China Factory Due Diligence
Manufacturing due diligence is essential for any company considering working with a new factory, especially in China. This blog post provides a comprehensive manufacturing due diligence checklist covering the key areas companies should be examining when vetting a Chinese factory, as well as additional tips for conducting a thorough China manufacturing due diligence process.
The Genesis of This Factory Checklist
This post actually stems from a recent conversation I had with a client who somewhat embarrassingly told me he had learned “a ton” about China from the Doing Business in China for Dummies book. I told him not to be embarrassed because I had for years recommended that book to clients as one of the easiest to read books on China business, and yet also quite accurate. I then told him that I knew its author, Carson Block, who has gone on to become rather famous, as Muddy Waters, “a scourge of listed Chinese companies“. I then mentioned that I, consider Block to be the foremost expert at ferreting out fraud in Chinese publicly traded companies.
The China Factory Checklist for Dummies
That phone call caused me to revisit Block’s 2007 book on doing business in China and that in turn stirred memories of how I would often share Block’s factory due diligence checklist with clients, which checklist is still relevant. Block’s manufacturing checklist suggests that your on-site factory due diligence consist of you considering the following:
- Cleanliness. A sloppy workplace (including workers’ appearances) indicates a sloppy attitude, and most likely sloppy performance. Check not just the production floors, but also communal areas like bathrooms and dining halls. Disorganization can indicate poor employee practices overall. Make sure safety gear and hygiene fundamentals are being utilized on the factory floor. This protects your brand reputation.
- Organization. Be sure to take some time to understand the entire workflow. Does it make sense? Can you see any bottlenecks? Look for logical workflow between stations – this minimizes bottlenecks. If you do not understand something, ask questions. If you cannot ultimately understand why a factory’s workflow is a certain way, it may be a warning signal. Ask questions if the layout seems disjointed or illogical and keep probing until satisfied. Unclear organization is a red flag.
- Machinery. Get thorough explanations of what the machines do, where they are from, and other detailed questions. Asking detailed questions about the machines will make you seem smarter (thus less gullible). Listening to the answers will in fact make you smarter. Once you have toured several factories, you can make comparisons.
Get details like age, brand, and maintenance records. Newer tools indicate the factory invests in quality. Ask technicians to explain key processes so you understand capabilities. Cagey or vague answers often presage future problems
- Quality Control. The key here is the number and location of QC checkpoints. More checkpoints increase the odds of catching defects. Figure out how the rejected parts are handled. If you cannot understand that it is likely that the workers also cannot. Ensure failed parts are quickly quarantined and addressed at the source. Disorganized handling leads to issues being missed.
- Employee Conditions. Happy workers make for productive workers. Be sure to see how the employees eat, sleep and live when they are not on the floor. Engaged and content workers translates to better product consistency. Ensure adequate access to clean dorms and dining facilities. This promotes better retention and performance.
- Location. The factory should be close to its suppliers – otherwise, there can be supply bottlenecks. It should also be close to a port from which it can ship. Finally, learn about whether there are utility quotas in the area that affect production – this is especially important for electricity
Additional China Due Diligence
In addition to the above checklist, it is also important to consider the following company factors when conducting manufacturing due diligence in China:
- The manufacturing company’s reputation and financial stability
- The manufacturing company’s compliance with Chinese laws and regulations
- The manufacturing company’s management team and their experience
- The manufacturing company’s customers and suppliers
Though Block’s checklist serves is an excellent baseline for manufacturing due diligence, the intricacies of the Chinese market often demand a more customized approach. Use this list as a starting point, but engage experts as needed to tailor evaluations to your specific priorities and concerns when vetting Chinese factories.
In many instances, clients of ours were able to avoid potentially damaging manufacturing relationships by identifying inconsistencies during the due diligence process. Though Block’s checklist serves as a great primer, the nuances of navigating China’s business ecosystem often demand a more in-depth and personalized approach. Our law firm performs foreign company due diligence that goes much more to the heart of the company with which our clients will be doing business, as opposed to the factory itself.
When it comes to reviewing Chinese factories, many of our clients retain highly qualified and experienced factory inspection/QC companies to inspect their factories before the first purchase, and these QC companies often stay on for subsequent purchases to perform ongoing product QC.
China Factory Due Diligence Done Remotely
Though on-site due diligence is always ideal, remote due diligence can be a viable option in some cases, and we have clients that perform the following remote checking on monitoring of factories
- Digital Auditing Tools: Using digital auditing tools to conduct real-time monitoring and audits to collect insightful data and analytics on a factory’s operational efficiency, compliance, and quality control measures.
- Virtual Reality (VR) Inspections: Leveraging VR technology for immersive factory tours and to engage in a comprehensive virtual inspection experience, bridging the geographical divide and allowing decision-makers to conduct assessments from afar.
- Blockchain for Supply Chain Verification: Utilizing blockchain technology to foster transparency and traceability in supply chains, enabling them to verify the authenticity and compliance of their manufacturing partners.
- AI-Powered Quality Control: Using artificial Intelligence to enhance quality control processes by predicting, detecting, and rectifying anomalies in real-time, ensuring the consistency and quality of products.
- Remote Monitoring Systems: Deploying remote monitoring systems to provide continuous oversight on production processes, worker safety, and environmental compliance, delivering a holistic picture of a factory’s operational landscape. we had a client who literally decades ago would have his people in Seattle used video to okay or decline shipment of fish from China.
Virtual factory tours, digital documentation verification, and online interviews with factory personnel can be used to screen potential factories and eliminate any that are not a good fit. By leveraging digital tools and in-country QC companies, you can obtain a clear picture of your prospective Chinese partners’ operations and adherence to quality standards without having to travel to China. However, it is important to note that remote due diligence cannot completely replace on-site visits.
Manufacturing due diligence is essential for any company considering working with a new factory, especially in China. By following the tips in this post, you can reduce your chances of working with a fraudulent or unreliable factory and ensure a successful manufacturing partnership.