Uncertainty of the US global trade policies is not new these days. Add to that the trade wars escalating and tariffs on imports increasing – all of it making some organizations nervous and ready to relocate. Find out why our author Rosemary Coates tells us to buckle our seatbelts and get prepared. Our takeoff and rise into a turbulent sky will get bumpier for contract management before calm settles in.
A perpetual state of turbulence is the best way to describe today’s global trade environment. Perhaps you have seen some of the signs:
- increased pricing requests and adjustments due to tariffs
- unstable government policy requiring contract changes
- global business uncertainty
- changes to global production locations
These are just a few of the signs that contract professionals have to deal with. Nearly 6,000 Harmonized Tariff Schedule (HTS) item classifications have already been identified for the imposition of a 25% penalty tariff on imports from China and there are more to come. Tariffs will increase to 30% staring Oct 1, 2019. Steel and aluminum tariffs apply more broadly to imports from many countries with tariff rates up to 400%.1 It appears that the trade wars aren’t going to end anytime soon.
The Chinese have a saying, “to eat bitterness” as a way of explaining perseverance through times of hardship. The Chinese are prepared for the long term in trade negotiations. In fact, although Chinese economic growth rates are down, their export numbers are actually slightly up. The Chinese have increased tariff rates on United States (US) goods, and lowered rates on imports coming from other countries such as Canada. While the US is suffering through significant declines in exports and increased costs for imported products, the Chinese are waiting patiently and enjoying lower prices on imports from non-US countries.
What countries might be next?
If you have contracts with suppliers or customers in Mexico, India, South Korea, Vietnam, Australia or EU, you should be concerned and be preparing a strategy for how to respond. The Trump administration has already been sabre rattling regarding Mexico, India has been removed from the Generalized System of Preferences (GSP) import list, Vietnam is in the cross-hairs, and the EU has been threatened with tariffs on aircraft and French wines. Australia’s robust mining industry is rumored to have put the country on the list of considered tariff targets.
No one can be certain what might happen next, so businesses must prepare alternative plans and strategies to respond if additional trade wars are initiated by the Trump administration. Section 301 of the Trade Act of 1974 provides the United States with the authority to enforce trade agreements, resolve trade disputes, and open foreign markets to US goods and services. It is the principal statutory authority under which the United States may impose trade sanctions on foreign countries that either violate trade agreements or engage in other unfair trade practices. It is up to Trump to decide what are unfair trade practices.
The Huawei and ZTE effect
In addition to tariffs, certain Chinese companies are also targeted for trade restrictions. Huawei, accused of spying via its software, and ZTE, accused of selling products to Iran, have been singled out for severe trade restrictions. Other Chinese companies have also been the targets of investigation.
If your company is buying from or selling to these companies, you can expect changes to, or violations of your contract terms. No matter what your contract says, if the US government decides to apply restrictions, US law will prevail. It seems more of this kind of turbulence can be expected.
What will you leave behind?
Because of the unstable global trade environment, there is much uncertainty in American businesses. Executives are now developing strategies that include alternatives that can be put into place as a fast response, such as moving operations to another country.
Companies are relocating some production lines to other Asian countries or elsewhere, while continuing to manufacture in China for the high-growth Chinese and non-US markets. This is known as “China+1.” This allows companies to keep a stake hold in the burgeoning greater Asian middle-class marketplace, growing at about 14% per year, and avoiding the current China tariffs on imports.
In some cases, manufacturing is coming back to America, based on new Trump administration policies such as reduced environmental regulations, tax reform, and the repatriation of funds at a low taxable rate. In addition, Trump has “ordered” US companies to stop buying from China. Whether or not such an order can be legally enforced is uncertain, but these kinds of changes in policy are causing many businesses to rethink their strategies, resulting in a whiplash effect in global contracts.
However, it isn’t so easy to simply pack up and move to another location. If you are going to bring an early end to a contract with a Chinese manufacturer, many issues must be addressed.
- Most Chinese workers are on annual employment contracts, as required by the Chinese government. If you end the relationship early, you may have to pay out all wages due through the end of the employment contract period.
- If you have molds, tools, or dies you may not be able to retrieve them from the Chinese factory no matter what your contract says.
- If the mold has been outsourced to a third-party mold maker, who developed the mold – who has rights to it may be unclear.
- If the third-party mold maker designed and prepared detailed drawings and produced the mold, do they also own it? Perhaps.
- Can the mold be used to produce products long after you have closed down operations and moved out of China? Perhaps.
While you may think you have a solid contract by Western standards, these standards may not hold up in Chinese court. If it is not completely clear in your contract that you own all Intellectual Property (IP), – drawings, prototypes, and finished molds - your company may be stuck and have to leave molds and other equipment behind. Being aware and preparing your contracts to address these kinds of situations is key to minimizing the economic damage to your company.
Prepare Plan B and Plan C
Now is the time to prepare alternate plans. You should have at least a Plan B and a Plan C. With so much turbulence ahead, you need alternate options for operating. One of the most important things to do is stay closely aligned with your internal stakeholders, particularly if they are determining the strategy for operational changes. Don’t wait until the last minute to develop a contract strategy for a new agreement. New countries, new suppliers, and new logistics require changes that may be disruptive and concerning, and require new contract clauses.
Having alternate plans for writing and executing contracts in a new place may require doing some research. It’s likely the different cultural norms and country laws will require your understanding about the way other countries do business. Even if your sourcing and manufacturing is returning to the US you must pay attention to US laws regarding safety and environmental issues that are more rigid than China or Vietnam. If multiple countries are being considered, you should be familiar with how contracts work in each country and which clauses are in or out.
Stay attuned to what your business leaders are considering so that you are prepared and don’t get blindsided writing a contract or purchase order at the last minute.
A word about IP protection and counterfeit goods
Approximately 80% of all counterfeit goods come from China.2 We have all heard the horror stories about Chinese intellectual property theft. Today’s global counterfeiters make products that are nearly indistinguishable from the true brands. But simply moving out of China will not resolve these counterfeit or IP issues. In fact, there is much evidence that counterfeiters are leaving China right alongside global manufacturers. Counterfeit products and knock-offs are a growing trend in Vietnam, India, and parts of Africa.
Register your trademark To protect your company from IP theft, you must register your trademark in each country. You should also be aware of anti-counterfeiting laws in these countries. Unfortunately, these protective laws aren’t always very sophisticated or strong and sometimes weaker than the laws in China.
Counterfeiting and IP theft aren’t going away anytime soon. The European Organisation for Economic Cooperation and Development (OECD) estimates that counterfeits will escalate to about $2 trillion by 20203. Approximately 1 in 20 imports into the US and Europe are counterfeits. Counterfeiting is a big and profitable business and will continue to be in the future. The only way to combat counterfeiting is through consistent and persistent oversight of your supply chain and via legal action in the US and Europe.
This shouldn’t preclude you from adding anti-counterfeiting and IP protection clauses to your contracts. These clauses must be country-specific in order to hold up in a foreign court.
Observe and buckle your seatbelt
So, what should contract managers do now? Because of the uncertainty of the US global trade policies, the escalating trade wars, and the potential for changes in your company business strategy, watching what is happening, observing your own company’s alternatives, staying close to your internal stakeholders, and preparing to respond is the best approach. More turbulence is ahead, before we find calmer air. Buckle your seatbelt.
ABOUT THE AUTHOR
Rosemary Coates is the President of Blue Silk Consulting, a Global Supply Chain consulting firm, and the Executive Director of the Reshoring Institute. She is a best-selling author of five books including Amazon Top Seller: 42 Rules for Sourcing and Manufacturing in China and Legal Blacksmith - How to Avoid and Defend Supply Chain Disputes.” The author lives in Silicon Valley and has worked with over 80 clients worldwide. She is also an Expert Witness for legal cases involving global supply chain matters.
- U.S. Slaps Import Duties of More Than 400% on Vietnam Steel
- Definition: consumer goods
- OECD/EUIPO (2019), Trends in Trade in Counterfeit and Pirated Goods, Illicit Trade, OECD Publishing, Paris