Tellabs Inc. was ready to hop aboard the China bandwagon. The $1.2bn maker of communications equipment had an aggressive schedule for shifting part of its manufacturing from Guadalajara, Mexico to China, where production was significantly cheaper. But there were certain factors that the company hadn't considered.

Start with the time required for setup. Tellabs thought it could be up and running quickly, making a fiber product for a crucial subassembly which would end up in finished equipment for big telecommunications customers like Verizon, SBC and BellSouth. Shipping dates were set, based on that expectation. Then came the bad news: Tellabs would need three to six weeks to get the necessary plant fixtures to the contract manufacturer in China.

China's customs procedures appeared to account for much of the delay, says Ben Fabin, the FTTP (fiber to the premises) supply operations manager for Tellabs. Whatever the reason, the company quickly realized that it needed to look more closely at the logistics requirements for setting up manufacturing in China.

For many manufacturers, distributors and retailers, the pull of China is strong. They see a chance to slash overhead, at a time when operating margins are perilously thin. For Tellabs, the need to cut costs was especially compelling. The Naperville, Ill.-based supplier lost $29.8m last year, mostly due to acquisitions and other charges. (Minus those charges, the company earned $160m.) According to Fabin, Tellabs wanted to mesh subassembly in China with final packaging in Mexico, a strategy that could save the company money while retaining its ability to react to last-minute changes in the U.S. market.

But, as Tellabs learned, manufacturing doesn't exist in a vacuum. Companies must pay equal attention to the problem of logistics. While the notion of producing in China might be sound, one must account for the extra time and complexity involved in getting finished goods to the end customer in North America, Europe or even other parts of Asia.

The most obvious consideration-yet one that many companies don't fully address-is transit time across the ocean. The vast majority of goods travel by water, usually in containers. That means placing large amounts of inventory in transit for five to six weeks, Fabin says.

Tellabs knew it couldn't keep finished product in stasis for that long. It receives two to three engineering change orders a day. In the past, that might mean ripping apart finished assemblies to meet shifting customer requirements, even when production was in North America. In line with the move to China, the company would adopt a postponement strategy, whereby orders could be designed and configured at the last possible moment in Mexico.

"Before you consider outsourcing to China," Fabin says, "you might want to consider which aspects of production it makes sense to outsource. You need a clear picture of your total supply chain cost."

All well and good. Except that the China strategy had other complications as well. Localization of raw materials sourcing seemed like a good idea, for reasons of cost and proximity. But Tellabs's contract manufacturer would have to ship China-made parts to Hong Kong, then bring them back to the mainland, in order to avoid a 17-percent value-added tax, Fabin says.

Traffic Jam
Then there's the problem of congestion in the trans-Pacific trades. In the past two years, companies have found it increasingly tough to get their Asian-sourced goods into North America during peak shipping seasons, due to a recovering U.S. economy, capacity restrictions at ports and inland points, and the growing popularity of China as a site for manufacturing. The Tellabs logistics team has had to work closely with inventory planners to cope with the situation.

In fact, good cross-functional communications are at the heart of any successful strategy for outsourcing to China, Fabin says. Historically, supply chain management has been treated as a function within operations, one that isn't fully integrated with production-line management. In implementing its China plan, Tellabs has worked hard to bring together managers from sales, sourcing, manufacturing, inventory planning and transportation.

Any workable strategy for sourcing in China will combine good timing and deep analysis of total landed costs, says Bijan Dastmalchi, principal of Symphony Consulting in Sunnyvale, Calif. Poor planning can add greatly to the cost of moving product over the ocean. Experienced importers make peak-season arrangements with ocean carriers early in the year, Dastmalchi says. Stragglers who enter the trans-Pacific market in the third or fourth quarter are unlikely to find sufficient ship space at any price.

Airfreight isn't necessarily an option, especially for lower-valued goods. One Symphony client, a shipper of "pizza-box" type telecom products, found that flying just 10 percent of its quarterly volumes would wipe out its savings from producing in China.

For shippers of higher-value goods, ocean might be an unacceptable option, at least without proper planning. Inventory-carrying expense, including the cost of capital, obsolescence and storage, is about 18 percent a year for a typical high-tech company, Dastmalchi says. Moving goods by ocean can add significantly to that amount. Such a consideration must be part of any plan to source production in China.

When Plans Go Awry
Shippers often falter when they try to implement logistics plans based on best-case scenarios. They might promise carriers large volumes in return for low rates. But when something goes wrong, and the timing of shipments is upset, they could find themselves paying much more for freight than they anticipated, Dastmalchi says. And inventory levels could soar, as companies fill up the pipeline with safety stock.

New security concerns in the post-9/11 era can't be ignored. Shipping documentation has to be painstakingly accurate. Dastmalchi cites the case of one company whose paperwork for ocean transport correctly listed origin and destination, but failed to account for stops made by the carrier along the way. Homeland Security sent the FBI to the shipper's manufacturing plant, and pulled back a shipment that had already cleared Customs and reached the end-user's receiving dock. The goods sat idle for a month.

"If you're in non-compliance," warns Dastmalchi, "it could be a company-ending event."

John Rumasuglia, president of Vader Technologies in San Jose, Calif., says companies producing in China should combine lean manufacturing strategies with lean logistics. The goal is to avoid a buildup of inventory at various points throughout the supply chain-the kind of practice that forced Cisco Systems to write down some $2.2bn worth of inventory when demand for its high-tech components crashed several years ago. Even companies as innovative as Cisco can become victims of the bullwhip effect, whereby small inefficiencies at points along the way combine to create a huge impact.

Companies with long supply lines need to communicate demand signals to all of their supply-chain partners, says Rumasuglia. A change in internal practices, such as the degree to which various departments talk to one another, must precede the acquisition of new information technology systems.

Some increase in inventory is inevitable, as companies stretch their manufacturing supply lines from North America to China. Fabin calls inventory "the magic that allows things to flow smoothly to meet demand." But Rumasuglia says managers can minimize the variables through good planning, coordination and communication. Companies that remove waste from their supply chains can achieve savings equal to between 7 and 8 percent of top-line revenue, he says. Cash-to-cash cycle times can be cut by as much as 40 percent.

The Outsourcing Option
Outsourced manufacturing can go hand in hand with outsourced logistics, says Dean Strausl, executive director of the Electronics Supply Chain Association in Rancho Santa Margarita, Calif. One way to reduce inventory exposure is to hire a third-party logistics provider, whose services could include a vendor-managed inventory program. Goods can be held in special zones in the name of the supplier or 3PL until the moment they are needed by the manufacturer or retailer. "VMI becomes an almost critical element, especially in electronics," Strausl says. At the very least, the strategy mitigates the risk of getting stuck with obsolete or unneeded inventory.

Many companies with well-established global supply chains prefer not to bother with the details of moving product from plant to customer. Having outsourced the process to a trusted 3PL, they simply want to know when a shipment will be available, the so-called "black box" approach to logistics. But Strausl says it's too early to adopt that strategy in China. Most companies have only been there for two or three years, he says, and the potential for problems still exists at many points along the way.

Of vital importance is the need to communicate quickly with Chinese manufacturers. U.S. retailers must be able to react quickly to changes in product design and demand, says John Cestar, co-chief executive officer of San Francisco-based Freeborders. New technology for product lifecycle management across borders-and, in this case, an ocean-allow companies to slash order cycle times despite the longer distance, he says.

Gap Inc. used to take a full year from design to delivery of new styles on store shelves. With the help of PLM software, it aims to cut that period in half, Cestar says. To do that, it will have to standardize fragmented practices and technologies among key suppliers in China and elsewhere. Communications must also be streamlined, so that manufacturers can make last-minute changes to product specifications.

U.S. companies coming to China for the first time will find a highly sophisticated environment for design, manufacturing and logistics in major industrial centers such as the Pearl River and Yangtze River deltas. Elsewhere in China, the picture isn't so rosy. And moving product within the country can still be difficult.

According to Katherine Smith, a market analyst with Interliance LLC in Costa Mesa, Calif., China's infrastructure is still governed largely on a city-to-city basis. The lack of central government control over internal moves forces shippers to shift product between trucks or modes more often than they might like. And each time such a move is made, "a little bit more inventory goes missing," Smith says.

China has long been a favored production site for high-volume, low-mix products, Smith says. For products with lower volumes and more variations, however, "technological and communication problems begin to arise." It can be difficult finding Chinese suppliers that can receive and deliver real-time master scheduling production reports, read drawings, and practice lean manufacturing. Even locating those that conform to international quality standards can be a challenge, Smith says, stressing the importance of securing a partner that can eliminate language, geographic and logistical barriers.

Price Versus Service
Since China's allure consists mostly of low-cost labor and production cost, it's not surprising that U.S. business would focus on overhead in placing manufacturing there. But John Hafferty, vice president of EMEA and Asia for UPS Supply Chain Solutions, says it's possible to be too fixated on securing the lowest price for supporting logistics services. Rather companies should look at how a 3PL can provide end-to-end transport, incorporating shipping, warehousing and tracking every step of the way.

The price of failure is too high to ignore. Goods that don't reach their destination in time can force a plant to shut down, Hafferty says. Large 3PLs like UPS sell themselves on their ability to control the flow of product across supply chain partners. Value-added services include VMI programs and dedicated warehouses, if necessary.

Beyond physical activities such as warehousing, companies must pay attention to matters such as obtaining operating licenses and achieving smooth relationships with Chinese government officials. And they should be aware of instruments such as the Closer Economic Partnership Agreement (CEPA) between Hong Kong and mainland China, which allows Hong Kong-registered companies to run wholly owned operations in China proper, without the need for a state-owned partner. UPS SCS is one of the many companies to have taken advantage of that agreement.

Logistics infrastructure, including foreign trade zones, is well established at key locations within China, Hafferty says. But rail can still be a problem. The Chinese rail system still isn't able to provide consistent service for large amounts of commercial freight, although the government has announced plans for extensive improvements to the network.

Shippers looking to offset the impact of longer ocean transit should look to 3PL services that allow them to bypass North American distribution centers and deliver directly to customers, Hafferty says. Ocean carriers, too, have tried to forge links with inland transport providers in the U.S. in order to streamline intermodal movements there, although congestion has stymied their efforts to some extent.

There are ways to alleviate, if not eliminate, the impact of congestion, says Hafferty. UPS SCS is looking to hire more chartered vessels on its customers' behalf. Another strategy growing in popularity is the use of all-water transit from China to the U.S. East and Gulf coasts, via the Panama Canal. In the process, shippers avoid serious tie-ups at West Coast ports such as Los Angeles and Long Beach, although they can't put their cargo on the biggest and most efficient ships, which are too wide to fit through the canal.

Whichever route is employed, says Hafferty, shippers and their 3PLs must maintain year-round relationships with ocean carriers, who tend to favor their best customers when ship space gets tight and some containers must be "rolled" to later sailings.

Love or Hate?
Veteran shippers from Asia speak of the importance of collaborative relations with carriers. And that means looking beyond the issue of price. Toys 'R' Us deals with carriers at the highest level of its organization, according to Michael Jacobs, senior vice president of logistics. Speaking at the Journal of Commerce's recent Trans-Pacific Maritime Conference in Long Beach, he said the company is looking to break through the traditional "love-hate" relationship between shippers and carriers. "Ten months a year, we love each other," he says of the usual approach. "And for two months a year, it completely changes."

Toys 'R' Us wants lower-than-average freight rates in the China trade and elsewhere, Jacobs said, but it also understands the carriers' need to make a profit. The two sides work closely together to match exports and imports, minimize container repositioning costs, utilize a variety of ports and routings, secure volume commitments from the shipper, and capacity commitments from the carrier. Even so, said Jacobs, Toys 'R' Us has built an additional seven days into its trans-Pacific chain, to cope with congestion in the system.

Manufacturers and retailers sourcing in China are looking to take links out of the supply chain, says David Vernon, vice president of supply chain solutions with APL, one of Toys 'R' Us' favored carriers. Solutions include DC bypass programs and load building at the Asian point of origin. By placing warehouses closer to manufacturing points, companies can take better advantage of efficiencies such as cross-docking, he says.

The challenge is to design supply chains into and out of China that conform to the unique needs of each shipper, Vernon says. Multiple supply chain models can treat product differently, depending on its value, demand variability and time sensitivity. In some cases, that might mean boosting inventory levels. In others, the carrier will focus on keeping product in motion. The end result could well be a decrease in total inventories, Vernon says.

Many parts of China remain underdeveloped in their ability to move cargo efficiently, says Karl Mackey, chief operating officer of TNT Anji Automotive Logistics Co. That is a joint venture between TNT, the global provider of express, logistics and mail services, and the Shanghai Automotive Industrial Corp. It is today the largest automotive logistics provider in China, Mackey says.

Companies used to moving freight around the U.S. will find a different environment in China, he says. Provincial rules and regulations continue to hinder the flow of goods between regions. The situation has forced providers to maintain high inventories as a hedge against delayed shipments and other disruptions.

TNT Anji has been striving to reduce inventory at its various locations in China, and store what remains more efficiently. It plans to cut the number of warehouses storing automotive parts from 114 to around 32. At the same time, it wants to decrease inventory at each location from six months of supply to one month for major imported parts for manufacturing, and four to five months for locally produced parts. The goal is develop a smoothly running system for just-in-time delivery of parts to the plant, Mackey says.

TNT Anji oversees an operation that makes cars for sale within China. But its logistics challenges are similar to those of companies manufacturing in China for sale in the U.S. and elsewhere. Mackey says operating inefficiencies lead to high fixed logistics costs in China-18 percent of China's gross domestic product, versus 9 percent in the U.S. He expects that figure to decline to between 10 and 11 percent within five years, as China steadily improves its infrastructure, skills and technology related to the handling and movement of freight.

Que Viva Mexico!
Only a few years ago, manufacturers were touting Mexico as the ideal place to make products cheaply for consumption in the U.S. Now, the momentum has shifted to China. But companies are far from abandoning Mexico as an alternative. Mindful of the potential for supply chain disruptions, whether due to labor disputes, capacity shortfalls, bad weather, new security rules or terrorist threats, many producers are maintaining at least some presence just over the U.S. border. In the process, they can respond more quickly to sudden changes in customer demand, product design or supply-chain glitches.

Products with a large number of variations or low volumes are especially suitable for a strategy that places manufacturing closer to end markets, Dastmalchi says. "We tell our clients, don't overlook Mexico," he says. "It can offer the flexibility you need on very short notice." Morever, items that are primarily made in China can be supplemented by some production in Mexico, or assembled in final form there, as in the case of Tellabs's new strategy. Warranty and repair management are additional tasks that are better handled through a shorter supply line, Dastmalchi says.

Even the U.S. can continue to play a role in manufacturing. Rumasuglia points to Dell Computer's new plant in North Carolina as evidence that smart managers aren't blindly embracing China as the answer to their supply chain needs.

In any event, factors that influence global sourcing have a way of changing unexpectedly. Experts are already detecting a rise in Chinese production costs, including labor, materials and power. "People who go lock, stock and barrel into outsourcing to China assume that markets will continue," says Fabin. "They won't. A supply chain built around low-cost labor has got to consider that change is the only constant."