China manufacturing risks

1. Good Manufacturer, Good Manufacturing Contract, Good QC

We are always preaching that if you 1) choose a good manufacturer, 2) use a good Manufacturing Contract, 3) engage in good quality control monitoring, and register your trademark, the odds are overwhelming that you will do just fine in outsourcing your product from China.

The odds just went down.

Pre-COVID, I estimate that our law firm would receive two or three emails a month from someone who had sent money to a Chinese manufacturer and received no product. And of those emails, I estimate that pretty much all of them involved a relatively unsophisticated buyer who had done none of the three things listed out above.

 

2. COVID Has Made China Manufacturing Much Riskier

But since COVID, we have been receiving a lot more emails from buyers who have been burned by Chinese manufacturers but have a very different story to tell. These buyers have been burned by Chinese manufacturers with whom they have been dealing successfully for many years. The following is a fairly typical example:

I did not receive my most recent order from ____________ Chinese manufacturer. I have been dealing with ______________ for six years and we have never had a problem like this. We have had issues with them in the past but we were always able to resolve them. Now they are not even answering their phone. They owe us around $60,000.  Can you help?

I recently received the following email:

Two things I would love to get your opinion on:

1. As a director of a company that sources “promotional items” solely in China (assuming the quantity of goods is large enough), where else can we possibly be looking?  If we only did textiles I could set up in Vietnam or in Bangladesh; but we source plastic trinkets, low-end electronics, pens, lanyards, bags, and a variety of other LOW VALUE ADDED goods.  Is our only option to keep taking the price and tariff increases until someone finally starts making plastic toys and trinkets in another country?  From my experience these China manufacturers are NOT moving inland to cheaper places in China, but are instead just raising their prices or shutting down.  Keep in mind that the factories I’m working with are not huge Foxconn-like factories but private owned 50-150 employee factories.  What have you seen?

2. We work with over 100 factories a year in China. I’m trying to develop a plan on “How Not to Get Caught With Our Pants Down” where a manufacturer closes and takes our deposit, which happened to us three times in the last year as compared to zero times in the previous two years combined.  If a factory goes bankrupt I think the chances of us getting any kind of money back on a deposit no matter how well our written contracts are is low (maybe this is wrong?).  Our current plan is ‘hoping and praying’ on deposits less than $10k that wouldn’t really hurt our company, and making sure we send our QC team to visit the factory even if previously audited, for any deposits over $10k to ensure they have workers there, raw materials in storage, and are producing something. Does this make sense to you?

I would imagine many of your readers are facing similar situations.  It’s a scary time to be exporting from China.

I responded to this email by professing that I had no great solutions and that I would blog about it.

As for where to go, the answer is “that depends.”

 

3. How to Reduce Your China Manufacturing Risks

As for how to prevent yourself from getting caught holding the bag when your Chinese manufacturer disappears or what to do about it when that happens, I have the following advice, none of it great:

1. Redouble your due diligence in choosing a Chinese manufacturer. Check out the factory. Check out its company registration. Check out the rumors about it. Do whatever you can to try to gain a sense as to whether it is a company that is acting like it has a future. When our law firm conducts basic factory due diligence for our clients, we suggest they not move forward with their proposed supplier close to 40 percent of the time.

2. Reduce the size of your orders to the extent you can. This way whatever bag you end up holding will at least be a smaller one.

3. To the extent you can, try not to order anything in September, October or November. Chinese companies typically come up for renewal of various licenses in December and January and they often try to hold on up until the point they are supposed to pay these. That being the case, they take your money at the end of the year and then never ship and then cease to exist.

4. Increase your monitoring of the factory to make sure your product ships.

5. Do whatever you can to try to reduce the amount you pay upfront for your product. If you have been doing business with the same factory for five years and paying it 70% upfront, go to them and point out that you have always paid and ask to switch to a 30-70 or 50-50 payment plan.

Any other ideas out there?

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Photo of Dan Harris Dan Harris

Dan is a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

He primarily represents companies doing business in emerging market countries, having spent years building and maintaining a global, professional network. 

Dan is a founder of Harris Bricken, an international law firm with lawyers in Los Angeles, Portland, San Francisco, Seattle, China and Spain.

He primarily represents companies doing business in emerging market countries, having spent years building and maintaining a global, professional network.  His work has been as varied as securing the release of two improperly held helicopters in Papua New Guinea, setting up a legal framework to move slag from Canada to Poland’s interior, overseeing hundreds of litigation and arbitration matters in Korea, helping someone avoid terrorism charges in Japan, and seizing fish product in China to collect on a debt.

He was named as one of only three Washington State Amazing Lawyers in International Law, is AV rated by Martindale-Hubbell Law Directory (its highest rating), is rated 10.0 by AVVO.com (also its highest rating), and is a recognized SuperLawyer.

Dan is a frequent writer and public speaker on doing business in Asia and constantly travels between the United States and Asia. He most commonly speaks on China law issues and is the lead writer of the award winning China Law Blog. Forbes Magazine, Fortune Magazine, the Wall Street Journal, Investors Business Daily, Business Week, The National Law Journal, The Washington Post, The ABA Journal, The Economist, Newsweek, NPR, The New York Times and Inside Counsel have all interviewed Dan regarding various aspects of his international law practice.

Dan is licensed in Washington, Illinois, and Alaska.

In tandem with the international law team at his firm, Dan focuses on setting up/registering companies overseas (via WFOEs, Rep Offices or Joint Ventures), drafting international contracts (NDAs, OEM Agreements, licensing, distribution, etc.), protecting IP (trademarks, trade secrets, copyrights and patents), and overseeing M&A transactions.