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A Swedish supplier to the automotive industry have hired Scandic Sourcing to handle the construction of a two story office area in their newly rented factory space in Wuxi, a populous city a couple of hours car ride Northwest of Shanghai in the neighboring province of Jiangsu. Scandic Sourcing's blog follows our new coworker Edvard Olsson to Wuxi for the completion of the factory.

 Edvard was previously CEO for Ipeg in Shanghai and is currently responsible for factory establishments and interims management services for Scandic Sourcing.

Overview of the automotive industry in China. 

Our first stop is in the industrial zone Wuxi New Area where final negotiations are conducted with a Chinese design firm regarding the construction and decoration of the office area.

 

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The negotiations are in their final stage, the key is to have an eye for details and to have done adequate research. “We cross referenced with previous quotes from other design firms so that we know that their quote is reasonable in relation to the market price for this kind of construction. Then it’s a matter of knowing where there is room to negotiate the cost. Currently we are close to reaching the target cost set by our customers in Sweden”.

Factory establishment in China 

We then move on to the factory hall in another part of Wuxi; it is owned by a local landlord who owns a large area of industrial halls that he rents out. The landlord conducts business in a traditional Chinese fashion where agreements are reached in informal settings, so one has to be keen not to take anything for granted. 

 

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“The most important step in regards to permits is to get the new construction approved by the local fire department authorities”, says Edvard. We inspect the hall and especially the floor. “You always have to be aware of the fact that landlords sometimes try to take shortcuts to save money – one way they do that is to not use proper materials in the construction. For instance we have to make sure they used an adequate amount of concrete steel in the foundation so that it can hold the minimum weight we agreed on; in this case they followed the specifications”.

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Once the construction gets underway its important to inspect it continuously to confirm that everything is handled according to the original designs. The office building will be ready in November, so the construction will go quickly – the key to meeting the narrow deadline is to discover possible errors in an early stage to correct it in time. By March of 2016, everything in the hall will be ready for full scale production.

 

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Business in China is rarely, if ever a smooth ride, but there are certain steps you can take to ensure that you avoid the worst pitfalls. Finding the right suppliers and then building a relationship with them can serve to greatly stabilize your supply chain, and make your sourcing and procurement more effective and less headache-inducing!

1. Due Diligence

The best way to get out of trouble when dealing with Chinese suppliers is never getting into it in the first place, and that’s where Due Diligence comes into play. Due diligence, in its simplest form, is the act of evaluating a prospective business by investigating their  financial, legal, operational and reputational state, and it’s arguably the most important thing you can do when sourcing in China.

So once you shortlist potential suppliers and you want to decide who approach for your potential order, you perform Due Diligence. You scrutinize the Chinese supplier’s operations. You check the financial records which recently became more transparent and easy to do and you look for discrepancies and inconsistencies and clues – anything to weed out a potential fraudulent supplier. Is their factory address located in a residential area? Is their address the same on their English website as their Chinese website, and does it correspond with what they stated via Email? What does the supplier’s competitors, customers and related industry media say, have they even heard of the supplier? If yes, what is their reputation? 

Due Diligence is not easy, and the numbers and the information can quickly become confusing. The complexity of the Chinese market and the complete quagmire you might find yourself into with conflicting reports and discrepancies is the nature of information gathering in China; thus paying for a professional service provider to conduct due diligence is a small, but highly sensible cost when compared to the potential losses of not doing so and is something to be highly recommended. Just the benefit of visiting the Chinese supplier’s facilities in person is reason alone to either travel to China yourself or hire a third party that can conduct Due Diligence on site.

* Watch out for: Suppliers who offers the product or service far below the market value are high risk actors that you generally want to avoid. The quality of the promised product or service is likely to be below what's acceptable.

 

2. Meet the suppliers in person

China is a relationship driven society, and to ensure that communication is effective, it’s recommended to meet the supplier in person, either yourself or through intermediaries. Sealing all the details of a contract via long distance emailing or phone calls can quickly become time-consuming and confusing. Having an informal dinner where you spend time chatting and building a relationship can go a long way towards getting the supplier to agree on the terms you want, rather than sending email.

 

3. Draft an iron-clad contract

Your negotiations seems to be going well with your Chinese suppliers, they agreed on all the key issues and promised to deliver your goods in time, and with the right quality. This is all well and dandy, but it doesn’t mean anything, unless it’s stated in a contract that both parties signed and agreed on. Verbal communication and informal promises are especially difficult to rely on in China.  Due to the famous “cultural differences” you can assume that Chinese suppliers communicates in a way where they are focusing on avoiding criticism and addressing concerns indirectly rather than being completely transparent and tackling challenges head on. That means that when a supplier might tell you that they will “try to meet the shipping deadline”, what they are in fact saying is that “there is no way we can meet the shipping deadline”. This is an important cultural discrepancy to wrap your head around. The way to work around issue is to draft an iron-clad contract that leaves few points up for discussion and penalizes the supplier if they cannot reach the quality you ask for in your agreed on time-frame. Add penalization clauses for damages, defects, and delivery deadlines. For instance you might have informally agreed on that the supplier will ship your goods within 30 days. You will know for sure if this is the case if you add a late delivery clause where the supplier starts paying a daily penalty for each day he fails to deliver the goods past the agreed on deadline. Bonus: Such a clause might also get the supplier to prioritize you over other less zealous customers).

 

4. Use intermediaries

If negotiations turn sour and you hit a standstill on key issues with an important supplier, it is advisable to use intermediaries to continue negotiations, especially if your supplier relationship is getting strained in the process.  

Note: It’s almost never a good idea to directly confront your Chinese suppliers with strong or emotional language – keeping your calm is crucial; one outburst might erase months of relationship building.

A third party can emotionally defuse the situation and address issues in a non-confrontational manner and objectively solve them in a way that – crucially – allows the supplier to save face.

 

Bonus tips:

1. Be specific

Try to be as specific and objective as possible, even when faced with major issues. Instead of saying general terms like “everything is a mess”, remain specific and say “these many items had this specific issue” (not only will this be helpful towards solving your issues but this also notifies the factory whether your problems are individual control issues or molding issues that’s affecting the entire production). Specificity is key.

 

2. Be calm and rational

Always in dealing with Chinese suppliers, it’s important to never lash out in angry outbursts, (even when you feel you have all the right in the world to do so). The Chinese counterpart will almost always become defensive themselves if you do so. If they issues pile up, you might want to solve them through intermediaries instead, but if you cannot, staying calm and rational can make the difference between a successful project and a disaster.

 

3. Don't rush the negotiation phase

Chinese suppliers take pricing and your Request For Quote(RFQ)/bidding as a process. They use it as a conversation, hence they send incomplete info to elicit reaction from the other side and some will keep very large negotiation margins in the first stages; keep that in mind if you previously assumed everything will be settled in the first RFQ.

 

4. Don't assume anything

When importing from China, assumption is the buyer’s worst enemy.  Raise key issues in bullet-point specificity and back it up with an iron-clad contract.

 

5. Don't emphasize single details

If you over-emphasize a single technical detail (especially if you use emotional language), you might get the supplier nervous over a certain aspect, which will have them they will think that this aspect is the only aspect of importance and thus this can lead to that other areas being neglected.


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China is selling cars faster than anywhere else in the world. In 2007 it overtook Japan and two years later, automotive sales overtook the US to become the world’s largest automotive market. The staggering sales and output is showing few signs of stopping; in 2009 China outproduced the US almost 2 to 1 with 19.27 million units produced compared to 10.3 million units in the US. 2014 showed signs of a slowdown, as have the first quarter of 2015; total sales growth is still expected to rise with 8% reaching total sales of 21.3 million vehicles this year.

 

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The sales are mainly driven by Original Equipment Manufacturers (OEMs) and is funneled through China’s 2770+ authorized dealers. A rough quarter of the authorized dealers are so called mega dealerships which belong to a network of OEM-authorized auto dealerships that sell multiple brands under the same roof. The mega-dealerships account for close to half of China’s total auto sales.

As of 2011 there were 115 native automotive companies in China, despite government attempts to consolidate the industry into a few major players in accordance with the very succesful Japanese model. The major Chinese automotive manufacturing entities such as SAIC, Dongfeng, Geely, and GAC are State Owned Enterprises which focuses on output rather than quality and innovation and has done poorly in international markets. Repeated low ratings in safety tests have furthermore cemented the reputation about Chinese cars as being unsafe, despite efforts to correct this.

Domestically, Chinese brands account about 42% of total sales. As of last year, GM was the bestselling international brand in China with 14.7% of the market, closely followed by Volkswagen with 14.6% of the market share.


A brief history of China's automotive industry: Early Joint Ventures

 
Volkswagen made history as the first Western company to build a plant in China when it joined the Shanghai Automotive Company (now SAIC) in 1982. The Joint Venture set the stage for the model and policy dictating how the West would do business with China; by partnering up with Western car companies, the Chinese automotive companies got valuable lessons about R&D, while the access to the enormous Chinese consumer market was a deal too good to pass up on for Western car companies, despite difficulties of protecting their intellectual property in the JV. Currently, virtually every major car manufacturer is no collaborating in Joint Ventures with one or more Chinese counterpart.

 

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Volvo's latest R&D facility under construction constructed in the Jiading car district in northern Shanghai.


Policies for energy efficient vehicles


During 2009, the Chinese government introduced auto stimulus policies which led to a staggering 40% growth rate in China’s auto market during the following year. The stimulus was followed by a second stage of reconstruction, concentration and stability between 2011-2013. The current stage is one of “indigenous innovation” which focuses on new technologies to promote energy efficient automobiles, most notably Battery driven vehicles and Plug-in Electric vehicles. This is also in accordance with the 12th 5 year plan (2011 – 2015) which includes specific directives to promote New Energy Vehicles and is also part of China’s efforts to have its industry climb up the value chain.


The Chinese government is actively supporting this growing segment making it a major opportunity for foreign companies with expertise in this area. The stated goal is to have 500 000 Battery Electric/Plug-in Hybrid Electric vehicles on the roads by the end of this year, and a total of 5 million by the end of 2020.


Further trends & opportunities


Aftermarket sales as the market matures


80% of China’s current auto parts and accessories market revenue comes from new vehicle sales; only 20% comes from aftermarket sales (here being defined as car maintenance, parts, modifications and renting). This can be compared to Western markets where the aftermarket sales account for a whopping 60% of the total revenue. The aftermarket is part of a maturing car market and is where much of China’s future revenue will take place.


Used car market


As a testament to the rapidly maturing car market in China, sales of used cars went from 250 000 in 2000 to 3.3 million a decade later. Major auto manufacturers are intending to take advantage of this booming segment by offering used-car services in its certified dealers across China.


Recreational vehicles (Mobile homes)


A growing segment in China’s automotive industry is the Recreational Vehicles (RV) market which follows the new aspirations of China’s growing middle class as they go on holiday in China. China has over 3 billion domestic tourists annually. The RV-market is growing by 30% annually and is this year it’s expected that the number of RVs on the road will reach 15 000. The RV-market is still very small compared to Western countries but is expected to grow steadily. Following this development, the first RV camping site was established outside Shanghai as of last year.

 

The new tier 2 and 3 markets

Shanghai and its surrounding provinces (Zhejiang, Jiangsu and Anhui) still accounts for about 44% of all domestic production, making it a natural place to start when entering the Chinese automotive market as a Western subcontractor. But a lot of the most interesting development is happening in tier 2 and 3 provinces. The automotive cluster located in Chongqing in China’s inland for instance, accounts for 11% of domestic car production making the region China’s 4th largest automotive producer.

The prospects of cheaper labor and closeness to the new tier 2 and 3 consumers are growing increasingly attractive among Western car manufactures.

 

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Sustainability

 
Furthermore, the soaring car ownership in coastal Tier-1 cities such as Beijing and Shanghai is creating congestion where the current levels of vehicle growth per year (currently around 6-12%) cannot be sustained. In Beijing, vehicle plate registration is controlled by a state lottery and in Shanghai its regulated by its auctioning out a limited number of plates per month; in these auctions prices typically reach a staggering 70 000 – 80 000 RMB. Despite these efforts, almost 100 000 car plates are expected to be registered in Shanghai in 2015 as the roads are getting more and more congested.


New markets

 
Road grids in tier II and III markets inland are still able to absorb new traffic and is growing increasingly relevant for both domestic and international car companies. These markets focus on smaller and cheaper cars, such as the Baojun by the Joint Venture GM-SAIC-Wuling which was designed especially for the low priced market where it has experienced explosive growth. Similarly, a Nissan/Dongfeng JV has launched its on budget car called Venucia to compete in the below 10 000 USD market.


Conclusion

 
China’s automotive industry presents plenty of opportunities for Western subcontractors, especially in the field of New Energy Vehicles and in aftermarket services. Tier 2 and 3 markets are hotspots for international car brands selling smaller, low priced vehicles; development is sure to continue booming in industrial parks across regions like Jilin, Chongqing and Guangdong. Shanghai and surrounding regions is still a major hub for R&D and manufacturing and presents perhaps the easiest target for a Western subcontractor looking to enter China.


More information about China’s Business Clusters.


More information about China’s Tier 2 and 3 markets.

Even though China’s government and its Economic Development Zones have made it easier to register and setup a Wholly Foreign Owned Enterprise (WFOE), it is still a relatively complex and time consuming process. On an average, a WFOE registration requires about 600 signatures and 300 stamps. Below are three mistakes that should be avoided when setting up your WFOE in China.

Mistake nr 1: Not bringing in enough registered capital

Registered Capital (“RC”) and Registered Total Investment are the initial declared investment to your Wholly Owned Foreign Enterprise (WFOE) so that it can operate until it becomes profitable and represents the equity that an investor has in a WFOE. These capital declarations are required during the application procedure when your enterprise establishes a WFOE in China.

Even though China has liberated its minimum capital requirements, it is crucial to look beyond the minimum guideline amounts and make a realistic estimate of how much money your business needs to operate in China before you start making profits.

Otherwise, you might find yourself in a situation where your enterprise is undercapitalized and unable to pay its bills. You can salvage this by bringing in more money to your WFOE, but this is a time-consuming bureaucratic hassle, (not to mention that this money is taxed as profits); meanwhile your daily operations might suffer if you are out of funds and you could go out of business!

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WFOE registration in China is not an overnight affair.

 

Mistake 2: Being careless with the company chops

Where the Western world uses signatures, the Chinese uses company seals, or “chops” to legalize and ratify documents. Thus, the holder of the company chop can exercise power and sign for the company.

There are different types of chop that grants different authorities; the most important chop is the Executive director Chop and the Company Chop which needs to be strictly controlled.

Many executive directors are not continuously present in China and hence, the company chop is a practical way to delegate authority to a trustee. However, this practice can also backfire if the trustee decides to misuse the power granted by controlling the company chop. In fact, using a company chop, someone could for instance change the stock structure of your enterprise and have the control over your company signed over to another group or individual! Not realizing what role the company chops play can thus be a fatal mistake for your enterprise; they need to be kept under close scruitiny!

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Whoever controls the chops controls the company.

Mistake 3: Not defining an adequate business scope in the Articles of Association

When registering your WFOE in China, your company’s operations are defined by its business scope – which in effect is a one sentence description of the industry it is authorized to operate in. Unlike other countries, the business scope in China is more detailed and has more implications than in the west. An enterprise can only engage in operations within its business scope as approved in its registration with the Chinese authorities; thus this business scope needs to be carefully defined.

The articles of association are the operating rules of your company and is in effect as long as the business is operating in China (which could be decades ahead). If your company scope is too wide or too narrow, it could create problems with the tax bureau and customs if you are applying for breaks and incentives as well. Manipulating the scope of the business to get certain tax breaks if your actual business activities don’t warrant it is not to be recommended, avoid all advise to the contrary from local officials or other consultancies.

If you misalign the business scope with your actual business activities, you can either be fined, or in serious cases, have your license withdrawn.

 

 

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Image credit: Scandic Sourcing

A growing number of Western companies are bringing manufacturing back to their home countries in a trend known as "reshoring”. Is this trend the beginning of the end of outsourced manufacturing in China? 

Rising labor costs in China is making some American companies relocate on home soil. A survey conducted by the Boston Consulting Group in September 2014 showed a 20% increase in American businesses repatriating their businesses to the US or moving production from China to Mexico. 

However the trend of reshoring is still very small and limited to certain industries. It has also become a media buzzword, with more anecdotal evidence to support it than factual. While it is true that the textile, garment and footwear industries are showing trends to be moving out of China to countries like Vietnam (where worker’s salaries are roughly a third of their Chinese counterparts), or at least that textile companies are developing a China +1 strategy, the trend of reshoring does not seem to apply to industrial production. According to a manufacturing survey made by the Boston Consulting Group in February 2012, a majority of producers of fabricated metal products, electronic and electrical equipment, computer parts, and industrial machinery are not planning to reshore their businesses.

 

 

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80.000 manufacturing jobs reshored to the US in the past three years. However, the idea that manufacturing jobs in the West will have a big resurgence is far from realistic.


“The main reason China is still attractive for Western manufacturers is that there isn’t enough skilled labor back home, especially in heavy industry”, says Per Linden, CEO of Scandic Sourcing which consults Western businesses in China. “Skilled industrial labor such as engineers, machine operators and welders are still plentiful in China and the capacity for industrial production is enormous; the trend is not going to reverse in the foreseeable future”.

Most experts agree.

"It's taken 60 years for [offshoring] to happen, and it's going to take decades for it to reverse," says Harry Moser, the founder and president of the Reshoring Initiative who are actively lobbying for bringing manufacturing back to the US.

According to Moser, the phenomenon of reshoring can be overstated. "No one claims — at least we don't claim — that you're going to see a million new jobs from reshoring next year," Moser says. "That would be totally irrational, irresponsible. And we don't have the workers, the skilled workers, to do it”.

American manufacturing companies who have brought production back to US soil have experienced problems finding reliable staff workers who could pass drug tests, do basic math needed for the job, and show up on time the minimum wage, according to Forbes.

Another big reason to stay is China’s booming consumer market. With nearly 350 million people and growing in China’s middle class, the country is likely to be a company’s biggest target market over the next 20 years and that is reason alone to keep a foot in the door. Thus, even even textile companies that has much to gain by moving production to South East Asia keep production in China and develop +1 strategies rather than leaving China altogether.

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A big reason why companies want to stay in China is ready access to the booming Chinese consumer market.


Per Linden concludes that the sheer output and access to skilled labor in China will be factors that will keep a lion’s share of the world’s industrial manufacturing in China. Thus, the future of Chinese manufacturing looks strong despite rising Chinese labor costs. “Even in China, skilled labor is highly sought after, so the trend will be more automated factories with higher efficiency and more streamlined flows requiring less labor”, Per Linden concludes, which will make Chinese factories even more competitive in the foreseeable future.