US companies have captured only a fraction of China's potential as a source of low-cost products and plan to strengthen their purchasing activities in the country, despite high employee turnover and other difficulties. In a survey of 39 US companies with sourcing offices in China,¹ the respondents estimated that these companies buy only 30 percent of the goods they ultimately could buy there, though that figure will rise to 50 percent three years from now. Moreover, to date, the respondents' companies have captured only about one-quarter of the potential savings from purchasing in China—a proportion expected to hit 40 percent in three years. (Volumes increase faster than savings because it takes time for suppliers to squeeze out costs.) Notwithstanding all the press about Chinese exports to the West, only a fraction of the full potential has been captured so far.

Companies maintain that they are overcoming many of the cultural and logistical complexities that vex them. Some of the issues (such as communicating with corporate headquarters, training Chinese workers, and overcoming cultural and language barriers) are expected to be less pressing three years from now as companies gain experience and streamline their purchasing processes (Exhibit 1). However, companies expect that today's number-one challenge—retaining workers in their Chinese offices—will get tougher, in view of high demand for experienced people as multinationals expand their sourcing activities.

Despite the progress the respondents cite, companies worry that their procurement performance lags behind that of competitors. When we asked respondents how their companies compare with rivals in nine areas, from the total volume of goods purchased in China to the ability to develop a local workforce there, they felt that their employers trailed the competition on every point (Exhibit 2). They feel least secure about the size of the cost reductions they realize by sourcing products in China but also express concern about the quality of the products they buy and the slow pace at which volumes are increasing. Such concerns may reflect an awareness of the competitive challenge companies face in China and of how much improvement is possible.

To increase the savings, companies are shifting their Chinese purchasing organizations into a higher gear. Although respondents indicate that reducing the cost of the goods their companies buy will remain a significant issue, raising volumes—in part by giving Chinese sourcing offices more autonomy and responsibility—will become increasingly important. Companies plan to transfer to China some critical functions and decisions that are currently the responsibility of headquarters. Although today just 14 percent of all companies in China design products there, our respondents believe that the proportion will rise to 50 percent in three years. Likewise, while 34 percent of the respondents say that their companies' Chinese offices currently approve product prototypes, the proportion is expected to double in three years (Exhibit 3).

Companies expect that moving decisions overseas will yield competitive advantages, such as shortening the time needed to bring products to market. One European apparel manufacturer, for example, formerly needed 12 to 24 weeks to get new products from the design phase to the point when it could place orders with its suppliers. By cutting the back-and-forth between headquarters and the Chinese sourcing office, the company has already shaved that time by several weeks and ultimately expects to reduce it to 5 to 10 weeks—though progress toward that goal has been slowed by a shortage of experienced staff in China and by opposition at headquarters to the change.

Indeed, despite the potential rewards of shifting more responsibility to China, companies often encounter resistance back home, especially if the procurement process traditionally has been centralized at headquarters. A prerequisite for giving an office in China more authority—and for raising the volume of goods purchased there—is the ability to instill greater confidence about Chinese staffers, suppliers, and products among the company's internal customers, many of whom prefer to buy from familiar suppliers. Respondents say that their companies overcome such resistance in several ways: for instance, by inviting headquarters staff to China for frequent visits, by sending key Chinese employees to headquarters on job rotations, and by linking everyone's incentive pay to performance improvements that are realized in the Chinese sourcing office.

Companies are also upgrading the skills of their Chinese suppliers. Respondents emphasize initiatives that raise quality, cut costs, and improve the suppliers' ability to deliver goods on time. Their companies are focusing fewer resources on compatible IT systems, which haven't yielded big savings, and on efforts to help suppliers apply the principles of lean manufacturing, since they feel that neither the Chinese purchasing offices nor the suppliers have enough skills and experience.

Nonetheless, we have found that Chinese suppliers can cut a company's costs by 20 to 50 percent, primarily through improved techniques for buying parts and raw materials, as well as through better manufacturing practices. Rapid efficiency gains are possible: in just four months, one machined-metal parts supplier reduced the time between receiving an order and delivering a product from 14 days to just 3. The company also improved the timeliness of its deliveries, with 83 percent of them arriving when they were due, up from 60 percent. Clearly, companies can wring many more benefits from procuring goods in China.