Due Diligence
February 2018

7 China Risk Management Techniques to Protect Your Supply Chain

For multinational companies operating in China risk management is a subject never too far from the boardroom table.

Many foreign companies have come unstuck assuming that the checks and balances they have in place in their own country will work equally well in China.

This is usually not the case, so we asked China risk management expert Will Tang to share some of his best techniques for protecting your company's Chinese supply chain.

What is China Risk Management?

It is essential for all companies operating in China to have a program of controls that help to mitigate nasty surprises in their supply chain.

Choosing the appropriate techniques depends on a wide range of factors such as the size of the company, value of your goods and assets, intellectual property concerns etc.

But it is also important that the techniques utilized are appropriate to the business environment they are applicable to, and there are many factors which make China risk management particularly important.

When it comes to China and corporate risk management, the saying "an ounce of prevention is better than a pound of cure" certainly rings true.

Top 7 China Risk Management Techniques

From my experience as a China risk management specialist I have found each of these 7 techniques to be effective.

These techniques are some examples I’ve picked out that are typically
found in a broader risk management program and will reduce your China risk and help protect your supply chain.

1. Conduct Due Diligence on New Suppliers & Partners

In mainland China, all companies are granted permission from the authorities to operate within a business scope that outlines permissible activities.

I’ve seen overseas clients intending to purchase fabrics, textiles and clothing with a company in China that only had a business scope to manufacture furniture. At that time we informed our client that such a situation was a clear red flag - they should stop the agreement and not proceed with the transaction until clarification from the vendor had been received.

Not only was it questionable if the vendor has the capability to meet the order, there was a risk that they were dealing with unnecessary intermediaries or that the vendor could face compliance issues by exporting goods that were not specified within their business scope.

2. Perform Regular Vendor Revaluation & Audits

After vendors are appointed their competitiveness, product quality and value for money may evolve for the worse.

If you assume that once a Chinese vendor has been approved they will continue to deliver to the same standard, you are asking for trouble.

Even more so than in other countries, Chinese companies change quickly - they regularly change management, have high staff turnover and standards can fluctuate markedly.

Vendor audits and value reviews should be conducted by someone independent of the purchasing, sales, billing and receiving departments.

3. Set up an Internal Whistleblowing & Complaints Channel

Set up a Whistleblowing Hotline

Your existing employees are the best source of information to uncover internal malfeasance.

By implementing a basic whistleblowing system whereby, tip offs are securely received by say legal counsel, internal audit or even an independent supervisor, the senior management and the board can ensure appropriate follow-up.

I’ve found allegations made through such channels often carry much truth including cases revealing secret commissions, operating shell companies and bid rigging have been uncovered between management and suppliers.

Organizations should provide their staff in China with a confidential system for reporting concerns about vendors receiving favoured treatment. Once employees have confidence in the system the results can be very effective.

4. Have a Watertight Inventory & Equipment Counting Process

One of the most useful China risk management tools is to carry out a surprise stocktake within your business.

I have found that focusing on unexplained variances with units counted on the floor against what is recorded in the books is a great place to start.

Before adjustments are made to the books, perform some structured interviews with your staff to confirm discrepancies, identify root causes and remediate.

5. Perform Historical Financial Analysis to Identify Abnormalities

Organizations should review purchases for any significant costs that are out of line.

Start by running a report for a sample of vendors that lists unit prices of actual purchases vs prices from an alternative supplier in the Chinese market.

Investigate significant variances to manage inefficient vendors and to follow-up on opportunities to reduce costs.

6. Use CCTV to Monitor High Value Assets

CCTV systems can be effective

Investing in CCTV in high stakes area of your business will help to protect assets as well as elevate a culture of compliance.

Camera surveillance is useful to review footage of people, movement of assets and the presence of third parties.

This proved invaluable for instance when I investigated the disappearance of a large batch of semi-precious metals from the rural warehouse of a Chinese aerospace manufacturer.

The period of possible stock loss was narrowed down by examining periodic stocktake records, but the real breakthrough came from CCTV. 

CCTV recordings from the period in question were reviewed. To our amazement, a factory worker drove a forklift directly out of the warehouse with an entire pallet without authorisation and proceeded to load it into an accomplice's truck!

7. Use a Tender Process for High Value Project Work 

I’ve uncovered substandard quality defects in factory construction that has led to health and safety concerns just a few years after the construction handover.

No documentation was available to prove that the there was a proper bidding process before awarding the contract to the construction company.

Tender and bid processes should aim to prevent internal conflicts of interest.

A proper mix of different departments should be in place to govern such projects. Don’t leave critical decisions like these to just one or two staff.

China Risk Management - a Summary

Although I have found these 7 techniques to be effective, the truth is there is no magic bullet for addressing your China risk management concerns. 

A broad risk management program is needed which is adapted to your company's operations.

Verify a China Company.

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Further reading