Trend for 2020: Increased chance your “good supplier” will turn bad. Learn how to protect yourself!

China Business & Law Update for Busy Executives (Winter 2019/2020)

1. Trend for 2020:  Increased chance your “good supplier” will turn bad. Learn how to protect yourself!

Why now?

Background:

Beijing continues to aggressively pivot away from an economy based on manufacturing-for-export.

How will China’s move towards a consumer-oriented
economy impact its exports?

In simple terms, for consumerism to work in China, it needs a middle class with disposable income in their pockets.  Beijing feels the best way to get there is to continue to raise the minimum wage, year after year.  It’s working…consumption is on the rise and if the US-China trade war ever cools down, US exporters will benefit from a rising Chinese middle-class.

But if you are in the China sourcing game, the sad fact is that China is no longer a low cost manufacturing base for a growing list of production categories.  Faced with increasing costs of manufacturing, Chinese factories essentially have 4 options:

…..✓ Find ways be more efficient
…..✓ Pass the increased costs on down the supply chain
…..✓ Move out of China
…..✓ Close up shop

The Trump tariffs exacerbate the situation.  Increasing efficiency on the production line or passing costs to somebody else are easier said than done.  As a result, I am seeing a substantial increase in the number of long term suppliers who suddenly decide to move or close.

Ask yourself what would happen if your supplier decides to close up shop.

Do you think they would give you advanced notice so as not to impact your supply chain? Or would they keep it a secret and try to extract as much money out of your pocket as possible before they close the doors?

Sadly, after 20 years in China, it’s my opinion the vast majority of suppliers fall into the second group.  Worse is the fact that buyers are getting screwed in the process because they failed to put some simple/affordable protective measures in place.

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Case Study:

Let’s take a look at the case of a European buyer that recently contacted me for help.

They had been buying from a company called “Together Trading” in Qingdao China for many years without incident. They had a good contract in place that had penalties for quality defects and late shipment. They regularly visited the vendor.  They even had preferential payment terms.  On the surface, it felt like they were sourcing safe.

However, unbeknownst to the European company, their “good supplier” was preparing to close up shop on short notice. The buyer had two huge gaps in their contractual due diligence that the seller would use to exploit the situation resulting in great financial hardship to the buyer.

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BIG Mistake 1: Right Contract/ Wrong Signature

The contract in question had two chops representing the seller.  Unfortunately, neither was the right one!
…..✓ The red chop is shaped like a mainland Chinese chop, but as it has no Chinese language on the chop, it may not be legally binding in a PRC court of law.
…..✓ The blue chop is not the chop of the target company. It is the chop of a related Hong Kong company.
…..✓ The signature “William Gao” is not as legally binding as if his signature was in Chinese.

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BIG Mistake 2: Right Type of Account/ Wrong Location

The buyer was wise not to send money to a private account. They insisted on a corporate account.  But if you pay attention to the banking details above, you will see that the place where the money eventually ended up is with a different company at a Hong Kong address. Remember- HK is a separate legal entity- “One Country- Two Systems” as they like to say.  Neither the corporate name (Qingdao Together Trading Co.) nor the official address of the Qingdao company are found on this bank account.    “Qingdao Together Trading Company” not “Together Trading Company Ltd (HK)” is the actual supplier.

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Lessons Learned

Turned out to be another case of “good supplier gone bad” and I am already seeing a lot of them in early 2020!

The seller didn’t initially set out to scam the buyer when the buyer first started doing business with them years ago. But faced with a recent economic downturn, the seller made the decision to exploit the client’s naivety and extract as much money as they could before going into hiding.

In these cases, it is common for the seller to enticed the buyer with a fat discount in exchange for a “big, year-end order”. The seller gets paid, then they shipped a load of defective items.

Sadly, the European buyer’s lack of due diligence and poor contract terms made them a soft target when the supplier decided to “go bad”.  Luckily, the seller was not a professional scam artist and left a trail of evidence, but the loop holes explained above make it harder (but not impossible) for the lawyers to hold the Qingdao seller accountable.

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Related Content/ Resources

Want to make sure you are safe?

  • Option 1:  Do a self-assessment of your sourcing practices.Here is a complete tutorial on how to do it.   It’s a recording of 1 hour seminar I gave in Hong Kong to a paying audience on behalf of Global Sources. But I’m offering the tutorial at no charge to readers of this newsletter. I hope you find it useful.
  • Option 2:  Outsource the assessment using my Red Flag Assessment service.It usually only takes about 5 days and a few hundred dollars for my team to check for red flags using  proprietary, yet fully legal, methods & technologies developed during my 20 years in China. The subject company will not know the assessment is taking place. Visit here to download a sample Red Flag Assessment.


2. Best Practices from 2019:  10 Essential Elements for your China supplier contract

The two big mistakes mentioned in the article above could have been avoided if the buyer was aware of my check list for contracts.

Mike’s Top 10 lessons for Supplier Contracts – learned the hard way during 20 years in China:

  1. Use a Purchase Order! Get it chopped.
  2. State lead times & penalties
  3. Plan for IP protection
  4. Plan for non-conforming goods
  5. Know your risk as importer of record
  6. Clarify ownership of tooling
  7. Appropriate legal jurisdiction
  8. Bilingual contract
  9. Payment linked to performance
  10. Written QC Plan is integrated into contract
    (reference: “PQM” template at www.PSSchina.com)
  11. BONUS – “Same Name” on Contract, Bank Account & Factory Gate
If you would like full details on each of the 11 items, check out this video tutorial as the section on contracts starts at minute 31.

3. Best Practices from 2019:  Knowing the options: factory direct vs sourcing agent vs trading company

I am always happy to make introductions when readers contact me asking to be put in touch with a good sourcing agent.  I put the following template together to make sure they get pointed in the right direction based on their specific needs. Perhaps you may find it of interest as well.

3 Options: Pros/Cons/Costs

1.) A Sourcing Agent or Trading Company may be the best fit if you need help to find and manage suppliers in China. I have two teams I am comfortable recommending.

  • 1A: Local Trading Company:
    The first group is run by local Chinese. In exchange for a pre-agreed unit price (with their margin built in), a trading company coordinates a factory in their network, takes responsibility for the quality and uses their export license to coordinate shipping.

    Cons:
    ….✓ Lack of transparency. It’s hard to know the trading company’s exact mark up and the identity of the actual factory is often not disclosed.   It is very hard to protect intellectual property when there is a lack of transparency.
    Pros:
    ….✓ Simplicity. The trading company handles all aspects of the supply chain.
    ….✓ Pricing. A trading company can leverage multiple orders from multiple clients to get a better deal than if the buyer went factory direct on their own.I wouldn’t recommend a trading company for complex projects or custom designs, as in those cases the factory direct relationship is essential and the options below may be a better fit.  But you are buying a “standard widget” from China and put price above other attributes, then this mode of cooperation could be an excellent fit.
  • 1B: American Sourcing Agent in China
    If a Chinese trading company is not a good fit for you, then I’d be happy to introduce a sourcing agency in China run by Americans. While not as low cost as the trading companies they are still affordable, honest and provide a higher level of service/communication.  They charge a flat fee (I think it’s around 1000 USD for most projects) to find suppliers of the desired items. Then if you want their ongoing help, they charge a small commission (5 to 12% depending on the product) to manage the ongoing production, quality control and delivery.  The best part is the transparency.  No hidden mark ups by the agent.

    Pros:

    ….✓ Transparency. All supplier details such as location, name and factory-direct pricing is shared with the client.

    Cons:

    ….✓ Complexity. As the buyer is given transparency over the supply chain (and even pays the factory direct), the buyer needs to stay involved in the supply chain.  A good agent will steer the buyer in the right direction, but at the end of the day, the buyer is still making the big decisions as the agent is the buyer’s representative rather than the actual supplier/factory.

2.) Virtual Sourcing Office/ Virtual Factory

If you would like to have direct control over your supply chain, but not have the headache of setting up your own office in China, then please check out the company I founded almost 20 years ago- PassageMaker, at http://www.psschina.com/services-fees-contact-us/services-and-pricing/ .  PassageMaker can create the client’s virtual team in China by hiring and managing local staff who can be assigned a range of tasks related to finding suppliers, developing products and managing global supply chains.  We also can set up a team in our warehouse to offer  assembly, inspection & packaging.

PassageMaker vs Sourcing Agency/Trading Company:
If your project is stable, your order size is over 100,000 USD per year or you need at least 1 full time person in China, then PassageMaker is good fit and would end up saving money for you in the long run.  PassageMaker sets up teams as small as 1 or as large as a few 100!  Please watch the video here and fill out the short questionnaire on the same page to have PassageMaker work up a quote for you.

One-Off:
If your project is one-off or small in scope, then it would probably not make economic sense to set up a virtual office/ virtual factory in China.

3.) More Options

If you are unsure which option is best or you find yourself on a very tight budget and unable to hire any of the service providers above, please keep the following resources in mind:

✓ Hire a consultant to help you figure out the best strategy for your particular project.If you have some general questions, feel free to send me an email and I’ll do my best to get them answered (no charges needed).  If you are looking for more formal support to answer questions specific to your situation,  please keep our Business Advisory Service (BAS) in mind.  The BAS is explained in detail at http://www.asiabridgelaw.com/business-advisory-services/ , the rate sheet can be downloaded. I’m one of the advisors and would be happy to help you.✓ Take an online course offered by ChinaSourcingAcademy.com .   I joined Prof. Neale O’Connor in launching the Academy a few years ago.  I’m proud to say we have helped hundreds of buyers learn best practices and avoid common pitfalls in China.

✓ My book (“The Essential Reference Guide to China Sourcing”) is available on Amazon, but if you purchase it via the author’s website, you will be able to access various business templates and check lists as well.

Sorry for the long email, but I wanted to give you all the options.  Contact me if you have additional questions, I’m happy to help out!

4. China Scams & Bad Suppliers Exposed

I’m an avid reader of www.SupplierBlacklist.com  because it helps me stay away from the bad suppliers and the tricky scams.  Here are two examples posted recently:

The classic “bait and switch” scam is alive and well in China.  It is particularly dangerous to buy equipment (new and especially used!) from China.  Here are no less than 3 different buyers who got burned in the last few days:

  1. In this case, a buyer from the Middle East thought he found a great deal on a made-in-China food truck.  He was out 3000 bucks when a broken piece of used machinery showed up.  Anybody want to guess why the seller bothered to send anything?  I’m betting the buyer thought he was being safe by giving a deposit up front then paying the remainder upon provision of shipping documents.  That only offers protection if you also conduct inspection before the payment is made, before the goods are loaded!
  2. This American buyer thought he was getting one of those human powered mobile bars where people can drink beer and peddle the bar up and down the street.  It showed up 147 days late and promptly fell apart during the first use.
  3. This NZ importer purchased horse trailers from China. According to the listing, the items looked OK at first, but after a while the floors rotted out. This case serves to remind us that it’s not enough to have an in-bound inspection.  Importers also need to make sure they have warranty issues covered in their contracts with suppliers.

Related Content:

Tips for getting money back from bad suppliers

How to avoid bad suppliers in the first place