risk of obsolescence and inventory cost and the cost of lost sales,rendering these types of products less favourable for LCC sourcing. The coordination cost toget product customisation and the logistics complexity involved in the adopting of the designchanges critically affect the logistical total cost in LCC sourcing. Though the pre-transactioncosts are poorly documented we can clearly see that the cost elements are driven by the supplier



characteristics. Firm C, for instance, makes efforts during the pre-transaction stage to developlogistics capability so that it can reduce logistics cost and enhance logistics planning and controlduring the transaction and post-transaction stages. Firm B and Firm C perform vigorous sup-plier selection and monitoring as a means to reduce negative impacts on logistics due to suppliercharacteristics. Warehousing costs, ready to assemble costs, and handling and packaging costsare the costs that need to be looked into, and it is important to determine how the suppliers areable to support these logistics aspects. Product and supplier characteristics together affect TCO,but in practice only product characteristics and transaction costs are taken into account in costanalysis.

6. Summary and Conclusion

LCC sourcing decisions require us to take a combined approach to include logistics factors in bothsupplier selection and product selection. However, purchasing decisions include logistics issuesonly to a limited extent in the early planning stages of LCC sourcing. Even if they are included,these are in a limited way based on product characteristics affecting transaction costs. Supply sidelead time increases in comparison with sourcing from a nearby supplier, and this is occurring ata time when the customer order lead time is under pressure to be reduced. As stated in previousliterature (Lee 2002), all case companies find that demand uncertainty or lack of flexibility createsa major hurdle in LCC sourcing.

Aspects such as flexibility, customisation and country level factors are difficult to include in aTCO analysis. The study has shown that the logistics factors in LCC sourcing involve more thanjust looking into quantity and on-time delivery prerequisites, which are considered during thesupplier selection phase. Large price reductions in combination with the perception that logisticscosts are relatively low explain the current lack of focus on logistics issues of LCC sourcing andthe lack of explicit TCO analysis. For an effective LCC sourcing decision analysis logistics shouldbe integrated in both product selection and in supplier selection stages.

Logistics has a broader impact than just transaction cost and on-time delivery. Logisticsaffects the total cost of ownership across pre-transaction, transaction and post-transaction. How-ever, logistics factors are mainly considered from a transactional perspective alone and seldominclude pre-transaction and post-transaction. Companies that consider logistics proactively havea better understanding and control of logistics and costs. Logistics factors such as customis-ability, demand volatility, cultural difference across suppliers, and logistics capability of thecountry could not be evaluated with the TCO model. Though TCO is a dominant model forsourcing decisions from LCCs, not all logistics factors can be translated into cost aspectsfor TCO.

Though costs such as obsolescence costs and lost opportunity costs exist in literature they seemto be given less importance in practice, calling for proactive inclusion of logistics using crossfunctional teams. The reason could be that the case companies belong to the industrial productscategory. These would have been more appropriate from a fashion goods industry perspective.

We have refined the model to understand the logistics of sourcing from LCC. The modifiedmodel for analysing logistics factors in LCC sourcing is developed in Figure 5. In summary theconclusions are made:

(1) Purchasing needs to emphasise logistics factors much more strongly early in the sourcingdecision. Because of low unit prices of products up until now, logistics has not been regardedas crucial in sourcing decisions. However, companies need to understand landed costs beforemaking the product determination, since there are a number of cost-adding factors that willaffect the unit cost.


158 N. Kumar et al.

Figure 5. Logistics of LCC sourcing.

(2) Logistics is affected by characteristics across products and supplier (also see Figure 5):a. Product characteristics influencing logistics cost and service include: value density, cus-

tomisation, quality, rate of change (of product and process), readiness to assemble, demandvolatility, volume, packaging, cycle time and shelf life.

b. Supplier characteristics influencing logistics cost and service include: on-time delivery,logistics ability and awareness, TPL service, warehousing, transportation infrastructure,export procedure, cultural closeness and ITsystems.

(3) Presently, logistics is considered reactively in LCC sourcing decision models and is consideredfrom a transactional perspective based on product characteristics. Logistics is better addressedproactively, taking both product and supplier selection on pre-transaction, post-transactionand transaction levels. Figure 5 lists the different costs at different stages affected by productand supplier characteristics.

Although logistics has not been seen as imperative to analyse prior to making the final sourc-ing decision, the actual logistics issues will become evident when sourcing turns into suppliesi.e. deliveries. There are various aspects that can add to the understanding of LCC sourcing ofcomponents for manufacturing or final assembly. One is that when sourcing is made purely basedon lowering costs, logistics will have a greater impact on the sourcing decisions in the future.Questions that become important for companies regarding this are: 1) What is happening in theinfrastructure development in the LCC in terms of road, harbour and logistics facilities? 2) Howwill the individual LCC companies develop their logistics management and strategy, and will theydevelop from being “production sites” towards supply chain companies? 3) How will develop-ments in the shipping sector affect bottle-necks for container traffic (number of ships, containers,as well as routing and time planning to avoid the build-up of queues in harbours, etc.)? 4) How willthe receiving companies manage the receiving logistics in terms of planning for longer lead-times



as well as accommodating larger shipments with more storage facilities? If these developmentshappen, international LCC sourcing could develop well beyond the present level. Of course, thereare issues that go outside of this scope; for instance, in terms of political development and globalmarket growth, but also increases in factor prices, such as fuel, raw material and labour costs.However, when companies start developing sourcing practices not only for cost reasons but also toget close to LCC markets the rationale is different. The costs of doing business in these countriescan in such instances be seen as a market investment, where logistics costs are of less importance.Instead, building up relationships and getting an understanding of the market environment, andestablishing presence are aspects that become more important.

Acknowledgements

The authors would like to thank the Swedish Governmental Agency for Innovation Systems (VINNOVA) for funding thisstudy and the participating companies for their support. The authors are most grateful for the three anonymous reviewersfor their constructive comments that helped to improve the clarity and presentation of the paper.

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