Tips on how to prevent business risks in China
Co-authored by: Celeste Pacioni & Zara Kukkamaa
Have you ever wondered about what the right approaches are when starting a business relationship with a Chinese supplier in China?
As we all may be aware, China’s manufacturers have a significant cost advantage in sourcing globally, especially to the Western world.
Between the 80s and 90s, the Chinese economy could hardly provide enough employment to all the population (source: "Poorly made in China" by Paul Middler). For this reason, the country gradually relied on private industries for international competitiveness and employment.
Since 2000, China’s manufacturers gained support from political influences, which helped factory owners enter into deals and attract foreign currency. Attracted by the results of China’s development and its low-risk business environment, an increasing number of international investors started to enter the Chinese market. Of course, the well-performed speed and convenience of transportation were also factors contributing to the attractiveness of China.
In this blog, you will come across some interesting aspects of the Chinese business world that not so many international buyers are acknowledged with. All the tips are inspired by experienced businessmen and are most likely useful for westerners’ customers who intend to go to China to invest a big amount of money by finding a suitable Chinese supplier.
1. What role does culture play in your procurement journey in China?
In order to fill the cultural gaps between the East and the West, it is very important that every commercial strategy has a deep comprehension of distinctive Chinese cultural fundamentals.
It is not common in the Chinese culture for someone to be comfortable admitting his or her faults. However, Chinese often take their responsibilities very seriously, and they are usually available to discuss work at any time of the day even when off duty.
Some of the cultural aspects that should be taken into consideration are:
Being able to speak and understand the Chinese language:
Before starting an interaction with a Chinese supplier or manufacturer, it is recommended to consult sourcing companies or matchmaking partners who are specialized in this line work and can help you fight against any language or cultural barriers. Even though a small portion of Chinese wholesalers know how to speak English fluently, in many cases they rely on instincts and emotions when needed. It is recommended to communicate with them in the Chinese language in order to avoid misunderstandings.
If you visit the biggest trade fairs in China, the Canton Fair in Guangzhou and the East China Trade Fair in Shanghai, you can find thousands of suppliers and manufacturers who gather together with their buyers. On this occasion, you can create new business contacts by getting to know Chinese potential procurement partners, who operate in many different fields, and there you can stay in touch by exchanging your business cards.
The importance of exchanging business cards:
Business cards (“ming pian” in Chinese) have an important meaning in China: it is suggested that your business card shall be written in both English and Chinese (in simplified characters).
When you are about to hand it to a potential Chinese partner, make sure to hand it while standing up with both hands side up. Additionally, your card shall face your contact so that he or she can be able to read it conveniently.
When starting a conversation with a factory owner, an interesting fact is that they may introduce themselves as “Wo shi XXX gong chang”, which means ”I am a factory called XXX” rather than saying “I run a factory called XXX”, this shows how much Chinese vendors are defined by their career. It is very important to bear in mind that not examining a business card in enough details can lead to a bad impression.
2. What is “Guanxi” (relationship) in the Chinese business environment?
Before significant investment in made-in-China products while outsourcing in China, you may take into consideration that finding a suitable Chinese supplier takes a while and a great amount of effort.
2.1 The usual way of starting a business relationship
Establishing a relationship with a Chinese counterpart in procurement can potentially be problematic, not only due to the language barriers but also due to cultural ones. It is useful to know that when Chinese are about to start a business relationship, they first focus on getting to know you personally before serious discussions. This may be an opposite story in the Western countries.
In the process of getting to know each other between suppliers and buyers, most likely during dinners and Karaoke parties, Chinese counterparts tend to use alcohol as a bonding mechanism. It is used not only as a way of breaking the ice but also as a method to connect with the Western clients, and to find out some details of the deal, such as the size of the new purchase. It is important to bear in mind that business communications in China do not always follow specific conditions or contractual details, especially at the beginning before any signed agreements. Instead, it is a slow process of mutual learning.
2.2 Relationships in China are based on a hierarchical approach:
The beginning of a new relationship between the client and his or her supplier is, in most cases, pleasant and positive, because the supplier works hard to have a good impression on the new client.
However, it is wise to assume that in some cases the equal business relationship may not last like this forever. Once the Chinese supplier gets massive orders from you continuously, the relationship can potentially start deteriorating from its side by assuming an imperial role behavior. This may happen because it is very common that in China most types of relationships are based on hierarchical approaches, and in this case, the Chinese manufacturer may start to feel power over its customer as the customer’s gaining mostly depends on the constant supplies. A visible sign of the deterioration is noticed when the supplier begins to reduce the amounts of raw materials or components, or starts to manipulate the quality of raw inputs.
The circumstance of the last-minute price increase is not an unusual episode. Together with the quality reduction, the phenomenon of the last-minute price increase is an unpleasant surprise given by the supplier without any notifications to its customer before the manufactured products are almost ready to be shipped.
These above events often lead the Western customers to end the deal to find a new supplier very quickly. However, this costs you time and potentially increases the risks of selecting a worse supplier. To avoid this kind of situation, it is recommended to proactively utilize a 3rd-party inspector, who can apply a quality check in factories regularly. In doing so, your supplier understands that his or her work is kept under your surveillance most of the time.
It is worth mentioning that this circumstance is related to the fact that some Chinese consider prefixed contracts and negotiations less meaningful, as long as the business relationship is under their control.
3. Why is “Mianzi” (face) so important in business relationships?
"Mianzi" can be translated as “face” or “appearance”. Similar to “Guanxi”, “Mianzi” plays an essential role in Chinese culture.
“Mianzi” denotes the individual’s value in other people’s eyes. It represents the reputation that a person has acquired during his life through success and failure. This is why Chinese like to have Mianzi (in a positive way). If someone has Mianzi, it means that this person is considered by others as rich, generous, connected, and with good tastes.
The fact that Chinese like to keep Mianzi (this positive image of themselves) may lead to them not being completely transparent enough with business partners, especially when challenges or mistakes occur. It is very difficult for Chinese to admit their faults, and sometimes this may cause a certain loss for those with whom they engage in business activities.
Understanding both concepts of “Guanxi” and “Mianzi” and accepting their importance and associated risks, are vital for a successful business journey in China.
4. What happens when disintermediation takes place?
Disintermediation is a process in which the middlemen or intermediary is cut out from future transactions. This can be relevant in your procurement journey in China.
This concept tends to mainly benefit Chinese manufacturers. It involves three players: the manufacturer, the importer, and finally the retailer.
About such a case, an example is exposed in the book called “Poorly made in China”, written by Paul Middler: "An importer who was purchasing a product at $2.25, for example, might have sold that product to a retailer for $4.40. The retailer then got the idea: I’ll go around the importer, straight to his supplier, and I’ll pick up the same product for $2.25. However, when the retailer went direct, it was surprising to learn that the manufacturer was not willing to sell at $2.25, but was instead trying to get the same price ($4.40) that the retailer had been paying the importer. In the end, the factory would cut the retailer a small discount to entice the importer’s customer to cut the importer out of the picture. Once the supplier and the retailer had burned their bridge, the supplier was then, of course, free to raise prices further".
This phenomenon makes the manufacturers look like they are playing chess, while importers are mainly thinking checkers. This happens because Western businesses tend to be more straightforward, and as a result they’d expect to buy a manufactured product for two dollars and plan to sell it for four. On the contrary, Chinese manufacturers’ main concern is to catch their customers' attention and engage new personal connections with government officials by manufacturing a product for one dollar and selling at the same production cost.
5. How labor costs affect procurement in China?
Economies of scale do not always have the same force in China as in other markets. One of the reasons is that commodity prices are controlled at the national level in certain industries, and this may cause raw materials, that are sold on large-scale, are sold at the same price as the ones in smaller amounts.
During the last decades, China's industrialization was helped by its labor force competitiveness and availability, especially when compared with developed economies' labor forces. Wages were a major factor, given China's then low income per capita, but also, much greater flexibility in labor relations, an almost infinite supply of workers, among others.
While previous decades have been considered to be a permanent rule, the previous situation is not present anymore in many industries. Capital-intensive industries do not enjoy such labor economies, industries located near important cities now face higher labor costs, educated workers are sometimes more necessary than skilled workers, and so they require higher salaries, etc. It is true however that some industries are still very competitive due to the rising labor costs and the gradual currency appreciation. In 1998, unit labor costs in China started to fall and only started to increase by 2003. Despite the rise, China’s unit labor costs remain low compared to other Western countries.
Therefore, when thinking about China as a sourcing-market, the specific situation of the industry is vital to understand as well as each factor of its competitiveness. Counseling services ought to be adapted and have experience with the specific industry of interest.
6. How important is it to pay attention to Incoterms and landed cost?
Incoterms (shipping terms) are meant to establish what the seller’s and buyer’s obligations are, and when the transfer of risk happens between them. Both of them must handle the costs, responsibilities, and risks when due. Permits and insurances are also two important factors that need to be managed by both sides.
As shown in the diagram below, the whole process involves the movement of the goods from the factory onto the carriers. Once they arrive at the destination place, they are finally moved to the buyer's warehouse.
The determination of transfer of risk according to the Incoterms
The source: Projectmaterial. What are Incoterms? (ExW, FOB, CFR, CPT,…)
There exist two known Incoterms used for international shipment: the Ex Works (EXW) and Free on Board (FOB). The EXW is the Incoterm less commonly used mainly because the buyer is subject to all transportation costs, and in many cases, it is challenging to establish these costs at the beginning of the process. According to the FOB terms, on the other hand, the trader covers the costs and takes responsibility for the orders until it has been shipped on the carrier. At this point, once the orders are being shipped, the buyer becomes responsible for all costs and risks till the end of the whole procedure. Both types of Incoterms are useful to establish the landed cost. It is recommended to calculate your estimated landed cost beforehand since it can turn out to be expensive. In case the cost is higher than expected, consider negotiating with other suppliers in order to pay the costs within your budget.
Taking into consideration all the aspects mentioned in this blog can be useful for your company’s future in China. Dealing with a Chinese supplier counterpart can be challenging especially due to cultural barriers, but if you aim to adapt yourself to a different perspective, you may find it easier to overcome business struggles when seeking global sourcing China advantages.
Hohot Consulting Oy supports global partners in procurement management in China. With a strong knowledge of both the international and Chinese market, we are looking forward to facilitating your business success in China. Learn more about us here.
A little bit about the author:
Celeste Pacioni is an Italian sinologist who is very passionate about China and Chinese culture. She has a bachelor’s degree in Oriental studies with a focus on the Chinese language and culture. After spending one year in China, a semester in Hangzhou and five months in Canton, she obtained a master’s degree in “International Business in China” from LUM Jean Monnet University of Milan. She is keen on helping Western companies to build their success stories in China when dealing with Chinese procurement and market research.