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China's Big Political Picture Writ Small For Business.

By Dan Harris and Steve Dickinson

I am not generally a fan of extrapolating the way a country conducts its politics to the way its enterprises conduct its businesses even in China where so many businesses are government owned. I am not saying it cannot be done, but I generally find it too complicated for too little value. David Dayton, a guy who truly knows the way China conducts its manufacturing, just came out with an analogy laden post, entitled, "Rio Tinto and Urumqi as Corporate Culture Lessons,"linking China's recent handling of its Western region with how its factories treat foreigners. Though I am dubious of the value (beyond entertainment) of making this linkage, I am convinced Dayton is spot on regarding Chinese factories and I am going to focus on that. Dayton sees China using the following four step process to deal with its problems out West: 1. Round them up. 2. Insist everything is okay. 3. Identify a common enemy. 4. Show them the money. 1. Round them up. Anyone against the factory will be removed. In other words, that factory floor manager with whom you have had a great relationship for the last two years? He will go silent as soon as you have a problem. Dayton advocates handling this by tying payment to the Chinese factory not to its own assessment of quality, but to that of a third party quality assessment company:

This isn?t arrogant or obstinate it?s just a fact?3PQ reports are directly tied to payments and there isn?t really any room for discussion if the product doesn?t pass. Just stick to this and never give in and you?ll be fine. Give in once and every question from there on out will be a major battle. You?ve been warned.

I agree with Dayton on this. When possible, using an unbiased third party service to determine quality/payment benchmarks is a great way to go. The problem is getting both the foreign outsourcer and the Chinese factory to agree on the third party. 2. Insist everything is Okay. Deny any and all problems:

I?ve had people hold product and Pantone color chips and literally tell me that a red color isn?t really red but that my color chips must be old or incorrect or even that the colors match perfectly (even if they are totally the wrong color). My friend Mike tells of story of ?red? fire trucks that were actually florescent orange and the factory had no problem with the difference. Remember, if no one admits to the problem then it doesn?t yet exist (at least in the minds of the factory managers). And that?s the goal?to eliminate the idea of a problem rather than solve problems.

I am betting that every single reader out there who has dealt with a Chinese factory knows exactly what Dayton is talking about here and probably every single reader out there who has not dealt with a Chinese factory thinks he is grossly exaggerating. Trust me, he isn't. When faced with this, Dayton prescribes the following:

What can you do about this attitude? Probably nothing. Just agree with the fact that they do indeed do this for other people. But remember, it doesn?t matter what other clients accept or what the factory ?typically? does. If it?s not what you agreed to (in your written contract) then you don?t have to pay for it, regardless of how typical it is.

3. Identify a common enemy. Once you get the factory to admit there really is a problem, you then need to figure out from where it stems and how to fix it. Dayton very accurately describes the different thinking on this:

My experience is that while I?m interested in getting problems fixed (solutions to meet deadlines) the factory is more often concerned with finding someone to blame?usually a sub-supplier. It?s always the sub-suppliers fault. No matter how many times it happens it?s always amazing to me how factories are willing to throw their sub-suppliers under the bus and assume that they have no responsibility for their quality. Of course, they chose the sub-suppliers (often without telling us they were even involved) themselves and they paid them for work?and there in lies the problem. Factories just assume (or hope in vain) that blaming someone else will end the problem. It?s like they expect me to say: ?Oh, it?s the sub-supplier?s fault? Well then, we?ll just let it go. Sorry for bringing it up.? Once something has been paid for it doesn?t matter who the buyer is, a foreigner or a local factory, no supplier is going to fix stuff that is ?finished? and already paid for and shipped out. Bad quality components most often have to be replaced at the factory?s expense since they can?t get their sub-suppliers to pay for them once they?ve taken delivery.

Dayton's solution to this is to not fight the blame game, but to focus on fixing the problem. I would add one thing to this. Make very clear in your contract with your Chinese manufacturer that the manufacturer will be responsible for all quality problems and make very clear the extent to which subcontracting will be permitted, if at all. For more on how to handle the subcontracting issue, check out "The Six (Not Five) Keys To China Quality." 4. Show them the money. Dayton outlines what happens virtually every time there is a manufacturing problem and it goes like this:

This is what happens next. You find a problem, they deny it, then finally admit it, blame the sub-supplier and offer you a discount for the next order. Notice, fixing the problem, resolving the concern, changing processes, or giving you a discount for the current (incorrect) product are almost never options. The key is to get you to take as much of the current crap for the fixed price as possible and then spend money (future discounts) on other projects to pacify you. If they can get current product moved at the agreed upon price, the next goal is the reorder?if that means promising discounts now, so be it. There is always time to increase the costs late

Dayton does not tell us how we should handle this and that is the problem. My experience is that the foreign company pretty much has only three choices (really two) at this point. It can keep trying to negotiate better compensation from the Chinese factory, but it probably will not get it. It can walk away and never do business with this Chinese manufacturer again. Or, it can threaten to or actually sue the Chinese manufacturer. But if it does not have a very well drafted contract (preferably in Chinese) that outlines very clearly exactly what was expected of the Chinese factory, its chances in court are likely very poor. For what needs to go into your China OEM contract, check out, "China OEM Agreements. Why Ours Are In Chinese. Flat Out."

Full post as published by China Law Blog on August 23, 2009 (boomark / email).