Interesting article on China product quality over at the Knowledge@Wharton site. The article is written by Paul Midler, founder and President of China Advantage, which provides China product outsourcing and supply chain management services. Paul is a Wharton MBA graduate, who has been living and working in China off and on for the last 15 years.

The article is entitled Quality Fade: China’s Great Business Challenge and its thesis is that the current emphasis placed on importers in preventing quality problems is misplaced. Chinese suppliers that want to play games with their product are well positioned to do so and it is very difficult for Western importers to prevent. Midler defines “quality fade” as “the deliberate and secretive habit of widening profit margins through a reduction in the quality of materials” and he sees this as pervasive in China, with no end in sight.

I agree and I disagree.

The article begins by remarking on how supply chain professionals not directly affected by the recent spate of China product recalls are remaining “unusually calm” based on their belief that as China “continues to develop, the quality of its products will naturally rise.” Midler sees this assertion as sounding logical, but “not necessarily true” and he uses China’s own history with silk in the late 19th century and early 20th century is proof of this.

Midler then notes how Chinese manufacturers continue to deliberately and secretly seek to widen their profit margins by reducing the quality of materials they put into their products:

Importers usually never notice what’s happening; downward changes are subtle but progressive. The initial production sample is fine, but with each successive production run, a bit more of the necessary inputs are missing.

What is maddening to importers is that quality fade often occurs in the last place an importer thinks to check. One American company had been importing a line of health and beauty care products for over a year when the cardboard boxes that held its product suddenly started collapsing under their own weight. There was no logical explanation for the collapse except quality fade, and the supplier in this case blamed sub-suppliers for replacing an acceptable cardboard box with ones that were inferior.

Midler correctly points out that the “only thing passed on to the customer” from these quality fades is “an increase in product risk.” “Suppliers push the limit by taking more and more out of the equation until they are caught, or until disaster strikes.”  Why don’t product buyers do anything about this?

Even when importers catch suppliers in a quality fade, they frequently don’t do much about it. Many quality problems are seen as too minor relative to the difficulties involved in rectifying them. Customers may not notice a product flaw, but they most certainly notice when a product is not delivered on time. The chance of a product failure is usually remote, but the penalty for late delivery is an almost certain loss of business.

Some importers bravely attempt to fight back against quality fade by insisting a supplier replace substandard goods at the factory’s expense. A savvy supplier — and most are extremely savvy — can respond to such demands by threatening to terminate the supplier relationship. Or the supplier can respond by raising prices. Importers might then say they will switch suppliers, but the factory owner knows this is an empty threat as finding and cultivating a new supplier can take a long time. And anyway, there is no guarantee that the next supplier won’t engage in the same willful behavior as the first.

Midler asserts that Chinese factory owners who practice quality fade have “virtually nothing to lose and only margin to gain.” “When the factory owner offers his most sincere apologies and promises that it won’t happen a second time, importers simply close their eyes and hope for the best:”

If Adam Smith were around today, he would have had to write a separate chapter on global outsourcing. Because it takes importers a long time to find suppliers and to get them up to speed, importers keep their suppliers a secret. The last thing that an importer wants to do is let his competitors know the source of any supply chain advantage he may have. Even when it is in their collective interest to share information, importers keep to themselves. As a result, factories pay little, if any, reputational cost for production shenanigans. The invisible hand doesn’t work well when the manufacturers themselves are unseen.

This lack of accountability also has legal implications. When a product is recalled in the U.S., the importer pays the cost of that recall. It remains next to impossible to take legal action in China, and only in the rarest case can an importer successfully sue the supplier responsible for a product failure. Since most suppliers are paid in full well before goods leave the factory, the importer doesn’t even enjoy the leverage that comes with owing payment to the supplier.

Midler then talks about how Chinese factories get around third party testing and asserts that “testing doesn’t work well when a supplier sets out to circumvent the system.” He cites for support a U.S. Consumer Product Safety Commission study finding that of “nearly 200 recalled electrical products from China, 25% had prior approval by an international third-party testing agency such as Underwriters Laboratories (UL), Intertek Testing Services (ETL) or the Canadian Standards Association (CSA).”

Midler sees there being a “feeling” in China that one must work fast before the government closes the windows of opportunity. “For factories, that means taking shortcuts on quality. Many factory owners can’t see beyond the next purchase order.”

One reason for the short-sightedness may have to do with China’s political environment. The one-party government does what it wants, when it wants. And while there may be some advantages to a government that can operate without restraint or controversy, such a system limits predictability and leaves the business sector keenly aware that it is subject to the evanescent whims of officials who may or may not know which policy is best.

The U.S. administration has recently been applying pressure on China to revalue its currency in order to close the growing trade gap between the two countries. To appease the U.S., China has responded by reducing the tax rebates it offers to manufacturers. For some suppliers, the tax rebates have constituted a major portion of their bottom line. Massive and sudden changes such as these only confirm the factory owner’s paranoid suspicions that the manufacturing opportunity could disappear at any moment. No one in China is sure how long anything will last — a situation that keeps many focused on the immediate present.

Chinese manufacturers often focus on extracting profit through short-term maneuvers that militate against long-term development. Despite all of this, Midler does not consider the situation hopeless:

Japan was known decades ago for making inferior products, but that changed. The key to turning the situation around is to incorporate a habit of quality into the culture. China, however, has not shown that it has any interest in doing so. Recent accusations of unreliability in Chinese products are now being met with tit-for-tat claims that U.S. products are faulty. This is an unfortunate strategy for China, and it means that we will continue to see quality problems. China will not be able to succeed so long as manufacturers are competing in a race to the bottom.

Midler has his facts right, but I disagree with his analysis. There is such a thing as quality fade in China and our China lawyers are constantly telling our clients to prepare for the fourth shipment. In our experience, quality fade tends to happen disproportionally on the fourth shipment, probably because it is at this point that the Western importer starts to feel comfortable enough with its Chinese manufacturer to place a large order and the Chinese manufacturer is by this point feeling comfortable enough to cut corners.

Despite my agreeing that quality fade is a reality in China, I think the product situation in China is slowly improving and will continue to do so.

Instead of analogizing China today to China in the 19th century, I would analogize China today to Russia right after the fall of Communism. I would do this because both China today and Russia back then looked at their governments as mercurial and unreliable. When laws and power bases change frequently, the smart manufacturer thinks short term not long term.

More than ten years ago, I wrote an article setting out four principles for doing business in emerging markets. Principle four directly addressed this short term thinking phenomenon:

PRINCIPLE FOUR: Exercise Extreme Patience.

This principle stems from the maxim that everything takes twice as long as you think it will. If it takes twice as long in the West, triple that in emerging market countries. You’ll go in both as a businessperson and a teacher—and in both roles, the learning curve of your partner will almost certainly take way more time to deal with than you think.

For example, many emerging market countries have a history where “bad business” meant “thinking long-term.” A year or two after the fall of Soviet communism, I was involved in a matter where an investor put $250,000 into a Russian joint venture. The business very quickly was making good money and all indicators pointed towards steadily increasing profitability. But, quite quickly, the Russian company stole the $250,000. Was it so irrational for him to think so short term in a country where the government and tax systems had such a history of unpredictability?

Remember: It takes patience to encourage change of mindset. Extreme patience.

I can remember going into a toy store in Russia fifteen years ago to buy a puzzle for my kid. The two girls behind the counter made no effort to help me in my selection and they both laughed at me when I had trouble figuring out the proper bill to give them to pay. That sort of thing is far more unlikely to happen in Russia today. Now I am not going to tell you that one small example like this should be extrapolated to Russia as a whole, but I doubt anyone out there will dispute that Russian business has become far more sophisticated and “Western-like” during the last 15 years, even as its government has been backsliding. I see no reason why China businesses will not similarly evolve.

Though China’s business and tax laws are changing so fast as to make long term decision making difficult, almost without exception, the trend in those laws is inexorably towards a fairer and better economic system for doing business in China. Importantly, the more sophisticated Chinese businesspeople realize this.

Quality fade is a major problem in China. However, the reason why this is happening is not so much so Chinese manufacturers can rake in big margins, it is so they can survive. Many Chinese manufacturers have no margin whatsoever. With currency revaluation, massive competition, tax reform and the end of VAT rebates, huge numbers of Chinese manufacturers are operating at a loss. They are doing the quality fade in a desperate attempt to stay alive for a few more months or years. China is in a desperate situation of pursuit of the absolutely lowest price. China’s manufacturers cannot continue this race to the bottom and continue to survive. At some point, they will need to shift to higher quality goods at a higher margin. This shift is already happening in the market as a whole and I have seen individual Chinese companies make this shift as well. Just this month, a client of mine was told by his Chinese supplier that the supplier could not continue to maintain expected quality without a price increase. My client wisely went along with this. I have seen companies fight a price increase when they had to have known there was no way quality could be maintained without it.

In my view, it all comes down to economics and, contrary to Midler’s assertion, Adam Smith will do just fine here. Economics is what is driving quality fade right now (just as it did when Japan and then Korea were known not for the quality of their goods, but for their low price), not some special characteristic of the Chinese people. Since it is driven by economics, it can be understood. The next topic is to consider whether China can break out of the cycle. Japan and Taiwan did it and I do not see why China cannot do the same.

Though I agree quality fade is both real and difficult to stop, this in no way absolves the Western company of the need to fight it. We have said this many times before and we will say it again. Those of our clients who do the right things from the get-go in China have, almost without exception, experienced very few problems. Unfortunately, there is very little written or said about the small and mid-sized companies that achieve long term success in their China manufacturing. This month, The Washington Post and the Christian Science Monitor interviewed me for stories on China product quality. In both interviews, I talked extensively about our clients who have achieved consistent success in China and how they have done so.

Both newspapers asked me to arrange interviews with those clients. I called probably around ten such clients and not a single one of them was willing to talk, not even anonymously. One client told me something along the following lines:

“Dan, I see no upside for us here, only downside. We do not want anything out there highlighting that we get our product from China, or even that others in our industry do so. The product we get from China is some of the best we have ever gotten anywhere, but the American people either do not want to or are just not ready to believe this. The other countries producing __________are years behind China.

Though it is difficult to secure high quality goods from China, countless companies are (quietly) succeeding in doing just that, so it is clearly possible. Possible, but not easy, and what this means is that the cost difference in sourcing from China must be great enough to make up for the time and money that will need to be incurred to maintain quality. Very briefly, companies getting product from China should, at minimum, be looking at the following:

1. Chinese Suppliers. Since Chinese suppliers run the gambit from superb to criminal, you must check out any potential supplier in advance. A basic credit check will reveal whether the Chinese company with whom you have contracted is in fact the factory owner, not just some broker posing as such. A thriving company is less likely to risk its reputation by cutting safety corners than a company on the verge of going under.

2. Quality Control. Since most Chinese product arrives already packaged for retail sale, a statistically valid inspection system within China is critical. The Chinese government has its own inspection system for food and drugs, but to reduce costs, many Chinese suppliers intentionally avoid this system. It is your job to make sure your Chinese supplier is licensed to manufacture the product you are buying, licensed to export it, and follows Chinese government inspection procedures. It is your job to have the right people testing that product, be it your own people or a reliable third party tester.

3. Contracts. A contract with a China supplier should detail safety and quality control requirements and inspection rights. If the contract states you are responsible for inspection, you must actually inspect. Your contract with your Chinese manufacturer can either shift liability towards you or away from you.

4. History. You know who your problem suppliers are and you need to replace them now before they cause even bigger problems. Ask a product liability defense lawyer whether having to deal with a bunch of e-mails from you to your supplier complaining of “continual quality shortfalls” is going to be good for your product injury lawsuit. Actually, don’t bother, you know the answer.

5. Insurance. Insurance is NOT a replacement for the above, but it is your backup. Insurance almost never covers more than your legal fees and out of pocket damages; it will not cover your time spent defending lawsuits nor will it cover your damaged reputation.

6. Marketing. Do not make claims about your product you cannot support. Many North American importers claim their Chinese manufactured product is manufactured to a standard that simply is not followed in China. Things like this just give the plaintiff’s lawyer more ammunition against you in any legal proceeding.

There is obviously a lot more to protecting your company from dangerous China product than just the above and many of those things will be industry and company specific. But, at minimum, every company getting product from China should be reviewing at least these aspects of its business.

Midler’s article has already drawn considerable internet interest and for those interested in reading more on it, we urge you to check out the following:

  • Marquis de Prod

    Great piece. I saw Midler’s article and really liked it and figured you would do something really good with it. You have and I figure this will really generate good discussion on these important issues.
    My biggest beef with Midler’s piece (which I, like you, found very thoughtful), was that he seems too quick to believe the market will not eventually lead to better quality products coming out of China.
    My company has been using Chinese manufacturers for going on five years and though the trendline is most certainly not straight up, there is no doubt that quality has improved every year.
    I really like your point about other countries also. We outsource our products to four developing countries, and I would rank China first in terms of quality/value on that list. There is a reason everyone outsources to China and media scares are not going to change that.

  • Dan – A very good response to the article. I have just forwarded your blog url to several colleagues and friends. I will respond to some specific points made over the weekend. Paul Midler

  • Just wanted to touch on a couple of items…
    Firist, I have always said that quality in China is trending up. Quality fade is not meant to describe a macro situation; it applies to specific deals. As suggested in the original article, initial production samples may be all right. It’s in those subsequent production runs that we discover something has been removed from the equation. When too much is taken out, that’s when we get products that fail, as was the case with many recent product recalls.
    Second, it has been suggested that factory owners engage in quality fade because they are not doing well financially. That is not my immediate thought when a supplier picks me up in his new luxury sedan. Suppliers that engage in quality fade are often doing quite well themselves. Or, maybe it’s that some suppliers are doing well specifically because they know how to orchestrate. The domestic market remains highly unregulated and rule of law is hard to find; of course the unscrupulous are faring better than more honest dealers.
    On Friday, Premier Wen Jiabao called on Chinese firms to improve quality levels. While the gesture is a step in the right direction, it is going to take more than rhetoric to turn the situation around.

  • PaulW

    “The next topic is to consider whether the Chinese can break out of the cycle. Japan and Taiwan did it and I do not see why China cannot do the same.”
    At the moment I see little or no willingness among Chinese companies to do so. They seem content producing cheap and crappy imitations – not to mention downright counterfeiting, to make a fast buck.
    While still in its industrial infancy, the Japanese carried out extensive research of German manufacturing methods which were considered world leading at the time – and how they could be improved. The Germans had done the same in England at the start of the industrial revolution. That’s simply how technology progresses.
    When will we see Chinese on excursions to Toyota City? When will Chinese cars be more reliable than Japanese? When will business schools scrap their courses on kaizen and JIT in favor of a superior Chinese systems?

  • China-Manufactured Products and the ‘Quality-Fade’ Debate

    Recent international attention (and concern) over China’s product regulatory oversight has prompted at least some discussion of what leads China’s manufacturers to cut corners on quality in the first place, and whether the situation will improve. This …

  • Are Lenovo, Founder, Haier, Chery and that Nanjing company that bought MG not trying to break out of the cycle? Sure, in many cases the approach to improving quality is to buy it in from overseas or set up some JV that gets them access to better systems, but still, seems to me they’re working pretty hard to improve their quality and brand-recognition.

  • Heritage Tidbits

    Beware the “Quality Fade” from Chinese Suppliers

    Knowledge@Wharton has an excellent examination of the “quality fade” many Chinese suppliers engage in. The “quality fade” is the subtle, yet progressive degradation in product quality Chinese manufacturers engage in so as to cut costs and improve margi…

  • R Mitchell

    I would like to add a few points to “Why” there is a quality fade.
    Yes, the initial samples may fine, but remember:
    1) Most factories have their best skilled technicians working in the sample room, whereas average and unskilled workers work the assembly line.
    2) During the sample making process, the product passes through far less hands than during the actual assembly line process, meaning more care and attention to detail has been placed on that one particular item, resulting in a better quality product.
    There are other factors that can be considered for the “quality fade” on production deliveries:
    3) Your once “high priority” order may now be playing second fiddle to another customer’s order with bigger volumes. With many Chinese factories facing labor shortages, combined with large volume orders being key to survival, this is a formula for disaster for foreign importers, resulting in chronic defect rates, late deliveries, chargebacks from US retailers, recalls, lawsuits, high blood pressure and etc.
    4) Your local Chinese inspector who once was vigilantly overseeing quality control at the factory on a daily basis has now become comfortable or perhaps formed a bond with the factory owner. Now he is no longer viewed as the foreign customer’s representative, but a friend, who feels comfortable enough to accept payments by the factory to accept substandard goods on your behalf.
    5)Your China factory partner, more than likely, is not overseeing quality control at their vendors facility. As a result, non-compliant material make its way into your fourth production run. Unlike in the US, your factory partner typically has no recourse-ship it back for return or exchange. Or perhaps the recourse is viewed too costly (time, money, or guangxi) by your factory partner.
    I can go on forever about the “Why’s”, but whats important for foreign importers to know, especially during this time of hazardous imports, is “How” to circumvent the quality fade and consistently deliver quality goods, in a timely manner.

  • Ervin Thompson

    I am just your average joe-blow consumer trying to get by in life.
    It took me some time to notice that several articles of clothing, that literally fell apart after a few months, were all made in China. Now my awareness is raised. I look at the tag before purchasing to see what country it came from.
    Perhaps, if enough consumers start noticing this, it might help improve the situation long term.

  • nanheyangrouchuan
  • One other thing often overlooked on the quality issue, is the responsibility of the customer.
    I have seen many instances where the customer supplies poor quality reference samples, incomplete drawings, unrealistic delivery timetables, or worst of all selects a Chinese manufacturer on the basis they were ‘the cheapest’. You get what you pay for in the UK, and China is no different.

  • Samuel Conway

    The boss stands back shaking his head “Those Dam Chinese” he screams, however is he as innocent as he tries to portray when it comes to “Quality Fade”. The above passages paint an amazing picture of the reality of quality fade, but what I feel they have missed is how much western business and lowest possible price point is impacting on Chinese quality issues.
    There is no greater example of a company suppressing a market than Walmart, America’s largest retail chain. The term rape and pilage almost seems too generous when talking about their business practices. The real question should be does China have any chance to improve quality if companies like Walmart keep driving down the price without exception.

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  • Steven Chow

    I have worked in 3 factories and 2 trading companies, We never think “quality fade” is an option to us, it is likely suicide. I highly doubt the IQ level of a company owner if he play with the quality to secretly increase the profit margin.
    It is simply stupid.
    It is more like a hype, like the media, they need to write something to catch eyeball.
    I do think there is some company(short-eyed) playing with the quality, but it will be crazy to draw a conclusion that Chinese or Chinese companies are fooling around.

  • dale

    Dear listiner:
    I am in the process of becoming a wholesale distributer/importer of fine art prints from China. In regards to your topic on quality control, I have some questions: 1) As I don’t have time to personally travel to China, can I just run a free credit check over the internet? If so, how? 2) If I receive a good sample & they have many photos of their factory and are promt with their email service, will this be enough to be able to trust them? 3) I am also concerned about ethics. In that I want to source my products from China so as to be compeditive, but don’t wish to do so if it is hurting the local Chinese people in any way. Could anyone talk to me about this? Thankyou for your time

  • Melamine in Sanlu milk powder? Now that’s a crisis!

    If you want to get people mad –I mean fired-up, torch-and-pitchfork enraged– screw with their pets

  • China Melamine Yet Again And This Time It’s Getting Mighty Fishy.

    Most of you probably already know more about melamine than they ever expected. Melamine refers to both a chemical and to a resin produced from it. Human ingestion of melamine “may lead to reproductive damage, or bladder or kidney stones, which can lead…

  • bigfishsales

    hoping someone here would know a little about 4-wheeler ATV’s; what sort of quality issues to be wary of. thanks

  • Cleary if there are lots Chinese factories eager to make quick bucks, once that thought exsist in their mind, the Quality can not be as expected.
    Why they do that? I doubt the whole country’s system. The system made people to do something that they not willing in their deep heart.
    Anyway, it’s just a matter of time for supplier to realise how important is the quality control.

  • The discussion we are having is very interesting.
    As a third party valve inspection company, we have done Inspection for European and USA customers since 1997.
    In all these years, we have seen many companies buy good quality valves in China at competitive prices. They have done this with great success.
    At the same time, we have seen unfortunately much more companies which failed to achieve this.
    The successful companies have all the following points in common:
    1) They have clear and professional product specification.
    2) They do supplier pre-selection systematically, by people who know the products specification, know production process, and know quality system management.
    3) As paret of their supplier pre-qualification, they do RANDOM sample selection for test back home. This in order to get supliers’ actual quality level .
    4) They discuss and negotiate terms & conditions with suppliers in a clear and fair manner as partners
    5) They not only inspect final products but also do production supervise in a systematic manner (either self or using reliable third parties)
    6) They stick to the terms and agreements reached with suppliers and do not easily back down when non-compliances were found
    7) They do not sent too many different and un-related people from their companies to the suppliers, people without product knowledge or those who can not help the business commercially, people who just want some sight-seeing or fun.
    8) They handle daily communication efficiently.
    9) They normally continue with supplier selection for back-up or alternatives, and do this as seriously as they select their first supplier. And they normally do not make it a secret to their existing supliers.
    10) Through their own professionality, they get respect and good co-operation from the suppliers

  • marlon

    I read Midler’s book. It was a snooze. He has been saying the same thing for years. Watch out for China quality. The Chinese will cut the quality of the goods they send you. How is this any different from what everyone else has been saying?