Some importers can afford to conduct business in a friendly way with their Chinese suppliers. I am thinking of buyers who give regular orders to a few stable vendors, who don’t work under intense timing pressure, and who enjoy a large degree of flexibility (for example, they keep a safety stock in their warehouse).

But this is not the case of most importers, who absolutely have to find ways to minimize delays and non-conformities. They need to create a system of incentives that aligns the supplier’s interests and the buyer’s needs. Such a system must have teeth, or Chinese suppliers would try to play games around it.

One note of caution: the purchasing company should reach a certain level of maturity before putting penalties in place. If you keep asking your suppliers for favors and exceptions, the priority is to organize yourself. Put in place some procedures for your buying process. Then, and only then, can you force your suppliers to comply with your rules.

A few examples of penalties

Every buyer can make a list of things to avoid, and apply penalties for them. For inspiration, here are a couple of examples.

-1- Penalties for late shipping. Late shipments trigger extra freight charges (several shipments, air cargo…) and might even cause lost sales. How to force suppliers to respect the timing? Buyers can charge 3% for 1 week late, and another 10% for each extra week of delay. Another example is the payment of air cargo after two weeks of delay.

Similar penalties can be put in place against delays: penalty for late inspection date, penalty for late sending of shipping documents, etc.

-2- Penalties for non-respect of packaging specifications. I have seen very long lists of charge-backs. For example: incorrect price tickets = $1 per unit; incorrect shipping marks = $150 + $2 per unit; non-standard pallets = $200 per order.

Note: you will notice that the above issues (late shipping, non-conformities) can be prevented in good part by conducting inspections during production and before shipment. In my view, product inspections cannot be replaced by penalties, except after a long history of accepted shipments. But penalties can be quite useful in influencing the behavior of Chinese suppliers.

How to enforce penalties?

Penalties should be reasonable, systematically applied, and anticipated by the supplier. In practice, penalties should be mentioned on purchase orders. They should also be written in the contract and/or in the letter of credit (if applicable). Then the buyer only needs to issue debit notes for each penalty, and deduct them from payments.

It is very important to make sure the supplier is aware of penalties, and takes them seriously (Chinese exporters seldom read contracts).

Avoid unreasonable penalties

Penalties should be legitimate, or the supplier will feel taken advantage of.

Danger No.1: not taking responsibility.

Let’s say the buyer was unusually slow in approving samples. Production started later, and shipment is delayed. Should the supplier pay full penalties? Would it be fair? Of course not. If you expect your suppliers to behave honestly with you, don’t infuriate them!

Danger No. 2: charging penalties that have no relationship with your true costs.

I heard that a very large American retailer charges USD10,000 to suppliers whenever the approved sample is not presented to the QC inspector. This is just an example; they have such penalties for about everything.

In that kind of incentive system, the buyer actually makes money on the mistakes of his suppliers. It is not legitimate. The penalties should correspond to the true cost imposed on the buyer’s organization.

In the long run, what happens? The suppliers increase prices steadily, and the buyer has to switch to other vendors. Everybody loses.

In the end, the buyer’s objective should always be to avoid being in a situation where penalties apply.