International Manufacturing Price Risks

International manufacturing price risks

Spoke with a U.S. manufacturer the other day regarding the Manufacturing Agreement my law firm’s international manufacturing lawyers are drafting for them. This company has been manufacturing in Asia and in Mexico for more than a decade and their COO quickly let me know that one of the things that drives him nuts is how his Chinese manufacturers “change prices” on him, no matter what the contract says. He then asked if our Manufacturing Agreement could stop that. My response was “probably not” and then I explained to him why stopping it might not be such a good thing anyway.

“Take your widgets,” I said (actually I mentioned his actual product, but you know what I mean). “Stainless steel is a big part of that. If we put in your contract that your widgets have to remain at X price for three years, we may be asking for trouble. What happens if the price of steel doubles during that time,” I asked. “I’ll tell you what will happen,” I said. “Your Chinese manufacturer will either go back to you and ask to raise its prices in light of its greatly increased costs for stainless steel or it will secretly start replacing some of the stainless steel in your widget. Which would you prefer?”

His response was pretty much as follows:

I get it. You are right and I know that because that is exactly what keeps happening to me. The manufacturers start changing their products for me and always for the worse. Sometimes they do come back to me and ask for a price increase and then we negotiate one.

We talked a bit more and he agreed that the manufacturers that came back to ask for price increases were overall much better manufacturers than those that secretly changed the product and that he was no longer doing business with any of those.

I then told him that the best way to handle pricing in his situation is usually by setting a price for maybe a year, but be ready to be flexible even on that.  I then noted that many factories do not hedge their material goods pricing and that for right now at least, adjusting prices, no matter what a contract says is still pretty common.

I then asked him whether his company does anything to hedge against exchange rate risk and he said no and I connected him to a bank to see whether that might be a way it could reduce its product price fluctuation risks.

Nobody ever said having your products made overseas would be easy.

What do you think?

6 responses to “International Manufacturing Price Risks”

  1. I agree that it is better to let prices fluctuate, for the reasons you invoke.
    What I would suggest is (1) to get a good idea of the proportion of the final price that is directly driven by the main commodity’s market price, (2) to accept raises when they are justified, (3) to demand lower prices when they are justified, and (4) to look for ways to hedge against the main risks.
    I believe it is possible for a midsize company in the US to find a way to hedge against commodities price movements. Maybe their regular bank won’t allow them to trade options or futures, but many institutions that can be found on the internet offer this.

  2. You’re right, this happens all the time and it’s a source of never ending frustration. There are two parts to the issue though. One, you’ve mentioned is the changing nature of prices and the lack of forecasting by any chinese supplier/manufacturer–this just does not exist. While this change in prices (due to a lack of forecasting) is partial understandable, what’s not is the fact that prices will NEVER go lower than the contracted price. If the supplier gets a raw-materials windfall for some reason, there is no sharing of the profit. Price changes ONLY go in one direction. The other issues that you don’t mention is that it’s not just materials costs, but labor, electricity, taxes, transportation, etc. Any current item in the news can be (and will be) presented as a reason for rising costs that were not considered before. The list of possible factors for price increases is practically endless, leaving the buyer constantly on the defensive and constantly on the look out for (conscious) product fade. The only way to beat this is to a) have good contracts, b) have more knowledge about your industry (in China) than your supplier, and c) to have constant on the ground monitoring/testing to assure against quality fade.

  3. Sudden price hikes by your vendor even after you have agreed on a price in a sales contract is SOP in China, and there really is nothing you can do about it, that is if you still want your product. About the only thing you can do is to have a good relationship with your vendor and to give them good order QTYs so that they value your business more and are less inclined to see you as a short-term customer. But of course easier said than done.
    In all fairness to China vendors, they are not the ones who set raw material costs, the frequent justification for price hikes. The raw material supplier does that. In fact, a lot of raw materials in China do not come from China but come from places like, Thailand, Vietnam, Taiwan etc etc. and there are probably a lot of costs associated with bringing those raw materials into China. So you can never be sure what is happeing and when price hikes are legitimate or fictitious. I suspect that half the time when your vendor tells you the cost of raw materials is going up, they are simply passing on cost hikes to you that they have recieved from their own suppliers. And half the time they are just trying to up the price on you. But you really have no way of knowing without doing extensive research on raw material prices. And even if you challenge your vendor they are not likely to accomodate you unless you are a very good customer.
    The best advice is don’t get bent out of shape about it but plan your business and your margins so if a price hike comes you can still sleep at night.

  4. is this price raising problem not existing in American or European (i.e. developed country) manufacturer or supplier? I am curious what their typical practice is. more sophisticated in hedging commodity price?

  5. I usually had the opposite problem when buying from Chinese manufacturers–they knew the price of steel would fluctuate and thus sometimes refused to give us a product quote that was valid for more than a couple weeks out. In one case it was a heck of a time getting the factory to agree to factor the risk of material increase into their quote–they had never considered the possibility that there were ways to mitigate risk.
    A price valid over a year would have been unheard of, but I suppose we were better off than if the factories had just switched to aluminum without telling us.

  6. We operate on a much higher profit margin in the west, Chinese company’s operate on lower profits. I know one mobile phone maker that plans a profit of $1.5 on each phone. He makes 600,000 at a time so he is happy at that. The cost has to be flexible or can also make money by sourcing inferior spec components if the price is not.
    If your buying from China you should also be considering your mark up. We aim for at least 200 to 300% to cover overheads and everything that can and does go wrong.

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