Identifying Shadow Factories in China

Shadow Factories In China

Identifying Shadow Factories in China

How to identify and avoid ‘Shadow Factories’ in China?

Shadow factories is a good way of describing it! I’ve always described it as a showcase factory where it meets all the bells and whistles. No broken windows, well-marked exit signs, clean material, beautiful dorms that you want to sleep in. The food is even good in the cafeteria. So you might go there first, and the supplier might actually be planning to produce there. But then they get a couple of, Wal-Mart places a big order, and now they are at excess capacity, so they go out the back door to one of these shadows factories. And if you start to visit China, you will see that usually there is a big factory in the middle then a hub of smaller factories around it. They overflow. And so, is that a scam? Not really. But as buyers, we could protect ourselves, you could protect yourself in the following ways. I make it real clear in my contracts that I audited this factory at this location with a picture of these GPS coordinates. And my inspectors are going to come back to do a pre-shipment inspection at this address. And I also explain to the factory, “Hey, at some level, everything is outsourced.” The manufacturer of electronics probably doesn’t make the batteries in-house. So it’s really a question of sitting down with your suppliers and determining whether the key components, whether the key processes that you want to be done in-house and what is allowed to be outsourced. And I found that if you explain the reasons why you are concerned with the supplier, they might say, “Yah, you know what, 75% of our sub-component B is made at this factory. Want to come take a look?” So if you explain the reasons why you’re in it, you’re in it together, they’ll be open.

But you can put it in the contract that unauthorized outsourcing is not acceptable, and there will be penalties. You have the right not to accept the order if it’s found out. The other say that you are going to come back for inspection at this address. I had factories, produce the parts and then when my inspectors came; they trucked to the agreed location that we had in advance. That’s not, that cat and mouse game; I tried to avoid it by just saying, “Tell me where you are going to be running the parts if you reach excess capacity.” Now here is my advantage, “Okay, if you are going to outsource to some other factory, I want a 2% discount and let me do an independent inspection at that factory.” So you can flick it around and use it to your advantage. Cause often, that nice factory charges a premium. But be very careful, this happened just a few months ago. We have a very important customer in Europe, and a needle showed up in a toy to Europe. Luckily they caught it. How could this happen? My inspectors watched as the toys go through a metal detector, and it is also x-rayed. This shouldn’t happen. But it turns out that the factory was getting ready to move. Some areas of China are getting more expensive. They are getting ready to move. And they broke their normal material processing, and basically they outsourced some of the sewings. And the needle fell in and then it was brought back and put in front of the x-ray machines because whoever was in charge of the outsourcing didn’t know what protocol to follow because it was something they have never done before.

So, and my team did a random inspection. So if there were a needle in everyone, sure, we would have caught it. But, in that case, luckily there was another inspection being planned, we found it, we went back, what was the root cause. The factory paid a penalty. We got a huge discount on the next order. Everyone was happy. But if that pin had gone into some child’s eye, it could have been very different. So, you have to really keep an eye on things and outsourcing will happen. It is only a question of do you, can you manage it or not. How well do you manage it?

Dr. Neale O'Connor
Cofounder of the China Sourcing Academy, founder and director of the China Supplier 1000 Project. Senior consultant of the China Lab at Silk Road Associates (Hong Kong). Currently teaching at the Hong Kong Baptist University.