I was recently invited to address a conference for small- to medium-sized manufacturers who are considering how to cope with low-cost competition from China. These companies are too small to easily build a presence overseas but must still face the realities of competition from China. More and more American companies find themselves in this position. Considering China’s population (1.2 billion people) and rate of economic growth, this trend is not likely to be reversed anytime soon.

Sourcing Items in China

One response that will make sense for many companies is to take advantage of lower costs in China by sourcing components there and/or developing long-term relationships with Chinese manufacturers (via contract manufacturing arrangements or joint ventures). Before making a few comments about working with Chinese manufacturers, allow me to make a point or two relative to this overall strategy. Simply put, whether your competition is from China or elsewhere, in today’s economy, if you compete on price alone, chances are you will be in trouble soon enough. Markets move too fast these days for you to stay in a commodity business unless you have huge market share and can sustain economies of scale. Even if you begin to source components from China, you ought to consider adding a few other components to your strategy.

Moving Up the Value Ladder

As competitors attack low-cost products, are there more value-added products in your market segment that you could produce? To put it another way, though you might buy a Chevy from China to resell to your customers, can you make a Cadillac — or, better yet, a custom-designed, juiced-up, high-performance vehicle — for your customers? Not all companies will have this option, but the point is that you should look for ways to use the advantages you have over your Chinese competitors in terms of technology and customer relationships.

Focusing on Services and Distribution

One way to add value for customers is to provide services built around your basic products, including maintenance, custom design, inventory management and favorable distribution arrangements. The trend toward value-added services among manufacturers is already well under way in America. For manufacturers facing stiff competition from overseas, now is the time to think about how you might join that movement.

Working with Chinese Manufacturers

Approaches for sourcing in China range from spot purchases to long-term contracts to joint ventures, and may or may not include technology sharing or joint market development within China as well. While this column does not afford me the space to discuss the full breadth of issues related to sourcing in China, I would like to make several comments on this practice.

Payment Terms
Chinese companies can be reluctant to grant credit, particularly because collecting can be such a problem in China. Still, you should not pay upfront for products you have not had the opportunity to inspect, or for products coming from suppliers you don’t know very well. This sounds obvious, but the number of companies that commit this error would surprise you. Use letters of credit or other payment terms that protect your position.

Quality
Quality can be very spotty out of China. The first few shipments are often good, but then things tend to go downhill. Be sure you have a mechanism for monitoring quality that covers you beyond the first few shipments.

Supplier/Competitor Intelligence
If sourcing product in China is going to be a major factor in your production process, you are going to need to invest resources to make it work. You don’t want to be beholden to one Chinese company that may eventually find another partner, decide it doesn’t need you, fail to perform or otherwise disappear. Get to know as much as you can about Chinese manufacturers in that market segment. Understand their capabilities, their customers and their plans. The more you know, the better you will be able to react to changes in the competitive environment.

Multiple Sources
It follows from the above that you will be better off if you can find multiple sources in China. Companies that follow this practice domestically often fail to do so in China because of the extra effort involved. Don’t make this mistake. Unless there is a compelling reason to lock yourself up with one company, you should spread things around the same as you would domestically.

Supplier/Partner Evaluation
I could write a book on this subject alone, but here are some basic points. Under communism in China, all companies were owned by the government and were called State-Owned Enterprises (SOEs). As China’s transition to a free market economy has proceeded, private companies have become more prevalent. Today, some traditional SOEs remain, along with plenty of private companies and some hybrids. In general, the private companies are preferable. They understand capitalism better, which is generally reflected in the way they do business. You should not rule out SOEs, but you should be aware that they tend to be bureaucratic, unresponsive and undercapitalized. Regardless of which type of company you work with, if the relationship concerns an important component and requires a long-term commitment, you should be prepared to invest the time to get to know them.

Technology Sharing
Low-cost suppliers have a way of becoming low-cost competitors. With or without your help, the Chinese will improve their technical capabilities — but you shouldn’t help them unless it makes sense for you. Don’t teach someone to make your product unless you are absolutely sure you can protect your market position in the U.S. via your brand, service, distribution or by other means. A contractual agreement is not enough to keep a potential competitor from attacking the domestic market. Make sure you have a competitive advantage.

Pursuing the Chinese Market

If your agreement with a Chinese company includes joint pursuit of the Chinese market, keep in mind that most American firms in China make the mistake of overestimating the size of the Chinese market. You will need to do careful market research to avoid this problem. In addition, if your plan is to license your technology and then sit back and collect royalties on sales in China, think again. You will need to be engaged to protect your position. The danger is that you will give too much away in the hope of future revenue in China. You will need to do your homework and commit the resources to make sure those future benefits materialize.

It’s not a comfortable position, sitting in America and watching the competition gain on you, not knowing how to respond. I wish I could tell you it will be easy, but I can’t. Some industries in America will be radically restructured over the next decade due to competition from China. Now is the time to begin planning your response. You might need to rethink your business, and you will probably have to begin learning about China. In the end, many companies will learn, evolve and thrive. I hope yours is one of them.