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Adapting products to local tastes, offering customers multiple purchase channels, and committing to each foreign market, are success factors for SMEs expanding internationally.
When a small or mid-sized enterprise (SME) ventures abroad for the first time, its first aim is typically to kick-start sales and build a local market. That, however, only establishes a foothold. To continue growth and development in a new market, SMEs require a broader strategy aimed at developing and maintaining a strong local presence.
This growth strategy has many facets, depending on the nature of the SMEs business, its strengths in its home market, and the nature of its targeted foreign markets. For example, for many SMEs, sustaining growth abroad involves modifying products and even changing entire business models to suit local tastes and conditions. For others, sustaining growth entails partnering with multinationals or with other established players to provide initial entrée –and then ongoing access—to foreign markets.
For yet other SMEs, sustaining growth in foreign markets requires building on a unique proprietary technology and using existing distribution channels to extend the firm’s market reach. Paradoxically, other firms may find they can best sustain their international growth by pulling back from an overly ambitious expansion, thereby keeping the international business manageable.
ADAPTING TO LOCAL TASTES: THE GRAZE EXAMPLE
An example of successful adaptation of both products and business model to sustain growth in a foreign market is offered by Graze, a mid-sized UK snacks maker that made a successful entry into the US market in 2013. Several years before it took that step, the company, which is majorityowned by US private equity giant Carlyle Group, took several measures in its home market that later served it well in the much larger US market.
First, Graze switched from a subscription-only sales approach—in which customers signed up to receive snack packages periodically through the mail—to a multi-channel distribution system including subscriptions, sales of individual items over the company’s website, and sales of individual items through supermarkets such as Sainsbury’s and other retail outlets such as Boots. “Our customers are telling us it would be more convenient if the product were to be available in a number of different ways,” Chief executive Anthony Fletcher said at the time, a year before the firm introduced multiple sales channels in the US market as well.
Second, Graze built an efficient warehousing and distribution system in the UK, thereby acquiring expertise which later helped it to bypass distribution bottlenecks in the US postal system. And third, Graze developed expertise in gathering and analysing customer feedback to tailor products to local tastes. The firm employs a team of ten data scientists at its UK headquarters to analyse thousands of customer ratings, and responds with changed product offerings within a few months. In the US market, this meant dropping British staples such as mango chutney—a food item that befuddled many Americans—and introducing such US standbys as cinnamon buns and peanut cookies.
The distribution and product development expertise developed in the UK worked to Graze’s advantage in the US, the world’s largest snack-foods market. Within a year of entering the US market, the company’s US sales reached an annualised US$35m a year. In 2016 Graze started selling through 3,500 US stores, including Boots’ sister company Walgreens. Overall, the firm grew quickly since its founding in 2007, reaching a turnover of £70 million in the year to February 2016.
Along the way, the firm’s “unique selling proposition” has evolved along with its product line and business model. Originally focusing on snack boxes containing health-oriented basics such as nuts, grains and berries, Graze has since introduced healthy variants on fat- and sugar-intensive snacks. For example, the firm’s American cinnamon buns are not the familiar dough-based, fatand sugar-intensive US staple, but rather are cinnamon fig rolls which, the company says, are healthier and lower in calories. Similarly, Graze’s package of “sweet and salty cookies” sold in America actually consists largely of nuts and is marketed as protein-rich and low in calories.
In adapting itself to the US market, Graze essentially exported business-model modifications— such as continuous product development and multiple-channel selling—that it first introduced in its home market. In this, it is typical of SMEs going abroad: Try an approach at home, develop expertise, and then use it in foreign markets. Yet Graze’s example also shows the importance of building a new brand identity in a foreign market that suits the specific tastes of that market.
USING A LOCAL TOUCH: THE TED BAKER EXAMPLE
Ted Baker, a British luxury clothing brand listed on the London Stock Exchange, offers another example of developing techniques in the home market and then exporting them, while also ensuring a local identity within each foreign market. Ted Baker’s global presence relies on investing in the design of its distinctive and sometimes quirky clothing—as well as paying close attention to smooth-running warehousing and distribution. Much of this foundation work, on both product design and logistics, takes place in the UK. But the work is done with a view to serving a global market.
So, for example, in October 2016 Ted Baker opened a giant warehouse in Derby, UK, run by US multinational XPO Logistics, to operate a Europe-wide delivery system. Efficient distribution forms the basis for a network of own-brand stores and other outlets that has spread beyond the UK to Europe, North America and Asia. In less than three decades after its founding in 1988 as a single store in Glasgow selling men’s shirts, Ted Baker has acquired a global presence. It now has a total of 470 stores, concessions and outlets worldwide, led by the UK (186), North America (106) and continental Europe (97), with smaller presences in Australasia, the Middle East and Africa.
Significantly, all of the Ted Baker stand-alone stores outside the UK are designed to match the local style and culture, rather than following a single global template. The new store in Amsterdam, for example, uses parquet flooring and interior design celebrating Dutch artists including 20th century painter Theo van Doesburg. In contrast, its most recent store in New York City features walls with a rough concrete finish and brushed brass strips lining the walls to recall grids such as the New York street system. Scale-model buildings attached to the walls add a three-dimensional element to the notional cityscape. The overall marketing message in the design touches: Ted Baker, while a global brand, aims to establish a local identity and appeal to local tastes.
In addition to offering a local touch within its global network, Ted Baker provides customers a multiplicity of purchase channels: through Ted Baker-branded stores, concessions within department stores, and online. This variety of sales channels has allowed the firm to weather retail downturns. Any problems at stand-alone stores, for example, can be compensated for by booming online sales, and by concessions and licensing agreements with outside retailers and distributors.
The firm’s global-local strategy, and its focus on central product design and seamless delivery, appear to be working. The company increased sales by 18% to £456 million in the year to January 30, 2016, and then by another 14% year-on-year in the following six months, despite a generally flat retail market.
PARTNERING WITH ESTABLISHED PLAYERS: THE APMT EXAMPLE
Not all firms start an international expansion from a basis of heavy investment in product design and logistics expertise in the home market, which they then use to enter export markets. Some take a more direct route, partnering with multinational companies or with other local players who already have the foreign-market expertise and the distribution networks in place, and use these to gain a toe-hold in new markets.
An example is given by Advanced Polymer Monitoring Technologies (APMT), a small company in New Orleans, which grew out of academic research at Tulane University in 2011. It holds several patents for real-time monitoring equipment that, claims CEO Alex Reed, can reduce chemicals plants’ production costs significantly. With revenues of about US$1 million, APMT is clearly a startup, but one with high growth potential among plastics and pharmaceuticals manufacturers, among others.
To capitalise on that potential, and develop international markets quickly, APMT sought joint ventures with companies that can take its products to foreign manufacturers. In October 2016 it reached an agreement with Austin Chemical Company, a services and products supplier to the life sciences and specialty fine chemicals industries. This agreement should “expand the reach of our offerings to an international network of manufacturers and researchers,” according to Reed. For APMT the challenge is to get its technology adopted by a global industry. “Any of the production plants could use it,” says Reed, adding that real-time monitoring of production allows factories to cut waste and increase efficiency.
In addition to the monitoring technology, APMT has developed a light-scattering tool that helps drug makers test the stability of drug formulas. It shines a ray of light onto the drug being produced, which causes the light to scatter, or deflect. If the drug formula is incorrect then this will be detected through variations in the light scattering, allowing the formula and the manufacturing process to be corrected quickly.
Since APMT feels it has a hot technology in its hands, its aim is to keep its focus on that technology and rely on others for the sales function. Its market-entry strategy, therefore, is to benefit from the local-market knowledge and the marketing and distribution expertise of larger players, rather than developing these skills itself. This approach can allow it to start from a very small base and build up export sales quickly and sustainably.
BUILDING ON A PROPRIETARY TECHNOLOGY: THE GLOBALSTAR EXAMPLE
Some companies sustain their international growth by trying to extend their product range, building upon a unique technology and/or on existing foreign sales and distribution networks. A case in point is Globalstar, a long-established firm with a strong global sales network, which nonetheless needs to find a way to unlock mass sales. Globalstar is a US satellite communications firm set up in 1991 with $1.8bn in funding from industry giants including Alcatel and Hyundai. Now private equity controlled, it supplies navigation and communications equipment to those out of range of conventional mobile phone signals. “Much of the world’s land mass lacks mobile phone connectivity,” says its chairman Jay Monroe. “Even driving across the US there would be large areas lacking coverage.”
Yet with annual sales of around $90m, the firm lacks the product line and brand recognition to reach consumers beyond its small niche. The company has a global sales network in place, since it sells to individuals and firms venturing into remote areas, and many of these are in developing countries, for example in Africa, where mobile phone coverage can be patchy. But the market for its products is limited if the firm remains focused on specialist equipment such as satellite phones.
To address that problem, Globalstar plans to introduce a device that connects conventional mobile phones to its communication satellites when they lose coverage. Partly, it will sell these through its existing international network of dealers and suppliers. The firm is also talking with car manufacturers, who may add the device to improve the connectivity of vehicles.
Whereas Ted Baker has established a brand to market globally, and APMT sought help from multinationals to market an existing and promising technology, Globalstar is approaching export marketing from the opposite direction: seeking to develop technologies which it can market through an established sales network. In doing so, Globalstar hopes to build not only on its existing sales network but also on its core advantage: a satellite system that would be hard to replicate.1
MODERATION IN ALL THINGS, INCLUDING GROWTH: THE WIGGLE EXAMPLE
Either way—whether seeking products for an existing sales network, or seeking a sales network for existing products—amassing a portfolio of export markets can be a tricky business for an SME. As the local-touch strategy implies, every export market is different, with its own culture and history, consumer preferences, and legal requirements. Some SMEs find that building a sustainable international presence means picking and choosing among individualised foreign markets, to avoid becoming overwhelmed by having to meet so many different local market requirements.
A case in point is Butler’s Cycles, a UK-based bicycle store that expanded abroad and found itself a victim of too much success. Two decades ago, the Portsmouth-based shop launched a company specialising in mail-order sales of bicycle parts and accessories. It relied on the thennascent Internet first to build a UK customer base, and then to sell products abroad, eventually changing the name of the firm to Wiggle. Today, half the company’s £179m annual sales come from export markets. With bulk buying keeping prices low, and with efficient delivery, Wiggle was able to compete successfully against local firms even in countries as far away as Australia.
With backing from private-equity owners, Wiggle quickly reached customers in 120 countries. But to make the business more manageable, and to protect profitability, the firm recently cut the number of export markets back to 70. In particular, it chose to focus on fast-growing and profitable markets in the UK and continental Europe. Other markets, for example in Asia, were less lucrative, particularly as exchange-rate differences hurt sales and margins.
Like Graze, Wiggle shows how a successful company can use the Internet to gain entry into export markets globally. But sustaining that success sometimes requires taking a step back and assessing whether all expansions are necessarily good expansions. That calculation is not inconsistent with a key success factor for SMEs entering export markets—namely, the importance of establishing a deep presence in each market. Spreading a small company’s limited resources too thinly around the globe can mean devoting too little attention to acquiring a firm foothold in the markets that matter most to the firm’s growth.
Developing a recognisable local brand, tailoring products to local tastes and ensuring efficient delivery all require a certain focus. If an SME wants sustainable international growth, it may find that, in amassing a portfolio of export markets, sometimes less is indeed more.
The same principle applies to amassing a portfolio of foreign subsidiaries. Each subsidiary represents a range of costs, from start-up to maintenance to ongoing compliance expenses. Velocity Global, a consultancy, estimates the global average cost of establishing a foreign subsidiary at US$15,000-20,000, and the average maintenance costs at US$40,000 per employee per year. To this it adds indeterminate ongoing costs of staying current on changing local tax laws, payroll withholding requirements, employment law, and new banking regulations, among others.
CONCLUSION
There is, of course, no “recipe” for success in sustaining international growth by SMEs. But the experience of some successful SMEs points to guidelines to consider.
The examples of Graze and Ted Baker show the importance of adapting products—and when necessary, entire business models—to suit local tastes and conditions. APMT’s example showcases the advantage of partnering with established players to ensure both initial and ongoing access to local markets. Globalstar’s example indicates the value of leveraging a unique technology and existing foreign sales and distribution channels to extend market reach.
Wiggle, the UK bicycle parts and accessories exporter, offers a cautionary tale concerning expansion that is too fast and too extensive. In its case, sustaining international growth required, first and foremost, focusing on a portfolio of foreign markets that it could manage effectively.
All these examples show the diversity of strategies needed to sustain international growth. While the examples are diverse, they share an important success factor in common: All show the importance of firms committing themselves to their chosen foreign markets. More than anything else, that commitment is a prerequisite for sustained growth in those markets.
Information and communication technologies, among others, are helping mid-
Economic Development
SMEs entering new foreign markets should pay close attention to efficient
Economic Development
Even within a free trade zone, exporting can be complicated by varying
Hoping to profit from a wave of investment in China by large multinationals, small and mid-sizedenterprises (SMEs) based in Germany flocked to that country in the 1990s. China’s government welcomed them: like many other countries, China was intrigued by Germany’s Mittelstand firms— usually stable, technologically sophisticated, family owned firm —and wanted to learn from them. But despite the welcome—or perhaps because of that desire to learn from the newcomers— China often required the newcomers to establish formal joint ventures with Chinese partners. This requirement did not diminish the German SMEs’ interest; indeed, many Mittelstand firms saw the joint ventures as a way to get acclimated in China.
Today, though, the partnership requirements have eased for the approximately 5,200 German firms invested in China. As a result, most German firms have decided to go it alone in the Chinese market. Turck Technology, a family-owned German industrial automation company with annual sales of around €500m, is a case in point. It established a wholly owned subsidiary in China rather than partner with a Chinese firm. Its aim was to maintain control, ensure consistent quality, and protect its designs. The firm’s Chinese sales are about €40m a year, “the same level as our competitors,” says Christoph Kaiser, Turck’s managing director.
By now, only 12% of the German companies invested in China use formal joint ventures, says Alexandra Voss, executive director of the German Chamber of Commerce in north China. “Where the former joint venture requirements no longer exist, German companies tend to purchase the joint venture shares from their former partner rather than extending the agreement,” she says.
Between the two extremes—a formal joint venture and a go-it-alone subsidiary—there is a wide range of looser partnerships possible between SMEs in different countries. Among the most popular such tie-ups are those involving licensing and technical co-operation agreements. The challenge for SMEs in these arrangements—as in full-fledged joint venture deals—is to preserve their proprietary information while benefitting from enhanced access to the local market.
For example, James Cropper, a family-owned UK paper maker, expanded internationally in recent years, to the point where around half of its £88m revenue now comes from export markets. In China, it signed a technical co-operation agreement with a local firm to design fibres for high-end carbon bicycles. Despite cooperating on adapting products for the local market, the agreement sets strict guidelines to protect James Cropper’s know-how. “We wanted to keep control of intellectual property,” says its CEO Phil Wild.
Licencing agreements are another way to boost foreign sales without requiring a formal joint venture. Under such agreements, a local company buys the rights to market (and sometimes produce and develop) the exporting firm’s brand or products. The local partner does not have equity rights, making such agreements popular among small exporters with limited capital.
Australian pharmaceuticals firm Suda and its Chinese partner Eddingpharm provide an example of a licencing agreement. Suda, with revenues of just A$6.3m a year, would have struggled to afford to expand into China in its own name, or to invest in a joint venture. In late 2015, it signed a licensing agreement with Eddingpharm to produce and sell its drugs in China. Among the sweeteners for Suda: an upfront payment of US$300,000 and another US$200,000 when its product is registered in China. For small companies, licencing can offer an immediate cash injection, as well as a way to enter new markets.
A “lighter” variant of a licencing agreement is a simple sales-representative deal, in which a local firm contracts to market, sell and distribute the exporting firm’s products in the target market. David Butler, CEO of the South African Chamber of Commerce in London, says many of his country’s food exporters take this approach in the UK, benefiting from the market reach of UK retail chains and specialist distribution firms.
Such arrangements can help to avoid the biggest danger inherent in full-fledged joint ventures: their high failure rate. McKinsey, the management consultancy, estimates that up to 60% of international ventures fail.1 Among the major problems: partners may have incompatible objectives, for example with one wanting to maximise long-term market share and the other wishing to make a quick profit. The US advisory firm Water Street Partners finds that around twothirds of joint venture CEOs say the owners are misaligned on long-term strategy and on budget issues.2 A more limited technical co-operation agreement can sidestep such fundamental issues.
What all these partnerships—the full-fledged joint venture agreements and the “lighter” variants— share in common is the marriage of an exporting firm’s product know-how and a local firm’s market expertise. Regardless of the form that a partnership takes, the fundamental questions apply: how to find the right local partner, and how to structure the agreement to avoid common pitfalls.
“That’s the million dollar question,” says Mr Harris, the US lawyer. “[The answer] is usually based on the [specific] business involved. If you are an educational software company, you think about partnering with the top one or two companies in China that distribute or sell educational software. If you make high-end [technical] widgets, you may partner with the one or two best high-end widget companies in China—whose widgets, though high-end for China, are not nearly as good as yours, and therefore they could use your help. You find these companies yourself, or you hire a consultant to help you find them.”
The routes to finding foreign partners vary. James Cropper found its Chinese partner via the contacts it had made in the country by selling there directly. It sought out Chinese partners with expertise and complementary skills for its high-end fibres division. It also looked for Chinese firms with industry contacts and specialist expertise to sell to high-end bicycle manufacturers.
Indeed, the search for such partners is often mutual, with Chinese firms eager for foreign partnerships. Eddingpharm, the pharma company licensing products from Suda, first entered the business via licensing deals with multinational pharma companies Novartis and Baxter in the early 2000s. In 2012, backed by international investors, Eddingpharm established a US subsidiary to seek out other product lines for distribution in China, as well as deals to develop and market such products. Among its wins: an agreement with Suda to develop and market an insomnia drug which the small Australian company would have struggled to sell in China on its own.
Companies that lack contacts in a target foreign market often turn to consultants for help. Firms such as Prospect Chinese Services, which is staffed by Chinese nationals and has offices across the UK and China, advise clients ranging from hotels and universities to car manufacturers wishing to enter the Chinese market. It claims to offer a ‘one stop shop’ for UK companies, comprising market research and market entry strategy services, support with first contacts, and advice on negotiations.
Other match-makers include government export promotion agencies, which compile large databases of foreign companies and can put exporters in touch with potential foreign partners. Erin Butler of the US Export Assistance Centre says that US SMEs supplying the oil industry approached her for contacts in growth markets such as North Africa. Like James Cropper, the US oil industry suppliers also used their domestic sales forces to make initial contacts with potential foreign partners. The search criteria for finding the right local partners tend to be similar, across a range of businesses: that is, local partners who supply expertise, skills and contacts that are complementary to those of the exporting SME.
Exporters making a long-term commitment to a foreign market often acquire a local company to establish a stable presence in that market. One example is Palfinger, an Austrian SME and construction-machinery maker, which bought companies across the world to access their markets and to diversify away from over-reliance on building mobile cranes. Its foreign plants gave Palfinger a lower-cost, more flexible production base to supply new markets, which in turn helped it to withstand a series of economic storms.
A buying spree was not Palfinger’s sole expansion tool, however. It also established joint ventures with local companies in some major export markets, particularly in China and Russia, using the partners’ local market dominance to boost its own sales. In 2012 Palfinger established two joint ventures with SANY, China’s biggest manufacturer of construction equipment. One of the ventures was established to sell Palfinger products in China, and the other to distribute SANY products outside of the country. In 2013 the companies agreed to a share swap, with SANY taking a 10% stake in Palfinger in exchange for an equal stake for Palfinger in one of SANY’s operating units. For Palfinger, this helped to cement a deep presence in China, while for SANY the deal boosted its own globalisation efforts.
In 2014, Palfinger set up two more joint ventures, this time with Russia’s largest truck maker Kamaz. One builds chassis to hold Palfinger’s mobile cranes, and the other produces cylinders for construction machinery. Under the deal, Palfinger agreed to invest in modernising the production plant. In return, Palfinger gained entry to Russia’s specialist construction machinery market. “We couldn’t buy them [SANY and Kamaz],” spokesman Hannes Roither says drily when asked why the firm chose joint ventures.
Significantly, the local ventures provided a buffer when local markets weakened, due to their strong local customer base. “There have been serious market crashes in both countries” in recent years, Mr Roither says. “But we were able to protect our own sales by increasing market share when foreign competitors withdrew from the country.”
Similarly, the German luxury hotel group Steigenberger set up a joint venture with a local company to accelerate its expansion into India. Steigenberger owns 116 hotels in 12 countries, generating 2013 revenues of €500m. In 2016 it announced a joint venture with MBD, an Indian hotel group, with Steigenberger retaining a controlling stake. MBD will manage the joint venture including sales, while the German company will manage international marketing, training and brand development.
The companies have complementary skills, with Steigenberger a leader in five-star hotel management and MBD an established player within India. Also, and equally crucially, they share the same aim: the rapid roll out of luxury hotels in India. The joint venture plans to open 20 hotels over the next 15 years. Managing Director Sonica Malhotra Kandhari says it would take between three and five years for either partner acting alone to open a single hotel.
KEYS TO SUCCESS
Structuring any type of partnership agreement with a foreign partner can be tricky, says Dan Harris, a founder of the US law firm Harris Bricken, which specialises in joint ventures in China. He advises clients to keep a majority stake in a joint venture, and to protect their intellectual property zealously regardless of the nature of the co-operation. He offers the cautionary tale of a US firm whose Chinese partner began to manufacture the US partner’s products under the Chinese firm’s name. Some remedies are simple: “Many times we find that the [US] company had not registered a patent in China,” Mr. Harris says.
Beyond that, a key to success is to look carefully at the fundamentals: ensuring that the partners’ skills and expertise are complementary to those of the exporting SME; establishing that the aims of both partners are aligned; and making long-term commitments to the target markets. These elements—complementary skills, similar aims, and long-term commitments—are as close as an SME can come to finding a recipe for success in forming international partnerships.
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A small or mid-sized enterprise (SME) establishing a presence in a new foreign market faces steep learning curves on several fronts. It must familiarise itself with the needs and preferences of a new market, ensure compliance with a new set of laws, find and train local staff, arrange financing, and sometimes learn a new language at the same time.
In the excitement of establishing a foothold in unfamiliar terrain, small firms can overlook a less glamorous aspect of the process, but one that is crucial to success: ensuring that components, raw materials and finished products reach their destinations on time, in good condition and at competitive prices. That task—establishing supply chains and distribution channels—falls to logistics managers; the quality of their performance can make the difference between a successful international expansion and an expensive disappointment.
Logistics pitfalls abound even in an SME’s home market, and can be compounded when using an overseas manufacturer. One typical example, involving underestimating shipping costs, is related by Entrepreneur magazine1, a North American publication focused on small business. A small California supplier of wedding-cake toppers, Younique Boutique, received an order to ship wedding toppers to a television production set. When the order ballooned unexpectedly to 280 toppers and the television production set was belatedly revealed to be in Hawaii, the SME’s founder and CEO scrambled to fill the order using a manufacturer in China. Under time pressure, and without accurate information on the shipment method to be used by the Chinese plant or the added price of a rush order, the owner guessed that the added shipping cost would be $5 per item—an underestimation that ultimately cost the firm $800.
HIRING DELIVERY EXPERTS
Mistakes made under time pressure are hard to avoid, but the main lesson here for SMEs is clear: Regardless of where they operate, attention to the nuts-and-bolts of logistics is an important aspect of successful entry into a new market.
To avoid costly logistical problems, many newly internationalising SMEs outsource the logistics function, both for inbound components and returns, and for outbound finished products. They look for experienced logistics services providers, using either partners they already employ elsewhere, or local firms, or a combination of the two. This enables them to concentrate on their core business and leaves the details of deliveries to firms with distribution expertise in the new market.
Consider UK-based Childrensalon, which sells high-end children’s clothing via its website and through a shop in Tunbridge Wells, UK. It increased its sales tenfold over the past five years (to £63 million in 2016) by selling internationally via its web site. This expansion required a heavy investment in logistics, including building up the firm’s packaging staff and warehousing capacity, as well as updating its IT systems. For deliveries, however, Childrensalon relies on five international freight firms including UPS and DHL. “We found that some companies were more efficient than others for deliveries in certain parts of the world,” says human resources director Denise Hamilton, adding that selecting providers for each new market was a process of “trial and error”. These outside providers manage the paperwork, such as customs clearance, as well as the actual deliveries.
Childrensalon is hardly alone in outsourcing freight services in new markets. Toby Gooley, editor of the US-based Supply Chain Quarterly, says that most companies, large and small, outsource distribution to avoid devoting time and resources to a non-core activity. While freight services provided by a third party come at a cost, outsourcing this function means an SME saves on dedicated staff to deliver goods and to ensure legal compliance with import and export regulations, as well as saving the direct costs of buying and maintaining delivery vehicles.
For a largely web-based company such as Childrensalon, outsourcing freight operations has allowed it to sell, and source, worldwide: it now offers more than 270 different brands and sells to more than 120 countries, fuelling rapid sales growth in recent years. Given that complexity, outsourcing freight operations was a must—even if that meant paying the costs of both initial deliveries to customers and return deliveries when customers do not want an item they ordered. The cost of return deliveries, in particular, cuts into the margins of an online retailer, but is an unavoidable cost since customers cannot physically see or try the goods they order online.
So, for example, Childrensalon pays freight services providers such as UPS or Fedex £9.95 per delivery to an address in the United States, and a similar amount if the customer decides to return the item. The firm pays freight providers £3.95 for delivery to a UK address. Ms Hamilton says that the higher US delivery charges are passed on to US customers (who must also pay return postage costs themselves), who pay them because the charges are relative low compared to the high cost of the high-end products involved. While this works for Childrensalon, high delivery costs in export markets could hurt companies in more competitive industry segments by pricing their products out of reach.
In general, experts say distribution and logistics services can add 10%-15% to the cost of goods.2 One concern highlighted by Childrensalon is that SMEs often fail to shop around extensively among alternative freight suppliers, even though the cost of freight services can dent competitiveness. Jim Edmondson, CEO of the UK aerospace company Gilo Industries, a privatelyheld group with 2016 revenues of £3.2 million, is one example among many. His company is about to expand from a specialised to a wider consumer market, but so far is relying on a single supplier, UPS.
Gilo makes a very lightweight engine which can be carried in a backpack to create a powered paraglider (avoiding many of the stringent regulations for conventional aircraft), among other applications. With sales of a few hundred units a year of products costing thousands of pounds apiece, logistics has not been a great concern. Gilo has hired UPS to deliver worldwide, and will pass delivery costs on to customers. This is a practical solution for the firm at a busy time. But with sales expected to increase to the thousands of units when the new product is launched, logistics costs may become more of a factor in the firm’s profitability.
KEEPING CORE LOGISTICS IN-HOUSE
While some firms outsource product deliveries, they also keep some mission-critical functions in-house. As noted above, for example, Childrensalon invested in a made-to-order IT system to manage dispatching of products from a warehouse in its home town. Due to the surge in sales and international deliveries that followed its online expansion, the firm recently added two warehouses on the same industrial estate. It also increased its packing and fulfilment staff to 90 people, nearly one-third of its total staff. Centralised distribution makes sense for a company selling to so many different markets: the cost of setting up warehouses abroad would have been prohibitive. More importantly, the in-house central warehousing function allows Childrensalon to retain direct control over a critical service—dispatching products as specified in customers’ orders—and to provide direct customer support when needed.
The use of Childrensalon employees to answer customer queries and provide comprehensive product information before purchase has paid off by keeping return rates very low, the firm says. According to Ms Hamilton, only around 10% of orders are returned. This compares to an estimated returns rate of 25% for women’s fashion items in the UK, according to an executive of retailer John Lewis.3 Cutting the rate of returns translates into an improved bottom line. The consultancy Clear Returns says that returned orders cost UK retailers £60 billion a year, a third of which is generated by online retailers.
Managing returns is particularly important for companies trading internationally, where the cost of deliveries from and to the home base are typically higher than for domestic deliveries. Raj Sandhan, managing director of UK distributor Metro Health and Beauty, experienced the difference first-hand when it sourced cosmetics in the US. He says that freight charges of 8-10% on US imports, on top of import tariffs, cut deeply into profit margins. “Together, freight and tariff charges can easily wipe out half of an exporter’s margins,” Sandhan says. Metro turned instead to cosmetics manufacturers in France to reduce both tariff and transport costs, and deals with suppliers there directly.
The heavy capital cost of setting up foreign logistics centres (such as warehouses) mean that companies expanding into new foreign markets generally outsource this function at first. They are more likely to invest in such centres when they are well established in the foreign market and therefore can predict demand, says Christopher Van Riet, managing director of Russian logistics provider Radius Group. Metro’s Sandhan agrees, saying that firms tend to use external distributors for the first two to three years in a foreign market.
Van Riet cites the example of John Deere, a large American agricultural machinery maker that started local assembly of its products to facilitate sales to Russian dealerships. Initially, it leased a turn-key assembly plant built by Radius, which bolted together a small number of components imported from the US. Over several years, John Deere built up its own manufacturing operation to take on more complex work; it also started to use more Russian suppliers of components. Although it needed to assemble locally to avoid Russian import tariffs, John Deere built up its manufacturing and logistics operations gradually, to avoid heavy upfront investment in an unproven market.
This approach is different from that of retailers, who—due to the fast-moving nature of their business—are more likely than heavy-goods manufacturers to see warehousing as mission-critical. “Retail stores can open and shut,” says Van Riet. “The key for supermarket chains is [control over] warehousing and distribution, so that they can maintain and deliver goods to stores reliably.”
For example, Auchan, the French supermarket chain, said in October 2016 that it will spend over US$100 million on a big logistics and distribution centre near Moscow. It used Radius to develop the project but has kept direct control over the facility. Initially, it will service Auchan’s existing 50 stores in the region. But with capacity to load and unload more than 200 trucks simultaneously,
the warehouse is expected to help with future expansion of the retailer’s store network in Russia. Like Childrensalon, Auchan regards control of warehousing and stock as too crucial to outsource.
Similarly, Ted Baker, a UK fashion brand with 2016 turnover of £456 million, plans to consolidate warehousing and distribution after a period of rapid international expansion. Previously, the firm used three separate distribution centres, which it combined into a single large warehousing and fulfilment centre in Derby, UK in May 2016. Centralising distribution into a single, highly automated, location open around the clock will save money, as well as giving it extra capacity to serve a growing international market, the firm says. On the other hand, in contrast to Auchan, which will manage its warehousing function with its own personnel, Ted Baker outsourced management of its new logistics centre to a logistics supplier. The provider not only bore the upfront cost of setting up the consolidated warehouse, but also provided the IT systems to manage inventories and deliveries.
Given the diversity of SME approaches to balancing in-house control and outsourcing of logistics functions, warehousing and logistics providers are offering increasingly sophisticated menus allowing SMEs to pick and choose the services they want. Some services involve only freightforwarding— organising shipments from the producer to the final customer or distributor. Others are broader, and might encompass, for example, managing online sales, arranging transport including documentation, and delivering goods to customers. The Royal Mail, the UK’s privatised postal services provider, has agreed on such a comprehensive system for Alibaba, the Chinese e-commerce web site. Under this arrangement, the Royal Mail will establish a sales web site for British firms selling via Alibaba, and will deliver the goods to UK customers.
Choosing a supplier requires research into each supplier’s specific expertise. Ms Gooley of Supply Chain Quarterly says that certain logistics providers specialise in particular industries, others have a certain geographic focus, and still others perform the whole gamut of logistics functions worldwide.
MIXING AND MATCHING
It remains for SMEs to decide on the best balance between controlling their own logistics and outsourcing some of those functions. Some creative mixing and matching of logistics functions— some in-house and some outsourced—may be required. Matt McInerney, vice president of global forwarding sales at the US third-party logistics provider C.H. Robinson, gives the example of an upmarket US kitchen equipment maker that wanted to expand into the UK. C.H. Robinson set up this company’s warehousing operations in the UK, sparing the client a heavy upfront expenditure. However, the kitchen equipment maker kept many operational functions in-house, for example running its own fleet of 18 trucks to deliver products to a network of more than 100 dealers.
The same principle—choosing what functions to outsource, and avoiding over-reliance on an external supplier—applies as well to outsourced manufacturing and product-assembly services. Supply chains begin with suppliers—of finished products or components or various functions such as freight services—and therein lies a risk for SMEs entering a foreign market. The risk is that an SME will over-rely on a crucial supplier that later fails, causing knock-on problems for the SME.
UK toy-maker Hornby, which had 2016 revenues of £56m and is best known for its model railways, found this out the hard way. The firm had largely relied since the 1990s on a single Chinese supplier of manufacturing services, Sanda Kan. After a series of ownership changes from 2000, the Chinese firm encountered financial difficulties and was bought by Kader Holdings (owner of one of Hornby’s main competitors, Bachmann) in 2009. From 2012, Hornby found that supplies of its products became erratic, with many containers arriving without needed products, as the supplier could not fulfil orders. That hit Hornby’s sales and its bottom line. Hornby paid £500,000 to sever its contract with the Chinese company. To avoid a repeat of the problem, and to diversify its supply chain and reduce risk, it replaced Sanda Kan with ten different Asian suppliers.
CONCLUSION: THE TECHNOLOGY ADVANTAGE
The cost of logistics—sometimes overlooked amidst the challenges of entering a new foreign market—can prove dangerous to an SME’s profit margin. Some SME’s take this risk in stride, choosing to work for thin margins as part of the cost of establishing their brands abroad. The lucky few with a unique market niche, such as Gilo Industries or Childrensalon, can keep margins healthy by passing freight costs on to customers. But whether margins are thin or not, SMEs must find the right balance between hiring outside experts to provide supply management and logistics services and performing these functions themselves in an unfamiliar new market.
The bigger picture related to the cost of logistics is that the logistics function itself is undergoing a profound change, as sellers of a wide range of goods shift from distribution through physical stores and warehouses to global sourcing and fulfilment of orders via e-commerce web sites. Added to this transformation are potentially revolutionary changes in the nature of transport, such as the use of delivery drones or self-driving delivery vehicles. These innovations all rely heavily on information technology; it follows that SMEs with sophisticated IT systems will have an edge in securing the best and most cost-effective logistics support.
As a first step, advances in communication technology can help SMEs both in researching potential logistics suppliers and managing providers once they are chosen. Information technology can also simplify logistics functions, and can aid SMEs in taking advantage of technological advances in distribution and delivery. Childrensalon’s web site, for example, streamlines the sales and fulfilment process, in part by detecting where a customer’s computer is located and automatically translating product data and pricing into the local language and currency.
But automation only goes so far; sometimes firms have to intervene manually to fill logistical gaps. “One of our staff once flew over to the US to deliver a very expensive dress on time,” when delivery otherwise would have been delayed by a holiday, recalls Childrensalon’s Denise Hamilton. That is a shoe-leather approach to logistics: doing whatever is necessary, including wearing out one’s shoes, to ensure that products reach their destination on time. It is the sort of thing that modern logistics, backed by sophisticated communication technology, is designed to avoid. “Many SMEs see distribution and logistics purely as a cost,” says Ms Gooley. “In fact it is an investment.”
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