Factory vs Trading Company

Factory vs Trading Company

This is something I wish I knew more about when starting my journey into overseas production. In China you can generally source products from either factories or trading companies.

Factories are the actual manufacturers of a product. They own machinery used to produce a product, and/or have staff that physically assembles the products together. This doesn’t mean that the factory will produce the raw materials or components of the product themselves. Typically, factories will source raw materials/components from other factories, then assemble the various components into the finished product. This is normal, and how most factories operate. The key thing to take away is that the factory is actually doing the work to assemble the finished product. The cost they charge to you will include their costs to source the raw materials + assemble the raw materials into a final product + some percentage markup for their profit.

Trading companies are a level above factories on the supply chain. Trading companies do not assemble products. Think of them more like sales companies. They are likely sitting in a high rise somewhere on their computers, negotiating deals between purchasers and factories. Trading companies will charge you all the costs the factory is charging them + their mark up for organizing and facilitating the deal. Another good comparison to trading companies are real estate agents: they are selling the property and taking a cut for doing so.

So why would you ever want to work with a trading company when you can cut them out and work straight with a factory? Well, there can be a lot of benefits to using a trading company, especially when you are small.

For starters, trading companies can often offer lower Minimum Order Quantities (MOQs) in terms of purchasing. For example, if a trading company has 2 potential clients that want to purchase 500 staplers each, but the factory has a MOQ of 1000 staplers, then the trading company could produce the goods for both clients under the same production run, meeting the factories MOQ requirement and leaving both purchasers happy.

Another potential plus is that sales people from trading companies in China always speak great English, are readily available to answer questions, and are therefore easy to work and negotiate with. When you are producing anything overseas having clear communication with your factory is key. You want to ensure your ideas and product requirements are clearly understood by whoever is producing your goods. Having a trading company working on your behalf to clearly translate your requirements to the factory can be a good thing, especially if you have a complicated product.

Working with a trading company can also come in handy if you are putting together a product that consists of various different components from various different factories. For example, if you are putting together a corporate gifting product that includes a t-shirt and mug in each box. The t-shirt would be sourced from one factory, and the mug from another. But since you are working with a trading company you can let them do to work in finding the 2 factories, and have them coordinate with both factories to bundle the products together. So again, if your product offering is complicated, trading companies can come in handy.

One last potential upside of a trading company, if you are dealing with low order quantities, is potentially zero leadtime. Leadtime is the amount of time it takes to manufacturer your goods and have them ready for shipping. Sometimes trading companies will stockpile stock of popular items in their own warehouses. So, if you order that popular item from the trading company they may be able to ship it next day for you since it is already ready to go. Factories could not do this obviously since they would need to do a production run to create your products for you. The higher the leadtime, the more time your cash is tied up waiting for inventory to be produced, and the worse off you are for cashflow.

So, that was a lot of pros for trading companies. What are the cons? Well, the biggest one is the cost. A trading company will add an extra mark-up to whatever goods you purchase through them. Because, they have to make money too! So if a factory charges $8 to produce a product, the trading company may charge you $10 and keep the $2 as profit for themselves.

We talked above about how important having a low landed cost is to your business, so this extra cost that a trading company adds will either make your business less profitable, or potentially not profitable at all.

In reality, I think for new business owners, starting off working with a trading company is completely acceptable. Especially if you are starting small (as you should) with orders of less than ~$30,000 value. Working with a trading company can get you off the ground running very quickly, and simplify your production leg of the supply chain.

However, once you scale a business and your production costs for each manufacturing run start to exceed 50-100k, then I would definitely recommend finding a factory to produce direct. At that point, you need to lower your unit costs as much as possible, so it’s worth investing the time and effort to finding a factory directly.

When you are ready to move to a factory directly, you can also hire a ‘sourcing agent’ in China. A sourcing agent is basically a person (or company) you hire to work on your behalf to find, vet, and build relationships with factories. These guys are similar to trading companies, however they work on behalf of your business, not as a third party salesman. They offer a lot more transparency than a trading company would, showing you exactly how much they are marking up the factory costs for production. They can also serve as your QC/QA person on the ground in China for factory audits and inspections. Sourcing agents are often necessary because, unless you know Chinese and visit China frequently to meet with factories, you will need someone on the ground to meet and negotiate deals with factories directly. Here is one sourcing agency you can check out when the time comes: www.kanarysolutions.com
Back to blog