Outsourcing: Ripoff Nation

Even entrepreneurs who understand China are getting burned

By now, entrepreneurs who are considering outsourcing their manufacturing to China are aware of the risks: quality problems, postponed deliveries, and the ever-present intellectual-property theft, for starters. A big part of the problem is that U.S. entrepreneurs understand neither the language nor the way business is done in China.

Or so the story goes. But Edward Wu's experience suggests otherwise. Wu is vice-president of Aminco International USA, a 40-employee, $5 million Lake Forest (Calif.) company that makes commemorative pins and other accessories. He's fluent in Mandarin. His Taiwanese mother and his father, born in Mainland China, run the business with Wu and have broad family and social networks there.

A decade ago Aminco moved its manufacturing from Taiwan to China, decreasing production costs by about 20%. Then, about three years ago, Wu began seeing knockoffs of his products—with lower price tags—at conventions and trade shows in the U.S. He says the goods were manufactured by one of Aminco's factories (which he won't name). "We confronted them," says Wu. "They basically gave us some excuses and did not do anything about it." Wu understood that there was little he could do. The factory had simply bypassed him.

Despite efforts by the Chinese government to rein in counterfeiting, experts say manufacturers there can undercut their clients by producing similar products at cheaper prices in as little as two years. And Chinese American entrepreneurs have less of an advantage than one might expect. While they may initially get a leg up, economic factors soon trump everything else. "The Chinese American-owned business that goes to China may get to first base quicker...but the intellectual-piracy issues will not lessen," says Clarence Kwan, national managing partner of Deloitte & Touche's USA Chinese Services Group.

Sometimes a tough negotiating stance can backfire. "If the relationship is not 100% ideal to the Chinese manufacturer, and the margin the U.S. company affords them is slim, the manufacturer knows the enforcement of intellectual-property protection is not very strong," says former small business consultant Michael Chu, whose Web site, ChinaStar101.com, manages travel for entrepreneurs in China.

Piracy needn't be a deterrent to working in China. In 2000, Logic Solutions, a 45-employee, $6 million Ann Arbor (Mich.) software maker, contracted some software development to novice coders in Nanjing. By the time Logic set up its own facility in China years later, the programmers it had trained were working for a U.S. competitor. "I can tell you absolutely we understand how they work, and all of the cultural things, much better than our white-owned counterparts," says Grace Lee, the company's Chinese American CFO. She considers defections just another cost of doing business. The same thing, she says, happens in the U.S.: Think about what happened in the early '80s, when IBM hired Bill Gates to design the operating system for its new PCs.