How to plan Strategic Purchasing to avoid price increases in China?

by CIL1

How to plan Strategic Purchasing to avoid price increases in China?

by CIL1

by CIL1

Since joining the WTO (World Trade Organization) in 2001, China started shaping and presenting a new positive image to the world. However, the language barrier makes it more difficult for most foreigners to understand this mysterious Eastern country with a 1.4 billion population in 2019. Furthermore, it creates another obstacle for foreign customers to understand Chinese culture and its people’s mindset without speaking the language in a short time.

Take, for example; one of our clients, ended up losing 46,000 US dollars and time due to improper purchasing management – no actual agreement with terms and conditions agreed on price increases. Our client contacted us for the first time with the following situation.

1. The Use-case Scenario: Financial Losses in Purchasing Management

Our client found a factory online to produce the products for their company. The supplier seemed to know the client’s needs and requirements, and the client thought they were the right manufacturer to help them with production. Therefore, the client didn’t do any further supplier risk assessment and investigation before placing a production order after receiving the PI (Proforma Invoice / Production Invoice). The PI listed the ordered items with a value of 46,000 USD, a production lead-time of one week and a 100% advance payment due to the short lead-time as the main terms and conditions. With trust and the limited information, the client confirmed to proceed with the production.

When the production was almost completed, the client agreed to organise an on-site inspection in the factory. During production and quality inspection, everything seemed right as the factory provided the exact production that the client ordered. A few days later, the factory informed the client that he would need to pay an extra fee to cover the increased raw material cost after the inspection. The factory wouldn’t release the goods unless the client have paid the extra fee.

Since this was not agreed upon before signing the order PI, the client was unwilling to pay extra. It had been a week after internal consideration within the client’s company and communication with the factory on the price increases disagreement via E-mail. Meanwhile, the factory told the client that their goods had been sold to the other parties in the market because they didn’t reply in time, and asked them to pay the additional increased amount if they still wanted a new production delivered afterwards.

In the end, the client disagreed and requested a full refund, because they didn’t agree on: firstly the price increases; secondly selling the production to other parties in the market overnight.

However, the factory refused to refund by only giving a reason – the client didn’t reply in time.

Unfortunately, the client didn’t get the payment back and ended up losing 46,000 USD and time of sourcing, production, communication, negotiation, and having no goods to sell.

2. Problems Encountered

  • Sudden price increases from the factory after the client already paid according to an agreed price.
  • Factory was not willing to pay the payment back to the client.
  • Full order amount 46,000 USD was paid but no goods received.
  • Factory demanded more (increased amount) payment to proceed, even though this was not agreed upon.
  • Factory sold our client’s goods to another party which he had already paid for.

3. Origin of the problems: Price Increases and main problems clarified

(1) Bad Intentions of the Factory:
There’s no doubt that the supplier in China had a bad intention in the first place and took advantage of its client’s inexperienced manufacturing management.

On the other hand, the client’s unthoughtful vendor management in procurement gave the manufacturer a ‘chance’ to take advantage of their inexperience and increase the benefits by increasing the prices after receiving the full payment.

It made the client in a vulnerable negotiation position when the manufacturer refused to ship the goods or refund the full payment.

(2) No Sourcing and Procurement Strategies:
Lacking strategic sourcing and procurement planning, it becomes more difficult for our foreign clients to manage the purchasing and production processes in untrustworthy factories.

After our client seeking help, we executed a factory investigation and found that the factory has multiple penalties records given by the government.

What’s more, the factory was under-investigated for several trials and business disputes by the court.

It has been already challenging to deal with a factory like that, not speaking of without strategic detailed terms and conditions.

A few key factors to the origin of the problem:

  • No strategic factory investigation and visit before dealing with this factory.
  • No detailed agreement means the contract is open for “interpretation” by both sides during the period until the deal is closed.
  • Most importantly, the 100% advance payment term weakened the client’s negotiation position, relying on honesty and reputation from the other party.

4. A Practical Solution to Make a Strategic Purchasing Plan

Understanding the supply chain and manufacturing environment in China should be your first step and is highly recommended. To solve and avoid this issue or similar ones with a practical solution, a well-planned purchasing strategy is essential.

In general, it’s not sufficient simply to make a decision by only searching what can be seen on a factory’s website or sales platforms. To avoid this type of situation, such as price increases, the key is to really understand the reasons behind it and the trigger behind a Chinese manufacturer

Thus, it is vital to understand the Chinese culture, Chinese thinking process, and Chinese people’s mindset and values under different historical backgrounds, policies, and educational and living environments.

More importantly, factory investigation, factory visit, and risk assessment can lower the risk of losses in some respects.

Solutions by IAAD China Working Method.

Solutions vary in different situations and issues. You may take this case as a reference to apply the key of the solution to the same or similar cases with customised strategy when necessary, to prevent repeated issues.

(1) Interest – IAAD China Working Method

In this situation, there was no financial interest for the factory anymore to deliver the goods as they had already received the full payment before inspection or shipment. Therefore, creating financial interest would generate interest for the factory to release or not re-sell the goods.

The solution to this case would be:
In this case, balance payment is the certain financial interest drive for the factory to ship the goods with the requirements agreed according to the PI confirmed.

(2) Agreement – IAAD China Working Method

First of all, a solution to this problem would be to create and implement a proper agreement that possibly applicable to similar scenarios.

It’s critical to agree on terms and conditions for possible situations that might occur during the production. In this use-case, there was nothing agreed at all.

Whereas, the more you agree by a written agreement, the more the factory will consider its risks. In other words, the more the factory will consider its risks, the more it becomes clear to what responsibilities they can or want to commit. In this case, with an agreement as we proposed, the factory might not have accepted the order at all, which would have prevented the client from losing 46,000 USD and time.

(3) Strategic Terms That Would Have Avoided the Financial Losses
– Prices cannot be adjusted after payment of deposit or balance payment.
– Factory shall deliver the products according to the specifications and terms written in the contract.
– Factory is not allowed to sell the produced products to any other third parties unless appointed by the client.
– Payment terms: 30% deposit payment and 70% against B/L (Bill of Loading).

(4) Assessment – IAAD China Working Method
– Make assessments by implementing QC inspections.
– Check the goods on both quality and quantity according to the terms agreed in the contract BEFORE making any balance payment to the factory.

To understand more about Chinese culture and strategic purchasing management, contact us for the book IAAD China Working Method or a customised sourcing strategy and solution!