An offshore sourcing primer for small business: Leveraging Chinese manufacturing resources

(Published June 17, 2010)

Many in the West look to China as an exceptionally low-cost sourcing resource for manufactured goods. However, for those who are accustomed to dealing with contract manufacturing in Western markets, the first ventures into Chinese manufacturing will require a major readjustment in business approaches and expectations. Once oriented, though, the extreme low costs and minimum orders prove China to be a viable resource for many medium and small firms.

Using contract manufacturing to drive down costs is a well-established business tenet. Many of us focus on other parts of the value chain where we can add the most impact, and we contract out to others to supply products or components rather than owning or operating factories ourselves. In the end, this approach enables us to minimize the costs of production, and thereby drastically reduce the costs that we pass on to our customers. From auto manufacturing, with its complex layers of suppliers, to simple household items that reach us as individual consumers, contract manufacturing relationships are prominent and necessary.

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China as a Manufacturing Resource

Western entrepreneurs must first drastically modify their business mindset when looking to China for contract manufacturing. Chinese factories differ significantly from their Western counterparts in their manufacturing business approach. Each Chinese factory focuses its business model on the internal workings of the factory itself. On the whole, this type of self-contained approach considers the manufacturing capabilities of the factory only within the bounds of the techniques and tools that are currently in place. Thus, each factory is prepared to manufacture anything that they believe they can readily execute, regardless of market positioning or outlook.

In contrast, the Western factory business model is generally based on market research that is performed to understand the competitive markets in which its customers compete. For example, Western factories will identify and improve their capabilities based on the current trends in product design support for their customers. In order to better serve their customer’s particular needs, each Western factory adjusts its manufacturing capabilities accordingly.

Unfortunately, Chinese factories have yet to become the places where one would seek out product ideas or suggestions. Although they can mock up ideas very quickly, the ideas have to come from their customers. In effect, you will need to provide very specific directions to ensure that the products they manufacture for you are suitable to your needs. Contract manufacturing factories in China should be best thought of as providers of manufacturing services, rather than as manufacturers of products.

The Cost Threshold to Engage Chinese Factories is Relatively Low

The order value threshold to engage a Chinese factory is surprisingly low – while prices range, $5,000 USD is a common minimum cost. However, a relatively small monetary order does not necessarily translate into a small physical order. Consider the above-mentioned $5,000 – this would cover an order for about 20,000 eleven ounce ceramic mugs by example.
Given that a standard 40’ shipping container will hold about 54,000 of these coffee mugs (at a factory cost of $12,000), as a current rule of thumb you should estimate about $1,700 in charges for shipping from Shanghai to the US west coast. Including packaging and land transport to and from the docks will bring the post manufacturing total to about $3,500. Thus, your landed cost for those 54,000 coffee mugs ends up being around $15,500.

If you can only absorb smaller manufactured lots than our above-mentioned example, freight forwarders can arrange consolidated shipments when you buy less than a container load of goods. Your goods can be expected to arrive in the US through a west coast port about 4 weeks after they ship from China, as Pacific transit takes about 2-3 weeks plus an additional few days to clear US customs. While China’s 5,000 year old culture has a certain mystique, modern day buying and import from a Chinese factory isn’t mysterious. But, as with so many other things in life, it is helpful to know what to expect.

Some of the Lessons Learned from My Own Experience

After starting Branders.com, I moved my family to China and immersed myself in developing supplier relationships to ensure our success. Now that we are back in California and our supply chain is well established, I realize that I could have as effectively accomplished our business objectives without the move abroad. With the benefit of 20/20 hindsight, the preferred approach would have been to use a China mainland-based intermediary, supported by occasional travel to Asia Pacific, as I do now. Using an intermediary adds little cost and can often yield a net savings.

There are a few large intermediary firms (Li & Fung, for example) that are well established and quite dependable. My experience has shown that the cost of an intermediary is about 7% of the purchased goods price. An effective intermediary will easily save a newbie that much or more through improved negotiations and avoided hassles. For example, high-quality intermediary services will include introducing their clients to a potential factory by arranging for tours, personalized introductions and the like.

None of the first- and second-tier China intermediaries try to capture value by hiding information – you should expect them to provide a great deal of transparency at all stages of the relationship. Further, none of these firms will expect an exclusive relationship. You should openly work to get the best prices by simultaneously fielding your quotes to multiple agencies. China is an enormous economy and the factories are contract manufacturers who will sign up to make almost anything. As a result, your multiple intermediaries will not be covering the same ground.

By adopting this suggested approach, you will cut COGS by at least 35% even with China intermediary costs included, assuming that you are currently sourcing from the West, and even if your Western source buys in China. My years of experience and many successes in the Chinese manufacturing market give rise this strong recommendation to use intermediaries, at least until you achieve significant scale and get your sea legs.

Finally, business arithmetic and sound practices are universally applicable (like physics) regardless of the venue. Never accept “that’s how it is done in China” as justification for submitting to a practice that you normally wouldn’t in the United States or the West. If your instincts tell you something doesn’t sound right, it probably is not.

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Source: Idea Cafe Blog

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