A manufacturer in Malaysia has long been supplying high quality men’s underwear to an Italian company. The Malaysian SME procures its raw materials from India in bulk, the machines from Europe and sends the final items, minus labelling and packaging, to Italy. The Italian buyer picks up the shipment, sends it to his factory which adds the labels and packaging to give the final product an “Italian brand look and feel”and markets the underwear at up to 30 times the buying price.

Is this profiteering? Is the Malaysian SME not aware of the value of its product? The two parties actually have a long business relationship, says a member of the family running the SME, and neither makes that  big a margin, especially the Italian buyer. Factor in the logistics costs — freight, customs duties, labour costs (especially in Italy), insurance and finance costs — and the final price of the product when it hits stores in Italy is many times what it cost to make the underwear.

Welcome to the complex world of supply chains and the role SMEs play in them. As noted by Low Pooi Choon,  Logistics Bureau chairman of the SMI Association of Malaysia, “in today’s market, logistics cost has become an important part of the overall costing of a product.” Indeed, one global management consultancy estimates that the costs of managing the supply chain — inventory, the warehouse and distribution centre and freight — can represent 10% to 15% of the cost price of a product in most industries.

Most SMEs are struggling to cope with managing this. According to Low, who has been in the supply chain industry for over 32 years, “you have to pay a fortune to get a good logistics person. There are not many who can understand and handle the whole scope from A to Z, be it delivery, freight, warehousing, regulatory, customs and so on”.

Indeed, supply chains are not just confined to national borders or markets. In an international supply chain, state agencies, in particular customs, play an important role in its efficiency. There is also a heavy reliance on specialised logistics service providers, such as freight forwarders or customs brokers, who can facilitate the flow of goods across borders or develop logistics systems for their clients.

The key role of a supply chain is to assist in the production, consumption and distribution of goods and services. This means that goods must be produced and delivered to the market in the right quantity, with the required quality  and at a competitive price.

It is not surprising then that finding the right talent to manage this is very tough for SMEs. But an even bigger issue is when many SME CEOs  fail to appreciate how managing the supply chain well can help control costs and deliver better customer satisfaction.

According to Terence Kuah, vice-president of the Distributive Trade Bureau, “the biggest hurdle for SMEs to proactively address supply chain issues is cost. Especially when they have no volume, the cost of using a professional outsourced logistics company is high. And being cost-conscious, the SME CEO will decide that he might as well invest in his own truck and driver to better control distribution.”

But this is short-term thinking and potentially leads the company down a slippery slope of having to invest in more resources than it estimated and having non-professionals manage the logistics and supply chain even when volume and business grow and things get more complicated. There is some irony in this situation too because after the 1997/98 Asian financial crisis, SMEs became very cautious about fixed costs. “Anything that could be outsourced was outsourced,” observes Kuah. But this did not happen as aggressively in the supply chain functions.

A key weakness is where the role of managing the input and output to customers is handled by clerks. “Oftentimes, this is an accounts clerk sitting in finance or sometimes even a general clerk. They have no incentive or ... expertise to handle their roles in a manner that benefits the company,” says Kuah.

Low notes that even large companies get hit by this. One automotive company in Malaysia once lost RM10 million a year because various parts were held up at ports. It had been handling its supply chain functions in-house before finally outsourcing them.

Low is a big proponent of SMEs outsourcing supply chain functions so that they can focus on what they do best. He estimates that only abut 20% of Malaysian companies outsource to a third party. While many SMEs cite the high cost as a reason to not outsource, Low contends that the cost of not outsourcing can be even higher.

“You need to let experts handle all facets of your supply chain. These [companies] have specialists in all areas of the supply chain.”

Low uses the analogy of a worm, which knows every burrow in the ground. He says Indian customs has a rule that if a pair of shoes is brought in by sea, it will be taxed. But if only one shoe is brought in, it is not taxed. “An expert who knows this will bring in shoes through two ports in adjoining states. The shoes escape tax, are then reunited in a warehouse and sent on their way to stores. Imagine the cost advantage you would have over competitors who do not know this.”

The SMI Association is educating its members on the importance of getting an early handle on their supply chain functions. This is done mainly through talks and seminars by industry experts. “The message we are trying to hammer home is that they should start thinking about their supply chain from day one,” says Kuah.

But some SMEs are using a combination of outsourced and in-house supply chain functions. Take Lee Teck Meng, the managing director of Kleenso Resources Sdn Bhd. “I think SMEs will start considering outsourcing their supply chains when the volume justifies it.” Lee uses an outsourced partner to deliver his products to wholesalers because the volume justifies it and because he cannot afford to have either of the two trucks he owns waiting at distribution centres for hours.

He admits that he would prefer to outsource the portion of his distribution that he handles in-house as he worries that he will not be able to replace the reliable drivers he currently has. “It is also tedious work to manage the delivery of supplies and I would much rather focus my full energy on other operational issues.”

Another incentive for SMEs to get their supply chain in order is that it is an area that is easily corruptible, warns Low. “So, the boss must be involved and work with one logistics provider to get the best price and lock it in for a year. This helps  manage fixed costs too. But this will push your costs up.”

This is doubly dangerous considering that Malaysian SMEs are surrounded by regional competitors who are more cost competitive. It is therefore imperative that they do not underestimate the impact an efficient and lean supply chain can have on the bottom line.

This article appeared in Management@work, the monthly management pullout of The Edge Malaysia, Issue 852, Apr 4-10, 2011