China product sourcing

Had a long conversation with a client this morning about what we as China lawyers can do to quickly and cheaply try to figure out whether a China manufacturer is on the up and up. This below is essentially a rehash of that conversation as it is a list of the steps we typically take to smoke out the fake manufacturer or a broker claiming to be the manufacturer.

1.  A Chinese language internet search. This oftentimes is enough to determine that the company is not likely to be real or that if it is real, it is not a good company with which to do business. It is amazing how often the fake China company has a website in just English, with no Chinese. This is a tell. We also sometimes can learn a lot by

2.  We call the phone number on the Chinese company’s website and/or send a fax to the fax number, to see if those check out. If they do not, we have learned a lot.

3. We search government records to make sure that the company is actually registered. Depending on the town in which the company is located, this is not always possible, but most of the time it is. Some people simply ask the Chinese company to provide its business license, and that no doubt can be helpful. But we have seen so many fake licenses that we usually prefer to simply bypass that and go right to the government source.

4. If the company registration checks out, we send someone to look at the factory to make sure that it is still there and, if possible, ask people in the area about that factory.

The above will not definitely tell you that the factory produces good product, but it will at a very low cost increase your odds. If more is needed either because our own research is inconclusive or because so much is at stake, we bring in a consultancy specialized in China due diligence.

What do you do to scope out your China manufacturers?

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.

Every December, we get an even greater than normal number of phone calls from companies that have received bad product or no product at all and the past two weeks have been no exception.  And as is almost always the case, I blame the “victim.”

I blame the victim because without exception, in every single case where we have gotten such a call, the non-Chinese buyer has done a lot of things wrong in its sourcing of product from China and now it is, to put it somewhat harshly, paying the price for that.

But what so often really drives me nuts about these people is that after I tell them exactly why my law firm has zero interest in their case, some of them say something like “I knew you can’t trust Chinese companies” or “I knew they had no law there” and then they usually say something like “I’m never going to do business there again. The risks are just too high.”

Wrong. Wrong. Wrong.

What I always want to tell them, but pretty much never do, is the following:

What are you talking about?  You did NOTHING to try to protect yourself.  You didn’t research the Chinese company before sending them money.  You didn’t use anyone to monitor quality control.  You didn’t use anyone to write you a contract that would actually work in a Chinese Court.  So really, what did you expect? I hate to tell you this, but we have hundreds of clients who buy from China all the time and they almost never experience anything close to what you are going through.

It reminds me of a relative I have (not on my side of the family, I might add), who during the tech boom would brag about how he had gotten so good at the market he would be earning 20% a year forever.  Yes, he actually said that.  But what is even more interesting is that after the market crashed and he lost a ton of money, he then started preaching how the market was rigged and he would never buy stocks again, not once even referencing his prior claims.  As my older brother the stockbroker is always saying, “genius is a rising market.”  But the corrollary to that for this relative is that a falling market is a rigged market to be avoided by everyone.

Wrong. Wrong. Wrong.

Just like there are ways to do well in the stock market (over time), there are ways to do well in the China product sourcing market.  The way to increase your odds of getting the product for which you paid is to do the following:

1. Make your product purchases from China under a well-drafted contract that is enforceable in China. Purchases under informal purchase orders simply do not work for China.  For more on China OEM Agreements, check out the following:

2. The contract with the Chinese manufacturer must provide for a mechanism where the foreign buyer can exercise constant control over the quality of the Chinese product. Liability for defect must be made clear and it must fall hard on the Chinese side. If possible, no defective product should ever be permitted to even leave the Chinese factory. If defective product is discovered outside of China, the Chinese side must be absolutely liable for dealing with the problem. The standard procedure (in China, anyway) for dealing with defects through a discount on future purchases must not be used.

3. The foreign buyer must actually follow through and constantly monitor the quality of the product. The best contract with the best procedure is no good if the foreign side does not follow through by rigorously implementing the procedures outlined in it. As I mentioned above, this is an expensive and tiresome process. Parties that do not follow through are almost guaranteed to experience problems in China. These problems are an irritant to the Chinese side but can be fatal to the foreign side. For this reason, the only side that has any incentive to follow through is the foreign side.

Is China product quality getting  better?  Yes and no. Chinese manufacturers are not doing a better job on their own at maintaining quality. In fact, if left on their own, much evidence suggests they are doing worse. But yes, the legal system and quality control systems have progressed to the point where aware and active foreign companies can force Chinese manufacturers to operate in a reasonably acceptable manner. “Forcing” means doing things right.

What do you think?

Renaud Anjoran at the always on the money Quality Inspection Tips Blog has a post, entitled, “The 10 components of a good quality assurance strategy in China,” that very nicely lays out what it takes to get good product from China. The post breaks out the ten components of effective China product sourcing into the following four “themes”:

  1. Qualification of new suppliers
  2. Purchasing method
  3. Quality control
  4. Buyer-supplier relationship

Renaud calls for buyers to do the following (my comments are in italics):

  1. Conduct a background check on your potential supplier. Make sure they really are the factory, and not just an intermediary entity.  Agreed
  2. Audit your factory.  Agreed.
  3. Make sure the factory is the right fit for you, particularly in terms of size.  Agreed. 
  4. Avoid paying 100% upfront and use a good OEM Agreement.  Agreed.
  5. Make sure your own company follows its buying procedures.  Agreed.
  6. Define very clearly what you want from your Chinese factory and make sure that the factory understands what you want.  Agreed.
  7. Regularly perform quality control inspections, as appropriate.  Agreed.  A good Manufacturing Agreement is important, but it is not sufficient.
  8. Stay with the same supplier as long as the relationship is good, rather than abandoning them to save a few pennies somewhere else. Completely agree.
  9. Visit your factory on occasion to meet with their people face to face.  Agreed.  I am convinced that those factories that “know” their buyers and have real relationships with them are much less likely to provide them with bad product. 
  10. Contribute to your factory’s improving its operations.  Interesting idea. 

If you are buying product from China or planning to have your product manufactured in China, I suggest you read Renaud’s entire post.

What do you think?  Anything else that should be done to ensure you receive a quality product from your China manufacturer?

I constantly get e-mails from readers asking for “China expert” recommendations or just how to go about finding such a person. I do not think there is such a thing as a China expert and I would not recommend anyone who claims to being such a thing.

Nobody who really knows China claims to be a China expert. Need an attorney to assist in your China company formation? Who needs a China lawyer, I’m your guy.  Need an accountant to handle your Chinese tax issues? Who needs a China accountant, I’m your guy.  Need a business consultant to help determine the best location for your China manufacturing business? Me. Need consulting on China HR?  Me, again. Help with China manufacturing/engineering processes? Hey, count on me for that too. China quality control?  Piece of cake.  China real estate investing (retail, residential, office, manufacturing, warehouse)? I got you covered.  China supply chain management? Me again. China customs?  I know all that. Oh, yeah, I forgot to mention I am also expert on China economics, China history, Chinese psychology, and China sociology. Did I miss anything?

You get the point. The truly good China experts are at least somewhat specialized, just as is the case in the United States and virtually everywhere else. Anyone who claims to know too much about China almost certainly knows too little.

Before you or anyone seeking to act on your behalf can even begin looking for the right “China expert,” your must first have an understanding of the type of expert required.  Once you have some idea of the sort of expert needed, you then must, of course, find that expert within the particular China field. I wish I could pass on some big secret as to how to find that particular expert, but unfortunately, I think the best way is through word of mouth. The tough part is getting to the first mouth and making sure it is the right one.

Your regular lawyer can be a good source of referrals to experts. My firm constantly refers clients out to China accountants, China engineers, China investigators, China product sourcing, China real estate people.  Sometimes we will just refer the client out to the expert and walk away. Other times, we bring on the expert and work with the expert and the client together. Others in your industry or just someone you know who has succeeded in China (or is even just doing business in China) might also be good referral sources.

I am not aware of any association of China professionals with a legitimate policing mechanism, however ChinaSolved highlights professionals doing business in China and, based on the person behind this site (Andrew Hupert) and on the professionals (including the China attorneys) up there whom I know, I do think this is a viable starting point. [link no longer exists] (based here in Seattle) is setting up a community of China experts, but I do not think it does much (if anything) in terms of filtering.

There are countless truly excellent China business experts out there in a whole host of specialties, but there are also many who should be avoided. There is no surefire way to know where to turn, but talking with those people you already know and trust is certainly the best place to start.

More ideas on this are most certainly welcome; the comment lines are wide open.