Does a letter of credit really protect an importer in China?
We were exhibiting on a Hong Kong trade show this week, and I got to talk with many importers. I noticed that some new buyers hold the misguided notion that a letter of credit protects the importer.
For example, I asked one purchaser "do you already do some quality control?", and he replied "no need, we pay by letter of credit". I had to explain that the letter of credit triggers payment before he can see the products, so he'd better have someone check them before shipment.
Generally speaking, a letter of credit does protect an importer of China-made products, especially if he takes the time to list out adequate requirements.
How does a letter of credit work?
Basically, a letter of credit triggers payment to the exporter only after certain pre-determined documents have been sent to the bank.
For example, if the quantity of products shipped out (as seen on the packing list and on the bill of lading) is outside the tolerance set in the letter of credit, it causes a discrepancy. In this case, the importer has the choice to accept it (in which case he can receive the shipment, and the supplier gets paid) or to refuse it.
Therefore, the buyer does not (usually) need to wire a cash deposit that gets him "hooked" to a potentially unethical Chinese supplier. The importer keeps the freedom to refuse the products (and cancel the payment) if at least one document is either missing or not conform.
The two major risks to keep in mind
First risk: receiving defective or substandard products.
The solution: ask for a certificate of inspection, issued by the quality assurance firm of your choice.
Second risk: the supplier can cancel the order anytime (this usually happens only if they have not purchased the materials yet, or if they can use/sell the products with another customer).
The solution: choose your suppliers wisely, start small with first orders, and keep some flexibility in your plans.