What do price and terms of negotiations have to do with product quality?
All price quotations in China are calculated on the individual BOM (Bill of Materials) list. This is a document used by the manufacturer or other businesses to authorize purchases to be made, or to request materials be pulled from inventory to fulfill a customer’s order.
The BOM
Here is an example of a real BOM for a PCB (Printed Circuit Board) of an electronic item.
PCB Assembly
| Part | Description | Vendor | Vendor Part# | Quantity | Price | Subtotal |
|---|---|---|---|---|---|---|
| 1N4148 | Diode | Mouser | 78-1N4148 | 4 | $0.03 | $0.12 |
| 1N5231 | Zener Diode, 5.1V | Mouser | 78-1N5231B | 1 | $0.04 | $0.04 |
| 1N5234 | Zener Diode, 6.2V | Mouser | 78-1N5234B | 1 | $0.04 | $0.04 |
| 1N5819 | Schottky Diode | Mouser | 625-1N5819 | 1 | $0.14 | $0.14 |
| 2N3904 | NPN General Purpose Amplifier | Mouser | 625-2N3904 | 1 | $0.05 | $0.05 |
| MAN6940 | Seven Segment LED Display, CC | Mouser | 512-MAN6940 | 9 | $1.84 | $16.56 |
| Capacitor | Ceramic Capacitor, 0.1uF 50V | Mouser | 21RZ310 | 12 | $0.08 | $0.96 |
| Capacitor | Electrolytic Capacitor, 100uF 16V | Mouser | 140-XRL16V100 | 1 | $0.06 | $0.06 |
| Capacitor | Tantalum Capacitor, 10uF 16V | Mouser | 80-T350E106K016 | 4 | $0.48 | $1.92 |
| ECS-ZTT | 20MHz Ceramic Resonator, with Caps | Mouser | 520-ZTT2000MX | 1 | $0.40 | $0.40 |
| L78M05CP | Positive 5.0V Voltage Regulator | Mouser | 512-LM78M05CT | 1 | $0.36 | $0.36 |
| LED | Red LED, 3mm (T1) | Mouser | 606-4303F1 | 6 | $0.21 | $1.26 |
| LM317T | 1.2V to 37V Voltage Regulator | Mouser | 512-LM317T | 1 | $0.51 | $0.51 |
| LM393AN | Low-Power Dual Voltage Comparator | Mouser | 512-LM393AN | 3 | $0.33 | $0.99 |
| M74HC238B1R | 3-to-8 Line Decoder | Mouser | 511-M74HC238 | 1 | $0.50 | $0.50 |
| M74HC4316B1R | Quad Bilateral Switch | Mouser | 512-MM74HC4316N | 2 | $0.50 | $1.00 |
| M74HC573B1R | Octal Latch w/ 3-State Non-Inverting | Mouser | 512-MM74HC573N | 3 | $0.54 | $1.62 |
| PIC16F876A | Flash 8-Bit CMOS Microcontroller | Mouser | 579-PIC16F876A-I/SP | 1 | $4.53 | $4.53 |
| Resistor | 1/4W 5% Resistor, 1K Ohm | Mouser | 660-CF1/4L102J | 6 | $0.05 | $0.30 |
| Resistor | 1/4W 5% Resistor, 10K Ohm | Mouser | 660-CF1/4L103J | 24 | $0.05 | $1.20 |
| Resistor | 1/4W 5% Resistor, 100K Ohm | Mouser | 660-CF1/4L104J | 2 | $0.05 | $0.10 |
| Resistor | 1/4W 5% Resistor, 1.5K Ohm | Mouser | 660-CF1/4L152J | 1 | $0.05 | $0.05 |
| Resistor | 1/4W 5% Resistor, 220 Ohm | Mouser | 660-CF1/4L221J | 1 | $0.05 | $0.05 |
| Resistor | 1/4W 5% Resistor, 56 Ohm | Mouser | 660-CF1/4L560J | 1 | $0.05 | $0.05 |
| Res Iso DIP16 | Resistor Array, 150 Ohm | Mouser | 652-4116R-1-150 | 3 | $0.49 | $1.47 |
| Switch | Mountain Tact Switch | Mouser | 101-0621 | 23 | $0.30 | $6.90 |
| UDN2983A | 8 Channel Darlington Source Driver | Digikey | TD62783AP-ND | 3 | $1.23 | $3.69 |
| ULN2803A | 8 Channel Darlington Sink Driver | Mouser | 511-ULN2803A | 3 | $0.44 | $1.32 |
| PCB | DRO-350 Bare PCB | ShumaTech | #1 | 1 | $17.95 | $17.95 |
| Total | $64.14 |
Bills of materials are of course only one part of a product’s cost. Other costs such as factory operations, labor, and administrative costs all go into the net cost of a product. Finally, the supplier adds their profit margin before quoting their selling price.
When you negotiate prices with your supplier, the BOM plays an essential role in your supplier’s calculation. Because most of the other costs cannot be changed, it is actually the most important part . The factory cannot significantly reduce labor costs, otherwise workers will flee to other employers. The equipment the factory owns and the cost of energy for manufacturing are relatively set factory operational costs.
That leaves the BOM as the only negotiable cost. Just like most things in the world, this is accomplished by substituting cheaper materials from other vendors or outsourcing part of their production to subcontractors who are likely taking quality short cuts that your supplier does not.
You might point to the profit margin as a good place to trim the price. In reality, the profit margins are so thin that if they were further reduced it would not make much sense to even open the factory doors for business. Certainly, they do not want your purchase order if it means they will lose money on the deal.
I highlighted the total BOM cost in red color at the bottom of the form to draw your attention to it.
Both options that the factory has for reducing costs are bad for your quality requirements.
Sourcing cheaper components or materials usually means inferior parts or materials. Otherwise, the factory would already be using these less expensive components.
The Difference a Switch Can Make
I present to you a scenario of what could happen.
A factory receives a large order for 200K electric hair dryers. They face the situation where the customer’s requested price is too low. They scrutinize the BOM and find an electrical switch purchased from a reputable switch maker can be substituted with a lower cost switch made in-house.
The savings is only US$ 0.05 but when multiplied by the 200K dryers it becomes a US$ 10,000 cost reduction.
Now for the real quality issue. The switch from the specialized switch maker was lab approved and had its own approval certificate. The in-house produced switch does not have its own certificate. Rather the supplier covers it with the exiting certificate for the hair dryer.
You may think that an approval is an approval and it is a good way to cut costs. However, if something happens later on and the hair dryer starts burning because of a faulty switch, lacking the proper approval will become a big deal.
A component with a stand alone approval is always an advantage, but it does cost more money.
You can now see the direct relationship between negotiating cost and the effect it can have on quality. The more you squeeze your supplier, the more likely he will try and reduce the BOM cost by substituting good components or materials with inferior ones.
There is always the option of substituting A-grade components with B-grade or even C-grade ones. It is nearly impossible to discover these changes, but the result will be lower performing products. This is especially true of consumer electronics that need ICs, capacitors, and resistors in A-grade quality to perform properly.
If you have a good long-term relationship with a factory, you may have some reassurance that your factory will not use this cost cutting method, but there is no guarantee of it.
The other option of outsourcing part of the production to a subcontractor was sufficiently covered in the previous chapter.
Hidden Low Prices
Here is a little known fact that will probably surprise you. Insisting on longer than usual payment terms (L/C 90-120 days) will be reflected either in the product price or in lower quality.
The Chinese are usually good negotiators and know ways to persuade you to listen to their arguments. If they insist after several rounds of negotiations that they will lose money by meeting your target price, you should not continue pushing the issue or it will simply become hidden somewhere else. Look for some form of compromise to avoid getting into trouble with substandard production quality that could cost you much more than accepting an FOB price a few cents higher.