I recently came across an interview with an expert from BCG in China Sourcing (the sixth in a series) with some great insights to help understand the Chinese mindset. Among other issues, the story introduces and explains the concept of cheng bao. According to the interview, many Chinese companies like to operate with "arm's length" contracts that may incorporate multiple parties without the end-customer knowing about all of the parties taking part in the sausage making. The word for this is cheng bao. Here is a great example to explain it (taken verbatim from the piece).
Imagine that you jump "into a taxi in Shanghai and say, 'take me up to Suzhou,' which is a good long ride. It would normally be about 300 to 350 RMB on the meter. Let's say that would be about $45 to $50. You agree with the cabdriver on a fare and say, 'Don't do it on the meter. I'll just give you 400 RMB, tax, tips, tolls all included.' And you hop in the cab and he goes three blocks and then waves down his friend and says to him, 'Will you take these folks up to Suzhou for 300 RMB?' And the next thing you know you are transferred to the other taxicab. The first driver pockets the difference and you'll get your ride up to Suzhou." While this is an extreme example to make a point, it happens across the Chinese supply chain, even when contracts forbid it. According to the interview, "When you look, what you will see in many instances is that in violation of contract terms sometimes second-, third- and fourth-tier subcontractors are used. All this [is] aimed at getting the cost down."
But as supplier costs come down with these practices, supply risk goes up, given the lengthening of the supply chain. Not only do the chances of quality issues and supply disruptions increase with this type of behavior, companies also open themselves up to ethical sourcing risk by indirectly working with factories that they have not had the chance to inspect or audit. For protection, the best defense is an on-the-ground presence and IPOs dedicated as much to supplier development and performance monitoring as supplier identification and negotiation. Unfortunately, the skill-set for these resources is often much harder to find in China, leaving many companies with the only option of hiring outside auditors and consultants for a function that arguably should be core.
So next time you think about how supply risk, it's important to consider how best to monitor and enforce contract terms and conditions that can go overlooked in China. After all, when practices such as cheng bao are so ingrained in a culture, it's up to procurement and supply chain organizations to stay involved throughout the lifecycle of a relationship. With little legal recourse, sometimes the best defense is a good offense.
- Jason Busch