by Fredrik Grönkvist
Manufacturing is not a science. For importers, both big and small, it’s not a matter of if quality issues will occur – but when. So, what obligations do Chinese suppliers, both traders and manufacturers, actually have to compensate their buyers for such complications? The answer is simple: Essentially none. There’s no international treaty forcing the supplier to, by default, compensate defect items according to a pre-defined framework.
Yet, many Chinese manufacturers claim to offer a warranty, sometimes valid for years! In this article, we explain why a ‘warranty’ in outsourced manufacturing is not really what you think it is, and why you need to go to the bottom and dissect the actual terms, rather than making assumptions, that so often prove to be disastrous.
The term ‘warranty’ is very misplaced in a Business to Business context. A warranty, in the sense that most interpreters the term, is a mechanism to protect consumers. In company to company dealings on the other hand, it’s all up to the buying and selling party to negotiate terms on their own. This is in no way exclusive to China, but also valid in Europe, America and most other markets. That is not saying there are no regulations whatsoever, applying to business dealings.
When I go shopping for a new phone or computer, I know it comes with a warranty. If it breaks down within the set time frame, often one or two years, I can be sure to receive a refund, or a new computer – often the latter. Things are, however, not nearly as simple when importing from China – or anywhere else for that matter. I can assure you, that this supplier, assuming they even exists in 2020, will never provide their buyer with an unconditional refund or replacement product. It’s not even a remote possibility.
What I’m coming to is that a ‘Chinese manufacturer warranty’ is rarely a warranty in the sense that you and I know it. Instead, the term ‘warranty’ indicates that the supplier has some sort of program, or at least a set of terms that may be honored on a selective basis, specifying how they manage replacements, partial refunds, repairs or remaking – none of which is made based on their buyers good word. I think the phrase ‘compensation terms‘, or ‘defective product replacement policy‘, is much more suitable.
As said, a claimed ‘warranty’ is not much more than an indication that the supplier has some sort of compensation policy. That said, most suppliers will do anything in their capacity, and find any argument, no matter how absurd, to avoid compensating a buyer. It sort of makes sense. If Chinese suppliers were to include a set of extra services to their buyers, e.g. warranties, product development and shipping, they are for natural reasons forced to increase their prices. Chinese manufacturers operate on very slim profit margins.
Compensating a buyer for an entire order could wipe out their entire profit for months, or even a year. That said, negotiating clear, and fair, compensation terms is a critical part of any sales agreement. Keep reading, and I’ll explain how such a compensation can be made:
An order can either be refunded in full, or in part. The former is very rare, and certainly requires the supplier to have a very strong incentive to accept such a loss. The refund option also requires the supplier to have enough money, or other assets that can be quickly sold off. That is, however, not the case for most small to medium sized manufacturers.
Also, due to strict capital controls in China, there are limits on how much a company, and an individual, is allowed to transfer abroad. Thus, a refund may not only be hard to negotiate, but even harder to realize due to local regulations – or simply because the supplier is not liquid enough to make one.
It’s a lot easier to make a supplier agree to a remake, rather than a complete refund. However, there are a number of things to consider when drafting the ‘remaking terms’ on the Sales Agreement:
Warranty terms of many manufacturers is not much more than a written statement that they will ‘repair all defective items’. Now, that is a slight problem. They are in China, and you are likely very far from China. Thus, the first step is to get the items returned. As such, the following questions must be answered:
Some defects are just beyond the point of return. The same thing can also be said about items that are non-compliant with product standards and directives. You simply can’t repair a piece of clothing to magically become compliant with substance regulations, such as REACH (EU) or CA Prop 65 (US). That said, ‘the repair’ is often the compensation term of choice for many suppliers, as it leaves them in complete control over the process.
When buying machinery and vehicles, for example, from suppliers in the United States, Europe and Australia, you can be somewhat safe to assume that they have secured the replacement part supply chain. Machines, LED screens and many other products do need replacements on a regular basis.
Many suppliers, especially in the LED industry, provide extra parts together with each order – thereby enabling the buyer to replace malfunctioning parts, e.g. fans and power supplies, while the supplier ships additional replacements. When you draft the replacement part terms, you need to take all of the following into consideration:
Compensation terms, in a Sales Contract, is utterly useless if not complemented with a mechanism for filing a compensation claim to the supplier. What if the supplier tells you to document cosmetic defects on thousands of units? While Western societies are largely based on ‘trust until the opposite is proven’, In China, it’s rather the other way around. Chinese society is not built on trust between individuals (other than close friends and family), or businesses for that matter.
This is one, out of many reasons, Chinese suppliers are hesitant to compensate buyers. In fact, importers also try to scam suppliers, so it’s not really reasonable to expect them to accept a compensation claim without some sort of proof. This is why a highly specific compensation claim mechanism is needed. This mechanism, of course also part of the Sales Contract, shall answer the following questions:
As you probably noticed, the compensation claim mechanism is essentially about two things. First, ‘building a case’ that is sufficient for the supplier to base the compensation on, and secondly, to create a framework that avoids time consuming negotiations that lead to nowhere.
Then what if the supplier simply refuse to honor the compensation terms? It’s certainly not unheard of, and we receive such reports on a regular basis. Most Chinese manufacturers are, as said, operating on very slim profit margins. A supplier may not even have enough assets to compensate a buyer, regardless of their intentions. Suppliers also go bankrupt, while others simply could care less about their reputation. A supplier will only compensate their buyer when there is an incentive to do so – be it to maintain their reputation or keep a long term buyer.
There are no absolutes or certainties in international trade, especially not when involving developing countries. Instead, it’s all about risk management. Drafting clear compensation terms is critical, but don’t rely on your supplier to compensate you when things turn south. If anything, consider any compensation made by the supplier as a bonus.
Compensation, or ‘warranty’, terms is never a complement – or a replacement – for a properly executed supplier due diligence process, followed by a Quality Assurance procedure. In the end, everything that really matters is that the quality of the products, and that the items are compliant with all applicable regulations and labeling requirements, is what truly matters. The ship has, literary, sailed when the cargo is shipped. Consider any compensation made after this ‘point of no return’ as a bonus, rather than a factor to take into your business calculations. You have been warned.
Fredrik Grönkvist is the co-founder of ScandinAsian Enterprise in Shanghai. Since 2010, he and his team have helped hundreds of companies worldwide, primarily in the EU and US, to develop and manufacture products in China. He is also the main contributor on www.chinaimportal.com, a leading knowledge base for small- to medium-sized enterprises importing from Asia. For further questions, you can contact him on www.chinaimportal.com/contact-us/.