China contract lawyersIn my previous post in this series (here), I described the five basic attitudes Chinese companies have regarding advanced equipment being sold into China. Given these attitudes, what should a foreign seller do? In this part 2 post I set out two of five tactics high value equipment sellers should follow when selling advanced (and therefore expensive) equipment into China. In part 3, I will wrap it up with the remaining three tactics.

1. Do not discount. The first mistake most Western companies make when selling their high end equipment to China is to discount its price. The usual explanation my clients give me for doing this is that “we will discount the first equipment sale and then make up for that discount on future sales.” Wrong.

If you offer a discount you are simply confirming the China side’s basic assumption that your price is too high and you will virtually never get the opportunity to make up for the discount. The Chinese side will do one of two things. Some buyers (especially state owned enterprises or SOEs) will treat the initial discounted items as “samples” they will distribute to other enterprises to be cloned in China. For other buyers, the discounted price will treated as a new floor price for the product. If additional purchases are discussed, the Chinese company will then ask for an additional discount against your already discounted price.

It is therefore critical you hold the line on price. You may perhaps offer a very small quantity discount for purchases of multiple units. You may even offer a small “customer loyalty” discount for return purchases. But never offer a major discount for the initial purchase. Hold the line and explain that your price is both fair and the same price you offer to everyone in the world, on the same terms. What reason is there to change this policy for China?

2. Get paid before you deliver. For companies that are successful in selling to China, this is the golden rule. There really is no alternative. In many countries, issues related to payment can be resolved through the use of carefully drafted letters of credit. Chinese buyers, however, will only use Chinese banks for their letters of credit and those banks will always favor their Chinese buyer customers, so the letter of credit approach will not work for China.

For Chinese companies planning to clone your equipment in China, paying you by installments fits perfectly into their plan. The standard approach works as follows. Set up a system with five installment payments. The equipment will be delivered and installed in stages, in accordance with the installments. Then, the Chinese company will delay payment from the very start and then use the payment delay (which it will usually blame on China’s capital controls or some tax issue) to push the foreign side to deliver more than is required for each installment. The Chinese company will then reluctantly make a payment or two, all the while extracting equipment, training and know-how. When the Chinese side thinks it has gained  “enough” from what you have already provided it, the payments stop. The common standard is to make two of five payments in exchange for 50% of the product and expertise. Our China lawyers warn our clients about this all the time and yet it just keeps happening.

Other Chinese companies will use installment payments to force you to discount. The Chinese side will negotiate for a series of installment payments with a major final installment to be paid after installation and approval by the Chinese side. This approach virtually never works well for the foreign seller as Chinese companies are expert at finding problems with the equipment. The Chinese side will raise these problems as excuses for continual payment delays and then use their own delays to seek an after the fact discount in price from you, while holding the installment payments as hostage to achieve this goal.

If the Chinese company is unable to secure its desired discount from you during the basic installment period, it simply will not make the final payment, achieving a 10% to 15% discount by that single refusal to pay. If the foreign side threatens to sue for that final payment, the Chinese side will trot out a list of problems with the product and its installation — normally problems the Chinese company itself caused. However, this will still be enough to convince the foreign side seller that it will need to mount a long and expensive legal battle to get that final payment and that doing so probably will not make sense.

It is important to note that these tactics by Chinese companies are not unusual. Your price is too high, so they do not see themselves as acting unethically; they are just leveling the playing field. I have spent about half of my life in China and I have heard this reasoning about once a month while there.