Top 7 Things to Consider for Contract Manufacturing in China

You can add huge value to your business with contract manufacturing as long as you do it right.

This blog article was first published on www.sourcingallies.com

Known as the “World’s factory,” China’s manufacturing sector accounted for close to one-third of the world’s manufacturing output in past few years. On the popular marketplace Alibaba alone, there are millions of active sellers and buyers. Given the magnitude of options, finding the right manufacturer for contract manufacturing in China can be a daunting task.

From background checks to quality system auditing, establishing a rapport, to negotiating deals, there are several intricacies involved in entering into a contract manufacturing agreement with a supplier in China.

Here is an overview of contract manufacturing in China and the top seven things you need to know before finalizing a supplier in China.

Contract manufacturing in China: What is the scenario?

Despite the slump in trade activity during the initial months of 2020 due to the pandemic, exports in China rose to US $ 237.2 billion in October 2020. This shows an increase as compared to exports in the same month in 2019. Year on year, total exports expanded by 14.5 percent in October 2020 as compared to the 2.8 percent rise in September.

China has continued to be one of the major exporters since 2013, when the export value of Chinese goods reached record levels of $ 2 trillion. Trade in 2015 also reached $ 594 billion, which was another record high.

An export-focused growth strategy has enabled China to emerge as the top export partner for the United States and European markets.

Although China’s competitive advantage lies in manufacturing labor-intensive goods that yield significant cost advantages, in recent times, China has also steadily increased its exports of high technology products including power devices and computers.

Manufacturing is a major sector in China with a GDP contribution of close to 40 percent. The focus has shifted, particularly in the eastern coast of China, to advanced manufacturing. Labor intensive manufacturing and lower cost production is concentrated further inland in western and central provinces. You can get contract manufacturing done for almost any product in Shenzhen city in China, which is considered the Asian epicenter of manufacturing due to highly accessible service providers and manufacturers. The logistics companies for Amazon FBA are also located in Shenzhen.

Whether you are new to contract manufacturing or are considering outsourcing to China for the first time, there are important factors to keep in mind before venturing into contract manufacturing. Here are the top seven factors you need to focus on:

Top 7 things you should know about contract manufacturing in China

#1: Protect your intellectual property (IP)

Many business owners may think that their U.S. trademarks and patents are enough to protect their intellectual property when considering contract manufacturing in China. While U.S. patents are a great start, they will not protect your products when manufactured in China or other countries. This is why it is recommended to register IP in China when you intend to manufacture products in China.

Trademarks or TM: A trademark registration in China is fast, inexpensive and easy. Trademark registration is a must for those looking to manufacture in China and for sellers or operators in China. Unlike the U.S. which is based on a first-to-use system, China makes use of a first-to-file system. As a result, Chinese squatters search for startups and go ahead in registering their TMs. Once the startup forays into the Chinese market, the owner is in for a shock to find that their trademark has already been registered by someone else. Companies such as Groupon and Tesla also have experienced this problem. Some OEMs (Original Equipment Manufacturers ) may also register your TM and can threaten to sue you when you attempt to transition to new OEM or block exports.

Patents: Filing a patent in China involves translating your application into Chinese and filing it in China prior to making any public disclosure.

You also need to register your IP with China Customs which blocks products that infringe upon IP registered by someone in China. Products that violate an IP registration cannot enter or leave China, which is an effective way to prevent counterfeit products from being sold across the world.

Trademark applications are published regularly by the China Trademark Office. You can look into this and oppose any trademark application from a squatter or competitor before it is registered.

In addition, you must also ensure the contractor signs a ‘NNN’ agreement. While most business owners across the U.S. and Europe are familiar with NDAs or non-disclosure agreements, in China, the NNN agreement pertaining to non-use, non-disclosure and non-circumvention is crucial. This document has to be written in Chinese and prevents the contract manufacturer from using your TM/IP, making your information public/sharing with their ‘friend’, and selling your product at a lower price to your customers.

#2: Select the right manufacturing partner in China

The success of your Amazon selling business depends on partnering with the right contract manufacturer in China who not only understands your requirements but is reliable and committed to adhering to the contract terms.

Some of the important factors to consider when choosing a contract manufacturing partner in China include:

Capability- Making a list of the manufacturers’ capabilities, including their current assets, technology and equipment, is the first step to filtering them. You can browse on popular marketplaces such as Alibaba.com, Made in China, Global Sources and DHGate that list sellers in China. You can also visit trade fairs and conventions conducted annually in China such as the Canton Fair that showcases many products such as machinery, electronics, consumer goods, cosmetics, textiles, medical devices and gifts. International trade exhibitions are also organized by Hong Kong Trade Development Council or HKTDC. Visiting the fairs will enable you to talk to various manufacturers in person to assess their capabilities. Look into what capabilities and services the contract manufacturer offers and ask for more information as needed.

Experience- Evaluate if the contract manufacturer is particularly experienced in the industry/product segment that you are looking to source. Look into the number of years of experience the manufacturer has as well as if they have the necessary certifications and licenses to manufacture.

Quality- What quality control processes does the contract manufacturer follow? Do they have the relevant quality certification in the industry? Some of the quality certifications include ISO 9001 that indicates that the manufacturer has a quality management system in place and has cleared the certification process as per international standards.

The Conformité Européenne or CE certification is required for companies that are looking to sell or are based in the European Economic Area and indicates that the products adhere to EU safety, environmental or health standards.

It is important to verify if the ISO 9001 certificate is genuine by doing some background research. It does take a lot of time and effort to do this kind of research on your own as you have to understand all the elements on the certificate. You can also search for information in the database of CNCA or Certification and Accreditation Administration of the People’s Republic of China. Make sure the name of the company, address, and the activity that has been certified on the ISO certification matches with the manufacturer’s business license.

Capacity- This relates to the volume of an order that the contract manufacturer can handle and their scaling up abilities. Check if the supplier can address your needs if your orders are very small and also if they have the equipment, labor, space and equipment/technology to handle bulk orders or large volumes.

Equipment and Technology- The right manufacturing partner is one who utilizes the latest technology and equipment required to achieve your desired quality, particularly if you require a high degree of customization. From CNC machines, CAD/CAM or CAE engineering methods, robotics to other sophisticated tools, many China based manufacturers use high-end technology.

#3: Create a clear Original Equipment Manufacturing or OEM contract

The purpose of drafting an Original Equipment Manufacturing or OEM contract is to provide a guarantee that the products manufactured in China comply with commercial and technical requirements of foreign companies. The OEM contract also is evidence of the manufacturer’s compliance with the intellectual property rights and confidentiality of the foreign companies.

It contains other details including specifications, price, packaging and wrapping, design and models, equipment to be used, materials used, as well as protecting confidential information.

The other terms that the OEM contract must include are:

Termination clause and consequences of termination — Termination events can include, for instance, violation of intellectual property rights or non-compete terms or supplying poor quality products. Details of the consequences of termination need to be included such as sale of finished products, allowance for finishing up partially completed products, destruction of confidential information/ logos, trademark, and other materials.

Examination upon delivery — A timeframe for inspecting the products after delivery and acceptance has to be specified in the OEM contract. In case you accept the products without an inspection, the supplier is absolved of any further liabilities related to sub-standard quality.

#4 Factory presence

If you can afford the expense, ensure that one of your staff members is present at the factory in China on a regular basis. Having someone represent you at the factory in China is important to ensure regular contact and helps you ensure that the manufacturing is happening as per your quality and technical specifications. Keeping your people on the ground will help you micromanage the production, conduct spot quality control checks and maintain an ongoing dialogue with factory personnel.

A factory presence is vital despite having a OEM agreement with the contract manufacturer as things can go wrong at any time. While you can cite the agreement to ask the manufacturer in China to fix the problem, the lead time gets pushed back as do the delivery times. This in turn, can disrupt your inventory and customer experience. Conducting ongoing quality control inspections on site is the best way to prevent such problems and delays from occurring.

You need to visit the factory you intend to use. If you can’t go, have a China sourcing agent conduct the visit(s) for you.

#5: Evaluate samples

Product samples are vital when entering into a contract with a China manufacturer because they allow you to feel, see and evaluate the product before production starts. Samples are a key factor in evaluating if the contract manufacturer is up to the task.

The different types of product samples include:

  • Factory samples- that are ready made samples with the manufacturer that may not be as per the buyer’s specifications.
  • Production or batch sample- This type of sample is obtained from a batch of mass produced items and are typically used for quality control checks, laboratory testing, or functional tests.
  • Custom product samples- These are samples made as per buyer specifications
  • 3D printed samples and virtual samples- Virtual product samples range from 2D renderings showcasing the product design to 3D product models which can be tested digitally.

#6: Build a rapport

Many different languages are spoken across China, while the official language is Mandarin, or known as Putonghua in Mainland China. Close to 71 percent of the population in China speaks Mandarin but there are many other languages such as Mongolian, Cantonese, and Tibetan that are spoken in different regions and have official status. While English is considered a business language, only about one out of ten people in China can speak transactional English. When communicating with the supplier, you cannot assume that the sales representative or the supplier can speak English fluently or that they understand your requirements.

Apart from the language spoken per se, the communication styles also differ across the world, and particularly between the Western markets and China and there are significant cultural differences that influence communication. The Chinese do not give out information or feedback freely or openly, unlike people in the U.S.

Another factor to note is that in China, business transactions are based on the personal relationship/rapport or ‘Guanxi.’ It is important to take some time to get to know the supplier and establish guanxi before signing up an OEM contract. Guanxi refers to having personal trust and a strong relationship with someone, and can involve moral obligations and exchanging favors. With a strong guanxi, it is possible to get a favorable deal.

Hiring a translator is one of the ways to solve the communication problem but you need to ensure the translator is well versed with different dialects and knows the intricacies of contract manufacturing in China.

#7: Work with a China sourcing agent

Working with an experienced China sourcing agent is a proven way to ensure the following:

  • Selecting the right contract manufacturer with thorough due diligence
  • Communicating in Mandarin or other dialects to establish guanxi
  • Negotiating the best deals
  • Conducting in-person factory audits and quality inspection
  • Drawing up a detailed OEM contract
  • Verifying certificates and compliance of the manufacturer
  • Handling shipment
  • Creating a backup plan in case there is a problem with the supplier

A reliable China sourcing agent can solve the typical pain points in the supply chain and create a strong sourcing strategy that you can benefit from.