Are you planning to leave China? With nearly 6,000 Harmonized Tariff Schedule item classifications identified for the imposition of a 10% to 25% penalty tariff on imports from China, it is time to consider all your options. The future of new tariffs and penalties is uncertain. Will your products or Chinese-sourced parts be next?
This decision isn’t an easy one. With 1.4 billion people and hundreds of thousands of factories, China is likely to be your company’s biggest target market over the next 20 years. As the country moves toward more automation under its “Made in China 2025” initiative, robot sales and usage are growing.
At the same time, American executives are pushing to increase manufacturing in the U.S. and bring some of the outsourced production home or to other low-cost countries to avoid the tariffs. This represents a significant shift in thinking about a more global manufacturing strategy.
Wait a minute … it’s not that easy. Companies cannot expect to simply pack up shop, lock the doors, turn out the lights, and move out of China. There are many issues to consider.
American executive Chip Starnes is the president of a Florida-based medical supplies company that decided to exit its manufacturing site in China for a lower-cost manufacturing site in India.
When the Chinese employees got wind of what was happening, they locked him in his office for days and would not allow him to leave. The 80 or so workers who saw the equipment being packed for shipment to India, forced Starnes into his office, kept guard, and even deprived Starnes of sleep by shining bright lights and banging on windows of his office all night, until they were paid termination wages.
If a company has allowed open-term contracts with its employees, the employer may be required by Chinese law to compensate the employees for early termination. If employees are on fixed-term contracts, the employer may be required to pay wages until the end of the term — sometimes as much as a year or two.
Tooling and molds
Packing up and trying to ship tools and molds from a Chinese manufacturing site can also be problematic. Often, a Western manufacturer will send machine tools or molds, sometimes worth hundreds of thousands of dollars, to a Chinese original equipment manufacturer (OEM) or to their own Chinese factory.
If a company does not take steps to clearly identify ownership and sign an agreement to that effect, including serial numbers positively identifying each item, it may never see the tools and molds again.
Unless a company has agreed in writing otherwise, the Chinese team may believe that it has been given the equipment. In some cases, we’ve seen molds being held hostage until the U.S. company pays for them again, even though there was never a sales transaction with the Chinese in the first place.
If the tools and molds stay behind when a company leaves a Chinese factory, this equipment is likely to continue be used to produce the same exact products. These products are then sold domestically in the Chinese market, or into other markets around the world without the original company’s supervision or permission.
Companies may also be sourcing tools, dies, and molds inside of China for production there, but that does not automatically mean these can be shipped to the U.S. when the factory closes. Export rules from China may prohibit this.
When a company leaves China, it also leaves behind its manufacturing intellectual property if it has shared confidential production processes and methods with Chinese partners or employees. We’ve all heard the horror stories about IP protection, copying, and counterfeiting in China. To protect their IP, most U.S. companies now register their patents and brands in China. But production methods and raw materials aren’t always as well protected.
In reality, there are few if any practical ways to protect manufacturing IP once the Chinese factory work is over and manufacturing operations have been moved out of China. In planning for a closure, companies should expect the worst regarding IP and expect to have their products copied.
In addition to paying out employment contracts, foreign companies should consider other regulations. China’s Commerce Department has issued guidelines for withdrawal from China by foreign investors. The intent is to protect Chinese creditors and others from manufacturers that try to escape in the middle of the night.
Chinese law requires that foreign investors inform creditors of the closing, settle all outstanding taxes, pay all pending debts, liquidate property, and de-register the business. In addition, companies may be required to pay closure taxes.
If a business is partially run or owned by a state-owned enterprise (SOE), companies may also have to ask permission from the Chinese Communist Party to shut down. Getting permission to leave and pay all of the associated fees and taxes will take some time — probably three to six months. Leaving without completing the exit process is not recommended and may disallow companies from ever returning to China to manufacture there or sell products there.
The way forward
So many companies make the mistake of simply comparing labor or tariff costs when determining their get-out-of-China pathway. But there is so much more to a decision to exit China. In particular, companies should consider all of the exit costs including employee payments, tooling and molds, IP protection, exit taxes, and fees when considering the restart-up costs in the U.S. or other countries.
Most importantly though, is to ask the question, “Should we leave China?” If this rapidly-growing market is where your company will be selling products in the future, perhaps it is best to keep at least part of your manufacturing operations there.
About the author:
Rosemary Coates is the Executive Director of the Reshoring Institute. She is a best-selling author of 42 Rules for Sourcing and Manufacturing in China, Legal Blacksmith — How to Avoid and Defend Supply Chain Disputes, and The Reshoring Guidebook. Coates lives in Silicon Valley and has worked with over 80 clients worldwide. She is also an expert witness for legal cases involving global supply chain matters.