China Intelligence Report: August 2007

U.S. Hunger for Inexpensive Quality is to Blame for Mattel-like China Import Issues

With quality control issues continuing to plague China, the latest word is the government will be sending officials to the United States later this month to attempt to try and stem the tide of a wave of hyperventilating press and government officials over a series of tainted exports, from toothpaste, tires, pet food and fish to Mattel toys containing lead paint. As usual, the press and Washington has taken the simple approach of vilifying Chinese manufacturing and exporting in general for this rise of cheap and shoddy goods. Unfortunately, this topic is imminently more complex than a sound bite, and frankly the responsibility lies in many different areas.

As is ever the case, our U.S. buying habits consist of only purchasing the cheapest product we can find without much concern for value as it applies to high quality. America’s buying practices pressurize companies to concentrate 80 percent of their attention on delivering a lower-priced product. As a result, the quality, availability and longevity of a product all come a distant second to the price god that serves as the ultimate motivation.

In their efforts to survive in the global economy, many companies are taking the cheapest sourcing routes and thereby creating the opportunity for problems like these. Let’s take the issue of tainted toys as a particular case. Rather than invest heavily in their own manufacturing facilities in China, the Mattel toy company frequently subcontracts out to multiple small suppliers, allowing Mattel to then play them off against each other and with cost-reduction demands, ensuring they get the lowest cost product. Undoubtedly, Mattel went through significant and extensive initial research to establish the quality of the finished goods and the materials that were being employed. But it’s likely that constant demands to reduce costs forced some of the small suppliers to shortcut their quality systems. If a gallon of paint that was $20 is being replaced by one for $15, the $5 difference probably doesn’t encourage the small company to engage in a full chemical analysis for replacement paint.

Is this acceptable, justifiable or tolerable? Absolutely not. It is totally unacceptable, which is why Mattel’s end solution is to become more engaged, on a day-to-day basis, with their China operations. This includes being more involved with the process and a need to have their own people in the plant as they manage these multiple smaller suppliers. Alternately, Mattel could also build its own facility and manage its own processes. But we, the American consumers, are going to see price increases as a result, because at the heart of this whole topic, lies our propensity to demand American-made quality at China-made prices. These expectations are unreasonable, and one unfortunate result is the type of quality issues we are seeing today.

The failures have to stop, and it’s clear Mattel has taken the responsibility for the problem. In the future it is likely that companies will have no choice but to have people on the ground in China, pushing responsibilities down to suppliers. The axiom, “Don’t assume – check!” has become critical in our offshore, outsourced global economy.


Chinese Government Ready to Launch Plan Making Northeast Region a New Improved Opportunity for American Tech and Manufacturing Companies

Northeast China, once home to the nation’s old industrial base, is now the target of a new Chinese government plan to move the area’s economy forward. Although still not officially unveiled, the plan is believed to center on building an internationally competitive manufacturing machine tool base for Chinese domestic applications.

Northeast China, bounded by the provinces of Heilongjiang, Jilin, and Liaoning, became the “rustbelt” of China in the mid-90’s (think Pittsburgh in the 60’s). As the economy in China flourished, with thousands of export oriented manufacturers springing up along the coastal region, the Northeast clung to its old ways. State-owned industry, employment for life, the iron rice bowl, and a sense of entitlement made the region reluctant to embrace change. Furthermore, the appalling winter weather conditions and blighted landscape was a disincentive for foreign companies to invest there.

It was clear that Beijing needed to do something differently and they were hardly in a condition to encourage yet more export-oriented business, when elsewhere, they were trying to cool down the export centered economy. Since 2003, a slow evolution to turn that region of the country into a center concentrating on producing manufacturing industry equipment has been underway. Elsewhere in China many of the export companies have been importing manufacturing equipment, tooling and automation from offshore. But in the future, that equipment is likely to be manufactured in Northeast China for distribution around the country and potentially for export worldwide. American companies with technology needs in all areas of manufacturing and tooling might do well to investigate opportunities to either joint venture or start their own companies in this evolving region of China.


China VAT Increases More Complicated Than is Being Reported

By all accounts, you can probably expect the cost of sourcing from China to rise after changes to tax regulations in the country.

However, as the new rules do not affect all products, or even the same products made from different materials, buyers are urged to carefully investigate these changes. In July of this year, the Chinese government announced revisions of its Value Added Tax (VAT) policy. The move resulted in a dramatic jump in May and June to China’s reported GDP; these increases were to levels high enough to strike even more terror in the hearts of U.S. manufacturers. Of course in reality what was happening was that offshore buyers were doubling and tripling their order levels in an effort to export out of China ahead of what they believed was an upcoming change in VAT rebates, thereby taking advantage of the two or three months of the more beneficial rates.

Many exporters may have jumped too quickly as there was not sufficient data until July to understand what the true impact was likely to be. Moreover, at the heart of the VAT changes was some sound business decisions by China’s central government as many of these VAT rebate reductions were aimed at discouraging manufacturing in the high pollution commodity areas.

The rules themselves are complex, in that they affect a wide range of products and many of them were actually time-phased. Unscrupulous Chinese suppliers, brokers and agents rushed to create a sense of fear thereby increasing immediate shipping volumes in an effort to benefit from the changes. What is often misunderstood by American buyers is that many of the companies they source from don’t own their own export licenses and actually have to export through a co-government-owned trading agent. It is always unclear as to whether these trading agents return the suppliers’ VAT rebate to the manufacturer they support or whether they themselves retain all or some of the VAT. Without knowing all of the factors that come into play in your business, its’ really hard to know how these rebate changes will affect you and your business, but it’s clearly in your best interest to find out.

International-based tax and accountancy companies are a good source to start with, but as is always the case, this will cost you and will be at best, second hand data. We recommend that you consider being more pro-active by going to China and working your way through your specific requirements with your supplier and shipping agents on the specific aspects of the VAT laws that affect you as being by far the best approach. You will then have real facts to work from and are likely to make better long-term China business decisions.


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