In 2012, I wrote China’s Slowdown and American Business for the Wall Street Journal. There was a slowdown happening in China at the time and the China lawyers at my law firm were “feeling it” from the emails and phone calls we were getting from foreign companies doing business in or with China. My WSJ article sought to address the issues our lawyers were seeing back then. Since that article, China has gone through intermittent slowdowns and during each of those we see pretty much the same issues each time.
Because China is again going through an economic slowdown — due in large part to a trade war that is only going to get worse– I thought now would be a good time to reprise that article and write again on how to handle a China economic slowdown.
The Wall Street Journal chose the following subheading for my 2012 article : “Hardly a week goes by without complaints about payment problems or bankrupt debtors.” If I were to choose a subheading for this post today, it would be “Hardly a day goes by without complaints about getting bad product and hardly a week goes by without someone asking what will be required for them to shut down their China WFOE.”
The following are the key points from my Wall Street Journal that apply with at least equal force today:
Regulation. Assume that the Chinese government will respond to the slowdown by attempting to minimize citizen discontent so as to keep its hold on power.
Sourcing Problems. The slowdown is changing Chinese company interactions with foreign companies. Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering—in particular in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard. Hardly a week goes by without one of the China lawyers at my firm getting a call from a Western company experiencing problems. Sometimes the Western company has paid for a product and the company it paid no longer exists. Sometimes the company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.
Foreign managers need to understand what is happening in their own industries within China. This might mean visiting your Chinese factory, warehouse or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent.
The key is to be proactive: If you find yourself in a bad situation with a Chinese company going under, there usually is no remedy after the fact. Bankruptcy in China more often than not consists of a company shutting down in the middle of the night and its owner fleeing to another town.
The key to weathering China’s slowdown will be for foreign companies to go back to basics …. focus on scrupulous regulatory compliance; and renew focus on due diligence at a company-to-company level. Above all, no Western company doing business in China should blithely assume that a slowdown won’t affect it.
Updating the article, the biggest change from 2012 to today is the massive increase in Chinese companies willing to risk their relationships with the very same foreign companies with whom they currently do business. We wrote about this previously in Your China Factory as your Toughest Competitor. But it is now not just factories; our China lawyers are seeing this in all industry sectors, especially technology. Our China lawyers have become fond of pointing out that “since you will essentially be educating your Chinese party in how to compete with you, you need contracts that will at least limit what they can do when they do so.”
Why are China companies now so willing to risk losing out on business with existing customers to go into business competing with them? When times are bad, greater risk becomes necessary to pay employee wages and to stay alive.
China’s manufacturing sector has taken a hit from migration of international business to lower wage and cheaper countries across South East Asia. Since President Trump’s first round of tariffs, our international manufacturing lawyers have seen a near 50% increase in work involving Vietnam (mostly), Indonesia, India and Malaysia. And with one or more of these countries coming up in so many of our conversations with clients, we are quite certain this migration to SE Asia will only increase, no matter what happens on the trade war front. With manufacturing moving elsewhere, many Chinese companies rightly believe they need to do something different and they are seeking to compete with their own customers is that something different.
We are getting at least two calls/emails every week from companies seeking help in trying to remedy/stop their Chinese suppliers from using their molds or their information or their customers to compete with them. Chinese factories are more confident and willing now than they have ever been about going out into the world with their own products, and more willing to toss their foreign customers to the curb early. Without rock-solid China-specific contracts in place, suing these Chinese companies seldom makes economic sense. See China Contracts: Make Them Enforceable Or Don’t Bother.
The real trick here is to protect yourself early, when you still have leverage and before your Chinese counter-party has run off with your product, your software, your design, and/or your customers. For what you can do to protect yourself from this sort of competition, I suggest you read the following
- China NNN Agreements
- China Product Development Agreements
- China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents, Part 1
- China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents, Part 2
In every downturn for the last twenty years, the Chinese government goes after foreign companies operating illegally there. Why should the Chinese government allow illegal businesses to compete with their domestic companies, especially in a downturn? In particular, China goes after foreign companies that are paying individuals in China without paying the required employer and employee taxes. This time around, however, this downturn’s round-up of illegally operating foreign businesses has stepped up a notch and the Chinese government has become quicker to arrest and imprison people on criminal charges. See Doing Business in China Without a WFOE: Will the Defendant Please Rise. If you have “independent contractors” in China, please, please, please do not go there until you change how you are doing business in China. See Doing Business in China with Deportation or Worse Hanging Over Your Head and Hiring A Chinese Employee Without A Chinese Entity. Not Good at All.
If you are sourcing product or services from China or doing any other business where the financial health of a Chinese company is important to your company, I suggest you conduct due diligence on this company before you show them much of anything. Lastly, if you are looking to close down your China operations, consider the long term repercussions if you do not do so correctly and for that I suggest you read The Risks of Shutting Down Your China WFOE.
On the positive side, many companies are finding lower prices (due in part to the declining RMB) and many cities in China are offering foreign direct investment incentives better than we have seen in a decade.
What are you seeing out there?