The pitfalls of China's rough capitalism

January 12, 2008 6:31:48 PM PST
Ron Rust and Beve Kozub were poking around the toy booths at China's biggest trade fair two years ago when something caught their eye: pouty-faced baby dolls snuggling in light blue and pink fleece blankets, their eyes tightly shut or gazing with a newborn's woozy stare. The American dealers plunked down $22,052 for a shipment of 2,740. But the lifelike dolls turned out to be knockoffs. Rust and Kozub were slapped with a lawsuit that could have cost them their home in Harmony, Pa.

Despite getting burned, they were back in China this fall. For new products at the right price, China is "the only option at this time," Rust said.

The Americans fell prey to one of the many dangers of China's rough and raw capitalism. It's a cutthroat, predatory world where many factories cut corners to make an easy buck or just stay ahead of the thousands of others vying for their business. Safety scares, copyright ripoffs and outright thuggery are endemic.

Yet, foreign buyers keep snapping up toys, clothes, laptops and a myriad of other products that the world's factory floor churns out. Getting your hot product made in China is seen as a sure moneymaker. In the first 11 months of 2007, China's exports totaled $1.1 trillion, up 26 percent from the same period in 2006, according to China's Commerce Ministry. Chinese exports to the U.S. totaled $212.7 billion, a 15 percent increase from 2006, the ministry said.

The buyers are not blameless: Many breeze in on buying missions and don't stick around to ensure the goods are made right.

For consumers, it can be a dangerous and even deadly game. Chinese-made toy trains coated with lead paint ended up in playrooms worldwide. Cough syrup containing a poisonous chemical used in antifreeze killed dozens in Latin America. A tainted pet food ingredient killed dogs and cats in North America.

Chinese officials defend their factories, saying only a tiny fraction of the billions of dollars in exports each year have problems. But it takes just one bad batch of toothpaste to cause deaths.

American doll dealers Rust and Kozub have come to China on buying missions twice a year for the past four years.

"Before we ordered the dolls, we asked if the design was theirs and they said, 'Yes,' " said Rust.

The dealers had sold most of the order when they got sued by Ashton-Drake Galleries, a major American dealer that owns the copyright to the doll's design, including its clutchy little hands.

"When you're in China, how can you check on copyrights?" Kozub asked. "How would you know as a buyer to go check a hand?"

Their lawyers said they didn't stand a chance in court and would likely lose their home in a legal defeat. So they paid a settlement of $14,400 and destroyed the 107 unsold dolls.

"Our business was just starting to turn a profit," said Rust, who launched Springers Wholesale with Kozub five years ago.

In October, they returned to China's biggest trade show, the Canton Fair in the southern city of Guangzhou, to scout for new products and confront the supplier of the copied dolls.

The dollmaker's vice general manager, David Qin, sat at a booth lined with blonde, blue-eyed dolls - all different from those the Americans had bought two years ago. Qin, a pudgy man sporting a buzz cut and a blue polo shirt, wouldn't talk to them until he finished his takeout lunch.

He crossed his arms over his chest as Rust explained the lawsuit and requested a shipment of dolls as compensation. In the middle of the conversation, a saleswoman flicked a switch on a display doll dressed like a punk rocker with a mohawk, leopard skin coat and red guitar. The toy belted out the song, "Who let the dogs out! Hoo, hoo, hoo, hoo!"

Qin said the Americans were misled by a sales representative who no longer works at the company, Yangzhou Zhongyi Toys Co., Ltd. He repeatedly told Rust to find the former employee and take up the issue with him. He was unsympathetic to Rust's argument that the company should take responsibility for the dolls it produced.

Later, a company saleswoman, who declined to be named, tried to explain the piracy issue to an Associated Press reporter. "Well, you know, there are a lot of factories that make dolls in our city and our designs usually all end up looking the same," she said before pausing abruptly and adding, "But I'm not sure how it happens. It's unclear."

After the meeting, Kozub and Rust sat at a coffee shop at the trade show and shook their heads as they rehashed the meeting. "Sometimes we scratch our heads and wonder what we're doing here," he said.

Such incidents feed perceptions in the West that the Chinese can't be trusted. But Robert Kapp, a business consultant with a doctorate in Chinese history, noted that the term "snake oil" was invented in the United States during the era of cowboy capitalism.

"Every country goes through this period," said Kapp, who headed the U.S.-China Business Council from 1994 to 2004. "It may be that China is going through a growth phase we went through some time ago."

Most Chinese industrial leaders have relatively little experience. Companies that are at least 10 years old are rare. Modern principles of market research, quality control and corporate governance are virtually unknown to the new capitalists.

On the Chinese side, companies complain of incessant pressure from foreign buyers to lower prices, despite rising labor and material costs.

Toy prices haven't increased much in recent years, according to NPD Group Inc., a market research group. The average selling price of a toy was $7.53 in 2006, up from $7.17 in 2005 and $6.97 in 2004.

Some foreign buyers don't even care about quality, said Christopher Devereux, the Guangzhou-based managing director of Chinasavvy HK Ltd., which matches foreign buyers with Chinese factories.

Devereux, a tall silver-haired Briton, was contacted recently by an American who wanted to order 4,000 to 5,000 MP3 players. The buyer wasn't deterred when Devereux told him Chinasavvy lacked the expertise to do quality checks on the devices.

"He just said he wasn't too worried about the quality," said Devereux, who declined the request. "They think: 'Everything is made in China. Let's just place an order over the phone.'"

Foreign buyers play Chinese manufacturers off against one another, insisting that those with solid reputations match the prices of smaller factories that even the buyers know can't produce quality products, said Harry Chin, who was managing the booth for Guangdong Huawei Toys Crafts (Group) Co. Ltd. at the Canton Fair.

But Chin thinks last year's high-profile recalls, including Mattel Inc.'s, are curbing this practice.

"More and more customers are going to the big factories. They no longer go to the small factories," said Chin, whose big booth was lined with plastic dinosaurs, toy binoculars and singing Santa Clauses in red and green fleece snow suits.

Just 20 yards away lurked Zhang Mingliang, vice president and export manager for rival Jiansheng Arts & Gifts Co. Ltd.

Zhang was watching for buyers who showed an interest in the Santa Claus dolls. Sporting a Beatles hairdo with reddish brown highlights and a lavender shirt that reeked of cigarette smoke, he ambushed buyers as they came his way.

His company didn't rent a booth, because he feared someone would steal its designs, he said. He offered to produce the same Santa Claus dolls for a much lower price. "We can do it because we have the most modern work force and production lines," he said.

Figuring out whether to trust someone like Zhang is difficult for a smaller traders.

Furniture seller Frank Carroll learned that lesson after he closed his 20-year-old factory in Dublin, Ireland, and came to China six years ago.

The Irishman, who now prefers Tsingtao beer over Guinness, worked with a family-run factory in the southern Chinese city of Foshan. They became so close that he was invited to the matriarch's birthday party at the family's luxurious compound with swimming pool and snooker table.

But one day, the quality control worker employed by Carroll discovered invoices at the factory office for American-standard foam. That meant the 2,000 upholstered Regency-style chairs that Carroll had ordered couldn't be sold in the British market, which requires flame retardant "BS-standard foam."

The factory owner and his brother at first denied that the contract specified BS-standard foam, Carroll said. When he showed them the contract, they stalled for time. Later, the mother, father, three brothers and two of their wives showed up at Carroll's hotel.

"They weren't willing to fix the problem," he said. "They said, 'Can't you sell these chairs anyway? We won't tell anyone. Nobody will know.'"

One of the wives began sobbing and urged him to forgive her husband and take the chairs as a face-saving gesture.

Carroll refused: "Had I been found out, my business would be dead. If one person found out, I'd never be able to trade in the U.K. again."

It wasn't the last time he saw the chairs. "At a furniture fair six months later," Carroll said, "they were selling the chairs at a discount price."

The experience didn't scare him away. The trick is finding good factories and micromanaging them, said Carroll, who splits his time between Guangzhou and Dublin.

He doubts the product recalls will drive away buyers. Rather, the market will become more crowded.

"My biggest problem next year," he predicted, "will be finding suppliers."