Sourcing from China 101, part 5: Negotiation: The terms you need to discuss

By Renaud Anjoran

Chinese suppliers are good at detecting which purchaser is inexperienced.

If that’s the case, and if you are dealing with dishonest suppliers, they could think that they will be able to take advantage of you.

Therefore, it is important that you come across as someone who is fully prepared. You need to know what to ask, and how to respond when a supplier is being unreasonable.

Let’s have a look at the main terms you will need to discuss with potential suppliers. I advise you to discuss most of these terms in your very first discussion/meeting with each potential supplier.

1. Total lead time (and shipment date)

From the very beginning, you need to ask them two things:

1. What months are you most busy? And when are you less busy?
2. Once a perfect sample is approved, and you get the green light for production, how many days do you need before you can ship the goods?

Note: you should always keep these two pieces of advice in mind when discussing lead times:

• Whatever they promise you, add 3-4 weeks to your internal planning if they are a new supplier. And 2 weeks should be fine if they are already an regular supplier.
• When you discuss timing, always remind them that quality needs to be maintained to the approved standard. If you ask them to rush production, you are giving them an excuse for poor quality!

2. Incoterms

Along with their quotation, they should write something like “FOB Shenzhen” (or FOB another port). This means they pay the costs until the port of Shenzhen; you are then responsible for the shipment and delivery of goods to your final destination. FOB is by far the most common incoterm.

The good news is, you are in control of the freight if you buy FOB, but you will need to find a freight forwarder — You can find out more about your 4 options this article.

If the supplier offers to take care of the international freight, you should only accept it if the incoterm is DDP [your warehouse] or at a minimum DDU [your warehouse]. It means they will take care of all the freight until your warehouse, door to door. NOTE: in DDU terms, import duties are unpaid, so you’ll need to work with a customs and excise broker.

Important note: in most cases you should NOT accept CIF terms. In most cases, the price will be interesting but there is a catch… You will probably have to pay extremely high “local” fees.

When it comes to airfreight, specific incoterms apply. Your freight forwarder should be able to explain the nuances to you.

3. Intellectual property rights (if your product is unique)

Importers are often afraid of a Chinese company reverse-engineering and copying their products. But most cases of IP infringement involve the original supplier/manufacturer!

It should be no surprise, since they are the ones that went through the hard work of product development and getting the product into manufacture, they also have a sense of their buyer’s business model.

If you do not want your supplier to turn into your competitor, you should take a few precautions.

First, be aware of common legal strategies. You should register your trademark in China before production starts. And you should have your supplier sign a NNN agreement. Let’s break it down a bit:

• Non-disclosure agreement — most people think about this one. But the way it is written (in particular the jurisdiction that is competent in case of a breach) often makes it unenforceable.
• Non-use — since disclosure may be very difficult to prove, you want to make it clear that your confidential information will not be used outside of the intended project.
• Non-circumvention — you might not be able to prove that the receiving party disclosed the information or that they used it (it might be done in another facility, under a distant cousin’s name). But you also want to make sure they don’t try to sell your product to your own customer(s).

Second, use non-legal strategies. If you are ready to pay a little more to reduce IP risks, you should structure your supply chain yourself and place a firewall between its major elements:

1. Find and qualify the components suppliers (that’s not a must);
2. Distribute the processing and pre-assembly across several factories;
3. Give the final step (assembly & packing) to a manufacturer that does not know the other factories involved, or that is specialized in acting as a “black box”. There are a few of them in China.

4. Access to, and transparency about, the manufacturing site

Even if you have confirmed that you work directly with a manufacturer, your order might be subcontracted to a smaller workshop—either because they run out of capacity, or because they want to widen their profit margin. When this happens, you run higher chances of a quality disaster.

So, what can you do to prevent it?

• Make it very clear to your supplier that production is to take place in the approved factory only, unless they get your written authorization to do otherwise for a particular order. Get a written commitment about this, and place this term on your purchase orders.
• Have the supplier confirm that your representatives (be they your staff or a third party) can go in the factory and check your product at any time during production.
• Observe production if you can be on site, especially for the first run. You can also send in an inspector who will report on the location of production.
• Try to avoid your supplier’s peak season as well as the period around Chinese New Year.

5. Quality standards & product specifications, and certifications

In Chinese suppliers’ minds, quality is tightly linked to prices. If you ask for a low price, it is implied that you will be less strict on quality.

Therefore, one of the key elements while negotiating is: you can discuss prices, but you need to make it extra clear that your quality standard is not negotiable. Better still, you should define your quality standards precisely.

You also need to make sure the product you are buying is compliant to the regulations of the countries where you intend to sell it. Tell the supplier about those countries. If you buy an off-the-shelf product, do they already have the right certifications? Can you see them? If not, who will pay for them?

6. Payment terms

Accepting a slightly higher price in exchange for more favorable payment terms can be great business.

If you purchase products in a very competitive industry, and if you know that many suppliers will fight to get your business, you can try to negotiate the following terms: 30% before production / 50% just after shipment / 20% after delivery in your warehouse.

Similarly, if you plan to use letters of credit, you need to mention it the very first time you exchange with a potential supplier. If they refuse this payment mode, or if the amount of your orders is too low to justify a letter of credit, it is best to know about it right away.

The advantage of a letter of credit is that you don’t get “hooked” by a 30% down payment (which is never ever sent back by a supplier to a customer).

7. Other common terms

Some other common terms that are often included in OEM agreements are:

• Who pay for the first inspection and the first laboratory test, and who pays the following ones in case of a failure
• Penalties for late shipment, chargebacks for mistakes, etc.
• Control over price increases
• Compensation if the supplier cannot deliver
• Right to refuse orders

A lawyer can tell you more about all this. But I hope I presented an overall picture that will be useful to some importers.

Is there anything important that I missed?

Sourcing from China 101 Resources

Sourcing from China 101, part 2: How to identify potential suppliers?

Sourcing from China 101, part 12: How closely do you follow your productions?

Sourcing from China 101, part 11: Build good rapport with suppliers

Sourcing from China 101, part 6: Keep some leverage with suppliers

Sourcing from China 101, part 5: Negotiation: The terms you need to discuss

Sourcing from China 101, part 4: Second choices vs.

Renaud Anjoran has been managing his quality assurance agency (Sofeast Ltd) since 2006. In addition, a passion for improving the way people work has pushed him to launch a consultancy to improve factories and a web application to manage the purchasing process. He writes advice for importers on qualityinspection.org.