July 12, 2023, Update
I almost never update and re-run a blog post, but this will be the second time I have done so with this one, which shows how relevant, yet ever-changing the issue of China factory pricing is — especially since I updated it only about a month ago.
Since I wrote this post about a month ago, several clients have told me that they are seeing falling factory pricing in China and that they have been able to secure reduced pricing from their factories, using the instructions below. This is interesting, but what I find even more interesting is how many of those who were able to secure reduced pricing were worried about the viability of their being able to continue securing their products from China.
The Yin and Yang of China’s Plunging Economy
One client put it bluntly when he said that his happiness at securing an 7% cost reduction was tempered by the fact that his supplier flat-out told him that it was concerned about being able to continue getting the component parts it needed to make the client’s product because so many of its sub-suppliers were going out of business. This is the yin and yang of China’s falling economy.
In China’s economic woes may help lower U.S. inflation, Axios nailed how China’s “economic pain” is helping the U.S. economy. Per Axios (and per what I am seeing of what is happening with China’s factory prices), China “continues to struggle to shake off COVID induced woes, leaving it tottering on the brink of deflation — or falling prices.” The article goes on to note that China’s consumer price index is “dead flat — that’s an annual gain of 0% — over the last year.” Most tellingly, China “producer prices — prices at the factory gate, which are typically seen as a leading indicator of consumer prices — are deeply negative, falling 5.4% compared with June 2022.” That’s right, China factory prices are down 5.4% over the last year.
But it gets better. This 5.4% reduction in factory prices is — based on both what I read and on what I am seeing with my clients — is quite uneven across industries. Certain industry Chinese industry sectors like solar panels seem to be doing just fine. Others though are really lagging, and some of our clients are reporting double digit percentage price reductions.
The news today that Mexico took over the role from China as the United States’ leading trading partner is likely going to drive China factory prices even lower, especially when virtually everyone involved with international supply chains expects the exodus of foreign companies manufacturing in China to continue, despite China’s falling prices. This will continue because the sanctions and the trading restrictions between China and the West show no sign of abating. See China hits back in the chip war, imposing export curbs on crucial raw materials.
And what is good for the United States is good for the world as well, and Axios noted this by stating that “Chinese supply and demand shocks affect prices in other countries significantly,” wrote economists from Germany’s central bank in one of the best studies of the phenomenon.
The Rest of the Story
Below is more on how and why China factory prices are falling and, most importantly, it lays out how you should be trying to reduce your China factory prices without pushing so hard that your China factory starts thinking that if it doesn’t match whatever you want it will leave China. This is important because at the same time our international manufacturing lawyers are seeing China factory prices falling, we are getting more emails than EVER before from companies that have been cheated by their China suppliers and we are also dealing with more Sinosure problems than ever as well.
China Factory Prices are Falling
A client recently told me that using my instructions it had negotiated lower prices with all its China suppliers and the cost savings from this meant it would be keeping its China manufacturing in China “for a while longer.” I learned that a Chinese factory with which my client used to buy product had offered to start selling product to my client again at considerably lower prices than previously.
This Chinese manufacturer told my client that it had been losing business because a number of its buyers had “left China because of politics.” This Chinese manufacturer also told my client that with so many companies moving manufacturing out of China, “the government” had asked him not to lay off any employees but essentially gave him a free pass to reduce his wages by 30% and he had done so across the board. He also said that “the government” had also done “other things” to enable him to keep his employees. My client has no idea what those other things are, nor do I, but I’m guessing its payments or subsidies tied to not terminating anyone.
My client took this information and went to its existing suppliers (all of which were better than the one seeking to get my client’s business back) and asked for and received lower prices.
Then last night I watched a BBC Television News story on how China is suffering from deflation. The economist interviewed focused on how China’s economy is spiraling downward, driven by reductions in factory orders. This economist said that because Chinese economic numbers are usually compared to its numbers during lockdown, they are even worse than they initially appear.
In China’s factory deflation steepens as demand wanes, Reuters tells us in macro terms what my client told me in micro terms:
- “China’s factory gate prices fell at the fastest pace in seven years in May and quicker than forecasts, as faltering demand weighed on a slowing manufacturing sector and cast a cloud over China’s fragile economic recovery.”
- “China is battling a sharp decline in prices with factories receiving less for their products from key overseas markets.
- China’s producer price index (PPI) for May fell for an eighth consecutive month, down 4.6%, per China’s National Bureau of Statistics.” This is the fastest decline in China factory prices since 2016.
This all comes on the heels of China announcing that its youth unemployment is at record levels (exceeding 20 percent), with President Xi’s solution to be to encourage China’s youth to “eat bitterness.” See this recent New York Times article, China’s Young People Can’t Find Jobs. Xi Jinping Says to “Eat Bitterness.” and this Wikipedia article on Marie Antoinette’s “Let them eat cake” quote.
Getting Product from China Just Got Riskier
Tough economic times in China have always generated an increase in China manufacturing problems. In 2012, I first wrote about this connection for the Wall Street Journal, in China’s Slowdown and American Business: Hardly a week goes by without complaints about payment problems or bankrupt debtors. My WSJ article focused on how China’s weak economy had produced an increase in problems for companies that buy product from China:
Sourcing Problems. The slowdown is changing Chinese company interactions with foreign companies. Chinese exporters, particularly those that compete with companies from lower-wage countries like Vietnam and Bangladesh, are suffering — in particular, in low-tech, low-wage industries such as textiles, clothing, shoes and low-end electronics and toys. Foreign companies that do business with Chinese companies in these industries must be on their guard. Hardly a week goes by without one of the China lawyers at my firm getting a call from a Western company experiencing problems. Sometimes the Western company has paid for a product and the company it paid no longer exists. Sometimes the company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.
Foreign managers need to understand what is happening in their own industries within China. This might mean visiting your Chinese factory, warehouse, or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent.
The key is to be proactive: If you find yourself in a bad situation with a Chinese company going under, there usually is no remedy after the fact. Bankruptcy in China more often than not consists of a company shutting down in the middle of the night and its owner fleeing to another town.
The key to weathering China’s slowdown will be for foreign companies to go back to basics. Above all, no Western company doing business in China should blithely assume that a slowdown won’t affect it.
The biggest change from 2012 is the massive increase in Chinese companies willing to risk their relationships with their product buyers. In Your China Factory as your Toughest Competitor I wrote how I often find myself telling clients that “since you will be educating your Chinese party in how to compete with you, you need contracts that will at least limit what they can do when they do so.”
Chinese companies no longer see their foreign product buyers — especially those from the EU, North America, and Australia — as having long term commitments to China. One only need read the news (see this, this, and this) to know these Chinese companies are correct. With manufacturing moving elsewhere, Chinese companies feel they need to do something different and seeking to compete with their own customers is one thing different.
China’s economy is hurting. Its exports are plunging. Even official Chinese government statistics paint an economy in trouble. U.S. tariffs against Chinese imports don’t help nor does the Chinese government’s ongoing crackdown on private businesses. On top of the economic issues, many (most?) Chinese companies (like China as a whole) are wary of and angry at the outside world, particularly the United States, Canada, much of Europe, Japan, and Australia. China pessimism and anger increase risks for foreign companies. My law firm sees the results of this in many ways.
Practically every week one of our China lawyers gets an email or a phone call from someone who bought product from China and received nothing in return or something that does not even approach what they actually ordered. This sending of “junk” instead of real product has spread to pretty much every industry in China and ordering products from allegedly reputable online e-commerce and manufacturing matching sites provide little to no protection. The below are just some of the things you should be doing to reduce the likelihood of you writing/calling with a similar issue:
- These things usually happen when product buyers do not conduct sufficient due diligence on the seller. Do your due diligence before you send money. Send people you trust to investigate the manufacturing site. Do a site inspection on goods before payment. Make sure the company exists and is legally able to conduct the business for which you will be paying it. Doing just these few inexpensive things will greatly increase your odds of not getting scammed.
- These things often happen with Chinese companies that want to make a few final overseas sales before they shut down and disappear. Just imagine the profits to be made from three $350,000 sales for which laughably bad or no product is ever provided. Now just imagine the incentive Chinese manufacturing companies have to sell and not supply foreign companies right before (or sometimes even right after) they shut their doors for good.
- Oftentimes the Chinese company that committed the fraud does not exist. It is not registered anywhere in China or if it is registered as a real company in China it is registered for something like kitchen repairs, not for manufacturing whatever product it is they sold you.
- These fraudsters are smart and there are good reasons why they spend money sending you something instead of nothing and why they initially say they will remedy the problems and then often continue making that claim. Sending even terrible product is less likely to lead to criminal charges than sending no product. They can tell the police they sent you the product you ordered and it’s not their fault those foreigners are so picky and so hell-bent on trying to keep China down. Also, by stalling you they keep their scam alive. They’ve paid for advertising and a website, and they have terrible product in inventory, and they want to maximize these expenditures. Act early on these sorts of problems and your chances for recovery increase.
- Use a contract that works for China and that sets forth clearly what you are buying and what happens if your China supplier fails to comply. See China Contracts: Make Them Enforceable Or Don’t Bother and China Contracts that Work.
- Know the market price of whatever you are seeking to purchase before you purchase it. Do not trust a company that gives you an unreasonably low price.
- Consider a small trial order to reduce your risk. The problem with this is that many scammers will provide you with a good trial order and then scam you when you order the full amount. But if you combine this with a contract that works for China and proof that the company actually exists and is operating legally, you will be greatly lowering your risks.
- Do your due diligence on your manufacturer before you send them any money at all.
Do not buy product from China without first registering your trademark in China because many of the fraudsters sending out bad product are now also registering YOUR brand name and/or product name and/or logo in China as THEIR trademarks in China and then seeking to sell you these trademarks for a lot of money under threat of blocking your products from leaving China for violating THEIR trademarks. See 8 Reasons to Register Your Trademarks in China.
Speaking of trademarks and IP, we have over the last few years also seen a massive increase in what I call early IP theft, which also stems from Chinese companies’ lack of confidence in their future. For more on this, check out China Trademark Theft. It’s Baaaaaack in a Big Way and in Your China Factory as your Toughest Competitor.
Like clockwork, the downturn in China’s economy has led to an uptick in companies contacting my law firm’s international litigators for help in fending off Sinosure threats. For the full import of what I mean by Sinosure threats, I urge you to check out China Sinosure as Existential Threat. Sinosure is China’s Export and Credit Insurance Corporation, and it insures most of China’s exports. It insures those exports by paying its policyholders when a foreign company fails to pay for product it has received from its Chinese supplier.
This increase in Sinosure cases reflects the downturn in China’s economy because the majority of the many Sinosure cases we have handled over the years arose from bad product delivered by the Chinese manufacturer. The typical Sinosure case involves a Chinese company sending over (let’s say) $500,000 in bad product. The product buying company cannot sell that product for its usual $950,000, but instead is forced to unload it for $350,000. The product buying company then seeks to resolve its alleged $500,000 debt to its Chinese supplier with a one-time $250,000 payment. The Chinese company goes silent and a few weeks later, the product buying company gets a threatening letter from one of Sinosure’s lawyers.
In As trade war deepens, a state-owned insurer in China helps soften the blow, Reuters wrote about the increase in Sinosure cases:
Dan Harris, a lawyer who represents U.S. importers, said he has received increasing requests for help dealing with Sinosure demands for payment on behalf of Chinese exporters.
“Before the trade war, I might go … four, five months without getting a Sinosure email, now I’m getting four or five a week,” said Harris, managing partner at international law firm Harris Sliwoski
China has become riskier for product buyers, and it is important you recognize this and act accordingly.
How to Safely Reduce Your China Product Prices
Though lowering your China product prices would obviously be a good thing, you must be careful because just asking for lower prices from your China factory could cause your company blowback.
Chinese factories are tired of losing customers and they are wary of those they believe may leave them for another factory in another country, or even for another factory within China.
If you tell your Chinese factory that you “need” a price reduction, it will think you plan to move to another factory if it does not give you price reduction you request. If you tell your Chinese factory that if it does not lower its prices by ten percent, you will go elsewhere and your factory cannot lower its prices by ten percent, it will think the same thing.
In The Single Best Way To Avoid Being Taken Hostage In China, we wrote how Chinese companies 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 to our clients 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 and think carefully about where you stay and where you go. Most importantly, be careful with whom you meet.
You are probably wondering why I am discussing debt collection hostages in the context of reducing China factory prices. It is because when Chinese companies believe you will be leaving them, alleged debts come out of the woodwork. The tax authorities will come up with taxes you owe. Your factory will claim you owe it way more than you thought you did and Sinosure (see above) will come calling. Your factory’s sub-suppliers will send you bills for components you never ordered. You will get a bill for molds, tooling, and design work you that was to have been included in your product pricing.
Before you talk with your factory about lowering its prices, you should have a plan in place for what you will do if your relationship with your China supplier ends that same day, because it might. Sometimes when one of our clients goes to its China supplier to negotiate a lower price, the Chinese supplier responds with something like “we are done manufacturing for you. We don’t need you anymore. We are selling our products direct now.” And by the way, the product your manufacturer will be selling could well be your product.
Before asking your Chinese factory for a price reduction, you should be sure nobody from your company is in China. You should also be sure you have secured your molds/tooling and all product for which you have already paid. You should also make sure that your IP is sufficiently protected via any necessary trademark, copyright, and patent filings.
The bottom line is that when it becomes known that you will be leaving China, the vultures start circling and those who you thought were your friends are usually nowhere to be found.
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 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.
- Foreign company tells its China manufacturer it will stop using the China manufacturer for its production. Foreign company then learns 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. You can prevent this by making 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 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 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 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.
- 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. If you are planning to move your business to a country other than China, Sinosure’s power over you will be greatly diminished.
- 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.
With some of the bigger Chinese factories having cut wages by nearly 30% as compared to last year and other prices falling in China as well (see above), Chinese factories are well-positioned to reduce their prices. China’s eighth straight months of declining factory prices is proof of this.
If your company has not contributed to China’s deflation in producer pricing, now is the time to get your China factory to share its deflationary windfall and Chinese government largesse with you.
I suggest you do this by telling your factory that you have heard how China factory pricing is down and how China government subsidiaries to factories are keeping Chinese factory workers employed but at considerably lower wages. And then ask if they would consider reducing your prices by x percent if you were to agree to try to buy more over the next few months. Tell your factory how you realize this may cut into their profits a bit but that your profits have also been reduced because you are having to pay more for everything in your country, including rising energy prices thanks to China encouraging and aiding Russia’s war against Ukraine. I am not serious about this last part. Then tell them that because you have had such a great relationship with them over the years and because you intend to stay with them for many more years you really would like to see them reduce your prices.
This sort of price reduction request seems to be working often these days, though certainly not all the time. But it is working enough times for China factory prices to have fallen every month for the last eight months and if you have not seen your prices reduced, it is past time for you to seek such a reduction.
But plan ahead before you do so.
What are you seeing out there?
AN AI UPDATE: Though I’m obsessed with AI and I use ChatGPT, Bard, Bing and Anthropic pretty much every day, I have yet to find it helpful with blogging. But on a whim, I decided to run this entire blog post through Anthropic (that is the only AI engine I regularly use that could handle such a long article) and asked if it thought there was anything I should have added to this blog post to make it better. It came back with the following list, which though not all that relevant to the above blog post, is a darn good list of some of the problems China is going through and how those problems can and do impact foreign companies that do business in or with China.
I found this list particularly interesting because on Monday this week I gave a talk at a big Investors Conference in Boston on the topic of China risks, and much of my talk related to these items below. I think I will package up my talk as a blog post and run it next week. But for now, here is what Anthropic has to say regarding China:
“Here are a few additions I would make to the article:
1. Expand on the risks to personnel in China, including arbitrary detention, violence against foreigners, restrictive zero-COVID policies, and discrimination. Foreign employees face major risks in China that companies must consider.
2. Discuss how foreign-invested enterprises (FIEs) face disproportionate scrutiny and restrictions in China. FIEs have faced pressure to hand over IP or enter joint ventures with Chinese partners to continue operating. New laws place foreign companies at a disadvantage.
3. Note that China’s economy faces structural issues beyond current global conditions, including high debt levels, over reliance on investment and exports, and inefficient state-owned enterprises. A downturn was likely even without recent geopolitical tensions.
4. Consider comparing China to other emerging markets like India, Vietnam or Mexico as alternative manufacturing destinations. Discuss the relative risks and opportunities in these markets versus China.
5. Mention that SMEs are particularly at risk in China due to limited resources and ability to navigate the opaque regulatory system. SMEs should think twice about investing substantially in China, especially if another market could suit their needs.
6. Discuss that companies can continue selling to China through ecommerce platforms or by licensing IP without maintaining a strong physical presence. This reduces risks while still accessing China’s consumer market.
7. Note that China faces a demographic crisis with a shrinking workforce and aging population. Labor costs will continue to rise over the long term, reducing China’s cost advantage for manufacturing.
8. Discuss the threat of supply chain disruptions in China, whether from lockdowns, regulation, political tensions or natural disasters. Companies are often over-reliant on China as a single source for components and materials.
9. Consider emphasizing that China’s economy faces major issues, and its government’s tight control poses huge risks. Companies should take a long, hard look at their China risks and strategies. Reducing over-dependence is prudent.
10. You could re-title the article to something broader like “Why Foreign Companies Must Reconsider Their China Exposure” to emphasize the scope of risks discussed.
These are a few suggestions for strengthening and expanding the article. Please let me know if you would like me to elaborate on any part of this response. I am happy to revise or add further details.”