FOB vs CIF

I had an inquiry today from someone who wants to move their CPG ( Consumer Packaged Good) production from the US to China.  They want to ship CIF which stands for Cost Insurance and Freight.  In a CIF transaction the supplier/exporter is responsible for assigning a carrier/vessel and insuring the cargo.  Once the vessel lands at the destination port the buyer/importer takes possession.  The main advantage to doing a China order CIF, as opposed to FOB ( Free on Board) is that the supplier handles all the shipping arrangements for you.  You simply have to pick up the cargo when it arrives and arrange for transportation to your warehouse. In theory CIF reduces the work load on the importer and may seem like the ideal arrangement for a first time importer who has no experience with international shipping, which can be quite complicated.  The downside to CIF however is considerable.  Your product will cost more because you are asking your supplier to bear more responsibility and not surprisingly most suppliers will look at a CIF proposal as an opportunity to pad their margins. In addition, you lose transparency on the real cost of your product.  The real cost of your product is what it costs to make and package your product.  Not what it costs to ship your product ( which is landed cost and which varies depending on a number of factors). You will also have no control over shipping.  If yours is not a time-sensitive order then CIF might be OK.  But if you need your product shipped on a timely basis, to fulfill orders, you will be taking a big risk because you will have no control over transit times and carriers.  In fact, your supplier may not choose the best carrier but the carrier who offers them the most preferential terms.  Your supplier will act in their best interests, not yours.

With an FOB order, on the other hand, the importer, working with a Logistics company, has complete control over shipping.  If problems arise you can work quickly with the carrier directly to resolve them.  The downside to FOB is that, yes, you need a Shipping or Logistics Company to help you arrange shipping. This is of course another cost, one of the hidden costs to overseas sourcing.  But you have to look at it as one of the necessary costs and you should be prepared to bear it.

In the end your expenditure will probably be the same, whether you allow your supplier to arrange shipping, resulting in a higher unit cost for your product, or whether you enlist the help of a Logistics company to help you arrange shipping and handle documentation.   It is when problems arise that you are far better off with your own shipping agent as opposed to trying to resolve problems with an anonymous shipping company that has been selected by your supplier.

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China sourcing from the perspective of a Hong Kong Sourcing Agent

I had an email the other day from a Chinese sourcing agent who is based in Hong Kong, Chris Lo.  Chris said he enjoyed my blog and wanted to offer a few useful observations about sourcing in China from the perspective of an on-the-ground local Hong Kong sourcing manager.  Accordingly, here they are ( his observations in Italics ) :

  • Chris writes that when you deal with suppliers in China it is always good to use a factory with Hong Kong or Taiwanese management if you can find one.

This is correct.  The reason is obvious, the HK and Taiwanese managers are just more in tune with Western and Japanese business practices and they tend to manage their factories well.  The only caveat is that you will probably end up paying more for your product than you would were you to use a Chinese mainland managed factory.  Still, I think it is worth paying a little more to get better communication and often better quality and for this reason if you do have a choice between giving an order to a Hong Kong managed FTY or a Mainland managed FTY, you should always give the order to the Hong Kong/Taiwanese FTY even if the cost is greater.

  • Chris mentions that as the Guangdong Government is trying to phase out Low Cost Manufacturing, many industries are relocating to the Eastern China, Zhejiang, Shanghai, Jiangsu i.e. The Changjiang Delta area as opposed to the Pearl River Delta area in Guangdong. He says that he has heard from other Hong Kong based sourcing agents that the MOQs are very high in these areas now, while quality tends to lag.  One reason is that these are bigger FTYs and they need bigger orders to stay afloat.

That the Central Govt is trying to phase out Low Cost Manufacturing in the South of China has become something of a standard line in recent years.  Nothing new here.  But this is the first time I have heard  about higher MOQs and lower quality coming out of suppliers in Eastern China.  I think this makes sense because manufacturing around Shanghai, in places like Zhejiang and Jiangsu tends to be on a larger scale.  I have been in a lot of huge textile and furniture factories there over the years, much larger than anything I have ever seen in other parts of China. So it is quite natural that these bigger FTYs need bigger orders to stay afloat. I am not sure about the quality statement.  I think it depends on the industry and product.  I do think that the South is still a good choice to source products because the infrastructure and product knowledge have been there for several decades whereas only in recent years has other manufacturing moved up north. Of course I would qualify this by saying that once again it depends on the product and industry.

  • Chris mentions that Fujian Province is a good place to manufacture now. He says it is a very good place to send your apparel projects and that all of the big global brands have production there.

I was not aware of Fujian Province’s strength as a textile producing base. I have made 2-3 trips to Fujian Province over the last 10 years and my sense there is that prices are very low, but that quality is an issue.  But these were not textile orders I was working on so I would not know. Still, I would be a little cautious sourcing in Fujian Province. It does not have the infrastructure that the low cost South has, nor the sophistication that areas feeding Shanghai have e.g. Zhejiang and Jiangsu.

Finally I would like to quote Chris verbatim for something he says about the ease of online sourcing these days:

“Doing business in China without regular checking would have a high chance going wrong (but I guess it is same for everywhere.). So to me I’d like to comment also on the emerging e-platform, I think it is just for gaining exposure for the suppliers but you cannot do industrial production without directly getting to your supplier, having face to face meeting and in-line inspection; the old fashion way of visiting industry fairs, factory visits still has place a good value for doing so. Industrial production is not talking about selling one item with simple emails and clicks.” 

I like that about the “old-fashioned” way of sourcing.  I agree, it is just a much safer way to go about it. 

Thanks Chris !

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Why incentives from US companies are rarely effective in China

It seems that every company I have ever worked for has tried to implement an incentives program for vendors in an effort to get them to produce quality product and ship on time. I once worked for an American textile company, the owner of which had the idea to reward top performing vendors with trips to the US home office. What management of the textile company did not understand was that most of the vendors had absolutely no interest in getting on a plane and going to a country where the Chinese food in a five-star restaurant was probably inferior to the gruel they were accustomed to eating in their own factories. Not surprisingly, the incentive program was a failure. Another company I was employed by gave brass plaques to its top performing vendors, only to find that quality showed no improvement and, in some cases, got worse.  I mean what of what value is a brass plaque of recognition from an American company to a vendor far off in China ?  The answer is very little.

Providing vendors or workers with incentives is a classic example of a management program that works in the US but does not work in China. Why don’t these incentive programs work in China? I think there are a few  reasons:

1.) In China there is sometimes a tremendous degree of mistrust in personal and business relationships (perhaps the legacy of the Cultural Revolution when neighbors turned on neighbors). Most vendors regard incentives from US companies with a great deal of skepticism. They simply do not believe you will pay up, so to speak.

2.) More importantly, many vendors endured the bone-grinding poverty of pre-reform China and lost myriad career opportunities during the Cultural Revolution. For this reason, vendors have a “cash-in-now” mentality, and focus mainly on short-term gains. It never ceases to amaze me how few vendors in China look at relationships with American customers as long-term and mutually beneficial.  Of course incentives are part of a long-term program.

3.) To meet production goals requires vendors to invest more in production.  Yet vendors do not want to invest more in an order than is absolutely necessary.  No vendor in China is going to spend more out of their own pocket to get an order out on time simply because they covet that brass plaque you promised them.

More importantly offering incentives to your China vendor may in fact be counterproductive. If you give your vendor production or QA targets, he may feel he has reached these while you feel he has not. This just leads to conflict, an erosion of trust and you are soon looking for a new supplier. I have seen this happen.

For these reasons, it is probably best to avoid offering vendors any kind of special incentives. The best you can do is tell them they will get more business from you if the current order goes well, work closely with them on quality and hope they follow through accordingly. On your side, do everything you can to make those order QTYs bigger with each order.

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Is there any way around MOQs ? Unfortunately not.

One issue that small companies and start ups grapple with all the time when they source overseas is MOQ (Minimum Order Quantity).  I don’t think a week goes by when I don’t get an inquiry from a small company that wants to source a product in China but in very small QTYs, in many cases just a few hundred units. For example, a few weeks back a London based women’s apparel start-up emailed me.  They have 20 designs and want to order between 100-200 pcs per design.  They want good quality and a low cost.  I told them that I saw this as a very challenging project and I suggested that the only way to do this would be to reduce the number of designs and increase the order QTY per design. Only in that way could they think of meeting the fabric MOQs that vendors in China would likely be facing were they to take this order.  Like many small companies that hold steadfast to their designs, this company said they didn’t want to eliminate any designs and that was the last I heard from them.  I imagine they are back on alibaba looking for suppliers.

Although there are suppliers in China that will accept small orders, these are generally not reputable suppliers and if you do place an order with a vendor like this you might just be throwing away your money. The vendor makes a small profit and sends you an order you cannot sell.  I have seen it happen many times.

Just out of curiosity I went online to see how other sourcing consultants handle the issue of MOQ. In other words is there any way around MOQ ?   Some of the advice I saw is as follows:  limit product customization; negotiate a lower MOQ; pay a higher unit cost; streamline material usage; focus on buying from small suppliers etc etc. Let’s look at these strategies:

  • Simplifying product design. Conceivably, the only way this would get you around an MOQ would be if you were simplifying design to cut unit cost so you could order more of a product to meet an MOQ.  It sounds good in theory but I have never in fact seen a company do this.  Companies that change a design do so to lower costs, not to increase their costs.  I would add that modifications to a product design, unless major, usually result in very insignificant cost reductions.  But, as I said, I have never heard of a company doing this.
  • Negotiate a lower MOQ. I think this only works with vendors with whom you have had a longstanding relationship. They want to maintain the relationship and therefore will sometimes waive MOQ requirements.  This happens all the time. On the other hand, if you negotiate a lower MOQ with with a first time vendor, they will just seek to cut costs in your production and you may end up with goods you can’t sell.  I always advise companies not to get into protracted negotiations with first time suppliers because it just sends the relationship in the wrong direction from the get-go.  But OK if you are trying to get around an MOQ with a longstanding vendor.  It never hurts to ask.
  • Pay a higher unit cost. What you will have to do if you want to order less than the MOQ. If you have target costs this may make your project untenable. It also locks you into a higher price as your orders get bigger. Yet this is what many companies have to do to get around MOQ.
  • Streamline material usage: Not realistic unless you have a product you can do this with. Most small companies don’t.
  • Buy from small suppliers. Small suppliers are usually not reputable suppliers.  If you have any kind of strict design requirements, you will not have success with small suppliers who simply do not have the expertise to handle challenging designs/orders.

In fact, the only thing I advise small companies to do when they are inquiring with a China vendor about MOQ is NOT to ask the vendor first what their MOQ is but instead to give the vendor 3 QTYs to quote on, one for the minimum they think they can order and then in increments accordingly. For example if I wanted to make a wooden picture frame in China I might reach out to vendors and tell them that I am interested in QTYs of 1000/2500/5000 and ask them to quote on each QTY accordingly.  If the vendor really wants my business, they will quote me on my terms and will not mention their own MOQ, even though they may in fact have one.  I think this is really the only way to get around MOQ. But even this strategy has its limits because many vendors will just come back to you and tell you that they have an MOQ.

In short, this is why overseas sourcing is so challenging, because no matter how cheap the unit price is, you are not going to get that unit price unless you order a far bigger QTY of product than you might be able to sell.

 

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When to split a Production Order (PO) between vendors

I had an email today from Chuck over at Supplier Global Resource magazine, a magazine for the promotional products industry. Supplier Global Resource Magazine.  Chuck is doing an article on China and had a question for me as follows:

“The process you describe in your four-post series is pretty thorough, and seems to cover a lot of the bases. But I was curious if, at the end of the process, a company had 2 or 3 Chinese candidates they felt comfortable proceeding with – would there be any benefit to placing an order with more than one manufacturer, possibly splitting a large order, to best determine the qualities of each manufacturer?”

My reply:

Good question. It is a good theory but in practice I don’t think works, at least not for most of the small businesses I assist. And for this reason:  Most companies that source in China have hard orders they have to fulfill and there are expectations from their customers, usually big box retailers, as far as delivery dates, not to mention quality standards and pricing. So most small companies do not have the luxury of time nor the resources to try out hard orders on as yet untested suppliers. They usually have to designate one supplier and hope things go well. If they don’t they salvage what they can and move on to the next supplier.The one exception would be if I had a new product that I was marketing online only, and the scope of my business was small,  Then I might try as you suggest. In this case, I would not have firm delivery dates to meet and could proceed cautiously, maybe trying out multiple suppliers at the same time to see who might be a good long term partner for me.

I will say that I have worked with companies that have resorted to the practice of splitting large orders between suppliers but usually those suppliers are already verified suppliers. And usually there are two reasons they do this.

1.)  They have a big order and one supplier alone cannot meet the delivery dates. Most of the time it is for this reason.

2.)  They have had a problem with one of the suppliers in the past e.g. usually quality or late delivery and are nervous about giving a big order to this supplier. Dividing a production order among 2-3 suppliers ensures that they will have at least some good product to pass on to their customers in a timely manner.

I would add that I have always found it very risky to divide production between suppliers. The reason is this:  Let’s say you have an order for 50,000 promotional shirts for a large US retailer. This retailer has very strict compliance guidelines.  50% of the order you do with Vendor A and the other half with vendor B.  When the shirts come in you find that the shirts from Vendor A are a slightly different color than the shirts from Vendor B and the large sizes from Vendor A’s are also running small.  The result is that your customer is not happy with the  wide variance in quality, issues charge backs and cancels all future orders.  In short variation in production lots from just one vendor can be a major challenge depending on the product.  So when you have more than one vendor producing the same product it becomes a major challenge to maintain product standards and consistency.

In sum: I have always advised people to try to have as few vendors as possible, a major vendor or two and then a couple back ups.  In Chinese there is an expression. 人多手杂。 Trans:too many cooks spoil the broth

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The days of taking gifts to your vendor are over

This morning I was reading the Shanghai Daily over my bowl of Cheerios and I saw the headline that the Chinese are now the # 1 consumers of luxury goods worldwide.  Of course this should not surprise anyone, as China’s transformation from one of the world’s poorest countries to one of the richest is widely acknowledged.  But it does pose problems if you are travelling to China and want to take your vendor a gift, what overseas buyers have traditionally done over the years when sourcing in China.

As recent as 10 years ago when travelling to China it was never hard to come up with a gift for vendors, a carton of Marlboro cigarettes, or some Chanel # 5 would always go over well and would ensure that your vendors listened a little more carefully when you outlined all your production and lead-time concerns.  In those days, your average Chinese could not afford these products and when you showed up in China bearing luxury gifts, people were truly appreciative.  In fact, when I worked in wholesale and had a trip to China planned I always requested that management allow me to buy gifts for vendors and the people working on our orders, including office personnel and some workers.  It was an effective way to separate yourself from the factory’s other clients.

So last week when someone emailed me and told me they were headed over to China this week and asked me what kind of gift they should take to their vendor, I must admit I was at a loss seeing as the Chinese are now the World’s # 1 consumer of luxury goods and can pretty much buy anything they want. I imagine that nowadays if I showed up with a carton of cigarettes for a vendor they would just laugh and look down at me as a hick.

As I am wont to do when I have a question about China, I emailed my friend Jessie in Shanghai.  Jessie is an old colleague from my textile days, and one of the most savvy Chinese business women you will meet.  When I asked Jessie what is a good gift for a female vendor these days, she also didn’t have an answer.   Finally she suggested a handicraft gift, or something that would not be available in China.  This made sense and so I emailed back the person who had asked me what to bring and suggested she take a high-end designer bag that is sold in boutiques here in the Bay Area and NYC and is made in the Philippines.

But the more I think about this now I really am inclined to believe that the days of travelling to China bearing gifts for your vendor are over. Unless you have a very special relationship with someone there is no need to bring gifts I would say.  And the next time I go over I will follow my own advice as odd as it will undoubtedly feel.

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When you source in China, you need to think like a football coach

Tomorrow I am going to visit an electronics importer here in the Bay Area.  This is a small company but they are experiencing tremendous growth and want to ramp up their operations, which of course includes their China operations.  I was talking to the CEO on the phone the other day and he told me he was very happy with his main supplier now.  I asked him how long he has been doing business with the supplier and he replied three years. My first thought was that three years is not really a long time and that this company still needs to be careful and treat this vendor as a new vendor.  This means they have to do their part and get the vendor orders on time, clearly indicate product and testing requirements, avoid last minute product design changes and, of course, they have to inspect orders before they leave China. And they have to develop alternate suppliers in the event that problems arise with their current supplier, as far off as that scenario might seem right now. In fact, this is one of the Golden Rules of China sourcing, never feel complacent with a situation, no matter how long-standing the relationship with your vendor is and how well things seem to be going. Because something can always happen when you let your guard down.

A good parallel is this past weekend’s football game between Michigan and MSU. With ten seconds to go in the game and possession of the ball all Michigan had to do was punt the ball away and they would win the game.   What happened ?  The punter fumbled the snap, tried to kick the ball anyway ( when he should have just fallen on it)  and it was returned by MSU for a game winning TD.  In the post game discussions and write-ups all of the blame was directed at the punter, yet I think much of the blame should go to the coaching staff for not telling the punter what he should do if there was a bad snap or fumble.  That is what coaches are there for, isn’t it ? Yet the Michigan coaching staff just assumed the punter would kick the ball away and apparently did not discuss the contingency of a bad snap or fumble.  The lesson to be learned is this:  When the game is on the line don’t take anything for granted.  When you are a small business and are sourcing in China, and are succeeding at it, don’t feel  you have won.  You are winning but you have to be vigilant with every order and until the end.

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How to identify the region of China that is best for your sourcing needs.

I had a call from an entrepreneur in New York over the weekend. She has a succesful online apparel business and for the last three years has been using a supplier in Dongguan to make her products. She is about to head off to China for a few weeks, first to the Canton Fair and then to visit her supplier and other prospective vendors in and around Guangzhou.  She is doing the right thing by heading over there, to discuss issues with her current supplier and to scout new suppliers as her business expands.

She asked me if Guangdong Province was the right place to be looking for apparel suppliers.  It is a good question. I replied to her that historically much of the textile industry has been up north in and around Shanghai, in places like Jiangsu and Zhejiang Provinces.  If I were doing apparel or home textiles heavy in design I would target these areas.  About 50 % of the machinery in textile plants in Jiangsu meet international standards and design is probably more sophisticated given the province’s proximity to Shanghai. Having said that, Dongguan is home to over 6000 textile companies (about ¼ the number of textile enterprises in China ) and is probably as good a place as any to get started. If you are looking for a supplier then Dongguan is going to give you plenty of options, albeit much of the apparel production in places like Dongguan or Guangzhou is low value added product.   Nevertheless I have known apparel companies over the years that locate their production in the south, where labor costs and the costs of getting goods to port have always been lower.

One trend now is that more and more companies are beginning to source in Central and Western China as labor and operating costs in coastal and Eastern China go up. So in recent years one sees more and more textile production occurring in places like Henan, Hubei, Jiangxi et al. And more low value added production is moving out of China to SE Asia and India so Chinese companies can concentrate on more sophisticated product.

Another thing to consider, if you are doing apparel or home textiles, is if there is a major fabric market near your vendor.  If there is not your vendor may have trouble sourcing specific fabrics. In any case, it is good to do a little research to see where might be the best region to make your product.  There are a lot of resources online and the better you understand China, and how different regions may meet your needs,  the more smoothly your production will go.  As they say in China 量体裁衣, “ liang ti cai yi  trans. cut the garment according to the figure.

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Some things to consider when you have a new product and need a mold

Someone came to me with a new product the other day, an artistic and fanciful light fixture that they want to have made in China. They have tried to find someone to manufacture the product here in the US but, as you would expect, the cost is prohibitive.  The person has had some rough molds and prototypes made here and suggested that he could send these to China and have someone there run some samples for him and then maybe a small production order.  Not a good idea, I said.  There are a few things to consider here.

  • The molds this person has made might not be compatible with machines in China In fact, I bet this would be China vendor response were he to send the molds to China.
  • Compatibility of machines notwithstanding, vendors in China stand to make a good profit if they make a mold for a customer and they do not want to forfeit this profit.  And this is why when you get quotes for molded products the mold costs can be all over the board, so to speak. If you ask three vendors to quote on a mold, chances are their quotes will be off by thousands of dollars, because someone is making a hefty profit from the mold. I had project a few years ago for which I needed a mold and the quotes, for the same mold, were anywhere from $3,000.00 to $20,000.00.
  • If you send a vendor in China a mold you may not be able to get the mold back. You never know who you are dealing with and the vendor may just take the mold and start using it themselves.

If you do get your mold made in China make sure you know who you are dealing with because sometimes a factory will claim they own the mold, even though it is your design and you have paid for the mold.  There have been so many disputes like this over the years between SME’s and vendors in China that you just have to expect it to happen.  Just go over to the China Law Blog for some stories. To protect yourself you should have everything spelled out clearly in writing, as to who owns the molds and when they will be returned to you, and you should also be sure you have legal rights to your design before you ask someone in China to make the mold for you.

Finally, really the best way to do a molded product would be to have the CAD work done here in the US, including drawings and 3-D renderings, and then to send these to China so a mold can be made for you. In this way, you can project to vendors in China that you are serious about your product, for drawings look official and will show all proprietary information. Should any dispute arise with them you will have a record of your designs, what you would not have if you asked the vendor to do both the CAD and mold for you.

Needless to say, these are all costs you have to expect to incur if you have a unique product that you want to have manufactured overseas.  But if you can do it, it is worth it.

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Never think you are a big fish when you source in China

If you are sourcing in China you have to remember one very important thing:  that your product may not be a priority for the vendor with whom you have placed an order.  Most factories in China, big and small, have a myriad of production orders going at any one time.  Walk into any workshop in China and you will likely see orders from all over the world, from the US, from South America, from Africa etc etc. I am always amazed at the global scope of production when I visit factories in China.  And some of these orders can be huge, tens of thousands of pcs depending on the product. You might think your 5,000 pc PO is a big deal but for your vendor it may only be a small order when compared with all the other orders he/she is doing at the moment.  I remember working on an apparel project a few years back.  The company that had retained me sent me to China to do an inspection of a 20,000 pc order.  For my client it was major order.  But when I showed up at the factory I realized that my client’s order was the smallest of several orders going at the same time.  The vendor told me that 20,000 pcs was not a big order and as such I could clearly see that it was not being given priority by the workers or management.  They told me a big order was over 100,000 pcs.  I was surprised and wondered if my client knew this as well.  I can’t remember but I don’t think they did.

Can you fault the vendor in this case ?  Not really.  They have to prioritize their orders and their business. It is only natural that they are not going to give a small order priority over a large one.  Ideally they should communicate this to their customer but in China it does not work that way.  Vendors can be pretty lacking in communication and that is one of the big challenges to sourcing in China. Can I fault my client ?  Somewhat I think because they failed to acknowledge that the vendor had other orders at the same time, even though they had been to the factory, just a few weeks before I was there, and had seen the other orders in process.  They simply believed that their order counted most. So when it came time to get the order out and the vendor was behind my client just pushed the vendor, the end result being that the relationship turned sour.   Had my client anticipated a delay and built some extra time into the production and delivery schedule to accommodate for the low priority their order was given things might have proceeded more smoothly.

So how can you know if the vendor is prioritizing your order or not ?   Well the first step is before you do business with a China vendor, ask them about the size of their orders and what they regard as a small order, what they regard as a big order etc etc.  They will probably inflate these numbers wanting to lead you to believe they have and can do big orders.  But their reply will nevertheless give you a very rough idea of what to expect when you place an order with that particular vendor. For example, if you meet a vendor at the Canton Fair who makes shoes and s/he tells you that an average order for him is 5000 pairs of shoes and that a big order is 20,000 pairs, you will know that if you give them an order for 1000 pairs, it will likely not be a priority order for them.   You might even ask a vendor to show you a hard copy of an order for a large QTY.  You can tell them that you just want to verify that they can do what they say they can do.  And ask a vendor before you place an order what other orders you are going to be competing with ?  For some reason this is not a question that most importers are in the habit of asking their vendors, their thinking being that only their order counts.  But I don’t think it is a bad idea to try to find out what are going to be the challenges and potential delays once you place your order.

Finally, if you can, make a trip to China to inspect your order in process.  Simply by walking around a workshop while your order is in process will give you a very good idea of how a vendor is prioritizing things.  If only a little space is being devoted to your product, well, you know you have a problem in spite of your vendor’s reassurances.

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