Paying China suppliers: Make it problem free

Over my eight years as a purchasing manager based in China, I have placed thousands of purchase orders (PO) and structured sourcing programs in over 150 different production classifications, ranging from rubber ducky bathtub toys to electronic devices used in nuclear power plants. Here are some of the China payment lessons I have learned along the way:

1. Aim for mutually beneficial payment terms
In most cases, especially if it is an initial PO, China suppliers will rarely offer "net terms", for example, "net 30" (the buyer pays 100 percent of PO value 30 days after receiving the goods).

Keep in mind that for the Chinese factory, net 30 terms really mean 120 days of project finance -- 30 days to buy the material, 30 days to process and produce, 30 days to ship (to North America or Europe) and 30 more days to wait for payment. It is certainly possible to achieve net terms for payment to China, but it will probably be easier for you to move to better terms with your supplier after both sides have established a working relationship and mutual trust. Be prepared not to have net terms during the initial phases of the relationship.

Don't be surprised if a supplier asks for 100 percent payment in advance. But also realize this is negotiable, just as you wouldn't necessarily accept the first offer of price without a negotiation. I have found that "30-40-30" terms are often an acceptable middle ground on payment terms, fair to both parties.

Under 30-40-30 terms, the initial 30 percent of the PO value is paid up front as a deposit. This allows the supplier to buy materials and lock in the price, which can be especially important if you have a long lead time or deal in materials that face great price fluctuations, such as metals. The second payment, the 40 percent, occurs at shipping upon confirmation of quality. The final 30 percent is paid upon receipt and inspection at the final destination. Let's look at this 30-40-30 from both the seller's and buyer's perspectives to find why it is an acceptable middle ground.

Sellers worry the buyer will default on payment, so getting 70 percent (30+40) before the goods leave port limits their exposure. Since the average factory in China makes between 10 and 30 percent mark-up, the 70 percent covers at least the majority of the supplier's internal costs, meaning even if the buyer defaults it won't leave the supplier out of pocket.

Buyers' biggest concern is that the goods will have quality issues or not arrive at all. By holding out on the final 30 percent until delivery, the buyer retains some leverage if quality problems require re-work or replacement parts. It is also important to remember that the 40 percent is not paid until after the goods are inspected in China, so quality confirmation must be a key part of the payment process, and that brings us to the next point.

2. Financial exposure is really quality exposure
Quality problems are the number one source of payment friction between buyers and sellers. New buyers to China may think they are protected by good payment terms, but if you want real protection, you need to make quality risk and financial risk one and the same.

Let's assume you are able to extract some great China payment terms, for example net 30. So you have plenty of time to inspect the product at your warehouse before making final payment. But what happens if you find a problem? Who pays for rework, costs to ship back defects, and/or delays to the customer? What many new buyers don't realize is that third-party quality assurance (QA) firms are readily available and inexpensive (a few hundred US dollars per shipment) in China. Utilizing third-party QA agents to inspect the goods before the buyer pays the 40 percent (under a 30-40-30 system) is an excellent way to mitigate your financial and quality risk.

3. Stay ahead of currency issues
You may have heard your supplier say, "Sorry, we can't accept US dollar payment, we must have renminbi (RMB)." This is especially true these days, as the RMB is no longer linked to the US dollar at a fixed rate. To accept US dollars, your supplier may ask you to send funds to a private account (often the general manager) or to a third-party trading company.

This raises two points:
a) Bring up currency early in the negotiation process rather than after the PO is placed.

b) Due to currency regulations and business licensing, it may be true that the factory can't accept US dollars. But if you must send money to a third party, only do so if you get the supplier's seal on an official document stating that payment to the third party equates to making payment directly to the supplier and the supplier bears the risk if things go wrong for the third party. Having said that, this should only be applied to small value orders. Anything over $10,000 should go to a formal business account.

4. Due diligence is your best bet against traditional financial risk
Buyers importing from overseas face various financial risks that are less daunting when sourcing closer to home. At the more extreme end of the spectrum, there is the fear that a faraway supplier will run away with the deposit or go out of business before the goods are shipped. In practice, this probably happens no more often than with domestic suppliers, but the distance makes buyers feel like they have less control to avoid it. In fact, there are several tools to manage the financial risks.

a) Ask for references. If a supplier can't point to multiple satisfied clients, a red flag should be raised.

b) Financial due diligence is affordable (a few hundred US dollars per audit) and readily available from providers like Verify and Glo-bis.com. Use it to learn the ownership and financial stability of your supplier.

c) Most importantly, visit the factory to ensure they are not a trading company. Trading companies can disappear into thin air more easily than a legitimate factory, which has physical assets, a real address and employees. (See related article "What most sourcing agents and brokers don't want you to know about middlemen" to learn how to determine if your supplier is a trading company.)

To summarize, making payment to China suppliers will always carry more complexity than purchasing domestically. However, by negotiating mutually beneficial payment terms and staying a little vigilant, buyers can keep their financial transactions smooth and safe.

Learn more about Mike and PassageMaker at www.PSSchina.com.

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Readers have left 3 comments.

 1. Untitled
Guest User, Unregistered

knowledge is power

 Posted 2008-02-05 15:07:16

 2. Re:
Guest User, Unregistered

knowledge is power

— Guest User

 Posted 2008-02-14 23:44:20

 3. currency problem
Guest User, Unregistered

Dear Sir,
I'm working at an italian trading company based in Hangzhou, China. I'd like to know how is possible to use Euro to pay our chinese suppliers, is the same as USD?
Thank you for your attention
Elisabetta

 Posted 2008-05-20 18:20:57

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