A Vietnam consultant friend of mine sent me a Stratfor article (from about a year ago) talking about how rising labor costs in China were slowly causing low-end manufacturing to leave China for other countries, seeking my thoughts on the article. Stratfor’s theory is essentially that clothing manufacturing and mobile phone assembly are precursors to other industries and those two industries are already starting to leave China:

Even though the movement of two indicator industries — garment manufacturer and mobile telephone assembly — signals change, this is a transition that is as yet pre-statistical; few if any reliable trade numbers or volumes now exist to plot the contours of this shift. But it is, Stratfor has concluded, a shift that is already well underway.

Stratfor sees the following sixteen countries taking over (not necessarily completely) low end manufacturing from China, though “[T]he outlines of this group, what we call the Post-China 16, or “PC16,” are only now coming into focus. Indeed, the specific countries may change and the precise roles they play in this transition — their success in following the path China has trod — remain to be fully seen.

Stratfor came up with its list not by “looking for the kind of large-scale movements that would be noticed globally, but for the first movements that appear to be successful. Where a handful of companies are successful, others will follow, so long as there is labor, some order and transportation. Some things are not necessary or expected. The rule of law, understood in Anglo-Saxon terms of the written law, isn’t there at this stage. Things are managed through custom and relationships with the elite. Partnerships are established. Frequently there is political uncertainty, and violence may have recently occurred. These are places that are at the beginning of their development cycle, and they may not develop successfully. Investors here are risk takers — otherwise they wouldn’t be here.”

Stratfor does not see any one of these sixteen countries assuming the “factory to the world” mantle:

There is no single country that can replace China. Its size is staggering. That means that its successors will not be one country but several countries, most at roughly the same stage of development. Taken together, these countries have a total population of just over 1 billion people. We didn’t aim for that; we realized it after we selected the countries.

The point to emphasize is that identifying the PC16 is not a forecast. It is a list of countries in which we see significant movement of stage industries, particularly garment and footwear manufacturing and mobile phone assembly. In our view, the dispersal of industries that we see as markers of early-stage economic growth is already underway. In addition, there are no extreme blocks to further economic growth, although few of these countries would come to mind as having low political risk and high stability — no more than China would have come to mind in 1978-1980. I should also note that we have excluded countries growing because of energy and mineral extraction. These countries follow different paths of development. The PC16 are strictly successors to China as low wage, underdeveloped countries with opportunities to grow their manufacturing sectors dramatically.

Here are the sixteen:

  1. Mexico
  2. Dominican Republic
  3. Nicaragua
  4. Peru
  5. Ethiopia
  6. Kenya
  7. Uganda
  8. Tanzania
  9. Sri Lanka
  10. Bangladesh
  11. Myanmar
  12. Laos
  13. Cambodia
  14. Indonesia
  15. Philippines
  16. Vietnam

I find Stratfor’s analysis fascinating, but I am not so sure. I especially like how I have the benefit of analyzing the article a year later.

Booz & Company’s Strategy + Business website ran an article entitled, Is China the World’s Next Rust Belt?  The article is by John Juliens, a Booz partner out of its highly regarded Shanghai office. Despite the title, Juliens sees China manufacturing continuing to grow because the following five factors “likely more than offset the impact of China’s eroding labor cost advantage”:

1. Domestic demand. China’s rapid economic development will continue to add millions of new consumers to its already huge customer base. The country is, or soon will be, the world’s largest market for a wide range of goods, many of which need to be manufactured close to where they are consumed. In addition, Chinese tastes are sufficiently particular for it to often be necessary to design (and manufacture) products specifically for local customers. Technological developments, such as miniaturization and 3-D printing, will further enable these trends.

2. Urban–rural divide. China remains a highly diverse country with a wide gap between urban and rural incomes. In fact, almost two-thirds of its people still earn less than US$5,000 per year. In contrast to the nation’s more developed coastal regions, China’s less-developed inland regions continue to have low labor costs—suggesting that manufacturing activities could be shifted to retain the country’s labor cost advantage.

3. Operational excellence. To date, few firms have truly optimized their Chinese operations. This leaves substantial room for productivity improvements through, for example, more efficient machines and production setups, minimization of defects, leaner supply chains, and improved labor productivity.

4. Frugal manufacturing. China’s competitive advantage already goes far beyond cheap labor. For example, Chinese firms are often quite innovative in reducing costs by redesigning manufacturing processes, substituting cheaper “good enough” materials, and using simpler off-the-shelf components.

5. Investment versus comparative advantage. Economic theory dictates that when labor costs rise, businesses move elsewhere. However, countries can offer investment incentives to attract or keep businesses, and I believe that such incentives often trump the underlying comparative advantage. China, like Singapore—the country it most seeks to emulate—has the financial means and the will to wield this tool effectively.

I am not going to try to match either Juliens or Stratfor in analysis, but I am going to tell you that what our China lawyers have been seeing definitely more closely jibes with Juliens’ analysis than it does with Stratfor’s. We have seen straight line increases in interest in China manufacturing, both by companies already manufacturing in China and by those looking to start. If anything, I have been surprised by how unwilling both sets of companies are to explore other countries and by how those that have looked at other countries still so often choose China. Now admittedly, my law firm’s expertise/reputation in China is going to slant things towards China, but what I keep hearing from the newbies is how easy China makes it to get started and what I keep hearing from those already doing business with China is how easy it is to ramp up there.

In, China Factories Moving In Droves To Cambodia/Vietnam/Myanmar/Malaysia. NOT. we wrote on what we were seeing and nothing has really changed since then:

The article [Wary of China, Companies Head to Cambodia] does an excellent job at setting forth exactly what my law firm is seeing among its clients, which include the following:

  • Small clothing and shoe companies that seriously looked at moving operations to Vietnam or Cambodia but then chose not to do so because it would be “too difficult” to set up a supply chain in those places.  Just as described by Ms. Olchanetzky above.
  • Mid-sized and large clothing and shoe companies that have put their toes into Vietnam or Cambodia by doing a bit of outsourcing from those countries or by setting up small factories there.
  • Many companies of all kinds sending people to scope out Vietnam or Cambodia and, more recently and to a lesser extent, Myanmar.
  • Many companies looking at adding facilities or offices in Thailand or Malaysia or Indonesia, believing that those three countries are going to thrive in the next decade as ASEAN’s economic importance rises.
I actually think that my own law firm’s Asian plans are the norm, at least if our conversations are a good yardstick. Our clients are always asking us about our plans for more offices in Asia and we tell them something along the following lines:

Right now, our Vietnam, Cambodia, Thailand, and Myanmar work is all being done out of our existing offices by our traveling to those countries and working with the people we know there. Much of our work in those countries involves the basics like helping our clients contract with existing companies there and helping our clients register and protect their intellectual property there.  As more of our clients establish a permanent presence in some of these countries, we will look more seriously at opening a new office to serve that region.

The response to the above was invariably, “that makes complete sense and is pretty much how we are approaching things as well.”

But since we wrote the above posts, our Vietnam work has greatly increased and we view Vietnam as a viable China substitute on both ends of the manufacturing spectrum, but maybe not the middle. What we are seeing with companies manufacturing in Vietnam is that really large companies are going into Vietnam manufacturing with their own factories and SMEs are going into Vietnam to have things like clothing and rubber duckies manufactured there. What we are also still seeing is that China is still the place for most other manufacturing.

More importantly — and this holds true for both Vietnam and China — what we are really seeing is more and more companies looking to places like China and Vietnam as markets, not just as manufacturing centers.

Having said all this, however, we fully recognize that what one small US law firm is seeing now is not a great indicator of what is going to happen three, five, ten or twenty years from now, especially since much of the increase in our Vietnam work is no doubt due to Vietnam’s close connections with China.

So what is going to happen three, five, ten or twenty years from now? Will China be a rust belt? Will clothing still be manufactured there? Which if any of the Stratfor 16 can we expect to be ascendent and when? Answers please.

Though we have written about this scam a few times previously, I HAVE to write about it again because it just keeps happening, in even greater numbers and in even more diverse circumstances. And this is the one fraud to which I have time and time again seen extremely savvy and sophisticated companies fall prey.

And not only that, I learned a whole lot new about it at my lunch today with a local insurance coverage lawyer.

But first, more on the scam itself. I call it “the new bank account scam” and we described it as follows in a previous post:

“The new bank account to pay us scam.”  This is the scam on which we focused last year and it is still around and scarier than ever. I really really hate this scam because I have seen far too many smart companies fall for it and I view it as maybe the most difficult to detect.

This scam is usually employed against a foreign company that has been making purchases from a Chinese company (or any international company, as I learned at lunch today) for an extended period. The foreign company has been making its payments pursuant to purchase orders that specify the company bank account to which payment should be made. Suddenly, the “Chinese company” (note the quote marks here) sends an email to the foreign company requesting funds for outstanding POs be made to a new bank account. Often, the name on the bank account is not the same as the name of the Chinese company. Often, the bank account is in a different city or even in a different country. Often it is for Hong Kong.

What is the scheme here? Well, it is always possible that the Chinese company has changed its bank account, but you had better be quite certain of this before you switch your payment. In the old days, the scheme was either that the Chinese company had hit hard times and was seeking a double payment or an employee at the Chinese company was seeking to get your payment instead of the company.  The Chinese company would get the money in Hong Kong and then claim that you had never paid and that you still owed them money because it was completely your fault for having made the payment to someone other than to them.

Then last year this scam became even more sophisticated when computer hackers started hacking into computers and sending out invoices that purported to be on behalf of the Chinese company.

How can you avoid getting caught up in this type of fraud? Take note of the following:

  • The computer networks of many Chinese companies are not secure. The networks are subject to abuse by employees of the Chinese company and by outsiders. This means that you can NEVER trust an email communication from a Chinese company. Email is inherently insecure in China and you never know with whom you are really dealing when engaging in electronic communication with Chinese companies.
  • Chinese companies tend to be very loyal to their banks and so you should view with extreme suspicion any request to make a change in the payment bank. You should not even consider following such a request unless the request is made in writing on a revised purchase order stamped with the company seal. Even in that case, it is important to contact someone you know in the company with supervisory authority to ensure that the request is valid. Email requests to make a change should be ignored, but the request should be forwarded to your trusted Chinese company contact for an explanation.
  • Carefully review all bank account information. Monitor both the name of the payee and the location of the bank. Where the payee is even slightly incorrect, do not pay. Where the location of the bank is in the wrong city or country, do not pay. I have seen cases where foreign buyers paid to bank accounts outside of China to payees with no connection to the seller. These cases were all obvious frauds and the buyers lost their entire payment. I have seen millions of dollars vanish into thin air with this sort of scam. The Chinese parties committing the fraud will explain the need for this irregular payment as part of a plan to hold foreign currency outside of China. This kind of arrangement is no longer required in China. Explanations of this kind are indicia of fraud and should be ignored.

If you think you are immune to this scam, you are just flat out wrong.  This scam is hitting serious, savvy, large, internationally experienced companies and it is doing so because it is just so hard to stop. Our client who got hit with it was dealing with a large multi-national company based overseas (not in China). This company’s email got hacked and my client received an email with the PROPER invoice and a message saying that the company was consolidating its payment processing and going forward all payments should be made through its Guangdong office and to the following Guangdong bank account. Someone at my client’s company did exactly as told and now there is a problem between my client and this multi-national.

Now, about my lunch. This coverage lawyer told me that he is building up a cottage industry representing companies that have been hit with this scam. He said that he alone has taken on about a half dozen of these matters in just the last six months. And if he has taken on about a half dozen of these, that almost certainly means that he has reviewed about a dozen. What he is doing is going to the insurance company of the company that has been scammed and demanding that they reimburse his client for the money that they lost. This lawyer tells me that the insurance company’s initial reaction is to call his client an idiot, but as I pointed out, even if true (and I vehemently deny that it is), I have yet to see an insurance policy with an “idiot exclusion.”  This lawyer then convinces the insurance company that what happened is plain and simple employee negligence and that the insurance company must provide coverage.

Interestingly, most of his cases have involved the maritime industry and Korea and Russia, not China manufacturing.

Has he been able to get the insurance companies to pay his clients? Well let’s just say that he was thrilled to learn that I would be writing this post, so that ought to tell you something. So if you have been victimized by this now all too common scam, you should check your insurance policy and call an insurance coverage lawyer because all may not be lost after all.

Had a great discussion with a bunch of our China lawyers the other day regarding how so many of our clients are expanding in Asia beyond China and of how so many of them have an Asia strategy, of which China is just one large part and usually initial part.

We then talked of how this has changed the work we do as their lawyers, especially in IP.

Five years ago, our typical manufacturing client would call us for legal help in starting a factory in China or for outsourcing their product manufacturing to a Chinese factory. With the former, we would help them set up a Chinese entity (either a WFOE or a Joint Venture) and with the later, we would draft an OEM Agreement. In both cases, we would discuss their intellectual property and typically help them file for a trademark or a patent in China, occasionally a copyright. Most of these companies were new to Asia, though some had operations in Europe.

Things are very different these days.

Many of our manufacturing clients have been making product in China for years and they are now calling us to add some other Asian country (usually Vietnam or Indonesia) to their manufacturing mix or because they now want to sell their China-manufactured product in China and/or somewhere else in Asia. These companies either have an Asia strategy or are seeking our help in formulating one. Whereas five years ago, a common question for us was “Shenzhen or Suzhou,” today we equally often hear “Hanoi or Jakarta?” Five years ago, we would get asked what we knew about “exotic” places like Yantai. Today it is exotic places like Da Nang.

Needless to say, it is not just manufacturing companies that need to guard their IP in China. Software companies, gaming companies, food and beverage companies, and consumer goods companies are registering their IP in Asia at what feels like a record pace. Balancing all the talk of a China manufacturing slowdown is the year by year increases in disposable income.

The “China-plus” strategies of our clients means that our IP discussions need to go well beyond China to include pretty much all of Asia. Five years ago, only around twenty percent of our clients needed to consider trademark or patent or copyright registrations in a country other than China. They were new to doing business in China and so they needed IP protection there. We would ask about their IP needs for the US and for Europe, but they had been in both places for so long that they were invariably covered.

Today, about half of our clients need IP protection in an Asian country other than China. Fortunately, most Asian countries (Japan, Korea, Vietnam included) have IP regimes quite similar to China’s. The real key for foreign companies expanding beyond China with their products is to be sure to recognize that whatever IP you registered in China probably provides you with little to no protection outside of China. In other words, in most cases, you must register your IP in whatever Asian country in which you are doing business. Also note that in your IP analysis, you must treat Macau and Taiwan and Hong Kong as countries completely separate from the PRC.

Got it?

David Dayton over at the Silk Road International Blog did an excellent post on China manufacturing a couple years ago, but I just saw it today. The post is entitled, “What to ask for at a trade-show (and afterwards too),” and it starts off with Dayton saying that he is writing the post because he is always getting asked what to look at for at trade-shows.  The post is full of excellent advice, some of which I highlight below.

Dayton starts by listing “First questions” to ask of manufacturers you meet at a trade-show and are considering using.  A select portion of those questions are below, along with my comments in italics:

  • Where is the facility and can you go to visit (this week while you’re in the country)?  Visiting the facility may be the single best thing you can do to determine whether you are going to be dealing with a high quality Chinese manufacturer and, on top of that, I am convinced that just visiting increases your chances of being taken seriously by your manufacturer, which in turn, increases your chances of getting good product.  
  • Do they have business documents that they’ll let you see?  I am not sure exactly to what business documents Dayton is referring, but generally it is a good idea to, at minimum, make sure that the company you are dealing with is actually registered in China and is truly the same company that makes your product.  It also never hurts to see documents showing that your potential manufacturer has done this before. American companies tend to be reluctant to ask for this sort of thing, but you should know that Chinese companies are not.  Just asking for these documents will separate you out from many others and thereby earn you increased respect, which definitely can impact product quality. 
  • Will they let you talk with engineers and other managers?  If they will not allow this, you should be suspicious. 
  • Will they allow 3PQ?  If they will not, you should be suspicious.
  • Can they give you referrals?  Note that Chinese manufacturers sometimes refuse this request for valid reasons.
  • Can you meet and even QC sub-suppliers?  If your Chinese manufacturer is going to keep the identities of its sub-suppliers a secret, your odds of quality control problems just went up. 
  • How do they deal with non-conforming product?  Not sure if I agree with this one as we are of the view that our clients should be telling the Chinese manufacturer how to deal with non-conforming product.  Generally, we seek a refund of any amounts paid, along with the destruction of all of the non-conforming product.  

Dayton goes on to point out that even once you have found a “great factory,” you still have to determine whether it is a good fit for you.  He proposes asking the following excellent questions to find out:

  1. What is their average order qty?  Is your order similar?
  2. What is their average order time?  Is your lead time sufficient?
  3. Have they done similar projects (similar levels of customization, similar components)?
  4. Can you communicate with them effectively and do you feel comfortable working with them?

Lastly, Dayton lists out what Western companies need to do on “their end of the deal”:

  1. Always keep you word concerning dates and monies and anything else that is your responsibility.  Check.  
  2. Always take into account the reality that if you’re late with art (or money or answers) it will cause production delays (usually longer than your delay).  Check
  3. There will be problems, so take notes and keep records and follow up on anything that you’re not clear on.  Check.
  4. NEVER MAKE ANY ASSUMPTIONS.  Double-check.  For more on this, check out China Legal Issues For Business. The Ten Minute Version.
  5. Never make any changes to your specs or to your contract.  I disagree with this one, so long as the changes are handled appropriately.  
  6. File all legal work in your home country and in China BEFORE you start passing out specs to anyone (even at the show).  I think what David is saying here is that you need to make sure that all your intellectual property protections are in place BEFORE you start flashing around your IP.  For more on this, check out Register Your China Trademark Now. Then Register It Again With Customs.
  7. Spec out all your details and present them in a consistent and clear format.  Check.
  8. Meet FACE TO FACE with your factory as much as possible.  Check.
  9. Admit when problems are your fault and take responsibility for them.  Check.
  10. There will always be problems—usually you can work through them.   But always find a back up facility just in case.  Check
David’s post has many more tips for those looking to manufacture product in China and for those already manufacturing product in China and if you fit either of those two categories, I strongly urge you to check it out.
What do you think?

Just received the following comment to our post, How To Find And Deal With Chinese Manufacturers:

I have a question,
I sent a picture of a unique [product] and they sent back an email saying that they would like to manufacture it and when I said mine they corrected me by stateing ours.
is this normal?
How should I deal with them.
how does something like this work?
Thanks

We get this type of question shockingly often.  Usually, it comes from someone who just returned from China calling to say that they just spent the last week in China, meeting with a whole slew of potential Chinese manufacturers, and they just realized (oftentimes by having read one of our blog posts on the need for a Non Disclosure Agreement) that they should have required the potential manufacturers to sign a Non Disclosure Agreement BEFORE showing them their product or prototype.

So what can be done?  How should this company deal with their manufacturer? How can this company protect its trade secrets now?  With this particular company, all may not be lost. and that is why I struck its specific definition of their product and replaced it with the generic word, “product.”

If this company provided its product to just one manufacturer and is now planning to buy from just this one manufacturer, this company may end up doing just fine.

What this company should have done BEFORE it showed its unique product to anyone in China (or anywhere else in the world for that matter) is to have required that Chinese manufacturer to sign a comprehensive NNN Agreement written in Chinese and tailored for enforceability in China.  But that was not done, and the question is what can this company do now that it has returned without a China NDA of any kind.

This company can and should go to this particular Chinese manufacturer and say something along the following:

We want you to manufacture our product, but for that to happen, we need you to sign this OEM Agreement.

The OEM Agreement this company provides to its chosen Chinese manufacturer should contain each and every trade secret provision that should have gone into the NNN Agreement this company should have required the Chinese manufacturer to have signed before showing the Chinese manufacturer anything.  If the Chinese manufacturer signs the OEM Agreement, the company will have its trade secret protections. If the Chinese manufacturer refuses to sign the OEM Agreement, the company will have a big problem.

In our experience, Chinese manufacturers will virtually always sign a legitimate OEM Agreement containing trade secret protections becuase the Chinese manufacturer wants the manufacturing business.  I would estimate that Chinese manufacturers sign our OEM Agreements around 98% of the time and those few times that they do not it is because they are not a legitimate company and they do not want to be bound by legitimate requirements.  In other words, the Chinese manufacturer that refuses to sign an OEM Agreement does so because they intend to steal trade secrets or fail to deliver on their quality promises and they do not want to sign a contract that could effectively penalize them for doing so.

The much tougher problem is the company that comes back to the United States having shown its unique product to ten Chinese manufacturers.  That company can get a protective OEM Agreement from just one or two of them (i.e. the ones whom it is going to use for manufacutering) and it will then always have a problem with eight or nine of them.

The real solution, however, is not to go to China without an NNN Agreement at the ready.

If you are seeking to have your product manufactured in China, I suggest you scour  the following regarding NNN/NDA Agreements:

And the following regarding China OEM Agreements:

And the following regarding other key issues arising from China product outsourcing:

Michael Zakkour, who constantly deals with global supply chains as part of his job as a China/Asia market strategist at Tompkins International,made a great comment on exactly that at our Linkedin China Law Blog Group today.  Michael’s comment was in response to a Bill Dodson post entitled, “Backshoring to the Future.”  In just a few paragraphs, Zakkour nicely lays out exactly what I see happening out there and gives lie to the idea that there is any one country for anything:

I think a lot of pundits, analysts and otherwise sober business thinkers, including my friend Jim Fallows are

  1. Blowing this “trend” out of proportion
  2. Seeing it as a Black/White (or Red/Red-White and Blue) issue

The real issue is not a simplistic Off-shoring vs. On-Shoring debate. It is much bigger than that. We are in the middle of “re-globalization” – whereby companies have to consider “right-shoring.”

In other words a number of factors including:

  • Where your biggest customers are (what are your top three markets by region)
  • Cost of shipping, fuel and logistics
  • Cost of labor
  • Protecting IP
  • Profitable partnerships
  • What each country region does best
  • Infrastructure

These factors and many others will inform companies on what mix of “re-shoring” “near-shoring”, “off-shoring” is right for manufacturing as well as R&D, marketing and sales.

A company may well want to keep component manufacturing in SE Asia, 60% of final assembly in China and specialty, high-value add manufacturing in the US. Many are misinterpreting this trend to mean massive, assembly-line focused, dirty and low value add manufacturing is coming home in droves.

The fact is a smart company will consider a new mix of manufacturing, sales, marketing and logistics in a re-balanced and re-globalized world.

In that world China still has a huge role to play. As an example just consider “China for China” manufacturing. If you are an apparel company, and your biggest market for the next 10 years will be China, why on Earth would you move all your manufacturing back to the US?

Good points all, don’t you agree?

Or as we lawyers are always so found of saying, it depends on the specific situation.

 

This is a guest post from Renaud Anjoran. Renaud runs a product quality inspection business in Shenzhen and he also writes the truly excellent and perennially helpful Quality Inspection Tips. My firm has worked with Renaud on a number of China product matters and we have consistently found him to be highly knowledgeable about China product sourcing. This post arose from a long email “conversation” between co-blogger Steve Dickinson and Renaud, which ended as so many of those do: with me suggesting that it be turned into a blog post.

So here’s the blog post, written by Renaud Anjoran.

 

Most transactions with Chinese suppliers are done through bank transfers. This payment method was described in a previous China Law Blog post, China Manufacturing Payment Terms. Limit Your Risks.

Many importers/foreign manufacturers are not familiar with Letters of Credit (LC) as an alternative to bank transfers. Letters of Credit were designed to protect both product buyers and product supplier in international trade. In practice, they are usually more favorable to the buyer.

How a letter of credit protects the buyer

An importer that pays by LC does not have to wire a deposit before production and it usually has the option to cancel the payment in the following cases:

  • If a supplier does not ship at the right time.  Typically if this happens, the LC simply expires, but the buyer still has the choice to pay if it wants the goods.
  • If a supplier does not honor the product specification or if there are too many defects. One of the conditions of the LC should be that the LC will not be paid on unless and until the product buyer has signed off on product quality or a specified third party QC agency has issued its certificate of inspection.
  • If the seller fails to provide any document listed as required in the LC or the documents do not fully conform to the LC’s requirements.

Why letters of credit can be cancelled by the buyer in most cases

Even something as small as a typo in the LC, or the fact that a quantity is written in dozens rather than in pieces in the invoice is usually enough to cause a discrepancy in the LC, which in turn allows the buyer to cancel payment.

In practice, a small minority of LCs are “clean,” i.e., without any discrepancy. In all other cases, the buyer has the option to refuse payment and cancel the transaction, even if the goods are already on a boat (in which case the buyer will not get the documents to get the products out of custom).

CLB Note:  We are aware of a Seattle buyer company that refused goods that had already arrived in Seattle because the street address (which was irrelevant) of one of the parties in the letter of credit was off by a single letter.

Tips for negotiating payment by letter of credit

For the reasons mentioned above, Chinese suppliers typically refuse to accept Letters of Credit. Here is how you can increase your chances of finding a Chinese company that accepts this payment method:

  • When sourcing your product, try to identify as many potential suppliers as possible. This will at least increase your chances of finding one that will accept an LC.
  • In your first conversation with your potential suppliers, mention that you always pay by LC on your first order. Try to get the supplier to accept this payment method in writing
  • Sell your project to your potential suppliers. Good manufacturers are inundated with customer inquiries, so you need to make yourself stand out. Explain why they should work with you. Call the Chinese company’s sales manager if necessary
  • Send your potential Chinese manufacturer a draft of the LC before opening it. You will usually need the commercial invoice, the packing list, the certificate of origin and/or GSM form A, the bill of lading, and an inspection certificate. Try to avoid putting “soft terms” into your Letter of Credit that will make it even more difficult for suppliers to collect payment.
  • If possible, use a major international bank. This will tend to reassure your suppliers.
  • Unfortunately, bank fees are much higher for an LC than they are for a bank wire, so an LC only makes sense for transactions of at least USD$30,000.
  • Chinese exporters are good at guessing whether a project is likely to become a source of long-term business. When they see what they think will be a a one-shot deal, they generally insist on getting a deposit and will not agree to an LC payment arrangement.

In summary, Letter of Credit are a payment tool that makes it unnecessary to transfer a 30% (or more) deposit to your Chinese manufacturer. They are usually more favorable to the buyer’s side, and for that reason, many Chinese companies refuse to accept them. But some Chinese product suppliers have been paid via Letters of Credit from some of their foreign customers for years, and sometimes Chinese manufacturers will accept your Letter of Credit if they really want your orders.

 

What do you think?

I just finished reading (most of it anyway) Bruce W. Mitchell’s book/tome, 13 Steps to Manufacturing in China. Shoot me if I don’t use the word “comprehensive” or some equivalent at least five times in this post.

13 Steps to Manufacturing in China is a comprehensive, soup to nuts break down of what needs to be done to establish a manufacturing plant in China. It is a step-by-step reference book for establishing a factory in China. If you are considering building a plant, this book is an absolute must-read. But it goes far beyond that because all of the thirteen steps have at least some application for virtually any foreign (and probably domestic) business in China.

The thirteen steps are as follows:

  1. Establish Project Teams.
  2. Identify Potential Locations.
  3. Identify Industrial Park Incentives.
  4. Meet with Other Companies.
  5. Learn the Environmental Regulations.
  6. Select Desired Location.
  7. Establish Your Company.
  8. Import Used Manufacturing Equipment.
  9. Source Chinese Equipment.
  10. Select a Design Institute.
  11. Evaluate and Select a Construction Company.
  12. Construct the Manufacturing Plant.
  13. Hire Plant Staff.

And trust me when I tell you that this book comprehensively dissects each of these steps by providing thorough how-tos, forms, and check-lists every step of the way. Mitchell is an engineer and this book reads like it was written by an engineer. It is all business with no fluff.

If you want relatively light reading on China business, I suggest any of the following:

But if you are a serious manufacturer and you want a truly comprehensive, soup to notes, detailed, step by step guide to manufacturing in China because you are going to be manufacturing in China, you really should check out 13 Steps to Manufacturing in China.

Since we started this blog back in 2006, we wrote of how you should expect and prepare for China wages and other prices to rise. In our very first month, way back in January, 2006, in a post entitled, “China is Booming, Go There for Growth,” we warned of rising China prices:

This article discusses how “a majority of the world’s top chief executives plan to invest in China over the next three years to win customers” and to win market access, rather than just to reduce costs, which are expected to rise quickly over the next few years in any event.

SMEs should be thinking likewise.

For how much longer will China remain the world’s factory?

A month later, in, “Doing Everything Right in China — A Danfoss Primer,” we talked of the benefits of recognizing that “China has gone from being just a cheap place for OEM manufacturing to becoming a multi-tiered high growth market for goods.”  Then way back in April, 2006, in “China Is Expensive — NOT. Go Second Tier And Life Will Be Good,” we talked of how China’s rising prices were pushing foreign companies into China’s second tier cities.

And we have been writing of this ever since, most recently in a series of posts, we titled, “The End of Cheap China”:

The media has picked up on the whole “end of cheap China” meme and has been writing on it and its meanings frequently over the last few months. In “FDI in China: inland and at your service,” the Beyond Brics blog wrote of how China’s rising wages will push foreign direct investment (FDI) in manufacturing to China’s inland provinces, rather than outside the country.  Beyond Brics cites to an Economist Intelligence Unit (EIU) report predicting China’s inland provinces will be attracting “huge amounts of FDI in coming years.”

“The other big trend identified by the EIU is that services is attracting more investment than ever. FDI in both wholesale and retail has grown by nearly 40 per cent a year over the past five years.” Back in January, 2006, In part I of what became a twenty part series, called Service Sectors in China Will Reign, we predicted China’s service sector would boom.

We predicted all this (along with countless others) because it was all rather obvious. We knew that as foreign companies poured into China and hired Chinese employees, wages would have to increase and with that, spending. We knew that as foreign manufacturers poured into China or simply sourced their products to Chinese factories, the need for companies to service the manufacturers and those who profited from it would increase.

Earlier this year, in a post entitled, “The End of Cheap China, But Not China Manufacturing,” [link no longer exists] China Business Blog & Podcast wrote of how China’s rising prices would influence foreign investment into China. It too concluded that manufacturing would move inland.

In a recent article, “For Some U.S. Manufacturers, Time to Head Home: More companies are assessing the true cost of outsourcing,” Business Week too writes of rising costs in China and of how this is pushing low-end manufacturers to return home.

In Is the era of a ‘cheap China’ coming to an end, Week Magazine rightly views the end of cheap China as “an undeniable sign of economic growth and progress.”

In an oft-cited article from earlier this month, entitled, The End of Cheap China, the Economist Magazine seeks to answer the question of “What do soaring Chinese wages mean for global manufacturing?” Like China Business Blog & Podcast, it concludes that China manufacturing will shift inland and move up the value chain. The Economist concludes its article with the following statement that is actually THE big question:

The pace of change in China has been so startling that it is hard to keep up. The old stereotypes about low-wage sweatshops are as out-of-date as Mao suits. The next phase will be interesting: China must innovate or slow down.

Will China be able to innovate fast enough to make up for the fact that it is no longer cheap? What impact will China’s slowing economy have on all of this?

What do you think?

I have certain articles I send clients and potential clients in response to their questions. One of my favorites (and the one I send when anyone asks a question relating to what it is like dealing with a Chinese factory) is Ok, so it doesn’t meet your standards….so what? This post is by David Dayton of the Silk Road International Blog and I like it because it is just so dead-on in describing the aggravations of dealing with Chinese factories.

Fortunately, we as lawyers rarely deal directly with factories over QC problems, but I hear these same sorts of things just about every week from companies that contact us wanting to sue their Chinese suppliers. I always politiely hear the foreign company out and then explain that my firm long ago decided that we have zero interest in pursuing such claims unless there is Chinese-language manufacturing contract that clearly and specifically sets out the quality standards for the product and that has the Chinese company’s seal on it. Though as pointed out in the JLMade post, “Sampling Strife,” if you list out 9,999 points of control, there is still a decent chance the Chinese factory will do something completely weird and unexpected with one you never even deemed possible:

The sticky thing about controlling orders in China is that you can give the factory a list of 9,999 things to do and not to do, but they will still find something that’s NOT ON THE LIST! 
You’ll see factories make decisions that, in a million years,  you would not have considered they would make.  Something random, such as change the color when no color change was ever discussed, mentioned or needed. 

Their response:  “Well if you didn’t want it that way, then you should have told us.  You should have given us 10,000 points of control instead of 9,999!” 

Dayton’s article starts out by quoting the response of the three Chinese factories when confronted about  their quality control problems:

  • “Sorry it is not the same as the sample. We hope that you’ll accept it anyway.”
  • “Your QC is too strict. No one can expect to be 100%.”
  • “This is still within tolerance levels.” (No tolerance levels were ever given.)

Dayton then notes how all three factories then “moved to the dreaded show-down level of negotiations: “We won’t make it again. You can accept this standard or cancel (part of) your order.”

In one case, the Chinese factory completely backed down when Dayton refused to do so. The factory blamed the QC problems on a manager who Dayton had never met but who had supposedly been in charge of the project and fired him. As Dayton puts it, the Chinese factory “saved face, we got our product (re)done correctly and the exchange was relatively pleasant and not too confrontational, all things considered. Of course they ended this round of negotiations with ‘OK, but next time the price has to go up'”

If you have never dealt with a Chinese factory, you no doubt are having a tough time believing this sort of thing goes on. But if you regularly deal with Chinese factories, this same sort of thing has no doubt happened to you countless times. I am not sure if I can remember a quality control problem that was not blamed on a non-existent person who was just fired or on an unidentified subcontractor that allegedly made the product. But as Dayton points out, the goal is to remedy the problem, not to make sure the Chinese company loses face. 

Dayton then discusses how he oh so logically handles the “we didn’t really believe you when you said you were going to be this strict” line: 

Whenever we hear this our questions are always the same, 1. If you can’t meet this standard in production, why did you sign a contract saying you could (and why did you repeatedly tell us you could)? 2. How come you can do it for a sample but not for production (and if it is a different process, why did you bid on one process but plan on using another).

Dayton concludes his post by noting how “few and far between are the factories that admit that they over-estimated their abilities and give you your money back”

What have you experienced?