Doing Business in China - Doing due diligence and avoiding scams

While many Chinese factories are modern and automated, some are not. New Zealand fire detection equipment manufacturer Pertronic Industries warns that some of China's manufacturers can appear very impressive on the surface, but the quality control is abysmal and products are shoddy.

To ensure you are talking to the right manufacturer take on board advice from Alibaba.com, use local experts and get credit checks done.

Alibaba.com recommends the following steps:

examine their financial health, production capacity, quality of goods, client references, export history, intellectual property performance and level of experience with Western companies
compile as broad a list of potential factories as possible
get product samples - shoddy quality or unreliable delivery should immediately eliminate candidates
narrow down the field to three to five suppliers that look good on paper and produce good-quality products at a satisfactory price
order a detailed factory audit in China.

The last step is for your company to make a detailed, second-level assessment that integrates buyer requirements into the evaluation. This process usually rates the candidate as a whole, including all business practices, with a specific grading scale for each set of criteria. Your company can then either choose one candidate or start a bidding process between the potential suppliers on your shortlist.

Ask questions such as:

Does the Chinese vendor run its own compliance checks on quality control and have sufficient oversight?
Is the Chinese supplier likely to outsource the order? Second-degree outsourcing makes it more difficult for companies to monitor supplier quality and ensure that there are no environmental, health, safety or child labour violations in the manufacture of its goods.

(BPMC. (2004). Sourcing from China, Part 3: Assessing the costs. Hong Kong: Alibaba Group.)

Always visit the candidate factories before making a final decision.

Use local experts

Kiwi Scott Brown of China-based RedFern Consulting says simple checks can be made in China through companies such as RedFern that are capable of verifying the credentials of Chinese businesses and business people.

He also suggests:

where possible get public information from government agencies and other authorised bodies such as law firms
do a legal background check to ensure that ownership, structure and registrations are clear
consider contingent liabilities. Who really owns the shares or the parent company? Who really owns the land and what kind of rights do they have to it? What may seem reputable may often not be
meet company managers and judge their willingness to open their books, answer questions and provide legal documents. If a company is nationally reputable, or exports to large foreign clients, it will likely have been through this before
if the company has international clients, ask for the list and double check it
for quality assurance issues, you can use independent third parties to do an audit.

Do not trust financial data unless you have had this physically audited by experienced professionals. It is very common in China for local firms to carry multiple sets of accounts for tax or “management” purposes.

China-based consultancy Dezan Shira & Associates suggests getting a Capital Verification Report to check how much of a company's registered capital has actually been paid up. In China registered capital, one measure of financial size, isn't automatically paid up just because a business licence has been issued.

New Zealand Trade and Enterprise (NZTE) can provide a list of agencies capable of doing due diligence or seek recommendations from China veterans.

For background on Chinese business culture and ethics, see Dealing with China's culture and business protocols.

Get credit checks done

The four big credit rating agencies - Standard & Poor's; Moody's; Dun & Bradstreet; and Fitch Ratings - are all present in China and/or Hong Kong. There are also some local rating firms such as Xinhua Far East China Rating, Chongqing Business Credit Investigating and Consultation Centre and Huaxia International Credit Group.

NZTE can provide referrals to companies that can be commissioned directly. The work is out-sourced to local credit companies. The cost can range from a few hundred to a few thousand dollars depending on what is requested, the speed the report is required, the location of the company being checked and how much information is provided on the Chinese company.

For more information on sourcing a manufacturer see Choosing a manufacturer for your product.

How to avoid scams

As with many developing countries, corruption and scams in China are not uncommon. And while the situation is improving, anyone operating in China needs to be on their guard. In Transparency International's 2008 Corruption Perceptions Index, China scored 3.6 out of 10 (a mark of zero represents highly corrupt) and ranked 72nd out of the 180 countries surveyed.

As well as putting your integrity on the line by getting involved in scams or corruption, you are exposing yourself to severe penalties because the Chinese Government is cracking down on corruption.

How to deal with unsolicited enquiries

Only a small percentage of Chinese trade enquiries are of a dubious nature. Most are genuine enquiries that do not make unrealistic demands. NZTE is able to provide information on commissioning a report on the Chinese company if New Zealand exporters believe the trade opportunity is genuine and want to follow up independently.

It's common for first time exporters to be convinced that they have found the right partner through an email contact or an internet trading portal. There are innumerable cases of businesses transferring 'spotter-fee' funds to China and finding that nine times out of 10 the receiver of these funds has given a false address and pursuing them would be futile and very expensive.

The important point is not so much that all cold contacts are scams but that due diligence, checking on bona fides and credit worthiness, is vital before entering any transaction in China. Relying on an online site or an email contact to provide this is very unwise.

Points to consider when you get an enquiry include:

Does the enquiry fit your company strategy in terms of market and the sector within the market?
Is the suggested market entry strategy one that has been used by you in other markets?
How much does the enquirer appear to know about the China market, and about the details of entry and of the various legal requirements?
How much do you know about exporting and specifically about exporting to China?
Is your brand protected in China?

Some simple checks can be done to attempt to determine the credibility of the enquirer. If the enquiry comes from China:

look at the email address - the address of an ISP or a portal (eg gmail, hotmail, yahoo, sina, sohu, 123.com etc) often indicates a new or small company or an individual calling themselves a company, or an individual using a legal company's name
check the company name on Google - even if the site is all in Chinese that is a start
insist on the Chinese company providing a copy of their business licence as well as full contact details
ask for details on the company's trading history, including products and markets
ask for their experience
ask for references from other companies they have dealt with in New Zealand and internationally
do not be afraid to ask the hard commercial questions (eg how will you remit the funds to me).

Who can help?

NZTE has three offices in mainland China - Beijing, Shanghai and Guangzhou. Through its network in the region, NZTE stays up to date on scams and other market intelligence.

DiligenceChina.com has a list of sample due diligence questions to ask and tips on reference checking.

It also has advice on conducting due diligence on lawyers, accountants, business entry and HR consultants, business process outsourcing, and sales and marketing consultants.

Related Information:

› Dealing with China’s culture and business protocols

› Choosing a manufacturer for your product

Related Kiwi Lessons:

› Minimise risk
› Make sure you get the right partner

Access PDF resources here

Doing Business in China - Making the most of the free trade agreement