Inflation is in full swing in China.  A few weeks ago with little fan fare, the PRC canceled a leading inflation indicator, the Property Price Index.   In China today (March 2011), inflation is easily seen at the gas pump and the grocery store where prices continue to rise.  Every person in China is or will soon be affected by the upward price pressure.

Inflation in China is significant and important to you because it will inevitably be exported to your local shopping center.  As a manufacturer or an importer, the rumblings have been heard for several months if not years.  However, since 2008 it’s been managed by a terrific decline in trade volumes and a credit squeeze of historic proportions.  With colossal government stimulus packages now in the world economy, inflation is more likely than ever to become a lingering issue.

Inflation is also a significant weapon being deployed in a geopolitical and economic scrap between China and the USA.  There are many weapons, but inflation is the most contagious and will cause the highest civilian and business casualties.

The world economy will be worse off in the coming years as countries blame each other for their continued economic woes; China to USA for printing money to get out of debt and USA to China for its under-valued currency regime to spur exports worldwide.  One thing is clear the imbalances of the past canNOT be maintained.

The table is set for another economic blast as we enter the final stages of economic mania in China.  While at the same time we still cope with a massive hangover from a USA sub-prime loan bender propelled by fraudulent security ratings with worldwide distribution.

A quote from a leading financial historian, Charles P. Kindleberger in his book, ‘Manias, Panics, and Crashes’ is appropriate;   ‘Let us grant that swindling grows with prosperity.  It increases further in financial distress from a taut credit system and prices that stop rising and begin to decline.’  With inflation, manufacturing margins will be further gnarled and manufacturing ethics will be increasingly challenged.

So what does this have to do with sourcing, manufacturing and supply chain in China?  It has everything to do with it.

This scenario puts further pressure on the already challenged Chinese manufacturing and supply chain.  As raw materials become more expensive the need to come up cheaper production methods and materials will increase.  Long standing compliant companies will soon explore alternatives; many at the clients expense.   They will be forced to raise prices.  If history is anything to judge by we are in for another wave of sub-par or even dangerous production.

The status quo is changing and with it you need to be prepared.

In a previous post we discussed that punitive damages and recourse in international trade is very limited.  All countries have protected their domestic producers to some degree.  Some argue China has been fair with foreign companies and trade issues.  Others make very compelling cases that there are major faults in the China legal system and fair treatment cannot be relied on.  In the best of times accessing liability in international trade is hard.

However, as briefly examined above, we are not in the best of times.  In fact, we are in a state on economic war.  When the survival of domestic jobs is in question, what recourse or court judgment can you expect?  In a state of rising costs, what future discount can you hope for?  If the company is in severe financial distress, how can they pay your claim or give a deposit back?

We are entering a very challenging stage in the international trade cycle.

The fact is your claim recourse in China is diminishing day by day!  In addition, erosion of quality is a reasonable expectation when margins and profit are desperately challenged.

What to do?  How can an importing company defend itself?

As imbalances get corrected, there will be more opportunity to buy locally at competitive rates; logistics will be more expensive internationally.  Keep an eye out for emerging local companies that are now competitive.   This change in the international trade model will provide opportunities in unusual places; some will be next door.

If your products will be competitive from China for the foreseeable future, then pay even closer attention to the methods and materials used; even from your best suppliers.  Start to strengthen your inspection team and support manuals for production.

‘An ounce of prevention is worth a pound of cure’; get it before it ships!

The future of international trade from unregulated markets is ever increasingly Caviat Emptor or “let the buyer beware”!  The disincentive to follow specifications is getting larger!

Conventional wisdom suggests buying direct from a manufacturer is the best way to achieve the lowest cost.  This is a perception that continues today.   However, we are now exporting from unregulated countries into fiercely regulated ones.  There are significant front and back end risks with remote control transactions in unregulated markets.

In countries with a well established regulatory systems and consumer protection laws, manufactures have to be compliant.   There are punitive damages associated with cheating on ingredients and false claims on products.  Manufacturers are sitting targets; easy to trace, hard to move over night, asset heavy and with much more to lose than a few pennies of savings.  Subsequently these manufactures learned to obey the laws and the consumer was somewhat protected.   Under this model the buyer could focus on sales, while the manufacture focuses on meeting regulations and addressing market conditions for the products they produce.

In the 1990’s and ever increasingly in 2000’s two worlds collided that dramatically change the landscape of the world economy.   The two worlds are China and the Internet; and they were made for each other.

The continued developments in these two worlds, and the success stories surrounding both, have eclipsed the news of the casualties suffered in its wake.   The true issues associated with rapid development and wealth creation in an unregulated market did  not come as a surprise to those of us who have been raised in the Asian boom over the last 20 years.  Some of us have visited 100’s (if not 1000’s) factories first hand.  We knew there were issues looming… some of which would turn out to be fatal.

The result is that a purely price driven buyer (who never even stepped foot in a factory or if they did, had no idea what they were looking at) and a happenstance manufacture who filled the new buyers orders below budget are now in charge of the worlds supply and distribution chain.

To the unprofessional buyer, the products ingredients and process are not a function of the price.  That requires more work on the supply side.  The unprofessional buyer focuses only on the sales side and leaves the manufacturing to the manufactures (old model).  This buyer’s main concern is price and market share (based on prices it can get).

However, this new world buyer is forgetting he is dealing in an unregulated manufacturing market with no punitive damage laws.  That is, there is no recourse other than future business to subjugate the supplier to following regulations and specifications.

Without a real understanding of exactly when, we now have reduced lifespans for nearly all consumer goods.  This new supply chain has also distributed products that put poison on the shelf;  resulting in dead dogs in the USA and toxic Barbie Dolls.

In China and other Asian countries the results of unregulated manufacturing and purely price driven decisions based on uneducated and unprofessional buyers where even more devastating.   The food chain became infiltrated with chemicals known to cause ill effects and even death.  These chemicals were even put into milk and baby food.  Some of these companies had foreign shareholders and buyers for export.  Our food chain become seriously contaminated.

It is not a great leap to assume, if an unregulated manufacturer is willing to poison a baby or put down my best friend Rex, he just might, in the pursuit of a higher margin; switch the MDF, veneer, grade of wood, alloy, thread count, tempered glass quality, steel manufacturer, face yarn, adhesive, silicon brand, brass content, increase the surfactant content, reduce the flavor ratio, ignore the formaldehyde content and or otherwise ignore or alter your clearly defined specifications.  He may even have a counterfeit document to indicate compliance.

This is assuming of course the buyer even bothered to understand the process, materials and specifications of the products he is selling.  After all, this can get in the way of price negotiations.

The buyer’s lack of knowledge of what he is selling can be further exacerbated by the factories lack of experience and inability (or unwillingness) to hire qualified technicians and personnel that can formulate or understand the cause and effect of the degradation of materials on the end user of the product.  The unregulated manufacturing process and lack of punitive damages on suppliers locally and internationally make noncompliance all too profitable and common.

Even if one clearly defines the specifications there is little one can do from overseas or by remote-control.  Often the exporters local regulations are insufficient (non-existent) to protect the consumer and the buyer.  In most cases, if not all, the manufacture already has a sufficient deposit to make even the most vigilant importer ask himself if even wants to know.  After all, he did not produce it… he just sold it.

So how does the professional buyer address these issues?

Buyers need to protect their customers and their future through proper on site due diligence with skilled and knowledgeable manufacturing professionals.   In essence one needs to appoint there own regulators and or professional on site buyers.