Spoke the other day with a company that was contemplating suing a Chinese factory regarding bad product. This company bought about $300,000 in product that it simply cannot use. When it told its Chinese supplier of this and then held back its final ~$100,000 payment, the Chinese company said it planned to sue.

This company was referred to us by another company going through the exact same thing.  Our phones are ringing off the hooks with these cases and they are not good.

Let me explain.

Chinese factories, particularly in certain industries like clothing, shoes, gifts/tchotchke, are hurting in China right now. For those of you who always angrily write me whenever I even hint at a downturn in China, I suggest you instead read this New York Times article, entitled, “In China, Sobering Signs of Slower Growth.” What this means is that many of these factories are cutting corners.  Much of the bad product in these cases is not due to bad production, but rather to bad components. The factory that makes the sweaters is using lesser wool to save costs and that doesn’t work. The factory that makes the shoes is using a lower grade leather and that doesn’t work. The factory that makes the plastic toy is using a lower grade plastic. And on and on and all of this without giving any advance notice to the American buyer. Make no mistake, for the first time in a long time, quality fade seems to be on the rise in certain sectors in China.

But it gets worse.

In the old days when a Chinese factory provided bad product, they would usually eventually admit it, and blame it on either a subcontractor or a supplier.  Now they deny it and threaten retribution if they are not paid whatever is still “owed” by their American buyer.  I wrote about this way back in February, 2006, in a post, entitled, China OEM The Smart Way:

Good Chinese suppliers are usually very busy and they often subcontract out to lower quality suppliers. We have handled many cases for foreign companies that received bad product from their previously reliable suppliers and in well over half of these cases, the product quality problems stemmed from the supplier having subcontracted out the manufacturing.  The supplier usually freely admits to having subcontracted the work and sometimes even boasts that the problems otherwise would never have occurred.  The supplier admits legal responsibility for the quality control problem, but then almost always proposes remedying it by giving a small discount on future orders until the damages from the bad product have been covered. The foreign company is usually in no mood to continue doing business with the offending supplier and wants only a monetary remedy.  However, because the profit margins at most Chinese manufacturers are so low, they often simply cannot pay all of the damages caused by the bad product and a standstill results that can only be resolved through litigation.

Those were the good old days.

Today, the tactic is to threaten to prevent the American company from “ever doing business in China again” or, more specifically, to seize the American company’s product at the border.  We take these threats very seriously and they have altered our approach to these sorts of cases.

In the past, if an American company was seeking $200,000 in damages from a Chinese company for bad product, we would most of the time seek to dissuade them from even bothering to pursue litigation. Our thinking was that unless they had a kick-ass written (preferably in Chinese) OEM Supplier Agreement that made crystal clear the quality expectations and the penalties for not meeting those expectations, suing in China would just not be worth the time, money and hassle.  And suing in the United States typically made even less sense.  For an explanation as to why this is usually the case, check out “Why Suing Chinese Companies in the United States is Usually a Waste of Time” and “Suing Chinese Companies in US Courts.

But the strategy changes if the Chinese company threatens to close you down. We have dealt with cases where US companies were unable to buy from any Chinese supplier without paying 100% upfront because their alleged failure to pay had caused China’s export insurance agency to refuse to insure payments from the US company. We have also dealt with way more than our share of cases where someone or something from our client was held hostage in China to secure payment. For more on the hostage issue, check out “China Hostage Situation. Now IS A Good Time To Pay Your Debts” and “China Business. China Jails. China Hostages.

If a US company is facing the situation above, our advise is that they sue the Chinese company somewhere, usually in the United States. Being able to show the Chinese insurance company, the Chinese police, or the Chinese border patrol agents, that you have sued can be invaluable. Your complaint against the Chinese company shows that the situation is not as simple as the Chinese company is making it out to be. Your complaint shows that the Chinese company is not necessarily owed anything at all and that you are not clearly someone who does not pay your debts.

Of course, if your company has no intention of continuing to do business with China and your personnel will not be going there again, then the best strategy probably would be to just walk away, just as in the old days.

  • Anonymous

    Lack of integrity is what caused the down turn.  I hope the world will realize that buying cheap from China is costly, may even cost your firm.

  • Dan.

    Firms that place 300,000USD orders and do not taking the most basic step of sending someone (they trust) to oversee the packing of the container and conduct a final QC are either simply negligent in understanding and mitigating risk… or their own budgets are themselves so tight that they are cutting their own corners (and getting burned)

    So, while I know it is catchy to call it “quality fade”, these are really issues of being poorly managed in China.


    • Michael Farrar

      Sorry, but this response is knee-jerk and lacks an understanding of the complexities of dealing with manufacturing product in China and of the relationships that take place between those who have product manufactured and the factories and/or factory owners.

      You can do everything you are supposed to do to ensure that the product you receive is as you ordered, and still get burned by factory owners seeking to cut corners so they can increase their margins. The various games that get played are too numerous and voluminous to list in this response, but suffice to say that things are not as simple as you suggest; it’s also a bit harsh to simply “blame the victim” when most of these types of problems are caused by – wait for it – factory owners playing games so they can increase their margins.

      It is incumbent on purchasers of product to properly manage their manufacturing activity in China, but that doesn’t alleviate the responsibilties that factory owners have to adhere to the terms of the contracts they sign. Incidents like those Dan describes above are happening with increasing frequency and part of this is due to the fact that (1) Chinese factory owners think they can burn purchasers of product and get away with it because it is logisitically difficult to get money out of the factory owners pocket; and (2) Chinese factory owners think all foreigners – and specifically U.S. purchasers – have deep pockets and that the factory owners can lie to the insurance company(ies) in China about what really happened and the insurance companies will believe it and go after the foreign purchaser in hopes of getting a sizable payday.

      • Renaud Anjoran

        Yes, some suppliers have become very savvy at fooling buyers.
        But such a large order should have been inspected several times during production, and the loading of the containers should have been supervised.
        If the supplier does not even accept QC inspectors, get the goods in a third-party warehouse and check them before they leave the country (or choose another supplier). There are solutions for those smart importers who plan ahead and who refuse “calculated risks” that seem too high.

      • Michael.

        I am not going to argue whether or now Chinese factories (managers) play games, or why, because that is absolutely secondary to the fact that firms continually fail to make basic “China” risk assessments.. and act accordingly. 

        To place an order for 300,000 worth of goods (and structuring 200,000 up front/ 100,000 at site) without putting eye balls on the goods at any point in the process (particularly when the goods are being packed/ shipped) is to me a failure of the foreigner buyer just as much as it is the Chinese supplier. 

        But then again, I (nor any of my clients) have never lost 200,000USD to a thieving factory, so perhaps your right… maybe I don’t have the requisite experience to comment on said issue?


        • Michael Farrar

          It was not
          my intention to come across as overly harsh, only to point out that it’s unfair
          to blame the purchasers, alone, in these scenarios. I agree that anyone having
          product made anywhere needs to provide proper oversight, and that includes a
          comprehensive manufacturing checking system that starts with making sure that
          the correct raw materials are purchased/used, having constant review of the
          production line and final output, on through to checking the packing, loading
          and sealing of the container(s). Failure to do all of this is just asking for
          more than trouble.

          That being
          said, problems still occur that have nothing to do with what the purchaser did
          or didn’t do. The upshot is that if factory owners want business from outside
          China – and most people assume they do – it is their responsibility to provide
          product as required – as well as some measure of comfort to purchasers – and
          not hide behind insurance companies and threats of legal action when they, the
          factory owners, screw up.

    • CPG

      Agreed. Having this much wasted product seems to indicate mismanagement of their buying program rather than just a growing poor-quality trend in China. It could be just as likely that this resurgence is a factor of complacency by western firms that, coupled with Chinese companies being squeezed and having to cut corners, results in large quantities of goods being wasted.

  • Ben Shobert

    Dan – this is a fantastic post and a great reminder to everyone managing a China supply chain that now is the right time to go back and double check your purchasing and QC procedures.  Easy to fall asleep at the wheel when you have a history w/ a vendor.

  • Jeromecole

    I hope that the American government frequently and forcefully brings up the issues of debt hostages and Americans sometimes not being allowed to leave the country when involved in litigation. I want to know that my government is behind me and I believe that more forceful diplomacy would partially resolve these and other very serious problems with China. Unfortunately, the State Department seems to lack backbone.

  • Worrying trend.
    A key and recurrent piece of advice when procuring from China (from procurement experts I’ve interviewed in the past) is “Quality Control ALWAYS, even from your best suppliers”

  • For the industries you mentioned; I think some of it has to do with the country becoming more prosperous.  Whereas the quality of people working in a gift/tchotchtke (Promotional Products) are not the same that they were 5 years ago.  As designers, sales force, and upper management are becoming more educated and richer, they are not sticking around ball pen factories.   There is the next wave of low-cost factory worker that needs training in both the work and ethics.  

    On the flip side, the importer / overseas buyer is being less vigilant.  They are not using the same check-points and care that importers used 5-years ago.  To them, China has always been open, so they purchase from China with the same casualness they buy from their local grocery store and this comes back to burn them.  From my decade of dealing with China – I’ve never found it “safe”.  The principle responsibility lies with the importer to cross t’s and dot i’s.  Expecting the factory to adhere to their responsibilities is a lofty ideal. 

  • Very interesting post.

  • Hua Qiao

    i don’t know about the rest of the readers but I am a little confused.  The prior post (Litigating in China) presents a dispassionate, logical look at suing in China that includes such statements as “I am tired of hearing people tell me there is no point to litigating in China” and goes on to imply there is logic in the system and corruption is less than you think.  But this post suggests that we should think twice, sue somewhere else and links us to posts warning about hostage taking and retaliation.  
    I am an avid reader but sometimes i get the feeling this is a schizophrenic kind of website.  Perhaps all the nuances of China make it too complex to explain in one post. But you read one post and you come away thinking “China is moving closer to rule of law” then you read another that says “Run away before you withhold payment over quality disputes”.

    Wo hen hutu! 

  • Twofish

    This is also a reflect of the slowdown in the US economy.  QC inspections and keeping a staff to supervise vendors increases costs, and in a bad economy there are huge pressures to forgo them.  When the economy is good, then it’s easy to convince people that you should fly to China for an unexpected visit, but in a bad economy, travel and inspection budgets get cut.

    One other thing is that a lot of times factory owners play games to increase their margins, because the margins were unreasonable to begin with.  When times are tough, there are huge pressures to sign the contract with the lowest bidder without thinking too much of why the lowest bidder is so low.

    The other thing is that is that this is another situation where “if you win you lose.”  The basic problem is not that margins are low, but that the money is gone.  Chinese suppliers use foreign customers to finance their operations.  If you give a supplier $100K, that money goes immediately to pay workers, so if you want that $100K back, the supplier can’t give it to you because it’s already been spent.  If you win a judgement, all you’ve done is put the company out of business.

  • Jiang Tai Gong

    I found this article very interesting.  I have seen for years that “Quality Fade” occurs in USA manufactured products.  My first experience with “The supplier usually freely admits to having subcontracted the work and sometimes even boasts that the problems otherwise would never have occurred.” as a consumer was with a large USA company (that company no longer exist).  I wrote a letter to a large national historic electronics firm regarding a defective TV.  I wrote in the letter that I expected better quality from an American-made TV.  The VP of Quality corrected me in his response, he stressed in his response that the TV was “assembled” in the USA, not manufactured in the USA.  The TV company seem to “wash their hands” regarding the quality of the TV that had their name on it.

    • Anonymous

      Hey troll, what TV brand is still assembled in the US? None, go back to shoddy factory.

  • Chinese RMB’s currency inflation is starting to catch up to the USD from years of export economy. The low cost manufacturers will suffer first as there is no more “cheap” labor. China’s economy 20 years from now will completely depend on how they transition from low cost goods to high cost goods, i.e. what niches of the international market they can corner within higher cost goods. Officially, the government is investing heavily in green tech, EE research, and stem cell research. We’ll see if these and other directions come to fruition.

  • MLS

    Scary stuff. China should straighten this out. Problems like this can easily compound, hurting their economy even more as companies stop doing business with them.

  • James

    I would suggest using the following set up if you are a USA company purchasing a lot of product from China.

    Use an HK company that is owned / operated by a BVI. This eliminates direct purchases. It really does not matter what happens to the HK company. Direct ownership cannot be traced back to the USA company. It’s more difficult for the Chinese company to cause problems becuase all P.0. contracts are executed in Chinese between factory and HK company.

    This is what our company does. I am curious about your thoughts on this set up?

    BTW – I do a lot of traveling inside China. You are absolutely correct about factories hurting. A lot of factories will close this year. You can see and feel the slow down in the industrial cities located in Jiangsu, Zhejiang, Fujian & Guangdong.

    Also, have been in DB in China on ground since 2001. Thanks for keeping it real; when so many others do not.

  • sound2Sound

    My personal experience is that the new Chinese way of dealing with quality problems is to totally deny that the problem exists and act as though the problem is you and not their product. It is laughable but your hands are tied. Chinese manufacturers are not afraid to let got of multi-year contracts if you as a buyer start being problematic (= requesting quality rights and fairness) . This puts you in a tight spot. Go to China, try and negotiate your way through, pass through many frustrating months of emails and phone calls until they don´t answer either to get to the same place….Nowhere. The best thing to do is have someone cover the QC and have firm but fair contracts in place to defend against these issues. I have dealt successfully without contracts in place but have come up against these problems 2 or 3 times over 6 years of business. I could mention names but that isn´t the issue. The best thing is to develop a positive, good natured personal relationship with the supplier, factory or middle man. This way they will try their best to defend you if things go pear shaped. Try and pay a little more to avoid Quality problems. It is better that the Chinese have a slightly bigger margin than try to cut corners to deliver your goods at the price.

    • max

      Unfortunately, it happens that the Chinese goods to be sent completely out of order a few hundred pieces of structural defect. There is no one to talk to, no desire to repair. An example of such a company: [COMPANY NAME REMOVED]I would not advise this company cooperation.
      On the internet, of course, provide 100% quality control and service.

      I mean a good idea is to show the company public, so that others do not have problems in future.