Paying your Chinese Supplier – Know your payment terms and options in advance
Here at SourceJuice.com we get many questions from those beginning to source and import from China on how to pay Chinese suppliers from small to medium sized businesses to individuals starting their own business. For most people new to sourcing and importing from China, paying a Chinese supplier can be a very tough task and involve significant financial risk. Starting with this article, we will cover a variety of payment terms and resources from various websites that will help you learn from the experiences of many people and companies. In future articles we will go into more detail on the most widely used payment terms listed below which will be reviewed here.
- Advance, Cash in Advance or Cash Advance – these are known as payment in advance terms
- Telegraphic Transfer, Telex Transfer, Bank Wire Transfers – these are known as T/T or TT payment terms
- Wire and Funds Transfer Services like Western Union and Money Gram
- Internet payment companies like PayPal.com, Moneybookers.com, and Escrow.com
- Letter of Credit and the various options that banks offer on these instruments – these are known as LCs, L/C, or LC payment terms
- Documentary Collections like Documents Against Acceptance or Documents Against Payment – these are known as DA or DP payment terms and sometimes referred to as “Bills of Collection” or “Bills of Exchange”
- Open Account or Pay Post Receipt or Goods in Advance – When the Seller provides you Credit
As you can see from the above, there are a variety of payment terms and methods that deal with paying Chinese suppliers and the list above is only a sample of the ways that you can pay. However, you should absolutely know the differences of payment terms and methods to insure your financial safety and avoid scammers. The main purpose of this article is to educate those beginning the process of sourcing and importing from China as well as those that are ordering their first sample and have the question – How do I pay safely and what are the methods and terms?
As we review various resources and information from the Internet below, we at SourceJuice.com will present our experiences and opinions. Please note that all of the referenced websites are in English but in the near future we will be including detailed reviews of the payment terms and methods which will be available in your language.
So let’s start with something so important and the heading of this article – How to be safe and avoid being scammed! If it is your first time sourcing and importing from China then this story is one example that may provide you a valuable lesson. Go here to review the story titled “How not to be scammed paying suppliers”. Below is an excerpt from this story and the main point of how securing your ability to get your money back is very crucial.
So to recap, NEVER pay any supplier unsafely without a credit card through Paypal, not even for “small” test orders. I keep saying Paypal because I know of no other service that you can use your credit card with that doesn’t charge your credit card as a cash advance, such as western union does, which means you have NO PROTECTION.
As you can see from the above, there is a lot of pain in international trade when it comes to working with suppliers you never met especially when you are about to make payment to such a person or company that is your supplier. It should be noted that suppliers are concerned (just like you are with getting your product) about getting their money as well and getting paid by buyers they have never seen or done business with. If you haven’t already, take a look at our prior story on how to contact suppliers online here as well as our story on how to avoid getting scammed by using some common sense which can be read here. Not to forget, check out a good article for beginners to importing from China here. In the business of International Trade the key ingredient for successful business is trust – just as in any other business. Hence, the world is filled with so many ways you can pay your Chinese supplier so as to supplement a lack of trust with tools to reduce the amount of financial risk between both parties. So let’s look at all the payment options one by one in summary since we will cover these in detail in later articles. Finally, throughout this article, SourceJuice presents some links from the Internet that offer great insight and experiences on various payment terms, methods, tools and experiences. Please note that for each of these payment terms, there are so many options and unique situations that are different for new buyers to professional buyers. A case in point is that large professional buyers setup terms with their Chinese suppliers to pay in a variety of ways that most of us would not even be allowed unless we were buying in similar volume or had similar credibility (reputation, globally known, great credit and history with the supplier, etc.). Hence, this article is more about the first time buyer in that it acts as a reference guide on the many options to paying their Chinese supplier. For each payment term and method below we will outline what it is, when it is used, and how to be safe. So let’s start.
1. Advance, Cash in Advance or Cash Advance – these are known as payment in advance terms
What is it?
• Seller asks that buyer pays in advance in order to have product or products shipped to buyer. Seller will usually request payment be made using one of the payment methods listed later in this article (like T/T, Western Union, Money Gram, PayPal, etc.).
When is it used?
• Those suppliers that are legitimate and request this type of payment terms generally have either a very unique product (unique, rare, or very cheap) or have a history of electing this method of seeking the buyer to pay in advance of product shipment. Additionally, suppliers who provide custom prototypes or samples may request this payment term before beginning any work. Additionally, many scammers utilize this method and have been known to operate similar to legitimate sellers.
How to be safe?
• Please use common sense! Suppliers only accepting these types of payment terms pose you more risk than others who offer other terms.
• Buyer faces absolute risk when going ahead with this type of payment term. You can lose all the money you send if the supplier happens to be a scammer. It is best to ask the supplier to reconsider other payment terms or just go with a different supplier.
• If the supplier meets certain qualifications you deem necessary for the product and or sample you want to acquire but still only accepts cash advance terms then it really comes down to a buyer decision. It may be in your interest to introduce staggered payments (some in advance and some later) or move the supplier to considering other payment methods that still gets them money in advance but allows you to have some recourse – see PayPal below.
2. Telegraphic Transfer, Telex Transfer, Bank Wire Transfers – these are known as T/T or TT payment terms
What is it?
• T/T is a wire transfer from one bank to another. This can be done via cooperating banks. You must ask your bank if the Chinese supplier’s bank is one that is on their network. Bank of China is usually the bank of choice to wire into when paying your Chinese suppliers. Currently, most western banks will give you a warning that wiring funds to the Bank of China poses some risk. You will need the SWIFT code (an identifier code for all legal banks in the world. All legitimate banks have one) of the Chinese supplier’s bank and exact information to ensure your payment can be executed by your bank. The charge on this usually is $40 USD per wire and note that any large wires, usually greater than $10,000 USD, your bank will most likely report this information to taxing authorities as regulated by the government. In the USA, the IRS is notified when such transfers of $10,000 USD or more are sent.
When is it used?
• T/T is a very common method for buyers paying their Chinese suppliers. It is usually used in trusted relationships (where the buyer has a relationship established with the foreign supplier) or when the supplier requires what are called as prepayment or advance payment T/T. Most credible suppliers will work on a 30% prepayment or advance payment by T/T before shipment of your order and expect 70% payment by T/T after shipment.
How to be safe?
• Buyer assumes almost all risk when using this method. Be careful.
• If you read the story about PayPal above you will note the key to being safe is to have some ability to either get your money back or pay some amount after some event (like receiving paper work or an inspection or when it is shipped) and hold some funds until final receipt of your order. That being said, a T/T for your first order may be risky unless you know your supplier or have some references. In some cases, where you are requesting a sample, this may be the only method. In such a case, negotiating with the supplier for a 30% prepayment and 70% post shipment maybe a good alternative. Going back to the story about PayPal, it may be a better alternative to use PayPal if the supplier allows this – see that section below. Do note that using a T/T is common for buyers and sellers who have developed a relationship but not for first time transactions.
• When sending T/T make sure the account name (at the supplier’s bank) is the same as the company name. Sometimes it may be different but this is a warning sign.
• Being safe using a T/T payment requires trust as do almost all of these payment methods. Research your supplier, negotiate terms or select other payment terms and or methods.
3. Wire and Funds Transfer Services like Western Union and Money Gram
What is it?
• Both Western Union and Money Gram are financial companies that allow individuals and businesses to send money for a fee using electronic wire transfer or other methods such as money order documents, phone payments, and even web payments.
When is it used?
• Usually used by a wide variety of people and businesses for all types of reasons. However, not generally used for legitimate international trade. Please note, it has been our experience and the experience of many that these forms of payment are usually requested by suppliers that are scammers. We have never heard nor experienced any positive experiences being cited by these payment methods.
How to be safe?
• Buyer assumes almost all risk when using this method. Be careful.
• It is not safe. You are absolutely in risk when you pay this way. See for yourself what these companies have to say by going here and here. Once again – Do not pay Chinese suppliers using these services. These services provided by these companies are very good when you absolutely trust the supplier, person, company, friend, etc. In the situation where you are just starting, please do yourself a favor and do not pay your supplier using these services and if they still request you pay this way – leave them for another supplier. Go here and here and here for what others say on this hot topic at the Alibaba forums.
4. Internet payment companies like PayPal.com, Moneybookers.com, and Escrow.com
What is it?
• PayPal.com is an online money transfer company. They are a service for individuals and businesses and act as the financial intermediary between the paying and received parties. You can read more about them here and about user protection here. PayPal is used most often to pay for products on Ebay.com as well as a variety of online ecommerce sites.
• MoneyBookers.com is an online money transfer company similar to PayPal but has a unique and critical difference in that it offers escrow services. From their website they say that
“Moneybookers is a tool that allows you to safely send and receive money via email - instantly. You can send money from your credit/debit card, transfer money to and from your bank account.”
You can read more about their user services here which details the escrow services and merchant services here.
• Escrow.com is a financial intermediary that serves as a 3rd party between a buyer and a seller. From their site the following below describes their services.
Escrow.com, an accredited escrow company, acts as a secure third party to protect the Buyer and Seller.
How Buyers are protected:
•Escrow.com tracks the shipped merchandise and verifies it was delivered.
•The Seller isn’t paid until the Buyer accepts the merchandise, or the inspection period expires.How Sellers are protected:
•Escrow.com confirms when the Buyer receives merchandise.
•The Seller is authorized to ship only after Escrow.com verifies good funds.
When is it used?
• All of these services are used by many buyers and sellers around the world. The important aspects are in how you want to use these services. Take for example the PayPal story at the beginning of this article where the author of “How not to be scammed paying suppliers” points out that he used his credit card when using PayPal so as to ensure he has the ability to call his credit card company in case of an issue and get his money back. Do your homework when using PayPal since it does not offer that service to all credit cards. Here is a great resource on how to apply the chargeback if you have such a problem – go here to read how to do this.
• Moneybookers.com is relatively newer to most first time buyers, especially those in the USA. However, our personal experience left us pleased with their services. As we noted above, this company provides another layer of assurance with the escrow services it offers. It is absolutely worth your time to educate yourself with their escrow services. Depending on the amount you are about to pay for your first order or sample, it is worth exploring what this company has to offer if not using them where the supplier is both capable and able to be the selling party in the escrow.
• Escrow.com is also very new to many first time buyers. You can get details of how their system works by going here and reviewing all the links on each step of the escrow process. In its simplest form, as noted in a post at Alibaba’s forums that you can find here, using Escrow.com is like T/T but “with one difference. The buyer gets to inspect the goods before they actually pay for them.”
How to be safe?
• PayPal.com → Buyer assumes almost all risk when using this method. Be careful. Only when using a credit card that allows chargeback against PayPal do you have some level of safety.
• Moneybookers.com → Buyer assumes almost all risk when using the direct pay method. Be careful. Only when using the Escrow Services of this company can you share the risk with the seller. Remember, it is up to you as the buyer to make sure you prepare the escrow services in a way you know you are protected to the limit of what such a service provides.
• Escrow.com → Risk is shared between the buyer and the seller. Remember, it is up to you as the buyer to make sure you prepare the escrow services in a way you know you are protected to the limit of what such a service provides.
• In summary, PayPal.com, Moneybookers.com, and Escrow.com provide a variety of options and services. However, in terms of safety the services provided by Moneybookers.com and Escrow.com offer the buyer more advanced tools to manage the financial risk of doing business. The important thing to remember here is that the escrow services require more action and paperwork but also provide additional measures to protect your financial transaction. Which one is better depends on your experience. If you are a US Citizen, it may be better to use Escrow.com since they are based in the USA while Moneybookers.com is based in the UK (United Kingdom).
5. Letter of Credit, Documentary Letters of Credit, Documentary Credits, or Letters of Credit– also known as L/C, LC, LCs
What is it?
In summary an L/C is…
A letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped.
Thanks to Investopedia.com for this above - go here for this and other information.
• The details? It is best to let a large banking organization explain this. This below is from Barclays Bank in the UK. Please visit their site here for comprehensive information and a thorough overview of this payment term step by step – it is really worth your time to investigate their detailed and informative site. When you get to their site, click on the Features & Benefits link as well as the Key Stages link to get concise information on Letters of Credit. So here is what they have to say on what an L/C is.
Documentary Letters of Credit
A Documentary Letter of Credit (LC) is a written undertaking given by a bank on behalf of an Importer to pay the Exporter a given sum of money within a specified time, providing that the Exporter presents documents which comply with the terms laid down in the Letter of Credit.Letters of Credit can be for any amount, in any freely traded currency, and, subject to the presentation of compliant documents, may be payable:
- at sight, which means as soon as a compliant set of documents are presented to the paying bank; or,
- after a specified term, e.g. at 30, 60, 90 or 180 days of sight or Bill of Lading date.
- If the documents are not presented exactly as specified in the Letter of Credit, payment will not be made unless the Importer gives their authority to waive or amend the specified condition.
A fundamental principle of Letters of Credit is that banks deal with documents and not with the goods to which the documents refer.
For example, if the Importer is not happy with the quality of the goods but the documents comply with the terms and conditions of the Letter of Credit, the Importer’s bank is obliged to pay the Exporter.
Parties involved in a Letter of Credit transaction
In the process of a Letter of Credit transaction, there are essentially four parties involved. These parties can be referred to by a number of terms, outlined below.
• Buyer meaning Importer, Applicant, Accountee or Accreditor.
In this guide we use the term Importer.
• Seller meaning Exporter or Beneficiary; here we use the term Exporter.
• The Issuing or Opening Bank (Importers Bank)
• The Advising/Confirming Bank - usually a bank in the Exporters country which may or may not be the Exporters Bank.
Types of Letter of Credit
- Revocable - This is an LC that can be cancelled or amended by the applicant or the Opening Bank without prior notice to the Exporter.
- Irrevocable - With an irrevocable Letter of Credit the Issuing Bank gives its irrevocable undertaking to pay if all the terms of the LC are met. The Issuing Bank can only amend or cancel its undertaking if all parties to the LC consent to the change. NB: Although there are two types of Letter of Credit: revocable and irrevocable, LCs dealt with by Barclays are irrevocable. Under UCP600 (Uniform Customs and Practice for Documentary Credits), LCs are assumed to be irrevocable.
- Confirmed - A Confirmed LC is one to which a second bank, usually in the Exporter’s country and at the Exporter’s request, adds its own commitment (confirmation) that payment will be made. Confirmation is generally used when there is perceived to be some risk that the bank issuing the Letter of Credit may not be able to fulfill its obligation to pay. This could be due to bank failure or instability in the country of the Issuing Bank.
- Unconfirmed - If the LC is unconfirmed, the Advising Bank merely informs the Exporter of the terms and conditions of the LC without adding its own undertaking to pay or accept under the terms of the LC.
- Transferable - A Transferable Letter of Credit is one that can be transferred from the first Beneficiary to one or more additional Beneficiaries by the Transferring Bank. It is normally used in situations where a supplier sells through an intermediary or ‘middleman’ to the ultimate Importer and is in a strong enough bargaining position to insist upon payment by Letter of Credit. By using a Transferable Letter of Credit, the intermediary is able to provide payment by LC to their supplier without the need for their own credit line with the transferring bank. An LC is only transferable if it is expressly stated to be so by the Issuing Bank.
- Other - There are other less commonly used variations of Letter of Credit, for example Back-to-Back, Red Clause and Revolving. **see below**
Special Types of letters of Credit
Transferable
Transferable Letters of Credit are used when the Exporter is acting as an intermediary between the Importer and Exporter in a commercial transaction. In this instance, all of the rights and obligations of the LC are transferred from the intermediary to the ultimate supplier. The intermediary has no liability.
The terms of the transferred LC must be the same as the original except for the amount, unit price, expiry date, latest presentation date and period of shipment. All of these may be reduced, or brought forward.
The identities of the Importer and the ultimate supplier may need to be withheld from each other. Careful drafting of the original and transferred Letter of Credit is needed to ensure this occurs. (NB: Barclays assumes no liability or responsibility for any disclosure).Back-to-Back
In this instance, two LCs are established completely independently of each other. The Importer establishes theirs in the Exporter’s favour. The Exporter can then arrange a second LC in favour of the ultimate supplier of the goods or the supplier of raw materials.This type of LC should only become necessary where the underlying contracts are on terms which do not match or where a Transferable LC is unable to maintain secrecy on a particular aspect of the transaction.
Due to the greater risk involved with this type of LC, they are rarely issued.
Revolving
If an Exporter makes regular shipments to a particular Importer under a long term supply contract, it may be beneficial for a series of shipments to be secured by a single documentary LC.A Revolving LC can achieve this by the LC being reinstated for the original amount after a given period, and allowing the value of the LC to be drawn each time a shipment of goods is undertaken.
Be aware that as this is a continuing liability, it will have an impact on banking facilities.
Advance Payments (or Red Clause)
An LC that contains a clause, which authorises the nominated bank to advance a portion of the value of the LC to the Exporter before shipping documents are presented. This enables the Exporter to purchase raw materials or to pay other costs before receiving the full payment, once conforming documents have been presented.Advances are made at the risk of the Importer. Drawings under an LC are made against a simple receipt from the Exporter that they will refund the amount if they do not ship the goods as required. The Importer’s account is debited as soon as an advance has been made.
Standby
A Standby Letter of Credit is a type of trade debt guarantee that is only drawn against in the event that the Importer defaults in some way, eg. fails to pay for a consignment within an agreed period. A standby LC includes an expiry date, but no latest shipment date. Standby LCs will normally call for a statement of default from the Exporter and also evidence of default. Barclays is happy to discuss whether or not a Standby Letter of Credit is appropriate to your needs.
When is it used?
• Generally an L/C is used when the amount of money exchanging hands between the buyer and seller are significant and the paperwork involved for using the Letter of Credit (L/C) insignificant as well as the cost born in using this payment method. Many buyers argue that L/C is a must to establish trust with a supplier. Others say that when a certain value is reached (some quote that $50,000 USD is a good threshold to gauge when to use an L/C) it is an absolute. However, from our poll of some of our readers, especially those paying for the first time, it all depends on what you are about to source and import. If you are importing some very expensive products (like a boat or a batch of motor bikes) then this becomes a “must review” payment method. But if you are buying a sample MP4 player then this is something you will not even waste the time to review or even inquire about. The general consensus by import buyers is that L/Cs allow some measure of financial risk management to be put into the process of exchanging money for products and that it is a widely used method when the value of such goods is high enough to justify both the costs and the time required to execute on such a method.
How to be safe?
• Risk is shared between the buyer and the seller using such a payment term and method. However, how you prepare and how rigorous you are with the details will do more to protect you than just going into an L/C contract casually. Pay absolute attention to the details since L/Cs require total accuracy. Read below.
• The L/C is a method and tool that enables some amount of financial and buyer and seller risk to be managed by a third party (the banks) but is not absolute in ensuring that their will be no abuse by either sides (the buyer or seller). However, it is a payment term, method, and tool that allows more oversight and pays a third party (the banks) to provide that oversight. While it does not absolutely prevent a buyer or a seller from scamming the other, it does however provide a basis to put a measure of control into the relationship. Using good banks on both sides is critical as well as ensuring the details of the L/C are absolutely reviewed and thoroughly understood by both parties.
• Seek a good bank to review with you the various Letters of Credit and even how to use Documentary Collections (like Documents against Payment – DP; please see below for more details in the Documentary Collections section below) in conjunction with the L/C to offer you more security.
• Be prepared, be knowledgeable, seek a good bank that does a large amount of international business and gain knowledge and experience by reading up so you can be prepared. Here are some excellent sources for background information and experiences that you can put to use in your business dealings.
- A really excellent set of instructions, best practices, and checklists is provided by SITPRO which is an agency that facilitates trade. Go here for a wealth of information on Letters of Credit so you will be prepared and knowledgeable when using this payment method.
- An excellent overview of why Letters of Credit fail can be found at this site called creditguru.com. They explain the 3 most common reasons why they fail: timelines and milestones - not managing your date dependent milestones; discrepancies in the document such as missing a comma or a period in a sentence; and compliance around the documents themselves. Go here for the excellent article.
- Read even more about common defects in the documentation of Letters of Credits by going here to this reference page on Understanding L/Cs by the Credit Research Foundation. See the parts at the end of the page where it talks about common defects as well as tips for exporters (which are tips for you the buyer as well).
- The Credit Research Foundation provides yet more good lessons on common problems with L/Cs. Go here for some very good insight and knowledge.
- For a few more specific examples and extensions to the L/C as well as something (called the Demand Guarantee) similar but stronger and safer (but not widely used by smaller importers), visit the following pages from Investopedia.com
- Sight Letter of Credit requires a more thorough level of verification. Go here to see more details.
- Standby Letter of Credit used to show a buyer’s credit and give the supplier more confidence. Go here to see more details.
- When you want to promise your seller that your funds will clear, you may use what is known as a Fully Funded Documentary Letter of Credit (FFDLC) which is “A written promise of payment provided by a buyer to a seller that is guaranteed to clear by a particular bank”. Go here to see more details.
- The Demand Guarantee payment term and method – which is something more stronger and safer than an L/C but offers protection against non-performance, late performance, and possibly defective performance depending on how it is drafted. Go here for information.
- Go explore some issues that others have on LCs and learn from their experiences. Here are a few great resources from Alibaba’s forums once again.
- How many third parties are involved in a documents against payment collection? Go here
- What procedures are involved in a documents against payment collection? Go here
- In what types of situations is a documents against payment collection typically used? Go here
- When will a collecting bank undertake a protest action on behalf of a seller? Go here
- What is the function of a protest action in a documents against payment collection? Go here
- What recourse is available to the seller in the event that a buyer does not honor a sight draft presented under a documents against payment collection? Go here
- Should an exporter who uses a documents against payment collection as a payment method attempt to retain control over the product that has been exported to a foreign buyer until such point that the U.S. exporter receives payment under the documents against payment collection? Go here
- They had to have unique products.
- Specific models we were interested in needed to be available.
- The price had to be low. (After all, it always comes down to this in the end!)
- Ability to accommodate all export/logistics for the shipment was important to us as we didn’t have previous experience.
- Future capability for private label opportunities was important to us because we were considering starting our own brands.
- References needed to be available for review.
- You are not only qualifying the factory; the factory is also qualifying you as a buyer. Validating your company in the minds of the supplier is of the utmost importance.
- The initial communication, preferably through email, should include a brief introduction to your company, your position within the company, and include a statement of adequate buying power resources.
- Showcase your company with a polished website illustrating your industry and experience. The site should generate a logical understanding, in the mind of the reader, of why your company would be interested in manufacturing in China.
- Ensure the email asks for the specific information you require. For example, you may ask, “May I please have a price quote for item …” or “What is your sample availability and process?”
- Include the specific item or model numbers you are interested in, attach pictures from the factory’s website or other sources, and in general be as specific as possible with your requests.
- Indicate available contact methods for further communication (MSN, Skype, email, phone). In addition to email, most Chinese factories are on Skype and MSN and this sometimes is better than email because the “back and forth” is quicker, once an initial relationship is already developed.
• Here is a diagram of how an L/C works. Go here
• Here is a post and some discussion on how to formulate the L/C terms. Go here
• If there is an expert on L/Cs at Alibaba’s forums, a man going by the user of “Catalyst” would be it. Go here to find his profile and his answers to a variety of questions on Letters of Credit and more.
• Here is a post on how to verify and confirm an L/C. Pay attention to the response from the user “Ranger” who is a moderator for the forums and has provided some extensive background and experiences on a variety of questions about international trade. Go here. Go here to see all the updates by this “Ranger” user and moderator – it is worth your time.
• Here is some discussion on what you need to get from the supplier when you create an L/C using FOB terms. Go here
• Here is a lengthy discussion on L/C and various issues. This is definitely worth the read to see the various issues and how so many importers and suppliers don’t really understand the full details. Go here
• Here are some tips from a law firm for exporters on how to control the L/C. This is important for the buyer to know as well. Go here
• Some advanced topics
• L/C with Irrevocable at Sight by Payment versus Irrevocable at Sight by Negotiation – go here
• Establishing Back to Back Letters of Credit – go here
• Here is a discussion about how pro forma invoice versus a commercial invoice impact the L/C. Go here
• Dealing with partial shipments on the L/C terms? Go here for some insight.
• L/C and Bank Guarantee compared. Go here
6. Documentary Collections are Documents Against Acceptance or Documents Against Payment – these are known as DA or DP payment terms and sometimes referred to as “Bills of Collection” or “Bills of Exchange”
What is it?
To best describe this payment method, since there are so many explanations on the Internet, we leaned on the website at Wikieducator.org since their explanation best describes the details in a way that is more readily understandable for buyers and sellers rather than bankers. Go here to get a full overview of the explanation as well as additional details on other areas relating to international payment methods. From their site we describe what is it with the following:
Documentary Collections
A documentary collection is a payment mechanism in which a seller uses a bank as his/her “agent” in collecting payment from a buyer located overseas. After shipping the goods, the seller submits a draft (a demand for payment) and the relevant shipping documents to the bank. The draft will include instructions to release the documents to the buyer upon the buyer’s payment or acceptance of the draft. The seller’s bank sends the documents, draft, and collection instructions to a branch or correspondent bank in the buyer’s country. This bank carries out the seller’s collection instructions and, upon receipt of payment from the buyer, remits payment to the seller’s bank for the credit of the seller.
Documentary collection procedures are uncomplicated. After shipping the goods, the exporter submits to the bank:
• Shipping documents, including the bill of lading conveying title to the goods, as well as other documents related to the shipment.
• A draft, also called a bill of exchange, demanding payment from a buyer. Depending on the agreed terms of sale, this may be a sight draft, demanding payment on presentation, or a time draft, demanding payment at some stated future time after presentation or after the bill of lading date.
• Instructions to the bank as to how to handle the transaction. Note that a documentary collection requiring payment before the release of documents may sometimes be transacted without a sight draft. Under cash against documents (CAD) terms, the documents are released to a buyer against receipt of payment. CAD terms are generally used when the government of the importing country requires tax stamps affixed to drafts; by eliminating the draft, both buyer and seller avoid stamp taxes.
• Release documents to a buyer upon payment of the sight draft, which is known as a documents against payment, or D/P collection; or release documents to a buyer upon acceptance of the time draft, a documents against acceptance, or D/A collection.
The seller’s bank, called the remitting bank, sends the documents, draft, and instructions to one of its branches or correspondent banks in the buyer’s country. This bank, called the collecting or presenting bank, contacts the buyer and informs him/her that the documents have arrived and can be obtained when he/she complies with the payment terms, which may be documents against payment or documents against acceptance.
Documents against Acceptance (DA)
A buyer is required to “accept” a seller’s time draft, thus acknowledging obligation to pay at the specific future date. The time of payment occurs at maturity of an accepted time draft, 30, 60 or 90 days after date of acceptance or date of bill of lading.
Documents against Payment (DP)
A buyer is required to pay a seller’s sight draft in order to obtain shipping documents. Payment is made on presentation of the sight draft by a bank to the buyer, usually one or two weeks after shipment. Under D/P terms, the seller, through a bank acting as an agent, is able to retain control of the goods until the buyer pays. Under certain circumstances, such as to meet legal requirements of the importing country or to obtain a government permit for foreign exchange, the buyer will require possession of the documents before payment. The seller should inquire as to the practice in specific countries. Air shipments are often made under documentary bill collections. The buyer, as direct consignee of the non-negotiable air waybill, will be able to take possession of the goods before meeting his/her payment obligations.
Additionally, here are some more resources from the web that defines and describe Documentary Collections:
• Documentary Collection Process – Key Stages by Barclays Bank. Go here.
• Documents against Payment (D/P) flow diagram from the Alibaba forums. Go here
• How does documents against acceptance collection differ from a documents against payment collection? Go here to Gatti & Associates law firm’s excellent resource on international topics.
A few others from Gatti & Associates’ site.
• HSBC China Trade Services Overview on Documentary Collections as well as other payment terms, methods, and tools. Go here
When is it used?
• Documentary Collections are usually used between an existing and trustworthy relationship between buyer and supplier. The supplier may use these payment terms to lower the overall transaction cost (compared to other payment terms that have a 3rd party which is the bank in this case) as well as the handling for the buyer that is trusted, that the seller has experience with, and that the seller believes will fulfill the payment obligations. Usually, the supplier will elect to use Documents against Payment which pose less risk than Documents against Acceptance. From a buyer’s standpoint, the documents against acceptance is more preferred for it allows more financial flexibility but since the seller usually retains control of how Documentary Collections are created and executed, the buyer’s agreement to such payment terms is all that is necessary to execute against this payment term. Some major banks will offer loan and or credit facilities to the supplier against the supplier’s documents.
Additionally, here are some more resources from the web that identify when it is used over other payment terms:
• What is the difference between an L/C and D/P or DP (Documents against Payment)? Go here and read the comments from “Catalyst” and “zealotwan” toward the bottom for insight.
• An excellent overview of Documentary Collections and their advantages and disadvantages as well as what is being called a “real life” example. A must read for anyone interested in getting at the details of how these payment terms work. Go here to Credit to Cash Advisor’s site article on international sales transactions.
How to be safe?
• Generally, the buyer is more protected than the seller in this type of payment term and method. Documentary Collections are types of payment terms that are usually between two parties (buyer and supplier) that have had a good relationship of trust. However, there are suppliers who are legitimate that will provide such Documentary Collection terms such as DA or DP (usually DP if any) to new buyers. Many of these suppliers will use what is called documents against payment advised letter of credit where they mix a DP with an L/C to further minimize their risk. Once again, the paramount factor in all of these payment terms and methods is trust or the opposite of such which is generally called risk. The more the supplier trusts you the better the terms and the more you trust the supplier the more flexible you may be in which payment term you are willing to accept or get as your choice. Documentary Collections, in general, offer the buyer more protection and put more of the risk on the seller. See this forum posting at Alibaba where they discuss some of this and the risks born by the supplier and the buyer. Go here and look at the response from user “Catalyst” which is excellent and very detailed.
7. Open Account or Pay Post Receipt or Goods in Advance – When the Seller provides you Credit
What is it?
• Essentially, the supplier extends credit to the buyer. In this payment term and method, the buyer is allowed to make payment (using a bank wire or other agreed upon method or instrument) after the product is received by the buyer. Usually the terms to when the payments are made, how the payments are made, and how to address any issues are identified and agreed upon prior to such a payment term being issued by the supplier. Since the supplier faces absolute risk (this is opposite to the buyer’s cash in advance or cash advance payment noted at the beginning of this article), it is presumed that this type of arrangement is made between trusted parties. By providing the buyer what is essentially credit (short or long term depends on the schedule of when payment will be made by the buyer) financing, the supplier is assuming almost all financial responsibility for the transactions.
When is it used?
• Mostly used in trusted relationships between buyer and seller. Additionally used by large companies (buyers) who require that new suppliers provide such payment terms to be part of their procurement program. Many suppliers have had very bad results using such payment terms even when the buyer maybe a very large multinational company with large financial resources. Buyers the world over desire such payment terms but in reality very few suppliers are willing, or shall we say foolish enough, in today’s world to provide such options.
How to be Safe?
• At SourceJuice we say this – Do not even waste your time if you are just starting to source and import from China and you get a supplier that wants to provide you an Open Account payment term because you are asking for trouble. There are no free meals in international trade and if it seems too good then it is too good to be true. Do not spend time with scammers since they know you better than you might know yourself when it comes to what you may be willing to do to get a better deal. As you mature your sourcing and importing programs and develop long lasting relationships with your suppliers, then at that point, such a payment term may be the best gift your supplier (or shall we say your partner at that time) can provide you to expand your business. Getting to that point requires you to survive the thrashings and tribulations of scammers looking for fresh new buyers not being well informed or well experienced to be taken as they say in America – “to the cleaners”. Being safe is just about being smart and doing your research and making an investment into doing business at a level where it’s not something you do but rather something you are executing against a fixed but flexible plan.
Summary
Paying your Chinese supplier for the first time is not easy nor was it meant to be when you want to protect your money while paying someone you may have never met all the way around the world. Thousands, if not hundreds of thousands, of people have done this before. Some lost money (some a great deal) and some lost nothing. Luck plays into the business of international trade as well, just as it does in any other business. The key to being one of the buyers that does not lose money and falls into what people call “lucky” is being prepared and learning from others. The best thing you can do is to educate yourself, ask questions, learn from others, and use good common sense to ensure you get what you want out of sourcing and importing as well as the advantages of saving time, money, and frustration by being prepared and ready. If you take a moment to realize that there are just as many (if not more) scammers on the buyer side as there is on the supplier side, then you will realize that this is why you have to be just as skeptical and informed as the good supplier is of buyers requesting payment terms that may impose all the risk on them. Reviewing the information presented in this article you can insure this – that after you leave here you are at least more informed than you were before and that makes you more prepared. In the end, trust is what makes successful business partnerships last but trust is not an overnight gift or goal that can be achieved no matter who you are. Payment terms are about levels of trust, the more you trust the less the barriers for doing business between a buyer and a supplier. The less you trust, the more you have paperwork and even 3rd parties like banks getting involved. Don’t worry, it just takes time and foremost – you have to begin by just doing it!
Good luck and thank you for stopping by.
The Sourcejuice Team
Walmart Reinvents the Milk Carton - Adjusting Packaging to Increase Efficiencies
SourceJuice recently wrote an article 4 Ways to Combat China Price Increases without Raising Prices to your Customer. Number 1 on our list was ‘Adjust Your Packaging Size, Colors and Materials’. While this may seem obvious on the surface, a recent example is sure to prove the point… that truly rethinking your product’s packaging can increase efficiencies and lower production and delivery costs.
The example is the 1 gallon milk jug and the forces behind the change are Walmart and Costco. The 1 gallon milk jug is a product that everyone, at least in the United States, is familiar with. We’ve grown up with it. Most people probably wouldn’t have ever thought about changing it. However with milk for the most part mass produced and trucked hundreds or thousands of miles to its final destination, the milk jug really isn’t the ideal packaging. So what are the changes exactly?
Superior Daily is the company responsible for designing the new jug and they’ve put together an excellent chart explaining all the benefits of the new milk jug compared to the old one. Click the chart below to make it larger.
Is everyone loving the new packaging? Of course not. Some people are claiming that it’s harder to pour. Others are loving the new jug, particularly how it fits in the door panel of modern refirgerators. Either way, with the new jug reportedly saving about 20 cents per gallon of milk, they’re unlikely to be going away anytime soon.
“This is a key strategy as a path forward,” said Anne Johnson, the director of the Sustainable Packaging Coalition, a project of the nonprofit group GreenBlue. “Re-examining, ‘What are the materials we are using? How are we using them? And where do they go ultimately?’ ”
So what are you doing to rethink your packaging?!?
Establishing a Sourcing Entity in China
China is in a constant state of flux, and the legal environment is certainly not immune to this reality. As a foreigner your behavior is often scrutinized more than a local so you need to constantly be aware of the legal bounds under which you and your business operate. This article attempts to provide an overview of typical legal set-up options for a sourcing company in China, including RO (Representative Office), WFOE (Wholly Foreign Owned Enterprise) and FICE (Foreign Invested Commercial Enterprise).
Choosing the proper set-up
The overall objectives of your operation are the most significant aspect to consider when establishing an entity in China. What are your short and long term goals? What types of products do you want to source? Do you want to distribute, assemble, or manufacture products domestically? Do you plan on employing local staff? The answers to these and other questions will help define your objectives so that you can formulate a legal strategy that best serves them.
It is important to note, that no one legal solution exists to accommodate all of your unique conditions. Therefore, the more detailed your understanding of your objectives, the better equipped you are to make good decisions. Further supplementing your understanding with proper due diligence is always important when making decisions of such lasting consequence. Let us now take a look at typical legal set-ups for trading companies.
Representative Office (RO)
This formation is popular because (1) the registration process is shorter in duration and usually easier to complete, and (2) there is no minimum level of capital investment required. An RO will be suitable if its planned functions are simply liaison, market promotion or research. For sourcing companies, it will mean you have to give up a significant amount of control over your operations. All transactions must originate from abroad, and you are required by Chinese laws to heavily rely on 3rd party services providers, such as an Import/Export agent, Logistics provider, and HR outsourcing agent.
International Trading Wholly Foreign-Owned Enterprise (WFOE)
With official minimum registered capital of RMB 100,000 for a single shareholder company (but closer to USD 60,000 to 70,000 in practice), an International Trading WFOE allows added control over your business operations. However, the enterprise must be located in a Free Trade Zone (FTZ) and it is usually limited to export activities. Those that wish to distribute within China must either use a 3rd party distributor or apply for a separate import/export license (which essentially qualifies them as a FICE in a FTZ).
Foreign-Invested Commercial Enterprise (FICE)
Unlike the Trading WFOE, a FICE has the ability to import and locally distribute on top of export activities and may also qualify for retail activities. Both have the same level of required minimum investment, but in practice the FICE necessitates substantially higher levels (about USD140,000). The registration process is also more complex compared to that of a trading WFOE. A major issue to consider when evaluating the advantages of a FICE is location. Specifically, operating inside or outside of a Free Trade Zone significantly alters the investors options.
FICE inside a Free Trade Zone
A FICE operating inside a FTZ enjoys freedom in its business scope, but at a price. The FICE is unlimited in terms of what can be traded so long as it does not belong to a prohibited trade category according to the Chinese laws. A major drawback from operating inside the FTZ is that VAT invoices can only be issued through the relevant governing authority, creating a fair bit of logistical hassle. Additionally, you will undoubtedly pay a premium to exist in the FTZ - costs of services, talent, office space, etc tend to be higher. Finally, it will be more difficult to establish branch offices in other locations.
FICE outside a Free Trade Zone
Outside a FTZ, a FICE’s trade activities are limited to those relevant to its stated business scope. But it also enjoys some advantages. Unlike operating in a FTZ, the FICE is able to issue its own VAT invoices, operational costs may be significantly less, and branch offices can be set up more flexibly.
Manufacturing + FICE
Enterprises looking to incorporate manufacturing activities with its trading business can explore setting up a Manufacturing entity with an extended FICE status. However, such entities must maintain an above-50% revenue stream through its manufacturing activities. Historically, this requirement acts as a measure to prevent enterprises from abusing such entity status to access preferential tax policies granted to manufacturing enterprises. Even though the new corporate tax law has scrapped most of such preferential treatment, the authorities may still scrutinize enterprises enjoying tax incentives due to their encouraged status (eg. High and New Tech Enterprises).
Business registration is a complex process that involves navigating China’s far-reaching bureaucracy. While it is not compulsory, using a specialist service that understands not only the legal environment, but also the objectives of your business is highly recommended. Selecting the optimal legal entity from the beginning is crucial to your success in China. Don’t proceed without a thorough understanding of the legal implications of your actions.
For regular news and updates about China’s business environment, check out and subscribe to JLJ’s monthly newsletter here.
For more information on establishing a sourcing entity in China, please contact:
Ms Lynn Ng
Manager, The JLJ Group
Email: lynn.ng@jljgroup.com
Tel: +86 21 5211 0068 ext 821
This article is contributed by The JLJ Group – a one-stop service provider assisting foreign companies to enter and grow in China. Over the past ten years, JLJ has assisted more than 400 international clients with their China entry and growth projects. Their client base includes Multinational Companies, Small & Medium Enterprises, Government Organizations as well as individual investors from more than 30 countries in Americas, Europe and Asia-Pacific.
Contacting a Factory Online; Lessons Learned from the Field
Contacting a factory online is very common, especially with the growth on online directories such as Global Sources and Alibaba. However when most buyers contact a factory online using these websites, they are often frustrated by their experience.
Many buyers complain that the factories don’t respond to requests for information or requests for quotes quickly, if at all. Other buyers complain that when they do receive a response, the emails are very brief, don’t include the requested price quotes, don’t answer the questions that were asked, and in general don’t inspire confidence that the factory can meet the buyer’s requirements.
On a clear bright day in the spring of 2005, we made a decision to look East to procure building materials. At the time, real estate development in the United States was growing very fast as an industry. In particular, converting apartment buildings into condominiums was big business. We decided to launch Parkview Industries, which would help to increase our profit margins by importing building materials from China by acting as a distributor to our existing real estate development business.
Our top 5 qualifications when evaluating a potential factory were
We learned very quickly that in fact we were not only qualifying factories but also that the factories were qualifying us as buyers. The factories we took the time to develop a relationship with were much more forthcoming with information and price quotes. The factories that were not convinced in our ability to put containers on the ocean were much less helpful.
At first we thought ‘well if a factory doesn’t want us as a buyer, then that’s their problem’. However in fact, the reality is that these are sometimes the better factories, and they are nervous that you might be a competitor just trying to get their pricing information.
When making initial contact with a factory online, keep in mind the following
Given the experiences we have had with sourcing over the internet, there’s a lot more to each point we have made here in this article. We will expand on the key lessons presented here in an upcoming article that provides detail on what we learned and how it helped find us both good and bad suppliers. Stay tuned and thanks for visiting.
4 Ways to Combat China Price Increases without Raising Prices to your Customer
Inflation in China is soaring and price increases are being exported to the developed world. Customers are finding that factories are increasing prices almost weekly or biweekly depending on the product. Customers requiring their price quotes in US Dollars are finding their quotes only good for one or two weeks.
On the other hand, your distributor or wholesale customers will not accept price increases every week, nor if you’re involved in retail will the final consumer accept this. Even if they did accept the price increases, it’s not cheap to update your catalogues, your websites, re-train staff, etc. Given the fact that inflation is real and that prices will increase, how can you best plan for this and minimize the negative effects to your business? Readers of SourceJuice are sending emails, asking what we recommend to help them through these difficult times.
SourceJuice recommends you to take a good look at the products you’re selling and sourcing and do an analysis of ways you can decrease production costs, while still maintaining the quality of your products. We’ve developed a top 4 list that can help get you started with your analysis.
1. Adjust Your Packaging Size, Colors and Materials
Packaging often makes up a significant cost of the final good you’re manufacturing or sourcing. There are many ways to adjust your packaging that can help you save on costs without affecting the final product, and possibly not even the perception of your product in the marketplace.
Are you using a metal case? Steel and other metals have increased in cost drastically. If you’re using metal in your packaging, can you switch to plastic? Can you produce a slightly thinner case if you need to continue using metal?
Regarding colors, printing in many colors and with varying textures can add considerable cost. Can you decrease the number of colors or textures in your packaging?
Regarding size, can you make your package smaller? Can you take out some layers of packaging? Can you requiring a smaller number of different materials to be used, thus gaining economies of scale and simplified assembly?
2. Decrease Transport Distance Required for Final Assembly
The price of oil and thus transportation is increasing. With oil now well over $130USD per barrel, look for ways to reduce transportation distances. The most obvious example is to source closer to your final customer. However, even when you need to ship the final product long distances, you may still be able to optimize your supply chain here.
For example, do you manufacture a final product that requires the assembly of components from multiple factories in multiple locations?
If yes, you might consider consolidating your factories within more of a reasonable distance. We’ve seen customers make their final product in Guangdong province but they have a ‘legacy’ factory in Tianjin for one of the components. Each time they want to run of a line of product, they must ship goods from Tianjin to Dongguan by rail or road. Once they relocate this factory to near Dongguan, they will save themselves costs on shipping as well as time.
3. Cut Out the Middleman
Trading companies and 3rd party companies have their place, especially when they act as project managers and quality assurance specialists.
However if your product requires multiple components and you are purchasing some components from trading companies that aren’t adding value, cut them out! Moving further back on the supply chain and working directly with factories will help you to get the lowest cost possible.
4. Push Back on Price Increases
Do not just accept any price increase that a vendor or factory comes back to you with. You need to make sure that the increases they are requesting are legitimate.
For example, if the price is increasing because of a VAT rebate reduction, you should reference the VAT rebate chart to confirm your product is actually effected. You should also try to have the factory prove to you that they actually even paid VAT in the first place, as many factories don’t and are using this issue as a way to increase profits.
With regards to currency fluctuations affecting price increases, try to start having the prices quoted in Chinese Yuan (RMB). Yes, you will still experience fluctuations in price, but these will be market driven as opposed to having to renegotiate prices regularly with the factory.
Additionally, if price changes are because of raw materials cost increases, reference back to global prices and make sure that the increase your factory is quoting you is in line, at least within a reasonable percentage, to the changes in the global market for that commodity.
Supplier Diversification and Your Exit Strategy
Having selected a factory and developed your product in China is only the first step in your sourcing process. It is important to diversify your supplier base. Throughout the procurement process, there will be times when unexpected delays can turn into extra months for producing deliverables. The natural process is to accept the reasons for delay and “hope for the best”. When doing business in China, having patience with your supplier is not always the best method for action.
It is important to lay out strategic plans of action with measurable milestones. See your end goal and put the invested emotional quotient aside. In conjunction with these plans, penalties for lack of execution on both sides must be implemented. Enforce these penalties, but also expect to negotiate during the time for payment. During an import venture mentioned below, the supplier had to come to the table with a signed contract entitling me a 65% discount.
While the delays were excessive, you cannot expect the supplier to lose all profit and even material/labor costs. If communication has broken down, take the high road coming to the table with an understanding of the supplier’s perspective, but only to the degree of reasonable doubt on the reasons for the delay. Do not take the reasons for the delays at face value.
Other common schools of action are complaining (many of us do this in the wrong manner) and while this will put new thinking in the minds of your supplier (that you will not accept further future delays), the deed has already been done. Maintaining the right kind of respectful relationship is key to any business endeavor (or even personal relationship) and complaining in the wrong way can damage this fragile, long distance relationship.
The foundation for my understanding of the business principles, included in this article, in China, was derived from a venture into importing private label modular cabinetry. In my case an intermediary was engaged to resolve some of supplier problems. Read in detail my experiences in this area and specific actionable items in Avoid the Middleman and Seek the Intermediary.
My experience in producing cabinetry in China tells me that having an exit strategy is key to making a bad situation transcend the fundamentals of a failed import venture. If you have selected the wrong supplier, the first delay is not the end, but only the beginning.
There are times when the smart business decision is to cut your losses for the time being, regroup and engage your second supplier. The supplier always has the upper hand in your dealings with them. They have your deposit, you need the product and having to switch suppliers midstream would incur delays and costs. This balance of power can be flipped if you are open to turning the tables with diversification.
If the end result is obtaining the product in the required schedule, the second supplier you had lined up may be your lifeline. In the mean time, you can resolve issues with the current factory and complete the order post the newly engaged factory delivers. This scenario works if you will need additional inventory or you can negotiate with the current supplier to reduce order due to your delays and having to engage the other supplier to accomplish the endgame.
Should You Diversify Your Supplier Base?
It takes time to develop a successful relationship with suppliers. For many importers, once this relationship is stable, they are hesitant to keep looking for other factories to produce the same product. There are certainly benefits to working with as few suppliers as possible such as gaining economies of scale, stability in terms of quality assurance and predictability as far as shipping schedules.
However, with the recent inflation in China, partly due to decreases in VAT rebates, many factories are raising costs hand over fist. When a factory decides to raise your costs, you have 3 options:
1. Eat it - You need the product. You have no other options.
2. Try to Negotiate - Perhaps you can knock the price down a bit; however, you will still agree to a price increase and you have no real way of knowing whether the price increase is reasonable.
3. You’re Prepared with Alternative Factories - You’ve got secondary suppliers that could take up part of (or all of) future orders. You can play your suppliers off of each other, dangling carrots as necessary, and make sure that the price increases are reasonable.
Jason Busch at Spend Matters, adds an additional insight on why you should diversify your suppliers in his article Split of Business: The Best Sourcing Justification for Supplier Diversity?
By dangling the carrot of additional business out to the secondary suppliers, a buying organization can get them to invest more in the relationship than they otherwise would. Out of this might even come joint innovations or even new product ideas.
And at the end of the day, aren’t we all looking for better, more interesting products (at cheaper prices)?
The Right Suppliers at the Right Price; RFQ Strategy and Cultural Considerations
Finding the best supplier to manufacture your product and negotiating the best price can be a lengthy process requiring a great deal of research, a bit of strategy, a dash of cultural understanding and perhaps even a touch of luck.
We came across an interesting company called PassageMaker, headed by a gentleman from the United States named Mike Bellamy. According to their website, in 2006 PassageMaker became the first (and perhaps only) medium sized, 100% US-owned, assembly/inspection company in Shenzhen possessing the following: In-house licensed custom’s brokers, Full import-export rights, and authorization by the Chinese government to process Value Added Tax (VAT) rebates.
Mike has done some speaking engagements over the past few years and one of them is titled, “Sourcing Strategies - Find the right suppliers, assure quality and avoid knock-offs on a limited budget”. The videos are posted on YouTube in 4 ten minute clips. We’ve watched the first two, which are quite good, and have our ‘takeaway notes’ for our readers to review. In addition, we’ll post links to the videos below for easy access.
GENERAL
1. China, although uniquely different from the West, is very open to western business practices and you should not be worried about cultural mistakes. The Chinese don’t expect you to know their culture or language and are very forgiving of mistakes and cultural misunderstandings.
2. There are many factories that make excellent products but aren’t good at marketing themselves to the world. There are other companies that are excellent at marketing but aren’t factories themselves and misrepresent themselves to potential customers to win deals.
3. The areas to focus on are the Pearl River Delta which is in the Hong Kong/Guangzhou area and the Yangtze River Delta around ZheZhang and Shanghai. They both have different histories. The Pearl River Delta was designed from day 1 for manufacturing for export. The Shanghai area has a long history of manufacturing but developed to service the internal market.
4. How to qualify a vendor on a limited budget - use web directories and trade shows to find new suppliers but visiting the production area and walking the line is the only way to see that they really make the product.
5. The issue with dealing with trading companies is that there is no direct line of communication when there is a problem. Trading companies may not understand the product as well as the factory and may not be able to handle the issues that arise.
6. Hold negotiations at the factory. To see if they’re really making the product, try to spend as much time at the factory as possible. Look for signs you’re being duped such as the business card addresses of all the people not matching or if the person who is giving the tour of the factory doesn’t seem to know all the people.
COSTS
1. Tooling and setup costs should be quoted separately and compare the quality of the tooling among factories. Often longer lead times are required for better quality tools with higher grade materials such as steel.
2. Gather your quotes using the same incoterms - Mike prefers to use EXW (Ex works), which essentially means ‘finished and available at the factory’. SourceJuice wrote an article comparing FOB and CIF, detailing what’s included and what’s not.
3. Be clear on your quality standards and acceptable levels of defects as this may significantly affect pricing and you want to be able to compare applies to apples across factories.
4. Specify the grade of the materials in your bill of materials. There are many grades of metals and plastics and you need to be clear!
5. Ask them to identify their VAT structure. Some of the smaller suppliers are not paying VAT on raw material purchases and thus not getting the rebate when they export. This is ok for small quantities but when you need to ramp up, they may not be able to keep the same deal. In this case, you can expect a spike of 10% or more! For large companies, if you dont ask about the VAT refund, they may pocket it. For more information on the recent changes (and a general explanation) on VAT rebates, check out the SourceJuice article 4 Reasons Why Sourcing in China Will be More Expensive in 2008.
NEGOTIATIONS
1. Orient yourself towards the decision maker and not necessarily the guy who understands you best because of language.
2. The guy at the top usually doesn’t speak as much English since he’s older and grew up when China was a closed society.
3. Watch the Bai Jiu!!! For those who don’t know, Bai Jiu is a traditional Chinese alcohol made from rice. It’s very strong and it’s typically part of dinner banquets and can be abused easily with repeated calls for toasts. You don’t want a lopsided agreement and if you start to drink and then stop you may offend. Better to just say you’re allergic or that you can’t drink. Mike commented that he brings a bottle of tequila and when they do Bai Jiu shots, Mike requests that everyone do a tequila shot! That stops the drinking!
4. If you’re looking for a little strategy, bring a translator with you even if you or your colleagues speak Chinese. Don’t speak any Chinese during the negotiations. After a round of price discussions, the translator should excuse herself to go to the bathroom. The Chinese factory may continue to talk about pricing strategy with you in the room. — Just be sure they don’t pull this on you with English!
TRANSLATION
1. Use a professional translator who is familiar with your field if you don’t speak Chinese!
2. Go over the technical terms in advance and make sure you’re in sync. Otherwise your translator may not know the details of what you’re trying to communicate.
Is “Guanxi” still needed in China?
Guanxi in Chinese means “relationships” and most foreigners and Chinese alike will assure you of the need to have good Guanxi to get business done in China. While I doubt anyone who has done business or lived in China will argue that relationships aren’t necessary here, Shawn He Yuxun, from MeetChinaBiz offers some excellent insight in his blog post into the history of this infamous word Guanxi, its place within China historically and what place Guanxi may have in the future.
In his post, Shawn He Yuxun discusses the history of Guanxi as it relates to requiring personal favors to achieve economic means during a time when China’s economy was completely planned.
Prior to the 1980s, every aspect of China’s economic life was planned, controlled, directed and operated by the government. No private ownership of any property or asset, much less profiteering for an individual or group, was allowed. The government would allocate everyone a pre-defined slice of the “big pie“ (incidentally the equivalent terminology in China — where rice rules the dining table — was “Da Guo Fan“ (da-gore-fun), which means “rice in a big wok“). If one wanted any more than what was allocated to him/her, he/she would have to circumvent the system and rely on another individual in charge of a particular function in that “allocation chain” to do him/her a special favor.
As China began opening up in the 70’s, there was no effective system in place to foster individual economic relationships outside of the planned economy and this Guanxi system.
So by and large throughout the 80’s and most of the 90’s, having Guanxi this “ultra-relationship” or “super-connection“ ALONE had proven to be a sufficient, and in many cases also necessary, condition to get something done, regardless of the fundamentals. With Guanxi, a completely unqualified and incompetent person could land a very important job and/or position. Also with Guanxi, a company with no track record whatsoever could be awarded massive contracts. You get the point…
However, Shawn He Yuxun argues that as certain industries become more privatized, and with a history of economic relationships built outside of the Guanxi system, that Guanxi itself is less important. “Business is business” just like in the west.
As the economy becomes more and more marketized / privatized and competitive, the value and effectiveness of the Guanxi system has also greatly deterioriated. In industries that have been substantially deregulated / privatized or where there is much competition, business is business, and Guanxi has been neutralized / marginalized to resemble just what relationships and connections are like in the Western world.
So what do you think? Is Guanxi still required in China? Is the Guanxi of today different from the Guanxi of yesterday? Let’s hear from our readers about your experiences!
Beware the Middleman and Seek the Intermediary
So you come across what seems to be a stroke of good fortune. A company having experience in making your product and after calculating your landed price are once again surprised at how cost effective it is to manufacture goods in China. There is no substitute for traveling to tour the factory, but depending on your situation, you may not have the opportunity to visit. Having received some literature, a sample and verified the company’s references, what else can you do? What is the worst that can happen? Let me tell you the pitfalls and learn from my experience importing a new product, from a new company, for the first time.
This is a story as much about the intermediary as it is about the middleman. Both are important aspects to consider in the importing process. Both will cost you money and increase your landed price, but only one will add value.
Sourcing Companies vs. The Source
There are an unlimited amount of companies in China that represent themselves as the manufacturer and they can, at times, make it hard to make the distinction. These companies can do some of the leg-work for you of having to locate the manufacturer in person or on the internet. They can be useful in that they are creating a “one stop shop” to find and purchase all of your goods. Sourcing companies have created partnerships or special pricing agreements with the different manufacturers and in turn resell the goods to you. While I have found a number of sourcing companies that are useful, it is best to go right to the source. One issue, is that without dealing with the source, you do not know who or how your products are really getting produced and under what circumstances. Secondarily, if you have problems with your goods, you are going to have to deal with the source through another company (or two possibly – you just don’t know). Another important detail is that without dealing with the source, you cannot be sure that this isn’t the first time they have built your product. As in my situation, the company had produced similar “wood” products like front doors and figured that was enough expertise to build “wood” kitchen cabinets. As with many things in China, the country is amazing at being able to accomplish extraordinary feats of “Magic” that may not have ever been done before or at that scale. This can sometimes be dangerous for the consumer.
It is important to note that it is only good business ethic to do a trial run of any product you import for the first time at your own risk and not the clients’. This is the case for my venture into producing modular kitchen cabinets to add to our private label product line.
Pre-Manufacturing Design
One of the issues with working with the middleman or sourcing company/agency is that they may be knowledgeable about a wide variety of products, but not intricately experienced in any of them. By unknowingly using a sourcing company, I opened myself up to an extraordinary amount of work early on in my kitchen cabinet manufacturing venture. Aside from putting together kitchen cabinet layouts, order lists and color/style selections I immediately found myself in a storm of pre-manufacturing design related conversations with the “manufacturer”. The questions I was being presented with are ones that should already be known as industry standard specifications for a product. Check it out, an actual diagram from the sourcing company asking design related details to cabinet construction. It gets much worse, but you get the idea.
Delays & Intermediaries
Suffice it to say, design wasn’t the only head-ache, delays were inevitable. Production was looking to run past a year and I encountered excuses about material shortages, issues with paint drying due to the rainy season and hardware not arriving on schedule. I had no way to confirm production was actually moving according to the emails I am receiving. At the same time I was expected to make progress payments on the manufacturing. I became skeptical if I would ever receive the order when I asked that a sample door be produced, completed ahead of the order as to confirm quality and mailed to me. This was nothing more than an attempt to satisfy my curiosity of their actual progress. Additional excuses followed and with a 20% deposit on the line, I contracted an intermediary to do some due diligence on the company. The World Trade Group has offices here in the US and in various places in China. This is important as you have a local contact in both places in which to interface, send documents, etc. For a consulting fee they are able to fly a consultant out from a city in China to your factory and give us a detailed report with photos. This was invaluable in that for the first time we were able to get a vivid picture of exactly what and who we were dealing with.
Their Findings
The report from the World Trade Group confirmed that the factory was not being truthful as to the nature for the lengthy delays. By the time of their arrival, it was claimed my sample doors had “just shipped out” express mail. By hiring a consultant, we were able to reopen communications with the sourcing company since talks had broken down months prior. They also were able to begin to negotiate for a hard ETA on completing production and had a backup plan if they were not successful. Lets look at some of the details from the report. The report outlined an actual timeline of events generated from email correspondence on both sides. Also included was a description of the company outlining that it had been in business for ten years exporting wood doors and had started their new cabinetry product offering shipping only to Europe. There were six factories that the sourcing company was working with, each without a sign identifying who owned the factory or their affiliation. All finishing/paint coating was to be subcontracted, but at the time of the inspection by WTG, no contractor had been selected.
All door and drawer panels had been completed and stacked in the corner.
Of course reviewing all of this information gave me a false sense of security that everything will go on schedule from this point forward. As a contingency for further issues, a hard date was set for shipment and terms for late delivery established. WTG continued to monitor communications and status of shipment and when the factory again failed to meet deadlines, intervened. Due to the terms of our agreement, the shipment was so late that we had to again negotiate an acceptable discount even though we had an agreement in place.
Arrival/Conclusion
The order exceeded a year to conclude and with only one of the two containers finally shipped. At the final point, it was decided to have the cabinets painted and finished here in the United States for fear they would never be completed. The World Trade Group or other companies alike are essential in conducting business from the US. They provide a cost effective alternative to source new products, evaluate factories of interest, provide quality assurance measures, confirm integrity of products before shipment or mediate an already bad situation.
dylan@sourcejuice.com
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