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Oh, The Irony! Part 273

First, the irony of people who bought pirated software complaining about the fact that it still works but is not as pretty anymore just kills me.  If I buy DVD’s on the street, I don’t complain that they don’t work, I kiss my 5RMB goodbye and wait a couple of months till it comes out on iTunes.  But everyone online in China is mad at Microsoft for defending it self from the worst piracy on the planet!  YOU BOUGHT STOLEN PROPERTY!!!  Welcome to the world stage that you were so excited to be on back in August!  No one in China is mad that IP theft fuels the distrust of China by foreign companies, contributes to the lower-than-there-should-be levels of creativity and kills China’s own successfully branded companies.  Oh the irony!!

Second, Why China will not step in and save the world.  Um…maybe no one is asking them too.  I could be wrong, but while I’m seeing a lot of press on the idea that China could do something, I’ve not seen any governments say anything even remotely similar to “they should” do something.  China has enough of it’s own problems (and many more than are readily apparent) to deal with and probably would rather not get involved in the tangled webs that have pulled the rest of the world down.

I hope that I’m wrong, about China having too many of it’s own problems.  A strong China is better for the world economy, my personal economic well-being and global security and stability.

But remember, China is supposedly strong because of how insulated it is from the world, not how well connected it is.  Why, in the midst of crisis, would it want to burst that security bubble?!  Also remember, China wants a “peaceful rise” and does not want to be come a hegemonic power.  Now would be the time to move into the role as leading candidate for next hegemon.  But it’s not.  It’s constrained, in part by it’s own rhetoric, oddly enough, to try to fit in and not stand out too much.

Third, Retail sales are up in China, but the economy is bad!?!  Isn’t it?

Here’s some context.  Chinese people save 40%.  And….It’s not hard to figure out that after a disastrous 2007/early 2008 in the local stock markets that people are not buying stocks in China any more.  Nor is it surprising that with slumping housing markets that Chinese people are waiting, cash in hand, to buy a house until things hit bottom.  Furthermore, spending on luxury purchases is also down in China.  Combine all of these with the fact that for 8 months of 2008 the entire country was on a self-induced, nationalistic high and what do you get?  Consumer spending is up 4% year on year!!

So…let me get this right.  People had money, better attitudes, no bad news and nowhere to put it but in the shopping mall or the bank and they chose to spend a bit more?  No kidding?  Boy, aren’t those Chinese inscrutable?!  I’ll bet you’d find that bank savings rates were correspondingly higher too.  They’re still Chinese so the conservative sense that has helped them to avoid mortgages and save 40% of their incomes is still there.  But they also were openly celebratory for the first 8 months of this year—and celebrations cost money.

Now the Oct 29 China Economic Review blog says: “The disappointments continue as more Chinese companies’ third-quarter reports roll out.”  Who wants to bet that 4Q numbers for consumer spending this year track the poor 3Q corporate numbers?  Get back with me in February ’09 when the numbers come out.

And, in the US, the two worst airlines in the history of the world are merging.  Tell me how this is a good thing!

So, How Does the Carnage Look from Ground Level?

10/31 Halloween Update: A lot has been made of the seeming difference in my post here (it’s bad and getting worse) and another good post on Shenzhen Undercover (it’s been planned and happening for a while).  China Law Blog and 3PL Wire both picked on the “conflict.”  I’m personal not seeing any conflict.  In fact, my 6th point below points out that yes, this movement is both planned and has been happening from at least least year on.  I press that things were changing last year, have worsened this year; the timing of the international recession coincided with a year when change in Guandong and national level economic breaks weren’t supposed to hurt this much–so it’s unintentionally bad and the bleak numbers will continue.  Shenzhen Undercover, if I may summarize, details what Shenzhen is doing specifically to move up the product food chain–but doesn’t deny that there are economic issues with restructuring the economy.


10/28 AM UPDATE: Like I said, “Bad and getting worse.”  This morning Will Hutton (author of The Writing on the Wall) and even the China Daily agree.


I spoke with NPR again this week about the “feeling on the ground in southern China.”  And while I can’t speak for everyone, I know what I’m seeing across a large spectrum of industries and in a number of cities.

Basically, the euphoria is over.  Lack of any real press for the first 8 months of the year and no 3Q numbers until this last week meant that China thought it was immune from the global slow down.  Um, it’s time to wake up from the artificially induced “one world, one dream.”

What happened in the US with homes happened in southern China with export factories.  They mortgaged their future on the promise of continued growth and now it’s all gone and debts are higher than the value of inefficient factories and increasingly inexpensive labor.

With growth at 9% people are worried.  On the street that means a couple of things.  First spending will drop and conservative Chinese will save even more.  The domestic stock market scared millions of investors 9at least twice in the last decade now) and the US crash compounded that fear.  I don’t believe that the domestic economy is as impressive as the govt says.  It has never been the savior that MNC’s have dreamed and it’s not going to save the GDP this next year either.  People aren’t spending, they aren’t investing, the housing bubble is popping. The milk scandal has totally obscured any of the positives that the 0lympics created.  And it just keeps getting worse.

For more evidence look at housing prices in the east and now the 2nd and 3rd tier cities—they are all falling.  Look at investment rates in stocks (even in HK)—non existent. There is no domestic stock market to speak of anymore.  Our neighborhood shopping mall has 32 of it’s 110 store fronts EMPTY right now (33–new closure this AM!).  The mall two blocks away has more than 20+ of it’s 150 storefronts empty too.  And a third mall is being built next door?!!?

Second, the fact that the bottom dropped out of the 40% of the economy that was based on exports means that maybe up to 20% of the total economy is just gone now.  And it just will not be back next year either.  There is no way that the other 80% are going to remain untouched.  A few (or even a lot of) domestic infrastructure projects are not going to make up for that.

The buying slow down is going to kill the 4Q numbers too.  I have a friend in the technology business.  He told me of buyers that came over to finalize Christmas shipments of LCD TV’s for the US market.  They usually extract penalties and airfreight for the % of the Christmas orders that are late.  Not this year.  When the supplier said that 30% of the order would be late they told them to just keep it.  There is no market for it any more.

If I was a betting man, I’d put money on 4Q numbers being below 8.5% and next years numbers even lower.  (Honest numbers will be below 8.5% for sure but “official” numbers will not be that low because of the need to control a bit of the domestic collective psychology—like the US will never have another “great depression” because it sound’s so awful, 8.5% is the magic number that has to be hit just to keep the new entrants into the workforce employed in China.  A drop below 8.5% and people will start thinking ‘89 again.)

Third, like toys, many industries are now scared of being “Made in China” and will not come back (or will not come back as much as they were here before).   In the last year I’ve had three clients in the toy industry tell me that they’ll work with factories anywhere but China.  Even Chinese owned factories using Chinese materials in Cambodia, Lao, Indonesia or Burma are fine, said one guy.  Just so long that it doesn’t say “Made in China” on the tag.  This was happening before the slow down and so there were many factories that were compliments to the toy industry that were hurting and are now being pushed over the edge.

Most have seen the story of the Yantian port numbers and regardless of the cause, the export bonanza is officially over.

Fourth, this is exactly the “image” problem that people are writing about.

“China’s recurring scandals are clearly not stray incidents anymore, but systemic. This is in spite of China professing that it has adequate regulatory safeguards. The lack of transparency and suppression of information is increasingly becoming an issue. China needs to get its act together to improve safety norms, monitoring processes and surveillance. Prime Minister Wen Jiabao’s call to pay attention to “business ethics and social morality” is welcome. With China’s reputation as a reliable factory of the world at stake, and other competing countries offering quality and catching up with China, there is no guessing as to who the loser would be. This time around, an increasingly wary world is watching China carefully.”

Fifth, specific to GD province, the competition from 2-3rd tier cities hurts.  It started to show when 2 million migrant workers didn’t come back from Chinese New Year holiday this last year.  It’s continuing as people are realizing that being close to home may not only be as good as being on the east coast in terms of money per month, but also much safer as the economy slows down.  Sure the government wants to move another 100 million people to the cities in the next few years.  But “the cities” no longer mean Beijing, Tianjin, Shanghai, Shenzhen and Guangzhou.  “The cities” now means all the 2nd and 3rd tier cities more inland and closer to the rest of the teaming masses.

Sixth, combine that domestic competition with the fact that Guangdong province has decided to move up the economic food chain by raising labor rates and focusing grants and incentives on electronics and other higher end industries and you have a lot of factory closures here–“a lot,” by the way, means tens of thousands.

Finally, it’s going to get worse.  China hasn’t seen the worst of it and won’t until middle of next year at the soonest.  In the US, if the democrats get both the presidency and 60 seats in the Senate you will see both increased taxes in the US (e.g. less money in the economy to buy Chinese goods) and more protectionism for local industries (the left’s base has substantial union support).  I guess that we can hope that Obama will be as flaky as Clinton and campaign on one platform and then change immediately upon election and many protectionist policies will not be ultimately enacted.

Regardless of who wins, the US economy is not going to “recover” for at least 6 to 8 more quarters—and then who knows by how much or how quickly.  Most are saying ’09 is going to be worse and then we’ll see incremental growth starting summer ’10.  That means that if China’s domestic economy can’t pick up the slack (losing 20% of it’s economy) it’s going to a long couple of years for folks in the South.

The saving graces are the fact that China can still inject cash and still lower interest and tax rates to prop up the domestic economy.  Also the fall in the price of oil and other commodities will help to keep inflation down.  But if no one is buying anything out of fear of more turbulence these may not be enough to keep the Chinese economy above 8% next year.

More New Buyer Questions

More Questions from New Buyers at the Global Sources Hong Kong Show:

1.    Q: If I’m small can I do the QC myself?

A. Absolutely.  The reason that you are here in China, at a show is because you know your product better than anyone else (or you don’t have any one else to send).  The logic for QC is the same as for the trade show—who knows more than you?!  No one, so yes, you certainly can do it your self.

Now the caveat.  What do you really know about how to do QC, arrange logistics and negotiating with Chinese (factories)?  If the answers are nothing, less and “don’t they speak Cantonese in China?” then you’re in a bit of trouble.  BUT NOT ENOUGH TO DISCOUNT THIS OPTION ENTIRELY.  You need to be very careful about the way you handle this, but it is very doable.

First, you need to realize that you’ll need testing/QC or at least samples at the VERY LEAST three times in the production process.  First, you want to at least see if not test/QC the first production samples that come off the line—these are not the samples that you had built before production started.  I’m talking the honest first actual product off the line.  Problem is, if you don’t pull them yourself, how do you know they are production and not golden samples?  You don’t.  Pull them yourself or hire someone to pull them for you.  It’ll be worth the money to make sure that these are the real deal.  Trust me on this one.

Second, you need to do some sort of inline QC at about 20% to 25%.  This is to confirm that it’s all going well, that the samples, first samples and current production still match.  This is also the time to confirm what the packaging will be like.  At about 25% production you can start doing the set up and pre-packaging problems solving work on the fulfillment line.  This may take a week—confirming production, print checking the packaging, putting the first pieces into the packaging, teaching fulfillment QC what the packaging priorities are and completing some 100% correct standard samples.

Finally, you need to be there to check the finished product and confirm the truck loading before you pay for anything.  This last trip should not be confused with “I’m bring money to pay you” which is what the factory wants to have you come to do.  Your first priority is to check the quality of a large percentage of finished goods.  Up to this point you’ve honestly maybe seen 1% of your product finished.  So now it’s time to look at a random 10 to 20% (depending on how much time you have).  If you have done more in-line QC then you can check out less now.  If you’ve had more hands-on oversight during the packaging/fulfillment stages than you can do less now too.  But if you’ve only been in your supplier’s factory for a day or two at the 25% point, you need to be looking at a lot of product to make sure that you’re really getting what you expect.

A couple of warnings about doing your own QC.  You don’t need to let your factory know you’re coming.  If you have a production schedule from them and they know that you’re going to have QC drop in, that should be good enough.  Sometimes you want to be polite (the first visit) but you shouldn’t need permission or an appointment to see your own stuff.  Second, do not, under any circumstance, accept sub-standard product because you are being pressured or cajoled or even threatened.    Third, make copies of all your QC reports/list/documents (whatever you’re using) and get it signed and stamped by the factory manager—now he too knows that what is and is not up to standard to ship.  Confirm with whomever is in charge that your issues must be resolved before you’ll pay (and ideally before they do anymore work).  Finally take tons of photos and samples with you.  Write on them, mark them up, use them to talk with QC and line workers.  Sign good and bad pieces and make sure you and the supplier both have a copy of each.

2.    Q: Where should my QC office be?

A: As close to the site of production as possible.  If you are from the UK, as the guy who asked this question was for example, and you’re doing 80% of your manufacturing in China nowadays, why the hell would you still have your QC office and personnel based in the UK?!  Yup, at this point in your business life you’d better be moving your QC manager to China.  If you’ve still got a QC manager checking goods as they enter your UK warehouse, i.e, goods that have already been QC’s, packaged, paid for and shipped from China, then you are paying for nothing.  It’s too late to do any QC once pre-paid product hits your warehouse; especially if you’re the importer of record!

If you’re doing say, three production runs a year and each take 30 days, then maybe you only need to have your QC over here for 30 days a year.  Why 30 days and not 15 days?  Because 30 days divided by the costs of 3 trips is a much better deal than 12 days dived by the cost of 6 trips (two trips per order).  The point is, you get better product for less money if you have someone over here for longer times per trip.  The natural conclusion being that a full time body in the factory is both the cheapest and safest option.

Week Two HK GS Sourcing Show Questions, Oct 20

More questions from the New Buyers Seminar at the Global Sources Sourcing Show in Hong Kong.

1. Q: How do I get samples that are packaged correctly before the line work is done (or just by air at anytime)?

A: Specify your packaging needs.  Packaging for air and sea freight are most likely significantly different—at least they should be.  Shipping by air does not usually give you the packaging that you need to compensate for not having a container to protect things.  To compensate, you need to specify additional exterior packaging for all items going by air.  Remember, the rule for any product or packaging specifications: If you can’t or didn’t write it down, don’t expected it to show up correctly.

2. Q: How do I choose a 3PQ?

A: First, you first find someone that has an office in the same general area as your supplier or your costs will be more expensive.  This shouldn’t be a problem as must of the big (and many other mid-sized) 3PQ companies have offices all over Asia.  Second, you need to find a service provider that has experience in the general product area that you are working in.  They may not have experience with the specific product you are buying/manufacturing, but if they have experience in the general product area you can work with them.  Which brings us to step three, work with your 3PQ to create a QC program that is specific to your product, market and personal standards—remember you are paying them to represent you, so be specific with what you expect.  Fourth, confirm that your supplier has the licenses and certifications that they need to do business in China an in your product area.

3. Q: How can I afford to have a 3PQ come in and check the production 3-5 times (or more) if I’m a small business just starting out with production in China?

A: First, the real question should be this: How can you afford to have crappy product show up at your home country with full payment completed and no recourse for sending it back to or getting it replaced by your Chinese supplier?

Second, the rule we see is about $1000 direct investment into QC for every $10K of product you plan to ship.  This means that at about $300 per day (QC fee plus expenses) you get 3 QC days per $10K.  That would be about right—one to two days of in-line QC, one day of finished packaging QC and a day of loading/container confirmation.  For a larger qtty order, you need more days of in-line and final QC just to get the same level of assurance.

Third, I understand the intent of the question—“Wow!  QC be expensive, I wasn’t planning on spending that much.  I’m a small business and I was coming to China direct to save money, not spend more.  What can I do?!”  My experience in China tells me you have three options, you can pay for 3PQ to do it for you, like I just detailed, you can fly back and forth to China and do it your self or you can not do any QC and just roll the dice with quality.  There is really no other option.

Even if you are buying on a strict budget, spending the $600 to get at least two days (one in-line, one final) of QC should just be mandatory.  There is a reason why going direct is cheaper—you’re cutting out all the middle men.  And while some of them are just adding costs and not much service, some of the people you are eliminating are providing real services—QC and logistics, for example—that you now absolutely must pay for yourself.

If you are not going to do QC you might as well be going to Macao instead of buying product.  I’m sure your odds are at least as good.

China, the global financial mess and what it means for SME’s

So, what’s really up with China and the Global Economy?

Are they immune, hurting like everyone else, headed for collapse or what?  Options include:

1.    They are fine and will see few if any affects from the world’s economic slow down.

2.    They are not only fine but should help the rest of the world out.

3.    They may have some problems, but they’ll manage.

4.    They are going to be hurting just like the rest of us, just for different reasons.

5.    They are already hurting, we’re just not seeing it.

At least they aren’t at war with their neighbors, themselves and their own army.  So much for my dream of retiring in peaceful, quiet, Thailand.

So what’s the answer? What’s the situation in China?  I think that they will weather the storm but be hurt by the surrounding slowdown, no shocker there.  But, it’s also going to be worse than official figures will ever let on and it’s going to be difficult for SME’s throughout.

First, they have the capital to survive and the security in the banking markets that the US didn’t have to carry them through tough times.   The banks are relatively stronger than the US, but only because a highly capitalized and motivated govt will not allow them to fail. (For more on this read: The coming collapse of China.)

Second, they have the ability and willingness to sink billions into public works which not only employ people and infuse cash it builds the infrastructure for future growth (it also lines the pockets of government officials which also helps the high-end economy).

But there will be serious bumps.

There are 10’s of thousands of factories in the toy and furniture industries alone that have gone out of business in Southern China in the last year alone.  This has nothing to do with the economy, but rather higher taxes and the lead paint scandal respectively.  When you combine the closure of these thousands with the thousands more that are shuttering as the economy drops to a two-decade low of 8.5% growth and you have a serious situation on your hands.

The really interesting part is that we’ll never know exactly what the numbers in China mean because we’ll probably never know the exact numbers.  Why?  Because once the growth rather starts to reach the “politically sensitive” point, about 8.5%, the interests of the State will kick in to keep bad news out of general public consumption.

This is similar to the temperature in Chongqing.  When I was working at a university as a teacher in the summer of ’95 the temperature in Chongqing was sweltering.  The law was that if the gauge got over 40 degrees school and government offices closed down until it cooled down.  So we were stuck at an official 39.5 degrees for more than two weeks before, in an incredible atmospheric inversion in mid August, the official daily temp jumped to 44 degrees every day for the next week and a half and school mercifully closed.  Of course everyone’s personal thermometer had already been at 44 degrees for the last month.

Back to 2008 not much is different.  The fact that China took an 0lympic ego break from bad news for the first three quarters of this year does not mean that there weren’t problems; it’s just that no one was able to talk about them publicly.  Now, milk, Skype, mudslides, they are all coming roaring back into the public spotlight.  I dare you to run the same public confidence polls (Pew) that were run earlier this year again now.  Instead of 83% of Chinese being proud of their country, I’d be willing to bet you get half that number now.  If you think that this is the last problem we’ll hear about, that manufactures have learned their lessons, think again.  I’ve said before that with the economic squeeze on, there will be more, not less, likelihood of problems with inferior (cheaper) materials being used in production.

To understand the levels of, um…complexity involved in doing business in China, read this article about the lack of any legal action against Sanlun (the tainted milk supplier).

What do SME’s do?

The big guys are going to be more secure in their developed supply chains and supplier relationships. The domestic markets are also going to be getting some federal help.  So what about the impact on small to medium sized foreign buyers coming to China?  That’s where the pinch will be felt.  Smaller buyers are going to be fighting through the remnants of the closing down and the gone but still not closed and the suppliers that are still in business.  This group of active suppliers will continue to shrink.  The good news is that as large buyers buy less, there maybe room at larger suppliers for smaller orders.

You’re going to need to really do more due diligence in vetting suppliers than before.  Testing of samples and QC are also going to be even more important too.

Starting out in China for the first time, or even having been in China for years and starting a project with a new supplier, the reality is you can’t trust what’s in your product without doing independent testing.  This isn’t Sun Tze and it ain’t brain surgery either.  It’s just common sense.  If the people who are making your product are not invested in your relationship or the quality of the products then they will never be independently accountable for the results.

The current global crisis means that suppliers in China (and everywhere), no matter how insulated from the banking mess, are sill being negatively affected.  Orders from overseas are down and domestic demand, the mythical panacea for any of the ills of “capitalism” in “socialist” China, has yet to take up the slack.  What this means is that more than ever before your suppliers is being squeezed to get as much profit as possible from each piece that comes off the line.  As I’ve been warned by many many Chinese friends, there are not yet deeply ingrained ethical standards in China as you may be used to doing business elsewhere.  This means that when business is tight, and you’re not here watching the line, there is a great chance you will not be getting exactly what you are contracting for.

Even in, or maybe especially in, overly/closely regulated industries people that are willing to do the (western) “right” thing when push comes to shove with local officials are hard to find.  There is no recognized financial incentive to be transparent in China—so don’t expect it.  Ever.  The unfortunate reality of amoral capitalism is that profit is the ultimate end goal.  That can be good if there is a long-term mentality that weighs the costs and balances of the current order’s profit potential with the long term client relationship.  But in China, whose history is long but experience with capitalism is short, the attitude is often very short term.

To help create participation and responsibility in the processes work with your suppliers to build systems and infrastructure for the future that ensure people understand quality standards and are rewarded for achieving quality rather than achieving savings goals.

Random thoughts on recent related news articles that maybe of interest/help to you:

Continued news cover ups.  The question that I asked a few weeks ago, “is corruption endemic?” is only half of the question.  The full question should have been: “is corruption and the subsequent cover up endemic in China?”

More than the actual milk scandal, the cover up is what hurts China’s soft power and reputation.  This James Fallows article says the same thing.  Everyone has problems, but China kills itself because it just doesn’t manage the fall out from the problems well.

Call me crazy, but I always thought that to ruin one’s reputation you had to have a good reputation in the first place!!  When was China’s track record on product quality good?  Isn’t this the country that went from socialized mass production of crap to capitalized mass production of crap?  I, and thousands of others like me, indeed entire industries (3PQ), are in business because of how consistently bad quality control in China has been, is now and will continue to be.

My friend Mike was telling me about how factories get all their R&D for free from foreigners at shows and I commented that that’s the real economic miracle of China—FDI combined with free R&D would make anyone competitive!  So, where does the US still lead the world?  Even China knows that it’s in R&D.  Which makes Mike’s story about stealing at trade shows that much scarier.

Finally, be wary of anyone that claims that moving to Vietnam or Guiyang or Timbuktu will be better for your business simply because “labor is so cheap” or “there is so much potential” there.   Good article on Vietnam here.   If you can fit these production centers into your larger supply chain, that’s great.  We do, and there are real values out there if you already have a developed supply chain.  But don’t count on them replacing the Pearl or Yangzi river delta’s as your major supply centers just yet.