An Interesting Example of China Quality Scandal

The Changzhutan, a Chinese newpaper, just revealed one more food scandal. Most details have been translated by The Nanfang Insider into English.

1. The facts

Most street vendors sell beef and lamb meat-on-a-stick at the same price. It’s actually all beef meat. How is the beef taste masked? “By marinating and seasoning it with lamb flavoring agents”. Why? Because beef meat is much cheaper than lamb/sheep meat.

It will not come as a surprise to those who follow daily news here. For example, I read several stories about pork meat being “transformed” into beef meat on an industrial scale. But this story is interesting because several street vendors were interviewed. And they used excuses that are familiar to many importers…

2. The vendors’ justifications

They offered three types of justifications:

The “I don’t know the details so I am not guilty” defence:

The wholesaler told me this is lamb meat. If you were to ask me if this is really lamb meat, I couldn’t tell you.

The “only idiots really believe what we say” defence:

Calculate how much beef costs versus how much lamb costs.

The “everybody is dirty anyway” defence:

Everything has been altered; if it hasn’t been altered and doesn’t have the taste, who will want to eat it?

3. Lessons for foreign buyers

I think a few lessons from this example carry over to the international trade world.

Street vendors don’t risk much. They can disappear overnight. Same as most sourcing agents and many small trading companies.

There are many fly-by-night companies in China. Many of them are totally ruthless. The reason is, they can afford to. They have very little to lose. That’s why there are many scammers out there (yes, even among the Alibaba “Gold Suppliers”).

If a price is too good to be true, or if you don’t understand the economics of a deal, something bad is probably hidden in a closet.

As a buyer, try to evaluate the average market price for the product you are looking for. Any offer below the average price is suspect. Any offer 30% below the average is very, very suspect.

If the sub-supplier is at fault, your supplier will not accept any responsibility.

Most exporters do the assembly/finishing operations only. They purchase the components from sub-suppliers. And, in 98% of cases, they use whatever components they receive, for three reasons. First, their quality system is full of holes. Second, they usually don’t have time to wait for a new batch of components. Third, rejecting substandard components will cause the sub-supplier to “lose face”, so this is usually a big no-no.

In China, doing something shady is not a problem; only getting caught is a problem.

I have nothing against Chinese people in general, but one has to admit they live and work in a system that tends to encourage unethical behaviors. Therefore it is wise to be suspicious until proven wrong, rather than trusting people until proven wrong.

What do you think? Are there other lessons to learn from this food scandal?

China Manufacturing: Options for Payment

Many inexperienced importers accept the payment terms proposed by Chinese suppliers without thinking twice. Yet this topic is directly linked to the amount of risk each party takes. It is extremely important.

1. The most common payment terms for sea shipments

Chinese suppliers usually propose this setup:

30% by bank wire before production starts, 70% balance by bank wire before the goods are handed over to the forwarder.

And they can often (but not always) accept this alternative, which is more favorable to the buyer:

30% by bank wire before production starts, 70% balance by bank wire after the goods are shipped out and after the supplier has sent a copy of the bill of lading to the buyer

Notes:

  1. A Chinese supplier never wires the advance payment back. It should be called a “nonrefundable deposit”. That’s why buyers need to screen their suppliers carefully. And factory audits are very good tools to this end.
  2. Payment is done before the client sees the products in his warehouse. And faulty products can seldom be sent back to China for repair. That’s why a quality inspection before wiring the balance is a very good idea in most cases. If you find quality issues after 100% has been paid, you have no leverage over the supplier.

2. Letters of credit (L/Cs)

I described the way L/Cs work before here and here. Basically, the buyer’s bank promises to release the payment once it gets certain documents (commercial invoice, packing list, bill of lading, certificate from an inspection agency, etc.) at the condition that these documents are (1) received in time and (2) in perfect conformity to requirements. If that’s not the case, the bank finds “discrepancies” and payment is suspended.

Suppliers are well aware that there are virtually always discrepancies, and in the end the buyer has the power — he can wait a little if he is short on cash at the time, or he can refuse the transaction if he doesn’t want the goods.

L/Cs are also a good tool for importers who buy for the first time from a supplier. The key advantage is that no “nonrefundable deposit” needs to be wired prior to production. So, if the supplier messes up the order completely, the loss is inconsequential on the buyer’s side.

Fortunately, some serious suppliers accept an L/C. The difference between an L/C “at sight” and a setup whereby the 70% balance is wired after the goods are shipped is actually not huge for the supplier.

3. Hybrid solutions

I have seen terms calling for a 30% advance by wire before production starts and for 70% by letter of credit at sight. It makes sense, for example, if the supplier is to pay for molds or special tooling.

Another variant: 30% by bank wire before production starts, 40% by bank wire before the goods are handed over to the forwarder, and 30% after the goods are in the customer’s warehouse. This type of formula seems to be gaining in popularity.

4. Extreme solutions

I see more and more North American importers negotiating (successfully) for payment terms of 100% after reception of the goods in their warehouse. Naturally, it is easier for large and established companies — Chinese manufacturers in their industry have heard of them and are pounding their doors.

I also remember a few large European companies offering to work on “open account” terms — i.e. the supplier ships and the customer pays later, if they want to.

5. The value of contracts

Chinese exporters, as well as Hong Kong-based trading companies, seem to regard contracts as close to worthless. Hence the importance of well-suited payment terms.

By the way, foreign importers tend to overestimate the value of their contracts. Many purchasers don’t know that Chinese courts don’t accept judgements from certain countries, including the US (more details here).

What do you think?

China’s Logistical Challenges and Opportunities

Best Quality & Sourcing ArticlesHere are some interesting or useful articles that I found recently.

The flow of things

This article exposes China’s paradox when it comes to logistics: infrastructures are often excellent, but shipping products within China is particularly expensive. For example, “sending goods from Shanghai to Beijing can cost more than sending them to America.”

Silk Road Revival

Watch this nice infographic about a concept pushed by the Chinese central government, which has set aside 10 billion RMB to build the corresponding infrastructure (for example, a port in Malaysia).

Polar bearings

Beijing is starting to plan for a new route from China to Europe. It will be shorter, available only during the summer and will go through the Arctic Ocean.

Rise of the machines

Industrial robots are spreading in more and more sectors, and are fast becoming more affordable to many factories. In addition, China’s 12th Five-Year Plan is encouraging the growth of domestic robot manufacturers. The risk is actually over-investment in robot factories, as was the case recently with solar panels!

Timberland Meets Two CSR Goals Ahead of Schedule

Most consumer brands are afraid of potential PR disasters and focus their energy on auditing factories and ensuring the risk of child labor and factory fires is as low as possible. But other brands are more proactive and set themselves ambitious goals. Timberland is one of these.

59 China suppliers fail safety rules – Samsung

Meanwhile, companies like Samsung and Apple are still pushing their suppliers to improve on basic criteria such as the use of personal protective equipment.

Factory safety is improving in Bangladesh—but it still takes three months to get a new fire door

When it comes to dangerous working environments, Bangladesh beats China hands down. And, despite all the pressure to reduce the risk and the impact of fires, change is very slow.

In China food testing, safety inspectors are often one step behind

After yet another scandal in China’s food supply chain, journalists wonder how it could happen. And they point fingers to the auditing process. I partially agree — unannounced audits are relatively common in the food business, but it seems like Yum Brands and Mc Donald’s don’t use them sufficiently. The biggest issue, though, is certainly the low level of the factories they work with, as well as the price pressure they exert on suppliers.

Into the red

The RMB is slowly becoming a major currency in international trade and challenging the US dollar. In an HSBC survey, 22% of respondents said they already settle business with RMB!

Costs when importing from China – The Ultimate Guide

Good overview of the costs involved in purchasing products in China. Fredrik from ChinaImportal hasn’t forgotten anything important! Great read for buyers who are new to China.

Why Excessive Stock is a Big Problem in a Factory

Most Chinese factory managers have never completed advanced education. But they are generally very savvy at certain aspects of their job.

There is one thing they can’t wrap their head around, though: the fact that the rules of physics and mathematics apply in their factory’s operations.

And that’s a problem. If they accepted that fact, they could accept counter-intuitive conclusions much faster. I am going to walk you though a few such conclusions below, based on Little’s law.

As Pascal Dennis writes, Little’s law in factories is the equivalent of Force = Mass x Acceleration in general physics. Here it is:

Amount of work in process = throughput at the bottleneck x cycle time for production

If we see it from another angle, it is equivalent to:

Cycle time for production = amount of work in process / throughput at the bottleneck

And here are a few of implications:

  • There are two ways to reduce the time to produce a certain batch: release a lower quantity of work in process in the system, or increase the capacity of the bottleneck(s).
  • If we release more work in process on the factory floor, the cycle time increases. So making a batch of 20,000 pcs instead of 10,000 pcs means the cycle time automatically doubles (all other variables being held constant). (This is rather intuitive.)

We can see this in many situations. For example, when a factory moves to a larger building, it is often surprised that production lead times become much longer.

The reason is, each process has more room for stock and the planners try to take advantage of it by increasing batch sizes (in a misguided effort to reduce average cost per piece). Again, when work in process is higher, cycle time is longer.

Also, buyers should beware of workshops with an ocean of unfinished goods. A factory with large amounts of stock on the shop floor probably needs a long time to ship finished products (much longer than a similar factory with much less stock lying around).

We can also see Little’s law this way:

Throughput at the bottleneck = amount of work in process / cycle time for production

It means that, if there is zero work in process stock in a factory, the throughput is zero. In other terms, production is zero. There is no such thing as a zero-stock factory. The real enemy is excessive inventory.

Another reason why too much stock is bad is not linked to Little’s law but it deserves mentioning. Stock hides problems. When a machine is poorly maintained and breaks down, or 100 pieces are found with defects, everybody should try to understand where the problem comes from and fix it. But this is much less of a problem if there is a lot of stock. Production never needs to stop, so the problems are not visible and don’t get fixed.

Lean manufacturers gradually lower the level of inventory to make these problems appear and to address them. This approach is often presented this way (I found this image on the internet, but it’s been drawn in many different ways over the years).

Reducing the level of stock in a factory

What do you think?

Direct Sourcing in China: What Functions Do Importers Need to Perform?

Direct sourcing has been the dominant trend over the last 20 years. Importers have reduced FOB prices by going “factory direct” by eliminating trading companies. But, in some cases, it has often resulted in higher overall costs and lower reliability.

The good news is, importers can work much more professionally if they manage the whole process themselves. The bad news is, it takes serious work.

Fifteen years ago, most importers were working with trading companies (either intermediaries based in Hong Kong, or “import & export” firms on the mainland). This setup had a cost (the trader’s margin, at that time, was seldom below 20%), but purchasers were giving their business to professionals who were carrying certain functions (quality control, problem solving…).

As “cutting the middleman” became a common mantra, buyers sometimes forgot that they need local support. Let’s look at the main functions traditionally managed by trading companies:

  • Match making: either via a trusted network (for insiders only), or through a more scientific approval process comprising of supplier pre-qualification, background checks and factory audits.
  • Management of new product developments: many foreign buyers don’t know how to communicate clearly with Chinese manufacturers. Exchanging messages through a young translator, sending and resending samples, is frustrating and time consuming. Some trading companies and agents are very good at making this process more efficient.
  • Completing product specs: most importers don’t bother to define their all their expectations. Someone has to decide what packaging materials to source in 90% of cases. Relying on the factory is very risky, and a better solution is to pay a QC firm to define it clearly once and for all.
  • Quality control: by third-party inspection agencies or in-house staff. The use of statistical tools that are also used by retailers in the importing country reduces the risks of rejection of a batch that was accepted back in China.
  • Reducing payment risks: buyers need to use tools such as letters of credit or OEM agreements, especially when a relationship is starting and there is no trust.
  • Getting out of trouble: this is probably the most under-rated function of a good intermediary. When problems arise—and they will—an importer cannot just solve them by emails and phone calls.

Have I forgotten something?