managing the outsourcing process, from supplier selection to problem solving

8/10/2019 Managing the Outsourcing Process, From Supplier Selection to Problem Solving

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MANAGING THE OUTSOURCING PROCESS, FROM SUPPLIER SELECTION

TO PROBLEM SOLVING: THE CASE OF GLOBAL CONSULTEX IN CHINASteve Marineau, MBA

5395 Baldwin Street

Montreal (Qubec) H1K 3B4Telephone: (514)571-5434

[email protected]

Margaret Schomaker

Facult des sciences de l'administration

Universit Laval

Pavillon Palasis-Prince, local 1439

2325, rue de la Terrasse

Qubec (Qubec) G1V 0A6 Canada

Telephone: (418) 656-2131, extension 7675

[email protected]

ABSTRACT

As more and more elements of the value chain can be better or more efficiently

executed outside the company, the subject of outsourcing has received greater

attention from multiple fields of inquiry. Moving beyond consideration of the factors

influencing the decisions of whether and what to outsource and the impact of

outsourcing on the firm, this paper focuses on the process of outsourcing itself. We lay

out the various elements of the outsourcing process and argue that each of these

elements is affected by the home and host country contexts. This framework isillustrated via the case of Global Consultex Inc, a high-tech Canadian firm outsourcing

from China and whose primary customers are in Burkina Faso.

Keywords: outsourcing, international, China

Global Consultex Inc.

In order to be successful in its respective market segment, Global Consultex Inc. chose to follow

a differentiation strategy, believing it possible to create a product that was unique in the

market. It did so by developing its own version of a solar bag with proprietary specifications

which are thought to be better suited to meet the requirements of its customers. Having a

degree in electrical engineering, one of its founders developed the original product template

from which other models of solar bags would be developed afterwards.

The company determined that outsourcing production to another country would be the only

way to keep unit price competitive with other comparable products on the market, as the

product comprised components from two extremely competitive industries: electronics and


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textiles. Having established a strong reputation in both industries years beforehand, China was

the most obvious choice for the companys outsourcing needs. It was also a known fact that the

Chinese government had intentions of emulating countries like Germany in the development

and mass production of solar panel technology by heavily subsidizing these industries. This

tipped the balance in favor of outsourcing to China, rather than to countries such as the United

States or Germany, which had higher production. By developing its own solar panels, Chinacontinued to decrease its production costs and increase quality through the use of improved

raw materials and by adopting more modern production protocols. The last main component

used in the product, batteries was also something for which China had developed a vast

expertise in the previous ten years. Altogether these facts pointed to China as the most logical

outsourcing destination.

Initial contacts with suppliers in China were quite fruitful. The company was able to partner up

with a motivated and reliable supplier that was willing to produce the exclusive products

developed by Global Consultex. Unfortunately, the relationship came to a sudden stop several

months after the initial talks started, when Global Consultex learned that its new partner was

having financial difficulties and could therefore not continue to supply the solar bags. This bad

news also came in as Global Consultex had just finished signing a major deal with a local African

partner.

In order to fulfill the order that had just come in, the company quickly turned around and

approached a supplier it had previously met at a commercial fair. Once the samples from the

new supplier had been approved by Global Consultex, an order was placed to supply their

African customer. It was only after the order had been placed with the new supplier that some

unforeseen problems began to arise. As the order was nearing its shipping date, Global

Consultex contacted the supplier to obtain the production status. According to the supplier, the

order was nearing the end production and almost ready for shipment. Comforted by the news,Global Consultexs managers waited for the shipping confirmation; a week later, it still had not

been received. Over a series of follow-up calls, the supplier made excuse after excuse to explain

why the order had not shipped, placing the blame mostly on its own suppliers rather than

accepting it themselves.

Eventually, the order did ship, reaching the customer almost two months late, and bringing

along with it more bad news. More than half of the batteries shipped out to the customer in

the order were found to be defective, making most of the solar bags unusable.

Immediately advised of the situation, the supplier denied any responsibility for the defective

product and refused to do anything about the situation, leaving Global Consultex in anuntenable position. There was no other ready supplier to which it could turn and no way to

placate the customer. The incident left Global Consultexs reputation tarnishedand led to

significant financial implications as well, as the company decided to reimburse an already

unhappy customer. With no reliable supplier, the company was also prevented from accepting

new orders. Resolving the matter would be costly in terms of both time and money, resources

that a small company such as Global Consultex can ill afford to squander on damage control.


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Outsourcing in China

For many years, foreign companies have been looking for different ways of outsourcing

production of their goods to other countries in order to gain a strategic advantage in domestic

and foreign markets (Lei and Hitt, 1995). As time goes by and as international markets open up,

this practice once reserved only to large scale multinationals has become accessible tobusinesses of all types and sizes. Countries such as China have embraced such opportunities by

opening up and creating an environment favorable to foreign investment and rich in low-cost

labor (Malos, 2010). Technology has also played an important role in easing communications

and making important information readily available to important stakeholders.

While many foreign companies have greatly benefited from international outsourcing, many

have also failed in their endeavor. For organizations striving for success, international

outsourcing is a strategic approach requiring meticulous planning, careful consideration of the

risks involved often necessitating important changes from within. Regardless of the economic

openness a host country may have or the amount of technology available, the cultural

differences and local rules by which foreign companies need to play can in the end make orbreak a company. Managers must reflect on the extent to which they are willing to adapt

themselves and the organization in order to make the project a success. For some businesses,

these apparent exigencies might turn them away from outsourcing altogether. However, for

those who have decided that benefits outweigh the risk, the key questions are how to best

hedge against the underlying risks.

In the following sections we briefly review what is known about the role of country context in

outsourcing before returning to the case of Global Consultex. The key characteristics of the

company and its industry are outlined, after which we provide an in-depth analysis of the

cultural and institutional environment of China. We conclude by providing a framework formanaging the outsourcing processa framework that incorporates the considerations of

country context.

Outsourcing

While outsourcing has been defined in various ways by myriad researchers, Wiengarten, Pagell,

and Fynes (2013) provides a relatively succinct and straightforward definition that can

encompass both broad or narrow readings: Outsourcing can be defined as the allocation of

business activities that were previously done internally by an organization, which are now

sourced from the outside of the organization (p. 630).

Much of the literature on outsourcing focuses on the initial decisions of whether and where to

outsource. The location decision, in particular, has drawn attention. Trends in location choice

can be determined by the interplay of level of economic development, the industry, and the

role of technology (Palugod and Palugod, 2011). The country context can also create changes in

optimal outsourcing levels, as, for example, when countries such as China develop greater


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manufacturing expertise, making a shift to increase outsourcing there desirable (Mol and

Kotabe, 2011).

Beyond location choice, country context is known to have an effect on outsourcing outcomes as

well. A given countrys rule of law and various sources of risk affect inward sourcing all along

the process (Wiengarten et al., 2013). National culture, too, has an effect on the outsourcingprocess, though not always in expected ways. Handley and Benton (2013) find that cultural

distance is actually associated with lower control and coordination costs in outsourcing. One

explanation proffered is that that greater distance signals the need for firms to locate some of

their own personnel at the foreign sourcing location, thus creating a stronger conduit of

information and control. This is not dissimilar from the finding that greater linguistic distance

can result in better operations knowledge transfer due to the vigilance resulting from salient

differences (Schomaker and Zaheer, 2013). The role of culture has also received attention, not

only from researchers, but from the multinational companies themselves as well. Schmitt and

Van Biesebroeck (2013) find that while culture is tied to sourcing strategy, it is not necessarily

followed by outsourcing success. This could be due to the fact that being aware that a culture is

different is not the same as understanding howand why it is different.

The case of global consultex in china

While the existing literature on the process of outsourcing offers much information, the role of

the national context is less clear (Hahn and Bunyaratavej, 2010). We argue that it is necessary

to consider not just the host country context in and of itself, but the differences between home

and host country characteristics as well. In the following section, we will return to the case of

Global Consultex to illustrate the role played by country characteristics, using China as the focal

context. We begin by analyzing the cultural and institutional profile of China, showing how

country-level characteristics interact with industry- and firm-level outsourcing concerns.

Company Context

Global Consultex, based in Quebec, Canada, is a company specialized in the commercialization

of innovative, technology-related products, used to improve the everyday lives of its users

while being environmentally friendly. This is achieved through the use of green and renewable

energy sources. The company was founded in 2011, a formalization of a project undertaken

earlier in 2010. The founders focused on researching and designing products internally, while

outsourcing the manufacturing process to China. They also maintained a high involvement indistribution and commercializing activities.

Current production lines offered by the company mainly focus on technologies derived from

solar energy. The product line currently consists of a wide range of portable or hybrid solar

products. They propose laptop bags with integrated high-capacity lithium-ion batteries and

solar panels, allowing its users to power or charge different electronic devices on the go. The

founders have anticipated a need for these types of products in countries lacking reliable public


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infrastructures and where it is therefore difficult for most people to find efficient power

sources to recharge mobile devices as well as obtain consistent lightning. Supporting the

companys orientation towards portable solar products is the soaring popularity of mobile

devices, which, since 2009, has seen unrelenting growth, creating a whole new industry of

complementary products and accessories with the same upwards market trend.

Initially, the company decided to test its products on two different markets simultaneously, the

first being the local Quebec market, mainly because of its proximity. The second market tested

was Burkina Faso, a landlocked country located in western Africa and known to be one of the

poorest countries in the world with generally underdeveloped public infrastructures, a deficient

power grid, and an abundance of sun year-round. Being an ideal market for this type of

product, Burkina Faso was also the country of origin of one of the founders, giving the company

a solid foothold in the country and the benefits of an already established personal and

professional network. This is especially important in Africa, where approaching anyone from

the government or NGOs requires a certain level of credibility.

Industry Context

Factories can sometimes put a greater focus on the assembly line instead of on the production

line. While a number of Chinese factories claim to be specialized in the solar energy industry,

for many, their real efforts are invested at the production or product assembly level.

Furthermore, it must be understood that the finished or semi-finished product does not limit

itself to mono or polycrystalline cells, but rather at the level of the photovoltaic (PV) solar

panel. In this sense, the factory acquiring these products only rarely proceeds to testing them

and relies instead on the specs offered by the supplier, which are often erroneous (Philipsen

and Littrell, 2011). Subsequently, the solar panel supplier can, in addition to the latter, propose

a charge regulator, an inverter, as well as an integrated battery or other components,

depending on the case. Generally, these balances of systems (B.O.S.) are not developed

internally and still rely on the reliability of the primary supplier for the final product efficacy.

Thus, their assembly line remains flexible or adaptive in response to market trends or specific

production orders. The downside of rotating tasks, however, is that of the lowered

specialization of machinery and workers and their constant need to readapt and readjust which

increases the risk of errors.

Secondly, because these assembly factories do not always control for the quality of input

composites such as solar cells during the procurement process, this continues into the assembly

process and extrapolates itself even more during final product output (Philipsen and Littrell,2011). The end-product may thus function, but not at the intended industry standards of

efficiency or durability. Furthermore, the supplier may propose a testing sample that meets all

the criterias, but then intentionally produce a lower end version of it for the serial production

by using cheaper materials (Philipsen and Littrell, 2011). When being confronted on the issue,

they might admit that because the cost of raw materials had increased, they in fact had to do so

in order to respect final price agreements. Furthermore, they may offer a discount on the next

order as a form of compensation. Many Chinese suppliers use this shakedown strategy in the


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solar industry to encourage the customer to renew his order to benefit from the compensation

proposed (discount). (Philipsen and Littrell, 2011).

Finally, it remains difficult for a foreign enterprise to identify at what level of the supply chain

suppliers are truly specialized or mature in. To prevent any confusion, more in-depth

verifications are needed, with factory visits and audits, along with fabrication chain inspections,etc.

The influence of country context

Communication

The reality of doing business with foreign suppliers and partners can only be understood once

the cultural and institutional contexts are understood. In China, one of the major challenges for

foreign fims is communication. Communication is a problem because of cultural and linguisticdifferences that create barriers and force the involved parties to rely on interpreters in order to

comprehend each other, which may ultimately result in many elements being ignored or

misinterpreted (Stringfellow et al., 2008). While the words can be translated, the sense may

remain distorted without proper grasp of the cultural context (Hall, 1989). This becomes all the

more problematic when it concerns communication on technical matters between the

respective engineers. Indeed, the degree of comprehension or the delay in response is even

more critical regarding high technology. Additionally, distance and different time zones can

extend the problem at a higher level or once again be received negatively from the counterpart.

(Stringfellow et al., 2008)

While English provides a common language with widespread use in international business(Crystal, 2003; McArthur, 2002), not everyone speaks with equal fluency (Kachru, 1996); either

or both partners may be at a linguistic disadvantage and it is necessary to double check the

sharedunderstanding of each partys intentions and interpretations. This is particularly

important when discussing technical specifications, since the concreteness of the terms may

lead one to overestimate the ease of their comprehension (Amaral et al., 2011).

An additional complication is that what may appear of utmost importance to the foreign

enterprise in terms of expectations can be perceived as insignificant by the Chinese supplier.

We must then put emphasis on, and specify the importance of respecting the expected

standards and specs. Additionally, some explicit knowledge or aspects that we take for granted

in western countries, such as voltage (110 V/AC), should always be specified in the specs sheets

to prevent bad surprises (Polanyi, 1967). In the following paragraphs, we will examine another

intrinsic aspect of Chinese culture, which is that Chinese workers tend to hide their

incomprehension, when that is the case, due to the fact that they must always respond

positively to requests.


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Society

Before thinking of doing business in China, one must first understand the historical, traditional,

and cultural heritage that makes China what it is today, and what makes it different, in many

regards, to western societies. These differences manifest themselves on different levels and in

many different ways which inevitably have an impact on human and business relations, and inthe process, create challenges for foreign businesses that need to be considered. One of the

most significant characteristic of Chinese culture is the presence of Mianzi(Mavrides, 2010),

or the face culture, which can be partly equated in western culture to the reputation one has

in front of his\her peers. For the Chinese, face is a crucial dynamic that applies to both personal

and business relationships, and is also an inseparable component of guanxi(Verot, 2009) or

relations (Melndez, 2007). Both face and guanxi work hand in hand and must be understood

by anyone looking to do business in China, as one without the other makes the dynamic as a

whole useless, and, consequently, business relationships impossible. Face is actually a

bankablenotion in Chinese culture, meaning that one can keep, gain or lose face. Ultimately

for any Chinese person, the idea is to keep or gain face in front of his\her peers which allows

him\her to have good guanxi or in other words maintain or build good relations.

Hofstedes (1980) dimensions of culture provide further insight into the salient differences

between Western and Chinese cultures, and into the role these differences can play in a

business context. Figure 1 presents a comparison between the scores for China and Canada

(Global Consultex home market).

Power Distance (PDI)

The dimension ofpower distancedeals with the fact that all individuals in societies are

not equal it expresses the attitude of the culture towards these inequalities amongstus. Power distance is defined as the extent to which the less powerful members of

institutions and organisations within a country expect and accept that power is

distributed unequally.(Hofstede, 2001).

We tend to look upon the Chinese as a resilient culture seeing how socially stable the country

is despite the immense disparity in wealth. In fact, resilience can be partly explained by

where China sits in the power distance dimension, which is at the upper end of the spectrum,

as the Chinese in general tend to believe that inequality amongst people is something

acceptable (Stringfellow et al., 2008).


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China is a collectivist culture, scoring very highly in that respect (Hahn and Bunyaratavej, 2010).

One of the ways this can be observed is through the nationalism displayed by the Chinese

people who use the we when speaking about China related issues. People in China will usually

act in the interests of the group and not necessarily for themselves (Triandis et al., 1988).

Contrary to westerners who tend to criticize anything they feel is not in agreement to their

personal values; you will rarely see Chinese people criticizing China in front of a foreigner. In-group considerations affect hiring and promotions with closer in-groups, such as family and

friends, that are the typical recipients of preferential treatment. While an employee may be

committed to the organization and have positive relationships with colleagues based on

cooperation, this employees interactions with other people that are not within that same

group can be cold and distant. Chinese people place more value on relationships than on tasks,

which can also make things difficult in a business context for westerners.

Masculinity vs. Femininity (MAS)

A high score (masculine) on this dimension indicates that the society will be driven bycompetition, achievement and success, with success being defined by the winner / best

in field a value system that starts in school and continues throughout organisational

behaviour. A low score (feminine) on the dimension means that the dominant values in

society are caring for others and quality of life. A feminine society is one where quality of

life is the sign of success and standing out from the crowd is not admirable. The

fundamental issue here is what motivates people, wanting to be the best (masculine) or

liking what you do (feminine).(Hofstede, 2001).

Relative to Canada, China is considered a more masculine society as its orientation is more

success driven. The need to ensure success through sacrifice of family and leisure time

exemplifies this characteristic. Contrary to Canadians who place strong value on leisure, many

Chinese place little value on leisure. Nonetheless, it is important to point out that this

characteristic is not present in all social classes, as many Chinese feel that the disparity and

unfairness currently present in China does not allow them to dream and improve their

situation. As a result, many of these people are contempt with doing no more than what is

asked of them.

Uncertainty Avoidance (UAI)

The dimension Uncertainty Avoidance has to do with the way that a society deals with

the fact that the future can never be known: should we try to control the future or just

let it happen? This ambiguity brings with it anxiety and different cultures have learnt to

deal with this anxiety in different ways. The extent to which the members of a culture

feel threatened by ambiguous or unknown situations and have created beliefs and

institutions that try to avoid these is reflected in the UAI score.(Hofstede, 2001).


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The Chinese score low on uncertainty avoidance in relation with western culture, but for

Canadians and westerners in general, uncertainty and ambiguity is not tolerated in business

(Hahn and Bunyaratavej, 2010). Business relationships are based on mutual agreement and

trust, which typically takes the form of a written contract that is to be honored unconditionally

if the relationship is to last. This dynamic takes on another meaning for the Chinese who see

truth as something with a relative importance depending on how distant one stands in relationto the others social circle. In China, adhering to laws and rules also depends on how important

these laws and rules are judged to be in relation to the situation. It is also interesting to point

out that the Chinese language is in fact full of ambiguous meanings which are very complex in

nature and difficult to follow for Westerners.

Long-Term Orientation (LTO)

The long term orientation dimension is closely related to the teachings of Confucius and

can be interpreted as dealing with societys search for virtue, the extent to which a

society shows a pragmatic future-oriented perspective rather than a conventionalhistorical short-term point of view.(Hofstede, 2001).

The biggest difference between China and Canada lies in the long-term orientation dimension,

where China ranks highly relative to Canada, who, on the other hand, scores very low. What

this means is that China is a long term oriented society in which persistence and perseverance

are highly praised values. Personal relationships are ranked by status, and status and order are

closely followed.Important people are viewed as wise and willing to engage in argument and

investments are ultimately made for the long term rather than for short term gain. Traditions

can be adapted to context and the government is seen as ruled by men (human nature) without

the involvement of external influences such as god or law which play an important part in

western cultures (Philipsen and Littrell, 2011). The fact that Canadian and Chinese people do

not share the same relationship towards time, or do not place equal value upon it, can create

conflict. (Stringfellow et al., 2008)

It is, however, important to point out that Chinas emphasis on long term orientation has

somewhat decreased in the last 10-15 years along with the general opening of markets.

Chinese businesses now have to compete with businesses from all around the world, which

means that they have to be more reactive and work towards shorter term reactive strategies

that are aimed at staying competitive, rather than seek long term financial stability (Philipsen

and Littrell, 2011). These changes have also brought upon differences in the manner that the

Chinese conduct business and can be exemplified by the ``thick face, black heart`` philosophy inwhich breaking the rules, such as deviating from contractual agreements or product

specifications, is tolerated in the face of short-term economic gains (Philipsen and Littrell,

2011). However, the best way to build effective and sustainable outsourcing relationships is

through the increase of transactions under a long-term vision, or by bringing them more

benefits.(Dyer and Singh. 1998; Gulati, 1995; Kotabe et al., 2003)


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Technology

As previously mentioned, Global Consultexscore business is focused on the renewable energy

or green energy industry, and specifically, in solar power products. Energy that is considered

renewable is energy that comes from different natural resources such as sunlight, wind, rain,

tides, waves and geothermal heat. These are all considered renewable because they arenaturally replenished at a constant rate (International Energy Agency [IEA], 2002). With climate

changes and air pollution becoming a growing concern for many countries around the world,

investment in renewable energy technology has grown significantly in the last 8 years going

from $33bn USD in investment in 2004, and reaching $257bn USD in 2011 (see appendix -Global

new investment in renewable energy). The public and private sector has continued to increase

funding for these projects even in 2008-2009, despite the 2008 economic meltdown, which is a

testament to the strength of this industry. The renewable energy sector has since showed

strong growth, with solar power being one of the main drivers of growth, attracting more than

half of the investments made in the sector (Jordans, 2012). This has led to significant advances

in solar power technology making it ever more accessible and practical for consumers.

The current applications of solar energy are subdivided into two distinct categories, the first

being that of solar thermal energy, used as a source of heat, and finally that of solar

photovoltaic (Pearce, 2002) energy, which is used for producing electricity. The technology

commercialized by Global Consultexis of the latter, used in off-grid applications in systems that

are made portable and totally independent. Global Consultexsowners chose this orientation

because they felt that the growing number of mobile electronic devices people use, such as

laptop computers and smart phones, have created a growing need for portable energy sources

to supply energy to these devices. Furthermore, they chose to outsource their production to

China because of the ease of starting up production at a lower cost as well as to take advantage

of the access to raw materials. A final determining factor was the maturity of Chinesecompanies in the solar technology industry.

Massive investments in solar panel technology have begun taking place approximately in 2004;

at that time, many countries like Germany and the United States led the way by heavily

investing in R&D in order to increase the performance and decrease the cost of these products.

As the commercial viability of these products became apparent, many of these companies

relocated their operations to other countries such as China, to decrease production costs.

Fueled by massive foreign direct investments, the Chinese government started to shift Chinas

economy from a labor intensive one to a medium value added export-oriented economy, and

did so by heavily subsidizing the solar power industry right around 2007 (Nusca, 2010). These

subsidies encouraged many Chinese businesses big and small to start developing products usingsolar technology (Plumer, 2012). Although it is still true to say that Chinese businesses are not

known for their innovations, many of them have become quite good and efficient at producing

solar panel technology and finding new applications for these products. Today, China has

become the worlds largest producer of solar panels and derived solar products with over 65%

of the worlds total production(Stearns, 2012).


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Environment

In recent years, pollution has become a major source of unrest in China, especially for Chinas

middle class who have become more outspoken about potentially hazardous projects being

deployed around them. A recent example of the resulting general discontent brought by one of

these projects are the riots that broke out last October in the port city of Ningbo, nearShanghai, following the announcements that a large chemical plant would expand within the

city. The protests that followed quickly turned to violence and lasted 3 days as local authorities

attempted to regain control of the situation. In an attempt to relieve tensions in the area, the

government announced on October 28th

that it would put a halt to the development project

(Yu, 2012). With Chinas middle class rising and general living conditions improving in urban

areas, a new culture of the not in my yardmind set has started to rise, and, as a result, it will

become more and more difficult for industries operating in China to play by their own rules, like

they have in the past.

Due to increasing awareness of the problems posed by pollution, the Chinese government

started diversifying its energy portfolio as early as the mid 1990s, which, at the time, wasalmost exclusively focused on coal energy (Priddle, 1999). The government started investing in

many hydroelectric projects across the country, as well as other forms of renewable energy

technologies, such as solar and wind energy. Although pollution today is still a major problem in

China, the government now knows the cost of inadequate environmental regulations and

policies. More importantly, the Chinese government now understands that if China is to

continue growing, the environmental problems will need to be addressed.

Over the years, many multinational western companies and brands outsourcing to China have

been blamed for taking advantage of Chinas lenient environmental laws to produce goods as

cheaply as possible, with little or no regards for the environment. Many of these businesseshave come out in the media hiding behind their suppliers and claiming that they have little or

no control over how their own goods are produced. While many of these cases are still unclear

concerning who is to blame, what is clear is the that environmental regulations will get tougher

as time goes by. Above all, the Chinese consumer, who is becoming a powerful influence on the

world scene, will start taking notice of these wrongdoings, and consequences for the negligent

foreign companies could potentially be serious. As a result, western businesses need to take

notice of these new factors and be more cautious on how they carry themselves in China.

Institutional Framework

Legal structure. For many businesses today, the protection of intellectual property and

trademarks is often a concern that is decisive on whether these businesses opt to

internationalize operations or not. In order to promote and encourage creative thinking and

innovation, most western economies have put into place strict laws and regulations allowing

businesses to protect their intellectual property and trademarks. Unfortunately this is not the

case in many developing economies such as China, where the legal system is rather loosely

defined, giving rise to various loopholes in the law (Jayaraman, 2009). China has been an active


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member of the WTO (World Trade Organisation) since 2001, which required them to

implement international business laws and patent rights amendments. However, even with

these measures officially in place, China has struggled to control and supress patent and

trademark infringement (Philipsen and Littrell, 2011), which has cost billions of dollars in lost

revenues to foreign companies over the years.

The Chinese Shanzhai(Wesler, 2013) or what can be referred to as the copycat culture, is a

Confucian principle still predominant in todays Chinese culture which promotes individuals

that share their creations with the rest of society, with the belief that this will lead to harmony.

Another important related Confucian principle for Chinese people is the importance of finding a

worthy master in order to study his teachings and aspire to one day imitate him and honor his

work. Even though these values seem to be farfetched when looking at modern Chinese

society, they are still very much engrained in the beliefs of many Chinese people (Philipsen and

Littrell, 2011). With as much as 80% of counterfeit products being found today in US markets

and coming from the Chinese mainland, China remains the worlds largest producer of

counterfeit products (Hunter and Puliti, 2012). Part of this problem lies in the wordings of

Chinese laws, characterized by their vagueness and frequently interpreted in many different

ways, often depending on the geographical region of China where the law is applied. Laws in

regards to taxation and labor are frequently refined by the Chinese courts, adding to the

complexity of interpretation and opening doors to manipulation by local lawyers (Jarayaman,

2009). Many laws related to patent and trademark infringement currently exist in Chinese law,

however, in the end, the Chinese government officials and provincial officials have the

legislative power to overturn and block these laws at will (Philipsen and Littrell, 2011), making

investment in China a potentially risky affair.

Contract management and interpretation. The way Chinese and Westerners approach contracts

after reaching an agreement is very different. Westerners usually begin with a standardcontract, modifying it to cater to different circumstances, simply by signing the revised version

after the changes have been made. This form of thinking is based on commercial law. However,

commercial law in China, which was traditionally perceived as an indication of bad faith, has not

had much impact historically. The suggestion of a legal draft when discussing a deal is judged as

unnecessary, because it carried no sense of commitment. Rather, the sense of obligation of the

different parties involved came from the relationships themselves, not from business clauses

written on paper.

Today, however, bringing home a signed piece of paper has become a symbol of progress.

While the Chinese may sign contracts, it is, for some, only to accommodate their guests.

However, a contract can also be an indicator that both sides have developed a trustingrelationship. Furthermore, additional demands outside of the contract may follow, which by

Western standards is not expected, since the signing of specific terms and conditions of the

contract are usually already finalized at that stage.

Nowadays, it is very important to have a strong legal contract when dealing or outsourcing with

Chinese suppliers. They perceive this as a sign of seriousness and are less intent on playing


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around, especially if the contract is written in Chinese as well. As with many other legal

systems, you can always go to trial (Allen et al., 2003) if you feel that your counterpart failed to

respect the contract, however, this option may turn out to be both costly and time consuming

with an uncertain outcome. Instead, it is preferable to add legal clauses, such as arbitration

and mediation to the contract, which allows you to expose your problem to a neutral party

capable of proposing and imposing effective mechanisms of resolution. It is strongly suggestedto communicate your expectations and specifications before contracting, because simple

misunderstandings often occur and are at the source of most disagreements.

Arbitration system. The Arbitration Law in China was promulgated on August 31 1994, unifying

arbitration practices across the country, harmonizing China's arbitration system with

internationally accepted principles, systems and practices (Huang, 2003).

The China International Economic and Trade Arbitration Committee is the only arbitration

agency in China that handles international economic and trade disputes. It is headquartered in

Beijing, with branch offices in Shenzhen and Shanghai. Arbitration allows both parties involved

in a civil or commercial dispute to voluntarily submit the case to a third party, which willadjudicate in accordance with specified procedures and rules, following the principle of

impartiality, whereby both parties are bound to enforce the ruling. Arbitration, therefore, is a

judicial activity and a part of China's judicial regime.

Mediation system. Mediation is an effort by a third party to encourage those involved in a

dispute to voluntarily reach an agreement and resolve their dispute (Allen et al., 2005).

There are currently three types of mediation practices in China:

1. Civil mediation: Mediation by People's Mediation Committees outside the court.

2.

Judicial mediation: Mediation by a court of law in civil and economic disputes and minorcriminal cases inside the court. A court's mediation document is as valid as its verdict.

3. Administrative mediation: This can be outside-the-court mediation by grassroots

governments, such as a township government in ordinary civil disputes, or outside-the-

court mediation by government departments in compliance with legal provisions in

specific civil disputes, economic disputes, or labor disputes.

Framework for outsourcing to china

In this section, we will propose a standardized procedure for international outsourcing. The

objective of elaborating such a procedure is to help avoid quality issues, production delays,shipping delays and any other general misunderstanding or problem a business can face when

outsourcing to countries such as China. The procedure is covered by 8 distinct phases that takes

us through the whole process including conflict resolutions tactics which can come in handy in

case of a potential dispute. Phases 1 and 2 covers the identification and evaluation of suitable

suppliers. This is followed by phase 3, the selection of a supplier, and phase 4 which covers best

practices for contract formulation and negotiation. Phases 5 and 6 cover monitoring of overseas


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production and orders. Finally we end with phases 7 and 8, conflict resolution tactics. It should

be noted that while the framework here is phrased within the illustrative context of China, it is

intended to be generalizable and can be fit to any other country context.

Phases 1 and 2: Identifying and Evaluating Suitable Suppliers

Evaluation of needs. This first point may sound obvious but it is probably the single most

important element of your whole research. Knowing exactly what youre looking for is key and

will help you stay focused on your goal. The more precise you can be in terms of what you are

looking for, the easier it will be for you to find it.

Preliminary research. Use the internet to do some preliminary research and develop a

categorized system for your specific needs. On-line search engines are particularly useful for

finding information related to your product name or category. A website written in English or

an English spokesperson should not be taken as a good or bad sign; in some cases, it may only

be a faade and so the best approach is to remain neutral and not let yourself be impressed bywhat you see. Popular business directory websites offer structured information on foreign

suppliers. Globalsource.com, Alibaba.com, made-in-china.comare a few of those with good

information on China.

Trade shows. Attend trade shows such as the Canton Fair or visit permanent wholesaler

markets like Yiwu Futian Market(http://www.yiwu-market-guide.com ). China is the Mecca of

trade shows with over 200 trade shows open at any one time all across China. Tradeshows are a

great way to see the product firsthand and meet with the supplier. They are a sort of speed

dating in the way that they usually allowthe person visiting the tradeshow to gather lots of

superficial information on the product and business. They are in no way a place to negotiate as

the personnel working these shows are more often than not employees that have littleexperience and therefore do not have the mandate to discuss contractual agreements. They

can however provide information such as brochures and price lists which can come in handy

later on. Trade shows are usually either specialized where they focus on a specific trade-

industry or general where they include many different industries such as the world famous

Canton Fair.

Targeted industrial clusters. Most of Chinas industries are geographically segmented, meaning

specific industries are clustered in different regions of China.
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Figure 2Framework for Outsourcing Process (adapted from A+ Services, 2011)

Phase 3Supplier selection

You should always try to narrow down the list of suppliers you want to work with as much as

possible to make things more manageable. It is helpful to use a grid analysis in order to filter

out only the best candidates according to your selection criteria. A grid analysis allows the

company to: compare costs; ensure that the supplier can keep up with demand; demand

evidence that the supplier is offering products that respect advertised certifications; supplier

capacity & reliability; their corporate value system; quality of products; quality of facilities;

productivity; credit terms; proximity and distance; competitive pricing; warranty issues, after

sales support and response time, up to date product range, lower lead times (system

efficiency), financial stability and security etc.

It is of course equally important to ask many questions of the supplier, not only to obtain

information, but also to create bilateral communication and establish a relationship. It is crucial

to keep all historical exchanges through email or chat just in case disagreements should occur.

Phone communications are not recommended, even though they can sometimes help establish

a more intimate relationship with the supplier.

Government offices, embassies, chambers of commerce, trade associations, and current orformer clientscan be invaluable sources of information. Proceed with a background check and

obtain documented proof of acquired industry standards and compliance paperwork, etc. Ask

for business licenses and verify if their business scope matches what is advertised. Certifications

such as ISO or UL must be counter verified against infringement. If you have not already

imported to your market, contact your national customs office to get a historical list of their

shipments or contact an import broker, such as importgenius.com, to obtain that information.


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Order samples and proceed with quality testing. It is also important to review packaging and

instructions to make sure it matches your local requirements. It can often happen that samples

are of a very good quality, while the rest of production is not. This is often referred as the

golden sample trick where a supplier sends a sample that is better quality then what is

intended to be sent to the customer once the order is confirmed. It is important to be precise in

regards to the specifications of the product. The supplier must agree to these requirements as apart of the contract.

Visiting the suppliers facilities is not always possible. But when it is, a visit should be part of

your trip as many things can be learned / validated from a simple visit. Bringing a camera is a

good idea to take pictures or shoot videos of the facilities. Take the time to observe and see

how the goods are produced. Being familiar with operations management is a big plus as a

trained eye can pick up many irregularities which would not be noticed otherwise. Check if they

have a system for quality control and ask for the quality control systems records. Observe the

process flows and counter-verify all the data you have collected before on the product and

business. Insist to meet with their management team to see how they perceive your project or

partnership. If you are unavailable to visit their facilities, mandating someone specialized in this

field and who will create a good link between you and the potential supplier is a good idea

Ask for past examples of contract fulfillment with foreign businesses. You can ask your potential

supplier to prepare a list for the challenges and problems they frequently face when fulfilling

international orders. Difficulty in answering such questions can sometimes be a hint that the

company only sells its products on the Chinese market.

Find a local partner to accompany you during your visit. When we foreigners interact with

Chinese people, there is a lot of verbal & nonverbal information that we miss out on being that

our culture is quite distant from that of Chinese people. Having a Chinese partner to accompanyyou during a visit is a very good idea, ideally someone that knows both business cultures well.

Doing this will help you gather more information and give you a better idea as to if you are

dealing with the right person/business or not.www.yourchinatradingpartner.com

Phase 4 - Contracting

The contract should be negotiated before placing any orders.In cultures such as Chinas,

negotiation is a central part doing business. Negotiation involves knowing the market value of

the product beforehand. Fairness on price and general expectations with the supplier is usually

highly encouraged as it enables long terms business relationships. The exact terms of acontract are determined by both parties and can differ from one contract to the other, they

generally include the following:

(i) names of the parties involved and the place of business thereof;

(ii) subject matter;

(iii) quantity;

(iv) quality;
http://www.yourchinatradingpartner.com/http://www.yourchinatradingpartner.com/


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(v) price or remuneration;

(vi) time, place and method of evaluation in regards to performance;

(vii) liabilities of each party in case there is a breach of contract;

(viii) method of dispute resolution.

Negotiation of the contract. Price is often the first aspect to be negotiated in a contract,however by dealing directly with the manufacturer; many foreign businesses find themselves

confronted with the challenge of having to order fairly large quantities to obtain competitive

pricing! The MOQ or minimum order quantity is usually proportional to the price of the goods

and the production constraints involved in producing the goods. As a result, the MOQ

quantities can vary considerably but are usually around 500-1000 units. This quantity can

usually be negotiated and brought to smaller quantities. Chinese people and Chinese

businesses generally take decisions that aim for long term results and so many of them are

willing to accommodate small businesses that are willing to grow with them by allowing them

to order smaller quantities. If MOQ quantities expected by the manufacturer are too large,

dealing with a trading company should be considered as they can often offer the same products

with a lower MOQ but a higher unit price (usually around +10-15%; the percentage may slightly

vary).

Contract creation (clauses). After having agreed on price and the quantity, it is important to

include different clauses in the contract to protect your business and your investment and

ensure that the product or service will be delivered as per the initial agreement. Another

important aspect to consider is the level of quality required. This needs to be clearly defined

inside the contract including the level of quality required, criteria by which performance is

measured and exact specifications of the product. A clause must also be included if the product

does not satisfy the requirements. Finally, it is a good idea to include a clause that forbids

unilateral modifications of the product. Unfortunately, many Chinese manufacturers haveproved to be quite crafty when it comes to modifying products, even packaging in order to cut

costs and increase their profit margins.

Closely linked to the quality standard, the conditions related to warranty must be enclosed

within the contract. The duration of the warranty offered by the supplier also needs to be

specified. This clause would allow you to return a defective product or one that does respect

the specifications agreed upon, in the contract. Ultimately, the standard warranty offered by

the supplier will tend to vary according to what is generally offered in the industry for the

product in question.

Because quality issues and longer shipping delays are common with suppliers in China, it ispreferable to introduce the contract with a premise such as one of the following: Time is the

essence of the contractor Quality is the essence of the contract. Since late delivery can

impact profitability and reputation, the contract must outline this aspect by including an

incentive clause such as a bonus paid to the supplier if the merchandise is delivered in advance.

It can also be a good idea to add a punitive clause to prevent a situation where the supplier will

deliver later that the initial agreement.


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The in-transit liability for the order must also be defined with the proper Incoterm. The most

commonly used incoterm is free on board or FOB which means the supplier is free of

responsibility as soon as the order leaves the suppliers loading dock. Otherincoterms can be

used, depending on the needs of the business and level of risk it is willing to take. Reducing risk

through the use of other incoterms will have an impact on price with a level of added

protection that is more than debatable since incoterms do not have any legal value. Mostcompanies outsourcing to China will use FOB and try to minimize the risk using other means.

Payment terms, too, must be determined within the contract, again, while everything is

negotiable, common payment terms with Chinese suppliers are 30% of the total value of the

order to be paid at the time the order is placed (T/T). Upon confirmation of the wire transfer by

the bank, suppliers can usually start the production. The remaining 70% of the order value can

be paid when the order is on the dock ready to ship. Companies will usually request the

commercial bill of lading to be prepared and sent before the remaining payment is made to the

supplier. Letters of credit should be considered as a transaction means with new suppliers.

Contract resolution-litigation. Even though Chinese prefer mediation and stability in theircommercial or contractual relationships, it is always better to add an arbitration clause to the

contract. In fact, this clause can avoid many problems down the road that not only take time to

resolve but also generate significant legal fees.

A second clause regarding the Forum selection, exclusive choice of court agreement that

forms part of a contract should be added to treat any form of litigation. A good solution is to

prioritize transnational law as described in the Vienna convention regarding the sales of goods.

Litigation outside China against a China based manufacturer usually does not make

sense. Because most Chinese companies do not have any meaningful assets outside China

and because China does not enforce foreign judgments, getting a judgment outside China

against the Chinese company will likely have virtually no value (Harris, 2013).

Having at least 3 potential suppliers that are capable of providing what you are looking for is a

good way to gain additional leverage when it comes to negotiations.

Finally, it is important to note that many foreign companies rely on purchase orders orpro

forma invoices(P/I) when ordering from China. Unfortunately, these documents are of no legal

value and so it is highly recommended to use contracts instead especially for larger size orders.

We also suggest having the contracts written in Chinese to avoid discrepancies. To be valid, the

contract must be signed by the one of the suppliers legal representatives.

In fact, OEM Agreement do not really cost all that much in China and if you have

properly written into the agreement that the prevailing party gets its attorneys fees, such

a lawsuit can end up costing next to nothing. If anything, such an agreement is more

important for the small company than for the large one because it acts so well to prevent

the one bad shipment that puts the small company under. Having a really good contract


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in place (in Chinese) would make going after the Chinese supplier a whole lot easier and

cheaper than not having an OEM contract at all. Dan Harris, China Law Blog

Phases 5 and 6Monitoring of Production and Orders

Monitoring the progress of an order is one of the most effective ways to avoid problems such

as quality issues. Oversea monitoring can be achieved in the following ways:

o By relying on suppliers quality control letting them handle the whole process

o Mandating an internal resource to go on location and supervise operations

o By hiring a third party inspection company to represent the companys interests. (See

appendix 12 for list of recommended 3rd

party inspection companies)

Outsourcing process & production monitoring. Once the supplier has been selected (phase 1)

and the purchase order or contract is ready (phase 2), the company can focus on the

production of the goods by taking the following measures:

Pre-Production Inspection (PPI). Ideally once the sample has been validated and production is

ready to start, it is recommended to have the production equipment, raw materials and in

process goods checked to make sure they comply with the set production standards. The

foreign company should also identify key stakeholders capable of intervening into the

production process if needed.

First Article Inspection (FAI).Also referred as initial quality control, this procedure consists of an

inspection of the first production units manufactured. This procedure is to be performed when

less than 15% of the products are ready, allowing corrective actions if necessary. The inspection

is usually performed at the factory.
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Figure 3Operational Breakdown of Ordering Process (Adapted from Center testing

International Corp)

During Production Quality Inspection (DPI). This step involves a second inspection when

production progress reaches 15 to 50%, allowing implementation of corrective actions before it

is too late. The production quality inspection involves the inspection of the production batch,

on-site testing of raw materials as well as inspection of finished goods for possible defects. If

variations are observed on the production line, advice and corrective measures can be given to

the operations manager.

Defect Sorting Service (DSS). This step focuses on inspecting as many products as possible and

fixing the defective units found.

Production Monitoring (PM). Constant oversight of the factory, control and recommendations

for production processes and capacity, with daily reports on quality and production status.

An inspector will be the QA of factory and train factory personnel the factory to detect

problems on the production line

Random verifications on the production line each day with a daily report being issued
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Checks the production plan and makes certain it is in accordance with the client's

requirements

Provides technical advice during monitoring

Pre-Shipment Quality Inspection (PI). Proceed with a final random inspection when 80% to

100% of the products are wrapped and ready for shipment. The pre-shipment qualityinspection guarantees the conformity of production to the set specifications. This is also an

opportunity to check on safety, see if quantities match what has been ordered, workmanship,

function, colors, size, packaging, etc. It insures the function and appearance of products are

consistent with requirements.

Container Loading Inspections/Supervision (CLI/CLS). The container loading inspection and

supervision focuses mainly on the concordance between what is on the commercial invoice and

what is being shipped. The product type, quantity, labeling and packaging are verified to make

sure there are no errors. Finally, the loading process is supervised in order to reduce risks of

damage during that process.

Shipping. As specified in the contracting sectio, the Incoterms chosen determines the

responsibility and liability of each party after the goods are shipped. To minimize risk, it is highly

suggested to insure the value of the shipped goods through a private insurance.

Logistics. When the goods arrive in the country of destination whether they arrive by air or sea,

they are transferred to a customs bonded warehouse where they await for clearance. Customs

clearance can either be carried out by the importer directly, through the transporters local

agent or by a 3rd

party Logistics Company. This procedure is usually determined before the

goods ship out from the supplier. Logistics companies can streamline and simplify the whole

process however you will likely pay a bit more for their services then clearing the goods

yourself. Logistics can become a burdensome affair and so many businesses nowadays (evenlarge businesses) involved in import and export partner with 3

rdparty logistics companies that

handle the whole process from pickup at the suppliers to delivery at the final destination. We

therefore recommend the use of a 3rd

party logistics companies for paperwork preparation and

customs clearance especially for those that have no experience with the process.

Paperwork. Businesses looking to outsource need to first make sure they are allowed to import

the goods that they are trying to outsource. In Canada, importers are also asked to register

their business through the Canadian Border Services Agency (CBSA). A preliminary account can

be opened to verify the applicable duties and taxes applicable the imported goods through HS

codes. It is important to do so as tariffs can be quite high on some products.

Here are the different steps to follow (CSBA, 2013):

Registering the business(Business number, import/export account)

Reporting your shipment(Required documents)

Accounting for your shipment(Invoices, import permits, certificate of origin, duty

deferral program, international trade agreements)
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Examining your shipment

Release of your shipment(Release programs, posting security, transaction number)

Storing your shipment(Sufferance and bonded warehouses)

In fact, these different administrative tasks can be perform internally or by hiring an accredited

custom broker, such aswww.Cole.ca in Canada.

Final Inspection. When possible, it is a good idea to perform a visual inspection of the

merchandise at the custom brokers warehouse to make sure the order is complete. Any errors

or problems with the merchandise need to be divulgated to the supplier right away.

Phase 7 and 8 - Conflict Resolution

Resolving conflicts effectively requires good communication with the supplier and person

assigned to your account. The first thing that needs to be done is to clearly explain the issues

you are facing and then see if the supplier is willing to help you out with the situation.Depending on the problems, different actions can be taken. Cases relating to quality issues

should be backed up with technical reports ideally prepared by experts in the field. Picture,

videos should be used to back up the legitimacy of the request. If the supplier is honest and

wants to continue doing business with you, he will likely respect the clauses in the contract and

replace the defective goods compensating you for the loss incurred. Suppliers will often deny

responsibility at first only to admit their fault later on so being persistent in making your

arguments heard is a must in any situation. If all fails and compromise on the suppliers part is

not possible, legal enforcement is usually the next step. Before getting into a legal battle with a

supplier however, the first thing to keep in mind is that Chinese employees oftentimes avoid

reporting internal problems to higher level management that have the authority to dosomething as it can potentially reveal their difficulty to manage tough situations which would

result in them losing face in front of their superior. This is why it is important to find out who

the key stakeholders are inside the company and attempt to contact them before carrying on

with legal procedures. There are sometimes creative ways of getting a negligent supplier back

to the negotiating table. Different trade associations or local chambers of commerce who are in

the same region as the Chinese supplier you are involved with can also act as mediators

between the two parties and help to resolve the matter. Another avenue explored by Global

Consultexafter most other methods were exhausted was the use of local media to exert

pressure on the supplier. The company started by posting the story on different internet blogs

after which it decided to contact a famous newspaper, who then contacted the supplier in

order to get their take on the story. By doing so, Global Consultexgot an immediate responsefrom the Chinese supplier who seemingly wanted to avoid bad local publicity and was suddenly

willing to replace the goods.

Legal enforcement. Here are ways you can resolve a situation using legal enforcements:

1)If you have an arbitration agreement or clause, you can apply for arbitration according to

your agreement;
http://www.cbsa-asfc.gc.ca/import/ex-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/ex-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/release-dedouanement-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/release-dedouanement-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/warehousing-entreposage-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/warehousing-entreposage-eng.htmlhttp://www.cole.ca/http://www.cole.ca/http://www.cbsa-asfc.gc.ca/import/warehousing-entreposage-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/release-dedouanement-eng.htmlhttp://www.cbsa-asfc.gc.ca/import/ex-eng.html


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2)You can find a lawyer to talk or negotiate with the supplier. In China, if the response from

the supplier is negative, a lawsuit can be filed against the supplier in a local court;

3)A complaint can be filed with the local government or commercial department of the

government.

Conclusion

Through the presentation of this case we have sought to answer the question of how a

company can best minimize the risks inherent in overseas outsourcing. We have argued that

analysis of company and industry characteristics do not provide a complete picture of these

risks and that, in fact, the country context is paramount in shaping the considerations necessary

to optimizing the process. We have shown that the entire process of outsourcingfrom the

investigation of potential suppliers to the final receipt of actual goodsis subject to the

influence of country-level factors. Both absolute and comparative country analyses are a

necessary first step in preparation of taking a companys operations overseas. Armed with this

new knowledge, Global Consultex now faces new opportunities opening up on a market

showing promising signs for the near future.


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Appendix

managing the outsourcing process, from supplier selection to problem solving

Documents