It seems like 90 percent or more of the time when a company gets defective product from their Chinese manufacturer, the manufacturer blames a subcontractor.  Now I know that in some of these cases there was no subcontractor and in many more of these cases, it was not the subcontractor’s fault.  But we have always been of the view that subcontractors increase risk and, when possible, should be avoided. Far far too many China product sourcing problems stem from subcontractors.

In The Six (Not Five) Keys To China Quality, we spoke of why we typically write our OEM Agreements with Chinese manufacturers to preclude their using subcontractors:

We typically put a provision in our OEM agreements (which we nearly always do in Chinese for better enforcement in China against the manufacturer) mandating that the Chinese manufacturer cannot subcontract out the manufacturing. We have been doing this for years and, as far as we know, no manufacturer has ever violated this provision. I know many of you are dubious of this record, but hear me out. Let’s say the Chinese manufacturer has 30 customers for whom it manufacturers product. Let’s say only four of those customers have a no subcontracting provision (my guess is this number is more like to be two, but for the sake of argument, let’s go with four here). The China OEM manufacturer gets really busy and has to subcontract out some of its manufacturing. It can subcontract out the product manufacturing of any of its 30 customers, so why wouldn’t it choose to subcontract out the product for the 26 customers who have no contract provision prohibiting subcontracting? I call this the bike lock theory of Chinese law because the no-subcontract provision operates like a good bike lock. The thief can still steal your bike, but why would he when there are so many easier targets out there?

And when a subcontractor is necessary, we write into the OEM Agreement (and if there is a Supplier Manual, in there as well) that only subcontractors previously agreed to in writing by our clients may be used, along with a clear-cut liquidated damages provision for any violation.

I thought of the above today after a client of ours that supplies product to China told me of how Wal-Mart has adopted a “zero tolerance” policy regarding unauthorized subcontractors after a fire at a subcontractor to a Wal-Mart supplier in Bangladesh led to 112 deaths.

Bottom Line: If possible, your OEM Agreement with your Chinese manufacturers should prohibit subcontracting. If not possible, your OEM Agreement (and your Supplier Manual) should make very clear that only subcontractors authorized in writing by you will be allowed.  It (or they) should also make clear that any failure to abide by this policy will result in a stiff penalty (labelled as liquidated damages in your OEM Agreement) or, better yet, a termination of that particular supplier.

You have been warned.

  • It will be fun to watch Wal-Mart as they try to implement that zero-tolerance policy.
    It will be similar to their dumb zero-tolerance policy regarding excessive working hours in China. They know that getting their business without violating local labor laws is impossible, and they know that many migrant workers want to work these long hours, but they require a passed audit report… which means either the factory cheats (with a double set of books and a few lies) or the auditor gets bribed.

    The more I know about it, the more cynical I become… Sorry about that.

  • Traveling Gypsy

    So I must share…

    A few of my colleagues also read China Law Blog and on my way into the office this morning I received an email regarding this post. The email read, “Yeah right, can you imagine if we required our suppliers, via contract, not to outsource?” Solely going off that sentence and not having had the opportunity to read the post yet, I laughed to myself and thought, ” I am going to email Dan and say ‘Come On…’!”

    Having now read the post, I stand corrected on my assumption and could not agree more. My role is to o̶v̶e̶r̶s̶e̶e̶ ensure subcontracting doesn’t occur per a retailers requirements, specifically as the example noted in the post. Having lived in China, where I spent 7 days a week either in a factory or traveling to one, I probably have a more practical approach than most in dealing with the ‘requirements’ of compliance. I truly believe in order to be successful it’s about navigating the grey, understanding and accepting that it is never going to be 100%, but also never neglecting due-diligence. With that said, one can’t have a dogmatic approach, straying from implementing contracts and documenting expectations, just because a part of you feels “this will never be adhered to”. Sure, the likelihood of a factory following guidelines ‘To A T’ is unlikely, but having no guidelines… then what.. where can you ever go from there?

    The bike analogy is spot on and one of the best I have heard in some time, if ever. It totally encapsulates the approach that should be taken to approach subcontracting, compliance, and so, so many other things in life!

    By the way, Wal-Mart is extending a ‘grace period’ on their zero-tolerance of subcontracting for another month and a half….

    • I agree. The bike analogy is totally appropriate and explains why a “zero tolerance” policy is unrealistic. It is the same as locking a bike and saying “I run zero risk of getting it stolen”.

  • “We have been doing this for years and, as far as we know, no manufacturer has ever violated this provision.” In China the phrase “as far as you know” probably means it IS happening but you just don’t know about it 🙂