Payment terms with manufacturers in low-cost regions such as China is key. Here is how you broker favorable payment terms every time
When businesses source from low-cost regions such as China, negotiations with suppliers over price, leadtimes, and frequency of quality control inspections are a given. There is one aspect, however, which some purchasers do not pay attention to: negotiating payment terms.
Payment terms are the rules a seller imposes on a buyer that specify the proportion of the total value of the purchase order that the buyer will pay the seller at different points throughout the production process. These terms can have several combinations. Let us take for instance the 30:40:30 configuration. This commonly means 30% down payment, 40% after a quality inspection and shipping, and 30% upon receiving the shipment.
Just as clear communication with your supplier about product expectation and shipping dates helps them plan production, negotiating payment terms shows the supplier that you have thoroughly prepared for your sourcing project.
Both buyer and seller will want to negotiate payment terms that are favorable to them as this will have implications on their cash flow, protects them from financial risk, and gives them leverage in case problems emerge during the production process.
Payment terms include timing of payment and choice of payment method. Make sure you agree on these terms in writing before production starts. This is because any disputes over payment can delay production and shipping, which is a headache you don’t want to have.
Payment terms differ for the sample run, trial orders and mass orders. During the tooling/sample run, for instance, 50% down and balance on sample approval is common. This is because the order value is small and the supplier is taking a risk by spending time and effort on working on your product design, especially if it is a new design.
For subsequent trial orders and mass orders, however, a 100% upfront payment of the purchase order value wouldn’t be wise as larger amounts of money are involved, which puts the buyer at risk. Typical payment terms for trial runs are 20% down and balance on shipment while for mass orders it is common to see the 30:40:30 configuration for payment.
The 30:40:30 combination is quite common as it protects both the buyer and seller from risk. The 30% down payment allows the supplier to spend the down payment to buy raw materials and hire workers to kickstart the production process.
A 40% payment after the quality control inspection just before shipping protects both the buyer and seller from risk. From the buyer’s perspective, it will keep the supplier on their toes to ensure that the finished product meets all the buyer’s specifications. From the seller’s perspective, if the buyer, upon delivery, decides that they do not like the product and refuse to pay the remaining 30%, at least the supplier will have 70% of the purchase order value with them.
Some suppliers, however, might insist on being paid in full at the time of shipment. This usually happens if you both are in a new business relationship with each other. In that case, do ensure that the product has been inspected first and meets all your specifications and quality control standards.
As a buyer, here are three main reasons why negotiating for favorable terms is worth the time and effort you spend on it.
1. Cash flow: The less money you pay upfront, the more cash you have to run your business. This breather of a month or two before the next payment is especially valuable for smaller businesses, which have a relatively tight cash flow.
2. Gives you leverage: If the payment terms specify that the second or final tranche of payment will only be made after a quality inspection, this gives you some control over the supplier. It will be in their interest to ensure that your product matches the exact specifications and if that is not the case, you have the leverage to insist that they fix the problem. Leverage is also why you generally do not make a 100% upfront payment.
3. Protects you from risk: The less money you have paid your supplier towards the start of production, the less risk for you in case things go wrong down the line.
So how do you get favorable terms from your supplier? You need to first need to build a relationship of trust with them. Here’s how you can do it:
1. Be upfront
No one knows your business as well as you do. You know the demands of your market and have done immense research to ensure your product meets the demand. You also understand what type of payment terms your customers are expecting. These terms have an impact on your cash flow.
When you move to purchasing from low-cost countries such as China, if you know from day one that you will require certain payment terms in order to run your business efficiently, it is wise to be upfront with your supplier about this. This way they can invest their time accordingly and quote prices that make meeting your terms viable.
Suppliers who have put in time, money and effort to develop your product will feel tricked or belittled if one step away from mass production you tell them you require 60 days to pay their invoices or you cannot go ahead with the order.
If you want to build a relationship of trust with your supplier, it is best to be upfront about your requirements.
2. Be flexible
Sometimes the best way to get competitive pricing while sourcing from China is to be flexible with the payment terms. You will be surprised to see the discount you can attain by offering your supplier terms that are favorable to them.
Let us assume you have a well-established product that is in great demand. Since you know your market well, you know if the price of that product reduces, it will lead to more sales, and help you capture a larger share of the market.
If you can afford it, you could, for instance, offer to pay your supplier a larger down payment in exchange for a discount in the price of that product. The supplier will be happy to have more cash in hand as that reduces their risk. More competitive pricing will consequently lead to more orders for you, ensuring that you secure a larger market share over time.
This is a true win-win situation. It will help you gain your supplier’s trust, and even more flexibility with them. If there comes a time that you need more cash on hand, your supplier will be receptive if you need to renegotiate with them pricing and payment terms that favor your short-term cash flow needs.
3. Be patient
There are several cultural differences between the US-Europe and China. Of them all, I have always been struck by how differently trust is built in China.
Personally, I’d give my trust to someone who looks me in the eye and shakes my hand. As my dad would say, “That’s just how business is done. It’s called being a man of your word.” Overly simplified, in China trust is earned, not given. It is a process that takes time, so it helps to be patient.
In your communication with your supplier, be courteous with your feedback (consider “face”), be clear in your expectations, quick with your orders, and pay on time. It is that simple.
There is no easy way to establish a solid relationship with your supplier but a shortened path to success can be to team up with a sourcing agent like Sourcing Allies that has well established relationships with a variety of manufacturers. That is a value-add you will feel from day one.
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