Global Sourcing a Way to Reduce Manufacturing Costs if You Seize the Opportunity

Global sourcing is a term used to describe practice of sourcing from the global market for goods and services across geopolitical boundaries. Global sourcing often aims to exploit global efficiencies in the delivery of a product or service. These efficiencies include low cost skilled labor, low cost raw material and other economic factors like tax breaks and low trade tariffs.

For global companies who have already spent lots to time, energy, and money in setting up manufacturing plants and distribution systems to take advantage of these efficiencies they have increased their competitive advantages over their smaller competition. This same competitive advantage can be found in companies who provide global manufacturing sourcing that can bridge the gap between the different countries and cultures. One of those knowledge based companies is Padtech based in Delta, B.C.

Padtech transformed themselves from a 20 year manufacturing company who saw the need to make the switch from a small manufacturer to becoming knowledge based global manufacturing sourcing company. What is a manufacturing sourcing company and where does it fit in the manufacturing industries? Good question, we asked Dan Lionello, President of Padtech what the concept is and how they reduce the cost of manufacturing for its clients.

Padtech combines its expertise of understanding the manufacturing process from beginning to end and using the knowledge of manufacturing workflow to develop a process to in the last several years which combines taking a client’s engineering drawings into a common manufacturing production document, with its relationship based global network of  manufacturers in foreign countries to create a “Manufacturing ecosystem” which has saved its clients anywhere from 15 to 50% on the manufactured cost of their goods.

Common examples of globally-sourced products or services include: labor-intensive manufactured products produced using low-cost Chinese labor, call centers staffed with English speaking workers in the Philippines and India, and IT work performed by programmers in India, China, and Eastern Europe. While these examples are examples of Low-cost country sourcing, global sourcing is not limited to low-cost countries.

The global sourcing of goods and services has advantages and disadvantages that can go beyond low cost. Some advantages of global sourcing, beyond low cost, include: learning how to do business in a potential market, tapping into skills or resources unavailable domestically, developing alternate supplier/vendor sources to stimulate competition, and increasing total supply capacity. Some key disadvantages of global sourcing can include: hidden costs associated with different cultures and time zones, exposure to financial and political risks in countries with (often) emerging economies, increased risk of the loss of intellectual property, and increased monitoring costs relative to domestic supply. For manufactured goods, some key disadvantages include long lead times, the risk of port shutdowns interrupting supply, and the difficulty of monitoring product quality.

It is some of these pitfalls or hurdles which have prevented many smaller Canadian companies from exploring further the potential manufacturing partnerships in other parts of the world. Padtech however, has created this system of where they become the middleman between the North American customer and its network of partners throughout the rest of world to ensuring the manufactured products live up to the specifications and quality required by its customers.

Padtech is essentially an outsourced service with a major advantage over a smaller company trying to do this on its own, it’s the relationships built by them over the last few decades in other cultures and their ways of doing business to ensure that their customers get what they want at the time they want. They have learned to build those bridges with the other cultures which in North America many companies do not take only a year to build but in some cases several years before a supplier will do business with an unknown prospect to them. Padtech simplifies the process even further by developing a framework which takes the engineering requirements and developing a blueprint which engineers in other countries can decipher and use much more easily than a standard engineering document from a company in North America. What this also does is reduce the risk in prototyping and gives more transparency to the process instead of having the whole process done in house.

For global sourcing the investigation is definitely worth the risk as globally production is growing and being able to potentially reduce the manufacturing cost while maintaining product quality might be able a strategy to improve profits at the end.

Written by Richard Wong, CMA                   Email: rwong@firstchoicecapital.ca

Padtech logo

Myth 1:  The value of my business can be generally determined by using an earnings multiplier of my industry. ie. 3 times EBITDA

This is the most common myth. The earnings multiplier can be useful to get an overall general value based on the industry, but it doesn’t apply to all businesses within the same industry.  For example, your neighbourhood grocery store will not have the same earnings multiplier as the Safeway grocery chain.  Other factors of value such as supplier influence or technological superiority will also have an impact on the company’s value compared to its peers in its industry. Further, sometimes outside 3rd parties — such as the CRA, IRS, banks, courts, trustees, and other interested parties —  will not accept industry multiples to determine value.

Myth 2: Once I have an appraisal done the value will remain constant from year-to-year or period-to-period.

Businesses are not like the Canadian government savings bonds, there is competition, business environment changes,  new suppliers come into an industry if it’s profitable enough, some suppliers decide to divest of themselves, some competitors give up on certain product lines, while others join the market because they think they can make more money than some of its competition.

Businesses by their very nature are dynamic, not static and given this their values can easily change from year to year.

Myth 3: Valuation methods and approaches produce an absolute value.

The truth is, if you were to have 5 business valuators value the same business, all 5 will come up with a different value.  That is because each analyst may use different methods, approaches, discount rates, risk levels, and other variables to estimating the value.  But, if the valuator uses sound valuation methodology and approaches then you can assume the business valuation will be reasonable.

Myth 4:  We can have our accountant or lawyer do a valuation.

While these professionals seem like a good resource for assessing the value of your business, they may not be equipped with either the skill, qualifications, or experience to conduct the valuation process properly.  Even if they do have proper credentials for valuing your business you may want to reconsider having them perform the valuation.  The reason is there is a built in conflict of interest, since they will have an on-going interest in your business after the valuation study is completed, so there is a likelihood the value they derive for your business is biased, either high or low in favor of what you are hoping the outcome will be.

Myth 5:  The Financial statements of the company are good enough to determine value.

A company’s financial statements are the basis for a business valuation, but there are many other factors that affect value.  Some of these include : the competition, industry, economy, organizational structure, management, its capital assets, where along the business/product life cycle, as well as many other factors can affect the value of a business.

So you can see that in the process of a business valuation there are many factors which can determine the value attached.  These business valuation myths don’t use proven methodology, and best practices in determining value.   Taking the wrong approach on valuing your business can cost you a lot in terms of time, by prolonging the sale or financing process or money by not having an objective 3rd party opinion which are used to help settle law suits or prevent financing on time and on desirable terms.

Written by Richard Wong, CMA     rwong@firstchoicecapital.ca

In the sale or purchase of a private company its still necessary to use best practices in order to have the parties feel good about the transaction.  Using the services of a corporate financial advisor, a tax accountant, a corporate lawyer who work together as a team from the beginning will provide you with the ability to see things that are often overlooked by purchaser in a company.

In a past transaction the sole shareholder(owner) of a private company sold his shares to an independent purchaser and the capital gain realized was eligible for the small business corporation shares capital gains deduction.  So far so good for both parties.

However, one of the most common issues which is misunderstood by both the purchase & seller is the “Due to/from shareholder” account.  On the surface it seems like a fairly straight forward liability account, the credit balance in the account is owed to the shareholder.  Here is where the 3 professional advisors, a corporate finance lawyer, the tax accountant, and the corporate financial advisor know that this is a liability like any other liability and is owed to the shareholder.  Some accountants have trouble understanding this because they assume that the company had sold its shares, but the shares are separate from its liabilities.

Another effect of this “credit balance” in the Due to Shareholder account is when the new owner decides to draw money out of this account he will have been deemed to have received a “taxable benefit” under Section 15 of the Income Tax Act. Why? The withdrawal transaction isn’t a return of capital it’s a debt owed to its the former owner.  The capital gain for the seller of the business in this situation is also overstated which the capital gains exemption the owner has here.

An example might help here: the seller of the business sells her business for $500,000 and the owner has a credit balance of $150,000 in the Due to Shareholder account.  In the sales agreement the buyer of the business should ensure that the agreement reflects an allocation of the purchase price of $150,000 to purchasing the debt of the Due to shareholder account and the remainder allocated to the purchase of the seller’s shares.  The reason is that the purchaser has a debt owed by the company to herself and when she wants to withdraw some of it, it will be tax free unlike the prior situation.

This unfortunate situation can be reversed, but if the parties use best practices and have a coordinated team of advisors working from the beginning  it will save time and money for both the buyer and the seller.  But sometimes, the transaction go through due to no advice for either party and the consequences are a tax project case resulting in more money spent on a tax advisor later.  In a case documented in CMA magazine an accountant figured they fixed this by exchanging the debt for more shares, but caused more tax problems in the allowable business investment loss  issues and failed to take into account subsection 80(2) of the income tax act which allows the debt to be settled for the fair market values of shares issued.

The lesson here is that it is easier to have a team in place before you decide to do a sale or purchase of a private business to advise you on the issues, because they’re not as straight forward as you may think.  You can’t substitute the expertise of a group of advisors to help you save you money and headaches in the long run.

Written by Richard Wong, CMA      rwong@firstchoicecapital.ca

According to the BDC small medium sized businesses spend 45 to 65% of their revenue on purchasing materials and services.  This large percentage of the total costs of a business means that small savings, even 1% can mean instant addition to the bottom line but in today’s economy you can achieve even greater savings in the 10% to 20% range is possible.

Try some of the following to cut your spending:

1. Have your controller or hire a consultant do an expenses analysis
   - Review all parts of the product or service cost, break them down individually into:
   - Raw materials costs
   - Taxes, brokerage, tariffs, duties
   - Freight
   - 3rd party warehousing/logistics handling costs
   - Extra vendor charges
   - Vendor payment terms
2. Review your purchasing process on how to evaluate the best choice
   - What type of process is used for deciding to use one supplier over another?
   - How many people need to be in the decision making process, the fewer the number of people, the less the overall internal cost?
   - When deciding to purchase equipment is there a “Net Present Value” analysis of the different choices which examines the benefits over the asset’s life?
   - Have your staff included used equipment purchases as an alternative to purchasing new? Have they visited auctions?
3. Potentially sources from offshore countries
   - Start looking to buying from other countries to compare suppliers.  BDC studies show that only 42% of Canadian companies are saving money, but you could be one of them.
4. Review standardizing the number of parts in your product
5. Reduce the number of suppliers & forge strategic partnerships with a few to get better pricing, terms, or delivery.
6. Think about using technology to help track your business

Written by Richard Wong, CMA   email: rwong@firstchoicecapital.ca