08 Sep 2020 Sourcing in Mexico vs. China: Differences as Vast as the Ocean between Them
By Jeffrey Cartwright, Managing Partner | 8 min read
Practical differences in the law and its application pose potentially serious consequences for businesses sourcing in China.
China continues to occupy news headlines as the country’s system of government and law are substantially different than the U.S. Whether it’s Uighurs imprisoned in re-education camps, the imposition of national security laws in Hong Kong, the great firewall of internet censorship, or Huawei and Tik Tok posing a threat to national security due to the potential of spying on individuals and corporations on behalf of the Chinese government, one thing is clear. The way of life — and business — in China is vastly different.
Our purpose is not to discuss these social, human rights or national security concerns. Rather, it is to identify the practical differences in conducting business in China compared to the U.S. and Mexico.
INTELLECTUAL PROPERTY protection (patents)
Intellectual property is a hot topic in international business and has been for some time. While China is making progress on this front with new courts established to resolve disputes — foreigners winning many of these suits — it is important to understand the difference in patent laws.
China follows a first-to-file system for patents. Conversely, the U.S. system is based on a first-to-invent (prior art) system. Let’s look at this example:
My company had been producing folding metal chairs for more than 60 years. In the early 2000s, the decision was made to move production of the chairs to two partner factories in China and shut down the existing production lines in Indiana. We experienced some quality and cost issues with one factory and made the decision to move production to the other factory. When notifying the owner of the first factory of our intent to move production, he promptly said that it was impossible as he had patented the products in China. The owner claimed that he had made improvements to the products, such as changing the degree of rounding of small parts of the product, and therefore, it was not the same product that we had moved to his factory a few years earlier. In reality, these changes were cosmetic and minor and executed without our permission.
In the U.S. system, the factory owner’s claims would have been invalid because of the 60+ year history of the product. His claims were upheld as we did not hold patents on these products in China, and we were consequently unable to move our production to the more cost-efficient factory.
This situation could have been avoided had our company immediately filed patents in China when we made the decision to move production, or if we had signed a specific contract with the factory owner stating that the design remained ours.
OWNERSHIP OF TOOLING
When sourcing products in other countries, it is customary that the buyer of the product purchase the tooling for the factory to use in the manufacturing of the product. In the U.S. and Mexico, it is understood that the tooling remains the property of the buyer; therefore, should there be any issues, tooling can be transferred to a different factory.
The same does not always hold true in China. For example, our company developed a unique design of a hardware product. In this case, we had learned from the patent example above and we obtained patents in the U.S. and China before locating a factory to produce the product. During the start up at the chosen factory, we encountered many difficulties and, after several trial runs, decided to move the tooling from the factory in the Guangdong province to one of our partner factories in Fujian province.
Upon sending my director of international sourcing to China to meet with the incumbent factory owner to inform him of the decision and the need to crate the tooling for shipping to the partner factory, we encountered another difference in our legal systems. The factory owner claimed that ownership of the tooling was his instead of ours. After quickly consulting with Chinese attorneys, it was discovered that because we did not sign a specific agreement with him before the tooling was purchased, ownership was, in fact, his. The principle in ownership is that the tooling was purchased for the benefit of the Chinese people in the area (to provide employment) and as such, we no longer owned it.
This story does not end there. We purchased new tooling and successfully manufactured the product at the partner factory. One year later, while attending a Trade Show in Germany, the first factory owner was informed he could not display our product because it was patented. He asserted that our patents were filed in the U.S. and therefore unenforceable in China. Our Chinese attorneys informed him of the patents in China, and he withdrew the product from his booth. In this case, our intellectual property was protected.
thin, blurry line between civil and criminal
Bankruptcies, which are generally considered a civil matter in the U.S., may not be considered as such in China. In 2012, North Pole LLC, a U.S. company operating manufacturing plants in Bangladesh and China, filed bankruptcy. After filing, the CEO traveled to his manufacturing plant in Xiamen. As is typical during a bankruptcy, incumbent suppliers are not paid pending decisions in the bankruptcy court. The CEO was detained and his passport confiscated, preventing his return to the U.S. The United States Embassy in China was unable to resolve the issue, and his detention lasted nearly a year.
In China, bankruptcies are becoming more common. However, in 2012 they were not, and the assumption of the government was that any financial difficulties resulting in unpaid debts as a result of the bankruptcy process must have been due to illegal practices and criminal activity.
On the contrary, in the U.S., any mistakes that might have been made resulting in financial problems and bankruptcy are generally civil in nature. In China, there is a thin and blurry line between civil and criminal accountability under the law.
bribery in china
Perhaps, the blur between civil and criminal cases is because the norms of acceptable behavior vary between China and the U.S. According to a Charney Research whitepaper, bribery (official corruption) in China is widespread. A Charney Research poll (the first reliable, behavior-based data on official corruption in China) found that:
- Some 35 percent of companies in China say they have to pay bribes or give gifts to officials to operate.
- Officials have their hands out most often around Beijing, the capital and in the richer regions.
- Corrupt payments are more frequent among foreign and Hong Kong firms than among mainland companies.
- Corruption is the worst in real estate, followed by manufacturing.
- Local officials and tax collectors get corrupt payments most often.
- The chief reason offered for corrupt payments is competitive pressure.
- Most firms want more action against corruption – they don’t like it.
BENEFITS OF OPERATING IN MEXICO
Although there are differences between operating in the U.S. and Mexico, there are not issues involving the gray areas of intellectual property protection, ownership of equipment and tooling, and the blurry line between civil and criminal corporate behavior. As to the issue of bribery, there is corruption in Mexico, but rarely does it exist with U.S. business. The Mexico business culture is very integrated with the U.S. and as such, U.S. norms are the rule, not the exception.
shoreview management advisors and the mexico strategic sourcing alliance
Shoreview Management Advisors is uniquely positioned to bridge this cultural divide and close the gap in capabilities and execution. We have experience building multi-billion-dollar supply chains in China and operating manufacturing plants in Mexico for major U.S. marketing and distribution companies and have established strategic partnerships that bring unique capabilities in Asian sourcing and logistics including ocean freight, customs, overland transportation, and 3PL distribution.
- We have assembled a strategic alliance of companies that provide an engineering-based approach to sourcing with more than 20 years experience transferring products competitively to Mexico.
- We develop a thorough understanding of the specifications and required performance of the product with our clients. If required, we will assist the factory with qualifications and introduce the client companies to independent, third-party testing laboratories in Mexico.
- We perform supplier market research in Mexico to add to our list of highly qualified manufacturers. If necessary, we will reverse engineer the detailed product design from samples and create detailed bills of materials.
- We work with Mexican manufacturing companies in multiple ways to reduce their client costs and achieve competitive pricing. As part of this, the Alliance can provide a full analysis of the Total Delivered Cost, as well as an analysis on the reduction in working capital due to being closer to the factory. If necessary, we source components from Asia and import them into Mexico as part of the total supply chain.
- We can handle customs and duties, as well as delivery of product to the customer warehouse in the United States. In short, we provide a complete sourcing alternative to China which nearly always results in lower delivered costs to your distribution centers.
If you are interested in making the move from China to Mexico, contact us today to learn more about our expertise, and how we can help you make the decision that is best for your bottom line.