Coronavirus: Alarms & Opportunity for China Sourcing; Wuhan aftermath!

Coronavirus: Alarms & Opportunity for China Sourcing; Wuhan aftermath!

The Coronavirus appears to have slowed down significantly with factories and the manufacturing infrastructure coming back online. Cautious optimism post Coronavirus.

In today’s blog post, I’d like to look at the Coronavirus in terms of its impact specifically on the China sourcing industry.  For example, if you are importing products that are made in China, you probably want to know:

  • What is really happening in China at the factory level right now?
  • What issues that aren’t making the headlines could impact my bottom line?
  • What lessons can I learn from this mess so that my supply chain is left stronger and better off when the dust settles?

What does Mike know?

Before we dive into the issue, perhaps I should explain a bit about my perspective on China business as well as my experience with outbreaks in China.

Like they say at Farmers Insurance- “we know a thing or two, because we’ve seen a thing or two.”

I spent more than 20 years living in China full-time and was on the ground during the entire SARS scare. I currently have investments in multiple China-based companies ranging from manufacturing to consulting.  While my immediate family and I were lucky enough to be outside of China when the Coronavirus (COVID-19) hit, we are communicating daily with friends, family members and employees who are on the ground.

Why write a blog post on the Coronavirus today?

At time of writing (2/17/2020):

  • People are still dying but the spread of the virus appears to have slowed down significantly.
  • The week-long extension (on top of the usual 2-week national holiday for Chinese New Year) ended a few days ago.
  • Factories and the manufacturing infrastructure (banking, logistics, inspections…) are coming back online (that good!) but the situation is far from stable and in some cases- very unstable.

So today feels like an excellent time to write a blog post that would help readers get up to speed on what it happening in the China sourcing industry today and take a look at where it is likely to go tomorrow.

Coronavirus:  It could have been a lot worse for the factories

With so many people traveling for Chinese New Year, it was just about the worst time to have a viral outbreak in terms of containment.  It’s hard to talk about a silver lining when so many people are suffering in China, but if you are a professional importer or manufacturer, you were already planned for a production shut down. Adding another week or two is not that big of a deal in the big picture.  Image how much of a mess it would be if the factories had to close suddenly in the middle of the late Summer during the Christmas production rush!

Things that worry me

Besides the obvious concern that infections will spike if the virus isn’t fully contained, when I look at my China supply chain, I worry about how the factories will leverage Force Majeure.

Force Majeure refers to a clause found in a contract to remove liability for natural and unavoidable catastrophes that interrupt the expected course of events and restrict participants from fulfilling obligations. In other words, it’s a legal tool that Chinese suppliers can use get out from under the terms of your contract.

In the US, for example, the scope of force majeure is generally limited to very large events like wars and “acts of God” such as natural disaster. As such, it is very rarely invoked.   Even before the Coronavirus came on the scene, Chinese businesspeople were more liberal in the scope of what they consider to be “beyond their control” and subject to force majeure. Here are the two most common examples:

Even before the Coronavirus came on the scene, Chinese businesspeople were more liberal in the scope of what they consider to be “beyond their control” and subject to force majeure.
  1. Changes to government policy.
    When Beijing changes the tax code, environmental law or export quota, it has an impact on the Chinese factory’s bottom line. I have had suppliers try to invoke force majeure to nullify certain key terms in the contract and thus attempt to renegotiate a more favorable arrangement.
  2. Changes in the supply chain.
    If your supplier’s sub supplier goes out of business and forces your supplier to find new sub-suppliers at a higher cost, do you think Force Majeure is applicable?  Some Chinese do!

I’m fully expecting Chinese suppliers to claim Force Majeure, as the Coronavirus is giving them a “get out of jail free card” for unilateral changes in price, quality and lead time.  I’m also expecting the Chinese courts to share that same opinion!

You might be saying to yourself, “no problem, I don’t even have a force majeure clause in my contracts with suppliers”.

Sorry, wish it was that simple.

Even if the Force Majeure term is removed from the contract, given that Beijing has put containment of the corona virus as top priority,  Chinese courts will almost certainly interpret the concept of Force Majeure as being built into the Chinese legal system itself and applicable whether a Force Majeure clause is found in the specific contract or not.

The good news is that as the Coronavirus gets under control, the supplier’s ability to “play the force majeure card” will diminish.  But in the meantime, the techniques explained in the following section will offer some protection.

Protecting your interests in a post-Coronavirus China

In my book, blogs and this video tutorial I debunk the myth that “relationship is everything” when it comes to managing Chinese suppliers.  I believe that it is important to have a balance of relationship, contracts and monitoring.  It’s like a 3-legged stool, if one of the legs is missing or off balance, the whole thing collapses.

Protecting your interests during the time of the Coronavirus. I believe that it is important to have a balance of relationship, contracts and monitoring.

But thanks to Wuhan virus and Force Majeure, we can’t count on the “contract” portion of our supplier management framework to protect us over the next few orders as we wait for the day that the current outbreak is no longer an issue.

What to do if you suddenly find yourself without the ability to fully leverage your contracts to enforce terms for price, quality and lead time?

Short answer: Go all in on Relationship and Monitoring for the short term.

Answer explained in detail:

Have a contract

It’s still worth having a bilingual contract even if this force majeure situation weakens it. At the very least, a contract sets the tone of the relationship, states the goals and shows the China side that you are both professional and serious.  Skipping the contract is a great way to lose a lot of money, IMHO.

But don’t take my word for it, just visit www.SupplierBlacklist.com and note that the vast majority of buyers who had a falling out with their suppliers didn’t even have a contract, let alone a bilingual contract. The sad part is that it is not expensive to retain a China lawyer.

Here is an excerpt from an interview I did with Smart Company magazine:

While the Chinese can be hard negotiators and the cost of frequent visits to China is not insignificant for start-ups, Bellamy says putting the effort in to build strong relationships is worth every cent. 

“It’s important to be seen as a person rather than as a purchase order number. You don’t need to come here every week to build a bond of trust” Bellamy says.

Bellamy adds that inviting factory leaders out to your home town, sending Christmas cards and encouraging your kids to be pen pals are all great strategies for developing strong ongoing relationships. And those items don’t cost much.

In the past week, there has been a thaw in China-Japan relations because the Japanese government sent loads of medical masks to China.  This was a great PR as well as the humanitarian thing to do.

Take a cue from the Japanese as perhaps the Coronavirus can be an opportunity for you to build a better relationship with your Chinese suppliers as well.

Take a cue from the Japanese as perhaps the Coronavirus can be an opportunity for you to build a better relationship with your Chinese suppliers as well.
  • Have you asked your supplier how they are doing, or do just beat them up for being late with the order?
  • Masks and Hand Sanitizers are in short supply in China. Have you offered to buy some back home and ship them to China?
  • Show the suppliers the light at the end of the tunnel. Now is an excellent time to share your long-term forecasts and mentioned the orders you are ready to place if the supplier can find a way to stay the course in terms of the price, quality and lead times that were agreed before the outbreak.
  • Get eyes at the factory! I’m not saying you should fly yourself to China anytime soon, but now that the cities are no longer on full lockdown, it’s possible to get inspection agents and other buyer representatives into the production zones to see things first hand.
  • Even before the virus outbreak, Chinese suppliers were reluctant to share bad news or even ask for help because they fear the buyer will switch suppliers. Make extra effort to explain to your Chinese partners that you are “in this together” and that the more transparency they offer you into what is really going on, the better you can work to keep the global supply chain flowing for mutual advantage.  Let the suppliers know you have invested a lot of time and money in vetting them on to your approved vendor list and you don’t casually drop vendors.

Things that made me mad this week

I’ll try to keep this list short but here we go:

  1. Factory owners in China (especially non-Chinese factory owners!) continue to get squeezed
    1. A few weeks ago, the central authorities in Beijing basically told everybody to “take an extra week of holiday” and “your employer will pay for it.” Not such a big deal if these were normal times, but many factories are struggling to stay afloat thanks to the trade war and the rising costs of doing business in China.
    2. To add insult to injury, now that the Chinese holiday is over, the authorities are encouraging workers to stay home if they feel sick in any way. That’s not a bad idea. But the policy is worded such that employees can stay home for as long as they like, with no burden to prove they are sick, and once again- you guessed it- at the expense of the employer.  The government will strictly punish any factories that fire staff or fail to pay sick leave during this crisis.  Just like “force majeure” gives the factory the ability to play games with the international buyers, the “stay home for free” rules give the factory HR department all sorts of headaches.  This directly impacts production schedules which further complicate your global supply chain.
  2. Ambiguity
    One of the classic China headaches for foreign business people is the ambiguity of the rules and the randomness of the interpretation/enforcement of those rules as one move from federal level to provincial to local and even area to area within the same city.For example, one of my suppliers has been lucky in that none of their staff are sick and all have returned to the factory ready and willing to work.  They have even provided each employee with 20 masks each, more than enough to last a few weeks. But the production line has ground to a halt because the local authorities won’t let the factory start production until they can show that the factory has 50 face masks in stock per person.

    Why 50?
    The upper levels of government stated something along the lines of “everybody can get back to work if suitable safety measures are in place”.  Sounds reasonable enough, but the problem is that it was left up to the local authorities to define “suitable”.  And if the virus springs up in their area of control, they know there is a high likelihood they will get sacked. So naturally, they are extremely conservative.  It’s in their interest to keep everything on lockdown until the central authorities declare the emergency is over.  Some factories are back to work, many are not.

    If you operate in China, you have learned to work around the constant ambiguity, it is part of doing business.  I’m just happy that I’m not a school teacher because a few days ago the government basically said “holiday is over, school is back in session, but the kids can’t come to school, so teach them online” and by the way, the teachers were not given any tools or training on how to run a virtual classroom!

What I don’t see happening because of the virus

“The Coronavirus will cause manufactures to leave China”

The Trump tariffs and the rising costs of manufacturing is indeed driving some factories out of China, especially the lower-tech products.  S. Asia, S.E Asia and Mexico are the winners.  But moving to those destinations because you are worried about a future outbreak in China doesn’t make sense because no one can predict where the next global outbreak will take place and if the virus was to break out in places like Vietnam or Bangladesh, it is unlikely their governments and infrastructures would be able to muster the level of resources that are available to Beijing.  Try building a 1000 bed hospital in 10 days in Pakistan! For that matter, can you imagine the chaos if the US Government tried to lockdown an entire city let alone a whole state!

Cautious Optimism: How things could actually work out for the better

Factory owners may get some much-needed relief, this could trickle down to international buyers. First a look at the big picture for manufacturing in China:

In the years leading up to the current Coronavirus crisis, Beijing has been aggressively pivoting away from an economy based on manufacturing-for-export towards a consumption-based economy.  For consumerism to work in China, or anywhere for that matter, a middle-class with disposable income is necessary.

Beijing feels the best way to get there is to continue to raise the minimum wage, year after year.  It’s working. Consumption is on the rise and if the US-China trade war ever cools down, US exporters will benefit from a rising Chinese middle-class.

But the down side of the pivot is that China has become too expensive for a growing list of production categories.   It’s my belief that the powers in Beijing did the macro level math and had a target for just how far they could build a middle-class at the expense of the factory owners.  They are willing to sacrifice a pre-determined segment of the manufacturing base in order to build a larger middle-class. But it is a delicate balance- push the factory owners too far and they start to close up shop or leave China. If there is too much unemployment, there is the potential for social unrest. Beijing doesn’t take that risk lightly.

I doubt Beijing’s balancing act had enough padding to cover the impact of Trump’s trade war, let alone the Coronavirus.  Perhaps the pendulum will finally start swinging back to the benefit of Chinese manufacturing and their overseas customer.

For example, as discussed earlier in this blog post, at the beginning of the outbreak, the factory owners (regardless if ownership was Chinese or American) were asked by Beijing to absorb the costs of the Chinese New Year holiday’s extended paid vacation and a liberal sick leave policy. But just a week later, perhaps sensing that they put too much burden on the factory owners, some local governments made the surprise announcement that the landlords who own the industrial parks will be asked to reduce the rents charged to the manufacturers.

Why is this a BIG deal?

  1. Despite the slowdown in GDP growth, despite the increased number of factories leaving China, rents have continued to rise for over a decade with no signs of abatement… until this week!
  2. Many of the industrial parks are owned by the local government and even when the land is in private hands, the owner almost always has a close relationship with the local government. These local entities must have been poked from above, perhaps all the way back to Beijing. As an exporter of goods made in China, I’m delighted to see that the central government may be thinking about how to prop up the manufacturing sector. Playing around with the VAT rebate rate is normally Beijing’s preferred tool for supporting the manufacture-for-export sector.  Glad to see rent reduction may be added to Beijing’s tool box as well.

About the Author: Michael J. Bellamy

About the Author: Michael J. Bellamy

Originally from Upstate New York, Mike moved to Asia in 1993 and is a China business advisor to both Fortune 500 companies and small businesses.  Recognized as an expert on doing business in China, he has been interviewed by WSJ, CNBC, FT & Bloomberg.

A featured presenter on China issues at seminars, trade shows and corporate events across the globe.

Learn more about Mike and AsiaBridge Law at
https://www.asiabridgelaw.com/business-advisory-services/

Mike is the author of “The Essential Reference Guide to China Sourcing
(available on Amazon).

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