Forbes 2014 By Richard N. Frasch and Charlotte Zhanghaixia Westfall
China’s impact on American business has always been the source of strong emotions among Americans. Bret Harte (1836-1902), a famous American author and poet who wrote about early pioneering days in California, once stated, “We are ruined by Chinese cheap labor.” Nevertheless, today’s successful American entrepreneurs have learned not to compete with China but rather to make money working with it. Consequently, a more modern take on China may be seen in a recently popular song by Kelly Clarkson, “What Doesn’t Kill You Makes You Stronger.”
China today is full of incredible business opportunities for American entrepreneurs and business owners, but like any country in the West, it is not a perfect paradise. You must accept the risks of sourcing goods in China while embracing the opportunities that come with it. The good news is that you can manage and reduce these risks with a methodical approach to sourcing in China.
This article is second in a series exploring how U.S. companies can source goods in China, and it discusses eight common mistakes U.S. businesses often make, with a focus on small businesses. (The first article discussed eight basics you should know when sourcing in China. The final article in this series will discuss how larger companies can establish a physical presence when sourcing in China.)
Here are the eight common mistakes U.S. companies should avoid when sourcing in China:
- Lack of a Well-Defined Strategy
When sourcing goods in China, you must have a well-defined sourcing strategy or “road map,” including locating the best supplier for your particular needs. Too few small companies do the proper due diligence when shopping for goods in China. As a result, they may not get the best deal in terms of price, quality, functionality, or timely delivery.
To avoid this mistake, you must have a methodical sourcing strategy. Successful sourcing strategies typically include:
- Identifying suppliers through the Internet, social media, and trade shows
- Verifying and vetting suppliers
- Insuring payment and managing quality control
- Deciding which sourcing method (direct purchase, commission-based sourcing agent, using a sourcing provider or a trading company) best fits your needs
- No Well-Defined Standards for Suppliers
Before searching for suppliers, it is important to have defined standards. Well-defined standards can determine whether sourcing efforts are successful. For example, a company might initially purchase a small order of electronic parts from a Chinese supplier and be happy with the product quality only to learn that delivery on larger follow-up orders would be delayed due to the supplier’s limited production capacity. If the company needs the parts delivered on time to capitalize on the holiday season sales rush, it runs the risk of losing profits, all because it did not eliminate potential suppliers with limited production capacity.
Once supplier expectations are identified, only suppliers that can meet those standards need to be contacted, which can keep you focused, save a lot of headaches, and avoid disputes down the road.
The following is a checklist to consider when identifying supplier standards:
- Geographic location.China is a big country. Does it matter where the supplier is located in China? Does it have to be in or near a big city? Would it matter if it is located in a smaller city or even in a rural area?
- Production capacity.You need to figure out what your company’s needs are at present and in the near future. Then, you can choose the right size of a supplier. If the supplier is too small, it may not be able to ship your products on time. If the supplier is too big, there is a risk of not getting enough attention.
- Quality standards.What is the quality standard you expect from a supplier? What is your expectation of the quality control and verification process from a supplier?
- Price range. What is your price range for the products you are sourcing? Create a list of suppliers to compare, then cross out the ones whose prices are too high.
- Technology and communication capabilities.What is your tolerance level for a supplier’s lack of technology and communication capabilities? The reality is that many good Chinese suppliers may not be equipped with the most advanced technology to assist with logistics and communication. You have to run a risk-benefit analysis, balancing a supplier’s track record and reputation against its technology and communication capabilities.
- Inadequate Due Diligence Performed on Suppliers
Due diligence is perhaps the most important step when sourcing in China, yet many companies fail to perform adequate due diligence and end up being scammed. Some fail to perform due diligence at all!
The following is a list of resources to consider when performing due diligence on suppliers:
- Check online reviews. If you located a supplier on an Internet sourcing platform, you may be able to read reviews from past customers to see if there are any complaints.
- Review supplier websites and follow up by telephone. You should review the information on the supplier’s website, but do not forget to pick up the phone to call the number listed on the website and ask for additional information. Some suppliers do not have websites, but that is not necessarily a deal breaker. There can be many reasons that a supplier may not have what we think of as a necessary component of a business. So keep an open mind — but keep your eyes open, too.
- Verify its registration and certification.If you obtained a list of potential suppliers that were verified by a big B2B platform (like a gold member at Alibaba), you may not need to verify the actual existence of the suppliers. Otherwise, you need to do further due diligence on the supplier in addition to your online background check.
- Ask the supplier for a copy of its business license. A Chinese business license will show the company’s name, address, legal representative, registered capital, and other official company information. Suppliers that refuse or are unable to provide their business licenses are probably not worth your time. Dump them if they refuse. Note that a Chinese business license is only written in Chinese, so you may need a Chinese speaker to assist you.
- Verify the supplier’s local registration.Local level Chinese governments have an agency called the Administration for Industry and Commerce (AIC). The local AIC has official registration records of all companies in their local jurisdiction that can be accessed online. The official registration records include the company’s registration number, registered name, registered address, registered capital, business status, business scope, and other basic information on the company. Note that, most local AIC websites are in Chinese only, so you will need a Chinese speaker to assist you with this step as well. (For example, Shanxi 山西红盾信息网: http://www.sxaic.gov.cn.) Be aware that the information on the local AICs may not be always up-to-date.
- Visit a local AIC office. To get the most accurate and updated registered information on your suppliers, you could hire a Chinese lawyer to visit a local AIC office in person to review the hard copy of a company’s official registration records.
- Visit suppliers yourself.You could go the extra mile to visit a few selected suppliers yourself. While it may seem like a lot of work at the beginning, it could pay off handsomely in the long run. When you talk to your potential suppliers face to face, you can often get a better sense of who they are as a person as well as assess whether they would be a good fit, even if you need a third party to facilitate the communications. During the meeting, you can inspect their facilities, ask questions about their production capacity, product quality-inspection process, R&D capacity, and other important business aspects.
- Hire a sourcing service provider.Sourcing providers can assist in you in vetting suppliers, but you will need to perform some due diligence on this third party before you entrust them with the most important task of performing due diligence on potential suppliers. You need to know and verify key factors about the sourcing service provider, including its references, track record, reputation, expertise, and cost.
- Lack of Protection for Payment and Quality Issues
Sourcing in China is, after all, an international transaction. Before you make a payment, you need to think about how you are going to get your money back if there is any dispute over product quality or delivery. Otherwise, you are at the risk of losing your money.
The following is a list of practical actions you may consider to protect yourself from payment and quality concerns:
- Choose a safer payment method, like a bank line of credit and escrow service. Avoid risky payment methods like credit cards and wire transfers. When using an escrow service, be sure you understand how the escrow service you are considering works and what time limits and other conditions you must meet to get your money back in the event of a dispute.
- Set a clear definition of “quality” in your contract with the supplier. What is the exact standard of product quality? What are the exact delivery terms? This will set expectations for both parties, and may determine whether you can get your money back if a dispute arises.
- Consider placing a small initial order for samples, rather than making an initial large purchase. Once you are satisfied with the samples, you can then place a series of increasingly larger orders from the same supplier over a “probation period.” If the supplier develops a track of record of delivering quality goods on a timely basis, the trust between you and the supplier is established and you may proceed with larger purchase orders.
- Identify and use multiple sources of goods so that you always have an alternative in the event that a supplier seeks unjustified price increases or the quality deteriorates. It is like dating — keep your options open.
- No Written Contracts
To adequately protect your interest, you must have a detailed written contract. Any oral agreements or invoices may not adequately protect you, especially when different cultures and languages are involved. You should understand that the legal structure and enforcement options in China are different than in the U.S.
Well-written contracts typically include the following provisions:
- Parties involved
- Terms on samples, price, quality management, logistics
- Definition of product quality, quality satisfaction, timely delivery
- Payment terms
- Liability for breaching contract
- Choice of law
- Dispute resolution
- Arbitration clause
- Attorneys’ fees
- Written Contracts Not Reviewed by Attorneys
Some people download a copy of a form contract from the Internet or simply use a form they used in the past. Sure, most provisions are similar for a typical sales transaction, but the devil is in the details, so it is likely in your best interest to consult an attorney to help draft and perhaps negotiate the contract for you.
A good cross-border transaction attorney can draft a contract with more favorable provisions to buyers (namely, you) and better protect your interests. For example, your attorney may explain to you the pros and cons of contract provisions that dictate what law applies to contractual disputes between you and the supplier, or the method in which such disputes are to be resolved, like arbitration. Each of these decisions will have its own ramification if an actual dispute occurs, so there is real value in having the options explained to you clearly, not to mention the peace of mind that comes from having a well-written contract in place.
- Ignorance of the U.S. Foreign Corrupt Practices Act (FCPA)
It is also useful to consult an attorney about what laws will impact your business in China. Both Chinese and American laws need to be considered and depending on your business dealings, many legal issues can be involved, including labor law, trademark law, IP law, anti-monopoly law, and commercial law.
One law that U.S. companies often to fail to pay attention to is the U.S. Foreign Corrupt Practices Act (FCPA), which broadly prohibits payments to foreign government officials to assist in obtaining or retaining business and has no exception for local customs. You may have been told or read that gift giving is viewed in Chinese business culture as polite and friendly, a way to build a business relationship. An attorney can help you understand when giving a box of Godiva chocolate to your potential suppliers in China can land you in hot water. When in doubt, consult an attorney.
- No Mandarin Speaker on the Team
The importance of having a Mandarin Chinese speaker on your team is second only to due diligence on Chinese suppliers. In cross-border transactions, you cannot afford to settle for “maybe” or “probably” by saying that you and your supplier kind of understand each other’s expectations, which can lead to failure, to say the least. No guessing games, period!
If your supplier speaks fluent English and can understand your English well, you may get away without a Mandarin speaker’s help. Otherwise, you should consider engaging a Mandarin speaker, preferably a native speaker who also knows the business culture to help make sure your suppliers understand your expectations clearly and completely. At minimum, you need a fluent Mandarin speaker on your team, at least at the crucial stages of the transaction, like clearly setting product quality expectations. Finally, it is generally preferable to find your own Mandarin speaking team member, rather than relying on your supplier’s interpreters.
Of course, a native Mandarin speaker is indispensable for U.S. companies that wish to establish a physical presence in China when sourcing goods, which will be discussed in the next article.