Should you pay the factory before or after the goods are made?
This article is part of my Manufacturing for a Kickstarter series.
When and how much you pay is dependent on the industry standard and how much clout the factory and the customer has.
Deposits
Some factories will ask for a deposit (down payment) after a contract is signed as collateral to make sure that the customer is serious and to help finance the purchase of raw materials.
Deposits typically range from 10% to 50% and depends on the risk of the customer abandoning the transaction and therefore leaving the factory with goods it cannot sell.
Customers like Walmart have a lot of clout and therefore pay no deposit. In those situations, either the factory puts up its own money to manufacture for Walmart or an intermediate agent puts up the money. Factories like to manufacture for Walmart and produce cheap goods, because their order quantities are big which allows their factory to remain busy for a long time and a tiny profit over a big quantity equals a big profit. Factories also like the prestige of working for a big player.
Most large factories have clout on the basis that they are large and therefore more desirable. These factories are big and therefore less likely to cut corners on your product since it jeopardizes their industry name if they are found to produce shoddy products. Most large brands will only deal with large factories for this reason among others.
Historically, many factories would accept a “Letter of Credit” in lieu of asking for a deposit. But after the global financial crisis, many banks are no longer extending credit to factories. Most factories nowadays are asking for deposits.
The rest of the money
You should determine with the factory the schedule for the final payment before signing the contract.
There is no right and wrong answer because there is significant risk on both parties.
If a customer wants to pay after the goods leave the factory, the factory will worry that the customer doesn’t pay after the goods leave.
If the factory wants the customer to pay before goods leave the factory, the customer is worried the factory won’t ship the goods after the customer pays.
Some factories use escrow services provided by banks. A factory will deliver goods to the customer’s designated warehouse and show the collection receipt to the factory’s bank as proof of delivery. The factory’s bank will then contact the customer’s bank and the customer’s bank will send the money to the factory.
However, not all factories will accept escrows as banks charge a fee depending on a percentage of the goods and some banks will not work with a customer’s bank if the customer’s bank is not a “well known” bank.
An escrow service also does not verify that the factory shipped what they said they shipped. They could have shipped bricks instead of iPhones to the warehouse.
There is no perfect solution and which party accepts the risk is dependent on supply and demand.
Most customers take a cautious approach and only order a small quantity in their first transaction with a factory and build up trust over time.
If financially feasible, some customers send staff to the factory to inspect the goods during the manufacturing process to at least know they’re not getting a pallet of bricks.
Short-term credit
Some factories provide short term credit to their customers when they write “net-30” on the contracts, which means the payment is due 30 days after the invoice was issued.
This mostly only exists for large customers who demand it from their suppliers or from factories that offer it to attract a particularly lucrative customer.
Some customers, like Walmart even require “net-90” on their supplier’s contracts, which mean factories must wait 90 days after goods ship before asking Walmart for money.
Incoterms
When a factory quotes you the cost to manufacture goods, they usually give the quote together with an “incoterm”.
The incoterm determines when the factory’s responsibilities end and consequently when you are expected to make the final payment. Depending on the incoterm, the factory may be responsible for delivering the goods to a destination, or may simple end when you pick it up at the factory.
Most overseas factories quote a price that includes delivery to a freight forwarder of your choice. Some quotes even include the cost to ship the goods to a port in the destination country.
A few popular incoterms are:
- EXW (Ex Works): The cost of the goods don’t include shipping.You are expected to pick up the goods yourself and need to pay when you pick up your goods at the factory.
- FCA (Free Carrier): The cost of the goods include trucking to the freight forwarder and covering export paperwork for the goods to leave the origin country. You pay when the goods arrive at the forwarder or are loaded on the boat.
- CIF (Cost, Insurance & Freight): The cost of the goods include shipping the goods to your destination country up to the arrival at the designated port in your country. It does not cover the import paperwork. You pay when goods arrive in your country.
- DDP (Delivered & Duty Paid): The cost of the goods includes shipping and delivering right to your door, but not the unloading cost at your door. It includes the import costs to your country. You pay when goods arrive at your door.
When asking the factory for a quote you should reference the relevant incoterm that you want and keep in mind the more you expect the factory to cover, the more risk they assume in terms of time and cost and therefore the higher the price. And note that some factories have limited expertise and therefore can’t offer all incoterms.
DDP vs. FOB
Sometimes your factory will ask you whether you want to use DDP or FOB, both being the 2 most common options.
If you are new to importing, your best bet is to choose DDP. The factory handles the importing and customs clearance, which are not easy tasks and themselves carry certain risk.
If the ship sinks at sea (touchwood) or if President Trump suddenly decides to increase the tariffs to 200% or if the US customs department suddenly made importing soaps with microbeads illegal, you would be protected with DDP.
DDP can also be cheaper (after taking into account all costs) because there are no agents in between adding additional charges. Factories which regularly ship goods to your country/state can also consolidate your goods with their other goods to save on shipping and handling costs.
FOB can be cheaper if you can use economies of scale and consolidate your goods from multiple factories into one shipment. It can also be cheaper if your factory charges a premium to use their DDP service (because of their increased risk or if they need to use a third-party in the US to provide the DDP service).
