Starting with General Electric, American companies have been outsourcing manufacturing to low-cost regions of the world since the 1970s. Lowering costs and maximising profits for their shareholders was offered as the primary motivation for this.
US companies first outsourced manufacturing to Mexico and later to China. Over the decades, the US and other western countries also moved to also outsource business services to India and Malaysia, and (more recently) to countries in Eastern Europe such as Poland, Ukraine, Romania and Belarus.
The decision to outsource anything – be it manufacturing or business services – is never an easy one because it entails a sea change in the way a business works. It has implications related to organizational structures, employee strength as well as not-so-obvious ones on inventory and logistics operations.
But business leaders often take this decision for the same reason General Electric’s CEO Jack Welch did about 40 years ago: because it makes financial sense. Outsourcing allows businesses to remain competitive by cutting costs. Businesses can then use these savings to expand or innovate.
Having said that, despite the reasonably long history of outsourcing in the world, the exercise is still not as simple as identifying a supplier in a low-cost region such as China and signing a contract with them. Then, as now, business leaders need to be aware that manufacturing in one’s home country is different from manufacturing abroad. There are differences in language, culture and even laws that need to be considered. A good leader will be aware of these differences and will design their strategy keeping these factors in mind. It is only then that their outsourcing project will be successful, which is the only way it will deliver its intended benefits.
As an expert in sourcing from China – having helped businesses in the West manufacture products and components in China since 2006 – I have a good sense of what it takes for such sourcing ventures to succeed. I will outline my top five learnings below.
1. FINDING A CHINESE MANUFACTURER: DEFINE YOUR STRATEGY WELL
A well-defined strategy is critical to the success of any project. So once you decide that you want to approach a Chinese manufacturer to outsource production, take the time to identify, analyze and consider the variables before you, as well as the opportunities and the risks.
A good strategy will take all these points into account:
- Bring everyone on board: A project is more likely to succeed if it has the support of all its stakeholders. To start with, the business owner or leadership team should be convinced about the viability of the China sourcing project. Once the top team is invested in the idea, it gets easier to convince employees who will be executing this project.What I have found is that in bigger businesses, the one group that is most likely to be sceptical about the project are middle-level managers who have practical fears such as decline in quality or loss of control over the production process and even job losses. All these can, however, be tackled if the company leadership can demonstrate how the benefits of sourcing in China far exceed the costs of finding a Chinese manufacturer and the associated risks.
One of the ways this can be done is with a total cost of ownership analysis, which helps you determine the complete direct and indirect costs of the proposed project. It will help show that outsourcing manufacturing to China still has clear financial benefits that will exceed the higher initial costs of the exercise in the long term.
Once the decision to outsource manufacturing has been made, bigger businesses can set up a team that will handle the project. If you are a smaller business such as a start-up, appoint a project manager to take charge.
- Plan for the long term: If you plan your outsourcing manufacturing for the long term, it will be more likely to be:
- Financially rewarding.
With regard to financial rewards, many of the cost advantages of outsourcing manufacturing boil down to order volumes. This is especially true if tooling is involved. Tooling is a one-time cost for the process of engineering the tools that are necessary to manufacture components. The cost of tooling can be high, but spread over several manufacturing cycles, it evens out because of volume. Basically, the more units you manufacture of that product, the lower the per unit cost.
Similarly, a long-term approach is also important for the success of the project overall. I have noticed that one mistake businesses often make is that they allocate teams and resources to help kick-start the outsourcing project and wind up the team after they receive their first shipment, thinking that everything will work like clockwork now that they have found a good supplier, one production cycle is complete, the shipment was delivered on time, and it met all specifications.
This attitude is a sure shot recipe to disaster. If you do this, you will notice that the quality of your product will deteriorate in the second shipment, and the third shipment may be unsaleable.
- Decide whether you want to work on this alone, or with a sourcing agent: It may be a good idea to decide at this stage whether you want to set up a team in China, or employ a Mandarin speaker for the project, or hire a company that will take care of your outsourcing project for you. Several businesses that are new to outsourcing as well as those without the resources or inclination to set up an office in China could team up with China sourcing agents who guide them each step of the way.
2. CHINA SOURCING: CHOOSE THE RIGHT PRODUCT OR COMPONENT
You may have a vast catalogue of parts or components that you can manufacture abroad. But it is best to focus here too. Start small. Choose a product or component that has enough value and can be ordered in quantities that will make a difference to your financial statements. Here are a few questions you could ask yourself.
- What is the quantity you are looking at? The larger the order, the lower the overall unit price especially if there is tooling involved (as mentioned earlier). The size of your order also matters because it gives you more control over the factory and its quality control processes.
- How labor intensive is it? Outsourcing labor intensive products is likely to bring you bigger savings.
- Is it a prototype or innovation? In my opinion, it is better to avoid these for your first outsourcing project. There are many reasons for this. One, such projects can be a drain on resources as constant modifications in tooling can lead to additional expense and time delays for your project. Two, from what I have observed, suppliers are not very keen on such projects either and are not necessarily motivated to carry out modifications and sample runs repeatedly. Three, when you first start outsourcing, you need to see quick results because of the scepticism among your team about the project. Prototypes or innovations rarely give you these motivational wins.This is not to say that you should abandon any hope of developing prototypes and innovations with your Chinese manufacturer. You should not rule out the possibility completely. But it is advisable to go down that path of china sourcing only once you have established a good relationship with your supplier and are confident of its capabilities.
- Do you have up-to-date drawings for the product? Choose a product for which you have up-to-date drawings. You know your product best and must communicate its specifications to someone halfway across the world. If your drawings and specifications have been revised â€“ and have red felt pen marks all over them – draft a final version of it before you send it across to the factory in China. Once you identify a supplier, you could also find out what file format of the drawings the supplier needs and send across that version. This attention to detail helps minimise misunderstandings or mistakes, helping contribute to your project’s success.Similarly, from your experience of manufacturing that product at home, if you are aware of any potential problems that can crop up during the process, do attempt to resolve them before you outsource manufacturing as – in my experience – any problems you face in a factory at home will rarely disappear in a factory across the world.
3. IDENTIFY SUPPLIER, VERIFY SUPPLIER
Identifying a reliable supplier is crucial for the success of your outsourcing project. You can do this sitting in your home country with the help of the internet. For verification, however, it is recommended that you visit the factory at least once before production starts unless you have appointed a sourcing agent to handle the project for you (because then the agent handles this for you).
- Identify supplier: You can search for suppliers on Google, by:
- Assess supplier: Once you draw up a longlist of suppliers from these sources, assess them on the basis of their production capacity, quoted price, quality standards, location and ability to communicate clearly and promptly.You should know that certain provinces in China specialise in manufacturing specific products – Zhenjiang province, for instance, is known for electrical appliances and plastics while Guangdong province is known for machinery, electronics and lighting. Identifying factories for your product in geographic areas where similar factories are found helps keep costs down because the manufacturing supply chain is more efficient in these regions.
Similarly, you should know that inland factories are likely to offer you cheaper prices per unit than factories near ports, but then your shipping costs may increase.
Assessing production capacity is important because the supplier should be able to manufacture your current requirement, as well as any projected increase. At the same time, signing on a supplier who has a huge capacity may not be the best thing if your order will not engage the whole factory because their attention will be spread over a number of businesses and not exclusively on yours.
You need to take into account all these factors while determining which supplier to shortlist.
- Verify supplier: Once you have a shortlist of potential Chinese manufacturers it is time to verify their credentials. This is to:
- Check if the shortlisted companies can indeed manufacture what they say they can and have the capacity for your current and future orders.
- Ensure that the shortlisted supplier is a manufacturer and not a middleman or trader. Many suppliers on B2B websites happen to be middlemen who don’t offer the best price because they take a cut. You will get the best price only from a manufacturer.
- Protect yourself from fraud as you need to be absolutely sure of who you are dealing with before sending across any money – even if it is for a sample.
Here are a few ways you can conduct verification on shortlisted suppliers:
- Review the supplier’s ratings on B2B websites
- Check if the supplier has a website, find out the contact information and call the office to ask a few questions about who they are and what they do.
- Ask the factory or factories for their business licences, registration and certification details as well as audited accounts and Value Added Tax invoices.
- If the factory is a small company and doesn’t have an online presence, you could identify its Chinese name and location and then identify the local government office that will have kept that factory’s registration records. You can tally the details the factory has sent you with these documents. These documents will be in Mandarin though, which is why it is important to have a Mandarin speaker as part of your sourcing team.
- Visit suppliers yourself: If you have a large order or are keen on bagging a supplier for the long run, it is best to visit the factory yourself as part of the verification process (most sourcing agents do this for you too). During your visit, take a look at the factory floor to make assessments on cleanliness, attention to quality and worker safety. Does the factory look organised? Are the offices and factory spaces clearly demarcated and labelled? Make a request to take a look at their inventory. This will give you a sense of the raw material they use, their production capacity and current orders.
4. COMMUNICATE CLEARLY
In our experience, a lot of problems that crop up with regard to manufacturing in China have a communication problem at the root. This is rarely deliberate, it is just due to the differences in language and business culture.
In India, for instance, most middle management employees are able to communicate with foreign customers in English. In China, however, barring factories located in developed coastal provinces such as Guangdong and Jiangsu, not all staff (probably only sales employees) are proficient in English.
The language difference along with differences in business culture – where the Chinese party is wary of asking questions because of a cultural belief that asking questions makes them look bad – is a potent cocktail for disaster.
But entering a business relationship anticipating these pitfalls helps you take steps to prevent misunderstandings from happening.
One way of doing this is to write down all standards and specifications and acceptable deviations clearly – in Mandarin – in the manufacturing agreement.
This is to prevent any problems from cropping up later in the production process that will be expensive and sometimes difficult to fix.
Deviations that seem acceptable to many Chinese manufacturers are quite unacceptable to many buyers and their customers. For instance, specifications such as – smooth finish - could mean one thing to you and another thing to the assembly line manager or engineer in the Chinese factory.
In my experience, deviations from stated standards are something buyers really have to stand their ground on, and having clearly written technical specifications often come to your aid in this.
5. DRAW UP CONTRACTS IN MANDARIN, ENFORCEABLE IN CHINA
No business transaction is complete without a contract. When you outsource to China, any contracts you draw up with your supplier must be specific to China. A template that you have used in the US will simply not do.
This contract must be drawn up by a lawyer, written in Mandarin (with an English translation, of course, but the Mandarin version should be the one that prevails in case of a dispute) and enforceable in China.
All terms related to the parties involved, the agreed price, payment terms (mode of payment, frequency, exchange rate etc), quality specifications, mode of shipping, timely delivery must be defined clearly in the agreement.
The liability for breaching contract and dispute resolution methods should also be made clear.
One of the most common agreements signed between the buyer and the supplier is the NNN (non-disclosure, non-use, non-circumvention) agreement, which is a stronger version of the NDA or Non-Disclosure Agreement that is popular in the US.
Signing a NNN is particularly important if you want to protect your IP Rights in China. Write in a strong contract damage provision in this agreement to deter your supplier from copying your product.