On the multitudinous perils of Chinese sourcing and manufacturing
From Paul Midler's Poorly Made in China
This is a fun blast from the past for me. When I was in college, I invented a new type of flip flop with a hidden pocket, and manufactured them in China to create my first company, and then continued doing business in China over a couple more companies over a decade or so.
If you’ve ever done business in China, or wondered what it’s like, this is a nice, short primer on sourcing and manufacturing there.
Because what is China? A land of shadows and mummery and Potemkin factories, where everything is promised, many things are delivered (at least at first), but the centre inevitably cannot hold, and things gradually spiral into oblivion.
The book is a compendium of the many ways that things go wrong when manufacturing in China.
It’s a portrait of the median manufacturing experience in China.
Our protagonist, the author Paul Midler, is basically a one-man sourcing / problem solving shop for Western companies wanting to source in China. An Ivy MBA, fluent in Chinese, lives there for nearly two decades. The book is based in that heady time from 2000-2010 or so when China was booming so much that the skyline of Shanghai changed on a nearly monthly basis.
The majority of the book centers on his largest customer, who sells lotions and soaps and body washes to large American retailers. Think dollar stores and CVS and Walgreens and Target, and they’re in the process of closing a deal with Walmart as the book ends - big players, in other words, selling to the top tier of retailers, although they themselves are simply middlemen and not actual manufacturers like Johnson and Johnson or similar companies.
So this customer, Bernie, comes into China. It opens with the author being asked to check out a factory. He goes there, and it’s the typical Potemkin village factory - all a show to make it look like a serious operation. He has to put on a clean room getup, goes in, sees a little. Sees some inconsistencies - like a worker who doesn’t seem to know how to operate the machine they’re using. Later after the factory tour, he’s waiting for his ride, and goes back to look at the factory again, and it’s completely empty, nobody is in there at all. “The workers are taking a rest,” he’s told.
Seems suspicious…but Bernie, the customer, says “Great! They must really be hurting for business, I’ll be able to get a good price.”
And he does! He gets them to around 30c a bottle. Just as an aside, you never really know the (astonishingly low) true price of things until you start learning the FOB prices of various goods in the country of manufacture. Expensive sofas (large, leather or nice materials) cost a couple hundred bucks at most. Divide pretty much any retail priced consumer good like clothes or shoes by 10 and you’re generally pretty close to the FOB price. Solar panels? Batteries? Maybe 1/5 to 1/8 the retail prices in the US. Furniture? Divide by 10. Tools, appliances, small electrical, plumbing stuff? Divide by 5, roughly. But I digress.
Bernie does some quick napkin math, he knows all the costs of labels, plastic bottles, and freight, and doesn’t understand how the factory can be making any money at the quoted price, but goes ahead anyways.
And so begins our litany of woe. Because the way that Chinese manufacturers work, which Midler relates throughout the book, is to agree to whatever price gets a valuable customer in the door (with more on what “valuable” means here in a little bit), but then unilaterally cut corners a hundred different ways to make up the difference.
How many ways can a manufacturer cut corners?
And infinite variety of ways, but just for the soaps and lotions in the book:
In label size, or quality, or in slipping “recalled” labels into the production line
In using boxes not rated for the weight of stacked boxes of the product
In cutting corners on the lids, such that pumps don’t work properly, lids break off easily, etc
In progressively using less plastic in the plastic bottles
In cutting the quality of the product itself, so it has different PH, different properties, different cold or hot weather behavior, and so on
In cutting the quality of the scent ingredients (he ends up with everything being “almond” scented at some point except the “cherry” bubblebath, which switches to smelling like a “medicinal” cherry because it’s a cheaper scent)
And finally, price increases, which we’ll talk about anon.
Why do Chinese manufacturers do it this way?
Well, as anyone who’s spent significant amounts of time overseas can tell you, Americans get the cheapest, highest quality products in the world.1
America and Europe are “first market” countries. Places where companies innovate in design and spec, and then share those innovations and design specs with their manufacturers, who are by now mostly Chinese.
The rest of the world - the Middle East, Latin and South America, developing countries, are “second markets” and pay a lot more for everything. Even things like soap and laundry detergent, but *especially* for things like electronics, cars, and appliances.
“First-market importers might generate no profit at all, and a manufacturer’s entire bottom line could, instead, derive solely from second-market customers.”
What the Chinese manufacturer is getting from the first-market companies are designs. The new, the cutting edge, the market-proven - these first-market companies have competed in the richest and most competitive markets, ceaselessly honing their product lines for maximum appeal, features, and lowest cost. That’s a valuable thing to have done, and when a given manufacturer gets one of those products and is tasked with replicating it, they are being given a battle-tested product that has proven appeal and can be sold on to second-market consumers and companies. This also leads to “gray market” runs, where manufactures just run the same production line for longer, to sell non-canonical products in these and other secondary markets.2
This is why they’re willing to bid essentially at cost for new business with first-market companies.
“For manufacturers willing to engage in an illicit practice of this kind, it made sense to agree to produce the original order at close to cost. The margin that could be earned on surplus product in some categories easily exceeded 100 to 200 percent, and trying to earn a modest 10 percent profit on the original order might mean losing out to a competitor who would bid lower.”
This definitely leads to getting jerked around if you’re a smaller company that doesn’t come out with new product lines a lot - they’ll backburner your production run in favor of bigger companies with new stuff if they can.
So okay - they give you a good price, but then they start cutting corners. The worst part is, and I confirm this from personal experience as well, they do it in dumb ways.
“It was easy to see how product recalls came about. Manufacturers manipulated product to save only the tiniest amounts of money. When caught at something silly, like trying to save a few dollars by knowingly using incorrect labels, Sister did not express the least bit of shame. In fact, she was glad that I learned of her secret—that we could share in her achievement. She wanted to be seen as clever.
The first shipments of shampoo began to arrive in the United States, and we received bad news. The cardboard that we used was apparently not up to the task of holding the product, and cartons were collapsing. A number of pallet stacks had been crushed under their own weight, causing bottles to break. As a result, the floor of one warehouse was covered in liquid soap.”
In this case, they used a “BB” grade box instead of a “BA” grade box that could have withstood the weight, and it was probably on the order of a penny cheaper per box.
In one of my examples, they used a cheaper fixative glue on straps for the flip flops, leading to many broken straps and returns. Which is dumb for several reasons - fixative is cheap, and broken straps are an obvious problem that people are going to notice and call out.
You see, Westerners tend to approach things from a contractual view.
“Bernie had a tendency, like other importers, to take the contractual view. When he placed orders, he wanted a precise result based on expectations. As a customer, he was entitled to certain things, and I understood what he was trying to do. By playing tough on this smaller issue, what he was really hoping to do was prevent the manufacturer from delivering an even bigger problem down the road.”
“Factories did not see an attention to quality as something that would improve their business prospects, but merely as a barrier to increased profitability. Working to achieve higher levels of quality did not make me a friend of the factory, but a pariah.
Importers learned quickly that improved quality raised their costs. Every time Johnson Carter managed to find a problem and asked the factory to correct it, the factory shifted the cost back to us. Over the long run, when an importer was seen as working too hard to improve quality, it was viewed as a meddlesome customer”
This is Midler’s summation - I’ve got some real issues with him, in the sense I think he’s just literally bad at his job. His job IS to deal with this stuff, but he basically let’s himself and Bernie get pushed around by the factory owners continuously, and never does anything actually smart to mitigate his problems. His excuse is:
“Contract manufacturing was not like buying fruit, where if you didn’t like the goods at one shop, you simply walked across the street to a competitor’s. Supplier relationships took a great deal of effort to set up, and it took a long time to work out the kinks. Outsourced manufacturing was a bit like marriage in some ways; even when things got rocky, it generally made more sense to work things out than to leave in the hope of finding a better partner elsewhere.”
But again, DUMB.
I mean, we’re really just getting into the tip of the iceberg here, but he gets jerked around like this the whole book, sometimes in business-endangering ways - the entire book is just one continuous narrative of his customers getting progressively more ripped off and screwed, and he acts like he’s just powerless to do anything throughout. He never once considers real solutions. You see, it’s simply impossible to turn on a dime and get another manufacturer, because that takes weeks or months. But you were trained in finance, guy, have you never heard of spreading risk over a portfolio? You should have two or three manufacturers at all times, and be playing them off each other, the same way the factory owners play multiple customers off each other.
He also never once tries to install his own permanent QC people in the factory, despite the entire thing being a litany of QC problems. He is even whacked over the head with a gigantic clue-by-four that this is the way to go, because he talks to somebody at a real top-tier manufacturer who says they never have problems because they have 90 of their own QC people on their various manufacturers’ factory floors at all times, and he just ignores it. And he’s doing production runs in the hundreds of thousands of dollars per run, and many runs per year, he’s got more than enough volume to amortize some full time QC people of his own over any run.
I think he’s really just too soft. Another reason he struggles is he’s a boy scout. I’m not going to go into any significant depth here, but to do business in any Asian country, but especially China, you need to eat extravagant banquets, drink more than three frat boys put together, and get up to wacky and sordid “party and night out” hijinks with your business partners3 to establish a relationship where they actually like you as a person and trust you.
And he doesn’t do that, he doesn’t engage in the traditional Asian way of doing business, he specifically eschews it. Which fine, I guess, we all make our choices and live by our own personal moral standards, but maybe you’re in the wrong business, my guy, because it is screwing both you AND your customers to do things the way you are doing them.
So besides cost cutting in a hundred different ways (that you have to continually update your QC spec for), what else do Chinese manufacturers love to hit you with?
Price increases!
“Decisions were made by committee, and prices were always agreed to in advance of any green light for a production run. Bernie was sure to confirm prices with the factory before confirming his own pricing with his customers, but then right after Johnson Carter received its order from the retailer—often just days before he planned to wire transfer funds to China—the factory would notify Bernie of a slight price increase.”
And yes, this is absolutely the median experience. Bernie is hit with this all the time, in a number of different ways, and it’s really business-endangering, because Paul is not doing his job and disintermediating the risk by having multiple manufacturers or creating personal levers he can pull on with the owners.
Despite running ever-larger volumes and doing great on the business development front, Bernie takes a net loss in some time periods due to shenanigans like this. Because he’s quoted one price to his customers, and any changes have to go through a committee, he has to eat whatever losses appear due to manufacturer price increases or quality issues. And obviously, his real problem was expecting Paul to I don’t know, actually do his job and take some of these risks away, but Paul kinda sucks.
Still, it’s an education, because this is indeed how it usually goes. This is because the risks are assymetrical. What are you going to do? You can’t sue your manufacturer for quality problems:
“China manufacturing had no concept of punitive damages or penalties for bad behavior, which was another contributing factor. If (or rather, when) the factory was caught in some scheme to manipulate product quality, the only thing that the factory could be expected to do was remake the product properly. The importer would never be reimbursed for damages arising from a loss of business or reputation. The only cost to the factory for getting caught with their hand in the cookie jar was being made to put the lid back on the cookie jar.”
You’re leveraged already, and have made promises to your customer, and all your decisions are time dependent and you bear all the reputational and financial risk:
“Johnson Carter assumed a great deal of risk. On all of our orders, the factory insisted on receiving full payment—in cash—before it shipped out any product. While the importer paid the manufacturer in advance, its retailers in the United States received credit terms.
As many as six months passed between the time that Johnson Carter paid the factory and when it received payment from the retailers. If at any point a problem was discovered, a retailer could stop payment, leaving the importer stuck with a loss. Worse yet, the retailer could also charge Johnson Carter for labor associated with removing product from store shelves, as well as the cost of transportation and warehousing. ”
And because there’s no real legal remedy, the factory can only benefit from these shenanigans, as long as you discount transaction and search costs of finding new customers:
“Our job in the cat-and-mouse game that the factory had set up was to discover where the product was being manipulated. If we found the distortion, the factory might be convinced to revert to the original design. If we failed to uncover its scheme, the factory pocketed the savings. In any case, it was left to us to do the uncovering. The factory gained sometimes, but it never lost.”
Finally, even if you got the manufacturer to assume liability for some particularly egregious mistake, their downside isn’t all that bad:
“If we rejected a large shipment of our shampoo, there were agents who would help move the product out of the country into one of many growing export markets. And even the domestic market had developed to the point where an agent might be able to find buyers of surplus inside China.
One of the many reasons that quality problems were on the rise was because of this increase in salvage opportunities. Knowing that there was somewhere to dump product from a quality manipulation plan gone awry actually helped increase the likelihood of production shenanigans.”
There’s basically no downside to doing this, for the manufacturer, and a good bit of upside. Why wouldn’t they do this all the time?
Problem solving in China is as much about your relationships as it is about the literal problem. Paul illustrates this with a story of a broken toilet in a “5 star” hotel4 he’s staying at:
First pretend to fix it and leave
Then suggest it makes a noise, so it’s not completely broken
Third try to actually fix it
Fourth give up and ask if the guest can just live with it
Fifth accuse the guest of breaking the toilet
Sixth when asked if a five star hotel should have working toilets, offer a number of unconnected excuses
Seventh ask if there’s anything else the guest needs
Eighth mention as an afterthought right before leaving that the hotel engineer who understands the entire plumbing system will be back at work tomorrow, and he couldn’t be here because it was his day off today
“Why such a basic piece of information came only after so much wrangling was anyone’s guess, but then the entire process of solving problems in China was itself an enigma.”
I mean, it’s just a different approach, but I agree this is a fine representation of the usual problem solving process. Face and reaching mutual understanding is generally seen as more important than actually solving any problem, and this is where good personal relationships shines, which he never actually establishes with his factory owners.
Another great technique you’ll see - subtle misunderstandings, that are always in the manufacturer’s favor. In one of his (non Bernie) stories, he gets some metal tubing made, and the manufacturer quotes 1.9 on the phone, but bills 1.99 on the invoice.
“The difference between 1.9 and 1.99 was almost 5 percent though, and it was a problem. His anticipated gross profit had been closer to 10 percent.
While I worried about Doug, I could not help but be impressed by what this industrialist had done. Nearly half of the expected margin had been wiped out with just a single turn of phrase—you heard me wrong.”
Then they nail him again with meters vs feet, quoting in 10 foot lengths, but billing in 3 meter lengths, which is another 1.6% haircut. So before any problems or costs with anything else, the guys 10% margin has been cut to <4%.
On nobody actually knowing what is in any of our products
Some of the more paranoid-minded among you out there may have been thinking as you read this “wait, if the manufacturers change formulations and things willy nilly, how do you know the stuff on the ingredient list is actually in there, or that bad stuff ISN’T in there?”
You don’t! At all. Nobody does, except maybe the manufacturer, if they’re tracking it, and they’re probably not because that would be proof they were intentionally altering it.
There are many entertaining asides in the books about the ph coming in wrong in various products, of the products gelling into a sort of solid when exposed to cold temperatures, of them not containing the actual ingredients, of having to find the most open minded and compliant “testing labs” and sending multiple samples to get back even one verifiably good testing label they can share with customers, and so on.
Our author Paul Midler eventually gets so disenchanted with quality fade and the fundamental lack of knowledge and trust regarding what’s actually in the products he’s getting made that he personally stops using soap and shampoo:
“I found myself using less body wash, eventually relying on only hot water for my showers. When no one seemed to notice the difference, I stopped using the wash altogether. And then I stopped using soap, as well. This was not a conscious decision, but in the back of my mind, I had begun to think: Why take any chances?”
And this should really come as no surprise to us, given we’ve lived through melamine in pet food, melamine in baby formula, lead paint on Mattel toys, and much else in terms of “recall scandals.”
To give you an idea how ubiquitous this is, the factory that used lead paint on Mattel toys was owned by a very successful Chinese guy, worth at least one USD billion, who had a 15 year relationship with Mattel. I’m sure heads rolled at the lower levels of his company after it came to light (and they *literally* did with the melamine in baby food company, Sanlu Group, several executives were given the death sentence or life in prison), but this just shows that it’s such an ever-present, routine thing that it happens all the time.
Why don’t we hear people worrying about this more? Optimism and lack of recency bias, mostly. There certainly aren’t anything like rigorous testing protocols. Any QC is up to the Western companies sourcing in China, and they’re going to be playing whack-a-mole like this all the time, and there’s no rigorous testing method to ensure something like “all the things on the ingredient list are here in the right proportions, and no bad stuff is in here,” that’s a pipe dream.
Midler explictly talks about this - the position of Bernie’s company is “we are 100% willing to test for whatever you would like to test for,” but because it’s expensive to do any testing, and because labs can only test for listed and specific contaminants, bacteria, or heavy metals, nobody ever takes them up on it. Testing one run of shampoo just doesn’t matter enough for anyone to actually do any testing over, and any testing is going to be a shot in the dark in terms of guessing about a list of bad things that might be in there, then testing for them.
And as we know, it’s pointless, because the as-manufactured formulation is going to change by the next production run anyways, even if the ingredients list doesn’t change at all.
This is also why we keep discovering things like lead and cadmium in cinammon and chocolate, and all sorts of fun things. You can only find anything retroactively, after you have an active suspicion, and can elucidate specific things to test for.
And if you think food is any better, I’ve got some bad news for you on that front, too.
So yeah. We don’t know what’s in any of our products, NOBODY does, not the companies listed on the bottle, not the middlemen, not the retailer, and probably not even the literal manufacturer, who if they did actually know, wouldn’t tell you. Oh, and everything is manufactured in China now. So, best of luck?
So what would have actually fixed some of the problems here?
Paul sucks, but we don’t have to. You’re still going to run into problems, and be fighting a constant battle - but that’s life generally. Here’s the stuff that he should have done that he didn’t:
Create your own rigorous QC spec, and staff your own QC people in each one of your factories to make sure the spec is followed, and continually update this spec.
He should have divided his total manufacturing volume into thirds or fourths, and spread them across multiple manufacturers. This is smart anyways - then you get the cheaper honeymoon period, before all the price increases, 3-4 times instead of just once (this is what Walmart did for a few decades, moving around to different manufacturers quoting honeymoon prices so they could say they manufactured for Walmart). Also, now you can move product lines from one to the other, as you run into problems or as a negotiation point with other factories.
He should have gone to the trouble to establish personal, long-standing relationships with his factory owners such that they would actually do him favors or give him a break sometimes. He was in China, living in the same city as them, *anyways.* The fact that he DIDN’T do this is mind blowing, and I chalk it up to not wanting to socialize the ways they probably wanted to, mainly because he thought it was icky or low class or whatever. But man, way to screw your own customers, as WELL as totally giving the finger to the culture you’re supposedly fond and admiring enough of to immerse yourself in for decades. The business culture in the country your business is in, that you are trying to portray yourself as an expert in!
He should have looked for leverage points and used them when available - he has an extended story where the factory owners build a brand new, much bigger, state of the art factory a mile or so away from their first one, enabled by the volumes and money Bernie was putting through them. Instead of identifying and using this obvious leverage point to bargain against future QC problems or price increases, or to use this as an obvious take-off point to find an additional manufacturer and maintain some of that leverage, he and Bernie just throw up their hands and despair that the owners are obviously going to be raising prices on them even more in the future to pay for that new factory. But the factory owners are in the weak position right now! They have a half-built, expensive new factory with ZERO ORDERS, and you’re the main source of those orders for the future, and are also covering their cash flow in the meantime. This is definitely the time to use that leverage and nail down some points in your favor, on multiple fronts.
Still, overall a fun book, and I’d recommend it for anyone interested in what sourcing in China is like.
And this is still true - look up the price of a top-spec iPhone or M3 laptop by country. Look up the cost of steaks, or fine cheeses, or wines. Look up the cost of cars! You’ll generally see the USA coming out notably ahead of everyone else, and despite the unmistakable enshittification of Amazon, the quality in America is generally higher than anywhere else because of more rigorous QC practices and standards from US-based retailers.
“The United States was one of the wealthiest economies in the world, and yet Americans paid less for their products than consumers did elsewhere. It was in fact one of the great ironies of the global economy. Products that retailed in the United States for only $1 in a U.S. dollar store could be found in the developing world selling for $2 and $3, and it was one reason why tourists from poorer economies took their trips to the United States as shopping sprees.”
“An example in counterfeiting illustrates how some manufacturers took advantage of the arbitrage opportunity in an outright sense: A manufacturer accepts an order for 500,000 pieces from a first-market importer that produces a unique design. Rather than merely fill the order, the supplier keeps the machines running and its people working until it produces a total of 700,000 pieces. The original customer gets his order for a half-million pieces, and then the factory sells the surplus of 200,000 pieces at a considerable markup.”
This is also the source of the best quality counterfeit stuff that you find in China itself. As Midler points out, it’s a common rite of pilgrimage to go shop for fake watches and purses and jewelry when you’re there, and the top grade fakes are basically indistinguishable from the real thing because often they were run on the same production lines. And the price multiple is once again mind blowing. Like $4k+ purses indistinguishable in quality for ~$40-$200. Jewelry and watches at that price tier will actually use base metals, though, you’ve got to be paying a little more for those.
You’ll think I’m joking, but the Southpark “COVID explaining” Mickey + pangolin night out with Randy is preeeeettttyyy close what doing business in China is like. If you want a taste, just watch that episode.
Hotel star ratings in Asia are completely made up, there’s no reference standard or checklist you have to follow.