This is clearly not an inexpensive approach to the problem, but Wartsila is committed to producing in China. "Our intention is to buy as much as possible from China," Bargard says. "So far, we have not experienced any quality or delivery issues, but it has taken a bit of effort."

Risk experts stress that assessing risks in China will be one of the most difficult tasks most companies will wrestle with in the next five years, but one that will be impossible to avoid given the evolution of the global supply chain. "The more that supply markets are distant from the ultimate point of purchase, the more difficult it is to execute a proper supply chain risk management plan," says Greg Cudahy, global managing partner of supply chain strategy at Accenture.

Over the last year, the risks of doing business in the world's most populous country have become all too apparent in the wake of last year's headlines on exploding cell phones, unraveling tires, tainted food and children's toys decorated with lead paint. Last year, the U.S. Consumer Product Safety Commission traced 60% of all product recalls in the U.S. to quality problems in China.

There have also been financial risks. The dollar was down against a renminbi buoyed by China's booming economy–exports surged 25.7% to a record $262.2 billion last year. This forced U.S. companies to deal with a weakening exchange rate and the inevitable price inflation.
And then it snowed. In late January, the country endured the heaviest accumulation of snow in more than five decades.

Roads, seaports, airports and trains shut down, and power brownouts affected half the 31 provinces. "Certainly, it has taken some of the gleam off sourcing from China," Accenture's Cudahy acknowledges "It no longer seems to be the be-all and end-all." That said, finance executives whose companies do business in China assert that the country's virtues far outweigh the pitfalls. One need only look at the labor cost differential–even after inflation. The workforce provides more than a trillion dollars in goods and services each year at an average labor cost of a dollar an hour compared to the $15 to $30 an hour that factory workers receive in the U.S. and Western Europe. Then, of course, there is the always enticing prospect of a market with close to 1.3 billion consumers.

Obviously, China is not the only emerging market to struggle with massive infrastructure, financial and political risks as became painfully evident in February when several undersea cables were severed offshore India, disconnecting U.S. companies from their suppliers in that country for several days. "There's risk in sourcing product pretty much anywhere," says Pat Furey, senior category manager at Ariba, a Sunnyvale, Calif.-based spend management solutions provider. "The reason China gets the bad press is because so much is sourced from there, often without the necessary infrastructure in place to monitor quality and make sure suppliers are doing what they're supposed to be doing."

So where to begin managing risk? Given the suppliers–to-the-suppliers-of-your-suppliers relationships in abundance–and the array of risks, any assessment will not come cheap. So it probably isn't surprising that many companies aren't on top of what their suppliers are doing. While 80% of respondents in a survey by Accenture acknowledge concerns about supply chain risk mitigation, only 11% said they were capable of actively managing those risks.

But there is some help out there for those trying to get a start in developing a risk management process for China. "There is so much demand for product quality monitoring from our clients sourcing in China and other developing countries," says Gary Lynch, global leader in the supply chain management practice at New York-based insurance broker Marsh. To meet the need, Marsh recently unveiled a supply chain monitoring and mapping service that assesses product quality, logistical networks, technology, the labor infrastructure and potential political pitfalls.

Smaller companies have recourse to such vendors as Ariba, as well as quality monitoring services from independent testing agencies like Intertek, OnSpec and China-based Li & Fung. All of them provide the same kind of services as Wartsila's in-house supply chain managers. Intertek, for example, boasts more than 900 testing labs in over 100 countries. "The million dollar question is `do you trust your suppliers in China to put in quality controls that measure up to your own?'" asks Gregg Tiemann, president of the commercial and electrical division of London-based Intertek. Based on client requests, Intertek samples manufactured products, their components and even raw materials–at manufacturing sites, assembly locations, depots and ports, right up to the manufacturer's loading dock.

"The truth is there have been only a few problems that can be directly attributable to China and not, for example, to the design flaws of manufacturers themselves," Tiemann asserts. China "takes these issues very seriously and, in the last few months, has caught up quickly. They are doing all they can to protect their brand."

Nevertheless, he concedes that quality is not assured. "We try to delve as deeply as we can, but it is impossible to go all the way down and have it still be cost-effective for clients," he says.

Furey shares this view: "We can help a company identify the supply chain risks in China, but it is difficult to quantify them all. You factor all the risks into a total cost of ownership analysis. You then regularly audit each risk toward your targets, constantly weighing the pluses and minuses in each country of changing suppliers."

Beaumont Vance, senior enterprise risk manager at computer maker Sun Microsystems Inc., which sources components from China and other developing countries, has a similar take. "You need to start with how your company generates revenue, take it apart and then trace it back to the origin," he says. "The important thing is to look at all the key components of your product. You may have a product that is partially manufactured in China, but that manufacturer is relying on six manufacturers relying on six other manufacturers. Asia is very good at turning things into cheap commodities, but there are a lot of blind spots. Any one component that is inferior can cause you grief."

More than product quality can doom an otherwise sound supply chain risk management strategy, however. Cudahy recounts the decision of a major electronics manufacturer to move its electronics production from China to Mexico because of perceived logistics risks. "They were concerned about extreme extended supply lines in China and the cost of transport," he explains. "With a high clock-speed consumer item like televisions, Mexico could give it a two-day lead time, whereas it was taking three weeks of transit from China. If a seaport shuts down in Mexico, you can always truck the item up. In China, you're out of luck until the port is back in operation." Credit risk is another nemesis for companies engaging Chinese suppliers. "You really can't get credit reports on them," Vance says. "You could be sending them money for products that will never be delivered because the company is now insolvent."

Currency exchange rates also create risks. "The yuan (renminbi is the other name for the Chinese currency) has appreciated against the dollar by about 15% over the last two to three years," Furey notes. "This may not seem like much, but if you're manufacturing in China and your costs are appreciating against the dollar, you now have a significant currency risk." Energy and raw material costs must be taken into account. Both went up 2.4% last year in China, forcing many factories to increase the cost of manufactured products. Labor rates also are higher in China. The New York Times reported in February that factory wages have risen 80% or more in many coastal areas.

Then, there's political risk–the threat of a coup d'etat resulting in the nationalization of foreign assets. But, coups aren't the only political risk challenging global supply chains. Add corruption, bureaucracy, labor strikes, civil unrest, and kidnap & ransom schemes to the risk profile.

On the bright side, Boston Consulting Group says even a 15% annual increase in labor rates in China over the next five years would bring per worker labor costs to about $2 an hour–still a far cry from what U.S. factory workers earn. China also ranks pretty well on the political risk meter, according to Aon Trade Credit, which measures, quantifies and maps such exposures for clients. "We characterize political risks in China, Brazil, Russia, South Korea and Mexico as medium-low or medium," says Corina Monaghan, Aon vice president of political risk.

That said, Aon acknowledges that continued economic growth in China could lead to a widening income disparity between rich and poor, which could lead to a slight rise in political unrest this year.

Attacking such a broad range of supply chain risks requires an enterprise approach to ensure flexibility. "You don't want to lock in a low-cost area and then find out by the time you're producing there that the costs are up 20%, and the Philippines is the new low-cost supplier," says Vance. "You have to take a macro view, doing good probabilistic modeling of all supplier risk scenarios, and utilizing expert opinions in putting together your models. Let the risk-reward ratio guide your supplier choices."

One option is to reduce the number of suppliers to make it more cost-effective to monitor quality and logistics. With 90% of product sourced–China being one of its biggest suppliers–The Toro Co., a Minneapolis-based lawn care equipment maker, decided to employ this tactic, according to Dave Hennes, Toro director of risk management.
Lining up backup suppliers, in case suppliers in one country go bust or can't meet delivery schedules, is another tactic, but there's cost involved. "You don't want to go to China and have a supplier that saves you 4% and then spend 10% getting a second supplier prepared in another country if something goes wrong in China," says Vance. "It's just not cost effective at that point."

Insurance also provides risk transfer for many supply chain risks, but it is not a panacea. While global property insurance policies offer contingent business interruption coverage for both non-owned and owned locations in China, in case they're shut down by natural disasters, the devil is in the details. "Risks like a labor strike that closes down a factory might not be covered," explains Bob Howe, who runs Marsh's global property risk practice. "You might also need to get a different insurance policy to cover inferior quality products. Bear in mind most property policies will not necessarily cover the suppliers of suppliers, although some insurers are willing to negotiate on the subject."

Other insurance policies considered de rigueur are credit insurance and political risk insurance. Nevertheless, as Hennes says, "insurance should be a fallback. [When] your customer is depending upon a product that [doesn't] show up, unfortunately, there is no `loss of customer' insurance."