About a month ago, we did a post, entitled, “Buying A Chinese Company? Why China Deals DON’T Get Done,” on why (in our experience) so few deals to buy Chinese companies actually close. Our explanation was that the cost structure of a Chinese domestic company is going to radically increase when and if it becomes a United States owned entity (WFOE). This will occur because the Chinese domestic company is (in most cases) not paying the taxes foreign entities simply cannot get away with not paying.
In that post, we talked quite a bit about a particular deal that had not gone through after the client determined that labor costs would pretty much double. That case involved an American company that felt almost compelled to buy its Chinese supplier because the owner of that supplier was retiring. In the end, the client chose not to buy the Chinese company because of the increased operating expenses it would need to take on. However, in a stroke of luck, the manager of the Chinese company stepped in and bought the company and the long-term successful buyer-seller relationship was maintained.
My thinking was “mission accomplished.” But in a post entitled, “Beware Captive Buyer’s Syndrome- The Risks to your China Buying Program,” The China Performance Group Blog (CPG) rightly disagrees. In that post, CPG points out how our client is still running “captive buyer” risks:
Now on the surface, this post about a foreign company buying a factory they had been working with reliably for many years may not seem to be related to China sourcing as it rather addresses issues related to market entry and M&A. However, what particularly caught our eyes here at CPG was this: “The potential deal was for a US manufacturer that had been receiving its product from the same China manufacturer for about fifteen years… the two companies had a “fantastic” relationship.”
Most experienced companies avoid setting up sourcing offices in China. This is typically because it is expensive and cumbersome from a management point of view, but they will have alternative approaches to create a reliable source of supply. One of these approaches is to set up a long-term relationship with one Chinese supplier, as with the US company in the post quoted above. It is only when that relationship is threatened that the vulnerabilities of this approach begin to become evident.
The post goes on to posit that “(1) the foreign customer (our client) is what we call a “captive buyer” and (2) they are paying too much for the product.”
I buy both points.
The post goes on to define a “captive buyer” as “someone that does primarily most of their buying with one factory, and since their whole relationship is with one buyer, they have no Plan B with other vendors. This indicates that the vendor has acquired dominance in the relationship, and can afford to start taking advantage of the buyer (inflating pricing, etc.).”
The post then rightly notes that the buyer often views the higher price as a fair trade-off in return for getting a reliable supplier, but even reliable suppliers carry risks, made even bigger if there is no plan B. According to the post, plan B would be to closely monitor your existing factory and have contingencies in place, such as a back-up supplier or a sourcing company at the ready.
So what’s a product buyer to do? Try the following:
- Do whatever you can to solidify your relationship with your good supplier(s). For more on this, check out “Manufacturing Your Product In China.The Extreme Basics.” This will help prevent your having to resort to plan B.
- Have a plan B in place. This plan B is going to depend on your company and your situation. If you are buying massive quantities of product from one supplier in China, consider adding another supplier. Think of the extra cost of doing so as your risk insurance. If you are not willing to add another supplier, at least have duplicate tooling and/or molds made and be aware of who your next supplier might be.
- Get product interruption insurance. I am not terribly familiar with these sorts of policies, but I know they exist. The potential shortcoming of insurance like this is that your getting a million dollars is not likely going to go very far in convincing your own customers that they can trust you to deliver your product on time the next time.
What are your thoughts? What else should product buyers do to protect themselves?
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