Your China Supply Chain: Do You Feel Lucky, Punk?

Earlier this week, in COVID in China Will ONLY Get Worse and Supply Chain Problems WILL Increase, I wrote how most (but not all) companies should be looking to move their manufacturing out of China because of COVID and because of the gradual yet unrelenting decoupling between China and the West, accelerated by Russia’s war against Ukraine. See Russia’s War Will Impact Your China Business.

Today, I look again at what is happening with COVID in China, but this time I dig deeper into the specific risks facing companies that get their products from China.

1. Our Earlier Predictions on COVID’s Impact Were Borne Out

But first a quick bit of history on my earlier COVID predictions, which I set forth below to show how way back in December 2012, we called what is happening today with China-dependent supply chains. I do this to lend credibility to what we are saying today. On December 31, 2021, in Omicron and Supply Chains: Buckle Up, we wrote how China would not achieve Zero-COVID and that supply chains tied to China would be hit hard by that failure.

I then put that blog post up on LinkedIn (here), with the following summary:

Omicron will lead to China factory and port shutdowns and convince more product buyers to diversify out of China. Omicron is incredibly contagious and China is not well-equipped to slow it down to the same extent it has done with previous COVID variants.

A sampling of news headlines within the last 24 hours bears out our December/January predictions:

1. China’s widening COVID curbs threaten global supply chain paralysis. Al Jazeera.

2. Supply Chain Worries Are Finally Going Viral: A new Covid wave in China has made the world once again wake up to the risks of a concentrated manufacturing base. Bloomberg.

3. China’s lockdowns could trigger a logistics snarl that may ‘dwarf’ 2020 and 2021. CNBC.

4. Shanghai Factory Closures Mount as Covid-19 Lockdowns Hit Supply Chains: Second-largest assembler of iPhones suspends work at two plants. Wall Street Journal.

What is being written by the media completely jibes with what I am hearing from clients and from some of the China sourcing and risk analysis experts I know.

Our international manufacturing lawyers have been kept incredibly busy of late trying to help clients with the following:

1. Helping companies move or diversify out of China. This is work we have been doing for clients that more than a year ago retained our law firm to help them move or diversify out of China and it also includes work we are doing for new and returning clients that have in the last three months – or even three days – sought our help moving out of or diversifying away from China.

2. Helping companies diversify within China and helping companies diversify their supply chains by adding China. You heard it right, and believe it or not, this work has actually picked up in the last few months. When I ask these companies why they are sticking with China, they typically say either that it remains a part of their diversification strategy or that there really is no other place nearly as good for what they are doing.

3. Helping companies better protect themselves from China. These are companies that are not really changing much, if anything, of what they are doing in China; they just realize that their China risks have increased and they want to better protect themselves.

4. Helping companies that are having China product delivery, quality control, and IP problems. Not surprisingly, these sorts of matters are shooting through the roof.

2. Your China Manufacturing Risks RIGHT NOW

Yesterday, product sourcing superstar Renaud Anjoran asked me on Linkedin to weigh in with my views on what is happening and what will happen with China manufacturing:

In the next 12 months, will there be a wide area manufacturing consumer goods (say, all the North of Zhejiang, or all the Pearl River delta, or all of the South of Jiangsu) where the manufacture and/or the flow of materials gets stopped for several weeks?

I’d put that probability around 25%. If that happens, tens of thousands of importers will be screaming …

Much more probable is the intermittent instances of stop & go like we saw in and around Shenzhen in March. With enough such instances, it will have a strong impact on supply chains, too. Dan Harris, does that make sense to you?

My response was as follows:

A lot of 3-4 week delays. But if there are a lot of those delays and they are spread widely (I am being intentionally vague here), I fear that they will pile one on top of another and it will for many become nearly impossible to get all components necessary to make the product and there will be massive delays and shortages, much like during early COVID times. Do you agree with this nightmare scenario? Is this the 25 percent scenario you are seeing? I have real trouble putting a percent on this just yet because it is so dependent on COVID. My cop-out would be to say that there is about a 90 percent chance this will happen to a few products but who knows what products. Or as I have been thinking a lot lately when talking to clients, “Do you feel lucky?” Let’s just say if my widgets are being made in China, I (a lawyer trained to see potential problems/risks everywhere) would have left China long ago for Mexico or Poland or India or wherever. OR I would be sleeping about an hour a day by now.

Renaud then responded by saying that we should expect many 3-4 week product delays, that he is already seeing those, and that there is a 50-50 chance they will increase/accelerate:

Yes, what you describe – “a lot of 3-4 week delays” – that hits many product categories is probably going to happen. I’d say it’s more than 50% probable. In a way, for many buyers, it has already come true in the past 2 months.

Agreed, it’s stressful. Many importers are trying to get more inventory because of this higher supply risk. And it keeps making the logistics situation worse.

At this point, Michael Fass, Director of China Operations for Kastus, weighed in by talking about the on the ground impacts he has been seeing:

I would say, based on Ningbo, Guangzhou, Shanghai and other areas all experiencing lockdowns, that the effect will be nation-wide and across many industries. I’ve already had my own business severely impacted since last month when lockdowns in Quanzhou, Fujian took place.

3. How Your Company Will be Impacted by China COVID. Do You Feel Lucky?

The conversations I have had online and in real life have helped crystalize for me the impacts COVID in China is having on companies that have their products made in China and what those future impacts will be as COVID inevitably spreads even wider in China.

To summarize, some companies will not be impacted at all, some companies will be mildly impacted, some companies will be hit hard, and some companies will be completely obliterated. The problem is that there is no good way to determine the category under which your company will fall.

I can tell you, though, one very bad way for you to make this determination: asking your China supplier. I say this because your China supplier very likely has no clue and pretty much no matter what will give you a line intended to make you believe that you have nothing to fear but fear itself. Unless your China factory is Foxconn or Midea or a near equivalent, they almost certainly do not closely monitor their own supply chains, nor are they getting good information from anywhere else in China.

4. Lessons to be Learned from China COVID 2020

To a certain extent, China manufacturing right now feels like China manufacturing back when COVID first came to China. This being the case, I went back and read China’s Coronavirus Impacts Everything: What Your Business Should Do NOW (which I wrote in January, 2020) to see what I could glean to apply to China’s present situation. That post had the following advice, much of which applies today:

Your business should do the following:

1. Recognize the situation in China. Recognize your company’s situation in or with China.

2. If your company has its widgets made in China, you need to realize that your Chinese factory might shut down tomorrow or next week or next month. If your Chinese factory is within or near ground zero for the virus, it has probably already shut down. Even if your factory does not shut down, you should expect some or many of its employees not to show up for work because they can no longer get there or because they do not want to work cheek by jowl with 3,450 other people, some of whom might be spreading the coronavirus. Even if your Chinese factory continues to produce your widgets, you should consider its diminished ability or complete inability to get those widgets seamlessly transported from the factory to a port or airport and then from there to your preferred destination. There will invariably be slowdowns.

You also need to realize that even if your widgets keep getting made in China and shipped to you, your chances of factory problems have shot through the roof. Just last week, in Manufacturing in China: Minimizing Your Risks by Doing Things Right, we wrote how our international manufacturing lawyers have been seeing massive increases in China factory problems, and the potency of that post should be doubled or tripled now.

Chinese factories are hurting these days. Bad. Their sales are way down, especially to the United States. In China’s Manufacturing Exodus Set to Continue in 2020, the South China Morning Post made this starkly clear with statistics:

Tariffs saw China’s trade in goods surplus with the US fall by 7.9 percent in November, according to data released by the US Census Bureau on Tuesday. This was amid a 20.84 per cent fall in Chinese exports to the US from a year earlier, including items like cellphones. US purchases of Chinese goods are now at their lowest point since March 2013.

Of equal importance is that China factory exports are expected to dip even more in 2020:

For every foreign company that left China in 2019, there were two to three more seriously contemplating doing so and we expect more companies to leave China in 2020 than in 2019.

Chinese factories are well aware of these numbers, and they are terrified by them. Chinese factories see American companies reducing their purchases to buy their products elsewhere. “Compared with June 2018, the month before the trade war began, US imports of goods from Vietnam have soared 51.6 per cent, Thailand 19.7 per cent, Malaysia 11.3 per cent, Indonesia 14.6 per cent, Taiwan 30 per cent and Mexico 12.7 per cent.” This massive downturn in American companies manufacturing in China has greatly impacted Chinese factories and greatly influenced how they see things.

Chinese factories believe their existing American clients will be leaving China in 2020, and they also believe their newest American clients are using them as “test kitchens” to develop products and then move production outside China once the product is developed and selling. Our China lawyers know this because Chinese factories have told us this, and because we see what Chinese factories are doing.

What exactly are Chinese factories doing? They are getting aggressive with requirements to get started on manufacturing with them. They are getting less concerned with the quality of goods they make and sell. And they are stealing IP (especially trademarks) far sooner and far more often than even a year ago.

Let me explain …

Chinese factories that used to help American companies develop their products without any written guarantee regarding product purchases by the American company are seldom doing this any more. Chinese factories no longer believe it makes economic sense for them to spend time and money developing a product for an American company that may never produce that product in China or will produce it there for only a short time. What our China manufacturing lawyers are seeing now is Chinese companies helping American companies develop their products, then claiming the developed product belongs to the Chinese company, not to the American company. In other words, the American and the Chinese company work together on developing the product and then once the product is developed, the Chinese company refuses to make it for the American company, choosing instead to sell it under its own brand name. The best way to prevent this  is with a China Product Development Agreement. See also China Product Development: Manufacturing Rights are Key.

Chinese factories have also become much sloppier in terms of product quality. Why should a Chinese factory bust its butt making high profile-quality product for an American company that will likely move its manufacturing to Vietnam or Mexico or Thailand no matter how well it performs? The best way to prevent quality problems with your China factory is with a Manufacturing Agreement that is clear about quality requirements and clear about the damages the Chinese factory must pay if the contractual quality standards are not met.

Perhaps most chilling is how Chinese factories are stealing IP so often and so quickly. In the good old days, Chinese factories typically would wait until their relationship with their customer had declined before selling their customer’s products and registering their customer’s trademark in China as their own. Now, our China lawyers are constantly seeing Chinese factories going off and registering those trademarks literally days after they first learn of them. We are seeing American companies send an email to a Chinese company inquiring about the possibility of having that Chinese company make widgets for it and that Chinese company a day or two later filing to register the American company’s trademark in China. We are seeing Chinese companies sell foreign company products worldwide before they even sell one to their foreign company customer.

What should you do about all of this?

If you are thinking about moving your production out of China, NOW is the time to go from thinking to doing. See Moving Your Manufacturing Out of China: The Initial Decisions and Moving Manufacturing from China: Where you Gonna Run? But do it the right way. See THE Rules for Manufacturing Overseas.

3. Coronavirus likely will constitute force majeure event for your Chinese counter-parties and this will mean they can breach their contracts with you without many if any legal repercussions. This also likely means some Chinese companies that are not yet truly impacted by the coronavirus will seek to use the virus as a basis for terminating or breaching or revising their contracts with you.

4. If you have people in China, bring them home. NOW. If you were planning on sending people to China or even to Hong Kong, DON’T.

5. If you have an office or offices in China, figure out the local situation and start devising contingency plans. If your business depends on people in China, find new people outside China for help. Our law firm long ago made the decision to base most of our China lawyers outside China. We believed then and we even more believe it now that our people would be safer outside China and freer of local threats/politics/influence/pressure and therefore better able to provide objective legal advice. We have also always been concerned about data security in China. China’s New Cybersecurity Program: NO Place to Hide and China’s New Cybersecurity System: There is NO Place to Hide. We set ourselves up so we can fully function even if all our people are expelled from or have to leave China. I am not going to claim our law firm saw the coronavirus coming — because we obviously did not — but I am going to say that we years ago became wary of putting too many eggs into the China basket, and this has informed the legal advice we give our clients.

In early November last year,  in How to Conduct Business with Chinese Companies That See a Dark Future, we outlined the many China risks and called for companies to — if possible — lessen their China exposure:

For some companies, China’s increasing risks now exceed its rewards, but for others this is not at all true. Do you really need a legal entity in China with Chinese employees or might your company be better off with no operations in China beyond a third-party distributer or reseller? Our China lawyers have been doing a lot of work in the last six months helping our clients reduce their China footprints and thereby reduce their China risks. No matter what you are doing in or with China, now is a good time to look at how you too can reduce your risks.

6. Move your people and your offices out of Hong Kong. Now. This will likely be the final blow for Hong Kong as an international business center as companies come to realize that basing operations in a city that is unable (on so many levels) to protect its citizens no longer makes sense. See Hong Kong for International Business: Stick a Fork in It. See also Macau vs. Hong Kong: And the Winner is Singapore.

7. Stay abreast of the virus and what can be done to try to avoid contracting it. See e.g. The Wuhan Virus: How to Stay Safe.

Monitor. Stay in touch with those who know what is happening. Be careful and be thoughtful. And being thoughtful should include the realization that it is human beings on the front lines of this crisis and the human side of all this should predominate.