This section highlights the options open to you when launching your company's presence in China.

Each company must make its own decision to move to China, and a careful cost analysis is a critical part of this decision. A China-based competitor's price, adjusted for quality and market position differentials, can serve as an initial guide. Total cost analysis will incorporate cost savings (the largest portion of which is usually cheaper labor and components) and additional costs incurred, such as the initial setup costs and higher freight costs and duty payments. A more complex model will include sensitivity analysis to anticipate different scenarios, such as a government-forced slowdown or widespread power shortages.

Choosing the right path

Perhaps the easiest way for a company to source in China is to link up with an existing supplier's operations there or to encourage an existing supplier to also make the move. This allows for Chinese production prices at a familiar level of quality control and delivery.
Another way to find partners is through industry trade fairs in China; referrals from officials in the relevant ministry or local government; discussions with the American Chamber of Commerce, the US-China Business Council (publisher of this article), the US Commercial Service, or other trade organizations. Firms can also ask existing Chinese partners about potential partners or suppliers in other product areas, keeping in mind possible biases they may have.

Companies that are understaffed or on a tight budget can turn to sourcing agents. Outside help on sourcing ranges from matchmaking to consulting on logistics and quality control. According to McKinsey Quarterly, procurement agents' fees range from 3 to 12 percent of the purchase price, depending on the level of service. Of course, careful vetting of sourcing firms is crucial.

Five Options

Think strategically and consider long-term plans before you pick your path.

Structure Pros & Cons

1. Source selective components using sourcing agent
PROS: Easy to set up
CONS: Low-cost savings; little awareness of China markets

2. Source products through representative office in China
PROS: Hands-on approach and development of local expertise lets you sleep easier at night CONS: Increased management demands

3. Establish global procurement center
PROS: Maximize savings internationally; build deep relationships with PRC suppliers
CONS: Requires good enterprise and communication systems within the company

4. Set up joint venture or wholly foreign-owned
PROS: Production with rapid response; better positioned to capitalize manufacturing enterprise in China on growing PRC strengths
CONS: Large fixed investment

5. Create full manufacturing, distribution, and sales network
PROS: In some industries, China is the major growth market
CONS: CEO or board decision; must have long-term investment and exit plans

Do due diligence

The next step is to conduct due diligence on PRC factories: Examine their financial health, production capacity, quality of goods, client references, export history, IPR performance and level of experience with Western or US companies. It is important to compile as broad a list of potential factories as possible. According to BCG's report, Carrier Corp., an air-conditioner manufacturing subsidiary of United Technologies Corp., obtained 1,600 quotes before making its first order. Product samples are the first bar?shoddy quality or unreliable delivery should eliminate candidates.

After narrowing down the field to three to five suppliers that look good on paper and produce good-quality products at a satisfactory price, a detailed factory audit in China should follow. During the inspection, it is important to bring a good translator and to take the time to understand each candidate's production process and ensure that it meets international product and labor standards.

US companies will want to ask questions such as: Does the Chinese vendor run its own compliance checks on quality control and have sufficient oversight? Is the PRC supplier likely to outsource the order? Second-degree outsourcing makes it more difficult for companies to monitor supplier quality and ensure that there are no environmental, health, safety or child labor violations in the manufacture of its goods.

The next step is for your company to make a detailed, second-level assessment that integrates buyer requirements into the evaluation; this process usually rates the candidate as a whole, including all business practices, with a specific grading scale for each set of criteria. Your company can then either choose one candidate or start a bidding process between the potential suppliers on your shortlist.

Source: This is an excerpt from an article originally published in the Sept-Oct, 2004 .issue of the China Business Review. Reprinted with the permission of The US-China Business Council, Washington D.C.

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