Buying from a large private Chinese factory

by Renaud Anjoran on 21 September 2009

Small importers tend to have the feeling that buying from a large factory is more expensive but more reassuring. There is some truth regarding the higher prices, but risks are not necessarily lower. Buyers should be aware of the different dynamics at play here.

What do I call a large private factory in China?

I have three things in mind:

  • At least 2,000 workers (and sometimes many, many more).
  • The target market: most of the production is sent to large buyers in the US and/or in Western Europe (e.g. large retailers such as Wal-Mart, Carrefour, Ikea, The Home Depot…). If they sell on the domestic market, the goods are sold in high-end distribution channels.
  • The company’s ownership: the capital often came from Hong Kong or Taiwan, and with it different organization methods. I am not discussing state-owned enterprises in this post, even though they are often pretty big, because they follow an entirely different logic.

I noticed many similarities among the large factories that I visited and where I performed inspections.

Why are these factories generally more expensive?

Small private companies generally offer lower prices than the largest companies. How is that possible?

  • The prices of many raw materials are administratively fixed in China, so large buyers pay (roughly) the same price as smaller operators. I would actually bet that they tend to pay a little more on some inputs, because of hidden commissions pocketed by some of their purchasers… The boss can’t place his family members at all “sensitive” jobs, because of the size of the operations.
  • Their largest customers tend to push prices down to a level where the factory makes little or no margin. But the supplier still accepts orders from famous buyers. Why? Because volumes are huge, and so that other potential customers think “if that buyer does business with them, I should be fine”. But someone needs to compensate for these slim margins. Who pays higher prices? Smaller importers!
  • Structure charges tend to constitute high fixed costs: professional management, more administrative and QC staff, sales offices…
  • Their product line is broader than that of smaller and more specialized workshops. Higher variety in manufacturing drives costs up.

Main advantages of very large factories

  • They tend to be careful about their reputation. Small Chinese factories have more of a tendency to cheat with raw materials and cut corners in production, because nobody will know about it besides their current customers–if they notice anything.
  • The organization of production incorporates some practices borrowed from abroad (’5S’ is a classic). There is an effort to make some progress and gain both in efficiency and in quality. This effort often originates from the boss, who comes from outside the mainland. My inspectors told me several times “quality is good, which is not surprising since this factory is an investment from [Taiwan/Hong Kong/Singapore]“. However, 99% of these factories still process enormous batches at a time, and going lean is not even on their radar.
  • To pass the strict audits from their largest buyers, they had to improve their organization in a way that makes them more reliable. Quality control is more frequent along the production chain. But it also includes compliance issues (e.g. the respect of regulatory norms for the staff canteen) which contribute to push costs up.
  • They are familiar with regulatory requirements in their export markets. They can advise you about what other importers generally require, and they already have test reports for their existing products. Seeking advice from a recognized laboratory or any other third party is strongly recommended, though.
  • They understand foreign markets, and they might accept to finance the development of new designs–if they really believe in their potential. They might even have in-house designers who can work on your projects.

Main drawbacks of working with very large factories

  • Some of your competitors may already buy from the factory you are doing business with. Do you want to produce your new lines there? Are you sure the salespeople will keep their mouths shut about your orders?
  • Worse yet, if you are not a retailer, your customers might also buy from them. They might notice your products while visiting the plant, either in the showroom, in the lines, or on the cartons in the warehouse. They can get an instant quotation, which might actually be lower that the price YOU pay–if your customer represents a large buying potential.
  • Another problem is that large manufacturers often enjoy all the power in the relationship with their small buyers. Once production is under way, they can often dictate all the conditions. For example, one of my friends, who works in a 5,000-people factory in Guangdong, told me the following story. A European importer developed a line of new designs in my friend’s factory, to sell them into a major supermarket chain. The importer tried to delay the final payment. My friend told him that, in these conditions, he would cancel the order and sell the products directly to the supermarket chain, which was already his direct customer. He also uses this tactic when his goods are rejected on the ground of poor quality. He can’t push this too far or do it too often if he wants repeat orders, but small importers cannot impose their terms.
  • The top and middle managers might have some discipline, but they often have the same bad habits as smaller manufacturers. A few examples: (1) Subcontracting happens, and buyers are usually not told about it. (2) Inputs are not systematically checked… Do you think Mattel was buying its lead-paint toys from a small workshop? (3) If a key customer places an urgent order that uses the same machines as yours, your production will likely be on hold for a few weeks–or will only be processed by a few operators and will take a very long time.
  • Finally, large factories are generally less flexible. They have their way of working, and you won’t change it unless your business is very significant to them. I remember some large factories refusing to let us do in-line inspections as we required, because they thought we would disrupt their operations. On the other hand, a large Jiangsu factory explained to me how they let Marks & Spencer send a whole team to reorganize their QC procedures… Because their reputation, their prices and their volumes were so attractive.

Each importer can evaluate these pros and cons based on his situation and his industry. But one thing is for sure, many large factories cannot be counted on to deliver acceptable and on-time products in a consistent manner. Quality control is still necessary, except in a few particular situations.

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