Beyond the Hype - The Truth About Representing Products From China
by Michael Bloom
Chairman, Offshore Solutions, Inc.
There's been a lot of hype recently about representing products made by Chinese factories. The truth is that there are at least as many pitfalls as there are opportunities. Sales representatives know that adding Chinese resources to their palette of domestic offerings is essential. The hype makes it look easy . too easy.
A word about our perspective.. Offshore Solutions has worked in China for nearly 15 years to provide custom engineered products to U.S. industry. In the course of those years significant infrastructure has been built in China and every conceivable mistake has been made (and corrected) along the way. Offshore Solutions is currently developing a U.S. network of sales representatives, and, as MANA members, has insight into China sourcing from the perspective of both principal and sales representative. Offshore Solutions considers itself a "Full Service Provider" as well as a "Global Sourcing Partner". For the purpose of the discussion below when Offshore Solutions or other companies who offer similar services are referenced they are referred to as "FSPs".
The pitfalls will be explained issue-by-issue and recommendations will be made on how to overcome them and provide expanded services to your customers.
Customer Fears
Customers are inherently frightened by purchasing from China. They worry about extended lead times, difficulties in communications, quality problems, political risks, customs clearances, legal protections, intellectual property, and problems caused by cultural disconnects. Addressing these concerns requires a paradigm shift from "product provider" to "service provider". Unless you proactively address each of these concerns you are unlikely to secure an order in the first place. Even if you do receive an order, unless you have truly addressed them the likelihood is high that the project will fail at a crucial point. With this in mind, let us examine these concerns.
Reviewing a Request for Quotation
Some projects are well suited for manufacture in China and some are not. Some are better done with your domestic principals and some are not. Before you accept an RFQ be clear on whether you will take this to a domestic principal or to a foreign one. Since there is likely to be overlap (i.e. a domestic die caster and a Chinese die caster) speak to your domestic principal to make sure it understands that you will be taking some RFQs offshore. As a matter of ethics and contractual obligation, don't let it come as a surprise through some third party! Projects that should be taken to China should be: 1) mid- to high-volume; 2) within the technical capability of Chinese factories; 3) of sufficient value vs. density to make shipping economically feasible; and, 4) sufficiently mature with clearly defined specifications. Projects that should be kept with domestic principals are:1) low- to mid-volume; 2) projects with very advanced technology; and, 3) projects in development, prototype or early production stages.
Before RFQs are sent to China a thorough review is crucial. The drawings and specifications should be checked for completeness and clarity. Don't assume that the Chinese factories have access to referenced standards (i.e. ASTM, DIN, JIS). Purchase and send them the standards. Clearly specify the shipping terms. Will the goods be shipped FOB China port? Or CIF an American port? Or FOB the customer's factory? Is warehousing necessary? The decision as to shipping terms will affect quoted cost, who performs customs clearances, who pays the customs duty, and when invoicing can occur. If you source through a Full Service Provider (FSP), instead of working directly or through an agent, these concerns are readily addressed.
Choosing a Chinese Factory
Of all issues this is the one most likely to cause problem and failure. China is a huge country with factories clustered in many regions. Quality and capability vary widely and are widely misrepresented. No industry-wide guide, such as Thomas Register, exists for China. Unless you have someone on the ground in China, such as an employee, an agent, or an FSP, any choice will be somewhat random and haphazard. Every sales representative should strive to represent best-in-class factories in China. This is a daunting task for several reasons. Locating candidate factories is often a matter of networking and this requires local presence. Some regions of China are generally more suitable than others depending upon technology and product. For example, Guangdong is preferred for electronics and Shanghai/Jiangsu for metal fabrication.
FIG 1. An on-site audit provides the best proof of factory capability. (Armature winding in a motor factory)
There's a big cultural issue here. Most Chinese factories will greatly oversell its capabilities since Chinese culture frowns on admitting weakness or denying a request. Choosing the wrong factory is a fatal business mistake. At best you will waste time and need to select another factory. At worst your customer will lose confidence and cancel orders. The only reliable method of assuring capability and quality is to perform a thorough on-site factory audit.
Auditing A Factory
At the risk of redundancy, do not accept verbal or written assurances. Visit the factory or have your employee, agent, or FSP do so. The audit should take between half a day and an entire day. There are many audit methods and techniques but we prefer to do a QS9000-level audit even if the factory is not QS9000 certified. Plan on having the factory's management present, especially the Quality Assurance Manager and Factory Manager. Don't head straight for the factory floor; plan on meeting first to explain your auditing process and your expectations. Begin by asking for the following documents for parts similar to yours: Control Plan, Process Flow Diagram, Dimensional Report, Capability Study, Gage R&R, and Production FMEA. The availability of these reports will give you a fast read on the factory's quality level.
Now to the factory floor
We suggest you review every stage and in the following order: Incoming Raw Material Storage -> Tooling Workshop -> Production Process Workshops in the Order of the Control Plan -> Final Test and Assembly -> Laboratory. The complete details of what to inspect and how to analyze the results are beyond the scope of this discussion, but there are courses available from industry groups that can provide you with training in the auditing process.
FIG. 2A/B. An on-site audit begins with inspection of incoming raw material receiving and storage (Fig 2A) and ends with final packaging and storage (Fig 2B.) (Lens factory, with lens blanks imported from Germany)
FIG.3. Quality should be apparent at every stage of manufacturing (Shaft grinding in a motor shaft factory.)
FIG 4. Logical organization of the production line is an indicator of quality. (CNC machining factory)
FIG 5. An on-site audit reveals test methodologies, equipment and training. (Testing motor performance)
Multiple Bidding (or not)
Depending on the nature of your relationship and contractual agreements with a Chinese factory you will either grant the factory the exclusive right to quote a project or you will quote among more than one factory. Here's where the choice of sourcing method gets interesting. If you represent one Chinese factory for, say, ceramic magnets, are you truly serving your customer by quoting from only one factory? Are you providing the highest quality at the lowest price? If you represent an FSP instead of a particular Chinese factory once the FSP has identified best-in-class factories they will typically have several factories quote the project. Since the FSP has many projects in these factories and since the factories are forced to compete with each other the FSP can often provide more competitive pricing. Further, since it offers considerable business to a factory, even if your project is not a large one, the FSP has the fullest attention of the factory.
Waiting for First Samples
The purchase order has been received and tooling begins, leading to production. Beware! What happens next is what may be referred to as the "black hole". Information may be scarce during this time. Chinese culture expects the customer to "trust" the factory that progress is being made so information may not be forthcoming. An even greater danger is the reluctance to admit problems, so if the factory is heard to say "mai ven ti" ("no problem" in Mandarin) be especially concerned. Again, there is nothing like the assurance of having eyes on the ground and inside the factory. When problems arise this facilitates consultation between the factory and the customer. Perhaps the customer has seen this problem before.
First Samples Arrive
It's our experience that customers already nervous about doing business with China have a low tolerance for sample failures. This should be avoided at all costs. Good Chinese factories typically provide samples with various kinds of test reports. We strongly recommend that all such samples be tested by an independent domestic 3rd party laboratory. This is a value-added service to your customer that will pay dividends in avoiding embarrassing failures. Since the factory data should be tied to identifiable samples, using a 3rd party lab allows you to double check the factory's test results and to spot correlation problems. A sophisticated FSP usually handles the lab test and correlation issues. Be sure to add a week to ten days to your sample delivery schedule for lab testing.
Production Begins
Samples have been approved and your customer has authorized production. In the most critical case if you do not deliver product on time the customer's production line will shut down. The factory may be forced to air ship parts; potentially much more expensive than the value of the parts themselves. The factory may be liable for lines-down penalties. Unless this is provided for in advance this often leads to an adversarial situation between the factory, the sales representative, and the customer. Therefore, it is critically important to plan for realistic production scheduling. This may be further complicated if the customer requires warehousing or Kanban where the trans-oceanic pipeline must be kept filled and minimum and maximum inventory levels maintained. At Offshore Solutions we have developed custom software programs to optimize this process. In short, the consequences of production scheduling errors tend to be much for serious for foreign vendors compared to domestic ones.
FIG. 6. An on-site audit can also reveal serous problems. Here, a "shaft knurling workshop" consists of a single knurling machine covered by a tarpaulin stretched between two buildings!
When Things Go Wrong
Inevitably, there will be problems. Defective parts may ship, delays may occur, factories may even shut down in the middle of a project. To some extent on-the-ground due diligence may provide early warning but this only mitigates the problem: it doesn't solve it. It pays to have a mechanism in place for corrective actions. At minimum the factory should issue a Corrective Action Report displaying understanding of the causes of the problem, steps taken to quarantine defective parts, actions taken to prevent a recurrence, and a plan to deliver perfect replacement parts by the fastest means. Although the factory bears this responsibility you will certainly feel the heat. We recommend having an alternate factory pre-approved and ready to step in, in the event of failure of the primary factory. This tends to run counter to the direct-exclusive sales rep model so again there is an advantage to other, more flexible, sourcing models.
Customers worry, with cause, that if things go really wrong they may have little or no recourse from the factory. One worst case scenario is that payments have transferred to China, defective goods have been received, and the factory is unwilling or unable to refund the payment. Due to Chinese currency exchange laws it is generally difficult to export hard currency from China. The legal system is still in its infancy and is unevenly drafted and inconsistently applied. The use of Letters of Credit with requirements for 3rd party inspection can provide some protection but it's not uncommon for a 3rd party to authorize a shipment without noticing a major defect. As a sales representative you probably won't be financially responsible in such a situation but such an occurrence poisons customer and supplier relationships. The use of a 3rd party, such as an agent or an FSP, operating under U.S. law, having good financial liquidity, is the best solution. Such companies often have legal representation in China on a standby basis.
Another worst-case scenario is that the customer is sued for loss, injury or death resulting from product failure. Everyone connected to the product is often sued. Many customers are now requiring a certificate of product liability insurance, endorsed to that company, as a condition for doing business. This is not available from China and, post 9/11, is difficult and expensive to obtain in the U.S. although companies such as Offshore Solutions do carry such policies.
FIG. 7. Product liability insurance is a must for safety-related products. (Investment-cast truck hitch casting).
Intellectual Property Rights
As a condition for its ascension to the World Trade Organization, China agreed to increase enforcement of international agreements on the protection of intellectual property. Even to the casual observer visiting China, enforcement has tightened considerably. Still, designs may be copied and tooling paid for by one customer may find itself being used for another. Enforcement is impossible without vigilance and the best oversight is a surprise factory visit and is best accomplished by Chinese nationals working in your behalf.
Facilitating Communications
At the beginning of this discussion we noted that the "product provider" shifts to a "service provider" paradigm. The range of paradigm shift can be thought of as follows:
The Sales Rep as Broker
Factory <-> Sales Rep as Broker <-> Customer
In this model the sales representative services or generates sales leads, and literally buys and sells goods. He is more of a broker than a sales representative but this is a common model used by U.S. sales reps in their early attempts to sell Chinese products. From the standpoint of communications the factory and the customer never communicate directly. The sales rep takes the financial and credit risks but the profit margins are higher than other models. There is some danger of circumvention since there is economic advantage for the factory and customer to work together directly. Neither side may perceive much value-added from the sales rep once a project begins. Customer and factory begin to suspect that that the rep as broker is taking a large profit and the lack of direct communications causes further anxiety.
The Sales Rep as Transparent Facilitator
Factory <-> Rep as Transparent Facilitator< -> Customer
This is the model used by most U.S. domestic sales representatives for domestic principals . The sales rep has a portfolio of factories (principals), and services or generates sales leads. To a varying extent the sales rep stays in the loop as a facilitator between particular factories and the customer. He takes no financial risk and works for some agreed upon commission rate. There is still risk of circumvention, though less than for the sales rep as broker. Since circumvention is often a result of the stakeholder's diminished perception of the value-added by an intermediary, the more the sales rep can show value the less likely circumvention is to occur.
The Sales Rep as Global Partner
| Factory | | | |
| Factory | | | |
| Factory | | | |
| Factory | | | <->Full Service Provider<-> Rep as Global Partner<->Customer |
| Labs | | | | |
| Shipping | | | <----------------------------------------------------->| |
| Logistics | | | Direct communications channel |
| Banking | | |
This is the model introduced by Offshore Solutions and other Full Service Providers. By using the resources of the Full Service Provider the sales rep offers the customer turn-key solutions to the customer's global sourcing requirements. Imagine accompanying a purchasing manager along a production line indicating which components can best be sourced domestically and which are best out-sourcing to China. You can do this with the knowledge that you can most likely source any suitable part. This model allows you to tailor a solution that meets the customer's price, quality and delivery needs. It lets you offer logistic services including customs clearances, warehousing and JIT deliveries. It lets the customer pay on normal payment terms (i.e. Net 30) and move away from letters of credit. It reduces the quality risks and opportunity risks inherent in offshore sourcing. If this scenario begins to sound familiar it is! It is the same model that customers now enjoy from domestic sources but now the sources are an ocean away!
In this model the sales rep sees the Full Service Provider much as he sees a major domestic principal; except that this principal is the gateway to China. This effectively doubles the sales rep's palette (think "line card") since almost every domestic principal is likely to have a corresponding offshore principal. The circumvention risks are greatly minimized. Even though direct customer to factory communications channel is encouraged, the customer and factory both experience a high degree of value-added by the combination of FSP/Sales Rep. From the factory's perspective the combination offers powerful entrée into the US market. The customer sees something almost too good to believe: a source that looks like a domestic source but is able to deliver goods at lower costs, with delivery from a common warehouse across different families of parts, with a sales representative to facilitate the entire process. Rather than being isolated from Chinese factories he receives detailed factory audits, well-presented quality documentation, and a helping hand should he wish to visit the factory.
There is no doubt that China is the next frontier for U.S. sales representatives. By all means explore the sourcing opportunities available from China and then choose your working model. But be careful. forewarned is forearmed.
