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Category Archives: China Sourcing

Hoverboards are very popular holiday gifts this year, but the stories about the boards that explode are all over the news.  Many retailers including Amazon.com and Target stopped selling them, and several commercial airlines banned them aboard their aircraft.

So what happened in the manufacture of these items to make them so dangerous? In the reported incidents, the lithium ion batteries in the hoverboards caught fire while charging or just riding them. The reasons for the combustion process is well-known when a battery is defective. The problems with these batteries were identified in laptops and cell phones a few years ago.  What isn’t so transparent are the sourcing and manufacturing processes for the boards being produced in China.

Hoverboards are new, exciting and popular products and this combination creates a frenzy of manufacturing opportunity for Chinese manufacturers. Because of the popularity and the potential for high volumes and high profits, knock-off brands proliferate very fast in the extremely competitive changed to avoid patent infringement laws. The raw  materials sourcing for knock-offs may come from completely different suppliers. Cheaper knock-off products means cutting corners in the factory to keep production costs low.

US safety standards are not all in place yet for these new products. US Customs may be allowing imports to enter the US based on safety standards for similar products, following the current requirements for imports. Some manufacturers may have obtained UL certificates on certain component parts, but not for the hoverboard as a whole. Raw materials such as the actual batteries may be knock-offs, too. You cannot trust the  well-known top brands either. The high demand is likely to cause sourcing from multiple Chinese factories with limited experience and untested component suppliers. No Chinese agency is overseeing the quality of exports from China.

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Montgomery County Fire and Rescue

It’s common to evaluate potential supplier and supply chain partner’s financial position before placing an order or signing a contract. In fact, most purchasing departments these days, require obtaining supplier key financial data as a standard part of the procurement process. This financial data is then evaluated by the company finance or accounting department and the risk associated with the supplier or supply chain partner is determined. If the supplier is a publically traded US company, that’s easy to do as these companies must comply with SEC rules on financial reporting. But you should be leery of accepting information provided by Chinese suppliers at face value.

China’s largest banks typically only lend to the largest corporations, leaving small and medium sized suppliers to obtain loans from friends and relatives or from a “shadow bank.” Shadow banks are private lending companies that are not regulated by the Chinese government. These shadow banks lend money at a much higher rate of interest, squeezing the small suppliers’ already-thin profit margins. So if you are buying from a Chinese supplier, you should ask and verify where their working capital comes from. You just might find that some suppliers cannot make their loan payments and will simply shut their doors and disappear, leaving you scrambling to find another manufacturer. Finding working capital in China is risky business.

Enter: The Bank of Foxconn. Foxconn, the world’s largest contract manufacturer and maker of iPhones, iPads and many brands of laptops, has ventured into the lending world. To protect its suppliers from the pitfalls of shadow banking in China, Foxconn is now making business loans. That makes Foxconn the banker for the world’s electronics supply chain. And Foxconn isn’t the only company to provide banking services in China. Baidu (the “Google” of China), Alibaba (the “Amazon” of China) and Tencent ( WeChat and mobile games) all have lending banks, too. Lending to small and medium businesses provides higher returns to Foxconn than they can make on their contract manufacturing business. It also provides an opportunity for suppliers to borrow at a lower rate than from shadow banks. Foxconn reportedly has obtained licenses from Chinese local governments to provide loans, factoring, financial guarantees and equipment leasing.Foxconn

When evaluating suppliers, be sure to ask where their funding comes from, and don’t be surprised if the answer is the Bank of Foxconn.

fork-in-the-road-what-now

I can’t get that hit rock song by the Clash, “Should I Stay or Should I Go” out of my head.

“Should I Stay Or Should I Go” by the Clash
Darling, you gotta let me know
Should I stay or should I go?
If you say that you are mine
I’ll be here ‘till the end of time
But you gotta let me know
Should I stay or should I go?

I’ve been talking to companies that are now making decisions about keeping their manufacturing and supply base in China or bringing manufacturing back to the US. They are asking the question, “Should I stay or should I go?” and that triggers the song playing in my brain…over and over and over. I wake up hearing it and it plays in my head all day long.
In the 1990s and 2000s, companies went to China out of fear of being left behind, not necessarily because they had made an informed decision based on data about the Total Cost of Ownership (TCO). Now it seems they are coming back for fear of being left behind again.
Total Cost of Ownership is an all-encompassing estimate that helps business people determine direct, indirect and consequential costs of one decision versus another. The idea was developed in the 1980s and applied to the costs of implementing software over its entire lifecycle. But when using TCO in a manufacturing or sourcing decision to stay in China versus moving back to the US, there are many more components to monetize and compare.
For example, you may find additional factors that must be considered beyond simple labor costs, import and logistics costs, such as supply base considerations, automation opportunities, supply chain latency, cost of travel, IP theft, quality and so on.
There are also costs associated with leaving China such as buying out employment contracts, obtaining permits to shut down operations, and the tools and dies left behind. The legal ramifications of these things can add up quickly. There is a lot to consider and trying to monetize all of the hard and soft benefits can be very challenging.
Nonetheless, it is important to consider all costs for a true comparison before you decide, “Should I Stay of Should I Go?’

2013-07-05 01.58.31I took the bullet train from Shanghai to Nanjing today, a journey in a pleasant 1st class, sparkling clean rail car at 200 km/hour, for about $30.  Rail is such a great way to travel in China.  It’s efficient, convenient and inexpensive, plus you see things you would never see from an airplane.

Along the way, in every direction, are miles and miles of factories.  They come in all shapes and sizes – small and squat to enormous smokestacks –apparently producing simple assembled products, electronics, plastics, castings and everything you can think of in between.  

Chinese Finance Minister Lou Jiwei told the G-20 meeting in 2014 that manufacturing accounts for nearly 60% of Chinese GDP, an unsustainable share which has created the problems of pollution and overcapacity, he said.  This is very evident as I traveled through the manufacturing areas between Shanghai, Wuxi and Nanjing.  The pollution was overwhelming; the skies were thick with a smoky fog and the sun was a muted disk low in the sky.  The pollution gets so bad from time to time that people wear surgical masks whenever they are outside during the most dangerous periods.

The Chinese government is no longer shying away from or denying allegations of the horrendous air quality.  In fact, in the latest government Five-Year- Plan, China is finally putting real muscle and money into environmental clean-up.  I expect to see substantial improvement over the next few years.  In addition, China plans to use the excess manufacturing capacity to address the needs of their own burgeoning middle class by producing products demanded at home.

Americans need to work on balancing the difference between the Chinese economy supported by 60% manufacturing and the US economy where only 11-12% is based on manufacturing.  Manufacturing is the fundamental backbone of a healthy economy.  We need to bring some of it back to the US- but very carefully.  We want skilled jobs that pay a living wage and don’t pollute the environment.

flag (2)There are some fundamental differences in business practices that you should know when working with Chinese suppliers.

Culture impacts everything

China’s 5000 year history and traditions affect everything.  The dichotomy of modern industrial China, superimposed with traditional values and approaches to doing business, is often a surprise to Westerners.

Guanxi is not networking

Guanxi is someone’s personal network and long-term trusted relationships between parties. It is not simple networking.  It involves a commitment over time. You cannot do business effectively in China until you build this type of trusting relationship.

Validate everything in writing

Even though there are more English speakers in China than any other country in the world, it is often a mixture of Chinese and English that is not understood by either party.  Just because a Chinese business person speaks English, does not mean he understands the nuance of the language.  Every detail of the contract, specifications for production, expectations, etc., should be put in writing, discussed and confirmed several times.

Contracts are viewed differently

In the Western world, contracts represent the culmination of negotiation on price, delivery, specs and other terms.  In China, a contract is viewed as just the beginning.  Just as an American high school student may view graduation as the end, parents view it as commencement or beginning.  A contract in China is a commencement and the start of real negotiations.

Quality fade

Quality fade, the process of quality degradation over time, is the single biggest issue in low cost manufacturing countries. It happens frequently in China where manufacturing processes are immature and competitive pricing drives the profits to extremely low levels.  You have probably noticed quality fade, but didn’t know what to call it, or understand how it happened.  Maybe you noticed a plastic shampoo bottle that seemed too thin.  Maybe that hand-held electronic game you put in your son’s Christmas stocking stopped working after a few days.  Maybe the zipper in your pants broke after a few zips. The initial production may have met all expectations, but over time, there was degradation in production quality.

Outsourcing and subcontractors

China business is typically a combination of primary manufacturers and many sub-contractors that provide parts and services.  Without regular monitoring of the production processes in China, this common practice of sub-contracting and outsourcing gets out of control.  US importers find it harder and harder to control quality over time and sustain delivery schedules from Chinese vendors.

Importers must remember that doing business in China is not at all like doing business in America.  The processes, culture and legal environments are a world apart.

I am in China again this week and it seems everyone wants to know about the US elections.  They watched the Presidential debates and the election news with great interest and a kind of wondrous amazement.  “We heard what your politicians believe and what they will do,” one executive told me.  “In China, we have no idea what the policies of the leaders will be.”

I hadn’t really considered the difference in politics this way.  Americans have access, information and a fundamental understanding of what the leadership is planning.  Chinese people have none of this.  Most people have no clue about what is in the new Chinese 5-year plan, or how the new Communist Party Chief Xi will lead the country.

With the US elections now over and Obama reelected, the new President Xi assuming the leadership of China and Putin in Russia, we should all be wondering what will change in the world.   These three super-powers will surely bring dynamic change in the world order.

The Chinese Communist Party began its leadership transition as the 18th National Congress opened in early November.  This transition in leadership happens only once every 10 years. The new President Xi will be charged with executing the new Chinese 5-year Plan, developed earlier this year.  This plan includes a heavy emphasis on the environment, and from what I have observed in China, whatever the government decides to do, gets done.

In the US we have had the privilege of watching the Presidential and Vice Presidential debates, listened to endless TV advertising and news reports.  We have a pretty good idea about the President’s agenda.  But how that agenda will interact with Xi’s and Putin’s is a big unknown.

I visited a State Owned Enterprise (SOE) machine shop near 5th Ring Road in Beijing one very hot and humid August afternoon.  The machine shop was located among a cluster of buildings that didn’t seem very remarkable from the outside.  But inside was a different story.

We were greeted by the Plant Manager and the Operations Manager, who were expecting us for a visit that afternoon.  After the greetings were exchanged, the two managers disappeared to take a phone call and we were left to wander the plant by ourselves, unescorted. 

We walked down the center aisle of the machine shop, surrounded by giant drilling and cutting machinery making thunderous noise and throwing off metal shavings.  We were offered no eyewear protection, no foot/toe protection and no earplugs.  The Chinese machine tool operators were wearing black cloth shoes with rubber soles; not the steel-toed boots you would expect in a US factory.  About half way down the center aisle, a chemical smell was so overwhelming, that I looked for an open window or door to gasp some “fresh Beijing air”.  I was allowed to take as many photos as I liked.

The lack of safety standards and allowing us to walk through the factory unescorted was a dose of reality regarding Chinese manufacturing.  China’s steady climb in the industrial world has not been paralleled with world standards for safety.  The climb to achieve these standards in China is extremely steep.

Recent stories in the Western press describe impending doom for Chinese manufacturing, relating the Chinese demise to Japan in the 1990’s.  But to real China-watchers and experts, this is a naïve view.  It assumes that the Chinese government will sit back and do nothing to correct the trends and that the Chinese economy will stagnate.

While Chinese manufacturing is not known for innovation, it really is just a matter of time.  With 700,000 graduating engineers per year, China is quickly becoming the world’s powerhouse in manufacturing engineering and in continuous improvement.  The next phase is innovation and optimization. 

To address innovation, the Chinese government advocates student exchange programs and invites thousands of visiting US professors into its universities to infuse creativity into the education systems. Over time, this will reignite the creative innovation spark that the Chinese displayed over thousands of years, inventing printing, gun powder, deep water bridges, massive sailing ships and irrigation to name a few.  While US politicians tell us not to worry because China cannot innovate, the Chinese are busy proving them wrong.

To address optimization, China has started on the journey to automation.  Automation and the adoption of software systems will dramatically increase productivity at the factory level and will drive continuous improvement and optimization.  Although this is a long road to travel, it is nonetheless the road Chinese manufacturers are on.

It’s time to wake up and smell the green tea.

Mike Daisey, a journalist and feature writer, delivered a radio show about Chinese factory workers on NPR “This American Life” in January.  I listened to the show one Sunday morning with a friend and kept thinking how odd it was that the things he was saying about his interviews with workers outside of Foxconn, just didn’t ring true.  I remarked to my friend throughout the broadcast that his examples weren’t true, or were odd. For example, he claimed he talked to several young girls who told him they were 12 and 13.  If they were underage workers at the Apple factory, why on earth would they say so and risk losing their jobs in one of the best factories in China?  In another example he talked about guards at the factory gates toting guns.  I have never seen anything like this in the factories I have visited.

Well, it turns out that Mike Daisey lied and embellished his story for NPR and for his off-Broadway monologue called “The Agony and Ecstasy of Steve Jobs”.  Only a few parts of his story were true…enough to make it sound real.  NPR has broadcast a retraction and the world press has skewered Mike for lying.

It’s not that those of us with China experience don’t believe there is room for improvement.  Chinese factories in general have a long way to go to improve working conditions and address human rights issues.  Conditions are not consistently up to world standards yet.  But the Foxconn factories are some of the best places to work.  Apple, HP, Dell and other companies have taken pains to monitor the production environments to make them humane and safe.

What bothers me most about Mike Daisey’s lies is that he has incited people to believe more fiction about China.  It’s time we dig deeper and question stories like this in the Western press and demand that our news companies verify all facts prior to printing or broadcasting.

On Nov. 8, 2011, the Senate Armed Services Committee held a hearing on counterfeit parts in the defense supply chain, including electronic parts used to manufacture weapons and other defense department equipment. Investigators found that counterfeit or suspect electronic parts were installed or delivered to the military for several weapons systems, including military aircraft such as the Air Force’s C-17 and the Marine Corps’ CH-46 helicopter, as well as the Army’s Theatre High-Altitude Area Defense (THAAD) missile system. Legislation is being proposed to require defense contractors to certify all parts for authenticity.  This will place a tremendous burden on defense supply chains in terms of authentication process verification

But of course, counterfeiting is not limited to defense goods.  Any electronic gadget or equipment is likely to include some counterfeit parts, and the counterfeiters are getting better and better at it. It is so difficult to tell counterfeit from legitimate parts, that industrial buyers are often fooled.  Even the price of counterfeits may be equivalent or close to legitimate parts, thus eluding suspicion about parts origins.  This is a problem of such magnitude, that we are just beginning to unravel the stories.  Counterfeit parts may cause your iPOD to fail early or not work properly at all.  But think about the real danger in counterfeit parts in machinery, automobiles and aircraft.

The only way to control counterfeiting is to maintain control over your entire worldwide supply chain.  This means verifying and monitoring all parts suppliers, distributors, subcontractors and manufacturers.  Take nothing for granted. Know your supply chains from start to finish. Verify and monitor every step of the way.