Does local sourcing help to balance social good & profitability?

Dr B K Mukhopadhyay

(The author is a Professor of

Management and Economics, formerly at IIBM (RBI) Guwahati. He can be contacted at m.bibhas@gmail.com)

Dr. Boidurjo Rick Mukhopadhyay

(The author, international award-winning development and management economist, formerly a Gold Medalist in Economics at Gauhati University)

Whether it's a big retail chain like Walmart or Spencer or the coffee place next door to your house, procurement and logistics continue to be huge components affecting cost and related business decisions. Typically, depending on the size of the market and nature of the industry that an organization finds itself in, the common problems around why most organizations may not choose to go with local sourcing are inadequate or poor-quality input, insufficient and unstructured delivery system, lack of availability or accessibility, and non-competitive price level. The company selection criterion is of course a big consideration involved in the process. Although it might be 'logical' to switch to local suppliers from imported products or dwell on a longer supply chain with established partners, the choice is not always simple. Price and standard of products are key, and also whether there is state support to motivate local sourcing. Developing the indigenous production capacity for any industry of choice is a consequence of this process in the long run. For example, the heavy reliance on Chinese solar energy technologies has now significantly dropped in India since the indigenous capacity of 'Naya Bharat' to develop cheaper and better renewables products have improved over the past decade. Sourcing locally certainly also has dimensions of capacity building, local job creation and boosting the regional economy.

The usual benefits that come with local sourcing are first, reduced logistics costs and related expenses which in the long run also improves environmental impact and reduces 'fair treatment (or the lack of) of supplier or labour challenges often involved in cross-border logistics. Also, the different industrial or technical standard requirements in each country needs to be maintained; secondly, avoiding risks related to currency volatility and this affects the large retail chains significantly as they cope with this across different markets and political regimes; thirdly, sourcing locally creates an opportunity to work closely with local players who tend to be more reactive to demand changes than suppliers who are located far away. This not only improves lead time but also allows time and space for developing customised products when required. In addition, local suppliers also have information on new patterns of demand changes and market trends that could help business growth planning, sales projection, and importantly getting the timing of launching new products right.

While the above sounds good for good PR and improving the local image of the companies (local or international), it can be a double-edged sword for the very same reasons. For example, if there is a fallout with local suppliers, the effect can be felt at different levels of production, stakeholder network, and also public image. More so, if the supplier was a key player in the region, cutting off ties would mean a fall in the product quality due to the lack of the right materials or in worst cases, product lines made redundant altogether. Additionally, although working with local suppliers offer a range of benefits in regards to market knowledge, customised product delivery - it can also resist change and innovation at certain stages to avoid risks of jeopardising existing market configuration. Therefore, companies might find it subsequently challenging to jump on a new growth curve and might limit both the scale and scope of their operations and strategies.

'Buying fresh' is a customer need today, and therefore a brand that sources locally, e.g., food, will experience increased sales. In the US, a report from the Department of Agriculture shows that the sales of locally produced food hit $12 billion in 2014 which is projected to be $24 billion in 2021. The majority of customers are willing to pay more for local products. This stands true for locally raised products from fields, bee-yards, bakeries to small factories that have experienced a shift in customer demand patterns. At the same time, due to the increased demand, farmers and grocers have been struggling to work together. This is because small farms are stretched to capacity for meeting increased demand, so there is a push for further investment to help them scale-up and sustain operations.

For global companies in specific industries, e.g., US coffee chains have historically procured from Guatemala and Colombia for cheaper and high-quality coffee while maintaining their global presence and a happy scorecard for their ever-expansive shareholders and country managers.

The decision to procure locally or internationally goes beyond some of the salient points mentioned earlier, it also depends on how manageable and economic the manufacturing costs are relative to the immediate competitors. The more economical the manufacturing costs are, the higher the chances of procuring large quantities in bulk which is a good option for start-ups, for example.

At the same time, as the demand for a businesses' output grows over time, the choice of procuring locally or internationally becomes more complex. For example, if a business is dealing with rare products, it may be the case that it is obtainable only via an overseas supplier who works in selected networks only. This not only maintains the rarity and unattainable nature of the products but also could lead to an ability to offer a specific type of product or service in the market that goes unrivalled for some time. In addition, working across suppliers – local and international, offers a contingency during natural disasters or a pandemic, for example.

At the same time, depending on the nature of the contract - it might put the local suppliers at risk if they are working with one big retail chain, for example, if the contract prohibits them from supplying to a competitor of the retail chain. This is a very common problem. For such B2B models, it is important that the volume of order and contractual agreements work for both parties (equally), which is not always feasible to work out.

Once again, even though sourcing locally can reduce costs on the logistics and associated expenses, along with the convenience of managing a shorter supply chain, there is a host of complications as mentioned earlier in the article. Ensuring a high-quality standard is often one of the biggest issues, for example, research by Harvard business review looked at the implications of sourcing locally by the restaurant industry and how it might actually increase costs. Chipotle, which sources locally, had to hire food safety experts while also investing $10 million to help smaller suppliers meet required safety and quality standards. So, on one hand, we have McDonald's or KFC in the US who sources all its chicken from a selected range of five or six big suppliers, e.g., Tyson Food, and they have food inspectors on-site in chicken farms and processing centres; on the other hand, Chipotle who sources food locally may not possibly monitor all local suppliers on-site at every location. Therefore, there may be a bit of autonomy and trust (risk) on the part of local suppliers to ensure quality control guidelines. In this particular industry, data shows that most local suppliers lack historical success in ensuring quality testing of their products while on the contrary large suppliers, such as Tyson Food, have demonstrated certain consistency over time.

'We source locally', 'we support our community, 'our local branches are staffed with local people who are pleasant to hear and may work well for a company's CSR (corporate social responsibility). But then there are considerations for principles of governance and pre-imposed conditions to work with the Government as a key stakeholder. For example, if a company works too closely with a few suppliers only while there are others available, it might raise questions around fairness or ethical issues around supplier selection. Also, some Governments may have an expectation or put a condition to ensure that the businesses will need to support the community by not only doing CSR or/ and philanthropic activities but also actively investing and engaging with SMEs and micro-enterprises - this may not be the most cost-effective option after all. Consequently, making it harder to balance the ROI associated with local sourcing and doing social good, community development/ PR at the same time.