Cablegate: Consumer Product Safety in South China

DE RUEHGZ #0836/01 2060745
R 250745Z JUL 07




E.O. 12958: N/A
SUBJECT: Consumer Product Safety in South China


REF: Beijing 4808

1. (U) SUMMARY: At a time when the safety and quality of goods being
exported from China -- not just to the U.S. but elsewhere in the
world, from the Philippines to Europe -- has been called into
question, foreign companies in this consular district, especially in
the Pearl River Delta, are looking at best practices and retooling
the methods they use to protect the integrity of their goods and, as
importantly, their name. "Due diligence" may be an old phrase in
the lexicon in the West, but in some places in China it is a new
catchphrase. Companies without in-house quality control operations
are increasingly depending on third-party inspectors for the
certifications necessary to export their goods to the U.S. market.
Insurance companies are ready, willing and able to sell liability
insurance so that U.S. companies can protect themselves, but those
same companies often perform but the most cursory of due diligence
before issuing policies. For some insurers, like AIU, which are
intent on educating the Chinese about product liability, this likely
spells the beginning of a very, very lucrative market. END SUMMARY

Keeping South China Reliable -- It's all in the Details
--------------------------------------------- ----------

2. (SBU) Although the cost of sourcing products destined for the
U.S. market is generally less competitive in South China than other
rural regions in the Greater China area, factories in this consular
district tend to be and are considered far more reliable -- which
accounts for the cost premium in the Pearl River Delta's favor.
However, Jake Phipps, CEO of U.S.-based Import Agency BCD, Inc.,
warns against sourcing directly from a factory without first
obtaining the assistance of an agent or regional representative.
This is critical when doing business without a detailed contract in
place, as factories will generally look to save money by altering
specifications and safety standards.

3. (SBU) When asked how the recent wave of U.S. litigation over
China product safety has changed their business practices,
businesspeople in the region unanimously responded that while their
approach to due diligence has not been altered, since many were
already investing substantially in this up front, their insistence
upon detailed specifications in supplier contracts has increased
exponentially. In short, importers are increasingly looking to
protect themselves by giving their suppliers little or no
contractual latitude to avoid responsibility for non-compliant

Third-Party Inspectors Lending a Helping Hand

4. (SBU) Consensus among business professionals in the region is
that local third-party inspection companies (TPICs) can be relied
upon only/only when dealing with low-risk product liability items.
For instance, BCD, Inc., which consults primarily on transactions
involving building materials, almost exclusively relies upon Chinese
TPICs to provide its inspection certificates. This practice is not
without its share of risks. According to BCD's CIO, Eli Ben-Avner,
in the past two years alone, the company has had three reports of
inspectors being bribed by local factories to submit fraudulent or
inaccurate inspection reports.

5. (SBU) In contrast, U.S.-based kitchen appliance importer Aroma
Housewares has only received one fraudulent inspection report in its
25 years of doing business in South China. The difference probably
lies in the TPICs retained by each company. Since Aroma's products
are used by U.S. consumers in food preparation, the FDA regulates
its imported shipments; local Chinese TPICs' certificates will not
be recognized by the FDA. According to Grace Wang, Head
Merchandiser for Aroma in Guangzhou, the company relies solely on
certificates from internationally well regarded Swiss-based TPIC,
SGS, which issues FDA-standard inspection approvals to Aroma's
factory suppliers. The suppliers sell the product to Aroma, which
imports it for U.S. distribution. NOTE: The cost of this process is
substantially reduced when selling to other regions, such as South
America, because South America does not demand FDA-equivalent
standards. In this case, Aroma utilizes an entirely different
production facility, and relies on local Chinese TPICs for its
inspection certificates. END NOTE.

6. (SBU) While factory insurers do not typically require TPIC
reports before issuing insurance certificates, an exception is
occasionally made for electrical products. According to Simon Foo,
General Manager of AIU Insurance Co. in Guangzhou, who is organizing
product liability seminars for Chinese companies (and who hopes in
the process to increase the amount of product liability insurance
sold by AIU), this practice is due to the failure of electrical
production facilities in South China to meet international UL
minimum standards, as required by the U.S. and other Western

GUANGZHOU 00000836 002 OF 003

markets. Foo remains confident, however, that those products, which
are eventually exported to Western markets from South China, are
generally safe, particularly since UL can be tracked online to
prevent the issuance of any fraudulent certificates.

Investing in Due Diligence

7. (SBU) Companies importing from South China appear to be investing
substantially in due diligence by their suppliers. Aroma Housewares
is acutely aware of the potential costs imposed when a company fails
to take such measures. In 2002, the company was forced to recall
over 100,000 juicers that it had imported from China, due to more
than 32 reports of injuries suffered by American consumers who had
purchased the faulty product. Since that time, Aroma has invested
heavily in product development, employing a full-time staff of
engineers whose sole responsibility is to visit the factories daily
and inspect for compliance. According to Lisa Huang, Chief
Representative for Aroma in China, the decision was an easy one.
The added costs pale in comparison to those incurred from
product-liability class action suits.

8. (SBU) In a similar vein, companies with a strong brand find it
imperative to protect their reputation for producing quality goods.
Tupperware Product Marketing Director Jonathan Cox did not appear
worried about the recent China product quality scandals, noting that
the company's quality control section was "anal" about quality, and
that "97 percent" of Chinese factories were not up to Tupperware's
standards. He also noted that Tupperware's marketing strategy was
based on product quality, not price (its competitors' prices are
generally one-tenth those of Tupperware), so quality control was a
top priority.

9. (SBU) Not everyone in the region has learned this valuable
lesson, but the message does appear to be getting through to most.
When asked about the division of their production costs, the
overwhelming majority of companies with suppliers in South China
stated that a major percentage of their resources are spent ensuring
product safety and specification compliance. Companies like IAS
Electronics in Shenzhen almost exclusively invest in product
compliance and factory due diligence. According to an IAS China
representative, to do otherwise would likely guarantee
specifications short of the internationally-recognized ISO quality,
and the company would be left with a warehouse full of product and
no market willing to accept its distribution.

Insure or Beware

10. (SBU) To provide added protection, most companies sourcing
products from South China are now insisting that their factory
suppliers have insurance certificates, both for warranty compliance
and product-liability suits. Due to reports of fraudulent
certificates surfacing in the past, companies are further demanding
that policies be issued by large insurance companies, such as AIU,
which already have online tracking mechanisms in place to prevent
any fraudulent certifications.

11. (SBU) Surprisingly, insurance companies, which would like to
reap the windfall on liability premiums, often do not appear to be
investing much in due diligence prior to issuing policies to local
factories. According to Tracy Zhang, Manager of Casualty
Underwriting at AIU's Guangzhou Branch, this is partly due to the
insurance companies' own lack of resources. As Zhang explains, it
would simply not be cost-effective to thoroughly investigate each
factory before issuing insurance certificates. Instead, insurance
companies in the region will typically choose to avoid issuing
policies to certain "high risk" industries altogether. (See
paragraph 13, below.)

12. (SBU) AIU's General Manager Simon Foo, nevertheless, does not
rule out the possibility that the company might occasionally engage
in factory due diligence prior to issuing a comprehensive insurance
policy. According to Foo, the decision to do so does not depend on
the product, but rather on the source of procurement. For instance,
if the factory is supplying goods to a low-level importer for the
U.S. market, AIU will almost never investigate the factory
operations. If, however, the factory is supplying goods directly to
Wal-Mart, AIU considers it mandatory to conduct a thorough
background investigation before offering an insurance certificate.
At times, this may even cause AIU to insist that the supplier
include warning labels or certain language in its instruction
manual. As Claims Department Manager Adam Yip explains, AIU will
have its engineers investigate the supplier's operations, at which
time the right to determine the language may either be written into
the insurance contract or informally suggested to the claim holder.

Insurers Avoiding the Risky Business

GUANGZHOU 00000836 003 OF 003

13. (SBU) Tracy Zhang, AIU's Manager of Casualty Underwriting, told
us that over 90 percent of the insurance policies issued by AIU in
South China are related to products intended for the U.S. Of that
90 percent, less than one percent of the claims are eventually
filed. Zhang attributes this to the company's sweeping avoidance of
issuing policies to suppliers in critical industries, like auto
parts, food additives, gas products, medicine and pharmaceuticals,
and bicycles. According to Zhang, these suppliers are often forced
to look overseas for insurance certificates, because local insurers
like AIU lack investigatory resources to mitigate the risk.


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