Challenges Faced by American Vendors Operating within China

November 25, 2010, Revised March 5, 2011

This paper is written from the perspective of an American “vendor” operating in China to provide services to this vendor’s American “client”. This vendor delivers mostly one-of-a-kind goods and services, or small quantities of goods, as opposed to mass produced goods.

The purpose of this paper is to relate, based upon our own experiences, the challenges facing an American vendor seeking to procure and produce within China. The reader is assumed to be an American unfamiliar with doing business in China.

Our message may be summarized as follows: Given sufficient experience with the issues to be faced, the required quality is attainable, but not without extraordinary budget and schedule uncertainty owing to the significant variables which are not within a vendor’s control, or anyone’s control. The cost of mitigating the budget uncertainty will significantly erase the China cost advantage. The schedule uncertainty can only be addressed by building contingency into the schedule.

As with all work, quality communication is the key, but dramatically more effort must be devoted to ensuring quality communications. The following are essential:

  1. Specify everything, in writing, completely, clearly, using only basic English vocabulary. Realize that analogies, uncommon words, and word-expressions that immediately clarify issues for a native English speaker usually mystify the non-native English speaker. Well annotated pictures are very effective.
  2. Ask detailed random questions to insure understanding of both written and spoken communications. It is pointless to ask “do you understand?” A teaching dialog is very effective. Assuming nothing. Understand that the pre-existing expectations of your Chinese counterpart are very unlike your own, so misinterpretations are inevitable.
  3. Inspect at every stage. Inspect the final result, right down to sealing the package, crate or container.

Caveat: Although we write with five years of experience doing business in China, having delivered hundreds of unique items of equipment, particularly control systems and lighting fixtures, mostly to theme park clients, totaling U.S. millions of dollars of products and services originating from within China, there is a caveat to the applicability of our experience in China: thus far about 95% of what we have produced within China has been for export out of China. There are some differences when producing goods and services for delivery within China. Hence the specifics of some of these challenges will change when delivering within China. Undoubtedly, the broad themes of the challenges will be the same.

Topics to be addressed in this paper:

  • Logistics. Logistics, and in particular Customs issues, are consistently the greatest area of uncertainty, impacting both cost and schedule. The methods required to mitigate this area of risk change randomly and are too frequently uncomfortable for the American, even though they are completely within the bounds of what is normal in China.
  • Taxes. It is difficult for a vendor to quantify how much of the theoretically recoverable VAT cost will actually be recovered. The magnitude of the uncertainty is on the order of half of the vendor’s budgeted profit.
  • Currency. There is a currency cost associated with doing business in China, more so than in other countries, with or without a pegged currency. The movement of money in and out of China is restricted, not only business capital, but also payments. You will occasionally find that there is no legal way to get money from outside of China into the hands of a Chinese business that is willing and able to make a sale to you.
  • Approvals. The budget and schedule implications of local compliance for delivery of goods and services within China are as yet difficult for us to assess. Thus far compliance requirements appear to be somewhat arbitrary and difficult to learn, but not particularly onerous.
  • Quality and efficiency. Cultural issues weigh on the effort to obtain consistent quality to a significantly greater degree than we have encountered in Hong Kong, Japan and Singapore. Quality is attainable but non-obvious steps must be taken to maintain quality. Constant supervision and oversight are required. With adequate dedication, excellent quality is attainable.
  • General. What are the broad lessons that we have learned doing business in China? Business in China is conducted in a more arbitrary fashion, absent much of the planning expected by an American client, perhaps owing to a learned futility of planning on the part of Chinese vendors.

Logistics

Logistics (particularly clearing Customs upon entering and exiting China) is, for us, the single most unpredictable and frustrating aspect of doing business in China. Our Chinese associate businesses feel similarly. Logistics is both the budget and schedule item most difficult to estimate.

These are some of the logistics-related issues:

  • HS codes. When importing and exporting anything, much rests on the proper choice of the HS code and statement of the country of origin. It is by no means clear which HS code is “proper”. The creator of a product would seem to be in the best position to select the code, with help from the logistics experts. At times there may appear to be two or three reasonable codes choices. There is a natural desire to choose the HS code which will invoke the lowest duty, however if Customs disagrees with your choice, the penalty will be delays and fees getting the goods through Customs. Thus, there is a greater desire to choose the proper HS code, yet Customs may disagree with your choice nonetheless. In fact, Chinese Customs may require an HS code which is clearly incorrect, perhaps because they do not understand the product, do not care to take the time to understand it, or for other reasons which are unfathomable and never explained. This can affect the duty to be paid but more importantly it can create a delay varying from a couple of days to two weeks. There are also “fees” related to solving the problem.
  • No explanations, no second chances, no lessons learned. Don’t ask, don’t tell. Customs doesn’t have to explain their reasoning, and they don’t, in our experience. It may be more accurate that the explanation is not one that our translator believes useful or worth relating to an American, understanding an American’s expectations. If Customs determines that you have made a mistake, your goods are trapped in Customs until the problem is resolved. You usually cannot ask for your goods back to start over – we’ve only been successful at that with the aid of a local lawyer. You are just told what you’re going to do to solve the problem – it is always a matter of “fees”. There is no rate schedule for these fees. This information is relayed through the trading partner who has the import/export license, and perhaps also through an interpreter. You are thus effectively denied the opportunity to learn from your unfortunate experience. (We have gradually come to accept that often there is nothing to be learned – the fees are arbitrary.) It is pointless to be stubborn and hold out until you have a reasonable explanation for the “fees”. There are “storage fees” while you wait. Eventually you have to refocus on your main goal which is to get your goods and build your product.
  • Holiday periods. All government and most of private enterprise stops for a week for the National Holiday at the beginning of October, and for another week at the Chinese New Year, usually in February or late January. Moving product through customs before and after these weeks is also difficult because of the compression of anticipation and recovery. The Chinese New Year week is especially problematic for getting shipments through Customs smoothly. It has been suggested to us that this is because Customs agents expect more Hongbao (a red packet containing money) at that time of year. We have learned to avoid shipping anything but essentials through Customs around the Chinese New Year. Chinese New Year occurs during a different week each year, usually in the last half of January or the first half of February but may be as late as early March.
  • CCC mark. Many products coming into China which are not for incorporation into an assembly which will be exported from China are required to bear the CCC mark. (There is elaborate procedure for ensuring that non-CCC products entering the country to be incorporated into assemblies for export actually do leave the country.) The list of products requiring the CCC mark is increased every year. As we have not yet built much equipment to remain in China we have little experience with this issue. We expect it to be quite a challenge with an as yet unknown cost. It would be wise to take a list of the most common items which must be shipped into China and then attempt to assign HS codes (note that the Chinese HS codes are slightly different than US codes) to determine which items will require the CCC mark. Of course one person’s determination of an HS codes does not mean that Customs will agree, but it is a start. This can be done online.

A series of examples will further illustrate:

  • Treated wooden crates. It is a requirement that the wood which comprises a crate entering China must be certified as treated by acceptable methods and bear and IPPC marking to ensure that it does not harbor an infestation of insects. However a Customs official may challenge the IPPC markings as fake and require fumigation. This happens unexpectedly from time to time. There is a delay, and a “fee”.
  • Temporary import for testing. On one particular project several years ago we produced a control cabinet in Hong Kong for delivery in Hong Kong but it was needed for a couple of weeks across the border in Shenzhen as a part of a system test. After working with our logistics company for quite some time we realized that there was no legal mechanism for taking our control cabinet into China the purpose of taking it back out again two weeks later, without misrepresenting the facts of the situation. Our logistics company presented a number of “workarounds”, all of which involved lying in one way or another. Finally we asked our client for help. Our client’s logistics company did get the cabinet into and back out of China. We later learned that their logistics company used one of those “workarounds” that we had been unwilling to use. It was called “buying part of a shipper’s quota” and was explained as “paying to put our cabinet in the middle of a big truck with a lot of other things which were sure to sail through customs.”
  • Commodity inspections. There are several products that we ship into and out of China often enough that we should know what to expect. Often things go smoothly. Sometimes however we are told that there will be a “commodity inspection” without regard for the fact that products with our particular HS code should not require a commodity inspection. We may be requested to produce documentation and a unit which we are told will be tested and may perhaps be destroyed in the process. (That could be a problem because usually our quantities are relatively low and there are no extra units, however so far, nothing has actually been destroyed.) We wonder, “Why this time? What are they testing? What will cause us to pass or fail the test?” There are no answers to these questions. We pay the fees and the product promptly passes the “test”. Typically this is a three working day delay to obtain the Commodity Inspection & Quantity (CIQ) but it can also be as long as five working days.
  • The right wrong HS code. Customs may declare that we have used the wrong HS code. It may be obvious that Customs is dead wrong but there is no path for appeal. For example, consider a low voltage LED (a.k.a. light emitting diode) mounted on circuit board to which we assigned the proper HS code for low voltage LED lighting fixtures. It was returned by Customs saying that it is not a diode, but rather our product falls under the HS code for high voltage light fixtures such as a HID street lights. Under this code our product was required to be submitted for a commodity inspection, incurring a delay. The most expedient solution: change to the wrong HS code, pay the fee, and incur the delay.In another case we went to considerable effort to justify that we had actually filed under the proper HS code. Our trading partner wrote:

    Dear [Birket], [Freight forwarder] could use your nominated HS code for custom clearance, but we cannot promise whether custom will re-check the cargo. As you know, no one could control the action of custom, and if custom still believe this is wrong HS code, they will hold the cargo again. Thanks for your understanding in advance.

    That is to say, we were politely told by the expert to quit trying to use the proper HS code and just do as we are told so that we can get our product through Customs.

  • The wrong kind of help. None less than FedEx recommended that we revise our choice of an HS code to that of a porcelain sink in the belief this would help expedite the export of our lighting fixtures that had been detained by Customs, explaining that HS codes for lighting fixtures are “not good right now”. In this case we were successful at explaining to FedEx that there really is a difference between a porcelain sink and a lighting fixture. We also removed the freight from their care, sending it to another freight forwarder to handle.
  • Used clothing. We design and produce within China the LED lighting components which go into a particular type of illuminated costume – lots of them. Installation of these components into the costumes is time-consuming and appeared to be an excellent candidate for execution within China. Unfortunately “used clothing” is prohibited for import into China. The first batch of parade costumes were crated and shipped to China but held in Customs because of the problem of distinguishing them from used clothing – pay no attention to all those LEDs wired into the costumes. After paying a “fee” and receiving no real answers we finally gave up. The best explanation that we got was that “no Customs employee is going to risk his career on declaring that our costumes are not used clothing.” How about “theatrical props?” “No, they are used clothing.” We have since performed thousands of hours of costume assembly work in Florida at a far greater expense to our client because of this problem.Why do you suppose that in this case it was so important to be right when so many of Customs’ other decisions are obviously wrong and arbitrary? It has been suggested that the answer may be that we are caught in an area of international trade tension. In other words, the US is hassling China over certain type of import so China reciprocates, and we get caught in it.

    In this case, we could have continued paying the “fee” but considering the considerable value of these costumes we didn’t want to risk running afoul of the system and completely lose the costumes, so we moved the work to Florida.

  • All for VAT avoidance. Without informing us, a previously trustworthy vendor decided that since the product that they were to assemble for us is intended for export, they could avoid paying the VAT on some of the components by purchasing those components in Hong Kong and importing them into China for export in our assembly. (Note that this is a clear indication that it is not as simple to recover the VAT as it should be – something we discuss elsewhere in this paper.) In this regard, our vendor’s action was neither illegal nor entirely irresponsible. They were probably within their rights to exercise this cost-saving move. Unfortunately our vendor completed the paperwork incorrectly causing these goods (which were anxiously awaited for incorporation into our assembly) to be held in Customs for a week, impacting our delivery schedule. The only good news was that in this case it was our vendor who was solely responsible for paying the “fee” necessary to get the goods out of Customs.
  • Piggybacking. We learned that our vendor’s trading partner has another client who had not properly prepared their paperwork to import their components into China. Our paperwork was in order so this trading partner decided to slip their other client’s goods through with our shipment. Customs found problems with the piggybacked product, causing our products to be held in Customs until the unrelated problem could be resolved. We only found out about this because we demanded to see the paperwork and realized that it had been altered.
  • A new trading partner. In one of our most difficult and unfortunate experiences thus far, a trusted vendor with whom we had a significant history of successful projects, was forced to change their import/export trading partner. We’re told that the original trading partner who had served us so well had been caught engaging in “corrupt practices” and was shut down. This made it necessary for our vendor to contract with a new trade partner. Our vendor chose a trading partner which is partly owned by the government hoping that this would avoid a repeat of losing the trading partner due to corruption. However this new trading partner cannot seem to do anything right.
  • For lack of an import license. (This was our first major logistics disaster – it occurred a few years ago. As a result of this experience we no longer trust our vendors with import and export activities. We first ensure that our vendors have the proper license or trading partners, and we review their paperwork ourselves.) One of our vendors, more accustomed to exporting than importing, did not realize that either an import license or a trading partner was required to bring our components into China for assembly in their factory. Thus upon arrival in China, our component goods were held by Customs. After coming to terms with the magnitude of the problem, we took the matter out of the hands of our vendor and hired a US freight forwarder with an office in China to handle the problem. First, they hired a Chinese lawyer to argue that the goods were mistakenly shipped to Shanghai but should really have gone to Hong Kong. When the goods arrived in Hong Kong, the freight forwarder opened our crate, repacked all of our goods into personal travel bags, hired a bunch of locals and a drove several vans across the border where our components were reassembled into a new crates and shipped on to Shanghai. It was only after delivery that we learned what had been done. All of this was orchestrated by the vice president of the freight forwarding company who flew from the US to China to personally manage the situation for us. You can imagine what all of this cost, but this was the only way to meet our deadline.

These are just a few examples. There are many others. We slowly learn new ways of avoiding problems but we can never hope to avoid all the problems because it is all so arbitrary. The details of the problems change constantly but the theme is always the same: something unexpected is wrong and it can only be fixed for a fee. There will be a delay, but fortunately the delay is usually not much longer than it takes to arrange payment of the fee.

You might wonder, have we suffered all this grief at the hands of one particular trading company or freight forwarder? No, we have worked with numerous companies, some of whom are contracted to us and some of whom are contracted to our vendor. The theme is the same regardless. Chinese vendors suffer from these problems just as much as we do as an American company. Keep in mind that this is a 90/10 thing. 90% of the shipments go through customs without a problem but the other 10% are responsible for 90% of the effort, delays, and “fees”. Mostly, it is the unpredictability that is the problem. There may be five shipments associated with a particular project but there’s a 50-50 chance that one of those shipments will become a problem and impact our ability to deliver the whole project on schedule. The only solution is to build contingency time into the schedule.

In our experience of producing control system equipment and lighting products in China, we have learned that on average we can readily procure in China about 80% of the component line items on a bill of materials. The remainder must be purchased outside of China for one of three reasons: (1) the items are simply not available for purchase in China, (2) the lead-times from the Chinese suppliers are unacceptable, or (3) the item is unreasonably expensive when purchased from Chinese suppliers. It is this 20% of the components which must be brought in from outside of China which cause the overwhelming majority of the schedule delays and unbudgeted costs, because they must pass through Customs. For these goods which come in from outside of China, the following costs can be anticipated:

  • duties of 2% to 25% of the value of this 20% to 40% of the dollar value of the goods.
  • trade agency fees of about 5% of this 20% to 40% of the dollar value of the goods
  • the occasional “fees” which are not usually large now that we have learned how to avoid most of the really big problems.

In an effort to gain better control over these issues we will obtain an import-export license and hire a very experienced Chinese logistics person to work directly for us, putting as many as possible of these variables under our control.

Meanwhile another solution that we use is to work with multiple trade partners so as to identify the ones which are most effective. There must always be a contingency plan when working in China.

Taxes

  • VAT. China has a 17% VAT. It is administered in a way that is quite different than Americans expect. Of course the intent is that the entire tax be passed on to the end-user but because of the method of administering the tax, this is not assured. There is a fair chance that we may unexpectedly have to bear the burden of part of this tax. This is significant because this one unpredictable element alone has the capacity to wipe out about half of the budgeted profit on a project.So why may the VAT be so problematic? First, let’s compare China’s VAT with the similar taxes in other countries as a way of illustrating the problem. In the US, we have state sales taxes with an affect somewhat similar to the VAT. Although laws vary from state to state, in general a business is excused from paying the sales tax on goods which are for incorporation into a product which is to be re-sold (the “reseller exemption”). That same business does not collect this tax if selling to another reseller. The tax is only collected from the end-user. That is the intent of both the US sales tax and a VAT because if these taxes compounded at every level of “value-added” they would be astronomical in the end.

    Singapore’s VAT is called a Goods and Services Tax (GST). When a business purchases goods which are for incorporation into a product which is resold, the GST IS paid (it is called input tax), but this expense is recovered from the GST charged to the next recipient of the goods (called the output tax), with the difference (input tax spent minus output tax collected) being remitted to the government. So again, it is only the end-user who actually pays the tax, because the end-user alone is unable to collect any tax from which to deduct the taxes paid. The Singapore method of implementing a VAT introduces a cash flow problem for businesses. If a large project spans a tax reporting period, the business may be out-of-pocket an important amount of money because the GST paid during that reporting period may exceed the amount collected in that period. It becomes necessary to wait until the next reporting period to recover the tax on goods for incorporation into the product for resale. The government gets its money first, even if that money really just constitutes a short-term loan to the government from the business. In the end however, all VAT taxes paid are recovered by the business, so that other than the possible carrying costs, there is no real VAT cost included in the product which is passed on to the next reseller. The system works reliably as long as the business devotes adequate energy to administering the process.

    Note the differences between the US and Singapore systems. The US system places the latest burden on businesses by relying more upon trust. The Singapore system is more tightly managed by the government but places a higher burden on the businesses. At least in Singapore, if the business tends to the details accept the impact to cash flow, the business can be assured of passing on the entire cost of the tax. The Chinese system is another big step in this direction, placing an even bigger burden on the business. The problem in China however is that diligence and attention to detail does not guarantee that the entire tax can be passed along. Enter that element of uncertainty again. It is difficult to reliably predict how much of the tax will fall to the business.

    In China, as with Singapore, the input tax is always paid on materials to be incorporated into a product for resale. Again the intent is that the tax paid on goods which are to be incorporated into a product for resale be taken as a credit against future VAT output taxes collected, with only the difference between the two being remitted to the government. However the process of taking the credit is convoluted and there is no guarantee, or even any dependable way to predict, if indeed the VAT taxes paid can be recovered. It appears that the method that China uses to enforce payment of the VAT was optimized for a different type of business activity than ours. The procedure goes like this: When making a purchase it is necessary to get an official receipt, a 发票 “fapiao”. This receipt may be in the form of a coupon purchased by the seller from the government to give to the buyer. It may be printed from a machine in a way not unlike we print postage from a postage meter. The fapiao proves that the government got its money, so it is this fapiao which businesses must use to substantiate the input tax paid when deducting from the output tax collected before remitting the difference to the government. That means that the fapiao is handled much like money – kept in a safe with other money until it can be used. If it is lost, money is gone. There is no other way to prove that the tax was paid.

    Two problems are that (1) a fapiao expires in three months and (2) it can only applied to claim from VAT receipts which are in the same category as the fapiao. Frequently on our type of projects we must expect that our fapiao will expire before we can use them, and we may have difficulty matching categories because of the unusual nature of our work – we don’t know yet. There are two possible solutions to this. One is to sell our fapiao at a discount to another business that is in a position to use them immediately. Another solution is to pay the seller to delay issuing the fapiao, despite having already paid for the goods and the input tax. Chinese business owners report that extraordinary effort goes into the activities of bartering and managing the timing of the collection and claiming of the fapiao in order not to lose the ability to claim the VAT expense against VAT collected. We are led to believe that our circumstances may be particularly challenging in this regard. We can expect to either sell our fapiao at a discount or to watch them expire. Given that material costs are such a large line item, this fapiao problem alone is capable of erasing a significant part of material markups or project profit. Since budgeted profit too often becomes the contingency used to deal with other problems on a project, the fapiao problem has the potential to put a project into the red unless we can learn to anticipate the cost and budgeted into the project.

  • Profits tax. The good news with profits tax of course is that if you are paying it, you had a profit! Thus a profits tax is less sinister than the unrecoverable VAT problem. Still however, the Chinese profits tax is considerably higher than the profits tax in Hong Kong and Singapore. This creates an incentive to do outside of China any work that can be done outside of China. Administration of the profits tax is also more difficult in China. As our Hong Kong tax accountants explained it to us, “China has been taking its lessons from the US IRS, not the Hong Kong IRD or the Singapore IRAS”. Thus, any business capable of operating outside of China and the US will want to do so. For example, we may wish to provide our design services under a separate contract to our Hong Kong Corporation.

    Short story: When we came to China in 2004 as a complete stranger to the land we knew that we needed a Chinese partner. We could not have found a better partner. He was a Taiwanese businessman who had been extraordinarily successful selling an enormous amount of product in the United States, developing several factories in China in the process. He had retired in Orlando but was anxious to get back to work in China – this time as a developer of theme parks, hence his interest in teaming with us. Over a period of about three years he became our friend and mentor in China. Together we met with an endless succession of businesses, factories, and government officials in pursuit of business opportunities. All along the way he was constantly teaching. Our time together culminated in the signing of a deal to develop a theme park in the center of China’s sixth-largest city, only to watch the deal fall apart for some interesting reasons. Our partnership disintegrated and the friendship was lost principally over one point: he genuinely believed that it was proper, his right and obligation, to cheat on our tax obligation. (In deference to him I must relate that he was adamant that he was not “cheating”. Nonetheless what he was doing was in direct conflict with the law.) After buying him out of our partnership we contracted with a major accounting firm and begin to learn how to conduct business by the rules, including a re-audit of our past business activities. We came to realize that what we had learned from our partner related to taxes and accounting were the widely accepted methods of working around the system and that he did not really know much about real accounting and tax law. Nevertheless, the lessons learned from him, a wide variety of lessons, were invaluable. It is noteworthy that his extensive business operations in China were conducted in complete harmony with a broad network of other businesses and government officials – in other words, things go smoothly when cheating on taxes because it is the norm. That is not an approach that an American businessman is likely to adopt.

    As a general rule it is best to conduct business through a corporation incorporated in the country where the work is actually performed so as to avoid the very messy and potentially costly problem of one country’s tax authority attempting to reach across a border to tax activities performed by a corporation in a second country because that corporation performed those activities in the first country. This is not a cost-of-goods sold risk, rather it is an administration and tax risk, but nevertheless something of which we should all be mindful when contracting work. It will be desirable, almost necessary, to split up contracts into “work executed in China” and “work executed in Hong Kong” or elsewhere so that the work can be performed by our corporation in the country where the work is executed.

Currency

Currency fluctuations. Continued appreciation of the RMB seems likely. If for example we are contracted in Hong Kong dollars or US dollars, but the RMB has appreciated by the time we are in a position to make a required purchase in RMB, this would injure us. Thus to the extent that purchases must be made in RMB, we will want RMB payment terms to avoid the cost and complexity of hedging. Much of this problem can be solved by contracting with our corporation in the country where the activities and expenses will occur, and contracting in the local currency. For example, we might contract design work through our Hong Kong Corporation but contract fabrication and installation work through our PRC Corporation.

Limitations on cross-border transactions. A lengthy approval process is required to move money in or out of China. If for example a business such as ours is more liquid outside of China, and cash is needed within China, it will not be possible to move that money into China quickly. We will require payment terms which ensure that we do not get into a position of costs in excess of our billings.

Approvals

Having delivered relatively little for consumption in China we have limited meaningful experience with compliance issues. We expect that there will be both local and national agencies with jurisdiction. We have one of each experience that is worth relating:

CSEI approval of a roller coaster in Beijing. We are under contract to a US roller coaster manufacturer to provide the software for fairly sophisticated high-energy coasters in four Chinese cities. So far we have only witnessed the CSEI approval process from the sidelines. The CSEI has expressed no interest whatsoever in the control system or software. Their only requirement related to the control system has been to require that the ride run for a period of days without generating any faults. We are of course in complete control of what faults the software reports. They have inquired about the faults that are reported. They have not asked for or seen any of the software development documents. It’s evident that we could choose to suppress the reporting of faults in order to pass the requirement of operation with no faults. The only “test” they performed was to press an E-Stop button to make sure that it stopped the ride – the least and most obvious of the myriad of the safety control system’s functions. On the other hand, our client reports that the CSEI has been quite involved with mechanical and particularly structural issues, although we are told that some of their concerns have been arbitrary and misdirected. There was a meeting prior to construction when our client was required to present structural, mechanical, and electrical power distribution documents to the CSEI for approval. There were no submittals required related to the control system.

We do not believe that much can be read into these observations. It could all change quickly. As is the case in all jurisdictions, it is undoubtedly wise to be proactive with the authority, if necessary teaching them what they should be looking at, and leading them through it to make them comfortable with it. We believe that we should anticipate that their level of oversight will increase.

Projection screens at the Shanghai Expo. You may have heard about this issue as it received some international press and was quite an expensive problem. There is an acoustically transparent material from which large high-gain projection screens are made. The particular material at issue has been used repeatedly around the world, including in several previous installations in China. Local authorities routinely require that the material pass a flame test, and this material has repeatedly passed that test, in China and elsewhere. For some reason, the piece of the product that was cut from two Expo theaters did not pass the flame test. As a consequence, the local authority required the installation of a very expensive deluge system at a time when schedule and access made such an installation impractical. All of those involved were convinced that the test results were in error. The US contractor with the most to lose asked if we had any ideas, if we could help to resolve the problem. I put the question to the engineer/manager of our Shanghai office. Her first (joking?) reaction was that this was probably an ornery inspector “waiting for an attractive young woman with a fistful of 100 Renminbi bills.” I then showed her a copy of the test results, all written in Chinese, of course. She quickly reported, “There is a real problem, and nothing can be done about it.” We got into quite a heated discussion. I repeatedly explained that there is always something that can be done. I asserted that we should ask about the test criteria, the test conditions, and we should challenge the validity of the test. I suggested that an expert be hired to challenge the results. We certainly don’t begin by accepting defeat. She kept pointing to the words at the top of the page. She said “this report is generated by the China National Testing Laboratory. That means that there is no method of recourse and there is no expert who will challenge the report.” I went on with my arguments and she made some phone calls to humor me but in the end no progress was made. We heard that Secretary of State Clinton attempted to intervene (because the timely opening of the US pavilion was at risk) with no success.

If there is a lesson here for us it is that Chinese in China do not see any point whatsoever in challenging anything decided by an arm of their government, except perhaps by exercising any available close personal relationships with government officials.

Quality and Efficiency

These are some issues about which an American operating in China must be ever-vigilant:

  • Perhaps because affordable labor has historically been abundant, China has not developed the “do it right the first time” mentality to the extent that we have in the United States where multiple “fix it” operations are intolerably expensive.
  • Perhaps because our Chinese coworkers, and the staff in the companies with whom we contract, are accustomed to getting so much more out of a dollar in their daily lives, they naturally make decisions in their professional lives intended to conserve expenditure of relatively small amounts of money in favor of larger expenditures of labor. Sometimes however, the labor that they are expending is that of their American counterparts who place a much higher value on an hour of time.
  • The Chinese are naturally inclined, quite innocently, to interpret a specification and a bill of material in ways that allow them to purchase less expensive parts, as much to save us money as to save them money. We might do the same thing but they will do in a much more cavalier fashion.

    Examples: A vendor proudly explained to us that they had saved us money by eliminating all of the nuts and washers, using self tapping screws instead. In some cases that might actually be okay, but of course they need to ask first. In another case, anxious to meet a deadline, a blue indicator light was substituted for an amber indicator – what possible difference could there be any way? In this case however another person followed our “double confirm” rule and brought it to the attention of the proper person. Of course it would also have been caught in a final inspection.

  • Knockoffs are a concern although not a major problem, partly because only a few of the items we purchase are knocked-off. For those which are, by insisting upon purchasing through proper distribution we are able to reliably obtain authentic parts. We also choose to provide such items as wires with UL listings from reliable vendors who export to North America and Europe. We have established these supplier relationships so that we can direct our assembly vendors where to buy and how to negotiate price.
  • Every American working in Asia has experienced that, after making a careful explanation to an Asian colleague, and then asking “do you understand?” the answer is always “yes”. This is perhaps intended as much to save the American the embarrassment of realizing his or her failure to explain effectively, as it is to save the Chinese colleague the embarrassment of admitting the failure to comprehend. Either way it is necessary to ask different types of questions to get the real answer. Yes or no questions are to be avoided. Even better is to find and surround yourself with those unique Chinese personalities who enjoy telling you when you have made a mistake! They are to be treasured, and well paid.

All of these issues can be addressed with diligence.

We should remember that over the last 30 years China has optimized itself for delivering commodity products in large volume. As we all know, it seems as though everything consumed in America is made in China. In general we are not having a problem with the quality of our commodities from China. Therefore it is unmistakably true that China is completely capable of delivering the quality we expect if that expectation is properly communicated and the results are inspected.

What we do not appreciate is the magnitude of the initial effort that went into setting up those assembly lines and the extent of the quality monitoring programs that were developed to keep quality product coming off of those assembly lines. That initial cost and effort is justified by the volume. The problem with everything that we have done and will do in China is that the quantities are small, often a quantity of one. Thus the cost of the effort to attain quality is a significant part of the cost of the goods and services we deliver from China.

Bottom Line: It is necessary to provide more staff than would normally be necessary to teach, coach, and continuously inspect and monitor progress. Do not ever assume that previous successes will be repeated when nobody’s watching. This is a never ending challenge that comes at a cost which significantly erases the much-anticipated China cost advantage.

General

Doing business in America we generally accept that we can reliably conduct our affairs, especially our business affairs, within a framework of laws, rules, procedures and customs all of which are comparatively stable and clearly-defined – able to be learned and applied repeatedly with the same results each time. We also accept our right to appeal decisions and even to question problematic laws and rules.

To be certain, there are plenty of laws and rules within China, but there is an important difference. We’ve heard it described as “in China, rather than the rule of law, there is rule by law.” The subtle difference is that the end justifies the means. Rather than attempting to apply an immutable law to circumstances to determine the proper outcome, those who are in a position to assert themselves (public and private) establish their goals and then apply the rules as necessary to attain those goals. There is usually no clear path of appeal and it is often difficult to get the rules in writing.

We note the evolution of our own expectations over the years of learning to do business in China. In the beginning, we viewed our disappointments (failures?) as opportunities to learn and improve. Every problem is an opportunity, often just an opportunity to learn how to do better. We believed that by learning the new rules of the game, then developing new procedures and methods to operate according to those rules, we could obtain the desired results. To a degree this has worked, but we gradually have come to understand that there is a different dynamic in operation in China. Many of the rules are unwritten, deliberately un-learnable, and too frequently changing – at least the explanation of the application of the rules is always changing. Further, our Chinese business associates, those with whom we must cooperate to meet our objectives, do not always operate by the rules. The unpredictability of the application of the rules creates an environment within which avoiding and circumventing the rules becomes a sport. If you don’t play, you lose. To an unsettling degree, business is conducted in spite of the rules, by constantly maneuvering through and around the rules.

To attempt to rigidly operate by rules (or to even to attempt to fully discern the rules) is to deny oneself the full utility of those who are most able to help achieve the goals. All of this is confounding for an American attempting to do business in China until he or she learns, within the limits of what is ethical and legal, to accept and embrace the process.

When bidding work, a China-based vendor such as Birket is simply unable to budget project costs with the U.S. accustomed accuracy. The familiar dilemma – guessing low and losing money versus guessing high and completely losing the opportunity to earn money – is magnified in China. In the US, the approach to the dilemma is to make the best possible guess about costs and then add an amount for “insurance” hoping that over time the sum of these little insurance premiums are enough to cover the total incidences of guessing low. The size of the insurance premium must be a function of (1) the amount of money at risk and (2) the degree of uncertainty involved. (Admittedly the process is often more subjective than analytical, but it occurs nonetheless.) In China, both factors related to the unknowns (value and risk) are larger than in the United States, Hong Kong and Singapore, thus the “insurance premium” that is built into the cost proposal must be larger.

The building of lasting personal relationships is always key in business, but more so in China. It is important to devote time to the building of these relationships – many long meals in noisy smoke-filled rooms with plenty of 白酒 to drink.

Lessons learned doing business in Hong Kong and Taiwan are useful but not entirely applicable in the PRC. Lessons learned in Singapore are less helpful. Only a very few of the lessons learned in Japan are applicable in China. It’s important to note that the Chinese economy has evolved rapidly and recently, thus it is to be expected that the Chinese are most tied to thought processes learned in an earlier era which was dramatically different from those thought processes which are familiar to Americans.

Example: There is a small street that we walk each day from our office in Shanghai to our apartment. We have always called it “Crazy Lane” because it was such a ram-shackled mess. The city decided to redevelop this lane about a year and a half ago. First the businesses and residents were gradually relocated. Buildings began to come down, in no particular order. One would be partially demolished and then left while another was partially demolished. Then disconnected parts of a new sidewalk, curbs, and road would be built between partially demolished areas. All the while we and the hordes of people would continue walking through the evolving mess. Gradually, finally, order began to reemerge, and we could see the designer’s intent, or so we thought. The road was irregular in width, and oddly routed, and the sidewalks were wider than the road. Surely there must be a reason for this, we thought. Then, up came the new sidewalks. The curbs were jack-hammered out. New forms were put in for the curbs, then removed and relocated again. Eventually new sidewalks were put on top of what had been the new road. The road was straightened and routed through areas that had previously been the new sidewalks with telephone poles and a tree. I watched cement being poured around the base of that large tree and the telephone poles – yes, the road was routed through the tree and the telephone poles without removing them first. About a week later someone came to cut down the tree. Presumably the telephone poles will be next. Meanwhile, there is a hole in the road where there had been a tree, and three giant telephone poles smack in the middle of a brand new road, encased in cement at their base – all destined to become patched spots in an otherwise new road. Of course there are footprints and tire treads throughout the cement.

Of most concern should be that I found none of this particularly unusual as I watched it unfold over the months. Certainly none of our Chinese staff have thought any of it at all unusual.

Good reading. Of all the books I have read on doing business in China, perhaps the most practical has been “One Billion Customers” by James McGregor. It’s not just about cultivating the Chinese market. It contains a lot of wisdom and examples directly applicable to the work that we all expect to do in China. Another is “Mr. China” by Tom Clissold – older, but many of the lessons are still valid.