- We delve into the dos and don’ts of choosing a distributor in China and the key things you should consider, from contracts to IP protection.
You are ready to venture out for your company’s overseas expansion. Green and inexperienced when it comes to the Chinese market, you are however reluctant to jump in at the deep end. Ease, efficiency and cost-effectiveness are your top-of-mind priority. Partnering up with a local distributor is often designated a safe way to test the waters, but is it what it seems? Its all-too-often accepted label as a “soft landing” belies traps and trouble, so keep your wits about you when dealing with distributors.
Essentially, a distributor acts as an intermediary bridging the gap between the producer and those further down the supply chain, for example, a wholesaler, retailer or the end buyer. The usual practice is for the distributor to buy directly from the producer and then to sell the products on to another entity, thereby assuming the role of a reseller. The key advantage is that you can hitch your wagon to a distributor’s firmly established sales channels without a substantial initial investment in setting up your own infrastructure and logistics network. In addition, a distributor’s scope of operation can be considerably wide, ranging from customs clearance, shipping and storage to sales and marketing; therefore, those that prefer an all-inclusive service may be inclined towards this mode.
The most common ways to find distributors are, for example, through referrals, chambers of commerce and services provided by specialist agencies, at exhibitions and trade shows as well as on online platforms. However tempting it may be to shake hands on a deal with the first prospective distributor that approaches you, utmost circumspection is needed since unscrupulous distributors could ruin your business in China.
These are the main things that you should look out for:
Make sure to conduct robust due diligence to weed out rogue distributors
Prior to doing business with a distributor, you should conduct a thorough due diligence investigation to ascertain their legitimacy and that they are not hiding behind the veil of a false identity. Based on the registered name of the company, its accompanying identification number and the name of the legal person, you can check with the Administration for Industry and Commerce to ensure that they have been duly registered. Furthermore, the distributor’s financial health should be scrutinized by examining, for instance, bank statements, bank loan and mortgage records and debt records. If the distributor is able to produce many positive references, this is often a sign of credibility and reliability.
Make sure that legal safeguards are in place from the outset
It is indispensable to draw up legally enforceable agreements to safeguard your company’s interests from the very beginning. Contract provisions should outline the distributor’s scope of work and actionable steps in the case of non-compliance or breach. In addition, a clear definition of the role of the distributor is a must: will they be acting in the capacity of a seller, buying stock from you and then selling it on to a third party; or in that of an agent, pocketing commission and brokering the deal between you and the customer?
Provisions in respect of price control are prohibited as, in accordance with China’s Anti-Monopoly Law, you cannot require the distributor to sell your products at a specific resale price to, for example, retailers.
Another important consideration is that, if your partnership involves faithful adherence to your strategy, prominent use of your brands and trademarks as well as a transfer of proprietary knowledge, you may inadvertently slide into franchiser–franchisee territory. The host of regulations governing the latter relationship may thwart your efforts to stay on the side of relative simplicity.
Prepare for the event of the partnership ending
You should by no means assume an amicable break-up, for relations can turn sour and acrimonious very quickly. For this reason, the contract should clearly provide for where and how disputes will be resolved, the orderly transfer of ownership of e-commerce stores, websites and accounts on social media platforms as well as the handling of leftover stock – whether it will be sold off by or bought back from the distributor.
On the other hand, the termination of a distribution agreement is usually less of a legal hassle and financial burden, since distributors in China are not afforded the same level of protection compared to their counterparts in some countries, who may have a right to claim compensation or an indemnity payment.
IP protection should be at the forefront of your mind
It would be no overstatement to say that proper registration of all your intellectual property – prior to doing business in China – should take pride of place among your considerations. China operates a first-to-file, rather than a first-to-use, system, which means that you will have to wait until the trademark has been fully registered to enjoy protection. This process can take up to a year and a half. Unfortunately, its attendant consequence is that your trademark is susceptible to infringement even during this interim period. Furthermore, watch out for flagrant violation by “trademark squatters” who are on the constant lookout for promising international brands. After appropriating their trademarks, “trademark squatters” lie in wait for the legitimate owners to enter the Chinese market so that the latter are left with no choice but to buy their own trademarks back.
Never register your trademarks in your distributor’s name. Even though there have been cases of the distributor taking the pre-emptive step of registering trademarks on the foreign company’s behalf because of the latter’s delay in doing so, this is generally speaking ill-advised, as you would be relying on the distributor’s conscionable conduct. If they act unscrupulously and refuse to hand over the ownership of rights, then you might have to brace yourself for a drawn-out and costly legal wrangle, which may result in the deprivation of rights altogether.
To be or not to be exclusive?
It is important to define the type of partnership between you and the distributor, since the classification will have implications for both parties’ respective rights in selling and distributing the products in a particular territory.
Typically, there are three kinds of distributorships:
- Exclusive: You engage only one distributor who is the sole point of sale in a particular territory. There are obvious pitfalls in restricting yourself to merely one distributor, while your distributor has free rein to work on behalf of other – sometimes competing – brands. Watch out for underhanded behaviour of some dishonest distributors, who may, unbeknown to you, stop selling your product in favor of other brands so as to sideline and exclude you from competition.
- Sole: Similar to the above, a sole arrangement permits only one distributor, but you can sell your own products in a particular territory.
- Non-exclusive: You work with a number of different distributors, through which you can gain access to a broader range of customers; this may indeed be a better option in light of China’s size and diversity. The upshot is also lower risk, as all your eggs would not just be in one basket.
Keep your distributor on their toes by way of sales targets
In order to make sure that the distributor puts their hand to the plough and does not slack off, you should set adequately high sales quotas – especially if you have an exclusive distributor agreement. A blanket target can be set across all the products or individual targets that vary from product to product. Typically, sales quotas are set quarterly irrespective of province, and such quotas should be formulated clearly and precisely. In addition, the distributor should be prepared to face the music if their performance is not up to par, which may lead to the termination of the distributorship or the loss of exclusivity as provided for in the contract.
Achieve a level of brand recognition before entering the Chinese market
In reality, the partnership may not be as rosy as you would like to picture it: distributors tend to be relatively short-sighted in that they prefer reaping short-term profits over long-term rewards. Contrary to the seller–distributor partnership model prevalent elsewhere, whereby you and your distributor work side by side to build your brand from the ground up, this is generally not the case in China. In part, this is attributed to Chinese consumers’ fleeting tastes and ever-changing preferences. To cater for their customers’ low brand loyalty, distributors do not usually like having excessive inventory pressure.
You may find yourself in a dilemma: distributors may turn down your product because your brand is new to the Chinese market, although your product could turn out to sell like hot cakes in the near future. Of course, the inherent paradox is that the lack of distribution would preclude any sales growth. Therefore, you should build some brand awareness before entering the Chinese market with the help of online platforms.
Extensive preparation and sound judgement in your dealings with distributors would go a long way towards ensuring a “softer landing” upon your entry into the Chinese market. But if you throw caution to the wind, an unwise alliance with an unscrupulous distributor can have detrimental consequences for your business.