You are a new company just starting out. You have a great product and you have no other options but to have your product made in China, a country to which you have never been and know little to nothing about. What do you do?
You essentially have two choices. You bring in and pay a person or a company to help you find the right Chinese manufacturer or you do it yourself. Both of these have their pros and cons but in our experience, using an intermediary tends to be riskier, and that need not be the case. If you were to understand the role of your intermediary and work to smooth out the rougher edges of that role, you could make using one no riskier than going it alone.
In working with an intermediary to get your products manufactured in China, you must understand how you are paying them and even how much. There are multiple ways to pay these intermediaries, including the following:
1. You pay the intermediary an upfront flat fee for the intermediary to, among other things, find you a China manufacturer and to negotiate with the China manufacturer on your behalf. Typically, in this sort of arrangement, the intermediary drops out after you place your first order and that order is completed. The biggest pro to this method is that you pay once and the intermediary has less incentive to permit the China manufacturer to overcharge you. The biggest con is to this method is that you must come up with a large chunk of money right away and it is still possible (and not all that uncommon) for your intermediary to strike a side deal with your China manufacturer to get a 5-40%+ secret commission on every sale. If your intermediary does have a side deal with your manufacturer, it also has incentive to use a too-cheap manufacturer so as to be better able to hide its secret commission from you. Too-cheap manufacturers are more likely to have quality control and delivery problems.
2. You pay the intermediary by the hour to, among other things, find you a China manufacturer and to negotiate with the China manufacturer on your behalf. In this sort of arrangement, it is not uncommon for the intermediary to remain on board indefinitely to help with quality control issues. The pros and cons of this payment method are similar (though a bit reduced in terms of the upfront payment) to the pros and cons of method one.
3. You pay the intermediary some percentage on top of what the China manufacturer charges. In this sort of arrangement, it is typical for the intermediary to find you a China manufacturer, negotiate on your behalf with the China manufacturer, and remain on board indefinitely to help with quality control and to keep collecting the percentage payment. The biggest pro to this method is that you do not have to pay anything up front. The biggest con to this method is that it seems like 90% of the time when our China lawyers have been called in on one of these once problems have arisen, we discover that the intermediary’s 5% commission was actually anywhere from 20% to 300% — yes 300%. Again, to the extent your intermediary is hiding the amount of its commission from you, it has incentive to use a too-cheap manufacturer, which heightens your risk of quality control and delivery problems.
4. You pay the intermediary some predetermined fixed amount for your widgets and the intermediary steps in and essentially becomes the seller. This means that the intermediary is clearly responsible for quality control issues and — if you have an appropriate contract with this intermediary, this also means that the intermediary is legally liable for bad quality and late deliveries, etc. The biggest pro to this method is that it is usually the most honest. You know what you are paying for your widgets and the intermediary does not lie to you about what it is paying for your widgets because that figure is irrelevant. When I buy cheese at my grocery store for eight dollars, I hardly care what my grocer paid for the cheese and no representations about what it paid are being made. If the cheese is bad, the grocer is on the hook, plain and simple. But, I am no doubt paying more than if I were getting my cheese straight from the dairy farmer.
We have seen competent and incompetent and legitimate and illegitimate intermediaries use all four methods. Is going it alone better? Much of the time it is, but certainly not always. When is it best to go it alone and when is it best to use an intermediary? Answering that would take a book and we as China lawyers are not the right people to write that. In the end, you pretty much just have to trust yourself and your own comfort level.
BUT, no matter whether you go it alone, there are certain things you can do to reduce your chances of problems. On what problems should you focus and how can you minimize those problems? I will discuss these issues in parts 2 and 3 of this mini-series.