Protect Yourself When Outsourcing to China

August 18, 2013, 4:49 p.m. ET

Protect Yourself When Outsourcing to China

SAABIRA CHAUDHURI

Q: If you’re going to source your product or parts from China, what special safeguards should you take?

A: Start the process of finding the right manufacturer using a site likeGlobalsources.com, which aims to help buyers connect with China-based suppliers, suggests Mike Bellamy, an author and owner of PassageMaker Sourcing Solutions.

When you find factories that might meet your needs, ask for references and find out if the manufacturers have a history of respecting intellectual property and doing solid work. But don’t offer those factories complete specifications or samples of the product you want created, advises Mr. Bellamy, since your idea might get filched. Instead, send or show them a similar product for comparison or some rough sketches. And ask for samples before you commit to an order.Anil Gupta, a professor of strategy and globalization at the University of Maryland, says one way to protect your idea is to have your product made in several different places. It also makes it less likely a manufacturer will impose a last-minute price increase, which he says is a common practice in China.

Still, spreading your business across various factories could increase your costs, while decreasing the likelihood that factories will accept your business, warns Paul Midler, an author and founder of manufacturing consultancy China Advantage.

When you’re ready to commit to a supplier, Mr. Midler says bargaining is essential. “You need to haggle, or you’d be considered naive and taken for a ride,” he says.

And be sure to watch out for “quality fade” over time, says Mr. Bellamy. Sometimes the first few batches of a product are made according to specifications, but then manufacturers start to cut corners—say, by using cheaper material.

He suggests structuring payments according to performance. Make sure your contract allows you to reserve the right to pay less or impose a penalty if a batch doesn’t meet your expectations. Another way to combat quality fade is to make your contract painstakingly specific about how products have to be made and when they have to be delivered.

As for patents, don’t put too much stock in them. A U.S. patent can’t be enforced in China, says Timothy J. Malloy, chair of law firm McAndrews, Held & Malloy Ltd. You can apply for a domestic patent, but the “enforcement of Chinese patents in China is far behind the rest of the modern world.”

For instance, Chinese companies can domestically manufacture a product based on someone else’s idea—as long as they sell the product abroad. Mr. Midler suggests filing for patent protection in all the markets where you’ll potentially be selling your product.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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