The right way to reduce your China product costs

By Dan Harris

In China Factories Are Exporting Lower Prices Around the World, Bloomberg News wrote this week about something our internmational manufacturing lawyers have been seeing: Desperate Chinese factories are lowering their prices. Are all Chinese factories desperate? Absolutely not. Are all Chinese factories lowering their prices? Near as we can tell, a great many are, especially for their best customers.

But you must be very careful in negotiating lower prices from your Chinese factory because just asking for lower prices could cause your company some very serious blowback. The first thing you should know is that Chinese factories are sick and tired of losing so many of their customers and they are very wary of anyone who they believe may leave them for another factory in another country.

China’s factories just suffered their third straight month of declining production and nearly all legitimate economists see this decline continuing. More importantly, nearly all Chinese factory owners see the same thing. This is important because if you tell your Chinese factory that you “need” a price reduction, it will think you will leave if it does not give you the full amount you request and this can be dangerous. If you tell your Chinese factory that if it does not lower its prices by 10 percent or you will go elsewhere and your factory cannot lower its prices you just put your company at major risk. In The Single Best Way To Avoid Being Taken Hostage In China, we wrote of how Chinese companies often take hostages to try to collect on alleged debts or to protest employee layoffs or the closing of a China facility:

As the [Associated Press] article states, “it is not rare in China for managers to be held by workers demanding back pay or other benefits, often from their Chinese owners, though occasionally also involving foreign bosses.”

My law firm’s advice every single time to our clients who are laying off workers in China or closing a facility in China or allegedly owing money in China is to stay outside China for all negotiations. One only needs to be a regular reader of our blog to know that we took this position long ago and have never waffled:]

If you are in a debt dispute with a Chinese company, the best thing to do is not go to China at all.

If you must go to China, think about using a bodyguard or two and think very carefully about where you stay and where you go. Most importantly, be very careful with whom you meet.

Consider preemptively suing the alleged creditor somewhere so that you can very plausibly claim that you have been seized not because you owe a debt, but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China.

You are probably wondering why I am writing about debt collection and hostages when the theme of this post is reducing your China factory pricing. The reason is simple: when Chinese companies believe you will be leaving them/leaving China, alleged creditors come out of the woodwork. The tax authorities will come up with taxes that you owe. Your factory will explain why you owe it way more than you thought you did. Your factory’s sub-suppliers may send you bills for components you never ordered and never knew you were responsible for paying. You will get a bill for the molds and the tooling and the design work your factory did years ago and you thought (rightfully so until now) was included in your product pricing. These sorts of things do not always happen, but they happen often enough that you need to be prepared for them. The first rule is that you should have this discussion with your factory from your own country, not at a face-to-face meeting in the corrupt Chinese town where your factory wields its power.

If the “bad things” described above happen and none of your personnel are held hostage, can you not just “walk away” in the middle of the night never to return to China? That is possible, but that comes with risks and it seldom will make sense unless you absolutely certain neither your company nor anyone who can be relatively easily identified with your company will ever again do business with China or find itself in China. As someone who has many times been in an airplane that had to land somewhere other than its intended destination (I once spent four unplanned January days in Magadan, Russia, when the city had essentially no fuel for heat) you also will need to be completely certain that neither you nor any of your personnel will ever involuntary find yourself in Mainland China (or Hong Kong or Macau?).

if you are going to try to negotiate lower prices from your China factory, you need to have a Plan B setting out what to do if your relationship with your China supplier ends that day. These days, about 10 percent of the time when one of our clients goes to its China supplier to negotiate a lower price the supplier flat out says something like “we are done manufacturing for you. We don’t need you anymore. We are selling our own products direct now.” That ten percent figure is even higher for any foreign company whose products are being shipped to the United States because so many Chinese companies have come to believe those companies will soon be leaving China entirely — and they are right. Oh, and its “own” product that it will be selling (or has been selling already for months) could very well be a clone of your product.

What then should you do to plan in advance for something as simple as asking your Chinese factory for a price reduction? First, make sure nobody from your company is in China when you make the pricing request. Second, make sure that you have secured your molds/tooling and all product for which you have already paid before you do anything that might tip off your China supplier regarding the possibility that you may start manufacturing elsewhere. Third, line up new suppliers (preferably outside China) that can start producing quickly.

Over the years our China manufacturing lawyers have repeatedly seen the following:

• Foreign company tells its China manufacturer it will be ceasing to use China manufacturer for its production. China manufacturer then keeps all of the foreign company’s tooling and molds, claiming to own them. The way to prevent this is to get an agreement from your Chinese manufacturer that you own the tooling and molds before your Chinese manufacturer has any inkling you may be moving on. For more on the importance of mold agreements, check out How Not To Lose Your Molds In China and Want Your China-Based Molds? You’re Probably Too Late For That.

• Foreign company tells its China manufacturer it will stop using the China manufacturer for its production. Foreign company then learns that someone in China has registered the foreign company’s brand names and logos as trademarks in China. Foreign company is convinced its China manufacturer is the one that did these registrations, but it has no solid evidence to prove this. Foreign company is now not able to have its product — at least with its own brand name — manufactured in China. Foreign company is also now faced with having to deal with a low cost Chinese competitor that can legally make products in China with the foreign company’s brand name and logo and sell those products anywhere in the world where the foreign company does not itself possess the trademark rights in its brand name and logo. The way to prevent this is to make sure your IP registrations in China are current before you say anything to anyone that may lead them to believe you may be leaving them, or even just reducing your purchases from them. See China Trademarks: Register Yours BEFORE You Do ANYTHING Else. Not long ago, a U.S. company came to us after having told its China manufacturer that it would need to add an additional manufacturer because it needed much greater production capabilities. The China manufacturer responded by saying that “we own the China trademarks to your products and the China patent to your product designs and if anyone else in China tries to make your products we will get an injunction to stop them from doing so and another injunction to stop any of your products from leaving China. SIX lawsuits later the warring companies reached a settlement. Do not let this happen to you!

• Foreign company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. A few weeks later, foreign company has its products seized at the China border for violating someone’s trademark or design patent. The foreign company is (rightly) convinced that its China manufacturer is the one behind the product seizure, believing the Chinese manufacturer registered the foreign company’s brand names as trademarks in China long ago and is just now using that trademark to seize product as revenge (or just registered the design patent). China has laws forbidding its manufacturers from registering the trademarks of those for whom it manufactures, but because it is usually not possible to prove that your manufacturer in Shenzhen had a cousin in Xi’an do the registering, this sort of thing goes on unchecked. For how to prevent this from happening to you, check out the following:
  • Register Your China Trademark Or Go Home
  • Register Your China Trademark Or Go Home, Part II.
  • China Trademarks. Register Them In China Not Madrid.
  • China: Do Just One Thing. Trademarks.

• Foreign company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. China manufacturer then says that it will not be shipping any more product because foreign company is late on payment and owes it hundreds of thousands of dollars. China manufacturer then reports foreign manufacturer to Sinosure and Sinosure then ceases to insure product sales to this foreign company, which can have the effect of convincing other Chinese manufacturers not to sell to foreign company without getting 100% payment upfront. For more on Sinosure’s role regarding China exports, check out Be Sure Regarding China’s Sinosure. Note that if you are planning to move your business to a country other than China, Sinosure’s power over you will be greatly diminished. More importantly, note that with the downturn in Chinese manufacturing, Sinosure has gotten incredibly aggressive at going after foreign companies. See this Reuters article, As trade war deepens, a state-owned insurer in China helps soften the blow

• Foreign company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. China manufacturer then either threatens to or actually does hold people from the US company hostage for alleged debt. For more on the problems that can arise from allegations of not having paid a debt to a Chinese company, check out China Hostage Situation. Now IS A Good Time To Pay Your Debts and How Not To Get Kidnapped In China, Part 3. Resolve Your Debt Problems Before You Go.

The bottom line is that if your Chinese factory believes you may be leaving it or leaving China, your company is at risk and asking for a price cut will often be viewed as your having one foot out the door.

Despite all the risks, now is the ideal time to be looking at moving your supply chain out of China and/or trying to get your China suppliers to lower your product pricing. Our international manufacturing lawyers are working nearly non-stop to help our clients move all or diversify their manufacturing to countries outside China — so far this has mostly been to other Asian countries, such as Vietnam, Cambodia, the Philippines, Malaysia, Pakistan, India, Thailand and Taiwan, but also to Mexico, Colombia, Eastern Europe, Portugal, Germany and Spain. Even to Canada and the United States — more so after the announcement of the “new NAFTA” agreement, a/k/a the USMC.

But what if you have no choice but to stay in China? Seeking to lower your product pricing will be your best option.

What you need to know about the new realities of China factory pricing is that the Chinese government is doing whatever it can to prop up its factories. More than anything, the Communist Party does not want to see factories closing and jobs being lost and huge numbers of people marching in the streets, as is happening in Hong Kong.

So to avoid that, China has been doing the following (and more)

1. It has reduced income tax rates for Chinese export manufacturers, thereby reducing overall costs by about 4%.
2. China has reduced its VAT rates for the export of various (but not all) products, thereby reducing overall costs by roughly 4%.
3. China has pushed down the value of the RMB, thereby increasing by about 4% the amount of RMB Chinese export manufacturers get from their Dollar/Euro sales.

So right there we have about a 12% reduction in costs for China Factory. Note that the numbers above are rough calculations and individual valuations will vary. Note also that we are hearing rumors that Sinosure is now providing export insurance to Chinese factories at no cost and this is just one of many cost/expense subsidies/reductions of which we are hearing. But because we have not run down any of these rumors, we will ignore them for purposes of today’s cost-cutting discussion.

What you need to do then is try to get your Chinese factory to share at least some of its 12% windfall with you. Tell your factory that you have heard that China’s recent income tax reductions and VAT rebate increases and RMB devaluations — and who knows what else the Chinese government is doing and will do to subsidize Chinese manufacturers — has reduced its manufacturing costs by 15% to 20% and with all this it ought to be able to cut your pricing by 10%. Tell them how you know this will cut into their profits a bit but your having to pay the tariffs has cut into your profits and because of your great relationship with them over the years and in recognition of your plans to stay with them for many more years, they should reduce their prices to you.

This sort of price reduction request works sometimes, not all the time. But it is obviously working often enough for Bloomberg to write about how China product prices are declining.