challenges of hong kong toy manufacturers operating plants in the

Article

Challenges of Hong Kong toy manufacturers operatingplants in the Pearl River Delta

S.F. Luk1, H. Noori2, and T.P. Leung1

1 Department of Industrial and Systems Engineering, The Hong Kong PolytechnicUniversity, Kowloon, Hong Konge-mail: [email protected], [email protected] Laurier School of Business, Wilfrid Laurier University, Waterloo, Ontario, Canadae-mail: [email protected]

Abstract For years, Hong Kong has been the world’s largest toy exporter. However, asthe costs of rent and labor have increased drastically over the past years, Hong Kong toymanufacturers have moved their labor-intensive operations to other lower-wage areas.The Pearl River Delta (PRD) region of the People’s Republic of China (PRC) has beenone of their favorite choices for outsourcing because of cheap and available labor. Thispaper explores, using data culled from interviews with the senior management of fiveleading Hong Kong toy companies, how some Hong Kong toy manufacturers overcamevarious strategic management issues after having made the move to the PRD. The resultsare presented within five major areas of concern: rules and regulations, the less-developedinfrastructure, R&D, relationship with suppliers, and new technology, and they are usedto show how the manufacturers were able to overcome various strategic constraints inorder to accomplish outstanding performance. Supporting data were gathered throughfactory visits in order to better understand the actual operations within the PRD. Thiscollected experience should be beneficial to other manufacturers interested in operatingplants within the PRD.

Key words Toy industry · Strategic management issues · Pearl River Delta · Hong Kong ·People’s Republic of China

1 Introduction

1.1 Background

Zhujiang Kou is the mouth of the Pearl River, known in the People’s Republic ofChina (PRC)1 as Zhujiang, and is located in the southeast of the PRC (Figs. 1 and2). Figure 1 shows the location of the PRD within the PRC, while Fig. 2 displaysthe location of the major cities of the PRD.

1 After the sovereignty of Hong Kong was returned to the PRC on 1 July 1997, the governmentthen enacted its famous “one country, two systems” policy. In this paper, Hong Kong and thePRC are treated separately in order to facilitate discussion.

International Journal of Asian Management (2004) 3: 121–133DOI 10.1007/s10276-004-0018-9

122 S.F. Luk et al.

Fig. 1. Location of the Pearl River Delta, PRC

Fig. 2. Major cities located in the Pearl River Delta, PRC

Challenges of Hong Kong toy manufacturers 123

1.1.1 Historical overview The move to the PRD needs to be understood withinthe context of the history of the last decade.

Table 1 and Fig. 3 together show the cost structure of toy manufacturing inHong Kong in 1994 according to a publication of the Hong Kong Trade Develop-ment Council (HKTDC) (1997). At that time, the labor cost and overheads of toymanufacturing were 17% and 16% of the total factory price, respectively.

In making the push toward lower production costs, especially those concerninglabor and overheads, Hong Kong toy manufacturers have been actively seekingoffshore production facilities (e.g., within the PRD). As a result, Hong Kong’srole is shifting towards quality control, management, marketing, product design,trial production, and production planning. In the wake of this relocation, manyHong Kong toy companies have been reclassified as nonmanufacturing establish-ments. This helps to explain the dramatic decline in the number of toy manufac-turers from 428 in 1996 to 297 in 1999 (see Table 2 and Fig. 4). The number ofHong Kong residents engaged in the toy industry fell from 3627 in 1996 to 1956in 1999 alone (HKTDC 1997, 2000). This does not mean, however, that HongKong has lost its leading role in the export of toys.

According to the website of the International Council of Toy Industries(ICTI), the total toy market of the world was worth US$71 billion in 1999 (ICTI2001). In terms of total exports (domestic exports plus re-exports) in 1999, HongKong’s export of toys was worth HK$85.6 billion (US$10.97 billion), whichaccounts for 15.5% of the total world toy market (HKTDC 2000). As a result,Hong Kong is still the world’s largest exporter of toys (HKTDC 1997, 1998, 1999,2000).

Table 1. Cost structure of toy manufacturing in Hong Kong in1994 (HKTDC 1997)Cost structure %

Labor 17Raw materials and supplies 45Overheads and other operating expenses 16Net profit before tax 22

Total 100

Fig. 3. Cost structure of toy manufacturing in Hong Kong in 1994 (HKTDC 1997)

124 S.F. Luk et al.

1.1.2 Problem overview Around 1980, the PRC launched its “open door” policyto encourage foreign investors to set up plants within several Special EconomicZones (SEZs) along the coastal region. Those cities within the SEZs offer variousbenefits (e.g., tax exemptions) in order to attract foreign investors in establishingplant operations. However, different cities within the SEZs of the PRD haveestablished different local rules and regulations, for example, by levying differenttaxes. The respective local officials may also have varying interpretations of thesame rules. In addition, the central government has set up increasingly sophisti-cated regulations in recent years, implying that it might not understand what isgoing on in the regions. Thus, the local governments may try to postpone theimplementation of some rules from the central government if there is determinedto be a large negative financial impact on the local economy. However, otherrules have been announced and implemented within a short time. This discrep-ancy demonstrates that legal issues may pose constraints on the operations of toymanufacturers.

Table 2. Number of establishments and people employed in the Hong Kong toy industry(HKTDC, 1997, 1998, 1999, 2000)Year Sep 96 Dec 97 Dec 98 Sep 99

No. of Plastic toys 306 220 258 198establishments Metal toys 101 66 58 90

Electronic toys 21 10 3 9Total 428 296 319 297

No. of people Plastic toys 2927 2340 1354 1538employed Metal toys 392 256 230 290

Electronic toys 308 72 113 128Total 3627 2668 1697 1956

Fig. 4. Number of establishments and people employed in the Hong Kong toy industry(HKTDC 1997, 1998, 1999, 2000)


In the past, there was often questionable access to essential resources: manu-facturers would have constant electricity supply for only two or three days of theweek, telephone services were inadequate, and long-distance calls often tookseveral hours to connect. Moreover, roads were not sufficient, and serious trafficjams in the urban areas resulted. In addition, the facilities and capacities ofcontainer ports were insufficient, meaning that many goods had to be trans-shipped through Hong Kong (Chan et al. 1991). The quality of the water supplyhas also been poor in some areas.

Although the PRC has many universities and institutions that train new engi-neers, the recruitment of experienced and competent engineers for the operationof new technology by the toy industry has been a problem. Furthermore, the PRCis a very large country in both population and geography, and so the enforcementof laws protecting intellectual property rights with regard to new products andprocesses has proved rather difficult. Manufacturers have found difficulty inmaintaining the confidentiality of R&D information on both new products andmanufacturing processes.

The business culture of local PRD subcontractors is different from that ofHong Kong toy manufacturers. The local subcontractors believe that payingmoney “under the table” or doing things through “back doors” is acceptable.The quality concept of the local companies is poor, and the Hong Kongtoy manufacturers may therefore still be finding difficulty in dealing with localsuppliers.

Because the information flow of new technology is limited within the PRC,some foreign countries have reservations about exporting high-technology equip-ment to the PRD. There are few PRD engineers who are capable of operatingnew equipment, so manufacturers may encounter many difficulties during theacquisition and implementation of new technologies.

This paper reports on a study that set out to investigate how Hong Kong toymanufacturers could overcome various strategic issues after moving their plantsto the PRD. It should be noted, however, that during the time of their relocation,the PRD was regarded as far less developed than it is today.

2 Literature review

Industry realignment is typically carried out by means of consolidation, adminis-trative cost reduction, rationalization of logistics, plant utilization, and productlines (Wilson and McCoy 1998). Also, plant relocations to lower-wage areas areevidenced in the passive-component industry as a means of cutting costs (Levine1998). Such a notion is naturally applicable to the toy industry. For example,Mattel announced in 1997 after acquisition of a rival toy maker that it would closea plant in northeast England and move its production to Italy in order to combinethe operations of both companies and reduce production costs (New York Times1997). Over a decade ago, some research was carried out to study the cost ofproduction in Shenzhen and the surrounding area of the Pearl River Delta(PRD). Compared with Hong Kong, a savings of about 32% was evident in a

126 S.F. Luk et al.

typical toy factory due to lower labor costs and overheads in Shenzhen. Thepayback period of transferring a toy operation from Hong Kong to Shenzhen wasfound in 1991 to range from 7.5 to 13.8 months. A few general management issuesin Shenzhen have also been discussed by Chan et al. (1991). However, no system-atic analysis in overcoming various strategic management issues in the PRD hasbeen found. The aim of this paper is to complete such an analysis.

2.1 Emergence of a technology hub

In terms of a global company, a technology hub is defined as the location at whichmany of the R&D, design, and process-engineering activities are concentrated(Noori 1998).

When a firm moves manufacturing to an offshore site shortly after a newproduct introduction, the traditional learning period associated with ramping upto mass production does not exist in the home country. Accordingly, the resolu-tion of manufacturing process problems often becomes the responsibility of theforeign site where the manufacturing is now located. This in turn enables workersat the offshore site to develop the skills necessary for the design and developmentof new, evolutionary products based on existing technologies and processes. As aresult, the home base, as in the case of the Hong Kong toy industry, graduallyloses its design and engineering operations to the low-cost area, such as the PRD.However, the process does not stop at this point. Rather, there is often a “con-tinuous migration” of manufacturing to lower-cost countries.

3 Methodology

Data collection was conducted through properly structured interviews with thesenior management of five Hong Kong toy companies. Following formal analysisof these interviews, visits were carried out to the factories to better understandtheir actual operations within the PRD.

Profiles of the five interviewed toy companies are briefly described below, withthe results summarized in Table 3. Company B is ranked as one of the top threeHong Kong toy companies and has annual sales above HK$1.5 billion (US$192million). The other four companies, with annual sales above HK$200 million(US$25.6 million), are ranked within the top 20 Hong Kong toy companies.

Company A was established in 1965 and is an original design manufacturer(ODM) and an original brand manufacturer (OBM). It started moving itsproduction facilities to Foshan in the PRD around 1981. After three years, themove was abandoned and was considered to have failed. It tried again in 1990when it completely moved its entire production plant to Dongguan.

Company B was established in 1989 by merging three companies. It isan original equipment manufacturer (OEM) and an ODM. It was one of the firstto take advantage of China’s “open door” policy to operate factories in the PRD.In 1999 it established two toy factories in Zhongshan, one in Panyu and onein Dongguan. The company invested over HK$203 million (US$26 million)

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128 S.F. Luk et al.

in machinery in its PRD factories. It became publicly listed in Hong Kong in1991.

Company C was established in 1995, according to the newsletter published bythe Toys Manufacturers’ Association of Hong Kong (TMHK) (1999). It is anOEM. At first, it subcontracted all of its orders. In 1996 it acquired a factory inZhuhai to start manufacturing soft toys and then in 1999 established four moretoy factories, three in Dongguan and one in Shenzhen.

Company D was established in 1978. It is an OEM. It started to move manu-facturing facilities to the PRD in 1982. In 1987 it opened another factory inGuangzhou. Afterwards, all production facilities were moved to the existingfactory in Dongguan. It became publicly listed on the NASDAQ exchange in1997.

Company E was established in 1976 to export toys (TMHK 1999). Later, itbecame an OEM, an ODM, and an OBM as well but still subcontracted all themanufacturing processes. It has 120 staff employed in the PRD whose majorfunction is to visit the vendors and partners and give them technical support.These staff members are responsible for quality control, quality assurance, andsome manufacturing functions.

Formal interviews and research findings were clustered around the followingareas:

Coping with the local rules (e.g., taxation) and regulations (e.g., environmentalprotection)

Dealing with a less developed infrastructureConducting R&D at the local plantsManaging relationships with local suppliersManaging the acquisition, transfer, and implementation of new technologies

4 Results and discussion

For purposes of convenience and confidentiality, the results will be discussedaccording to the five areas described above.

4.1 Coping with local rules and regulations

A number of problems arising from the local rules and regulations were foundin the collected data. The most common problems from this category are listedbelow.

Whenever discrepancies are discovered between the amount of imported andexported materials, the Hong Kong toy manufacturers are suspected of smug-gling materials and have to pay penalties or taxes.

When trucks pass through the PRD customs check, if a query should ariseregarding any errors found in the shipping documents, the officials will ask thedriver to park the lorry at the border crossing for investigation. Customs mighttake a few days or a week to clarify the queries, and then ask the Hong Kong toymanufacturers to pay the parking fee.


In order to deal with these problems, some Hong Kong toy manufacturers haverecruited as a senior staff member a local Chinese resident who has a goodrelationship with the local officials. These locals can carry out the negotiationand liaison functions more effectively, since some local officials might waive thepenalties or charges as a result of the good relationship.

If the Hong Kong toy manufacturer is not able to comply with the law, eitherit has to pay money as a penalty to settle the offense or, if the penalty is verylarge, it has to bribe the officials to waive it.

Informants report that there are instances of local officials abusing their powerin enforcing the law. One way of resolving this issue is to compromise with thelocal officials; the other way is to go to a higher authority and ask the higher-ranking officials to control their subordinates.

Recently, more young PRD officials have begun to work at senior-level andother important positions. They are well educated and concerned with the imageof the country. The current level of corruption is down compared with that of 10years ago. When compared with other countries, such as Indonesia and Vietnam,the situation in the PRD is ostensibly better. Some informants believe that theHong Kong toy manufacturers can do a proper job without being totally influ-enced by corruption.

Most of the interviewed Hong Kong toy companies prefer to export all the toysmanufactured in the PRD or to sell only a very small portion locally. In this way,they can avoid paying “under the table money” in order to get more localbusiness.

4.2 Dealing with a less-developed Infrastructure

In the early 1980s, although the PRD government was very supportive, theHong Kong toy manufacturers were faced with problems due to the less devel-oped infrastructure of the region. The ways in which the Hong Kong toy manu-facturers managed this situation are briefly discussed below.

4.2.1 Inadequate supply of electricity The Hong Kong toy manufacturersresorted to changing a working day to a rest day when there was no electricitysupply. Some of them installed their own generators to generate electricity inorder to run their production continuously, but the cost proved high.

4.2.2 Insufficient telecommunications infrastructure Some Hong Kong toy manu-facturers established their own telephone lines through satellites so that theycould send faxes unhindered and make telephone calls without delay.

Recently, all kinds of computer hardware and software systems have becomeavailable in the PRD, including software houses with good consultant services.However, some minor problems still persist with regard to Internet services inparticular. For example, Internet services frequently experience downtime due totechnical difficulties at the service provider location.

4.2.3 Logistics problems The Hong Kong toy manufacturers have alsoconvinced their subcontractors to move their plants to the PRD in order to

130 S.F. Luk et al.

minimize the effects of logistics problems and to ensure more effective supportsystems.

Staff members from the Hong Kong offices have also had to make someadjustments. They now often stay at the plants for a few days at a time, or at leastfor a longer time than is usual, so as to minimize the frequency of travelingbetween the PRD and Hong Kong.

Company cars are also registered in both Hong Kong and the PRD so that theycan be easily moved through both locations in order to shorten the paperworktime while crossing the border.

None of the interviewees have any concerns about the quality of water supply.As the infrastructure has improved over the past years, the Hong Kong toymanufacturers have started to conduct systematic studies to ascertain whether toalso shift various supporting functions to the PRD in order to achieve betteroverall support and communication.

4.3 Conducting R&D at the local plant

At present only a few Hong Kong toy companies conduct their own R&D. Someof them spend about 1.5% of their total annual sales on R&D, which is relativelylow. In fact, most of the R&D is carried out in Hong Kong or overseas. Thereasons reported are as follows.

4.3.1 Difficulties in recruiting competent engineers in the PRD The Hong Kongtoy manufacturers must go to universities within the PRC to recruit fresh engi-neering graduates, and then subsequently train them in-house. They have to setup information and advertising booths at Human Resources exhibitions in orderto recruit experienced engineers.

4.3.2 Difficulties in keeping the confidentiality of R&D information Some HongKong toy manufacturers always keep the most important part of their designseither in Hong Kong or overseas. After most of the technical aspects have beencompleted, the projects are transferred to the PRD. The engineers in the PRDwill make the tools and prototypes, but they may not understand the wholeproject. Only the labor-intensive work is to be carried out in the PRD. Themanufacturers believe that this is the best way of maintains the confidentiality ofthe R&D information.

From time to time, some design concepts have been offered by PRD engineers,but most of the concepts are basic ones. At present the Hong Kong toy compa-nies are looking for high technology or more high-end toy products, but there isa shortage of capable designers and engineers in this area.

4.4 Managing relationships with local suppliers

Another key issue is to find suitable suppliers and to develop and maintain a goodrelationship with them. Besides delivery dates, price, and quality, the majorcriteria for selecting suppliers are the engineering and production support that


they can offer. Most of the Hong Kong toy manufacturers prefer to purchasematerials or parts from two major suppliers instead of from many suppliers. Theycan then give more business to each supplier, develop partnerships with them,and have more bargaining power. Using two suppliers instead of a single sourcecan provide a chance for the suppliers to compete with each other. This canensure that they will provide better quality at a lower price and with reliabledelivery.

The Hong Kong toy companies usually give their suppliers some indication ofthe annual order quantity (especially for key components), the required specifi-cations, and the inspection criteria for the parts. The suppliers can then plan thecapacity, prepare the annual budget, and confirm their commitment.

Since the local suppliers have a different business culture, they have to informthe local vendors not to bribe their staff in order to get more orders. Asmentioned above, the Hong Kong toy manufacturers have influenced most oftheir Hong Kong subcontractors to set up plants close to their PRD factories.Hence, the majority of the PRD suppliers are Hong Kong-based companiesoperating plants over the PRD region. The components are delivered directlywithin the PRD. As a result, the orders given to local suppliers are still verylimited.

4.5 Managing the acquisition, transfer, and implementation of new technologies

The means by which the Hong Kong toy manufacturers managed the acquisition,transfer, and implementation of new technologies seems to be another key issuein the realignment of their manufacturing methodology, as discussed below.

4.5.1 Problems in sourcing new technology Suppliers selling new technologyusually contact the big Hong Kong toy manufacturers. Small Hong Kong toymanufacturers have, however, found difficulty in sourcing new technologies.Since the small Hong Kong toy manufacturers do not have an independentdepartment to source these kinds of new technologies, new ideas normally comefrom the senior management, who have tried hard to solve this problem bygleaning the information themselves by visiting exhibitions, trade fairs, univer-sities, etc.

4.5.2 Justification for acquiring new technologies Some small Hong Kong toymanufacturers are reluctant and relatively weak in dealing with the acquisitionof new technologies in the PRD because the variety of toys changes every day.However, production is market driven. Hence, the customer may sometimesallow a higher cost for applying a new process or technology to a product if it isdemanded by the market. Occasionally, potential revenue/profits can be derivedafter the acquisition or development of this kind of new technology.

4.5.3 Problems in transfer and implementation of new technologies Some bigHong Kong toy manufacturers have already built lecture rooms and theatreswhen designing their plants in the PRD. During the implementation of new

132 S.F. Luk et al.

technologies, they must often run their own training programs to develop thecompetence of the PRD engineers. Given that the manufacturers are oftenunsuccessful in recruiting experienced engineers, such operational training hasbecome increasingly necessary. Interviewees report that many young PRD engi-neers are “willing to learn and can spend all day and night learning how to usenew software or technology if so required.”

Only small Hong Kong toy manufacturers have found problems in sourcingand acquiring new technology. Most of them have faced some human resourceissues during the transfer and implementation of new technology.

5 Conclusions

Over the past two decades, all Hong Kong toy companies and manufacturershave faced strategic problems, such as the pressure of increasing manufacturingcosts, especially the costs of labor, and insufficient direct-labor supply withinHong Kong. Like other manufacturers in other industries, most of the HongKong toy manufacturers have made the strategic decision to move their plants tolower-cost areas. Using a top-down approach, they decided to move their plantoperations to the Pearl River Delta (PRD), which is in close proximity to HongKong, in order to make use of the abundant labor supply and cheaper overheads.At first, the toy manufacturers incurred many risks in setting up their plants in thedifferent cities of the PRD, and so it is not surprising that some of them failed andmoved the production back to Hong Kong. However, after a few years of plan-ning, these companies used their experience and again attempted the move to themajor cities where other toy companies had moved successfully.

At first, the Hong Kong toy manufacturers moved only their most labor-intensive operations to the PRD. After the move, however, they were suddenlyfaced with a whole new set of management issues. The manufacturers foundmuch difficulty in understanding and complying with the often inconsistent localrules and regulations, which resulted in the necessity of establishing good rela-tionships with local officials in order to facilitate plant operations. Also, theyfound ways to improve upon the relatively less developed infrastructure of thePRD, although most of the changes have come about only recently. Some of thecompanies decided to develop themselves as ODM and OBM instead of onlyOEM in order to maintain their competitive edge. However, they are still facedwith the challenges of recruiting competent engineers to the PRD and of main-taining the confidentiality of their R&D. In general, they have managed toreceive very good support from their suppliers by maintaining strong relation-ships with them. Moreover, it has been the small Hong Kong toy manufacturerswho have had difficulty in sourcing and acquiring new technology. The largercompanies have resorted to conducting large training courses in-house in order tomitigate the human resources issue of locating experienced engineers. In sum,most of the Hong Kong toy companies and manufacturers have devised andimplemented both short- and long-term solutions to the five strategic issuesinvestigated in this paper. Their methodologies have been based on long-term


benefit models deemed profitable in maintaining the competitive advantagesneeded in the global market to sustain an outstanding performance.

Having learned from their experience and having had time to settle intothe new environment, the Hong Kong toy manufacturers have begun to study thefeasibility of now moving other supporting functions from Hong Kong to thePRD factories. This move will minimize the communication and transportationtime between the Hong Kong offices and the PRD factories.

The research results indicate that the PRD is not yet a fully developed techno-logical hub, but is nonetheless progressing towards such a status.

Acknowledgments. This research was supported by a Hong Kong Polytechnic Universitygrant, no. G-T014. Support and assistance from the following people and organizations incompleting this project are fully acknowledged: Mr. Danny Ngai, President of ArtinInternational (Holding) Ltd.; Mr. Lewis Luk, Deputy Chairman of Hutchison HarbourRing Ltd.; Samson Chan, Chairman & CEO of Manley Toys Ltd.; Tony Wu, ExecutiveDirector of Smart Union Industrial Ltd.; C.W. Ng, V.P. Operations of Zindart Limited,and the Toy Manufacturers Association of Hong Kong.

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