Once your company finds a Chinese partner, how do you structure the relationship? Some companies make frequent buying and audit trips to China or use a full-service sourcing agent. Though this is an easy way to test the waters, it fails to capture many of the long-term advantages of sourcing from China. Setting up a PRC representative office to manage sourcing operations may be a better choice.

The representative office is relatively simple to establish, although it cannot export goods on its own account. Another similar option is to set up a sourcing coordination center in Hong Kong, which allows control of shipping and more security over transactions (at the expense of higher operating costs and greater distance from the manufacturing plant). Companies with longer planning horizons, more management heft, and a commitment to the Chinese market may choose to set up a wholly foreign-owned enterprise (WFOE), a more popular means of entry than the joint venture Some companies acquire a PRC firm to jumpstart their WFOE formation.

No matter what route you take, maintaining high product quality will be challenging. For critical components with a low tolerance for error, having an employee on the ground to monitor the manufacturing process is indispensable. For other goods, regular onsite inspections, random product sampling, and periodic holistic evaluation of supplier operations generally suffice. One US company holds monthly online performance reviews with each vendor. These reviews are public to competing suppliers, creating a unique info-sharing and peer pressure environment. The company also conducts direct performance reviews two to four times per year, depending on the sensitivity of the product. Quality maintenance, delivery performance, inventory, and cost savings should all be reviewed, with the supplier submitting specific evidence to show that it is verifying process control and implementing agreed-upon standards (local and otherwise). If there are breaches, the PRC supplier must have a non-negotiable timeline for returning to the standards.

The rules for quality control hold equally true for social responsibility standards. In many cases, the PRC vendor is aware of the local environmental, health, and safety standards but is uncertain what action to take to meet these requirements. If forced by local content requirements to choose vendors less savvy about regulatory compliance, a company may need to invest resources to educate and upgrade the supplier. One of the benefits of this approach is the usually favorable relationship that develops between the vendor and the buyer.

Strong communications systems are critical to supply chain management. According to sourcing firms, the order-to-delivery lag can be as short as twelve days but can run up to eight weeks. If demand changes unpredictably or there is no capacity for excess inventory, good communication between China suppliers and US clients becomes crucial. One US company uses an online supplier databank to allow Chinese suppliers to submit all documents, including invoices, online and also to enable buyers to track purchase orders.

Communication is also necessary between the head office and the office responsible for China management. For multinationals or companies with multiple business lines, good online technology also encourages local operations to coordinate buying efforts and thus maximize the cost savings that Chinese procurement brings.

Don't rest on your laurels (or your cost savings)

Finally, companies already in China cannot afford to be complacent. It is no secret that the PRC manufacturing environment is changing quickly, especially in terms of diversification. Companies should plan annual or biannual reviews of their product lines to see if sourcing or logistics operations need to be modified. Sourcing consultant ThreeSixty Sourcing Inc. estimates that even their clients with operations already in China often achieve cost savings of 25 percent. Other sourcing firms cite inability to keep track of regulatory and operational developments as a primary reason that companies retain them.

The standing lesson from the failed wave of foreign investment in China in the 1990s is that companies that refuse to adjust to changing local conditions put themselves at a disadvantage. As the Chinese say, "It is the flowing water that stays fresh" (liushui bu fu). This is true not only in the PRC consumer market, but also in the manufactures market.

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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