Options for Establishing a Supply Chain with Chinese Manufacturers

For years now, there has been three words that practically every person across the globe sees on a daily basis: ‘Made in China’.

This is an indication of how the world has become smaller, and trading is now done on a global scale. Today, many organisations are faced with having to bring a China element into their supply chain. If they don’t explore this option then they tend to experience erosion in their sales due to current – or new – competitors bringing lower cost imports into their home markets.

As organisations explore how to bring China into their supply chain, they need to explore the options that are available to them in terms of sourcing partners and decide which approach best fits their needs. There are many options out there – however, this article will focus on the four most popular options currently being used.

Employing a Sourcing or Purchasing Agent in China

A sourcing agent’s role is to source factories for their clients. For small and medium-sized enterprises (SMEs) this is the most common option open to them. The trading agent is typically found via product sourcing search engines, such as Alibaba or Made in China. Surprisingly, a high percentage of organisations think that they are dealing directly with the manufacturer, whereas in most cases they are not.

A sourcing agent will usually charge a percentage on each transaction and are a low-cost option for organisations that are new to sourcing in China. The sourcing agent will have many manufacturers on their books and will give an organisation a quick result. Its staff will also have a good command of English and be able to act as a go-between the organisation and the manufacturer.

There are many risks associated when using a sourcing agent. Every organisation should ask themselves the following questions:

Conflict of interest?

The sourcing agent charges a percentage of the transaction total. It is important to find out if you are the only party paying them. When investigated, most sourcing agents tend to direct their clients to manufacturers who also offer them a percentage of the sale as a sales commission.

What is the role of the sourcing agent?

Sourcing agents will try to match an organisation with a manufacturer who claims that it can make the desired products. And they will promise the universe to get their client to purchase from their manufacturer. A common saying is “don’t worry”. It has been proven many times that, in fact, clients should worry.

What roles won’t a sourcing agent perform?

Sourcing agents make their commission solely by introducing parties and tend not to work on the important areas of building and maintaining the supply chain, nor do they dedicate time to introducing procedures to reduce the risks of product failure on behalf of their client.

Who is accountable when things go wrong?

The simple answer tends to be the unfortunate organisation that purchased the goods. When an issue arises, these organisations tend to find that their sourcing agent contact is off sick, has gone away or even died.

Sourcing agents will always play a role in sourcing from China. With that in mind, below are some ways that can reduce the risks associated with sourcing agents:

• Buy small: when starting off always buy small. Sourcing agents and manufacturers will hate this, but always remember that it is better to have 20 faulty products from China than 2000. In the majority of cases, even though they always will say you need a container full, you should push and push again for the smallest amount of goods. Calling it a trial in order to ‘build a good business relationship’ is a useful term to use.
• Get the factory independently assessed: many organisations tend to omit conducting due diligence when dealing with manufacturers in China. Having an independent organisation visit the factory and confirm its details and ability to manufacture the products will ensure that both the sourcing agent and the manufacturer know that you are also checking them out before you proceed with any transaction.
• Insist on a purchase contract with the manufacturer: always make sure that the manufacturer agrees to your terms and product requests before handing over any money. This will ensure that the manufacturer knows that you mean business and is fully aware the implications if it fails to meet your terms.
• Only pay a deposit before production: at all costs avoid paying all the funds up front. This will focus the manufacturer on producing a quality product for your organisation, as it will only make its margins when you have fully paid for the goods.
• Ensure the products are inspected in China: it is better to have the headache of wrong products at the factory’s doorstep rather than your own. Using independent inspectors will ensure that the goods have been reviewed before you take ownership.

Trading Companies

China was introduced as a trading partner for the west with Marco Polo’s famous trading visit around 1271 AD. Similarly, today trading companies foster the link between products manufactured in the east with western buyers.

Trading companies focus on selling products directly to buyers. They very rarely produce the products themselves and can source the same product from different manufacturers. This is a very common option that fits the supply chains of SMEs that primarily have a trading background.

The trading companies will have a certain range of products that they trade internationally. They are easily found on product sourcing websites. Their ability to speak English helps to encourage organisations to choose this as an option. This approach is easily understood by western organisations as they can easily work out cost plus transport to determine their actual landed costs.

While trading companies are popular, organisations should be careful when dealing with them. They should ask themselves the following questions:

• Are the products that the trading company is offering suitable for my home market?
• Will an organisation’s home customer base accept products that are currently being sold in another country? A typical example is Coca Cola, which designs its drink to suit the local markets. This means that the Coke produced for the UK market will taste different than the Coke produced for the Philippines market.
• Will the products meet local health and safety standards? This may not be widely known, but with the World Trade Organisation (WTO) Free Trade Agreements to reduce punitive taxes and promote free trade, clever trading blocs have decided to bend the rules by imposing safety standards on certain products. These safety standards can be easily upgraded, which makes it easier for local manufacturers to adapt to the new rules but harder for foreign manufacturers to change.
• Who is the manufacturer making my product? Often the buyer does not receive an answer to this, as the trading company will want to protect its assets. However, it is important to visit the factory that is going to become part of your supply chain.
• Who is to blame if things go wrong? The simple rule of thumb here is ‘buyer beware’. Trading companies will continue to sell by promising to fix any problems on the next order. What happens if there is no next order? The answer here more often than not will be that nothing will be done.

Organisations wishing to reduce the risks from purchasing from Chinese trading companies should use the same steps as used with sourcing or purchasing agents.

Establish and/or Manage Own Production Centre

This is an option that is favoured by medium-sized to large organisations. There are three main approaches: apply for a wholly owned enterprise licence (WOFE), work on a joint venture with a Chinese partner, or establish a representative office. All options will allow an organisation to have a direct involvement with a manufacturing factory in China that solely produces for their organisation. For example, Apple and Foxconn have production centres in China.

This is approach will initially have a high cost of investment, both in terms of capital and resources. But it will provide these organisations with the ability to modify their current supply chain and cost base, and bring in savings that will improve their bottom line figures.

Organisations that follow this strategy will keep complete control of the production process and ensure that they can implement practices and procedures to maintain quality and reduce failure costs.

There are risks and costs associated when deciding to relocate production. Every organisation should consider the following areas:

Know what licences are required

China is one of the most regulated states in the world. A licence is required for every conceivable thing, therefore foreign organisations must ensure that they have the correct licences. There are many organisations over the years that have invested a lot of time and capital into structuring their China business, only to be told by a government official that they have to begin anew as they did not have the correct licence.

Have a good Guanxi established

As the old cliché goes ‘it’s who you know, not what you know’. This is could have been written for China. Chinese culture through Confucianism is built around the collective. This means that no one works to benefit themselves, rather they work to benefit the group. In business this point is illustrated by the networks that people operate in and how they assist each other.

What are the real cost savings from China for my organisation?

In one word: labour. If organisations are looking to primarily move to China for any other reason that saving labour costs, they should review their figures again.

Organisations should always consider China as a country to establish a production centre, but to reduce risks they might face they should look into the following areas:

• Bring in expertise to assist in the project: these experts have deep insights into China both culturally and commercially. They will ask the right questions and work with a team to provide solutions to ensure that the production facility in China is a success.
• Get to know the local officials: in China knowing the local government officials will allow your organisation to develop and grow under the watch of the government. Good officials are always eager to see success for organisations under their watch. This will help them build up their reputation and gain promotions.
• Choose the right location: China is over 1.5 times the size of Europe. Western people only associate China with the well-known locations such as Shanghai, Guangzhou and Beijing. The values to be achieved from these places are long since gone. The real value is elsewhere in China and the Chinese government is actively promoting other locations.

Outsource the Purchasing/Production Departments

This is an option that is gaining much popularity as it provides organisations with the advantage of low-cost set ups and also the benefits of controlling the supply chain. These are licenced organisations that work on the client’s behalf to establish and build relationships with manufacturers, and draw on their expertise to implement the correct controls and procedures to reduce the costs to their client.

These organisations work directly for their clients, and in order to ensure that no conflict of interests arises they refuse to work on commission. They usually charge a flat fee per month, which tends to be the equivalent cost of a western employee.

A good outsourced department should always be focussed on getting to know their clients’ products and working on areas for reducing risks. Areas where they would assist their client include:

• A comprehensive and targeted China strategy: the outsourced department would be able to sit down and work with its client on requirements, resources and timings.
• Product profiling: they will draw up detailed profiles for each of the products that the client wishes to get produced in China. This will in turn allow both parties to draw up the criteria required of a manufacturer.
• Manufacturer search and consultation on factory selection: the outsourced department will be able to search China to identify and contact factories that meet the criteria of its client.
• Build up their client’s Guanxi: the outsourced department must continue building a network of relationships on its client’s behalf. As these organisations tend to be international managed organisations with Chinese staff, they will be able to bring their clients into networks that have already been established for other international clients.
• Trained price negotiators: as the outsourced department is working on a flat fee with no sales commission to worry about, it tends focus more on the prices and order quantities that would not have been available with the commission-based agent option.
• Supply chain establishment: an outsourced department will work with its client to establish a supply chain that will meet the demands of its client’s organisation. The outsourced department will then manage the supply chain on its client’s behalf.
• Risk reduction practices: these organisations will have purchase contracts and non-disclosure agreement templates that they tailor to meet their client’s needs and demands.
• Inspections: these organisations will visit the manufacturers and inspect the products to ensure that their client does not receive failed products or experience production time delays.

There are costs and resource requirements when an organisation decides to use this strategy. Every organisation should ask themselves the following questions:

Can I allocate a resource to liaise between my organisation and the outsourced department?

These organisations will always depend on their client responding and advising them of any requirements or decisions.

Have I got the full information regarding products that the outsourcing department will be working on my behalf?

Remember the outsourcing department is not only there to find and work with the manufacturer but also to implement practices and procedures that reduce the costs of product failure to your organisation. They know how to provide business solutions in China, but they will not know what your customer wants from your product.

What are the implications of dealing directly with the manufacturer?

The outsourcing department should be thought of as an extra employee in your organisation. This means that all the contracts and agreements are between your organisation and the manufacturer. The risk will rest between both parties involved in the contract, not the outsourcing department.

Conclusion

China is now so open that any company of any size can bring China into its supply chain. However, they must always go in with their eyes open and not only look for the correct manufacturer but also look at where the risks of product failure can occur and work to reduce these risks