Managing China supplier payment - There are several options when paying your supplier in China. Here are our top 5 tips.
‘How do I pay my China supplier?’ is an important question that importers in Western companies must answer to avoid putting themselves in a position of significant risk. The five tips in this post cover the following topics on managing supplier payments:
- Different payment methods, including the pros and cons of each
- Upfront versus installment payments
- Paying suppliers in Chinese Yuan/Renminbi
Direct bank transfers from your local bank or internet bank to the supplier’s bank account have their advantages and disadvantages. They are accepted by all Chinese manufacturers but you’ll have to pay a fixed fee for each transaction while the supplier is charged a fee on incoming wire transfers. Banks also have pretty terrible exchange rates, emphasizing that moving money costs money. You can work around the high costs in two ways:
- Negotiate a lower transfer rate with your bank in exchange for using their service for all your overseas payments to the supplier.
- Negotiate who (the supplier or you?) will pay the incoming fees, outgoing fees, and intermediary fees, and include those terms in your written contract.
Processing times of two to five days create a risk of exchange rate fluctuations from the time the payment order is signed to the date payment is credited to the supplier’s bank account.
The know-your-customer (KYC) procedure to verify individuals and businesses makes payments pretty reliable. Paying the supplier in tranches (discussed further) offers a greater degree of protection.
A Letter of Credit is a letter from the bank guaranteeing full and timely payment to the supplier after shipment of goods. It is geared towards large orders and offers substantial buyer protection.
You don’t have to make a deposit payment. An L/C has an expiry date, which creates pressure on the supplier to meet delivery deadlines. The supplier must provide a bill of lading showing that the goods were shipped in accordance with the date stated in the letter of credit. Banks deem a late shipment a ‘discrepancy’ but you have the final say in accepting or waiving the discrepancy. You can even cancel the L/C, which does its part to keep the supplier on their toes and meet the requirements promised to you.
As prices are specified in the L/C and can only be modified by the importer, you are insulated against any last-minute price increase. Additionally, payment is released only after the supplier has fulfilled certain requirements. Before a transaction occurs, the supplier must provide quality inspection and laboratory testing reports.
The problem with this mode of payment is that it involves a lot of paperwork. The process is intensive, discouraging buyers and suppliers who aren’t confident about handling all the requisite documents.
PayPal is a safe, low-risk and paperless payment method. On the flip side, paying with PayPal is expensive and suitable for a small order or initial sample.
The online payment service charges a standard fee of 2.90% plus 30p per transaction. Chinese users pay 4.4% plus 30p. Chinese suppliers have to use a third-party payment service to move money from their PayPal account into their Chinese bank account. They incur withdrawal and conversion fees, and have to wait two days to get their money.
There’s also a currency conversion fee on balance and cross-currency payments. PayPal charges a commission of 3% for balance conversions and 3.75% for cross-currency payments. They don’t offer the best exchange rates and aren’t feasible for large orders.
Chinese suppliers may decline PayPal payments to avoid buyer chargebacks. Unfortunately, PayPal lacks a straightforward dispute resolution and claims management process. Sellers may have a hard time resolving any issue where the buyer may have reversed the transaction after taking delivery of goods.
PayPal’s seller protection is also inadequate in another way. It covers a supplier if the buyer claims an item was not received, but not if the item is ‘not as described’. After a dispute is initiated, the supplier and buyer have 20 days to resolve the issue. The seller’s funds are temporarily unavailable when the dispute is in process.
The payment service appears to be on the side of the buyer, although payment protection policies for the party receiving the goods are also complicated. For this reason, it is best to use PayPal only when you’re purchasing samples during the supplier testing phase.
You may find a PayPal fee added at the bottom of product listings. This is the supplier adding a premium to the total of the invoice to make up for the fees incurred when selling goods. The cost of sending money can eat into suppliers’ already-thin margins, and given PayPal’s weak protection policies, the supplier may not be taking any chances with customers.
The fact that most PayPal accounts are held by individuals or Hong Kong registered companies managed by individuals based in the Chinese mainland creates a different type of risk. If you must, reserve PayPal for very small orders and use T/T or LC for actual orders.
Suppliers may ask you to prepay 100% before production, especially if they’ve gathered that you’re venturing into importing for the first time. As a large amount of money is involved, making a full upfront payment instantly puts you at risk. Moreover, the supplier has no incentive to remediate issues with product quality after delivery.
Generally, payments to Chinese suppliers occur in two or three stages per order, and payment processing fees will apply to each transaction. A typical payment agreement can look like this:
- 30% of the full amount before starting production
- 70% after the order is complete
Suppliers are also open to a 20:80 split on an initial order where the larger balance is paid on shipment. A lower initial deposit is recommended for standard products that the supplier can easily sell to another importer.
Mass orders usually have a 30:40:30 configuration. The 30% down payment allows suppliers to purchase raw materials and hire workers to begin production. The 40% payment is made after pre-shipment quality control (QC) inspection. It serves as motivation to ensure that the finished product meets your specifications. If you refuse to pay the remaining 30% after you’ve received shipment, the supplier will still have recovered 70% of the purchase order value.
- Choose the Free on Board (FOB) incoterm, which puts you in control of your international freight. You can obtain lower freight rates with freight forwarders, and negotiate a schedule that aligns well with your needs. If the supplier manages the freight, they will apply transportation costs to the product price. You will not have control over costs and be compelled to accept the supplier’s terms.
- Pay the deposit only after you have the sales contract and pro-forma invoice signed by an authorized individual from the supplier’s company.
- Pay the balance after you receive quality inspection reports or products test results.
A note on sourcing highly customized products
If you’re relying on the supplier to make a highly customized product, offer to pay for non-recurring engineering costs. This is typically a one-time cost of researching, designing, developing and testing your product. When the supplier does not ask you to pay non-recurring engineering costs, it may be an attempt to create a situation to increase the projected unit price of your item. They may insinuate that they cannot meet your quality requirements or delivery schedule unless they do so, so you would be better off paying this one-time cost up front.
You may respond by asking the supplier for the prototype so you can have the product made at a different factory. The supplier will argue back saying they own the intellectual property rights (IP) and that the prototype will remain with them. So, while they will manufacture the product exclusively for your business, you will need to work with their terms. Moreover, if you’re unable to meet a certain sales target, the supplier will cut ties and market the product themselves.
To avoid this situation, it is imperative that you draft an air-tight contract describing who owns the IP and the specifics of what either party can do with the finished product. Agreeing to pay for the costs of non-recurring engineering work persuades suppliers to reach a fair deal.
Before you begin payment negotiations, consider factors beyond costs to you. Paying a large amount upfront will affect your cash flow but paying for molds or tooling can give you leverage and/or reduce risk when you’re looking to bring a new or customized product to market. Discuss the trade-offs and potential implications with an attorney specializing in international law and ensure that everything in the documents is 100% clear to your supplier.
Paying a supplier in Chinese Yuan/Renminbi (CNY) can give you a better exchange rate compared to USD payments, resulting in a small price reduction. Converting dollars or Euros into Chinese Yuan and paying the supplier in their local currency is also faster and more efficient. The supplier doesn’t have to pay to change from USD to RMB, or wait up to 10 days to get cash in RMB. On the other hand, settling trade in RMB is subject to local restrictions, the reason why USD continues to remain the dominant global currency.
Exchange rate movement between the date of purchase and change of payment creates a price risk for the supplier. Anticipating a drop in USD/RMB exchange rate, the supplier may try to negotiate a percentage increase in the total price, which will impact your margin. When it comes to negotiating the payment currency, you have to think about who will bear the burden of currency exchange rate fluctuations.
Suppliers will have a buffer on the sell-side to protect against currency fluctuations. You could ask suppliers to give quotes in RMB but work out a deal that allows you to pay in USD or Euro at the day’s exchange rate.
A forward contract offers protection against currency depreciation. You can lock in an exchange rate for up to 12 months and have some level of certainty about the costs incurred in completing a purchase.
Paying your supplier through a China sourcing agent is a convenient option. The agent serves as your domestic representative and eliminates the risk of fraud that presents itself when you’re directly paying a Chinese company. It would be in addition to their sourcing fee, but as long as the agent charges you a reasonable fee for managing supplier payments, this route could offer you the highest protection.
Sourcing Allies is a team of expert China sourcing agents that has helped western customers manufacture and source products from low-cost regions since 2006.
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