1. China’s Slowing Economy Will Impact Your Business
You have no doubt seen the stories: China’s economy is hurting, and quite a bit worse than most. See e.g., China growth to fall behind rest of Asia (Financial Times); More Trouble for China’s Export Juggernaut (The Wall Street Journal); European Interest in China Investments Wanes (The New York Times). China’s slowing economy is already impacting companies that do business in or with China, and that impact will no doubt increase.
In 2012, I wrote China’s Slowdown and American Business for The Wall Street Journal. There was a slowdown happening in China 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 facing companies doing business with China. China (like every country) has always gone through intermittent slowdowns and during each of those we see pretty much the same issues.
Because China is again going through an economic slowdown — due to massive COVID lockdowns, its decision to support Russia’s war against Ukraine, its rapidly sinking real estate sector, and a government at war with private enterprises, now is a good time to reprise that article, update it, and write again on how to handle a China economic slowdown.
The Wall Street Journal’s subheading for my 2012 article was: “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 (or no products at all) from a Chinese manufacturer and hardly a week goes by without someone asking what will be required for them to shut down their China WFOE or move their manufacturing out of China.” I would then add that hardly a day goes by without a company asking our international lawyers whether and/or how they should reduce their China footprint or whether and/or how they can move their manufacturing elsewhere. See Manufacturing Outside China: Nike Likes It And You Should Too.
Lately, and even more troubling, we have gotten by far the most contacts ever from companies that are being hounded by Sinosure for debts owed (and allegedly owed) to Chinese factories.
2. You Need to Protect Your Company Against China
The following are the key points from my Wall Street Journal article 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, usually there 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 it will be unaffected by a slowdown.
Chinese companies see how sanctions have decimated Russia’s economy and they figure that the West/Japan/Australia inevitably will increase sanctions against China. In the West, our analysis is essentially that if China is viewed as aiding Russia any more than it is doing already, sanctions will increase against China. But in China, where the CCP has been pushing the mantra that the West/Japan/Australia will do anything to “stop China’s rise”, there is a ready “market” of Chinese companies that believe China’s decoupling from the West/Japan/Australia is a done deal. Chinese companies believe they need to do something different to survive. That “something different” is to compete with and/or steal from their own customers. But none of what we are seeing coming out of China over the last few weeks has been a surprise because these things have always become more common when China’s economy is hurting.
3. Hell Hath No Fury Like a Chinese Company in Economic Trouble
Updating my Wall Street Journal article, the biggest change from 2012 to today is the massive increase in Chinese companies willing to risk their relationships with the foreign companies with which they are doing business. We wrote about this previously in Your China Factory as your Toughest Competitor. But it is not just factories; we are seeing this in all industry sectors, especially technology. We often find ourselves telling clients “since you will essentially be educating your Chinese party in how to compete with you, you need contracts that will limit what they can do when they do so.”
Chinese companies on the verge of going under feel they have no choice but to risk losing existing customers by competing against them. In just the last few months, a number of companies have told me that their Chinese “partners” have (somewhat apologetically) told them that they had essentially stolen from them because they needed funds to pay their China employees. China’s COVID lockdowns are crushing those that are locked down and, more importantly, they are serving as warning signs to other companies as to what could happen to them. These lockdowns are — rightly — scaring the hell out of China businesses everywhere and leading to an increasing number of them acting desperately.
What this also means is that Chinese factories are going to Sinosure faster than ever, to report slow payments and to get reimbursed by Sinosure, which is itself a Chinese government entity and seems to be dishing out money left and right to try to keep Chinese factories in business. Tip: If Sinosure is at your door and one or more of your Chinese suppliers are claiming that you should go ahead and conduct business as usual with them, they are flat out lying. If you have one Chinese supplier and Sinosure is at your door and that supplier is claiming not to have ratted you out to Sinosure, that supplier is also flat out lying.
Tip: If you are buying products from China, there is a lot you can and should do NOW to prevent future Sinosure problems and to ameliorate those problems if they arise. Regular readers of this blog know that we virtually never hold back on here with our advice on how to avoid China problems, but when it comes to Sinosure, our lips are sealed in public because we do not want to lay out our Sinosure solutions here for fear that Sinosure may enact new policies to react.
4. How to Protect Your Company Against China
China-specific contracts go a long way towards preventing Chinese companies from using your IP to compete with you. See China Contracts: Make Them Enforceable Or Don’t Bother. The key is early protection, 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
We are also seeing an increase in Chinese companies taking foreign company money and then disappearing. For how these thefts typically go down, check out China Business Scam Week, Part 2: Bricks for Products. The best defense against these sort of thefts (though far from fool-proof) is to conduct due diligence on the company to which you will be sending funds. See On the IMMEDIATE Importance of China Manufacturer Due Diligence (which applies with equal force to all Chinese companies, not just manufacturers).
China’s slowing economy and its causes are increasing the risks for nearly every company that does business in or with China. Most companies realize this and seek to respond to it. Our law firm has a flat-fee package we internally call “China risks and revisions.” This package consists mostly of our analyzing a client’s China risks and then working with them to reduce those risks by “fortifying that which protects them and by lightening their China footprint.” Our goal is to reduce the client’s China footprint and thereby reduce their China risks, while at the same time balancing that against the goal to retain all or nearly all of the benefits the client gets from doing business in or with China.
To get a sense of some of the things that determine China risks, check out How to Evaluate Your China Risks. Reducing China risks tends to be incredibly specific by industry, by company, and by what the company is doing in China. For a company that buys all its products from four suppliers in China, we might suggest it find at least one supplier outside China, and then we help them do that. See How to Move Your Manufacturing Out of China Safely. For a company in a China joint venture with ten of its own people in China, we might recommend contracts or IP registrations to protect their IP from their joint venture partner and/or we might recommend it switch from a joint venture arrangement to a distributor-distributee relationship or, to achieve an even lighter China footprint, leave the JV and license its products/technology/brand name to a Chinese company. There are all sorts of risks out there and all sorts of options for reducing them. For a company that has operations in China, our advice usually leans towards strengthening their existing legal systems, especially as relating to their relationships with their employees and other companies.
We live in interesting times. Be careful out there.