Spoke with a US manufacturer the other day regarding the OEM Agreement we are working on for him.  This manufacturer has been manufacturing in China for about a decade and he quickly let me know that one of the things that drives him nuts is how his Chinese manufacturers “change prices” on him, no matter what the contract says.  My response was to say, “I know.”  He then asked if we could stop that with our OEM Agreement.  My response was “probably not” and then I explained to him why stopping it might not be such a good thing anyway.

“Take your widgets,” I said (actually I mentioned his actual product, but you know what I mean).  “Stainless Steel is a big part of that.  If we put in your contract that your widgets have to remain at X price for three years, we may be asking for trouble.  What happens if the price of steel doubles during that time,” I asked. “I’ll tell you what will happen,” I said.  “Your Chinese manufacturer will either go back to you and ask to be able to raise its prices in light of its greatly increased costs for Stainless Steel or it will secretly start replacing some of the stainless steel in your widget. Which would you prefer?”

His response was pretty much as follows:

I get it.  You are absolutely right.  I know that because that is exactly what keeps happening to me.  The manufacturers start changing their products for me and always for the worse. Sometimes they do come back to me and ask for a price increase and then we negotiate one.

We talked a bit more and he agreed that the ones that came back to ask for a price increase were overall much better manufacturers than the ones that secretly changed the product on him and that he was no longer doing business with any of those.

I then told him that the generally best way to handle pricing in his situation is to set a price for maybe a year but be ready to be flexible on it.  I then noted that very few Chinese factories hedge their material goods pricing and that for right now at least, adjusting prices, no matter what a contract says is still pretty common in China, probably more so than just about anywhere else.  I then told him of how Chinese companies drive our commodities clients crazy.  One client in the paper business says that when the price of paper plunges, the way non-Chinese companies typically handle that is to pay the higher price to which they previously agreed or to come clean and say that they cannot afford to pay that price and then negotiate a lower price, with the expectation that they will be indebted to the paper seller for the foreseeable future. But Chinese companies, I am told, simply reject the paper, claiming it is bad and thereby avoid having to pay the higher price.  In other words, Chinese companies out of all companies seem to be the least willing to recognize that a price is a price.

Just one more thing you need to account for in doing business with China.

What do you think?

In a recent post by Renaud Anjoran, entitled, Bad relationship with a Chinese supplier: just end it!” Renaud asks when a buyer of goods from a Chinese manufacturer should end its relationship with its Chinese supplier. I often wonder the same thing.
Let me explain. 
I often get called by buyers of Chinese product who want me to write a killer manufacturing contract with their Chinese supplier right after their Chinese supplier has provided them with poor quality product and refused to give a refund for it or to provide new product at no cost. In these situations, I always tell the buyer that, at minimum, they should also be looking for another/backup supplier. Many times their response is that they do not have time. I then tell them that I have real doubts about their supplier and that even the best contract can only do so much in such a situation. See e.g., the Powerpoint of a recent speech I gave in which I set out the two key factors for avoiding a dispute with your Chinese partner: 1) a good partner, 2) a good contract.
I am always concerned about these situations because I have always felt (I am intentionally using the word “felt” here because I lack empirical evidence on this) that once a Chinese supplier provides bad product, things rarely, if ever, get better from there.
Now back to Renaud’s post.
Renaud seems to be thinking the same way:

Many importers have a bad relationship with their key Chinese supplier(s), but they don’t look for other companies. Sometimes it leads to unbelievable situations. For example, some buyers got screwed on 3 orders in a row by the same manufacturer!

On the face of it, it is surprising, especially given the thousands of Chinese exporters competing for buyers’ attention. When one supplier is not performing as expected, the importer should terminate the relationship, right?

Unfortunately, things are not that simple.

Reanaud then goes on to methodically set out why this is so often the case:

  1. It takes time to develop perfect samples, and some materials/processes have to be adapted to the factory’s capabilities.
  2. Buyer does not check quality until delivery in importing country (i.e. after full payment).
  3. Quality issues are discovered; buyer asks for a compensation.
  4. Supplier only promises a discount on the next order; buyer has no leverage to negotiate a better deal.
  5. Importer is upset, but places a second order to get the discount.
  6. Manufacturer finds a way to increase the price after the deposit of the second order is wired; importer has no choice but to accept.
  7. This time, buyer checks quality before shipment. Some issues are noticed. Supplier refuses to repair. Importer’s customers are asking for the goods. Shipment is authorized, and part of it is by air (at buyer’s costs).
  8. Buyer looks for another factory, finds a few candidates, is very wary this time.
  9. Production has to start again fast. New developments with a new factory would take 2 or 3 months. Importer gives a last chance to the same supplier.
  10. Third order is even worse than second order; buyer gets really upset and desperate; production is canceled and deposit is lost.

Renaud notes how the buyer did many things wrong in this situation, including having failed to qualify the supplier properly, failing to have followed quality closely, and failing to have secured a back-up manufacturer. It is a no-brainer for me to agree.

Renaud then asks when in a bad situation should a buyer of Chinese goods cut off its Chinese manufacturer for good:

But, after he was engaged in this situation, when should he have stopped the relationship? Just after the first order? Or maybe the second order should have been smaller? There is no right answer.

In any case, a back-up source should have been developed right after the first quality problems were found (and after difficult negotiations led nowhere).

Am I right?

Is Renaud right? I think he is and, in fact, it is easy for me as a lawyer (as opposed to someone who needs product right now) to say that the best time to walk away from your Chinese supplier is at the first hint of trouble. But at the same time, I also recognize that no Chinese supplier is perfect and that some of them must recover from their problems.

So here’s my question. What percent of the time does a Chinese supplier who has provided bad product and not owned up to it provide good product the next time? What has your experience been? Please speak up.

Just back from China (Hong Kong, actually), where I saw a television interview with Jack Ma of Alibaba. He never fails to impress the hell out of me and every time I see him my first thought is BUY.

But then I think about all the harm Alibaba has caused to so many Western SMEs and I change my mind about calling my broker/brother. Alibaba makes the naive think China sourcing is easy. I realize blaming Alibaba for the mistakes companies make in using its site is really not fair to Alibaba, but at the same time, I do not see much use for the site beyond its serving as a really good directory of potential manufacturers of particular products.

Turns out I have company.

Paul Midler (who is believed to have coined the term “quality fade” to describe how Chinese manufacturers eventually reduce their product quality), over at his new blog, The China Game [no longer exists], just came out with a post where he questions Alibaba’s value and posits that its usefulness has declined and will continue to do so. The post is entitled, “Irrationally Exuberant: Is Alibaba.com Really Worth US$7.8bn?” and Midler has this to say about Alibaba’s value to product buyers:

Alibaba.com is a website that provides information on China manufacturers (Yahoo! owns a 39% stake). The website serves as a kind of directory. Consider it a Yellow Page for prospective importers. Those who say that website is a great business model emphasize the company’s first-mover advantage. Many also get excited about this being a “B2B play” — the phrase is so “2000,” but never mind that part. My lack of enthusiasm for the IPO has more to do with many uninspired experiences with the company’s website. To be frank, I just don’t get it. Aren’t the best China supplier relationships those where the supplier and buyer are known to each other, where the two have an on-going work relationship? Established players have little use for the website after the relationship is in play, and it’s hard to imagine that, for example, Mattel, ever used Alibaba.com (its supplier relationships predate the Internet).

Midler goes on to say that though Alibaba has some value to fledgling Chinese factories looking for buyers, this is a consolidating market:

If the website has any value at all, it’s in enabling fledgling factories to find would-be buyers. If you believe there is value in such a proposition, let’s reference all of those financial analysts reports that suggest the industry is rapidly consolidating. It would be one thing if factories were like single people — dating websites enjoy a steady stream of new single customers — but manufacturing is not the same. In the long run (or sooner?), all capable manufacturers are known to the market. The website works best in a world with murky market data. We are heading away from that world, not towards it. There are already websites that allow companies to list information for free and Chinese are using these sites with greater frequency.

Despite all this, Midler has “no doubt” Alibaba’s upcoming “IPO will come out strong” because it involves both China and the internet. Throw in a few more Jack Ma TV interviews and it seems Alibaba’s stock will be unstoppable. In the short term anyway.