The behavior of Chinese companies when buying high value equipment from overseas is quite uniform, and so it is possible for me to present a uniform approach to selling this equipment into China. Before moving to a detailed analysis, it will be best to step back and consider how Chinese companies view the process. Once the fundamental viewpoint of the Chinese side is understood, it is then much easier to determine how to craft an effective sales strategy for China.
Chinese companies purchased a fair amount of advanced equipment from foreign companies in the 90s. But these purchases slowed considerably as Chinese companies shifted their focus to manufacturing for the export market. However, these export oriented Chinese companies have recently started showing a renewed interest in purchasing advanced equipment from foreign manufacturers. That China is now Germany’s largest trading partner is good proof of this.
The reason Chinese companies are buying more advanced equipment from overseas is clear to anyone who visits Chinese factories. The simple truth is that much of the production equipment in these factories is old technology nearing the end of its useful life. The Chinese businesses that have made China the factory of the world have pushed their manpower and outdated tools to the limit and for them to continue to compete in the world manufacturing market, technical upgrades are required. Chinese companies are mostly unable to innovate in this area on their own; so they are reluctantly making purchases from foreign entities.
Though the world has greatly changed since the 90s, the attitude of Chinese companies towards the purchase of foreign equipment has not. There are five basic beliefs that drove Chinese advanced equipment purchases back when I was working on them in the 1990s and those same five basic beliefs drive these purchases today. Once these beliefs are understood, Chinese behavior on these equipment transactions becomes easy to understand. Once you understand the basis for the behavior of your Chinese counterpart on these deals, you can design a program that can be successful in the Chinese market.
In entering into a sales agreement with a Chinese factory interested in buying your high value equipment, you should understand that the Chinese factory owner almost certainly holds the following five fundamental beliefs that will drive its behavior in the sale process:
1. Your price is unfairly high. The important thing to know is that the Chinese side believes your price is both too high and fundamentally unfair. The Chinese side views this as the legacy of foreign imperialism, designed to keep the Chinese down, always under the thumb of the foreign oppressor. This attitude is supported by the general ideology of the PRC government. Under this basic belief, the Chinese factory owner feels morally justified in working to avoid paying you the full price for the equipment.
To achieve this, the basic strategy of the Chinese side will be the following:
a. Insist on paying in installments, then not paying the last installment.
b. Insist on a major discount, in the range of 30% to 40%. This then becomes the new base price for the equipment.
c. After paying the discounted price for the first two units, insist on an additional discount for future purchases.
2. Training is not necessary. Any requirement for training the Chinese side in how to use your equipment is just another way for you to unfairly extract more money from the Chinese side. It is also a way to keep the Chinese side down by showing that the Chinese have something to learn from foreigners. The Chinese believe that operation of the equipment is governed by a simple magic pill. Foreign companies that insist on a training program are withholding access to the magic pill.
3. Proper equipment set-up is not necessary. Your requirement that the Chinese side retain you for proper equipment set-up is a waste of time and designed to shift blame for operational failure onto the Chinese side. The Chinese side believes the equipment should “just work.” For this reason, elaborate site set up and pre-operations testing should not be required. Just turn the key and go.
4. After sale support and maintenance is not required. Requirements from the foreign equipment supplier for such after-sale support is designed to do two things: unfairly extract more money from the Chinese side and keep the Chinese side employees ignorant about the true nature of how the equipment operates. That is, you are unfairly hiding the magic pill from them. In addition, the equipment should “just work,” with no need for after sale maintenance or support. Your requiring a service contract or related after-sale support is either your admitting that your equipment is fundamentally defective or your trying to unfairly milk more money from the Chinese side.
5. Your attempts to protect your IP is foreign oppression. Intellectual property protection that prevents the Chinese side from copying your equipment is just another form of foreign oppression. The Chinese side does not believe the design of your equipment is the result of years of hard work and R&D and it wants to be able to copy it so that it can be manufactured in China at a “fair” price.
This then means the Chinese side’s standard strategy will be to purchase as few units as possible and then use its initial purchase(s) to extract the “magic formula.” The strategy is to abandon future purchases and have clones of your equipment manufactured in China.
Obviously not all Chinese companies subscribe to all five of these beliefs and some Chinese companies do not subscribe to any of them. But most do and I know this from what they have told me (in Chinese), from what I have overheard (in Chinese) and from what I have read (in Chinese). I mention all this because foreign companies find this all hard to believe and even when they do believe it, they find it hard to truly internalize and adjust their selling behavior accordingly. The typical Chinese factory owner will negotiate and implement its purchases of advanced foreign equipment based on these five beliefs. Many foreign suppliers, when faced with the resulting behavior, will conclude that the Chinese are operating in bad faith. However, to deal with the Chinese buyers, the first step is to understand that they believe their approach is fair. They are simply working against the unfair advantage of the foreign seller by making a more level playing field.
The important thing from the standpoint of the foreign seller is to recognize the following:
- These basic beliefs are natural and will not be changed.
- Since these basic beliefs are pretty much universal among Chinese companies, it is easy to predict how the Chinese buyer will behave at every critical point in the sales process.
- Since the approach of the Chinese side can rarely if ever be changed, foreign companies that want to sell their high value equipment to China should design their sales programs based on what the Chinese side will do, with contracts that protect the foreign seller from the negative consequences of near certain Chinese company actions.
Given these attitudes, what should a foreign seller do?
1. Do not discount. The first mistake most Western companies make when selling their high end equipment to China is to discount its price. The usual explanation my clients give me for doing this is that “we will discount the first equipment sale and then make up for that discount on future sales.” Wrong.
If you offer a discount you are simply confirming the China side’s basic assumption that your price is too high and you will virtually never get the opportunity to make up for the discount. The Chinese side will do one of two things. Some buyers (especially state owned enterprises or SOEs) will treat the initial discounted items as “samples” they will distribute to other enterprises to be cloned in China. For other buyers, the discounted price will treated as a new floor price for the product. If additional purchases are discussed, the Chinese company will then ask for an additional discount against your already discounted price.
It is therefore critical you hold the line on price. You may perhaps offer a very small quantity discount for purchases of multiple units. You may even offer a small “customer loyalty” discount for return purchases. But never offer a major discount for the initial purchase. Hold the line and explain that your price is both fair and the same price you offer to everyone in the world, on the same terms. What reason is there to change this policy for China?
2. Get paid before you deliver. For companies that are successful in selling to China, this is the golden rule. There really is no alternative. In many countries, issues related to payment can be resolved through the use of carefully drafted letters of credit. Chinese buyers, however, will only use Chinese banks for their letters of credit and those banks will always favor their Chinese buyer customers, so the letter of credit approach will not work for China.
For Chinese companies planning to clone your equipment in China, paying you by installments fits perfectly into their plan. The standard approach works as follows. Set up a system with five installment payments. The equipment will be delivered and installed in stages, in accordance with the installments. Then, the Chinese company will delay payment from the very start and then use the payment delay (which it will usually blame on China’s capital controls or some tax issue) to push the foreign side to deliver more than is required for each installment. The Chinese company will then reluctantly make a payment or two, all the while extracting equipment, training and know-how. When the Chinese side thinks it has gained “enough” from what you have already provided it, the payments stop. The common standard is to make two of five payments in exchange for 50% of the product and expertise. Our China lawyers warn our clients about this all the time and yet it just keeps happening.
Other Chinese companies will use installment payments to force you to discount. The Chinese side will negotiate for a series of installment payments with a major final installment to be paid after installation and approval by the Chinese side. This approach virtually never works well for the foreign seller as Chinese companies are expert at finding problems with the equipment. The Chinese side will raise these problems as excuses for continual payment delays and then use their own delays to seek an after the fact discount in price from you, while holding the installment payments as hostage to achieve this goal.
If the Chinese company is unable to secure its desired discount from you during the basic installment period, it simply will not make the final payment, achieving a 10% to 15% discount by that single refusal to pay. If the foreign side threatens to sue for that final payment, the Chinese side will trot out a list of problems with the product and its installation — normally problems the Chinese company itself caused. However, this will still be enough to convince the foreign side seller that it will need to mount a long and expensive legal battle to get that final payment and that doing so probably will not make sense.
It is important to note that these tactics by Chinese companies are not unusual. Your price is too high, so they do not see themselves as acting unethically; they are just leveling the playing field. I have spent about half of my life in China and I have heard this reasoning about once a month while there.
3. Do not deliver the equipment until first verifying that the conditions for its installation have been met. Remember that the Chinese side believes your equipment works based on an almost “magic” formula and your rules on how to set up for its installation and the specifications for its use are just a subterfuge you use to “hide the magic.” The detailed set up work is therefore unnecessary. Meeting the specifications is not necessary. So the Chinese side will not do the proper set up and they will ignore the specifications. But then when your equipment does not work as it was supposed to, the Chinese side will blame you for its failures.
The following are two (of many) true stories that illustrate how this typically goes down:
- A heavy equipment manufacturing company delivers iron pipe casting equipment. The conditions of sale provide that the floor of the casting room must be perfectly level. When the equipment is delivered, the casting room has an uneven dirt floor. The casting machine does not work and the Chinese side does not pay a single penny on the contract. The Chinese bank that guaranteed the payment sides with the Chinese buyer. Why create a level, clean concrete floor for a dirty machine used for metal castings, one of the China company’s engineers asked at one point.
- A water power equipment manufacturing company delivers a new hydropower generation set of equipment. The specifications provide that the current flow can never exceed 6 knots. When the equipment is delivered, the Chinese side installs it in an unapproved location where it is well known the current exceeds 8.5 knots. Within one year, the entire facility is destroyed. The Chinese side defaults on the last payment and the reputation of the foreign company is destroyed. The foreign company lost money on the project and never did another sale in China.
Foreign equipment sellers cannot rely just on clear contractual specifications and then relying on the specifications when there is a problem. The foreign seller should itself ensure the conditions are met before it delivers the equipment. And if the conditions are not met, the foreign seller should not deliver. If there is a cost in confirming your Chinese buyer has met the specifications (and there usually will be), you should build that cost into the cost for your product. Remember: the failure of the installation is always your fault and the Chinese side will always find a way to make you pay for that failure. We have said this before and it made people mad, but some of our most experienced and sophisticated and successful China essentially charge a premium to Chinese buyers simply to cover themselves in advance against these sorts of problems.
4. Build required training and after sales maintenance and support into the price of the equipment. No matter how much your potential Chinese buyer tries to get you to decouple the pricing for maintenance and support (and then eliminate it entirely) do not make these optional add-ons that are billed for an additional fee. If you make these optional and charge extra for them, the Chinese side will almost always choose not to pay. So you have to force them to accept training and support as part of your sales price.
Why do the Chinese refuse to pay? Your trying to require them to pay for after sales maintenance is just you admitting that your product is somehow defective and why should they buy a defective product. If properly manufactured your equipment should work forever, with no service or maintenance required and your trying to make the Chinese side pay for training and service as an add-on is you unfairly seeking to increase the price of a product that is already unfairly expensive.
There is one exception related to training. If the Chinese side is planning to clone your equipment, they will seek extensive training in how the equipment operates. Their goal though is not training; their goal is to somehow obtain the formula that will allow them to clone your machine. For this reason, you should carefully control your training with Chinese companies.
During training, the Chinese side will ask for more information and more training time than is necessary. They will also insist on visiting the U.S. manufacturing facility and they will expect to spend substantial time in that facility. For this reason, all training obligations must be carefully defined to prevent your costs from skyrocketing out of control. You should carefully limit time, location and access to information. One good way to control this is to require the Chinese pay by the hour for all training provided in excess of the basic training included in the purchase price.
Many foreign equipment suppliers say they will provide whatever training proves “reasonably” necessary. This sort of an approach is nearly always a mistake because neither Chinese companies nor Chinese courts truly understand or employ the concept of reasonable. You therefore should state state with precision the training you will be providing, where you be providing it, who will be providing it, and for how many hours you will be providing it. The same rules apply to provision for after sales support. Chinese companies tend to abuse after sales support obligations. So those obligations should also be spelled out clearly in your contracts as well. Again, I base this not on any “feelings” I have about China, but based on my having represented countless foreign equipment sellers on countless China equipment transactions and on what I have heard from other equipment companies and from other China lawyers who represent them.
5. Protect your IP with a China-centric contract. Protecting the intellectual property you have in the advanced equipment you sell into China should be a core goal in all of your sales. Understand the basic approach from the Chinese side: your product is too expensive and b) any form of IP protection is just a unfair device you are using to force them to pay the unfair price of the machine. So the goal of the typical Chinese company is to purchase one or two items at a bargain price and then clone them in China at a “fair” price.
The obvious way to protect the intellectual property in your advanced equipment is to register your patents in China. But for various reasons (including time bars) this is often not possible. Where there is no patent registration (and oftentimes even when there is), your best solution is to incorporate basic IP protections into your sales agreement. This is essential for China.
To accomplish this, either your sales contract or a collateral agreement must provide for the buyer agreeing to the following:
- Buyer will not reverse engineer or manufacture a copy/clone of the product or engage any affiliate or third party to do the same. A complex legal definition is not required. A blunt, simple statement (in Chinese) is what is required.
- Define confidential information information (such as the information you provide in training and support) and require no confidential information can be used by your buyer or by any affiliate or by any third party to infringe on your product.
- Provide for monetary damages if these restrictions are violated. Injunctions rarely work in China, so contract damages are required.
- Impose these restrictions with a written agreement enforceable by litigation in China. This is a key requirement. Your English language sales agreement that is enforceable in the New York or in London or in Geneva is not going to be helpful in protecting your IP and if it makes sense for you to use that sort of agreement on the sell side (and sometimes it does), you should have a separate IP protection agreement in Chinese, subject to Chinese law and enforceable by litigation in China.