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China Manufacturing: The Real Story.

By Dan Harris and Steve Dickinson

Helen Wang over at the Chinese Dream blog is just out with an interesting post on innovation in Chinese manufacturing, or the lack thereof. The post is entitled, "Myth of China?s Manufacturing Prowess," and its central thesis is that Americans misunderstand what drives Chinese manufacturing. I agree with her and at the end of this post, I will explain how this misconception can negatively impact foreign companies that use China for their OEM manufacturing. Ms. Wang's post starts out discussing a common misconception regarding Chinese manufacturing versus United States manufacturing based on sheer volume:

In a meeting in Silicon Valley with high-tech and business professionals, I asked how many of them thought China was the world?s largest manufacturer. Almost 90 percent raised their hands. The latest data shows, however, that the United States is still the largest manufacturer in the world. In 2008, U.S. manufacturing output was $1.8 trillion, compared to $1.4 trillion in China (UN data. China?s data do not separate manufacturing from mining and utilities. So the actual Chinese manufacturing number should be much smaller). Contrary to the conventional view, manufacturing in the U. S. has been growing in the past two decades despite the decline in manufacturing jobs.

She then focuses on what I see as the more important misconception, that China is leading in manufacturing innovation:

It is true that China?s manufacturing is growing faster than that of the United States. However, there is a key misconception about China?s manufacturing prowess. In the United States and Europe, the manufacturing industry was created due to technology innovation. In China, the manufacturing industry is being created in response to global demand. Chinese manufacturers take orders from Western companies that have designed products for their home markets. They have no involvement with product development, innovation, market research, and even packaging.

She then talks about what this "pure manufacturing" (my term, not hers) impacts China's developing a middle class and I urge you to go to her post for that. She also notes how China's manufacturing methods have caused "many Chinese manufacturers [to] tend to focus on short term gain. They compete on volume and price, and only enjoy wafer-thin profit margins." I completely agree and I am constantly seeing how this impacts foreign businesses that outsource their manufacturing to China. The first impact is on the product itself. Foreign businesses going to China for manufacturing for the first time oftentimes have no idea what is really involved. Many of these foreign businesses believe they can take a concept or a design over to China and return in a few days with a completed product, ready to be manufactured en masse. Things rarely work that way. With any product that a Chinese factory has not manufactured previously, nine times out of ten, the best way to go to China with your product is to have it completed, along with a detailed explanation of exactly how you want it manufactured, including an exact list of the materials. If you do not have that before you go, you may find it will take months to get the product done right, if it ever is. The second impact is on how the Chinese factory handles quality control problems. The easiest way to explain this is by the following composite conversation between a US company and me:

Company: I got this large shipment of widgets and the quality is horrible. No way can I even sell them and I am out USD$500,000. Me: Okay. Company: So I've been trying to work it out with the Chinese company and we are not getting anywhere. Me: In other words, you have asked for them to return your $500,000 and they are saying that's not possible? Company: Right. Me: And I take it they have not offered you any refund, beyond a 5% discount on your future orders? Company: Right. How'd you know? Me: Because there is a really good chance this company doesn't have anything close to $500,000 to refund to you. What do you think they made from your order after paying for the materials? $5,000? $10,000? Company: I don't know, but it has to be more than that. Me: How much more? Seriously. Estimating as high as you can while still being realistic, how much do you think they made on your order? Company: Maybe $20,000. Me: So let's assume they cleared $20,000 on your order after paying for materials and let's assume they are the most efficient Chinese factory out there and that after paying wages and utilities and taxes they got to keep $10,000 of that and let's multiply that $10,000 out over all their other orders. Doing this, do you think they make even $300,000 a year in profits? Company: No. Me: So there is probably no way they can come up with $500,000 to pay you. Company: So what should I do? Me: You have a number of options. None great. You can retain a Chinese lawyer and sue, but the problem with that is that you will almost certainly need to come out of pocket for the court costs, which are based in part on the amount you are seeking and actually can be quite high as compared to the US, and you will probably need to pay the lawyer something as well. And you are going to have to ask yourself whether it will be worth spending real money to try to collect from a Chinese company that you yourself now realize probably will not be able to just pay. Or you can just try to get whatever you can from this company, maybe $20,000, $50,000 if you are really really lucky, and then just move on. But I have to tell you, most of the time it is difficult to get even $10,000, but you should at least try. Actually, the best advice I have for you is to take precautions to prevent this from happening the next time. Company: Well thanks. Me: Seriously, if there is going to be a next time, give me a call before you contract and we can work together both to minimize the likelihood of this sort of thing happening again and to better position you for recovery if it does. Company: Okay, thanks.

For more on China OEM manufacturing, check out the following:

-- China OEM Agreements. Why Ours Are In Chinese. Flat Out. -- China Product Quality. What It's Gonna Take. -- Manufacturing Product In China. Trust Yet Verify. -- "The Six (Not Five) Keys To China Quality." -- Six More Keys To Quality Product Made In China.

Full post as published by China Law Blog on March 13, 2010 (boomark / email).