Are you performing The Ferrari Test?

Don’t let the fact that the companies in this article are all large lull you into to thinking you’re too small to get ripped or that you’re too important a client for your factory to pull these kinds of tricks on you:

Despite well-known risks in China, auditors there often are not inquisitive enough or alert to possible fraud, some experts say.

Auditors in China may pore tirelessly over documents and yet “fail to spot the red Ferrari parked on the doorstep and fail to ask who it belongs to, how it was paid for,” said Peter Humphrey, founder of ChinaWhys, a Shanghai-based anti-fraud consultancy that has investigated white-collar crime and fraud at scores of multinational firms in China.

China experts said it is difficult to do business there without encountering demands for gifts or kickbacks.

Transparency International, a corruption watchdog, surveyed business executives who said Chinese firms in 2011 were second only to Russian companies in being most likely to pay bribes abroad.

As always, the key to being successful in any work in China is the Due Diligence done BEFORE the project begins–and don’t fret if this DD takes longer than the production time of your project itself.  It’s time well spent.

If you’re spending more money than you can afford to lose (or can afford to pay double for the same qtty’s) then you need to go to China BEFORE you ever start any work or sign any agreements.  Visit factories/suppliers actual facilities, not just their trade-show booth.  Go to at least 2-3 different cities as well (and I don’t mean three neighboring cities like Dongguan, Songgang and Huizhou either).  Spread your visit out over multiple provinces and cities so that you can really get a feel for the level of development in the surrounding area (likely where all the sub-suppliers will be located).

A trip to multiple cities in China for 7-10 days can cost less than $5K.  Compare that with the cost of being 14-30 days late or the cost of shipping incorrect, poorly produced and/or unacceptable product back home.

There are things on the ground that you can never get from Skype, email, photos and even trade shows–you have to be there to know what it’s really like.  Spend the money now to be assured that you know what you’re dealing with or spend it later on repairs, rejects, late-delivery and other hassles.

Good luck!

How to get off the negotiations carousel.

Great post by Dan over at CLB again today.  Talking about the difficulty in getting your supplier/manufacturer to give you and then stick with a fixed price.  Basically, it’s not going to happen.  But there are things that can be done about it to save both your bottom line and your sanity.

Price changes happen all the time and it’s a source of never ending frustration to just about everyone working in China.  But there are other parts to the issue beyond just changes input costs.

One that Dan mentioned is the reality of changing nature of raw materials.  But other companies in other countries deal with this all the time.  Is China more volatile than anywhere else (Vietnam?  Indonesia?  India?)?  NO.  The real problem with changing prices is not that they change but that there is a serious lack of forecasting by any chinese supplier/manufacturer.  Basically, this practice just does not exist in the Middle Kingdom.

While changes in prices (due to a lack of forecasting) is partial understandable, what’s not acceptable is the fact that prices will NEVER go lower than the contracted price.  If the supplier gets a raw-materials windfall for some reason, there is no sharing of the profit.  Price changes ONLY go in one direction.  I think that this is explained/justified by the ideas that a) Chinese think of business as a relationship and not just a transaction.  The contracts are never the most important part of the negotiations so there is no reason to not go back and negotiate again. b) Unless you’re getting completely ripped off, profit margins are typically so thin in competitive industries that there isn’t any room for raw-mateiral price changes and there is no way that a Chinese factory owner will lose money just because his salesman signed a contract with you. c) They think you can afford it.

Another issue is that it’s not just materials costs, but labor, electricity, taxes, transportation, holidays, water, etc.  can be used to ask for a cost increase.  Any current item in the news can be (and will be) presented as a reason for rising costs that were not considered before.  The list of possible factors for price increases is practically endless, leaving the buyer constantly on the defensive and constantly on the look out for (conscious) product fade.  I know that there are legitimate fluctuations in China that can’t always be accounted for, but I also know that actively taking advantage of the fact that most foreign buyers are ignorant of the Chinese market is a conscious method to getting more money in many many deals.

The only way to beat this is to have a well designed and informed plan BEFORE you get started in CHina.  a) Have good contracts.  Sure they may not save you in the end, but if you’re bases are all covered before you start then you’ve got both ground to stand on and some amount of legal leverage if things go really bad.   b) Try to have more knowledge about your industry (in China) than your supplier; or at least be as well informed as he is.  This means that you have to do homework and you likely have to speak Chinese (or hire someone that you TRUST that can do it for you).  This may also mean that you’re slower to market than you previously expected.  But, in my experience, you can take time up front and learn the road ahead of time or you can use at least as much and likely much more time later down the road in unprofitable re-negotiations, rejects/replacements and missed dates later.   c) You must also have constant on the ground monitoring/testing to assure against quality fade.  If you don’t have a & b (maybe you’re already into production) this can often make up for your lack of preparation–it won’t solve any pricing or contractual problems but it can at least defend against poor quality due to a factory trying to save money when you won’t pay the additional requested costs.

Why do good companies stumble in China?

This is a response to a question by Dan Harris of China Law Blog Fame.

why do some companies seem to just coast into China while others stumble in and never recover?  What more should we be writing about to help those seeking to do business in China or to sell to China?

Dan, you’ve hit the nail on the head once again.  The non-business aspects of business are so much more often the sources of business failure than the numbers/dollars/dates.  I’m constantly amazed at how many foreign clients will say to me about their Chinese counter part, “Yea, they agree with how we do business, but our relationship is worth so much to them that we’re not worried about them doing X.”  And then it happens and they’re shocked that money wasn’t the most important (actually it likely was, they just figured out how to make it without the foreign company).

Like what you’ve read about in New Guinea, China to has different reactions to Westerization/modernization—not the least of which is the rise of (actually continuation of) Chinese Nationalism, that often manifest itself as spats of anti-foreigner racism.  These attitudes are very close to the surface for many Chinese and can be expressed in myriad ways that will affect business but never show up in any due diligence report.  Experiences that we’ve seen over the years include: Chinese not wanting to see foreign companies prosper (relative to Chinese), Chinese managers/owners not willing to work directly with foreigners, openly admitted anger that foreigners marry Chinese women, and a number of other personal issues.  While racism can be the worst case scenario, to say that it’s uncommon is a bit naive, I think.

Less personally offensive, but no-less destructive to business success would be business goals and objectives of local workers, political leaders and/or factory management that conflict with the business goals of the foreigner partner/buyer.  These are often never identified in any business meetings and are only understood after the fact as bits and pieces of previous experiences are revealed by individuals and the larger context is understood in greater detail.

For example, how both groups of workers and factories managers deal with holidays, over-time demands, rejected product, and criticism of work quality are examples of things that happen on almost every project that are almost always at odds with what foreign companies expect.  The ages, education and experience levels are radically different in various parts of China and so expectations for factories in Guangzhou cannot be transferred wholesale to Chongqing or Ningbo—yet many foreign companies are doing just that; “Going to China,” as if it’s just one big homogenous industrial zone.

There are too many example to cite but in the last ten years, my experience has been that “non-business” factors are much more likely to sink projects than are the numbers/dollars/dates (as those are usually contracted out clearly before hand).  As you continue to identify these cultural issues for your business professionals, you’ll save them time and money.  Keep up the good work!

Culture of Copy

The money quote from Bianca Bosker, the Author of Original Copies, in an interview with the WSJ China Real Times Reporter James T. Areddy:

“In the West there is a sense that copy is very taboo. It’s a terrible thing. It’s a sign of a lack of imagination.

“In China, copy doesn’t have the same stigma. You can have a copy and it can be a sign of technological achievement and cultural achievement and it’s not inferior.

“It’s not to say that originality is not prized; it’s to say you can copy something and that it can retain – more so than we think in the West – character and essence of the original. Likewise, to copy something can actually be to show mastery of something, both figuratively and literally. I talk about the imperial landscape where rulers would replicate the kingdoms of conquered people within their own domain to show their superiority.”

The author is specifically talking about architecture but the cultural mentality applies to manufacturing as well.

For years now, I’ve been trying to help smart people (with MBA’s and lots of experience) understand just why their NDA’s and other expertly written contracts continue to fail with China suppliers.  They look at the words on the paper and can’t understand what went wrong.  They always come back with “we followed the law” or “our relationship is so valuable they’d never do XXX,” or something of the sort.  To be honest, they are likely right on both accounts, they did it the “right” way and their relationship is very valuable.  But that’s not all that is going on.

As much as we’d like to think that everyone speaks the same language (money), there are often many other factors involved in decisions that contracts and straight-forward business deals don’t account for; not the least of which being cultural demands (that most westerners don’t even know they don’t know about) and even more money (from other deals that you’re specifically not being told about).

Probably the biggest barrier that I have in working with western companies is the belief that “culture doesn’t really matter that much” when compared to legal contracts, money, etc.  I partially agree.  You must have all your legal ducks in a row BEFORE you start working with a Chinese manufacturer (or any one, for that matter).  And you definitely need to run the numbers on both your investment and the investment (time/money/opportunity cost) of your supplier in China as well.  BUT when you’re doing all of this you must realize that even the very idea of “doing business” likely does not mean the same thing to you as it does to you Chinese counter part.  As I’ve said many times before, for most Chinese win/win is a panda bear, not a business philosophy.  Sure the business offices look the same, the books (the copies you see) look the same, the software is the same (although it’s a copy too), the suits are the same and you’re likely all speaking English too.   But the motivations, the responsibilities, the opportunities, the goals and the perceptions of who you are, what the deal means, who should get what, your ethnicity and country’s history with China, etc. are all definitely NOT the same.

The point being, just because you’re dealing with an MBA in a suit in English in an office in Shenzhen does not mean that you have anything in common whatsoever–especially your motivations and values.  To reduce your relationship down to signatures on a paper after chatting on line a few times and now meeting for the first time means that you’ll likely not get what you want this time around AND that you’ll be missing out on so many other opportunities to make money (and friends) in the future as well.

If knowing really is half the battle (thanks, Joe) then knowing who you’re working with (read: their cultural baggage) is or should be one of the most important parts of due diligence that you do when working overseas.

On a related note, here’s some background on what your Chinese counter-part is likely most worried about right now. H/T Dan Harris at China Law Blog.

What happens when the miracle is over?

Not sure yet, but it looks like it will be very very bad.  And it’s coming sooner than many want to believe.

From the article:

We now know that [rehypothecated assets] has been happening in China with the most critical component of its economic growth miracle: steel. We will soon discover that all other assets: stocks, bonds, commodities (including gold and silver) and finally cash (think deposits) have been comparably rehypothecated and criminally commingled. The end result will be the most epic bank run in world history, which incidentally is precisely what the central banks are attempting desperately to delay as much as possible by generating excess inflation to “inflate” away the debt, leading to rematching of finite assets and virtually infinite liabilities. Alas, in a world in which credit-money liabilities are in the quadrillions, and in which the real assets are in the tens of trillions, only hyperinflation can seal the deal.

Or, in other words, lose-lose.