As a fix-it man for overseas importers and retailers sourcing from China, Paul Midler, a Chinese–speaking Wharton MBA grad, gained a unique perspective into the Made-in-China story. That experience, during which he worked with hundreds of Chinese factories, made him an eyewitness to the manipulation of product quality by factories and the other ways in which they bamboozled overseas businessmen and partners. In an interview to DNA Money’s Venky Vembu, Midler, author of Poorly Made in China, reveals the dark secrets of the Made-in-China story. Excerpts:
From your experience, how widespread is the problem of ‘Quality Fade’ with manufacturers in China?
It’s very widespread. When there was a problem with lead-painted toys coming out of China in 2007, the media said, ‘China has a toy problem’. When there were problems in China’s dairy industry, they saw it as a ‘dairy problem’. When it was tyres, they said, it was a ‘tyre problem’. There were others: toothpaste, petfood…
The problems in those specific areas came out of a certain behaviour among manufacturers in China. The instances of quality failure in the headlines are not the root problem, but the symptoms of the root problem, which is a certain attitude towards business, customer service, business ethics… the question of how you conduct yourself with somebody who is considered your partner. And that is something China is struggling with.
In the book, you call it a ‘China problem’.
It’s a problem that’s common in China, but that doesn’t mean China is the only place that has these problems.
Why did not these ‘symptoms’ – lead-painted toys and melamine-tainted baby milk powder – serve as a wake-up call for foreign importers as well as for Chinese manufacturers and the government?
People in the West don’t want to believe there’s a problem in China. They try to brush it aside and make excuses for China. These are people I call “China enablers”: those who enable bad habits and patterns of behaviour. In this instance, the US, as a big buyer, should be doing more, but instead people are making excuses for China, saying, ‘Well, China’s not developed enough’, or ‘They’re poor’, or ‘They were forced to do this’. This doesn’t help the situation. The factory owners and the China manufacturing industry don’t want to ‘lose face’, and people who deal with China want to be polite, so there are no frank discussions about quality in China. There’s nobody who thinks ‘What can do to make things better in China.’
Doesn’t the Chinese government have a stake in the gradual restoration of a brand image for the Made-in-China label? Where do they stand on the issue of ‘Quality Fade’?
There is in China a carrot but no stick. In the old days, which in China means about 20 years ago, the goal was to increase employment: factories were asked to hire as many people as possible; they weren’t concerned about profitability. And then the focus shifted to bringing in foreign currency. That is the sort of carrot the government put out there; they didn’t say, ‘We want you to do these things, but don’t do anything dishonest.’ The government understands that factories have to do certain things in order to conduct business. The government can stop it in an instant. This is a government that has no problem moving entire villages out of the way or in clearing large populations in order to turn cities like Beijing and Shanghai into showcases. So, it’s very hard to believe this is not in their control.
How much of the Quality Fade is because importers are trying to beat down the ‘China Price’ excessively?
If you’re dealing with someone who is unethical, and if you’re suggesting that that someone is unethical because the price is too low, my view is this: if they’re unethical at a dollar, they’re not going to suddenly become ethical for $1.20. The really unethical player would convince you to pay more and will still deliver bad products.
Let’s say a factory gives you a C-level product for a dollar; you want an A-level product for $2; instead of a C-level, you might get a B-level. But it’s still not the A you expect and are paying for.
Chinese manufacturers are savvy business owners. They operate in a tournament-like business environment: only the fittest survive. The factory owner knows how to prevent counterfeit goods from being passed on to him; in some cases, he may know how to engage in counterfeiting. He or she is very good at negotiating. I’ve a difficult time believing suppliers who say, ‘We didn’t know we bought things that had lead in it. We didn’t notice.’
I’ve seen factory owners, when they’re purchasing stuff, go piece by piece through things – because there’s so much corner-cutting in China…
Every manufacturing economy, from the US in the 19th century to Japan in the 1950s, went through a phase of ‘Quality Fade’. How is China different?
In terms of the quality, there is this tendency to compare China to Japan or Taiwan. I don’t think that’s what we’re seeing. The political environment in China may be contributing to it somewhat – I don’t say heavily; the Chinese government can change its mind at any time about anything. When you operate in an environment where you don’t know what’s going to happen tomorrow, you tend to think fairly short-term. And this has affected the culture of the manufacturing sector in China.
As someone who has visited hundreds of factories, what are the most common manufacturing ‘tricks of the trade’ you’ve encountered?
The business strategising aspect of China manufacturers is actually as interesting as the Quality Fade. Manufacturers are generally very quick to agree to certain conditions and terms: it’s part of the success of the China model. It’s not just that they quote low – low-balling on the bidding to win projects is common anywhere; what’s really striking about China is that you have operators that bid below any expectation of profits. In the book, I call it ‘Profit Zero’.
So, how do they find their profit margins? The key is to capture the customer. They know that down the road they can engage in some ‘price creep’, where the price will be ratcheted up in different ways. They do it just before the order can be produced, saying they need another 10%, which moves some of the profit margin from the importer to the factory in the short term. Then, over a series of time frames, they reduce the quality in small, incremental amounts that the customer doesn’t notice. In the meantime, they’re learning about the business. They say, ‘Maybe I don’t make any money on Customer A, but I can take this knowledge and information and I make money on Customer B.’ That’s also part of the business strategy.
There’s a willingness to move fast, they’re eager to please, they price low. Yet, a lot of American importers that go to China end up regretting it, because a deal with one of these factories is never as good as it is in the beginning. Things tend to get worse over time. That’s a bad sign.
If there’s hope for the China-US relationship, you’d think there’d be signs of the relationship getting better over time. With China manufacturing, it actually gets much worse over time. We’re being set up for being taken advantage of.
If that’s the case, why don’t importers switch manufacturers or countries? What about India, Vietnam, Bangladesh as alternative sourcing destinations?
India vs China is an interesting case, and before the book was written, I was listening to a lot of chatter about that. But one of the problems with India is lead time. Think about this: if China is competing with India in manufacturing, why are there so many Indians sourcing from China? I’ve had clients who are Indian, they could be sourcing from India, but they say they can’t wait six months for a product to be introduced.
There’s trade-offs between advantages and price. Vietnam is in a similar situation. The labour is cheaper, but unless you control your own production, it’s a nightmare to get anything done. No other country has put together what China has. Take China’s clustering phenomenon. You want to purchase knives? You go to a city where they have nothing but knives. I don’t know any other country that has not just economies of scale but levels of convenience.
China’s infrastructure is all set up, right down to a larger number of agents on the ground. In many cases these middle-men are the guys who are running the show: they make the decisions about where the product is to be made, and they are the real deflationary heroes, more than the factory owner who makes the product and the retailer who sells it. It’s he who keeps prices down, who threatens to move to another factory when things don’t go well…
But that never happens…
They say it all the time: it’s just a Western habit to bang on the table and threaten to walk away, but they never do. And the factories know this: they’re aware of American negotiating tactics. It never happens.
Also, in the past 10-15 years, there’s been a lot of disintermediation. Let’s say there’s an importer, who was importing $50 million worth of goods from China; one of his customers, who is purchasing $10 million, decides ‘I don’t need this guy, I’ll go to China myself and get better margins.’ Now, the customer who was importing $50 million worth of products from China is suddenly competing with five different customers who are importing products for $10 million each. That’s a proliferation of importers, and in such a situation your buying power shrinks. If I go to a factory with a $50 million order, my buying power is obviously stronger. If I show up with a $10 million order, my buying power is weaker.
These importers were made to think that things are so easy in China that they would somehow come out ahead. One of the factors for rising prices for American companies is that they are going to China with less buying power. And a lot of people who go to China directly realise it’s too late because they have already burnt their bridges with the big importer.
Why haven’t US consumer protection agencies, with their stringent regulations, been able to filter out low-quality goods from China?
One, these agencies are resource-constrained. The US Consumer Product Safety Commission, which is in charge of toys and things, just doesn’t have enough people. But even if they had, they just can’t inspect everything that comes into the US: the volume is too large. Most industries are self-regulated….
The other problem with these agencies is that when it comes to low quality, you have to know what you’re looking for. In China, you’re dealing with a partner who is not straightforward with you. A lot of counterfeiting goes on: the latest example of it is the Chinese Drywall, used in construction in the US, which is counterfeited, but although agencies in the US have been looking at it for months, nobody even knows what the fake material is. The Chinese aren’t helping either. If you don’t know what it is, how do you know what to look for? Now, with hindsight, everybody says, ‘Why weren’t we looking for melamine in milk?’ But a year ago, nobody even knew what melamine was.
When you send, say, a shampoo sample to the lab for testing, you can’t just tell the lab to make sure there’s no bad stuff in it. Labs charge by the screen, and want to know what screens to run. You have to tell them what you’re looking for. And each of those tests adds to the cost.
You also make the point that at some stage, some importers don’t want to know about quality problems.
Factories have their ways of making things cheap, and they don’t always disclose their production secrets. Sometimes we don’t want to ask. That way, we don’t know what they’re doing, so if something bad happens, we can say, ‘We didn’t know.’ But if we ask and we find out they’re using some chemical that’s not legal, we have a problem: now we know.
Why could not someone like you – who was on the ground in China (on behalf of importers) and who speaks the language, and who had access to factories –prevent Quality Fade and the other manufacturing tricks?
In matters like this, there has to be trust; there’s no other way to do it. For me to guarantee what’s in a shampoo, I shouldn’t have to stand in the factory on the days that they were mixing the shampoo, test every ingredient, ask them what they were putting in… There has to be a level of trust…
And you can’t trust Chinese manufactures?
I won’t say you can’t trust all the manufactures. But in China, it’s not just the number of quality failures that’s worrisome, it’s also the kind of quality failures. It goes beyond just accidents in the factory or negligence; it also goes beyond worker ‘laziness’ or a factory owner ‘cutting corners’. ‘Cutting corners’ is too benign an expression to describe some of the things that go on in China, where some people are going out of their way to ‘slip one past the inspectors’, as the melamine-in-milk scandal showed up. Not all the quality failures are alike: some of them are more unethical than others; but it doesn’t get any worse than the melamine case. Dozens of companies were involved, which means potentially hundreds of people knew about it. So why didn’t people talk? Why aren’t there whistle-blowers in China? It’s because employees don’t want their factory – or China – to lose face, so they think it’s better to sweep it under the rug.
You claim that the most bullish China analysts are the ones who don’t want to live in mainland China. What does the lived-in, grassroots experience of mainland China tell you that faraway analysts don’t see?
Right now, we’re in the middle of an economic crisis. When the book was being written, there was a much bigger gap between my understanding of the problems in China and the outside-in view of China as this paradise for investment or opportunity.
How do you have Wall Street analysts being so bullish on China when they’ve never seen what goes on over there and the problems there are in China? And when we’ve had some cautionary tales of people doing business and not succeeding, how can you acknowledge that it’s difficult to get things done in China – and yet hold this idea that there’s gold on the street? It’s quite a trick of the mind to be able to hold these two contradictory ideas.
One of my friends is a Hong Kong-based analyst. Like a lot of analysts, he talks about how he will be moving to Beijing (or Shanghai), but like a lot of analysts, he’s waiting for the “right time”. They never do it because in mainland China, the education system, the health system, pollution… it’s bad. It’s a huge irony; analysts are very happy to write about this fantastic phenomenon called China, but they just don’t want to be there. Something is not right here…
A great example is (US investor) Jim Rogers. He famously sold his Manhattan home and announced he was moving his family to China – because that’s where the global economic focus was shifting. Yet, after considering many Chinese cities, including Shanghai, Dalian and Qingdao, the ‘China bull’ finally settled in Singapore! There wasn’t a place in all of China that he would live in: can you imagine that! That’s the problem: there’s been a lot of bluster and a lot of boasting. You have to be a little frank with what you have here…
How did China change you as a person, and what lessons do you carry forward from that experience?
It’s one thing to say ‘China is bad’, and another to say, ‘China is good’. But I’m the guy who went to China thinking their way is better, and who when he first got to China, enjoyed being there, but who ends up saying, ‘This is not working. I can’t do this anymore.’ To that extent, I’ve been changed by it.
I was trying to see if there were any parallels for my experience, and I realised my experience was the opposite of the Dunbar character in Dances With Wolves, who initially is hostile to the Sioux Indians, but is gradually drawn to their lifestyle and customs. I went the other way.
People ask me what my motive is, whether I bear a grudge. My grudge – if you can call it that – isn’t against an employer or a factory. I’m not mad at myself for the time that I spent there. I just think there comes a time when you ask yourself how you can do what you’re doing. I’ve had talks with importers who had their doubts about the Quality Fade issue, but they just shut their eyes and hope for the best. Maybe in the beginning you can pretend a little bit, maybe you can pretend a litte bit more. But you get to a point where you say, ‘I can’t do this anymore.’
Under what circumstances did you move out of China and relocate to the US, and what are you doing now?
I don’t want to talk about what I’m doing. But my winding up here was related to a series of things that happened; it wasn’t so intentional.
Hasn’t the Made-in-China story been a force for good in any way at all?
People talk about the good that China does… But I have a difficult time saying big, positive things about China. On the one hand, people say China kept costs down for a lot of countries. But you go to Cambodia or Laos, and you can’t find anything that’s not made in China today. From a trade balance perspective, I don’t know if those countries are well off…
What’s the best thing you will say about the Made-in-China phenomenon? And the worst?
I think the best thing you can say is that a lot of importers got a lot of good foot massages in China! (Laughs) I don’t know about the worst.