Why Importers Must Understand the 5 Types of Supplier In China
The biggest challenge importers face when sourcing from China is selecting the right manufacturer. If you don't understand the type of factory you are buying from you risk paying higher prices, opening yourself up to IP theft, having delays with lead times, receiving defective product, or in the worst case, losing your initial down payment as the factory collapses due to unpaid debt obligations.
The process of selecting a manufacturer is significantly easier if importers have a background in the five categories of supplier that operate in China's manufacturing landscape. As this article will show, by understanding each category importers can identify which supplier is suited to manufacturing their product in terms of price, risk, and quality. What follows are the five types of suppliers.
Small Local Chinese Run Businesses (SCR)
Low Pricing, Low/Medium Grade Product, High Risk, Best Value
100% owned and operated by Chinese, these factories compete by providing a low-cost product. Most SCR factories don’t have strong management systems or quality control procedures in place. Without careful oversight, they’ll cut corners on upkeep, quality control and use substandard input materials to save on production costs.
Stiff competition and lower profit margins mean these factories live hand to mouth. They think in the short term and will often lie about their capabilities, even if it bites them in the long term.
So why bother with SCR factories? Because with careful oversight they can produce products competently and at rock bottom pricing. If you’re in a competitive market – say selling on eBay or Amazon – SCR factories are often the best choice for the pricing needed. Quite simply, few other factory types can match their pricing.
Example (negative): We ordered coffee tables for a client. Pricing was competitive. The factory produced samples, with strict packaging requirements. Samples arrived in good condition and well made. We approved the samples and put together a detailed contract which both parties agreed upon. This took 4 week’s work. We paid the factory on Friday. By Monday they asked for $2 more per table. We told them, “No. This is not possible!” We canceled the order and the factory returned the money.
Why did the factory do this? It's likely they received a large order from a large customer. They agreed to the low pricing at first because their factory was not busy and they wanted production lines to keep running. But once they got a better deal, they reneged. This happens with some SCR factories.
Example (positive): Easy Imex purchases a wooden piece of bedroom furniture for a client. The product is price sensitive. We found a small factory with no export license who sells to larger factories in the town. They produce the product for the USA and European market – but have never worked with direct customers before – only through other factories who subcontract to them. The boss is in his early 30s and has a passion for the product he makes. He strictly and personally manages the workers. He has few systems – so would be unable to scale easily – but he manages this factory tightly. His costs are dirt cheap. No marketing, no expensive management systems.
This boss focusses on making a reliable product. His pricing is exceptionally low as there’s no premium going to other suppliers. His factory is small, but well organized due to his micro-management. The capacity of the factory is the main issue, and a secondary issue is if something happens to the boss. But for the 2 containers per month required by our client, it’s a good fit. We ordered the product and it received very strong reviews from customers (average of 4.6 stars on Amazon USA).
Pros: The cheapest option for sourcing in China. Well suited to products sold on price-sensitive online markets, such as eBay.
Cons: Quality control is often poor. Factories are unreliable and require significant micromanagement to ensure specifications, quality requirements and lead times are met.
Large Chinese Run Businesses (LCR)
Low/Medium Pricing, Low/ High-Grade Product, Low/High Risk
These companies usually began as SCR factories and through shrewd business acumen, good timing and a bit of luck/guanxi/corruption developed into large multi-million dollar organizations. They capitalized on the golden era of manufacturing in China and used powerful connections with local authorities to maintain their home ground advantage.
LCR factories will have good production and quality control systems. Although their management techniques remain Chinese, there is an awareness/understanding of what foreign customers require. LCR businesses typically have English speaking staff and nice looking factory premises to present to foreign customers. These factories have decades' of experience – and have grown large because they service North American or European clients with huge volume.
Example: Whitegoods. If you want fridges or washing machines – there are a handful of companies in China reliable enough to get the job done. They’ve invested hundreds of millions in a plant, and are established and professional. If you went to a small Chinese run factory – you would run the risk of catastrophic failure – with a product which has many components that can go wrong. The large costs in this industry mean that larger factories are the only realistic options. Companies like Midea are examples of successful privately run factories that have grown over the decades into multi-billion dollar behemoths.
Pros: Can produce at a low price point and maintain high-quality standards. They have experience dealing with foreign customers and are familiar with the standards required to produce goods sold into foreign markets. Whether they are a good fit depends on the specific factory and your industry.
Cons: More expensive than SCR factories and will prioritize customers with large order quantities.
Wholly Owned Foreign Enterprises (WOFE)
High Pricing, High-Grade Product, Low Risk
WOFEs are set up so that foreign enterprises can shift manufacturing to China for the cost advantages while maintaining control over intellectual property/trade secrets and production quality. WOFEs are typically higher cost, but well developed with strong systems and procedures from overseas management.
Often you won’t be able to buy from a WOFE as they make exclusively for their parent company. If you do source from WOFEs, you can expect to pay similar prices to back home.
Pros: Similar production quality as back home.
Cons: Cost advantages only arise from scale. There are no cost savings unless order quantities are huge. Often exclusively manufacture for a parent company.
Foreign Direct Invested Enterprises (FDI)
Medium Pricing, Medium/High Grade Product, Low Risk
Foreign Direct Invested Enterprises are factories that have investments from overseas. FDI enterprises are often cheaper than WOFEs while maintaining advanced levels of quantity control. Their mentality towards production, management and quality control is similar to the standards of their home country and attitude towards service is also more in line with Western standards.
There are two notable subcategories under the FDI section – Hong Kong FDIs and Taiwan FDIs. Both leveraged their historical ties with the PRC along with their geographic proximity to move manufacturing to the mainland.
Example: Easy Imex required a high-quality office furniture product made of metal. The client’s existing product was locally produced and sold at a premium price. It also came with a 5-year warranty. Quite simply, the manufacturing needed to be impeccable for this type of product.
Ultimately we sourced a Taiwanese invested, owned and managed supplier – with factory based in Shanghai. The factory was compact, organized and had attractive pricing due to their efficiency and scale. The factory had moved from Taiwan to Shanghai in the early 1990s. But it had over 40 years manufacturing experience. They made a product no other factory in China could match, due to the special knowledge and expertise in this area.
We were able to get our client an OK price, but an outstanding product. The price was approximately 15% higher than other Chinese local suppliers. But the build and paint quality was outstanding and came with a 10-year warranty. From more than 6,000 units ordered the feedback was they had one defect. Which is exceptional!
Pros: Will consistently produce excellent quality. They are reliable and easy to deal with.
Cons: Significantly more expensive than Chinese run organisations. Only produce for customers with large order quantities.
State Owned Enterprises (SOE)
Variable Pricing, Variable Quality, High Risk
State Owned Enterprises are companies owned and controlled by the local or central government. China’s reform and opening up period has seen SOEs disappear from many sectors of the economy. However, they remain powerful in areas that are strategically important to the government.
Without proper market incentives, SOEs operate differently from other manufacturers. Incentives can be perverse and the requirements of the customer can take a back seat to objectives of government officials.
SOE’s operate in every field; machinery, automotive, constructions, metals, shipbuilding, shipping, aviation, telecoms, banks, oil production etc.
Easy Imex rarely deals with these large entities because they don’t suit our client profile. 42% of SOE’s made a loss in 2013. Nonetheless for large industrial equipment, steel, shipbuilding etc. SOEs are sometimes the only option.
Example: Easy Imex had a client involved in shipbuilding and wind turbine production. They required steel and port equipment. The only options were large state-funded entities. In the end, the client didn’t purchase for a variety of reasons. But the point was there were no other entities on this scale privately owned. The SOE’s visited tended to produce a low-quality product at a very low price, which didn’t suit the client’s requirements.
Pros: With certain products, they are your only choice of manufacturer in China.
Cons: Operate under perverse non-market incentives. Expect delays and poor quality.
This article has demonstrated that the landscape of suppliers in China is complex and inconsistent. Many importers have lost money, time and business as a result of selecting the wrong manufacturer. If you are looking to manufacture in China, expect to spend anywhere up to a month sourcing the right supplier. It's also worthwhile doing a thorough background check before entering into any contract with a Chinese factory.