China sourcing: Rising costs & payment issues (an insider’s look)

I recently had an interview about China sourcing with a reporter from Thomson Reuters. Here are some excerpts on the following topics:

1. Impact of economic slowdown
2. Rising costs in China
3. Payment issues between US buyers and Chinese sellers
4. What leverage do sellers have? (in this section I explain the twisted logic of why sellers ship defects on purpose!)

Q: What impact has the economic slowdown had on US buyer/ China manufacturing relations?

Before the global financial crisis (GFC), simply being an American was enough to get the sellers excited about doing business with you. The US economy was strong and Chinese factories wanted to work with you to get orders flowing to the USA. It’s very different now for the typical small to medium US buyer. You have to “sell the seller”. What I mean is that you need to make a case for why you will be a good customer. Can’t just contact 5 factories online and say “give me your best price and quality”. 4 out of 5 may not even respond, unless you order is really big. I’m not saying you should inflate your potential order or trick the suppliers into thinking you are a bigger buyer than you really are…I’m just saying you need to show a vision for your business and find the right supplier that shares your vision.

It’s not just the lame global economy, it’s also the rising costs of doing business in China that are causing headaches when Sourcing from China.

Quality Fade: when tight margins encourage cutting corners

As margins get tighter, some suppliers may be tempted to cut corners with quality or ignore intellectual property. For example, you may have heard the term “quality fade”. This is where you have a few orders that meet your specs, then all of the sudden the next order has a bunch of defects. The buyer is thinking, OK, first 2 orders went well, 3^rd should be ok too, right. Nope, because of the price pressure, the supplier may try to find hidden ways to make more margin. This means having a plan for independent QC is essential.

Where is the “next China”?

But it’s not like there is a “new China” in another part of the world ready to be the low cost alternative to China. Yes, low end products that have a high labor content (t-shirts and socks) are moving to places like Vietnam and Bangladesh, but when we talk about higher value products like electronics, there is no real alternative to China because China has the reliable infrastructure and proven supplier base. So the secret of successful sourcing, even in this economic slowdown is to find the right supplier (that is a good fit for your needs) and be diligent in watching the quality. That means doing the due diligence to meet with these suppliers in person, check references, run some test orders, get the engineering done to ensure your specs are very clear, setting up a plan to monitor the quality….all these things add to the bottom line, but not doing them could put you out of business. Imagine getting a truck load of defective products! So if you are sitting here saying, I don’t have the time or money to make a trip to China, or I don’t have a few 100 bucks to hire an agent or inspection company to check out my products…then you really shouldn’t be sourcing from China.

Q: How is payment between a Chinese manufacturer and a US purchaser usually structured?

It depends on purchase volume and relationship between buyer and seller.

For example, if you are a small buyer (10 tablet computers) you may be asked to pay up front. If you’re a really large buyer, you have the leverage to get terms. For example, some of my larger clients who buy millions of USD per month, get 90 day terms from the suppliers. Preferential terms are not given easily, regardless of your size. So if you pay on time, are a good client for the seller, I suggest you lay out a road map for getting better and better terms. Something like: “OK Mr. Li, this order is 50-50 as you requested, but assuming I pay on time and order X units each month as planned, I want to move to 25-75 then 25-75 next 15 then 25-75 next 60….”

Q: What action can a Chinese firm take if a US purchaser does not pay on time?

Not much. Unless the order is very large and a good contract is in place, it is just not economically viable for the Chinese side to fight a court case in the USA. Because the suppliers don’t have much leverage once the goods have left China, naturally they try to protect themselves and get as much payment in advance of ship date as possible. At PassageMaker we solve this problem by using our assembly/warehouse in China as a quality and payment gate in a way that benefits both the seller and the buyer. Because the seller gets paid before the goods leave China (after the independent QC check by PassageMaker) they are happy. Buyer is happy because they have the quality confirmed by us BEFORE payment is transferred to seller. So both sides are being safe.

Why some suppliers ship defects on purpose

Let’s say you don’t have an independent quality gate in place. Here is an example of a dirty trick suppliers pull and during my almost 20 years living in China, I’ve seen quite a few tricks the suppliers try to pull.

Because the margins are tight, the seller wants to lock in the buyer for multiple orders. Of course, the buyer won’t promise to place additional orders until the first orders arrive. Too many buyers forgot to have clear terms in the PO/Contract about how defects will be handled. Sellers can exploit this to their advantage in the following way:

When seller ships out the order, their “makes an error” and under-ship the number of units and/or they makes sure a certain percentage are defects. Since the buyer didn’t clarify what happens in the event of defects or under-shipment, the seller is now in the driver’s seat. Mr. Li will say “sorry for the defects, it was a mistake, won’t happen again, we’ll give you replacement products on the next order”. That’s how the seller gets locked in!

It’s easy to avoid this kind of drama.

1. Have a well written, bi-lingual contract, under official chop. A custom contract can be done up by an English speaking Chinese lawyer for just a few 100 USD. So in my opinion, a buyer is just plain crazy to skip this important step.
2. Apply a level of independent QC at the factory or consider having the product inspected 100% at an assembly/inspection facility.