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How to achieve problem-free China outsourcing. Or not

by Dan Harris in 'China Law Blog'

We are always preaching that if you 1) choose a good manufacturer, 2) use a good OEM 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.

In 2009 and 2010 and the first half of 2011, I estimate that I would receive maybe two 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.

In the last three months or so, I have received probably 4-5 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 $30,000.  Can you help?

I also just received the following email:

On July 21st, you wrote an article entitled “Factory Closings in South China.  All Part of the Plan," in which rising costs for low value added factories was cited as part of the reason for factory closings.  Lately there has been another string of articles floating around several websites about Guangdong wages increasing another 20% this coming January.  While I do realize the government often puts out feelers to see how people will react, it does seem realistic and inevitable that wages will continue to rise.

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 increase 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 either taking the increase or shutting down.  Keep in mind 95% of the factories I’m working with are not huge Foxconn-like factories but private owned 100 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.  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. I don’t know that this plan is the most technical.

I would imagine many of your readers are facing similar situations.  It’s a scary time to be exporting from China.  I’m shifting my studies and free time to learning more about China consumerism these days because I believe that’s where the money is for the next decade and beyond.  I enjoyed your recommendation of Billions: Selling to the New Chinese.

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."

As for how to prevent yourself from getting caught holding a 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.
  2. Reduce the size of your orders to the extent that 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. I have heard from a couple of clients that Chinese companies typically come up for renewal of various licenses in December and January and that they often try to hold on up until the point they are supposed to pay these. That being the case, they stop shipping a few months beforehand and then they are gone. It does seem to me that in prior years (2008 being a prime example), the number of disappearing Chinese companies increased during the end of one year and the beginning of another.
  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 then ask to be able to switch to a 30-70 or 50-50 payment plan.

Any other ideas out there?

Dan Harris is founder of the Harris & Moure law firm, a boutique international law firm focusing on small and medium sized businesses that operate internationally. China is the fastest growing area for the firm. Dan writes as a source of China legal and business information.

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