How to Outsource Your Manufacturing to China

Last Updated Jun 9, 2008 7:53 PM EDT

When it comes to manufacturing, few regions can compete with
China's labor costs. Companies that rely on outsourced products,
however, have lots of new hurdles to clear — just ask the firms that
wound up selling lead-laced toys made in China. So, is setting up shop in China
still worth the risk? Our sources say yes: Companies can maintain product
quality and safety while reducing costs. Here's what you'll
need to manage the process and keep your brand — and your customers —
safe.




Understand That Traditional Rules of Business Don’t
Apply


Goal: Eliminate dangerous misconceptions about doing
business in China


When confronted with the skyscrapers of Shanghai, it’s
easy to assume that doing business in China will be similar to doing business
in New York City or London. Nothing could be further from the truth, according
to Usha Haley, author of the best-selling book “ href="http://www.amazon.com/Chinese-Tao-Business-Successful-Strategy/dp/0470820594">The Chinese Tao of Business: the Logic of Successful
Business Strategy” (Wiley, 2004). “Professionals
from the U.S. think they’re dealing with a modern society, when in
fact they’re dealing with a business culture with roots that are
centuries deep,” Haley explains.

For example, because the Chinese have a cultural preference for
family-run businesses, 90 percent of all privately owned firms in China employ
fewer than eight people. As a result, the supply chain — even for a
simple product like a child’s toy engine — can involve
dozens of interlocking firms and a network of formal and informal relationships
that would boggle the mind of the typical western executive.

Then there’s the omnipresent Chinese government. “The
Communist Party is more powerful than it’s ever been, which has an
enormous impact on everything, even the kind of information that you can gather
while researching a potential partner,” Haley says. Sometimes that’s
good — like when you’re trying to get China to enforce its
copyright laws — but there are downsides, too. China’s
government is full of locally and regionally deployed bureaucrats, many of whom
may need to be convinced, cajoled, or bribed. “There are entire
consultancies whose sole purpose is to help other companies avoid compliance
with government regulation,” Haley warns. Because of this, it’s
hard to know whether your business partners are operating legally or just
getting around the regulations, so you'll need to independently test products
to ensure that they meet specifications.

In order to outsource to China without running into product
safety or quality problems, you’ll need to scrap your preconceptions
of how business should be conducted. The rules are different, and you’re
not going to understand the full range of those differences until you’ve
been deployed in Chinese firms for years, maybe decades. “It can take
a lot of time for western executives to learn how to work effectively in China,
but the benefits are worth the extra effort,” says Frank Liang, general manager in Asia for the Greater China branch of
semiconductor manufacturer Broadcom. For example, chip-design
engineers who earn six-figure starting salaries in the United States earn less
than a tenth that in China —
a cost-savings that an electronics firm can pass along to price-conscious
consumers.

Nitty Gritty

How to Behave

Addressing Colleagues

  • The Chinese give their last name first; it’s
    usually one syllable.
  • Use a title, such as profession (e.g. “Director
    Wang”) or Mr./Ms.
  • If you know a Chinese person very well, you can use their
    full name (e.g. “Wang Han”).
  • If you’re meeting in the United States, you can
    use the western order (e.g. “Han Wang”).
  • If you’re very old friends (20 years of history,
    say), you can use just a first name (e.g. “Han”).

Exchanging Business Cards

  • Present
    your card with both hands, your name facing outwards.
  • Never toss
    a business card onto a table.
  • Examine any
    card presented to you for at least 10 seconds.
  • Comment on
    it; say something nice.
  • If seated
    at a table, carefully lay the card out next to you.

During Meetings

  • Expect
    people to sit and stand too close for your comfort.
  • Never touch
    a colleague. No backslapping or hugging; handshakes are OK.
  • Forget
    jokes and business slang; they’ll get lost in translation.
  • Avoid broad
    gestures when you talk; they’re considered vulgar.
  • Present a
    small, wrapped gift to all meeting attendees.

Source: The U.S.-China Business Council


Recruit a Local Agent


Goal: Hire somebody who can navigate the local
business community


To conduct business in China, you’ll need a “local
intermediary,” an agent who can represent your interests, provide the
right introductions, and negotiate agreements. The ideal agent should be fluent
both in English and the local Chinese dialect in the region where you plan to
do business. Preferably, he will be middle-aged (the Chinese equate youth with
callowness), male (China remains largely patriarchal), and married (seen as
showing stability of character).

In addition, your agent should have at least a decade of
experience working outside China, preferably in either your industry or that of
your target customer, according to Tim Wang, regional president of Novellus
China, a subsidiary of the computer-chip manufacturer Novellus. “Essentially,
you’re looking for somebody who can command the respect of the
executives with whom you’ll be dealing,” he explains.

In most cases, the intermediary either will want to set up a
separate company or work through his existing company. The advantage to this
arrangement is that it isolates your firm from practices that you probably don’t
want to know too much about, such as bribery and kickbacks. On the downside,
the agent may act more independently than you’d like. “I’ve
seen situations where local representatives were running businesses on the
side, using the same contact lists, customer lists, and intellectual property,”
Wang says. To keep the intermediary honest, insist on an independent
translation of all documents pertaining to the negotiation of any contract,
says Tobey Marzouk, partner at Marzouk
& Parry, a law firm that specializes in software litigation.

Other Resources

Where to Find a Local Agent

Here are the six most likely places to find a referral for
an agent:

1. The U.S.-China Business Council. This Washington, D.C.-based
organization promotes trade between the two countries and maintains contacts
with many Chinese businesses.

2. Local trade associations. Many states have local trade groups
that are similar to the U.S.-China Business Council but smaller and focused on
relations between China and individual states.

3. U.S.-based MBA programs. A fair percentage of MBA students in the
United States are originally from China and may be open to returning to help
you bootstrap your project.

4. Alumni organizations for Chinese universities. Some Chinese
colleges — notably National Changhua University of Education —
have MBA programs that emphasize cross-culture business problems.

5. Your own company. If you belong to a big enough company, chances
are good that it employs somebody who hails from the region where you want to
deploy.

6. Your Chinese customers. If you’re actively selling
products in China, then you may already have a relationship with an individual
who knows your business and can navigate the local shoals.


Clearly Define All of Your Requirements


Goal: Ensure that the outsourced product fits your
strategic needs


In China, you can’t afford to take anything for
granted. Your product definition must specify not just how it will look and how
it will operate, but also quality standards for every component, every
subcomponent, and every material involved in the product’s
construction. More importantly, all of those requirements must be
reflected in a detailed contract that’s specific to that product and
that deal. This is not the time to scrimp on legal fees with the kind of
generalized, fill-in-the-blank outsourcing contract you’d normally
use with a U.S.-based firm.

That’s not all. If you plan to sell the outsourced
product in the United States or Europe, you’d be wise to specify
working conditions, the minimum ages of the workers involved, and even the
minimum wages to be paid to the employees. The last thing you want is for some
sharp-eyed investigative reporter to show the world that part of your product
came from a sweatshop full of starving children. And don’t forget
industrial pollution — a major public relations time bomb. In the age
of YouTube and camera phones, it’s only a matter of time before a
U.S. company gets burned for hiring a Chinese partner that’s dumping
poison into the local watershed.

Don’t fool yourself into thinking that the contract
automatically will be honored. Under no circumstances should you advance money
for the product prior to shipment. Instead, “conduct all business
through a ‘letter of credit’ that specifies what the
outsourcer will supply and the conditions under which the product will be
considered acceptable,” explains Brad Finn, president of Marlboro
Shoes, a multi-million-dollar shoe wholesaler that outsources heavily to China.
The letter will come in handy in Step 4, when you assess the product before
paying for it.

Hot Tip

Guanxi 101

Nobody can do business in China for very long without encountering
the term guanxi (GWAN-shee). Loosely (and inadequately)
translated as “connections,” guanxi refers to a set of
mutual obligations shared between individuals, irrespective of their position
in society or inside an organization. One earns guanxi by doing favors that
must be paid back in the form of return favors. Once a guanxi relationship is
established, either party may make demands on the other without warning and
without prior discussion. Chinese businesspeople keep close track of guanxi, and
if they feel that the implicit contract isn’t being honored, they may
become distant, unhelpful, and possibly even vindictive.

Guanxi is, in some ways, the grease that makes the wheels of
commerce turn in China. It provides a way of getting things done without
recourse to official channels. Unfortunately, guanxi is a double-edged sword. “While
your local intermediary, or the CEO of the firm that’s your primary
outsource, may have guanxi that proves useful to your project, unofficial
relationships open the possibility that your interests will be sacrificed for
the good of the relationship,” explains Guo Hai, a business
consultant based in Hainan, China. “Because of this, it’s
absolutely critical that you not depend entirely upon the guanxi of others.
Instead, you should strive to develop your own guanxi network, a process that can
take many years.”


Monitor, Monitor, Monitor


Goal: Make sure you’re actually getting what
you’ve paid for


Even with an ironclad contract and letters of credit, it’s
up to you to confirm that the product delivered is the one that you originally
defined. The best time to check is before
the product is in shipment, according to Finn. “Payment should be
entirely dependent upon whether those products satisfy your specifications,”
he says. Demand that an independent laboratory headquartered outside China
conduct any required testing, such as checking for lead content in paint. “You
should pay for the product only when you’re sure that you’re
getting what you want and that it was made in a way that won’t damage
your brand,” Finn says.

Monitoring the final product is not enough, though. “The
only way to truly ensure that you’re not importing a product that’s
hazardous, or supporting a pollution-generating sweatshop, is to demand
complete transparency of the supply chain,” according to Tom Travis,
author of “ href="http://www.amazon.com/Doing-Business-Anywhere-Essential-Global/dp/0471973173">Doing Business Anywhere: The Essential Guide to Going
Global” (Wiley, 2007). He recommends that you insist your
local agent provide a complete map (complex though it might be) of the entire
supply chain for your product and that you be permitted to tour the outsourcer’s
facilities — and the facilities of their suppliers —
without prior notice. “If you don’t know exactly what’s
going into your products, or exactly how they’re being made, you’re
putting your corporate reputation and your brand image at incalculable risk,”
he says.

Above all, do not depend upon the ability of the Chinese
government to monitor working conditions and pollution. “The problem
in China isn’t with the laws themselves, which are sometimes as
stringent, or more stringent, than comparable laws in the U.S.,”
Haley explains. “The problem is with enforcement, which is often seen
as a way for government inspectors to earn bribes rather than a way to ensure
that workers and the environment are protected.” In other words,
while the central government has good intentions, those intentions don’t
always filter down to the local level, where the inspections take place.

Voice of Experience

“One of the biggest challenges in China is
figuring out the fundamentals: how to find a partner, how to make an
investment, how to craft a business agreement. It’s difficult because in China
there are no credit records, no reliability, and often no record of debts and
liabilities. So it’s up to you to dig for the truth.”

Tim Bennett, former COO for the AeA, an electronics industry trade group

  • Geoffrey James

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