Would the Last Company Manufacturing in China Please Turn Off the Lights

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The title is an exaggeration, of course. But with my law firm’s international lawyers fielding a steady stream of client requests for help with leaving China for Vietnam, Thailand, Taiwan, Malaysia, Cambodia, India, Colombia, The Philippines, Indonesia, Mexico and Turkey (mostly), it does sometimes feel as though within five years nobody will be making widgets in China anymore.

On top of the client and potential client calls, we have also been getting a steady stream of reporters asking us for permission to talk to our clients leaving or looking to leave China. We tell them that for various reasons, none of our clients are likely to want to discuss leaving China and then they usually tell us that they “understand.” See How to Leave China AND Survive.

With the extreme reluctance for anyone to say they will be leaving China, whenever we write about companies leaving China (especially when we do so on our China Law Blog Facebook page) we get hit with invective claiming we are making this stuff up because we hate China. Well guess what everyone, there is now strong factual support for what we have been saying for the last few months. A huge chunk of American and European companies are looking to move their manufacturing from China.

In Many U.S. firms in China eyeing relocation as trade war bites, Reuters wrote how “more than 70 percent of U.S. firms operating in southern China are considering delaying further investment there and moving some or all of their manufacturing to other countries as the trade war bites into profits.”

In a business survey of 219 companies by the American Chamber of Commerce in South China, “64 percent said they were considering relocating production lines to outside of China.” And just as our international lawyers are seeing, and just as we have been reporting, “the trade war is shifting both supply chains and industrial clusters, mostly towards Southeast Asia” — in other words, Vietnam, Thailand, Malaysia, The Philippines, Cambodia, Indonesia and India. “U.S. companies reported facing increased competition from rivals in Vietnam, Germany and Japan, while Chinese companies said they were facing growing competition from Vietnam, India, the United States and South Korea.”

This has led to a slow-down in orders for manufacturers in China:

Customers are slowing down orders or not placing them at all, Harley Seyedin, president of AmCham South China, told Reuters.

“It could very well be that people are holding back on placing orders until times are more certain or it could very well be that they are shifting to other competitors who are willing to offer cheaper products, even sometimes at a loss, in order to get market share,” he said.

“One of the most difficult things about market share is once you lose it, it is very hard to get back.”

Companies in the wholesale and retail sectors have suffered the most from U.S. tariffs, while agriculture-related businesses have been most hit by Chinese measures, the survey found.

The survey was conducted between Sept. 21 and Oct. 10 and I would bet the percentages would be even higher if the survey were conducted today and much higher still after January 1, when U.S. duties are set to rise sharply.

“Around 85 percent of U.S. companies said they have suffered from the combined tariffs, compared with around 70 percent of their Chinese counterparts. Companies from other countries also reported similar impacts as their American counterparts.” This reinforces what my law firm’s international trade lawyers have been seeing, which is that our European clients have been nearly equally impacted because so many of them sell their products into the United States.

The problems extend beyond just tariff costs as “nearly half the companies surveyed also said there had been an increase in non-tariff barriers, including increased bureaucratic oversight and slower customs clearance.” It is not clear whether these customs problems are being felt in China or the United States or both, but from what we hear from our own clients, it’s both.

UPDATE: December 7, 2018

After reading the Wall Street Journal article, American Entrepreneurs Who Flocked to China Are Heading Home, Disillusioned, today, I feel compelled to write again on how companies are looking to leave China.

The gist of Areddy’s article is that American entrepreneurs are tired of China and leaving in droves and it cites a boatload of statistics backing this up. According to Areddy, “disillusion” has set in among expats in China, “fed by soaring costs, creeping taxation, tightening political control and capricious regulation that makes it ever tougher to maneuver the market and fend off new domestic competitors. All these signal to expat business owners their best days were in the past.”

Yes, but this is just the half of it. The other half is the more visceral feelings of those who are fleeing and Areddy nicely captures that too, as reflected in the following quotes from the article:

1. “He lost the feeling ‘it’s all happening’ in Shanghai and will try Thailand.”

2. “It’s harder for them [foreign entrepreneurs] to live here now.”

3. “How can it be that those who know China best, work there, do business there, make money there, and have advocated for productive relations in the past, are among those now arguing for more confrontation?” former U.S. Treasury Secretary Henry Paulson asked at a November conference in Singapore.

4. “The label of ‘foreigner’ is always on your forehead.

5. “China started to become less clear about what the endgame was for foreigners.”

The article notes how the climate for foreign businesses took a downward turn in around 2012 when Chinese government authorities “stepped up scrutiny of visas. . . ., reinforced China’s Great Firewall of internet controls. . . and [set up a situation where] big domestic tech firms thrived while laws excluded foreign rivals or pressured them to share technology.”

The international lawyers at my law firm have heard some variation of all of the above countless times from our own clients, and not just Americans; we hear it from our Canadian and our European and our Australian clients in roughly the same proportion.

And yet, most of the China complaints we hear are from companies that intend to STAY in China because the economics for doing so are still there. These companies are calling us seeking help to stay in China. Some of them are downsizing and seeking help in dealing with China’s complex employee laws. Some are looking for employment benefit advice in an effort to keep their foreign employees who want to leave. Most are calling for advice on how to make things better/safer for them in China. I alone have gotten more than a dozen calls/emails since China threatened “grave consequences” against Canada over Meng Wanzhou’s arrest.

What will China do against Canadian and U.S. companies and personnel? Hard to say, but if past history is any predictor of future performance (and we all know it is), you should expect China to (at minimum) continue to step up enforcement of its existing laws against all foreigners, but particularly against Americans and Canadians. If you are a regular reader of this blog, you know this sort of thing isn’t new as China has been stepping up its enforcement against foreign companies pretty much since we started this blog more than a decade ago. Way back in 2012, in an article I wrote [link no longer exists], entitled China’s Business Law Trends for 2013, I listed the following as the top three of four things to expect for 2013:

1. China will step up even further its crackdown on foreigners in China violating its visa/immigration laws. If you lack an employee visa, you are at risk. Yes, this is more likely to impact you if you are from Africa or the Middle East, but we are definitely hearing of increased problems for Americans and Europeans too.

2. China will increase its efforts to root out and shut down illegal and unregistered foreign businesses. China has especially stepped up its enforcement against American and European companies that operate in China but have an entity in Hong Kong without one in the PRC. We have seen such an increase in this over the last six months that we are wondering if maybe the PRC is using a Hong Kong list. Providing jobs to Chinese citizens does not let you off the hook on this one. Trust me on that.

3. China will increase its tax collection efforts. This has been going on for years now and if you are doing business in China already I am guessing that your response to this is “yeah, so.” In particular, China has stepped up its transfer pricing efforts and so if your China operations are not making a healthy profit, be prepared for the government to impute healthy profits to it. If you do not already have a good China accountant, get one. Now.

If you are a regular reader you know that our perpetual advice to avoid China’s stepped up enforcement against foreigners is to do whatever you can to make sure neither you nor your company become low hanging fruit for such enforcement. What does that mean for right now? It means the following, in a way that has become more pressing than ever before:

1. If you are doing business in China without a Chinese company (and by China, I most emphatically do not mean a Hong Kong or a Taiwan company), you had better be damn sure you do not need a company, especially since the odds are that you do. Doing Business in China Without a WFOE: Will the Defendant Please Rise.

2. It means paying whatever taxes you or your company might owe.

3. It means having your visa and the visas of all of your employees in good order.

4. It means not deciding you are operating legally in China based on something you’ve read on the Internet that feeds into your desire to believe that you are. See China Law on the Internet is All Wrong.

5. It means protecting your company from your China employees because the odds are good it will be one of your China employees who leads to your downfall either by reporting you to the authorities or by suing you and thereby exposing something you are doing that you should not be doing. Trust us on this one. Please. See China Employer Audits: The FAQs.

6. It means that if you are not 99.99% certain you are operating in China completely legally you either immediately do something to change that or you immediately leave the country and you take all of your foreign employees with you. And if for some reason you don’t care about one or more of your foreign employees getting into big trouble in China, note that people who go to jail for something that their company do have a tendency to sue their company.

7. If you are in a dispute with anyone in China regarding money, you should consider paying it and getting a valid and legally sound release in Chinese making clear that you paid it. See Maybe Owe Money To China? Don’t Go There. Or you should consider immediately leaving China.

I would also urge you to check out How to Calculate Your China Risks.

UPDATE: April 12, 2022

Moving Manufacturing From China is Also Risky and Sometimes Just not Possible

Why though if everyone “wants” to leave China are so few doing so? I see four main reasons for this:

1. Capacity. Countries like Thailand and Vietnam are literally getting overrun by American and European companies seeking to move their manufacturing and it has gotten to the point where if you do not use a sourcing agent with really good factory contacts in these countries you will likely find it difficult to impossible to find a factory willing to take on your product manufacturing.

2. Capability. Countries like Thailand and Vietnam have for years been great at manufacturing certain things and not others. They are both rapidly improving their capabilities, but they are not at China levels, at least not yet.

3. Knowlege and soft infrastructure. Many foreign companies already know China and know how to get a widget made there. Far fewer know Thailand or Vietnam or Indonesia, etc. And even if you don’t know China, it can be amazingly easy to navigate on your own and there are countless people out there who are super knowledgeable (and many who most emphatically are not) to help you. See China Manufacturing: To Sourcing Agent or not to Sourcing Agent, That is the Question. Our clients were having so many problems finding good people to help them with Vietnam and Thailand that we brought in house trusted Thailand and Vietnam people.

A story I love to tell is about a conversation I had with a Mexican lawyer friend of mine who studied law in Mexico, China and Canada. One day we were talking about companies moving their manufacturing from China to Mexico and how we both believed those moves would accelerate. My friend then mentioned how Mexico would be doing even better at increasing its manufacturing were it not the worst country in the world at luring foreign company manufacturing. I then said that if Mexico is indeed the worst country at that it is tied with every other country in the world except for China, which is a distant first. China is truly amazing at making it easy for companies to manufacture in China. But other countries — including Mexico — are slowly improving and will no doubt continue to improve.

4. Cost. Perhaps, most importantly, the costs in moving to a new country for manufacturing can be huge. First there is the cost of finding and testing out a new country and new manufacturers. Then there is the fact that despite all its problems and risks, China remains the cheapest place in the world for producing a wide swath of products. One can argue that when you add in the China risks, this is not the case, but that argument is difficult to make to a company that is looking to pay double per widget outside China. Then there are the costs of needing to secure and pay for the very same contractual and IP protections that you presumably have already done for China, but specifically tailored to whichever country to which you are going. The below are just some of the things that make every bit as much sense for wherever you go as they do for China:

1. An NNN Agreements before you reveal your product specifications or design or customers or any other trade secret.
2. A Mold/Tooling Ownership Agreement if you will be bringing your molds or tooling from China to the new country or if you will be paying (either directly or indirectly) for new molds or tooling in the new country.
3. A Product Development Agreement if you will be working with your new manufacturer to modify an existing product or create a new one.
4. A Manufacturing Agreement with whomever will be making your product. Go here, here, here, and here for what that entails
5. The need to secure trademarks to protect your brand name and your company name and your logo. This will likely be the most important thing you do.
6. A design patent or a utility patent
7. A copyright. Usually not needed, but when it is, it’s very important.

There is also the fact that China is the only place for manufacturing a wide range of products. In other words, some companies literally have no choice but to keep their manufacturing in China, at least for now

And moving manufacturing out of China often does not free companies from China’s inherent problems and risks. We had a client — a well known clothing company — that moved nearly all of its manufacturing to Vietnam maybe 4-5 years ago. They would often tell us how they preferred Vietnam to China in pretty much every way. Then all of a sudden they moved their manufacturing back to China and they would almost apologetically explain that they had to do so because they never stopped using China for things like their zippers and high end buttons and fabrics and the logistics of getting those things from China to Vietnam often meant slowdowns and to avoid those slowdowns they would often have to airfreight components to Vietnam at huge costs. In the end, Vietnam increased their overall costs so much that economics dictated their reluctant return to China.

So, yes, we are NOT saying everybody can or should move their manufacturing out of China because that is not the case. But we are saying that moving out is at least on the table right now for just about every company with whom we talk.

What Our International Manufacturing Lawyers are Seeing

Our international manufacturing lawyers are seeing the following:

Our biggest clients are mostly staying in China for the short term, but slowly moving production elsewhere and working on plans to move all or nearly all production out of China in the next few years, either by sourcing from factories outside China or by building their own production facilities outside China. These are the companies that have been manufacturing in China for a long time, either with their own facilities or with good-sized Chinese companies. These companies are mostly looking at Vietnam, Thailand, Malaysia and Mexico.
Our mid-sized clients are really all over the map, depending largely on their own individual situations. Some are already completely out of China, some simply cannot leave for a long time, if ever, and some are slowly shifting their production to other countries. Those companies that have others make their products for them have been much quicker to leave. Those with their own production facilities are for the most part reluctant to pay to build out new factories outside China until the future becomes clearer.
Our smaller clients are also all over the map, depending largely on their products. These are companies that do not have their own production facilities and they tend to be very risk averse. We are helping many of them find alternative supply sources in Vietnam, Thailand, Malysia, Mexico, Turkey and the Philippines. Finding alternative sources for many of these companies has been relatively easy and in most cases their new suppliers are charging less (oftentimes by considerable amounts) than what they were paying in China and that is not even counting their no longer needing to pay tariffs. But for certain products, China is pretty much it. Other clients sell such high quality, high margin items, that it just does not make sense for them even to bother trying to find a new supplier. One client has a medical item made in China for twenty cents, which it then sells in the United States for eight dollars. It sees no reason to spend time and effort trying to find and onboard a new supplier so as to save a nickel.

Then there is the issue of supply chain diversity, which I used to describe as something almost all companies want, something most companies talk about, but something few companies actually do much if anything about. Many companies are emphatically telling us that they are now serious about diversifying their supply chains. “Coronavirus has taught us a lesson,” they say. Will this be true though? Will companies truly diversify such that China’s next virus will barely impact their supply chain or will they just put a new factory in Vietnam and call it a day? How many companies will modify their supply chain so that they have redundancy in all 43 components of their product? And will that redundancy mean China and Vietnam (which tend to be subject to the same risks), or will it mean that all 43 components can be sourced from China and from Poland and Mexico? I have made up the term “true diversification” to describe a situation where a company has worldwide diversification of all components as opposed to country-next -door diversification of just the product?

China’s Manufacturing Future

I see the United States and the EU getting much tougher on China once the coronavirus situation is over. Before the coronavirus, there was a lot of talk and anger in both the United States and in the EU about imposing sanctions for China’s internment camps. The CCP has used the coronavirus to increase its control over its citizens. This too will likely not play well overseas. Both the U.S. and the EU have been pushing for China to open up its economy under threat of China being blocked or taxed on its products if it does not. The technology war is somewhat on pause right now but is bound to flare up once the coronavirus outbreak is over. All of these things bode ill for China manufacturing.

Doing Business in or with China After the Coronavirus — Stay Tuned

We have always put China business into two buckets. One bucket is foreign companies doing business in or with China to save money. Manufacturing is by far the largest component of this bucket. The other bucket is foreign companies doing business in or with China to make money. Selling goods and services to China is the largest component of this bucket. We see good things for foreign companies in this bucket after the coronavirus is gone and we will be writing on that later this week.

Five years ago, for every 100 companies our China lawyers helped set up contract manufacturing in China, we helped maybe one end its contract manufacturing in China. Two years ago, that ratio was maybe 100 going to China and five leaving. Today, for every company our law firm helps set up manufacturing in China we help around the same number leave or at least try to leave. And because far fewer companies realize the need for legal counsel when ceasing to manufacture in China (as opposed to starting to manufacture in China), I have concluded that far more companies are ceasing to manufacture in China than are starting to manufacture in China.

How To Leave China

My law firm’s advice every single time to our clients who are laying off workers in China or closing a facility in China or allegedly owing money in China is to stay outside China for any all negotiations. The same holds true for ceasing to manufacture in China. The below is our advice if you are in a dispute with a Chinese company or if you might owe money to a Chinese company. One only needs to be a regular reader of our blog to know that we took this position long ago and have never waffled:

The best thing to do is not go to China at all.

If you must go to China, think about using a bodyguard or two or three and think very carefully about where you stay and where you go. Most importantly, be very careful with whom you meet.

Consider preemptively suing the alleged creditor somewhere so that you can very plausibly claim that you have been seized not because you owe a debt but out of retaliation for having sued someone. If you are going to sue, carry proof of your lawsuit with you at all times while you are in China.

In a similar vein, we have also written extensively on the importance of preparing well in advance for terminating your China supplier. And by plan in advance, we mean make sure that you have secured your molds and all paid-for product before you do anything that might tip off your China supplier regarding your plan to start manufacturing elsewhere. It typically makes sense to have a new supplier lined up or at least in mind for when you make your exit. Last week, I worked on manufacturing exit plans for two companies, and both have a six month time frame, which is about average as they usually range from three to nine months.

For obvious reasons, few companies that have major problems trying to leave their China supplier speak about it to the press, but many years ago, in Jilted Chinese supplier tells would-be U.S. reshorer -“Not so fast,” an American toy company did, largely because it brought a lawsuit in the United States against its Chinese supplier. The article describes the lawsuit as based largely on allegations that the Chinese supplier ceased providing the American company credit and delayed deliveries, all in an attempt to make it impossible for the American company to start making its toys in the United States.

Though I have no idea whether the allegations in this lawsuit are true, I do know it is common for Chinese manufacturers to seek retaliation against their American product buyers that cease buying product from them. For this reason, we instruct our clients to line up new suppliers and have them ready to go before they even hint that they might cease production with their existing China suppliers. We give this advice because over the years our China lawyers have repeatedly seen the following:

Foreign company tells its China manufacturer it will no longer use its China manufacturer for its production. China manufacturer then keeps all of 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 will be moving on.
U.S. company tells its China manufacturer that it will be ceasing to use China manufacturer for its production. The China manufacturer then registers the U.S. company’s brand names and logos as trademarks in China and a key element of its product as utility patents in China and in the United States and then starts selling the U.S. company’s products around the world, using the U.S. company’s brand names. The U.S. company sues the Chinese company for patent infringement in China and for infringement of its U.S. trademarks in Seattle. The Chinese company then sues the U.S. company twice in Texas for patent infringement. The three U.S. cases are eventually consolidated (by agreement) in San Francisco and the U.S. company loses its patent challenge in China. I mention all this to tell you the high costs companies often have to pay for leaving their manufacturer without advance planning.
Foreign company tells its China manufacturer that 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 (rightly) 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 its product as revenge (or just registered the design patent). China has laws forbidding its manufacturers from registering the trademarks of those for whom it manufactures, but because it is usually not possible to prove it is your Shenzhen’s cousin in Xi’an that did the trademark registration, this sort of thing goes on unchecked. For how to prevent this from happening to you, check out Manufacturing in China: Minimizing Your Risks by Doing Things Right.
Foreign company tells its China manufacturer that it will no longer use it for its production. China manufacturer then says that it will not be shipping any more product because the foreign manufacturer is late on payment and owes it hundreds of thousands of dollars. China manufacturer then reports the foreign manufacturer to Sinosure and Sinosure then ceases to insure product sales to this foreign company, which convinces all of the foreign company’s other Chinese manufacturers not to sell anything to the foreign company without 100% payment upfront. We see this particular scenario all the time and for more on how these Sinosure cases go down, check out China Sinosure as Existential Threat.
US 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. For more on the problems that can arise from allegations of not having paid a debt to a Chinese company, check out Meng Wenzhou, the Two Michaels and China Hostage Taking: What YOU Need to Know.

You should always plan ahead for pulling your production from your Chinese manufacturer. This planning ahead usually involves the following:

1. Not telling your Chinese manufacturer you are even contemplating leaving it until you are completely prepared to leave.
2. Making sure you have good contracts with your Chinese manufacturer before you leave it. If you don’t have good contracts with your manufacturer now, get them. These contracts will make it much tougher for your manufacturer to sabotage you when you leave.
3. Make sure your IP protections are in order before you leave your Chinese manufacturer.
4. Make sure your alternative supplier(s) are truly lined up and ready to go before you leave. We have had clients who left their Chinese manufacturer for a new manufacturer in another country and then had to wait 6 months to get good product from their new manufacturer. I realize there is cost savings by not duplicating production, but there are also big risks.
5. Figure out exactly what your total costs will be before moving your manufacturing to a new manufacturer in a new country. We have had companies come to our law firm after their move seeking help with re-negotiating their arrangements with their new manufacturer because they didn’t realize that the shipping costs would be higher or that their widgets would be a subject to a tariff or that they were expected to pay xyz tax or whatever. Just realize that these sorts of “extra” costs can vary tremendously country by country, as can the expectation as to who is responsible for paying them.

When will you be leaving China?