Chinese Manufacturers and Profit Margins: What Profit Margins?

A loyal reader just sent me an absolutely fascinating “case study” on a small Chinese manufacturing business. The case study is called “The changing landscape for Chinese small business” and it highlights a company that started out making school uniforms for China’s domestic market and then shifted to making bags/purses/backpacks for export.

In reading the case study, just about everything in it sounded “typical” to me. This bag company sounded like most of the Chinese manufacturers from which my law firm’s non-Chinese clients buy their products. In particular, the company’s lack of rigorous accounting and pricing and its unbelievably low profit margins, rang totally true to me.

In 2010, the company had sales of 5,417,003.64 Yuan and profits of 983 Yuan (approximately $150 US dollars!). Even in its very best year (2006), the company’s profits were only around USD$44,000. The case study attributed the low margins to one of the company owners oftentimes providing discounts without the knowledge or approval of the other owners.

We are always counseling our clients on how Chinese manufacturers usually have incredibly thin margins. We do this for many reasons, including, the following:

  • If you buy product from a Chinese manufacturer for too low a cost, you are increasing the risk of that manufacturer cutting costs by doing something bad to your product without telling you. Believe it or not, you may be better positioned to know your Chinese manufacturers costs than it is.
  • If you buy product from a Chinese manufacturer for too low a cost, you are increasing the odds of that manufacturer shutting down the day after it gets paid for your next order.
  • Because your Chinese manufacturer’s margins may be so low, if you do get bad product, do not expect to just pick up the phone, tell the manufacturer what happened and wait for a refund of the USD$500,000 you just paid for the product. Your Chinese manufacturer probably does not have $500,000 so you are going to have to come up with some other solution. You also should be thinking about this before you place your orders.
  • With the margins being as thin as they are, think about what you ask for from your Chinese manufacturer. Should you require your Chinese manufacturer to provide product liability insurance or does doing so just invite the manufacturer to say it has done so but then never pay on the policy? Might it not be safer for you to buy the policy for yourself instead?  I am not saying one should always buy one’s own product liability insurance. I am just using this as one example.

As bad as things already are for this Chinese bag company, the case study predicts things will only worsen due to the following:

  • The US Government is continuing to put pressure on the Chinese Government to strengthen the value of the yuan and to do it fast.
  • The continuing rise in oil prices.
  • The long-term decline of available migrant workers to work in China’s factories

What are you seeing out there?