Beware Captive Buyer’s Syndrome- The Risks to your China Buying Program

There was an article we came across not too long ago on the popular China Law Blog called “Buying a Chinese Company? Why China Deals DON’T Get Done.” This was a great write up on, as the title suggests, why generally as a foreign company you DO NOT want to buy a Chinese company or factory as a way to secure a reliable supplier and maintain a good relationship. For those who aren't already familiar with it, The China Law Blog is a blog focused on “discussing the practical aspects of Chinese law and how it impacts business there”. Here is an excerpt from the post:

I have put the kibosh on many a China acquisition and that is what this post is about. The following is actually an amalgamation of many such potential acquisitions, but for ease of explanation and to camouflage the identities of those involved, I have amalgamated a bunch of them into one. Trust me when I say that the following is incredibly typical, including the retirement of the owner precipitating the need for the deal.

The potential deal was for a US manufacturer that had been receiving its product from the same China manufacturer for about fifteen years. The Chinese manufacturer had been providing about 90 percent of its product output to this one US manufacturer and the two companies had a "fantastic" relationship. The owner of the Chinese manufacturer had done very well over the years and he now wanted to retire and sell his China manufacturing business to the US manufacturer.

Now on the surface, this post about a foreign company buying a factory they had been working with reliably for many years may not seem to be related to China sourcing as it rather addresses issues related to market entry and M&A. However, what particularly caught our eyes here at CPG was this: “The potential deal was for a US manufacturer that had been receiving its product from the same China manufacturer for about fifteen years… the two companies had a "fantastic" relationship.”

Most experienced companies avoid setting up sourcing offices in China. This is typically because it is expensive and cumbersome from a management point of view, but they will have alternative approaches to create a reliable source of supply. One of these approaches is to set up a long-term relationship with one Chinese supplier, as with the US company in the post quoted above. It is only when that relationship is threatened that the vulnerabilities of this approach begin to become evident.

If you read between the lines, the "fantastic" relationship with the supplier tends to indicate two things: (1) the foreign customer is what we call a "captive buyer" and (2) they are paying too much for the product.

What does it mean to be a “captive buyer”? Generally, this can be defined as someone that does primarily most of their buying with one factory, and since their whole relationship is with one buyer, they have no Plan B with other vendors. This indicates that the vendor has acquired dominance in the relationship, and can afford to start taking advantage of the buyer (inflating pricing, etc.).

From the captive buyer's point of view, this is usually an acceptable trade off, i.e. "Yes I am paying more, but it is worth it because I am getting peace of mind". This is what happened to the US manufacturer in question: the changing circumstance of the factory owner wanting to retire, which would have compromised this reliable source, almost led the buyer into a situation which the Law Blog post calculates could have cost the customer as much as two times the price for the same product from the same factory. Fortunately the buyer was able to avoid paying these costs. Instead, ownership of the factory was passed onto the factory manager and the relationship continued on largely as before.

What does this mean in the context of the “captive buyer” storyline? Chinese factory owners have honed their skills to extract the most out of their business relationship with their buyers. It is the buyer’s responsibility to keep up-to-date with the factory’s situation and stay aware of any issues developing. Just because the current business relationship is a healthy one, do not expect the factory to give up the chance to increase their profits. Assess potential risks by conducting regular factory audits and having back up factories in place for emergencies. If this seems overwhelming, consult a sourcing company to represent your interests and professionally manage your program.