VZCZCXRO1726
RR RUEHCN RUEHGH RUEHVC
DE RUEHGZ #0836/01 2060745
ZNR UUUUU ZZH
R 250745Z JUL 07
FM AMCONSUL GUANGZHOU
TO RUEHC/SECSTATE WASHDC 6299
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUEAIIA/CIA WASHDC
RUEKJCS/DIA WASHDC

UNCLAS SECTION 01 OF 03 GUANGZHOU 000836 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ETRD ECIN EINV PGOV CH
SUBJECT: Consumer Product Safety in South China 
 
 
BUSINESS-SENSITIVE 
 
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 
goods. 
 
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. 
 
 
GOLDBERG