China Manufacturing Gets Riskier
Way back in October, 2018, in Would the Last Company Manufacturing in China Please Turn Off the Lights, we lead with the paragraph:
The title is an exaggeration, of course. But with my law firm’s international lawyers fielding a steady stream of client requests for help with leaving China for Vietnam, Thailand, Malaysia, Cambodia, India, The Philippines, Indonesia, Mexico and Turkey (mostly), it does sometimes feel as though within three years nobody will be making widgets in China anymore.
That post then noted how the international manufacturing lawyers at my law firm had been getting a steady stream of reporters asking us to connect them with our clients that were leaving or were looking to leave China. We would then usually tell them why it is not a good idea for companies to publicly discuss leaving China. See How To Terminate Your China Supplier: Very Carefully and How to Leave China AND Survive.
In October, 2018, in response to questions our international lawyers were getting we wrote the following:
A lot of foreign companies are leaving China now and we see that exodus continuing. It would hardly be an exaggeration to say that on at least one level, nearly all of our clients would — at least in theory — like to cease having their products made in China. Part of this is due to the hassles and the hard times they have gone through in China and part of this is due to the grass always being greener on the other side. But to a large extent, these (hurt) feelings are mostly irrelevant. What’s relevant is whether these companies can do their manufacturing in a country other than China and whether their company would be better off doing so. I think that in large part the answer to the second question will more often be yes than no but the answer to the first and more important part will more often be no more often than yes. Put simply, most of the companies currently having their products made in China have no choice. No country right now comes close to matching China for its combination of manufacturing sophistication and low cost, and until this changes, the overwhelming bulk of companies having their products made in China will continue to do so.
Then again in March, 2019, in Will the Last Company Manufacturing in China, Part 3, we wrote how foreign companies very much want to move their manufacturing from China, but there “three things” are keeping “a lid on a manufacturing exodus from China”:
One, capacity. Countries like Thailand and Vietnam are literally getting overrun by American and European companies seeking to move their manufacturing and it has gotten to the point where if you do not use a sourcing agent with really good factory contacts in these countries you will likely find it difficult to impossible to find a factory willing to take on your product manufacturing. Two, capability. Countries like Thailand and Vietnam have for years been great at manufacturing certain things and not others. They are both rapidly improving their capabilities, but they are not at China levels, at least not yet. Three, knowledge and soft infrastructure. Many foreign companies already know China and know how to get a widget made there. Far fewer know Thailand or Vietnam or Indonesia, etc. And even if you don’t know China, it can be amazingly easy to navigate on your own and there are countless people out there who are super knowledgeable (and many who most emphatically are not) to help you. See China Manufacturing: To Sourcing Agent or not to Sourcing Agent, That is the Question. Our clients were having so many problems finding good people to help them with Vietnam and Thailand that we brought in house trusted Thailand and Vietnam people.
A story I love to tell is about a conversation I had with a Mexican lawyer friend of mine who studied law in Mexico, China and Canada. One day we were talking about companies moving their manufacturing from China to Mexico and how we both believed those moves would accelerate. My friend then mentioned how Mexico would be doing even better at increasing its manufacturing were it not the worst country in the world at luring foreign company manufacturing. I then said that if Mexico is indeed the worst country at that it is tied with every other country in the world except for China, which is a distant first. China is truly amazing at making it easy for companies to manufacture in China. But other countries — including Mexico — are slowly improving and will no doubt continue to improve.
Perhaps, most importantly, that article also talked about some of the costs in moving to a new country for manufacturing, including the need to secure and pay for the very same contractual and IP protections needed for China, but specifically tailored for whichever country to which you are going, including the following:
- An NNN Agreements before you reveal your product specifications or design or customers or any other trade secret.
- A Mold/Tooling Ownership Agreement if you will be bringing your molds or tooling from China to the new country or if you will be paying (either directly or indirectly) for new molds or tooling in the new country.
- A Product Development Agreement if you will be working with your new manufacturer to modify an existing product or create a new one.
- A Manufacturing Agreement with whomever will be making your product. Go here, here, here, and here for what that entails
- The need to secure trademarks to protect your brand name and your company name and your logo. This will likely be the most important thing you do.
- A design patent or a utility patent
- A copyright. Usually not needed, but when it is, it’s very important.
Then in June, 2019, in Has Sourcing Product From China Become TOO Risky? we wrote how about the huge risks companies face from potential tariffs and duties in the United States (and eventually the EU):
First there are the tariffs, which come and go and come and go, but are always a risk for any company that buys product from China for sale in the United States. They are a risk because the $10 widget you buy from China today may cost you $12.50 if you end up having to pay a 25% tariff on it in the end. Yes, there are all sorts of things that can be done (and my firm’s international trade lawyers seem to be spending half their waking hours doing these things for our clients), but in the end your product prices from China will almost invariably go up.
Then there are the duties, which for many of our clients are (and should be) the scariest thing of all. These are typically anti-dumping (AD) and countervailing duties imposed on Chinese products by the United States and the European Union. Far too few companies are familiar with these duties until they get hit with a massive bill for them.
Manufactured products from anywhere run the risk of being hit with duties, but that risk is exponentially higher for products from China because these duties mostly apply to products that have been subsidized by a foreign country and China clearly subsidizes some of its products and arguably subsidizes all of them. China is by far the highest risk country and its list of products subject to U.S. duties is roughly five times more than any other country. These duties can be massive and they typically range from 50% on up to 200%+. These duties can also be imposed retroactively, which means you may be hit with a 200% duty on widgets you bought from China last year. And note that having your China products go to some other country before you bring them into the United States or the EU will not change a thing, other than put you at risk for illegal transhipment fines and criminal penalties. See US-China Tariff Updates: What You Can (and Should NOT) do NOWand How To Get Rich From Your Competitor’s Illegal Transshipping: Moiety and the False Claims Act. Any company that has products made in China and then exported to the United States is at risk.
In Importing From China (Directly OR Indirectly) has Big RETROACTIVE Risks, one of our trade lawyers (who just recently wrapped up working on a massive illegal transshipment case that led to a $62.5 million settlement), warned about the duty risks on China products: “If you are importing product originally from China covered by or even maybe covered by an antidumping or countervailing duty order, you must be very careful, no matter the country from which you are directly importing the product.”
The number of new anti-dumping and countervailing duty cases against Chinese products has exploded, to the point where one of our international trade lawyers had this to say about them in Yet Another International Trade (AD/CVD) Petition Against China: This Time it’s Metal File Cabinets:
The last few months have seen an onslaught of trade actions brought by U.S. companies against incoming products of all kinds from China. With all the trade issues involving China and bipartisan anti-China sentiment prevalent in the United States, now is a great time to bring such actions. The international trade lawyers at my firm almost exclusively defend against antidumping and countervailing duty claims instead of bringing them. So I say this not to encourage more such actions, but as a simple statement of fact. If you are importing products from China, now is the time to know the trade risks of your imports.
Again, the international trade lawyers at my firm make our money by representing the Chinese manufacturers and their US importers so the more petitions brought against incoming Chinese products the more money we make. The more petitions, the more our law firm financially benefits and the more I personally financially benefit.
And yet, from an economic and policy standpoint even I am starting to get concerned by all these cases. I say this because of the massive onslaught of AD/CVD cases being brought against China and how aggressively (on multiple levels) the United States Commerce Department has been on these cases. To the point where I am finding myself wondering how important a trade deal with China will be if the United States giveth on the one hand and then taketh via these AD/CVD cases on the other hand. And is it right for the United States government to almost “on the sly” be pushing American (and foreign companies as well) away from China, without making this policy clearer?
Based on all that I hear from my own firm’s China lawyers and international manufacturing lawyers, many American and European companies are decreasing or eliminating their business with China. It appears US foreign policy is to drive business from China to countries like Mexico, the Ukraine, Vietnam, Thailand, the Philippines, and Indonesia, among others.
It is open season on duty cases against Chinese products and if having to pay a massive duty on your products scares you, you should be looking beyond China for your manufacturing.
In Coronavirus: China’s manufacturing supply chain pummeled from all sides in efforts to restart, the South China Morning Post writes how China is not even close to being back to full manufacturing capacity and how it is not at all clear when it will get there. That same article talks a bit about foreign company frustration with China and of how the coronavirus and its handling of it will be the last straw for many:
These results suggest that foreign companies might re-evaluate their relationships with China. For many, the virus comes after two long years dealing with trade war tariffs and has added to the sense of China fatigue. It is for some “the straw that broke the camel’s back.”
Hetin Shah, the president of supply chain management company MES Inc, said that his US Fortune 500 clients “do not want anything to do with China right now”, with the supply chain risks deemed to be too severe.
Moving Manufacturing From China is Also Risky and Sometimes Just not Possible
However, if moving manufacturing from China were easy and cheap, there would be few foreign companies still manufacturing in China today. But it is anything but.
First, China is the only place for manufacturing a wide range of products. In other words, some companies have literally no choice but to keep their manufacturing in China, at least for now.
Second, China is still the cheapest place to manufacture a wide range of products and it will very likely get even cheaper over the next year — perhaps considerably so. The Chinese government is in panic mode right now because of China’s rapidly tanking economy. Car sales are down 92% and overall retails sales overall have plunged.
Restaurants and bars have been hit particularly hard. See China’s Damaged Economy Under the Coronavirus. Really Damaged. The Chinese government knows all this and it has been doing whatever it can to try to keep its economy afloat. This includes leaning on landlords not to collect rent. Giving out no interest/no pay loans. Paying companies not to terminate their employees. Reducing the cost and just not collecting for utilities. Issuing force majeure certificates to Chinese companies saying that the coronavirus has negated their need to pay or to perform under a contract. China has always heavily subsidized its leading industries (this is one of the things driving the US-China trade war) and it is doing so more massively now and that will not end when the coronavirus outbreak is finally controlled. These subsidies will continue and they will allow Chinese factories to reduce their prices so as to entice foreign companies to stay.
Third, moving manufacturing out of China often does not free companies from China’s inherent problems and risks. We had a client — a well known clothing company — that moved nearly all of its manufacturing to Vietnam maybe 4-5 years ago. They would often tell us how they preferred Vietnam to China in pretty much every way. Then all of a sudden they moved their manufacturing back to China and they would almost apologetically explain that they had to do so because they never stopped using China for things like their zippers and high end buttons and fabrics and the logistics of getting those things from China to Vietnam often meant slowdowns and to avoid those slowdowns they would often have to airfreight components to Vietnam at huge costs. In the end, Vietnam increased their overall costs so much that economics dictated their reluctant return to China.
So, yes, we are NOT saying everybody can or should move their manufacturing out of China because that is not the case. But we are saying that moving out is at least on the table right now for just about every company with whom we talk.
What Our International Manufacturing Lawyers are Seeing
Our international manufacturing lawyers are seeing the following:
- Our biggest clients are mostly staying in China for the short term, but slowly moving production elsewhere and working on plans to move all or nearly all production out of China in the next few years, either by sourcing from factories outside China or by building their own production facilities outside China. These are the companies that have been manufacturing in China for a long time, either with their own facilities or with good-sized Chinese companies. These companies are mostly looking at Vietnam, Thailand, Malaysia and Mexico.
- Our mid-sized clients are really all over the map, depending largely on their own individual situations. Some are already completely out of China, some simply cannot leave for a long time, if ever, and some are slowly shifting their production to other countries. Those companies that have others make their products for them have been much quicker to leave. Those with their own production facilities are for the most part reluctant to pay to build out new factories outside China until the future becomes clearer.
- Our smaller clients are also all over the map, depending largely on their products. These are companies that do not have their own production facilities and they tend to be very risk averse. We are helping many of them find alternative supply sources in Vietnam, Thailand, Malysia, Mexico and the Philippines. Finding alternative sources for many of these companies has been relatively easy and in most cases their new suppliers are charging less (oftentimes by considerable amounts) than what they were paying in China and that is not even counting their no longer needing to pay tariffs. But for certain products, China is pretty much it. Other clients sell such high quality, high margin items, that it just does not make sense for them even to bother trying to find a new supplier. One client has a medical item made in China for twenty cents, which it then sells in the United States for eight dollars. It sees no reason to spend time and effort trying to find and onboard a new supplier so as to save a nickel.
Then there is the issue of supply chain diversity, which I used to describe as something almost all companies want, something most companies talk about, but something few companies actually do much if anything about. Many companies are emphatically telling us that they are now serious about diversifying their supply chains. “Coronavirus has taught us a lesson,” they say. Will this be true though? Will companies truly diversify such that China’s next virus will barely impact their supply chain or will they just put a new factory in Vietnam and call it a day? How many companies will modify their supply chain so that they have redundancy in all 43 components of their product? And will that redundancy mean China and Vietnam (which tend to be subject to the same risks), or will it mean that all 43 components can be sourced from China and from Poland and Mexico? I have made up the term “true diversification” to describe a situation where a company has worldwide diversification of all components as opposed to country-next -door diversification of just the product?
China’s Manufacturing Future
On the plus side, once China manufacturing gets back on line, I see prices falling. Despite those falling prices I predict many companies that manufacture in China now will start leaving in six months or so because by then they will have found other options. This will likely lead to further price reductions in China but foreign companies manufacturing in China will nonetheless continue to leave for years.
On the negative side, I also see the United States and the EU getting much tougher on China once the coronavirus situation is over. Before the coronavirus, there was a lot of talk and anger in both the United States and in the EU about imposing sanctions for China’s internment camps. The CCP has used the coronavirus to increase its control over its citizens. This too will likely not play well overseas. Both the U.S. and the EU have been pushing for China to open up its economy under threat of China being blocked or taxed on its products if it does not. The technology war is somewhat on pause right now but is bound to flare up once the coronavirus outbreak is over. All of these things bode ill for China manufacturing.
Doing Business in or with China After the Coronavirus — Stay Tuned
We have always put China business into two buckets. One bucket is foreign companies doing business in or with China to save money. Manufacturing is by far the largest component of this bucket. The other bucket is foreign companies doing business in or with China to make money. Selling goods and services to China is the largest component of this bucket. We see good things for foreign companies in this bucket after the coronavirus is gone and we will be writing on that later this week.