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Mike’s suggested reading list for Summer 2011

Great China sourcing content worth reading

I founded PassageMaker over 10 years ago. Today we are a small but stable business (with almost 200 employees we are still small by Chinese standards!) and about 60% of the clients I am honored to do business with are also small businesses. I image that a good number of my blog readers are small businesses too.

So when I was asked to suggest a reading list for the beach or more likely the occasional long flight this summer, I did so with small business in mind. (like small business owners can find time to take a day off!)

I recognize the struggle (and sense of pride when things come together) that small business owners like us go thru. To give us a leg up on the competition, in my opinion, there are 3 books that people like you and I must read, if I may be so bold, as it’s not like I have the Midas touch and more money that I can count, but here they are:

The E-myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It

This is about how to organize a business. It totally changed my perspective on how to run a business and got me thinking in the right direction. When I read the book, I was just starting to hit a period of rapid expansion at my company and I don’t think I could have grown my company without it. I read this book about 6 years ago and after reading the book I came up with my company’s business philosophy which is still today the foundation for how we do things around my office.

Content Rules: How to Create Killer Blogs, Podcasts, Videos, Ebooks, Webinars (and More) That Engage Customers and Ignite Your Business (New Rules Social Media Series)

A great book about building your brand in the internet age. Read it a few weeks ago on the plane from Hong Kong to USA. I couldn’t put it down and read the whole thing twice before we made it to the Aleutian Islands.

The Referral Engine: Teaching Your Business to Market Itself

This one is a about leveraging your network to generate leads, essential for us small fish (with limited budgets) in a big pond.

Hope you enjoy them as much as I did!

At a distant 4th is my book on China sourcing (The Essential Reference Guide to China Sourcing). Ha ha.

Understanding VAT in China: Who pays?

Understanding VAT in China: Who pays?

In response to my recent blog post on VAT scams, Steve in the USA asks; “My understanding is that on direct exports from mainland China there is no vat tax that the foreign buyer need to pay the PRC government. Is that true?”

Here is my response to aid Steve and others in understanding VAT in China:

a) Unless the foreign buyer has an office in China and is the exporter of record out of China, the overseas buyer is not expected to pay any VAT to the PRC government.

Let’s say you are buying tennis rackets (I was watching Wimbledon last night) and the parties involved are the manufacturer, an exporter and you the buyer. The manufacturer is responsible for paying the VAT as they are “adding value” when making the tennis rackets. The exporter who ships the product out of China (assuming they are following the law) would get a VAT rebate . The VAT paid in and rebate out is all sorted before the goods are in the hands of the buyer.

b) Sounds simple right? But in practice, the exporter may work with the manufacturer to pull a fast one on the foreign buyer by exploiting the buyer’s lack of knowledge of the VAT process. It is not uncommon for the exporter to tell the foreign buyer that in addition to the unit price there is a VAT tax and or a import-export fee. Those items should be included in an “FOB port” unit price already, so if the seller tries to break them out separate, in addition to the FOB price, then it is probably a tactic to get more money out of your pocket.

Has anybody else out there come up against this “VAT trick” when dealing with your China supply chain? How did things work out for you? Was my assessment above accurate in your case as well?

How to keep China sourcing projects on schedule

How to keep China sourcing projects on schedule

In one of his posts a while back at “Whit’s Business Blog,” Whit Kelly gives 4 common causes for project delay. There are worth reviewing and a summary is posted below. The good news is that all of these pitfalls can easily be avoided if the buyer elects to take action.

Whit writes:

1. Incomplete Design Databases

This is the A-#1, super-duper granddaddy of all causes of delays. As I mentioned in some of my blog writings, you really, really, REALLY need to have all the elements of the design finalized before going to production. Leaving even the smallest element of the design open to interpretation will lead to the supplier interpreting it in the way exactly opposite from what you wanted.

2. Payment delay

China is pretty close to a cash economy unless you are a buyer for a Fortune 500 company. All Purchase Orders (POs) will require a deposit, in most cases because the manufacturer is going to use that money to pay cash for the raw materials. Tooling is typically 30% At Time of Order (ATO), 40% at 1st article and 30% at final approval, before delivery. Production is most often 50% ATO and 50% At Time of Shipment (ATS), which means in practice, 100% is due before the product leaves the factory. All these terms are clearly communicated early in the project, but at least 80% of the time, there are delays from clients not paying in a timely fashion.

3. The uncommunicative buyer

It is not uncommon for projects to get caught in the doldrums and go nowhere for days, weeks, even months because the client is AWOL. It is very, very common to play “hurry up and wait”.

4. The buyer who’s in a hurry

While this might seem to be right attitude to keep things moving fast, the buyer who is in a hurry often places speed over accuracy. They want to cut corners, skip prototypes, skip writing a Product Quality Manual (PQM) with us, not bothering to proof-read the PQM, etc. Sometimes this works out, but not often. More commonly when you deviate from the normal project flow, you end up causing more delays.

Chinese vendors screw up all the time, but the delay is not all the vendors’ fault as the four common pitfalls above explain.

VAT rebate in China: Scams exposed!

VAT rebate in China: Scams exposed!

This post is based upon a recent question that came in to our mail bag. To protect the sensitive nature of the individual in question, we have changes the names and product, but the issues concerning VAT discussed below are be applicable to buyers of any product coming from China.

Question: We are a wholesale manufacturer/importer of hand-woven textiles. Our tapestries are all 100% wool. We are using a new export company and we are not sure if we can trust the information they are giving us, because it is quite different from previous years.

1. What is the VAT rebate rate for these products?

2. What percentage of the VAT is retained by the export company, and what percentage goes to the factory?

3. The export company is telling us that since they are a new company and all export companies must show a profit to be eligible for the VAT, that they need bill us an extra 17% on each shipment. They are telling us that we will be reimbursed this amount in the coming months once they have applied for and received the VAT. Does this make any sense?

Any advice or help would be greatly appreciated.

My Response

Before you read my comments, as a primer on what we will talk about below, I encourage you to read my article “What is VAT and why should I worry about it?”  if you have not done so already.

My co-worker in the China office where I am based, who is a licensed customs broker, looked up that your products have a VAT rebate rate of 16%. If we know your HS code we can confirm for sure, but based on the information you have given me so far, I think the 16% is accurate.

In China, every aspect of a trade is up for negotiation. There is no law or even industry standard that dictates how much of the VAT is retained by the export company and how much, if any, is shared with the factory and/or buyer. I’ll explain more in my answer to your #3 question.

For many of the early years of my China career I banged my head up against the VAT wall, but after a lot of research and the experience of setting up multiple businesses in China that have import-export rights and VAT licensing, I now have fairly unique understanding of the situation you describe above.

A few months ago my book, The Essential Reference Guide to China Sourcing went to press. Based on your situation, I think you would gain a lot from reading my book, but in the meantime, to help answer your question, I’ll draw upon some lessons learned over the years of doing VAT and pull some tips from the guide book to help explain what may be going on at this Chinese company as well as give you some pitfalls to be aware of.

“New company”

The VAT rate of 16% mentioned above assumes the exporter has achieved what is called “normal tax payer status” in the eyes of the Chinese government. As I understand it, and have experienced setting up PassageMaker, when a new company is set up, they are on a kind of VAT probation for the first year under what is called “small tax payer statues”. And during this probation period, a much lower % of rebate is applicable. In my experience, the probation period last about a year assuming the business achieves a stable and larger scale of business. Some small companies remain small tax payer forever.

“all export companies must show a profit before factoring in VAT”

I believe that technically the laws here imply that a business should be profitable before VAT rebate in China is returned. But in practice, because the margins are so tight for most exports, a huge number (I am guessing the majority of suppliers) don’t make any real profit until the VAT rebate is returned. So it is a bit of stretch for your exporter to say they need to bill you an extra 17% and rebate you later. I suspect this is just a negotiation tactic which leverages the gray areas around VAT to build in hidden margins for the exporter.

VAT rebate in China: Scams exposed!

Pitfall 1

I am interested to learn how the supplier says they would actually pay you the VAT rebate once it comes back to them from the government. If they are running a PRC compliant set of books, it is not easy to legally send you funds overseas. I am betting they told you they would simply give you a credit on the next order. Sounds nice, but what happens if you don’t have future orders with them for whatever reason. You may find your funds are stuck in China with no recourse.

Pitfall 2

No tax agency/ government anywhere in the world gladly gives refunds. In China, especially for new or inexperienced exporters, it is a real paperwork nightmare to submit the supporting docs for the VAT rebate to the government. And the scary part is that the government has the right to say “sorry you filled this minor point out wrong, so no rebate for you on this order, thanks, try again on next order.”

If your supplier messes up the paperwork or doesn’t have good communications with the local government to sort things out, do you think the supplier will stand behind their promise to send you money or do you think they will just say “we didn’t get any money back, so we have no refund to give you”. Happens all the time.

Pitfall 3 “the partial refund”

I talk about these tricks of the trade in my book in detail, but here is the scam in short. Let’s say the rebate rates that the supplier gives you checks out at legit, and for the course of example, let’s say it turns out the VAT rate for this product should be 13%. Let’s even go so far as to say the supplier does indeed give you 13% back at the end of the process. Sounds pretty fair doesn’t it?

But what you may not realize is that in China the interpretation of the rebate amount can vary from port to port and from one tax official to the next. It is possible that a rug for home use has a 13% discount, but the same rug used in a hospital gets a full 17% as the government wants to promote so called high end exports like medical.

I have witnessed cases where the supplier tells the buyer the rebate is 13%, and the customs book also states 13% for the given HS code. BUT behind closed doors the supplier persuades the local officials at the port that the product is actually a different HS code or a different use (medical for example). Or perhaps via an under the table payment to the official, they get the rate set at 17%. The supplier keeps the difference and the buyer never knows.

You are not alone.

A N. American company was spending millions USD each year with a supplier. They had been doing business for 15+ years with that supplier in China. They had the tightest of margins negotiated and even got price concessions downward each year with the vendor. They knew the BOM and labor rates down to the cent, but for the life of them, the buyer could not figure out how the supplier had the cash to buy 2 new Porsche Cayennes, a new home and send the kids to university in Switzerland. That buyer smelled something fishy and hired us for a quick VAT study.

It was pretty clear from our research that the supplier has some hidden VAT rebate %. With that knowledge the buyer renegotiated with the supplier, moved some production to another source and had PassageMaker process all the VAT rebates for the buyer’s exports during the 2 years that the buyer needed to set up their own office in China to process under their own VAT license as suggested in the VAT study conducted by PassageMaker. This advise probably saved the client millions of USD over a 4 year period.

Some possible solutions for you to consider:

Explain to this trading company that you realize the VAT is a very complex subject and you like to keep it simple. Ask them to quote a “FOB nearest China port” price and any VAT issues are their problem. Under FOB, the price is already inclusive of VAT.

Do you have any back up suppliers that can provide you the goods without all the drama?

Do you happen to know the actual manufacturer? Perhaps the manufacturer has an export license already and doesn’t need the trading company. So often the trading companies tell you they are essential to the exportation, but quite often that is an exaggeration and trick to keep you from going direct. Not only could your exporter be pocketing some hidden VAT rebate, but they may even have a hidden commission with the actual manufacturer.

My sales team will be upset with me if I spend an hour on this email and fail to mention how PassageMaker can help. So putting on my salesman cap… perhaps you would consider the services of a 3rd party like PSSchina.com to help research and find a more suitable supplier in China and/or process the VAT under our company in a transparent and trust worthy fashion. Happy to give you references of clients we have helped out of China VAT jams. Sorry to slip into sales mode, but I wanted to let you know we can help if you need support.

Sorry for the long post, but I get very passionate, maybe patriotic, when it comes to helping other Americans avoid being taken advantage of in China.

Research potential suppliers and conduct an effective RFQ in China

Research potential suppliers and conduct an effective RFQ in China

When looking to source in China, you have a number of options to find supplier with various costs involved at your disposal. Below is a behind the scenes look at the pros and cons of each option as explained by Mike Bellamy (founder of PM and Advisory Board Member at the China Sourcing Information Center).

Learn how to conduct an effective RFQ in China

Choice One

Thanks to free and easy-to-use websites like Global Sources.com, generating a list of potential vendors has never been easier. But make sure you have the time, engineering and China sourcing experience to narrow a massive pool of vendors down to a handful of highly qualified vendors. Simply picking the first 3 vendors that come up on an internet search is highly unlikely to uncover the best match for your particular requirements.

Choice Two

Engage an intermediary (trading company, sourcing agent or factory representative) to conduct this research on your behalf.

It is worth paying for professional research if you don’t have the time and China experience to conduct the supplier identification research on your own. There are 3 common methods used in China to invoice for the initial supplier research:

Charge a % of the future PO value. Generally 5 to 15%. While this is an easy to calculate figure, unfortunately there is no incentive for the research partner to keep costs low. Actually the incentive is to steer the buyer toward the most expensive sourcing option.

Invoice a set research fee. At PassageMaker for example, a fee of a few thousand USD is charged per production classification researched.

“For Free”. Some companies will offer to conduct the initial supplier identification for free. However, while it sounds the most attractive at first, nothing is done for free in China and quite often the “for free” model is the most expensive in the long run. As explained in PassageMaker’s FAQ section, their team of experienced sourcing engineers will require 30-45 days and spend 100’s of man hours, leveraging years of China sourcing experience to narrow this list from 100’s of choices down to the top candidates.

If somebody offers to “do the research for free” this is what may be really happening:

They will decide which sub-suppliers to use. That means they may select the supplier which is best for them, not best for you. Perhaps where they have a relative, kickback or commission. In effect the buyer is getting steered towards a supplier which may not be the best match for the buyer’s specific requirements.

“You get what you pay for”. They don’t plan to conduct in-depth research on a national level. If someone is providing research for free, they may not be as conscientious about understanding your goals and helping to find the right supplier. Keep in mind that finding the right supplier is the single most important factor in determining if your project will succeed or fail.

They plan to cover the internal costs of the initial research by charging you an inflated per-unit cost once production starts. In the long run, the buyer pays too much.

Insider Tip:

If your “partner” is unwilling to state the name of the sub-suppliers and give the pricing points, then you are certainly paying too much. Furthermore, if they do not disclose the actual manufacturer, then you have no way to validate the quality process in place and you have lost control over who has access to your intellectual property.

Unfortunately, even if you pay a company in China to conduct this supplier research you can’t automatically assume they are looking out for your best interests. (Know more about common pricing scams in China.) It is common in China for trading companies to milk both ends, in other words charge the buyer for a research fee or commission while getting a kick back or other commission from the supplier. Therefore, you must perform due diligence on your research partners as well. Make sure you ask about ownership, compensation structure, client references, non-compete clauses, research methodology, full disclosure of sub-supplier pricing and identity, company history, warranty terms and the plan for protecting your intellectual property.

What you need to know about vetting suppliers in China!

What you need to know about vetting suppliers in China!

Back by popular demand….Reposting this article as “what you need to know about vetting suppliers in China!”.

PassageMaker is proud to be the assembly and inspection partner to clients in some of the world’s most famous supply chains. But before the bill of materials (BOM) can be assembled into a finished product under our roof, the sub suppliers of each of the BOM line items need to be selected. PassageMaker’s Sourcing Feasibility Study can be engaged to help clients find suppliers who meet targets for price quality and lead time. For those clients and readers who wish to conduct the supplier research on their own, we are happy to provide the following tip sheet for your review.

The single most important factor in determining the success or failure of your sourcing program will be finding the right supplier. It sounds obvious, but making apples-to-apples comparisons of vendors at a national level can be daunting. The following is a behind the scenes look at a how PassageMaker conducts this process. Supplier identification research should have a clear methodology for defining and measuring the desired attributes of the ideal supplier.

Step One “Defining”: The “right supplier” is unique to each buyer, as the relative weight placed on price, quality, lead time and other attributes differs from project to project. Below is an excerpt from the attribute survey template which is used to put down on paper the attributes of an ideal supplier.

atribserv

Step Two “Measuring”: A typical supplier identification research project takes 30-45 working days assuming multiple components and production methods need to be explored at a national level. The process is as follows:

Initial research generates a list of 50-100 potential suppliers using web directories like www.GlobalSources.com and industry/trade show directories.

Assume the vendor is a middleman until proven otherwise, not the other way around.

Avoid factories that refuse to list the name or location of the production facility. If they only show a HK, Taiwan or other non-PRC address, then they probably don’t own the PRC factory and are a middleman of some sort.

Focus on those factories that can clearly show production experience with your particular product or production method.

Be aware that polished English skills do not reflect production skills. Often the most polished websites are set up by trading companies.

Look for clear information about operation size, equipment and staffing.

Review the 50-100 candidates’ websites and brochures against client’s desired attribute list (but hold of on price until later) and narrow the field down to 15 to 20 candidates. At this point, “first contact” is initiated in the follow ways:

One: Send an e-mail to ask for initial product-specific information (price, minimum order size, lead time).

Two: Are samples available? If they don’t have samples readily available, they probably don’t deal in your product on a regular basis.

Three: Granted the sales team will be the most polished in terms of English skills, but how is their understanding of your basic requests? If you ask for information on a red umbrella and get sent a sample of a blue shoe, you are going to have problems with communication down the road!

Four: Confirm the actual production location and ask for ownership papers of the factory. Be explicit that the production location may be audited and that this location cannot be changed w/out approval of buyer. (You would be surprised at the number of middlemen who will take the buyer on a visit of a factory only to change the location to a less expensive and poorer quality option after the buyer leaves)

The above research should narrow the field down to about 5 highly qualified candidates. At this stage, Quality Auditors (www.AsiaQualityFocus.com for example) are engaged for a few hundred USA to verify the factory has a sufficient quality control system in place to make the desired product. It is also wise to conduct due diligence (www.CBIconsulting.com.cn is a CSIC sponsor and leader in this field) to confirm the factory has a good reputation, no legal problems and is sound financially. In other words, verify they are not going to disappear with your deposit and will be around long enough to complete your order! These are essential yet often overlooked steps by those looking to cut corners during research. Unfortunately, due to the massive number of trading companies and aggressive China sales staff who will say almost anything to get your business, visiting the production line in form of an audit is the only way to confirm the real situation.

Based on the results of the factory visits, the next phase is sampling, trial order or even Purchase Order placement with the top vendor or two.