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.

China sourcing: How to avoid potential disasters!

China sourcing How to avoid potential disasters

Back in 2011, I wrote a blog post called “seconds from sourcing disaster” using the format of the National Geographic channel program called “seconds from disaster.” Today we revisit that blog as the lessons are still applicable today.

The Nat Geo show takes nightmare scenarios like plane crashes and shipwrecks and walks the viewer through the steps leading to an actual disaster. In my blog post I walk the reader thru a case study involving how an international buyer let their China sourcing project go off the rails.

Unlike the Nat Geo disasters which have complex root causes that only experts can identify, the types of sourcing disasters I share in this post are very common and with a little bit of experience you too will be able to spot them and avoid them. In writing this blog, I hope to help the reader know what to look for and avoid falling into these common pitfalls.

This very long story made short:

Do your due diligence/audits on potential suppliers BEFORE you send money and make sure you check the quality before the goods ship out of China.

Intro to the full story:

Would you buy a car without taking it for a drive, even if the dealer was well known?

Would you buy a house without taking a tour first, even if the realtor was a famous agency?

Would you have major surgery without getting a second opinion, even if the doctor was from a prestigious hospital?

Yet for some reason far too many buyers place large orders in China without conducting proper due diligence. They put far too much trust in online directories and fail to do even a minimal amount of due diligence and quality control.

Additional Resources: Check out www.SupplierBlackList for a user generated list of underperforming suppliers.

Flying yourself to China and spending a few days at the factory is a tiny investment, especially when you weight it against to the cost of a lost deposit, quality failure or missed delivery date. And if you don’t want to fly to China, know that audits can be done by 3rd parties (check out at very affordable rates.


The full story (in Nat Geo’s Seconds from Disaster Format)

Witness (Purchase Manager): “Everything I am about to tell you we can back up absolutely with emails, photographs and videos.”

Investigator (me): “I have no reason to doubt you. Yours was not the first Sourcing train to wreck on the rails out of PRC.”
Witness: “I can tell you from firsthand experience the company has virtually no control over the crummy factories they contract with as it turns out. “

Investigator’s notes to self:

Clue #1: “as it turns out” indicates the buyer assumed the vendor was in control but later learned this was not the case.

In China if you “assume” or “hope” things will work out, you have already lost. Only if you are “sure” something will take place do you have a reasonable chance of it happening.

Probable Mistake #1: Failure to conduct due diligence or a quality audit. I suspect the buyer took the web page and factory sales people at face value when the supplier said they were a professional and experienced company.

Witness: “Even though we went to China to approve the first production sample the entire first container of our product was totally defective.”

Investigator’s notes to self:

I’m sensing some discrepancies in the story. If the entire container was defective, then all parts pulled from the production run were defective, so it is not possible that first production samples were acceptable. I suspect that the buyer THOUGHT they were looking at production samples when in reality they may have approved “golden samples” or prototypes provided by the supplier to ensure the buyer had something good in their hands before placing the order.

Wise move for the buyer to come to China, sad move that they didn’t stick around to confirm that the “so called initial production samples” actually matched what was being produced on the line for their particular order.

Likely Mistake #2: Lack of pre-shipment inspection to confirm that order was to spec as it was being loading into container for shipping.

Witness: “The company admitted to the defective product but in the process forced us, under duress, to place another order (twice as large) as a condition to take back the first order. Sadly it was not until the second container had departed and the company had received full payment we were than informed the second production run was also defective. This time they had purchased sub-standard parts and did not have the required finish.”

Investigator’s notes to self:

Repeat of Mistake #2: Failure to conduct a pre-containerization inspection.

Additional Mistake #3: Failure to link inspections with payments. The golden rule of sourcing in China is to pay your supplier (full or at least partial payment) AFTER inspection has been made on your order.

Witness: “The seller agreed to pay us to repair the defects which entailed taking every unit apart completely to replace the bad parts. They never paid for this work which we are now doing piecemeal to keep up with sales. They also “bought” hundreds of units from us two years ago but never paid for them. They are now attempting to coerce us once again to place yet another order to get the money they owe us which we are absolutely convinced will be defective.”

Investigator’s notes to self:

Train wreck imminent, yet passengers failed to jump off when the chance presented itself.

Witness: “To make matters worse while all this was going on we also had paid the company a huge deposit for tooling our commercial version of the product. The 10 production samples they sent us in time for a major show were worthless and broken. We found out later the supplier the company found was one they had never worked with in the past.”

Investigator’s notes to self:

Appears the buyer was dealing with a trading company rather than actual manufacturer. Trading company probably has a great marketing message and price, but no actual experience and little control over the manufacturer. The blind leading the blind, resulting from Mistake #1: failure to research your suppliers and verify their ability.

Witness: “When asked why the company would send garbage knowing they were no good the answer was “to make the deadline.”

Investigator’s notes to self:

Ramification of Mistake #3- not linking payment to inspections. Factory was incentivized to ship on time in order to get paid, rather than focused on “shipping products TO SPEC on time”.

Witness: “They owe us big money which they admit to in writing. Yet now in the latest email from the company representative she now states we never told them there were any problems until “months or years later.” We spent 3 days writing a reply to state agreed dates and specific emails to demonstrate this is a BIG lie.”

Investigator’s notes to self:

Missed Opportunity. Buyer should have launched legal action (at least a demand letter) (ask the author if you need an introduction to a lawyer in China to issue demand letters). Instinct tells me the supplier knows they are wrong and is throwing every last ditch excuse in hopes of getting the buyer to spend even more money.

Or perhaps the factory is using the time to liquidate their assets in case a lawsuit does come down.

Scenario is reminiscent of the old “guess which cup the ball is under” scam. The mark keeps paying round after round but never gets it right because the ball was removed from the cups when the victim wasn’t looking. In this sourcing case study, the buyer keeps putting good money after bad and the supplier may have no plans to actually ship quality product.

Witness: “I‘ll finish with one last example of the fraudulent nature of the company’s business practices. Our Netherlands distributor placed an order for 100 units which were shipped directly from the company. After the order was in transit we received an email from the company’s representative stating there was a problem and a tool was being made that would be required to repair each unit. She suggested we wait until the distributor took delivery before telling him we shipped him defective units. Needless to say we had similar issues caused by the company with all of our overseas distributors.”

Investigator: “I can’t say I didn’t see that coming.”
Witness: “As I stated, all of this is well documented and we are now seeking to discover what recourse we have to get our money back. If all else fails I may choose to put together a book proposal for my literary agent who is based in NY, to circulate to publishers. A good title might be THE GREAT CHINA RIP-OFF.

Investigator: “A book may help you vent your frustration, but it is not going to get your money back. Assuming you have proper contracts and a clear payment trail to the vendor, don’t rule out legal action. There are plenty of English speaking local lawyers based in China, and just like factory labor is lower than back home, luckily so are attorney fees. But before you engage a legal team, I would suggest the following:

a) Hire investigation firm to find out if the company you want to sue actually has any assets lawyers can sink their teeth into.

b) DON’T let your supplier know you are preparing a case. This will most likely not scare them, but rather give them time to prepare and perhaps hide assets.

Believe it or not, the China legal system has come a long way, and foreigner can get a fair shake in the courts assuming you have signed contracts and well documented order details.”

Witness: “Yes, if we choose to investigate you will hear stories from the company’s representative that our product is no good and is too hard to manufacture. “

Investigator: “Sounds like they have already started to prepare their defense.”

Witness: “Check out our website. Our product won an award and has been endorsed by industry pros. Ours is a great product that ended up in the hands of unethical amateurs not skilled in the manufacturing process and went for the cheap out of spec materials to make more money disregarding and interfering with our brand building process. “

Investigator’s notes to self:

Why would such a professional company let themselves do business in the first place with a sloppy supplier? The answer to this question will expose the root cause of this sourcing train wreck. By selecting the wrong partners in the first place, the buyer began a sequence of events that was more likely than not to end in the project’s demise.

Summary of lessons from the case study:

1. If you are going to use a trading company or broker rather than going factory direct, make sure they have excellent reputation and track record of success.

2. Link payments to performance/ inspections.

3. Do multiple inspections at various key phases of production.

4. Find the right supplier in the first place is the best way to avoid drama in the long run.

The best way to avoid defects in China? Clarify specifications

specs 300x243

In a recent blog post entitled “QC: OK to be picky. But be professional” I explain that as professional buyers we need to be picky with our China suppliers. But more importantly, we need to be professional in our ability to create a written standard for our expected quality.The best way to avoid defects in China is for the factory to have a crystal clear understanding in terms of what is your standard and how to inspect for that standard (including what tools and techniques are required).

The team at Asia Quality Focus wrote a similar blog post but included a check list. With their permission, I am sharing it with our readers:

The wordings “it”, “which” or “be picky” should be banned. It is better to clearly specify what is being referred to in the text.

The word “shall” is the best to use to define a requirement. The requirements expressed as “shall” must be fully and properly met.

Sentences should be short and direct.

Obvious spaces should be used only between paragraphs, to differentiate sections.

Each industry has a jargon and abbreviations. They all should be clearly defined one by one (the buyer could add a definition section at the beginning of the specification for example).

For all dimensions or weight requirements, it is important to mention the tolerance levels (+/-) and the measurement method applied.

For color specifications, the best option is to use a standard such as the Pantone code.

The conditions under which the item must meet the product specification should be specified. If the product performance is reduced at extreme temperatures and humidity is acceptable (this detail is still part of the product specifications).

When some specific tests are required, they should be specified and include the standards that should be used or the precise measurements to be done (Material, Conditions…)

The approval sample should be complementary to the product specification; it is an additional support only. In any case it can replace clear product specifications.

The best way to avoid defects in China Clarify specifications

Perhaps the best advice is this:

As a general rule, the buyer should write the product specifications pretending that the supplier is new to the industry.

Really “spell it out”. Here is another advantage of being detail oriented with your product specs:

As a matter of fact, the buyer should keep in mind that some suppliers will try to cut corners to decrease internal costs and bolster their profits. So ensure that the specifications describe all qualities of the product in such detail that corner-cutting is impossible.

Need QC support?

I’m on the board of advisors at Asia Quality Focus and recommend them with confidence for audits and inspections. Contact me here if you would like an introduction.