How to Outsource Your Manufacturing to China

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.

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.

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.

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.