Full Service Outsourcing in China: NOT Smart

Somewhat paradoxically, increasing tension and tariffs between the United States and China seem only to drove more companies to want “to go into China.” See Why NOW Is a Good Time to Double Down on Doing Business in China. Most of these companies looking to go into China are companies that sell something to China — either goods or services — and are looking to go into China to “solidify” their relationship with their Chinese customers.

There are obviously risks to going into China these days, chief among them that you will essentially be putting your company in harm’s way if relations between the West and China deteriorate even further. And yet, if past performance is any guide to future performance (and we all know it is), companies in China have for the most part been exempted from these sorts of problems. By exempted, I mean that we are simply not hearing of China going after foreign companies in China that are in full compliance with China’s laws. For the increasing need to be sure you are in full compliance with China’s laws, check out the following (now!):

Generally, “going into China” means setting up a company in China, be it a WFOE, a Joint Venture, or a Representative Office. It is also possible to go into China using a hiring agency, such as FESCO.  Sometimes referred to as third party hiring agencies, these companies will hire employees in China for your company and thereby (in some circumstances) allow your company to delay having to set up its own full-fledged entity in China. There are benefits to be realized from third party hiring agencies, but also considerable risks. This means that this sort of arrangement — if done properly, which they often are not — can make good sense for some companies and terrible sense for others.

There is also another kind of arrangment known as “full outsourcing,” (sometimes referred to as PEO) whereby a company in China essentially “becomes” the foreign company in China and does everything or almost everything in China for the foreign company. I am writing about this sort of arrangement for the first time because our China company lawyers are seeing a big uptick in companies asking us about these. And by big uptick I mean that over the last ten years we typically would get maybe one or two questions about this model per year and we are now getting maybe one a month.

To very quickly tell you how I feel about full outsourcing in China I show you the below email exchange (very much shortened).

Foreign Company: Is the full outsourcing model a bad idea for China or is it just something your firm does not do?

Me: Both.

Our China lawyers do not help foreign companies enter into full outsourcing arrangements in China because we deem them too risky and too expensive and, more importantly, because we do not believe they are legal.

In addition to their highly questionable legality, we have the following issues with them:

1. The main reason companies seek to go into China via full outsourcing is to save money. I get that, but to ameliorate the risks of such an arrangement, you need a really good contract and due to the complex nature of these arrangements, the cost of that contract could very well end up costing as much or even more than other (clearly legal) alternatives. So there goes what is usually the sole basis for such an arrangement. Think IP, taxes, office and employment issues, at a minimum.

2. Many companies choose full outsourcing as a way of “putting their toes into the China waters.” In other words, they view full outsourcing as a cheap and fast and easy way to “test” out China, all the while planning to go into China full-bore if the test succeeds. But what seems to never occur to these companies is how difficult and costly it will be to switch from full outsourcing to a WFOE or Joint Venture model. Think about it. With full outsourcing you have essentially turned over your IP (and you had better do this correctly or you could literally lose it) and your employees and your office and whatever else you are doing in China. Now tell me how smooth it will be when you tell your Chinese full service hosting company that you are done with them and you want them to “give” you all this back. And imagine having to now hire “your” employees and deal with their seniority issues.

3. These full service outsourcing companies nearly always have multiple clients and this usually means that “your” resources and even your employees may not be lent out to other companies.

4. What happens if you get all set up with your full service outsourcer and you end up not liking them at all? You will probably end up needing to negotiate a termination or having to sue on your contract, both of which can be time consuming and costly. And what do you do for China in the meantime?

5. How good can a full service outsourcing company be in conveying the full essence of your company?

Bottom LIne. When it comes to full service outsourcing for China as an option for going into China, there is pretty much always a better way.