Manufacturing in China

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?

I am going to be speaking at ASD’s massive consumer products show in Las Vegas on August 14 from 3pm to 4pm.  My speech is entitled, “What You Need to Know to Manufacture and Buy Products from China and Elsewhere in Asia” It will be at the Las Vegas Convention Center’s North Hall, Room #N246.

I mostly speak before lawyers so I am really looking forward to this opportunity to speak with the people who live and breathe China product buying/manufacturing every day. I plan both to allow questions at any time during my talk and to allow plenty of time for q & a after I finish.  If you go, please be sure to say “hello.”  For more information, go here.

I just finished reading (most of it anyway) Bruce W. Mitchell’s book/tome, 13 Steps to Manufacturing in China. Shoot me if I don’t use the word “comprehensive” or some equivalent at least five times in this post.

13 Steps to Manufacturing in China is a comprehensive, soup to nuts break down of what needs to be done to establish a manufacturing plant in China. It is a step-by-step reference book for establishing a factory in China. If you are considering building a plant, this book is an absolute must-read. But it goes far beyond that because all of the thirteen steps have at least some application for virtually any foreign (and probably domestic) business in China.

The thirteen steps are as follows:

  1. Establish Project Teams.
  2. Identify Potential Locations.
  3. Identify Industrial Park Incentives.
  4. Meet with Other Companies.
  5. Learn the Environmental Regulations.
  6. Select Desired Location.
  7. Establish Your Company.
  8. Import Used Manufacturing Equipment.
  9. Source Chinese Equipment.
  10. Select a Design Institute.
  11. Evaluate and Select a Construction Company.
  12. Construct the Manufacturing Plant.
  13. Hire Plant Staff.

And trust me when I tell you that this book comprehensively dissects each of these steps by providing thorough how-tos, forms, and check-lists every step of the way. Mitchell is an engineer and this book reads like it was written by an engineer. It is all business with no fluff.

If you want relatively light reading on China business, I suggest any of the following:

But if you are a serious manufacturer and you want a truly comprehensive, soup to notes, detailed, step by step guide to manufacturing in China because you are going to be manufacturing in China, you really should check out 13 Steps to Manufacturing in China.

I constantly hear that China manufacturing is cheap only for manufacturing in fairly large scale. Many (most?) Chinese factories are geared up for large orders and large production runs and they oftentimes reject smaller orders or price them prohibitively high. This “go big or go home” mentality/capability also holds true for companies that make a wide variety of the same product. For example, a company that makes ten different kinds of widgets might find itself paying a “small quantity price” for each of the ten, rather than being able to combine all ten to achieve a large quantity discount.

When clients bemoan this sort of pricing, I usually respond with something along the lines of “I feel your pain.”  After today, my response is going to change.

My response is going to change in light of a Financial Times Beyond Brics Blog post, entitled, “Vietnam: Agility Can Beat Scale,” touting Vietnam as a China alternative for small orders and for manufacturing that requires flexibility. The article talks of how Vietnam is capitalizing on its smaller size to win new manufacturing business  and it quotes the owner of a pottery business as saying “while China is good at producing the huge volumes that big retailers such as Ikea and Walmart require, Vietnam can be more flexible.” The article goes on to discuss how Western retailers are trying to “distinguish themselves by offering wider ranges,”  and of how Vietnam’s smaller scale better enables it to meet “this need for diversity.” The article concludes by noting the beginning of “a wider shift in global manufacturing from a focus on large scale, low-wage production to a more dynamic approach.”

What do you think? China for the big runs, Vietnam for the small?

In February, I wrote a post, “China Manufacturing: “We’re Bringing It Back Home,” talking of how my law firm had been seeing a massive uptick in companies shutting down their China operations and returning to the United States. A very recent (and very widely discussed) Economist article, entitled, “Moving back to America:The dwindling allure of building factories overseas,” talked of pretty much the same thing:

When clients are considering opening another manufacturing plant in China, I’ve started to urge them to consider alternative locations,” says Hal Sirkin of the Boston Consulting Group (BCG). “Have they thought about Vietnam, say? Or maybe [they could] even try Made in USA?” When clients are American firms looking to build factories to serve American customers, Mr. Sirkin is increasingly likely to suggest they stay at home, not for patriotic reasons but because the economics of globalization are changing fast.

Sirkin goes on to say that by “around 2015, manufacturers will be indifferent between locating in America or China for production for consumption in America.” 

In a recent post, entitled, “Don’t Leave China, Just Move!” Jack Perkowski of Managing the Dragon Blog cites to the Economist article, but calls on companies looking to leave China to simply move to a cheaper city inland. Perkowski argues that “there is still a strong case to be made for China,” including its huge population and economy. He then sets out the following “five reasons why companies should consider setting up operations in less travelled parts of the country”:

  1. Improved infrastructure. China’s road and train system has radically improved. 
  2. Lower costs. “Other than perhaps transportation to the country’s ports, costs are decidedly lower in second and third-tier cities in the interior. Labor, land, construction, management, supplier and overhead costs are all significantly lower than in the larger, more established cities in the coastal areas.” 
  3. Strong Local Government Support. “I’m a big proponent of the “big fish in a little pond” approach to site location. In China’s smaller cities, your factory may be one of the largest and best companies to work for in the area. As a result of its importance, it will receive strong support from the local government. The party secretary and city mayor will welcome your investment, large or small, and will bend over backward to help you develop your business. This can take the form of streamlined approvals, access to bank loans, less red tape and less hassle from local bureaucrats.”
  4. Lower Management Turnover. “If you offer attractive employment opportunities to the local residents, they will have little incentive to look elsewhere.”
  5. Enhanced Insight Into China’s Vast Local Market. “Locating at least some of your operations in less developed parts of the country will provide your company with valuable insights into China’s much larger local market.”

To which I say, “yes, but.”  

Before I counter the advantages Jack cites to locating in China’s interior, let me state the obvious. Jack Perkowski indisputably knows way more about manufacturing in China than this desk-bound lawyer.

Now for my counter, based not on any direct experience, but on what I hear from my law firm’s manufacturing clients:

  1. Improved Infrastructure. China is in the midst of what the State Grid Corporation of China is predicting will be its worst power shortage ever. I would bet that the old manufacturing standby locations will do far better in getting power than the inland upstarts, for reasons of both physical infrastructure and politics.   
  2. Lower Costs. I do not disagree with a single thing Jack says on this, but I have heard some of my clients bemoan lower worker productivity in China’s smaller cities. And though I cannot back this up with anything approaching scientific evidence, I get the feeling that the more remote one goes, the greater the risk of having insurmountable (and expensive) legal difficulties with Chinese partners, buyers, and vendors.  
  3. Strong Local Government Support. Yes, this can be great while you have it, but Beijing is increasingly cracking down on improper local concessions and, more importantly, local government support can quickly disappear. My firm gets a disproportionate amount of work involving ventures that have gone wrong in China’s more remote areas and I cannot remember a single case where I would say that the local government favored our foreign client over the Chinese local. In places like Guangzhou or Suzhou, the local government is more likely to remain neutral.  
  4. Lower Management Turnover.  I have no basis to dispute this, but I have also heard from many clients that one also has to deal with lower management quality.  
  5. Enhanced Insight Into China’s Vast Local Market. True enough, but for many manufacturers, small city sales might be years or even decades away.  

Perkowski ends his post with advise with the following advice on which I completely agree:
“In the end, you need to evaluate your company’s particular circumstances in making location decisions.” 

China manufacturing. Go inland or go home? And when? What do you think?

My law firm is always getting emails like the following (I got one this morning which spurred me to write this post):

I’m a __________ based business owner and widget designer. I’m developing my own line of widgets and I am now preparing to move forward by sending out my samples to factories in China. I am interested in knowing what my next steps should be from a legal perspective and how you can help me with those.

My response was and is usually along the following lines:

The first two things you will likely need are a Non Disclosure Agreement (NDA) and a registered trademark in China. We prefer to do what we call an NNN Agreement — non-disclosure, non-use and non-circumvention. This is an agreement that you use when you are trying to find manufacturers for a product. You have the manufacturer sign the agreement before you show them the product. It prevents manufacturers from stealing your design for themselves and from going around you to sell the product to your U.S. customers.

Here is some more information on NDAs/NNNs:

If you are not concerned about manufacturers in China copying your widget designs, you do not need an NDA/NNN Agreement.

The one thing you will almost certainly need to do (but maybe not right away) is to register your trademark in China. Before you use any of your trade names (think brands or product names) or trademarks in China (think logos), you absolutely must register them in China or someone else almost certainly will and then you will not be able to use your name in China, even if all you are doing is exporting your product from China. Here’s some info on that: China: Do Just One Thing. Trademarks.

Depending on your situation, you may also want/need a Product Development Agreement. If you are going to work extensively with a Chinese manufacturer to develop a new product, you need a specific product development agreement. These agreements cover the cost and procedure for development and ownership of the developed product. Many companies fail to enter into this kind of agreement and then discover the Chinese side owns “their” product and/or molds at the end of the process.

Once you have chosen the manufacturer for your widget, the next thing you will need is a Manufacturing Agreement (these are also called supplier agreements and OEM Agreements). Many U.S. companies do all their manufacturing in China based on purchase orders. This is very bad for the U.S. side. A good manufacturing agreement covers IP, quality control, NNN issues, warranty, ownership of molds, tooling, supplies, diversion, dispute resolution, and all the other various issues that arise in a manufacturing relationship.

Here is some more information on Manufacturing Agreements:

If you have any additional questions, please don’t hesitate to ask.

There are those who state confidently that China will own the worldwide car market within a few years (these people have been saying this for years — check out this post from three years ago where I rightly said NO WAY) and there are those who state it will never get there. My only qualifications are that I come from Michigan and I have represented a few auto and truck manufacturers and a whole slew of auto parts manufacturers, including many in or going into China. But like just about everyone else, I have a view, and mine is that China eventually will do well selling low end cars worldwide, but that it is not yet close to selling good cars in the United States. I spent seven hours in my car yesterday (driving back and forth to Wenatchee, WA) and there is no way I would have chosen a Chinese car for that trip. And it’s not just me.

I landed in Beijing last month with my wife and daughter. The first taxi in line was a very old VW. The VW driver started putting our luggage into his trunk when a Chinese woman came over and asked us in pretty good English whether we wouldn’t please take the taxi behind us (a much newer, but Chinese model) because she was going on a long trip with her family. My wife asked her why she wanted the one cab and not the other and the Chinese woman gave an embarrassed look, but said nothing. I explained to my wife that this woman did not want to go on a trip with her family in a Chinese car, but she was too embarrassed/nationalistic to say so. Since we were merely going to our hotel, it was no big deal and so we allowed the switch.

On that Beijing trip, I met with Bill Russo, a former Chrysler VP in China, now head of Synergistics Limited and, most importantly, a true expert on China’s auto market. One of the things Bill told me during our meeting was that the Chinese would rather buy non-Chinese cars but buy Chinese cars based on price. That has always been my sense, but since I mostly hang out with Chinese attorneys who drive Buicks and Toyotas (mostly), I am not going to claim to have a representative sample.

But the big question regarding Chinese cars is when they will make their mark outside China and Bill Russo just came out with an extremely thorough and thoughtful piece on his blog that says, “not yet.” The post is entitled, “The Path to Globalization of China’s Automotive Industry,” and it says that China auto must achieve various intermediary benchmarks before it is ready for the world stage. If you have an interest in China’s auto industry, this post is not to be missed.

A few weeks ago, I read a blog post from a Canada-US designer, Caroline Di Deigo, who traveled to China to, among other things, see the houses at The Commune at the Great Wall. She had been very excited to see these houses after having admired them in books, but upon seeing them up close, she was disappointed by their construction:

For several years I had been excited by images in architectural books of the houses at The Commune at the Great Wall, so this trip I made a detour from our group to see it for myself. The Commune at the Great Wall was developed by Zhang Xin between 1998 and 2002, when she commissioned 11 Asian designers each to design a house, situated in a rugged hilly location within view of the Great Wall. These houses, while privately owned, now function as a resort. In my opinion however, it is really a monument, or series of monuments, to design. At first glance it’s very impressive, with unique expressions of ‘house’, ‘home’, ‘dwelling’. On closer inspection though, I found them somewhat disappointing. Possibly due to their ultimate function, they lack much of a ‘residence’ feel, and seem a bit barren, very much like ‘public spaces’, vaguely ‘museum-like’. And to get really nit-picky, the quality of construction is unfortunately lacking, and from what one reads, certain of the designers were in fact quite disappointed with the implementation of their visions, as indeed I might have been.

Chinese cars are in many ways the same.

UPDATE: In his post, “Detroit, not Shanghai, is still the centre of the car universe,“Malcolm Moore, blogging for the Telegraph, agrees.

What do you think? Have Chinese cars arrived or are they three, five, seven, ten or more years away? When will a Chinese car brand have the reputation of Toyota, BMW or even Hyundai?

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Interesting post by Nina Ying Sun on the PN China blog on the inherent difficulties in monitoring your China factory. The post is entitled Hands-on due diligence in China, and it starts out with the following quotes from an interview with Alexandra Haney, author of the book, The China Price: The True Cost of Chinese Competitive Advantage:

  • “More than half of factories in southern China are falsifying payroll documents!”
  • “Many even create Potemkin factories…. Around the corner is a ‘shadow factory’ that produces the same goods under much less wholesome conditions.”
  • “There is even a cottage industry of ‘falsification engineers’ in China–consultants who specialize in doctoring payroll records and coaching workers to create a fiction of compliance with a Western buyer’s code of conduct.”

The post then cites some of Ms. Harney’s suggestions for dealing with your China factory:

  • Acknowledge that understanding what’s happening in the company’s supply chain is not simply a matter of risk management or good corporate citizenship; it is a core business issue and a valuable competitive advantage.
  • Build frank, long-term partnerships with Chinese factories, rather than moving orders quickly from one plant to another.
  • Take a field trip at least once or twice a year.

Ms. Sun finds this bit of Ms. Harney’s advice particularly interesting:

Schedule a visit to one of your suppliers, but arrive quietly the night before your appointment, perhaps with a Chinese colleague. Instead of having dinner at the hotel restaurant, eat near your factory and spend time with the locals. Ask them: What’s the average monthly wage in this area? Are wages going up or down? What time do most people get off work? What is considered the best factory to work for, and why? Have there been any problems in any of the factories recently, fights or disagreements?
Ask motorcycle drivers that work near your supplier about the hours your factory keeps its lights on, and whether they see a lot of traffic between your supplier and others in the neighborhood.

Ms. Sun very adeptly notes a flaw in relying on the motorcyclist:

When you meet the factory manager the next day, ask him the same questions and compare his answers to what you learned the night before.

Sounds like some good advice from a real China expert. However, don’t assume the locals and motorcycle drivers — if there are any — really know the answers to your questions, even if they provide you with information. Be aware that Chinese Culture 101 dictates that, out of politeness, Chinese people won’t tell you no. If the motorcycle driver isn’t sure about the hours of the factory, he will probably give you an answer anyway, just to complete the conversation nicely.

Anyone who has ever asked for directions in China will know whereof Ms Sun speaks. Ms. Sun’s good advice is that “like any due diligence work, talk to multiple sources with different backgrounds and interests.”

I read and enjoyed the China Price and I have been meaning to review it for some time now. The Parent Party Girl Professional and Philosopher Collide Blog (perhaps better known as the PPGPPC Blog?), does a great job summarizing the book in her post, Armchair China:

Alexandra Harney does a good job of documenting the price for Chinese ascendance. In The China Price she offers tons of documented facts, personal stories of Chinese workers and factory managers, and knowledgeable commentary about the cultural context. She manages not to weigh in emotionally, although she does assign responsibility.

Chinese workers, most very young or with impoverished families to support, are killed and maimed due to horrible working conditions. Cancer villages and widow towns dot the Chinese landscape. Chinese pollution shows up on the West coast of the US. Chinese factory managers, whose hours are just as inhumane and whose pay is often just as low-or their personal funds are drained in their hope of staying afloat-use a numbers game and falsified documents to try to appear to be adhering to fair labor standards, because to adhere to fair labor standards would drive the factory out of business, and many officials charged with making sure fair labor and safety standards are in place turn a blind eye. Wal Mart’s inevitable and witless commentary is present as well.

Many Chinese workers and their families have turned to studying the law and combining forces to sue for benefits after injuries. The seeds of something better appear to be planted and sprouting, slowly. But according to Harney, we all pay The China Price.

The China Price does a really good job explaining what goes on in China’s factories and, in particular, the whole system that has been built up in China for avoiding monitoring by Westerners. Ms. Harney’s thesis is that in many cases, Western companies producing goods in China know that the prices they are paying make fair employment and decent environmental standards impossible. I recommend the book to anyone interested in how China has managed to achieve the China price and what the societal and environmental costs of that price has been. I also recommend it to anyone thinking of doing any manufacturing in China (or even doing business in China at all), be it on your own or through outsourcing.