I've had the pleasure -- directly and indirectly -- of working with some Chinese suppliers (and an awesome partner on the MetalMiner front who used to be a supplier of ours in China before we developed a broader relationship that started first with buying a single container of material). From a relationship and negotiation perspective, the best Chinese suppliers are candid and upfront, especially when it comes to structuring agreements they can honor. I hesitate to use the word "contract" here because in China, the notion of a contract does not typically have the same real-world ramifications as it does in the West, even if there is officially a legal document. I have head about numerous circumstances in the past year where Chinese suppliers have failed to hold prices based on a contract (e.g., pricing for six months) given underlying changes in their cost structures. For many Spend Matters readers, this is old news. But why has this occurred and what can we do about it?
CSR Asia recently ran a useful analysis that gets at many of the underlying issues. In it, they profile specifically how energy, commodities and water shortages are "affecting supply chains." In paving the argument's foundation, the author suggests that "Raw material costs have been volatile as the twin forces of emerging market growth and economic problems in developed markets force prices up and down. Raw material price is a large part of manufacturing costs, and in China this can often be greater than in other countries." The article then features a chart showing how "raw material is a greatest proportion of costs in China for a type of cotton yarn."
This is a near mirror example of a conversation I had with a head of procurement in the medical industry that, among other categories, supplies hospital beddings (sheets, towels, etc.) who had an experience with a supplier that would not hold contracted pricing when cotton prices moved well outside their expected fluctuations. In part, the challenge for Chinese suppliers is that "credit has become harder to access and the price of money has risen, exposing Chinese manufacturers higher costs for materials, waste and energy." Moreover, besides raw materials, energy represents roughly "8% of the total manufacturing costs" in the cotton example they explain. And as we all know, coal prices have been as volatile as many other commodities, contributing to underlying volatility (and even availability) of power -- and power costs.
In this environment, how can we prep for negotiation battles with Chinese suppliers when they backtrack from a previously negotiated contract (or play hardball in new negotiations)? Check back in Part 2 of this post, which, incidentally, we think is appropriate not just in China, but in all emerging markets where supplier access to capital to fund or lock raw material purchases comes at a premium -- if it's available at all.