Evaluating the Different Ways to Pay Your Chinese Supplier

by Matt Slater December 11, 2013

Evaluating the Different Ways to Pay Your Chinese Supplier

In this article we take a look at the various methods to make payments to your Chinese supplier and evaluate the pros and cons of each.

When Payment is Made

Many explanations of payment methods for suppliers seem to confuse arrangements for when payment is made with actual payment methods. Mixing these up is unlikely to be helpful for new buyers wishing to understand how to pay potential suppliers, so we’ve separated them here.

Broadly, there are only three potential arrangements for when payment is made: advance, deposit / balance or on credit with the Chinese supplier.

Advance

As the name suggests, this arrangement requires that full payment is made to the supplier before production begins. This is often an extremely unwise choice, especially for new, small-scale buyers. Advance payment might be necessary if the supplier is producing rare or unique goods, or customised prototypes that they have developed specifically for the buyer. Apart from these cases, the risk to the buyer is unreasonably high and an alternative payment arrangement is much more advisable.

If a seller demands both advance payment and payment by one of the unsafe methods described below (such as Western Union), it should be a huge warning sign to you. These are strong indicators that the ‘business deal’ is actually a scam. Further, if a scammer does persuade someone to make advance payment, they will almost certainly go on to demand further payment as they recognise that the victim is now ‘captive’ and likely to continue paying in order to try and extract at least some value from the transaction (see sunk cost fallacy).

Key points:

  • Extremely high risk to the buyer.
  • There is no recourse for the buyer if things go wrong.
  • Preferred by scammers and fraudsters, for obvious reasons.
  • May be legitimate in unusual cases such as customised product development.

Deposit / Balance

This is the most common payment arrangement, especially for new relationships between buyers and sellers. The buyer makes an initial deposit in advance, which is a proportion of the total payment. The supplier then produces and ships the goods. The remaining balance is then paid by the buyer. In this way, it presents a reasonable mix of risk to both parties rather than requiring one side to take on all the risk. Typically, the deposit is 30% of the total order price, and the balance payments fulfils the remaining 70%.

One issue with deposit / balance arrangements for new buyers is that it may give them a false sense of security because they retain the majority of the order price until goods have been shipped. Firstly, they still stand to lose 30%, which may be more than enough for a scammer to set up a fake deal with this arrangement. Secondly, the buyer still has to ensure that the order meets their standards before shipping. Once it has been shipped, they are obliged to pay the remaining balance no matter what, and there is almost zero chance of being able to send the goods back in the case of problems.

Buyers should also be aware that scammers or even disreputable suppliers may attempt to ask for further payment in advance of the goods being shipped, despite having previously agreed to a particular deposit / balance ratio. This is because they know that once a buyer has made some payment, they will most likely be unwilling to let the whole deal slide and may concede to the extra deposit in order to avoid ‘losing’ the goods. Proper due diligence, including background checks, can help a buyer determine whether or not a Chinese supplier is trustworthy before they make any deals with them.

Key points:

  • Fairer allocation of risk to both parties.
  • A very common payment arrangement.
  • Buyer could still lose a significant amount of money.
  • It is up to the buyer to ensure that standards have been met before shipping.
  • Buyer should be very wary of attempts to get extra deposits not previously agreed to.

Credit

Some suppliers may keep an account open for buyers, with orders initially being made on credit with the balance being paid at a later date. In the past in some countries, this used to be the standard way of operating, but this is no longer the case. Understandably, suppliers are usually only willing to operate this arrangement with buyers who:

  • Have an excellent reputation;
  • Are known to the supplier;
  • Have good credit history;
  • Probably have an existing relationship with the supplier.

In general, a Chinese supplier will only open credit accounts with large, stable companies making significant orders, and who make this arrangement worthwhile for the supplier by bringing good business to them.

Key points:

  • Clearly very safe for the buyer.
  • Likely only available to large, well-established companies.

As you can see, the deposit / balance method is almost certainly the best choice for the majority of buyers. That covers when payment is to be made and in what quantities. Now let’s look at how payment is made.

Payment Methods

Any of the payment methods below could feasibly be used to carry out one of the payment arrangements described above. Some payment methods, though, incorporate a level of safety and recourse to a third party in the case of disputes, which can go some way to mitigating the risks of different payment arrangements. In any case, buyers should always exercise caution and perform due diligence before any transactions take place.

T/T: Transfer

This is a classic ‘bank transfer’. Today, most of the world’s banks are able to communicate about money transfers via the SWIFT system. Note that SWIFT only provides a communication system; the two participating banks must still have a specific arrangement with each other in order for money to be transferred between accounts they hold. Usually this is not an issue for major banks in most countries.

Bank transfers are generally inexpensive relative to the cost of an order, with most transfers incurring a fee of around 40 USD. Remember that if a deposit / balance payment arrangement is being used (which is advisable), then two transfers will be made, doubling the transfer fees.

As bank transfers are a favourite payment method for scammers, buyers should be fully aware of the risks before going ahead with this payment method. Learn about Chinese bank account licenses, personal and business accounts. Unfortunately, many legitimate Chinese suppliers also require payment to made by transfer, so it can’t be ruled out simply because it is unsafe. Other payment methods are preferable where available, though.

Key points:

  • Accepted by all suppliers.
  • Extremely high risk for buyer.
  • No way for buyer to get their money back if something goes wrong.
  • Buyer will incur at least one transfer fee.
  • Small issues or errors in details will incur further fees for the buyer.
  • Preferred by scammers and disreputable suppliers.

As always, buyers should be extremely careful, but doubly so for unsafe payment methods such as bank transfers. Simple background checks and due diligence on the supplier may avoid a lot of trouble for the buyer.

L/C: Letter of Credit

A letter of credit is probably the most formal and complex method of paying a supplier. Briefly, a letter of credit is an agreement involving a bank in which the bank promises to pay the supplier when certain documentation is presented (such as proof of shipping). The conditions on what documentation is required have been signed by both parties as part of a contract. The whole process usually involves a lot of paperwork and varies between different banks. Contact the relevant bank to find out the specific procedure.

Letters of credit are a standard tool in major international trade to allow payments between organisations in different countries. Despite the elaborate procedure, letters of credit do not cover many potential problems for buyers. Certain risks always remain no matter what the payment method.

Key points:

  • Ensures clarity for both parties.
  • Allows buyer to require documentation before payment is made.
  • Can be complex to arrange.
  • Potential for false documents being used to collect payment.
  • Potential for short shipment.
  • Offers no guarantee of quality, safety in transit, timings of delivery etc.
  • Many legitimate suppliers will not accept payment by letter of credit.

Escrow

These are online services that act as intermediaries for transferring payments between buyers and sellers. They take on some of the responsibility during the transfer of money. This can often be a good choice, as the involvement of a much larger third party can bring some safety to the situation. However, buyers should not lulled into a false sense of security when using these services; there is always risk and buyers should carefully examine the exact terms of payment via each service before committing.

The general system for escrow services works as follows:

  1. The buyer pays the escrow company. The buyer has parted with their money.
  2. The escrow company verifies the funds and confirms to the seller that they have received the money. The seller hasn’t received anything yet.
  3. Reassured that a large, well-established company is holding the payment, the seller dispatches the products. The escrow company still has the money.
  4. The buyer receives the goods and confirms that they accept them. The escrow company gives the payment to the seller. Now the seller has their payment and the buyer has the goods.

In this way, escrow services ensure that the buyer has leverage over the seller until they can confirm they accept the goods, whilst at the same time giving the seller the confidence to dispatch goods despite not having received payment.

Key points:

  • Provides trust for both parties.
  • Gives leverage to the buyer.
  • Incurs a fee.
  • Cannot guarantee that things will go smoothly.

PayPal

PayPal is actually slightly different to escrow services in that payment is initially made to the seller and they can access the money before dispatching the goods. Some buyers mistakenly assume that PayPal will always enable them to get their money back if things go wrong, which is not the case. Instead, the advantage of PayPal is that it provides an interface for credit cards to be used to make payment, and credit cards usually do allow payment to be reclaimed.

PayPal may be able to get money back if it can be demonstrated the the seller broke the terms of the trade, which will require documentation. However, this can’t be done if the payment is already complete and the seller has withdrawn the funds.

Key points:

  • Allows payment by credit card, which in turn should allow money to be reclaimed if necessary.
  • PayPal does offer dispute resolution (although this is not guaranteed to achieve anything).
  • Fees are likely to be low for smaller orders.
  • Once the seller withdraws from their PayPal account, payment cannot be reclaimed.
  • Incurs a percentage fee, which will work out higher than T/T fees beyond a certain point.
  • Many legitimate suppliers do not accept payment by PayPal.

Funds Transfer Services (Western Union etc.)

We won’t list the various companies offering these kinds of services as we think they’re an extremely ill-advised choice for buyers. The most common example is Western Union. The reason we advise buyers against using Western Union and similar services is that it is generally not used for legitimate international trade, and thus it is a big indicator that something is amiss when a seller requests it.

Key points:

  • Extremely high risk to buyer.
  • No way to get money back if something goes wrong.
  • Incurs a fee for the buyer.
  • Generally not used by legitimate suppliers.
  • Favourite of scammers.
  • These companies do not recommend their own services for paying suppliers.

As you can see, there isn’t anything good about Western Union and the like when sourcing products from China, so we strongly suggest that buyers avoid them and any Chinese suppliers that are asking for payment through them.

See Also




Matt Slater
Matt Slater

Author

Hi there, I'm a British-Australian Engineer and Entrepreneur, recently moved back to Brisbane, Australia after nearly 9 years living in Shanghai. I founded China Checkup in 2013 because I was frustrated by the scarcity of concise, high-quality and timely information about Chinese companies.
My team are proud that China Checkup's verification reports now help clients worldwide do business in China safely. Have any questions? Email me at info@chinacheckup.com

 


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