Contract manufacturing in China: Fight gray channel imports!

Contract manufacturing in China Fight gray channel imports

The following is a case study on how to protect your brand and prevent gray channels out of China from cannibalizing your markets.

I was recently contacted by an overseas brand of electronics to help them understand how and why the marketplace was being flooded with defective merchandise made under their brand.

Background: Contract manufacturing in China

Buyer designs and distributes electronics around the globe under their own brand.

They have almost a dozen suppliers/ contract manufacturers in China.

Brand is very serious about quality, customer services and maintaining their margins.

They recently discovered their products for sale online in China and suspect this may be the source of un-authorized “gray channel” imports into their major markets in N. America and Europe. The gray channel exports are priced well below MSRP and appear to have serious quality issues and could impact the global reputation of the brand.

Step One: Investigation

Technical review of samples found in the unauthorized gray channels confirmed that the products originated among the brand’s contract manufacturers in China. The factories do not admit responsibility.

Key finding:

Further investigations confirmed that the majority of products in the gray channels were directly linked to the batches of production in China which were rejected by the buyer due to quality issues.

Strategy implemented by PassageMaker (the sourcing services provider brought in by the brand to investigate and solve the problem):

Purchase Order Templates were adjusted to clarify that rejected goods must be destroyed by supplier at their cost.

3rd Party Inspectors would be hire to record the destruction.

Client’s brand was registered in China. Previously registered only overseas. With the IP now protected in China. The brand holder can take legal action in China if needed.

3rd Party Investigators were retained to monitor both Chinese and English language websites like TaoBao.com and T-mall as well as the websites of the contract manufacturers to look for unauthorized products.

3rd Party Investigators were retained to monitor tradeshows in China and HK to look for unlicensed products.

Brand holder clarified its marketing materials and product packaging to state that only product purchased from authorized distributors are under warranty. In this fashion the demand side could also play a role in preventing gray channels.

Between production runs the tooling was removed from the factory and stored at a 3rd party facility in China to avoid unauthorized production. (Visit  “Tool & Die Steward.”)

Important Concepts:

Before the adjustments above, the suppliers were essentially selling rejects out the factory back door to subsidize their costs of production. In some cases, because of the tight quality requirements of the buyer combined with the poor quality system of the supplier, this back door income was a significant source of revenue for the suppliers. Cutting off this source of revenue was hard medicine for the supplier to swallow. Two methods proved successful to remedy the situation.

Some suppliers were dropped and a sourcing feasibility study was conducted to find more professional replacements suppliers who could meet targets for price, quality, lead-time and trust.

The suppliers worth continuing to do business with were given a sit down to explain why it was good for the supplier as well as the buyer to cut out the gray channels. Key points included:

Unlicensed products cannibalize revenue of the brand owners. If they lose money, they can’t place as many orders to the factory.

Brand holder is no longer tolerating unlicensed products and the parties involved face significant financial risk when caught.

The defective goods finding their way into the market are hurting brand reputation. If the brand reputation is gone, the orders for everybody will be lost.

Perhaps the most important message conveyed to the suppliers is that the brand wanted to have stable long term relationships with partners who could be trusted. To show their commitment to the suppliers, and to help the suppliers, the brand owners provided the following:

Accurate annual forecasting and projections. Suppliers love stability almost as much as they love volume.

Technical support and training to help suppliers upgrade their quality systems and finally understand that avoiding defects in the first place, not selling defects out the back door, is the best way to protect the supplier’s margin.

Periodic engineering reviews with suppliers to look for ways to reduce costs in production methods and materials, yet not compromise quality. These saving were shared between the factory and brand holder.

Interesting Side Note about www.TaoBao.com :

To our pleasant surprise, once ownership of the brand was confirmed to belong to our client, www.TaoBao.com was cooperative in helping to remove unauthorized product from their website. Moral to the story: register your brands and IP in China even if you don’t plan to sell there. Here are some blog posts and videos addressing how to register and protect your IP in China:

Protecting your Intellectual Property

Where can I find a partner to help distribute a product under my license for the IP?

China’s Legal System

Michael Jordan forgets to register his IP. Learn how not to make the same mistake.

Land Rover fails to register their IP (lessons for buyers)

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