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

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, 3rd 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.

Is your Product Compliant with Government Standards?

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Exclusive Video!
Q&A with Mike Bellamy at the Australian International Sourcing Fair in Melbourne (Nov 2014).

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Topic: How to confirm if your product is compliant with government standards

If you are unable to view the video due to firewall issues, here are links to related articles:

Product certification and compliance in China – The key steps

PassageMaker’s assembly inspection facility passes BSCI audit with flying colors

About the speaker: For over a decade Mike Bellamy has been an advisor to both small and fortune 500 companies wanting to do business in China. Mike has overseen the sourcing of over 200 production classifications, ranging from components for medical and automotive applications to finished products such as toys, textiles and hardware.

Video: China Sourcing 2014-2015 – A round table talk with experts

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Raw Video: Panel Discussion: Various Topics/ Import-Export hosted by PassageMaker’s Mike Bellamy, China sourcing expert.

As presented at the Australian International Sourcing Fair’s Conference in Melbourne (Nov 2014) Day 2

Intro from the show organizer:

This exciting discussion panel will focus on international sourcing and provide practical tips, ideas and advice from industry experts. Mike Bellamy steers the ship on this discussion and leads a panel of highly regarded experts. Featuring Jane Tepper from EcoSleep & Mark Coleman from the Australian Chamber of International Trade, no stone will be left unturned as all the big issues are tackled. A valuable session for all delegates to interact and participate with industry leaders.

Visit Mike’s YouTube Channel for lots of video tutorials about sourcing in China… and don’t forget to subscribe!

How to Register, Protect, Monitor & Enforce Intellectual Property (IP) Rights in China

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Exclusive Video: How to Register, Protect, Monitor & Enforce IP Rights in China

Speaker: PassageMaker Founder- Mike Bellamy

As presented at Global Sources’ China Sourcing Fairs in Hong Kong (Oct 2014) and Johannesburg (Nov 2014)

If you are unable to open YouTube due to firewall issues, here are some related links for your reference: How to register, protect and monitor intellectual property (Part 1,2 &3 )

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“Pros to Know” award winners have provided the articles and video content listed above

PassageMaker’s assembly & inspection facility passes BSCI audit with flying colors

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The Business Social Compliance Initiative is a leading business-driven initiative for companies committed to improving working conditions in factories and farms worldwide.

PassageMaker is honored to join this effort and proud of our compliance with this industry leading standard.

The official audit report is available upon request from either PassageMaker or BSCI itself.

Click on the following links to learn more about PassageMaker’s corporate philosophy, manufacturing philosophy, vendor code of conduct, memberships and ISO accreditation.

China sourcing: Help creating a Purchase Order (PO) template

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The importance of having a good Purchase Order (PO) in place when sourcing in China can’t be stressed enough.

The document sets the foundation for your relationship with your supplier. A buyer without a good PO/Contract gives too much leverage to the seller and allows them to manipulate the relationship to their advantage.

As part of PassageMaker’s Import/Export Management service, our account managers take our in-house PO/Contract templates then work with the local lawyers and project managers to create a robust document specific to the needs of our clients.

However, if you are not yet in a position to retain the services of a professional buying agent like PassageMaker, here is a behind-the-scenes look at how any buyer (large or small) can create an effective and affordable Purchase Order template that offers real protection in China.

Let’s start with the free stuff:

Here are some blog posts I wrote related to PO’s/Contracts:

7 ITEMS YOU PROBABLY FORGOT TO PUT IN YOUR CONTRACT WITH THE FACTORY

PURCHASE ORDER

Now let’s look at some very affordable options for getting professional help writing your PO.

On Amazon you can find guidebooks (do an Amazon search for China+ Sourcing) that offer templates and samples of key documents, including the all-important PO/contract.

For example, My guidebook is available for 58 USD and includes various templates and check lists. The PO template is also available as a standalone document in excel format. I recommend buying the book and templates together as a package because the book explains how to negotiate the terms and set up the PO in a way that protects the buyer’s interests.

While a template is a good start, much better would be having a custom document in bi-lingual format that is specific to your situation. An English speaking Chinese lawyer in China can provide this for a few 100 USD. Here is more information: AsiaBridge Law

Consider engaging an advisor to look after your PO’s/Contract as part of supply chain management. Here are 4 options for your consideration ranging from freelancers to large consultants:

OPTIONS FOR SUPPORT WITH SOURCING AND SUPPLY CHAIN MANAGEMENT

you can also visit www.SourcingServiceCenter.com for my list of endorsed service providers.

In summary, now that you know how to get help building an effective document, even on a tight budget, there is no excuse for not using a well-crafted PO when buying from China.

China sourcing: Good Price and Quality but Limited Engineering/ R&D?

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What to do when the supplier has good price and quality, but limited engineering/ R&D?

Common dilemma: a small factory in China is excited about your order size, but they may not have the engineering chops of the big factories. The big factories have a full R&D department, but they are not interested in your small order.

A client recently asked:

I like my manufacturer but they are small, which is ok for now as I like the attention that comes with being a large client of a small but professional factory. But in other ways it’s bad, because they aren’t the fastest at developing new ideas or even getting all the kinks out of what they designed and made in the past. I am currently in talks with a couple other manufacturers, mainly for OEM products with our branding, but soon I will want to dive further into our ODM and need designers and such that I can trust. I trust that small factory a lot, but worry they can’t handle my need for R&D.

In general, these small companies are great at making a given widget at a good price when you give them your design with details of exactly how to make it. But they drop the ball when asked to create new designs.

Small factories are usually great at production but not R&D. The solution may be to let them focus on production and outsource design, to be specific, outsource the DFM (design for manufacture).

Here are my thoughts in detail:

Unfortunately, if you are doing anything new or customized, leaving the engineering to the typical small Chinese manufacturer is not the best option for the following reasons:

a) Intellectual Property Concerns.

Non-Disclosure/ Non-Compete Agreements are very hard to monitor and enforce with Chinese companies. Even if the supplier is paid for their engineering, they will feel a sense of ownership. That is very dangerous if you decide to change suppliers or stop production unilaterally. Some manufacturers will even leverage the engineering work done for your project to land other clients who may be your competitors.

b) Biased Designs.

The manufacturer will engineer the product as they see fit. That means engineering to Chinese standards rather than international standards. The engineering will also be tailored to the production methods of that particular factory, which may or may not be the design which leverages the best production efficiencies and technologies available in China at a national level. Furthermore, the engineering may be tailored for the Minimum Order Quantity (MOQ) that the factory desires, rather than the expected order size of the customer.

What are the global options for hiring an engineering firm to do the DFM?

If you find yourself in a situation where DFM work is needed but you are hesitant to allow the manufacturer or a Chinese based entity to arrange the DFM engineering files for the reasons stated above, don’t worry, there are still plenty of options.

To cut to the chase, my preference is to use China-based Western-owned Engineering firms. That means a pricing point for China-savvy engineering that is slightly more than a local Chinese firm but well below the hour rate back home. Plus they may even be willing to cap their engineering fees and ideally they have a policy to refuse to accept any compensation from suppliers. Because the last thing you want is an engineering firm that is secretly steering you towards a pre-agreed production method or location where they get a kick back. Let’s explore the other options for your reference.

> In India you will get slightly lower CAD/Engineering rates than in China, but if the production is going to be in China, they may not be capable of a DFM package fit for China in terms of using the right materials and production method. Savings gained from a good China-oriented DFM will easily out-weigh the upfront savings of Indian based engineering labor.

> Not only is N. American/EU/Australian engineering exponentially more expensive than Chinese, but also there are some common flaws:

a) A western production set up is highly automated due to costs of labor while in China there is more flexibility thanks to lower labor rates. A Western based engineering firm may not have a grasp on the realities of Chinese production. The result might be overspending on tool & dies and designs that aren’t efficient on a China production line.

b) Western engineering firms tend to operate like law firms in that they bill by the hour, sometimes without even a cap on hours in place. Also, they use junior staff behind the scenes to do as much engineering as possible in order to maximize their revenue.

c) Worst of all, engineers in the West tend to see their job as complete when the design is done, as opposed to China-based engineering that is more integrated into the trial runs and even production troubleshooting.

d) Because engineering is so expensive in the West, many engineering firms in places like the US and EU will quote engineering at/ below internal cost in exchange for a future margin or royalty when production starts. This is extremely dangerous because if the engineering firm is aligned with the supplier, they are designing for their benefit not the customers. Plus it is a common tactic to under quote the upfront engineering rates only to later raise the pricing on production once the client is locked in with the engineering/supplier partners.

One down side of using a China-based, Western Engineering firm is the time zone and ability to communicate face to face. Should you decide to have your engineering in China, make sure they have a good track record of keeping client’s happy as you’ll need to find a good communicator if you outsource your DFM to the other side of the world.

More tips for finding a partner for DFM and general engineering needs

Ask your account manager at PassageMaker for an introduction or visit the endorsed service providers list online (here) to meet reputable China-based engineering firms as we are happy to introduce the DFM firms we have used in past.

The next step is to contact the firms and learn if they will be a good fit for you. I like DFM providers that have at least 5 years of experience engineering in China for China.

Are they a legitimate company with proper business licensing?

Do they have a clear track record of performance? If they can’t give you some client references, run away. That is a very big red flag.

Are they focused on a certain set of services or do they try to do everything for everybody? Stay away from the sourcing-slash-engineering firms.

Once you narrow it down to a hand full of options based on initial talks and references, ask for an estimate on the DFM. What separates the great companies from the good ones will be the format and timing of their quote. If they take more than a few days to get back to you, it probably means that they don’t have well developed system in place. Try to avoid having your project serve as some engineering firm’s first attempt at doing DFM for China.

I like to have my payments staggered to the engineering firms so that they get paid for performance and only once pre-agreed project gates are reached.

Don’t be afraid to ask questions!Better to ask in advance before getting hit with surprise charges later.

Related Content:

Subscribe to the advanced buyer YouTube channel presented by PassageMaker

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YouTube’s Advanced Buyer Video Blog hosted by PassageMaker’s Mike Bellamy

Wishing you successful China sourcing!

Setting up an exclusivity agreement with a China supplier

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Summary of the 8 key items to consider when setting up an exclusivity agreement

A client recently asked “we have started working with a Chinese supplier and we want to get them to sign an exclusive agreement with us. How we could make this happen?”

6 items for the general relationship between buyer and seller

One:

Frame the discussion in a way that gets the supplier excited about cooperation. But don’t make promises you can’t keep. Be honest about potential growth and leverage your orders to get the supplier’s attention. For example, if you have big volume, explain that you are a major player in the industry and if they play nice, they will get a lot of business. You are willing to share your market and product intelligence in order to have a mutually beneficial partnership, but your require their confidentiality and exclusivity in exchange.

Two:

Make the terms of the exclusivity known to the group (key managers of the supplier) rather than just 1 negotiator. Contracts ideally are negotiated and signed in front of a group (even if via group emails). Loss of face for breaking one’s word is often more effective than fear of legal repercussions. For example, if the GM says to you he would never do business with your competition, then goes out and does that …all his co-workers will know he is a liar and he loses a lot of face. (unless they are all a pack of thieves)

Three:

On that note, to determine if they have a good reputation (not a pack of wolves), in advance of signing a contract:

a) Were you able to visit with some of their references? If they can’t give a reference or two, that is a big red flag.

b) This blog post explains how to do due diligence on a budget. Some of the tools mentioned can be done without them even knowing.

Four:

After the contract is agreed, don’t just let them sign it and forget it. Have the key terms regarding exclusivity attached to each and every PO. This shows you are serious about it and as the supplier’s staff come and go on the project, new people will see this is a key part of the relationship that must be respected. PO’s placed should also have an official chop by the supplier to confirm they accept the PO/ Terms. Since the supplier needs to sign (and “chop”) the bilingual PO/ agreement each time an order is made, he can’t look me in the eye and say he didn’t remember the terms of the contract about exclusivity.

Five:

Consider keeping an eye on the supplier to make sure they are respecting the terms. Periodically check the trade shows, their showroom, their warehouse, their catalogs, taobao, Alibaba and such. Even contact them under a different name now and then to see if they will sell you the items you have protected!

Six:

If you have IP or even brand names to protect. You can register them with Chinese customs and make it clear that only authorized parties are allowed to export. So if the relationship falls apart with the vendor, you can prevent them from exporting under your brand.

2 essential items to build into the terms and conditions of your exclusivity agreement

Seven:

It is essential that the contract is in Chinese or bilingual. There are many reasons for such an arrangement. First, to have any legal validity in China, you have to list the Chinese name of the suppliers. I’m talking about the Chinese name you see in their Chinese business license. Local authorities and courts only recognize registered Chinese names. So the English name, or whatever they call themselves for marketing, is not an official name. You can’t sue some company named “Best Good Star Mfg.” in China. But you can sue “最好星有限公司”.

Keep in mind that to litigate outside of China is for the most part meaningless. The vast majority of Chinese companies do not have any assets outside of China and a court in China does not enforce foreign judgments, so it means that you actually get nothing (except a bill for wasted legal fees) even if you prevail in a court back home. So if litigation is the only option to solve the dispute, a lawsuit should be filed in a Chinese court.

If your key documents are in English, it complicates things a lot. For example, before the courts can make a decision, the English documents/ supporting evidence will need to be translated into Chinese by a court approved translator for the court’s review. This can be expensive and very time consuming. Plus the defense can employ a stall tactic of fighting over the wording of the translation itself. It’s much better to have your attorney structure the wording in advance in Chinese rather than hope the court’s translation will be accurate. Be safe. Use bi-lingual contracts.

Eight:

Contracts should have a reasonable penalty about what happens if the terms regarding exclusivity are broken. This penalty needs to be stated in the contract, in advance, not only so the seller knows you are serious, but to make any potential future litigation go easy for you.

Details about Penalty Clauses in Chinese Contracts

Make sure the penalty is large enough to make the supplier take them seriously but not so large as to scare them away. As long as the penalty is reasonable, damages are enforceable in Chinese court and it will save you lot of trouble as without pre-agreed terms for compensation it is very hard to prove how much loss you have suffered. Plus, a pre-agreed penalty saves the judge a lot of time and makes his job easy. If you don’t state the penalty, he will probably ask both sides for the amount they feel is fair, then the judge will just split the difference. That method rarely benefits the damaged party. So it is obviously much better to have a penalty in place upfront.

The main value of putting a penalty in your contract is that it will motive the supplier to comply with the terms so that actually you never have to enforce it.

Hope these comments help get you pointed in the right direction.

Let me know how your exclusivity arrangements with Chinese suppliers have worked out.

Related Content:

(video) Negotiation, Contracts and Payments – The Ultimate Guide

7 items you probably forgot to put in your contract with the factory.

Protecting your Intellectual Property

Insider’s look at legal services in China: Contracts & Purchase Orders (Part 14)

Purchase Orders or Purchase Contracts?

Are Bilingual Contracts Necessary?

Common Mistake #8: ‘Leaky contracts’

A small buyer placing orders with Chinese Suppliers: contracts, travel, and other issues

I’m Just Getting Started. Tips for China?

What to expect from the courts when things go bad

Insider’s look at legal services in China: supplier in China: Introduction & Process (Negotiations, Demand Letters & Litigation) (Part 15)

China sourcing: Negotiation, Contracts and Payments

China sourcing negotiation contracts and payments

Exclusive recording of Mike Bellamy’s Sourcing Tutorial at the April 2014 Global Sources Trade Show in Hong Kong.
Learn the key factors and actionable knowledge that will help you prepare for “Chinese negotiation” and place safe orders!

Without a good foundation, your China sourcing project is likely to fail!

Mike Bellamy (PassageMaker founder) offers tips and best practices to ensure you are well positioned before the PO is even placed. Learn how to negotiate contract terms, and structure your payments, to protect your interests when doing business in China. The video tutorial covers some of the most important areas to consider before investing time and money on a China sourcing project. The recording of this seminar covers:

● The dos and don’ts of quality control, logistics and payment methods

● How to protect intellectual property

● Cost drivers and cost breakdown analysis

● Proven negotiation techniques

● Insight into the thinking of your Chinese suppliers

What I told CNN about China sourcing

What I told CNN about China sourcing

I was recently interviewed on camera by CNN at the Global Sources trade show on the topic of what buyers need to know about China sourcing. They put me in the hot seat by asking “give our viewers the 5 most important tips for successful China sourcing” and do it in 30 seconds or less! I wrote a 300 page book on that very topic, so I have plenty of tips, but picking the top 5 and explaining them in just 30 seconds with no chance to prepare was a little intimidating. I must have said something right as CNN aired it right away!

Here are my 5 tips as given to CNN:

Selecting the right supplier upfront is the single most important step in the sourcing process. Starting a relationship with the wrong supplier can be catastrophic. So do your due diligence and verify your supplier BEFORE you place the purchase order.

Use your research skills not your negotiation skills to get a good price/ quality/lead-time. If you know what the fair price in China is for a given widget, you can use that leverage to get a good price from your verified supplier.

Link payments to supplier performance. You may have to give a deposit, but subsequent payments should only be made once the seller achieves pre-agreed targets for ship dates and quality standards. For example, final payment could take place AFTER the final inspection is done by the buyer’s representative.

Make sure the name on the contract matches the name on the bank account and the business license at the production site. If you send money to one account and sign a contract with a different legal entity, good luck getting your money back if things go wrong. Many buyers don’t pay attention to the details and end up sending money to a private account or to a holding company rather than direct to the factory.

Be more than a PO# in the eyes of the supplier. Sell them on why you are a good partner worth of respect. If the supplier can grow with you and likes you as a person, you will find advantage when it comes to lead times, payment terms and quality.

What 5 tips would you suggest to CNN?