How to avoid China Manufacturing Problems

At least two to three times a we, one of our international manufacturing lawyers gets an email seeking help in resolving bad product or late product problems. With tensions rising with China, these emails are increasing.

Sadly, most of the time we have to tell them that it probably will not be worth their money to hire our law firm to try to resolve their China product problems after the fact. I then tell them that if they wish to avoid having the same sort of problems in the future, they need to start conducting business differently with their Chinese suppliers.

If you want to greatly increase your chances of getting good product from China on a timely basis, read and absorb the following:

Probably most importantly, you should also read this post, Register Your China Trademark Or Go Home, on how critical it is for anyone doing any sort of manufacturing in China (even if you are not selling there) to register your brand name and your logo as trademarks in China.

It’s sad but true that many of my firm’s best manufacturing clients are those who have been once burned.

We often write (see above) about the need to have a Chinese language Manufacturing Agreement with your Chinese manufacturer. In this post, we focus on what is truly important to include in that agreement, and even more importantly, the terms on which you should reach agreement with your Chinese manufacturer before you pay a lawyer to draft your agreement.

In working with companies that are new to manufacturing in China, we find that newcomers often concern themselves with the “wrong” issues. In our discussions with these companies, the primary issues that seem to be of concern to them are sophisticated legal issues such as ownership of intellectual property and indemnification for potential consumer product liability claims. Though these issues are important, the real issues they are facing in China are oftentimes much more simple and direct.

The key issues in pretty much any China manufacturing agreement are the following:

1. Price

2. Quantity

3. Delivery date

4. Quality

5. Payment terms

Newcomers to China manufacturing tend to think China is far more advanced that it actually is. In fact, China manufacturing is still dominated by relatively small, underfunded privately owned companies that operate on a fairly primitive basis. In fact, many of these companies will openly state that since we are giving you “the China price,” and since that price is so low, we should not be required to care about the other four issues listed above — quantities, delivery dates, quality, and payment terms. When working with this kind of company in China, you should focus on making clear that all five of the fundamental manufacturing issues are critical, not just price. Only after you have resolved this with your Chinese factory should you move on to other more complex issues.

The above five fundamental issues are crucial for business success when purchasing from China. We often see companies that have been bankrupted by mistakes in dealing with the five fundamental issues set forth above.

What are the standard mistakes?

1.  Price. The buyer will negotiate a very specific price list with the manufacturer, but the manufacturing agreement (a/k/a the OEM Agreement) is written so the Chinese manufacturer is not obligated to accept all purchase orders. So as soon as the agreed upon pricing works against the Chinese manufacturer, the Chinese manufacturer simply refuses to accept the purchase order and insists on a substantial price increase. When this happens in the middle of a sales season, it can destroy the business of the buyer. Our China attorneys get calls on this every year, not so coincidentally especially as Christmas approaches, which is why we are writing this post now.

2. Quantity. Chinese manufacturers commonly make short deliveries on purchase orders. If there is no penalty for a short delivery, the Chinese manufacturer can make short deliveries with impunity and they will often not hesitate to do so, especially if they have a new customer who is paying more for the same item. In fact, short delivery in some business sectors has become so common as to be predictable. The only way to prevent short delivery is to provide a severe penalty for short deliveries in your OEM contract and to regularly monitor the production process in the Chinese factory.

3. Date of delivery. Many Chinese manufacturers view the delivery date on a purchase order as a general form of guidance, rather than as a strict date. So long as the Chinese manufacturer delivers within two to three months of the delivery date, it feels it is doing just fine. This can of course be a disaster for the U.S. or European buyer who has made delivery date promises to its own customers. The most common situation is a buyer purchasing for the holiday season. The delivery date is September 15 and the Chinese factory delivers on December 15. The factory says: we were only three months late, what’s the problem? We had this situation once with a Christmas tree light company that contacted us in October after learning it would not be getting its two million dollar Christmas tree light order until December. Late deliveries can be particularly bad for foreign buyers who are feeding their product into a “just in time” inventory system. Late delivery means the whole system is affected, often subjecting the foreign buyer to crippling penalties.

4. Quality. Quality problems from Chinese factories are well known. Consider the following kinds of things that can go wrong, and these are just some of the examples on which our international dispute resolution lawyers have had to deal with on behalf of companies that retained us (all after the problems arose):

    • Staples for an automatic nail gun. The staples were beautiful, except they did not fit into the nail gun.
    • Hand blown Christmas tree ornaments. A whole container arrived and on time. The objects were beautiful. The only problem was that the small ring required to hang the ornament from a tree was missing, making the entire shipment useless.
    • Etched glass fixture installed between two sheets of glass in an argon filled custom window. Everything about the window was perfect except that when installed, a very prominent footprint was obvious on the etched glass, rendering the window worthless.
    • Custom door handles. The handles were well made and worked perfectly. However, the surface coating on about half of the handles was flawed. This required the buyer to open every custom package to individually inspect each item.

All of the above buyers made the same mistakes. They did not inspect the product in China and they paid for the product before they did their inspection in the U.S. They also failed to put clear quality requirements into their manufacturing contract, along with clear penalties to be assessed (liquidated damages) against the manufacturer for failing to meet quality benchmarks.

5. Payment Terms. The standard system in China for OEM manufacturing is for the Chinese manufacturer to require a 30% down payment with 70% due on shipment. Most U.S. and European buyers then wait until the product arrives in their country before they do their inspection. This means that when the buyer discovers the problem its Chinese manufacturer has already been paid in full, so it has little to no incentive to deal with the issue. And they usually don’t. Though it is possible to litigate in China to resolve these issues (assuming you have done everything right with your China OEM Agreement to allow for this), Chinese factories understand that the total value of any single container of goods seldom justifies the cost of international litigation, so they tend not to care. The solution to this problem is straight forward: do not make the 70% payment (or any full payment) for the goods until after an inspection has been completed and make sure your Chinese language contract gives you clear recourse.

Once you as the product buyer have clear control over these five issues, you can move on to other important issues. But you really should address the above five issues first.