Factory Direct Sourcing
By John D’Angola / 17 January 2019
Cut out the middleman to bring down price and increase profit.
That is the straightforward, if incomplete, logic to factory direct sourcing. But when searching for answers to tough problems, such as maximizing profit, it is the simple solutions that sometimes get us into trouble.
Warren Buffet is famously quoted as saying “Price is what you pay. Value is what you get.” Let’s take a look at the topic of factory direct sourcing through the lens of Mr. Buffet’s guidance, to help us better understand when factory direct sourcing makes good business sense.
“Price is what you pay…”
The notion that factory pricing is lower than that quoted by trading companies requires an untenable “all else equal” assumption. We would have to ignore obvious variables like order quantity, internal operating expenses and legal costs. That would be silly.
Order quantity is usually the main factor manufacturers consider in negotiating price. Because individual buyers typically order at lower volumes compared to trading companies, factories tend to quote individual buyers higher prices. Unless the individual buyer can match the volumes of the trading company, this economic reality will reduce the potential cost savings presented by factory direct sourcing.
Next buyers must consider relevant operating expenses. Selecting and vetting a manufacturer requires expertise and time, both of which have associated costs. Communicating with manufacturers and resolving issues during and after production is equally crucial and costly. These costs are not reflected in factory direct pricing, but ought not be forgotten.
Last but not least are the costs associated with the preparation and execution of the supplier agreement, plus potential additional costs for dispute resolution. Add these expenses to the overhead required to manage the project, plus the price difference attributable to order volume, and true the price paid for factory direct sourcing becomes a bit more clear.
“…. Value is what you get”
Trading companies present additional value to their clients in the form of manufacturing alternatives, trade expertise and communication.
Individual factories have limited product offerings and generally lack an incentive to direct you to alternative manufacturers should your job require a product or feature they themselves cannot provide. Instead, factories often persuade buyers to fit their needs to the factory’s capabilities. In contrast, trading companies have relationships with many manufacturers and are incentivized to match the buyer to the most suitable supplier.
As their name suggests, trading companies are built for trade. Freight forwarding, export/import regulations and proper licensing are areas where both factories and buyers tend to lack the infrastructure necessary to get the products delivered smoothly. In contrast, trading companies have streamlined these processes.
Another massive advantage, one which is often overlooked, is the value trading companies offer in the form of communication. To effectively minimize errors, buyers ought to communicate with suppliers in their language. But beyond that, fluency in the terminology specific to both product and process are crucial in ensuring all technical aspects of the job are properly managed.
Do the Calculation
When deciding whether to source directly from a factory or through a trading company, we recommend you ask the following questions:
Are our volumes large enough to secure good pricing?
Have we accurately assessed related operating and legal expenses?
Do we have alternative manufacturing options should we require it?
Can we get the product imported safely and securely?
Are we capable of communicating effectively with the manufacturer?
If you’ve answered “no” to one or more of the questions above, you may want to consider working with PDI.