“I found a supplier online. They look good. But how can I be sure the supplier is legit and will meet my needs?”
That is by far the most common type of question sent in to the CSIC from the buying community. In this article I will give our readers simple, effective and affordable strategies to answer that essential question.
In the China sourcing industry, when we talk about verifying the legitimacy of a factory we are generally looking at two aspects:
Quality Audit: Does the supplier have the ability to product the products I want to buy?
Due Diligence: Is the company a legitimate business with good reputation and not a scam or business on the verge of bankruptcy?
While Quality Audits and Due Diligence both fall under the category of supplier verification, they are two distinct professions which require radically different skill sets.
Quality Audits require auditors who are trained in ISO and familiar with the tricks of the trade on the production lines of Chinese factories. These auditors go out in the field to visit the factory.
Due Diligence on the other hand requires researchers who are skilled at desk research, data analysis and accounting tricks in China. They conduct interviews by telephone with the company and collect documents & data from the court systems, the real estate manager where the company is located, the media, business associates, banks and the local government office where the factory is based. The subject company is not even aware that they are being investigated, rather they believe they are participating in a general survey on companies in China.
In essence, field research and desk research are two complementary methods. When combined they give the buyer a comprehensive answer to the question “is this supplier legit?”
I sleep better at night when the feedback I get from my Due Diligence (desk research) matches what it coming back from the Quality Audit (field visit to factory). If there are discrepancies, I look a little harder until I am satisfied with the answers.
Quality Audit/ Factory Audit
This service is designed to ensure the supplier has the equipment and experience to make a given product. Audits can be conducted by the buyer, but usually 3rd party experts are hired to do the audit as it is a specialized skill.
There are various types of QC audits, but most buyers need not spend more than a 300 USD to have a proper assessment done on-site at the factory by a professional 3rd party.
Most simple factory audits (SFA) cover the following:
Quality System: on-site visit to confirm if there is a QC system in place. If yes, we’ll give you our general impression of the system
Factory Profile: official business name, ownership, organization chart, contact details, production line status, production capability and capacity
Employees and Workforce: overview of HR policies, management style and workers situation
Experience: trade history, client information, available samples
Verification of Documentation: review of licenses and certificates
Due Diligence (DD)
DD is an investigation of a business prior to signing a contract to ensure the supplier is who they say they are. There are various levels of due diligence a buyer can conduct. Here are four options:
It doesn’t cost any money for you to ask for references from the seller and contact those references. It’s a very bad sign if the seller can’t give you at least one happy customer to talk to!
www.SupplierBlacklist.com is also free and lists bad suppliers.
For a few 1000 USD, investigators can go undercover to investigate the seller’s business.
For under 500 USD, there are research firms who can access corporate filings, conduct interviews and check the factory for any red flags in China. The reports are in English and easy to follow. A due diligence report should cover the following:
Reputation: How do customers, employees and suppliers view the factory?
Financials: Are the in sound shape and not likely to close their doors in the middle of your order?
Legal: Do they have any court cases, past or present?
Confirmation of Factory Profile: Does the picture of their business given to you by their sales team and website match the information on record with the local government? This could include: scope of business (trading vs. manufacturing), ownership, size, history, export experience, registered capital and so on.
Due Diligence “Freshness”
Things change fast in China. If key managers leave or the product line is changed, good suppliers can go bad overnight.For example, I had a textile factory try to get into electronics with no prior experiences simply because they thought the margin would be better!
Speaking of margins, as a rule they are very tight in China. This means most businesses cannot withstand a downturn if it lasts more than a few months.
Several months after the global financial crash in 2008, some Chinese companies just sent their workers home and closed their gates, but were still accepting deposits on new POs with their clients.
Last year a chemical company in Shandong suffered such a debilitating explosion and it was forced to close down – but they were still communicating with clients as if they could complete the orders and happy to accept payment. So make sure your factory audits and due diligence is as fresh as possible.
The tools and techniques outlined above will significantly reduce the risks of entering into business with a bad supplier. However, audits and due diligence are just a few of the tools buyers should have in their sourcing toolbox. As buyers, we need to be vigilant and keep an eye on our suppliers at all phases of production, not just the initial supplier selection phase.
In my opinion, doing both the due diligence and QC audit is an essential step when sourcing from China. Perhaps I am jaded after living here in China for a long time, but I assume the worst unless proven otherwise. Trust BUT verify.
Resources and References
Readers may contact the author of this article (Mike Bellamy) via www.SourcingServiceCenter.com if you would like to be introduced to his endorsed service providers for Quality Audits and Due Diligence.
About the author
Mike Bellamy is an Advisory Board Member & Featured Blogger at the not-for-profit China Sourcing Information Center (www.ChinaSourcingInfo.org). He is also the author of, “The Essential Reference Guide to China Sourcing” (chinasourcinginfo.org/book) and founder of PassageMaker Sourcing Solutions (www.PSSchina.com).