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Gasp!

OMG, outsourcing to China has risks!

Found on Susie Madrak’s site, is a story about the risks associated with doing business in a country that is not the US, which she links to with the blurb “For outsourcing CEO’s” (which sounds like a really good idea).  Here is an  example of what can happen to companies that are not careful with their intellectual property when they outsource to China:

“For over three years, this engagement resulted in a very productive relationship, with Shinri manufacturing and shipping our goods to Fellowes’ locations throughout the world,” says James Fellowes, a third-generation chairman and CEO of Fellowes Inc. “Shinri enjoyed a 100 percent-plus return on investment for each of the years and this return on investment was always paid on time.”

But in 2009 everything changed when the leadership of the Chinese company shifted to another Zhou brother. Over the next year, the Chinese company “gradually attempted to usurp control [of our operations] in direct violation of the joint venture agreement,” Fellowes told a recent hearing of the House Foreign Affairs subcommittee on Asia and the Pacific. “Shinri methodically imposed unreasonable requirements on Fellowes in an effort to extort more profit and ultimately control the global shredder business in direct violation of our contract.”

Shinri insisted that Fellowes assign its 100 percent-owned tools to the joint venture. It required that Fellowes assign 100 percent of its engineering capability and its 100-percent owned Chinese sales division to the joint venture. It told Fellowes it must increase its prices immediately by 40 percent. It told Fellowes that it had to unilaterally contribute over $10 million to the joint venture and if it didn’t “then Shinri would close down our operation as the legal representative of the joint venture,” says James Fellowes. “When Fellowes refused these illegal demands Shinri proceeded to destroy our business.”

Starting on August 7, 2010, Shinri started to obstruct shipments of shredders from the factory, forcing the joint venture to stop production. “It placed security guards and trucks at the gates to prevent the entrance of our people, the shipment of our goods and the transfer of our wholly owned assets,” says Fellowes. “They expelled Fellowes’ appointed management personnel at the facility and they illegally detained Fellowes’ injection molded tools. This ultimately led to the bankruptcy of the joint venture.”

James Fellowes immediately flew to Changzhou to meet with Chinese government officials. “They sympathized with our plight but they were either unable or unwilling to force our Chinese partners to open our factory or facilitate a purchase of the joint venture by Fellowes. The cumulative impact of these actions is an economic loss totaling over $100 million to Fellowes.”

Fellowes has recently learned that Shinri is planning to compete directly against it in the shredder business using Fellowes’ custom molding tools “that represent the embodiment of Fellowes’ engineering investment and intellectual property,” says the company

CEO.

The court in China has gotten involved: It has initiated proceedings to liquidate the joint venture and auction the assets “to satisfy the debts of the joint venture” — suppliers who are demanding that unpaid invoices be paid, according to Fellowes. “The sale of Fellowes’ tooling and our finished goods inventory to anyone other than Fellowes would be a direct violation of our intellectual property rights. The immediate release of our tools is of great concern for us today. We have been restricted from these tools for eight months and that has greatly hampered our ability to recover.”

Fellowes wants to bring these tools back to the United States so that it can re-establish a manufacturing operation in Illinois. It is “working around the clock to retool our products and bring up new factories,” says Fellowes. “We hope the U.S. government will act to protect the rights of American companies like ours.”

{{snort!}}  Funny, he doesn’t mention how he hopes the US government will act to protect the rights of American workers.  It’s probably just an oversight.

Who could have predicted?   The Chinese are notorious piraters of entertainment industry copyright protected content. They have a record of hacking Google and the Defense department.  But that hasn’t stopped lots of CEOs from signing up with China for cheap labor covering just about every industry.  In the drug industry, for example, lots of medicinal chemistry jobs have gone to China.  Presumably, the executives are counting on the contracts they signed to keep the Chinese synthetic chemists from becoming too interested in their work.  I wonder if it ever occurs to the outsourcers that the last bunch of analogs they ordered could be held hostage or that the Chinese wouldn’t hesitate to tap the intranets of the intellectual property geniuses in the US to see what those analogs are good for.  Imitation is the highest form of flattery but theft takes less time.  And who could blame them?  Those potential blockbusters are being made in THEIR country by their chemists.  Wouldn’t it be weird if they *didn’t* want a piece of the action?

But it’s even worse than that.  It looks like Shinri got tired of being used as the slave labor by a modern equivalent of the British East India Company and asked to have a bigger share of the engineering aspect of the business.  Say what you will about their motives but Shinri asked for a measley $10M ransom payment.  It’s modest by today’s Dr. Evil standards.  But Fellowes turned them down and has consequently lost $100M in the interim.  How dare a Chinese company get all uppity and start issuing demands.

That’ll learn’em short term thinking MBAs.  ehh, who are we fooling.  These braintrusts probably got raises last year for reducing US labor costs.

Well, now we know such things can happen.  There’s a reason why the business environment in the US was so productive and innovative compared to the rest of the word.  Rules and regulations are intended to keep stuff like this from happening.

Let this be a lesson to the outsourcing CEOs.  Play fair or risk it all.

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