china's factory blues

8/8/2019 China's Factory Blues

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Entrepreneur Tim Hsu rst started making lamps

more than 20 years ago in Taiwan. And like tens o

thousands o other actory owners in Taiwan, Hong

Kong, and Macau, he later moved operations to the

Pearl River Delta region o Guangdong, setting up

his Shan Hsing Lighting in a sleepy hamlet o rice

elds and duck arms called Dongguan. Since then

the region has grown into the largest manuactur-

ing base in the world or a host o industries, including electronics, shoes, toys, urniture, and lighting.

The combination o low wages, minimal regulation, and a cheap currency was unbeatable. Hsu was so

condent o Guangdongs uture as the worlds workshop that he spent $7 million on a much larger ac-

tory, which opened earlier this year.Now many o Chinas manuacturersHsu includedare under-

going the kind o restructuring that tore through Americas heartland a generation ago. The U.S. housing

market, which generated demand or everything rom Chinese-made bedroom sets to bathroom xtures,

has plummeted. A new Chinese labor law that took eect on Jan. 1 has signicantly raised costs in an

078

BUSINESSWEEK I APR IL 7, 2008

By Dexter Roberts

Potograpyby Jade Lee

Te days o ultra-ceap labor and little

regulation are gone. As manuacturers

costs climb, export prices will ollow

Chinas

faCtory

blues

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already tight labor market. Soaring com-

modity and energy prices, as well as Bei-jings cancellation o preerential policies

or exporters, have hammered manuac-turers. The appreciation o the Chinese

currency has shrunk already razor-thinmargins, pushed thousands o manu-

acturers to the edge o bankruptcy, andthreatened Chinas role as the preemi-

nent exporter o low-priced goods.Hsus new actory, it turns out, is

running at just 60% o capacity, andhe predicts that hal o Chinas lighting

actoriesalmost all based in Guang-dongwill have to close their doors this

year. Shoe actories, clothing, toys,urniture, everyone is shutting down,

he says. Hsus not alone in his alarm.We spent 20 years building up our in-

dustry rom nothing to one o the big-

gest in the world, says Philip Cheng, chairman o Strategic

Sports, which produces hal the global supply o motorcycle,bicycle, and snowboarding helmets out o 17 plants in the

Pearl River Delta. Now we are dying. Cheng says he onceearned 8% margins. His margins now? Almost zero.

Comprehensive statistics on shut-downs are hard to come by. But the Fed-

eration o Hong Kong Industries predictsthat 10% o an estimated 60,000 to

70,000 Hong Kong-run actories in thePearl River Delta will close this year. In

the past 12 months, 150 actories mak-ing shoes or supplying shoemakers have

closed in Dongguan, says the Asia Foot-wear Assn. More plants will disappear

as demand slows: UBS analyst JonathanAnderson expects overall export growth

o just 5% or less or China this year.Chinese policymakers so ar proess

little concern. The closures are mainly

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IN DEPTh

APR IL 7, 2008 I BUSINESSWEEK

Chinas roCketinglabor CostsAverage one-year cost increase

TK TK

Management compensation 9.1%

Support-sta wages 10.3

Blue-collar wages 7.6

Raw materials 7.1

Daa: Booz Alln & Hamilon

San hsing

Ligting as seen

its already tin

margins srink as

te yuan as risen

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harder and be elt more widely

than oicials expect. So ar,many o the actory shutdowns

have been in Guangdong, but thepain is hardly limited to the re-

gion. When more than a hundredSouth Korean-owned actories

closed over the Chinese New Yearin the eastern coastal province o

Shandong, 1,200 miles rom thePearl River Delta, thousands o

workers were le without jobsand with unpaid wages.

losing its allure

The bigger multinationals maybe having second thoughts,

too. The American Chamber oCommerce in Shanghai ound

that more than hal o oreign

manuacturers in China believethe mainland is losing its com-petitive advantage over coun-

tries like Vietnam and India.Almost a h o the companies

surveyed are considering relo-cating out o China. The big

story here is that globalization isor realand China is no longer

what it was, says Ronald Had-dock, a vice-president at con-

sultant Booz Allen Hamilton,which wrote the report.

The rise o the yuan may bethe biggest single actor driv-

ing companies to relocate. Butother government policies are

contributing to the crisis. Lastyear, Beijing decided to cut or

even cancel tax rebates on morethan 2,000 items used in the

making o exported goods. Theimpact has been huge. The end

o rebates has raised the cost omanuacturing many goods by

14% to 17% at the actory level,says Harley Seyedin, president o

the Guangzhou-based American Chamber o Commerce inSouth China.

Now a tough new labor law requires companies to provideemployees with benets, including pensions; to boost the

minimum wage by 12%; and to hire workers or the long term.The law is raising operating expenses dramaticallyby as

much as 40% when you add spiraling wages in almost everysector. We knew it was going to be a more dicult year, but

no one oresaw 40% more in costs, says Willy Lin, vice-chairman o the Textile Council o Hong Kong. So when ev-

erything exploded in our ace, we started to ask: What can

hitting lower-value, labor-intensive exporters that polluteheavily and use energy ineciently. Beijing now wants clean-

er industries that produce higher-quality items or the localmarket, rom cars and planes to biotech products and soware.

That emphasis not only helps boost domestic consumptionakey national goalbut also reduces rictions internationally

rom the ever-swelling trade surplus. We are not abandon-ing the [exporters], said Guangdong Governor Huang Huahua

on Mar. 8. [But] selling domestically is good or the country,good or the collective, and good or the people.

Still, the shi in Chinas manuacturing base is likely to hit

080


Adidas supplier

Apace

Footwear

recently opened

a plant in India

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we do?

For many companies the answer liesoutside China. In early March, Hebei

Yong Jin Cable opened a actory inVietnams Tay Ninh province, near the

Cambodian border. In Hebei provincein China, it costs more than 1,000 ren-

minbi a month [to pay relatively unskilled workers], says QuHuijun, Vietnam project director at Hebei Yong Jin. But in

Vietnam, it is about 500 RMB. So the cost o labor is cheaperby hal.

The changing cost equation is also aecting sourcing deci-sions by the big apparel labels. Adidas, or example, has told its

suppliers in Guangdong to look at lower-cost regions in Chinaas well as abroad. So Taiwan-run Apache Footwear, which

has 18,000 employees in Qingyuan, Guangdong, is consider-

ing setting up smaller plants on the Guangdong border withHunan and Guangxi, where costs are lower. It recently opened

a second actory in India. We will reduce our percentage pro-duced in China because o growth in other countries, says Bob

Shorrock, Adidas global director or sourcing.Shiing manuacturing abroad, though, takes time and

money. Complicated sourcing and logistics networks thathave grown over more than a decade to support everything

rom computer makers to shoe actories will have to relocate

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IN DEPTh

APR IL 7, 2008 I BUSINESSWEEK

By Dexter Roberts and Ci-Cu Tscang

For the Wei amily, times should begood. The 41-year-old Wei Bin makes

$634 teaching at a local university, hiswie makes $986 working as a humanresources specialist at a civil aviationagency, while her two 60-plus-year-old parents who live with them earn acombined monthly pension o $845.They have their own our-bedroom, 600sq.-t. apartment in a plum location innorthwest Beijingjust several hundredyards rom the key Olympics acilities.From the balcony o their nine-year-oldsons room, they can just make out the

Birds Nest stadium where the openingand closing ceremonies will be held.

Nevertheless, the amily o ve is

eeling the squeeze like never beore.Monthly living expenditures havedoubled rom a year ago, to $282 today.Thats entirely due to a relatively newphenomenon plaguing Chinas consum-ers: runaway infation. While last yearconsumer price infation was 4.8%, thisyear it has spiked dramatically upward,reaching 7.1% in January and 8.7% inFebruarythe highest in China in 11years. What we eat and wearoil, milk,[and meat]the price o things that we

cant do without,

they have all goneup, laments Wei.With housing

costs soaring too,infation has rivetedthe attention oordinary Chineseand the politburoalike. The currentprice hikes andincreasing infa-tionary pressures

are the biggest concern othe people, said Premier WenJiabao in his annual report tothe nation on Mar. 5th. Severewinter storms will also damagethe harvest. To compensate,Beijing will expand productiono grains, meat, and vegetableoil, increase imports o selectconsumer goods, provide

subsidies or the most vulnerable in thepopulation, and require that provincialocials ensure adequate grain supplies.

For now, though, infation surges on.Rising prices o pork, up 100% overthe last year, as well as bee, eggs, milk,and cooking oil have orced the Weiamily to search or new ways to cutcosts. (Salary increases have not comeclose to matching infation, with Weiswages up only 10% or so over the lastthree years.) That has the amily eatingless ried ood (vegetable oil has morethan doubled in price to almost $10 acask) and more boiled oodswhich arehealthier anyway, points out Wei. And

how to cut costs when eating meat?Simple: We put less meat inside ourdumplings and add more vegetables. Itsthe same thing, says Wei.

With gas prices up, tootheyve dou-bled to 75 a liter in the past six yearssince the amily bought their Volkswa-gen Jettathe Weis are trying to driveless. That means ewer trips to the Carre-our that required a TK minute drive, andmore shopping closer to home. Noweager to buy a new car (the amily has

a little doesntgo a long wayRunaway infation is putting te squeeze on Cinas middle class

beijing says Cleaner, higher-quality produCers

will replaCe the Closed plants. but the shift

may hit China harder than offiCials expeCt

Aliquat

ulput dolore

dolestrud eum

mmmmm incilit,

se adigna

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as 25% this year. He recently passed on price hikes o up to 10%

to his customers, including Wal-Mart and Kmart.Some manuacturers will try to avoid those increases by

nding really cheap locales deep inside China. The answer tohigh prices in China is more China, says William Fung, Hong

Kong-based group managing director at the worlds biggestconsumer-goods sourcing company, Li & Fung. There are

still places like Sichuan or Hunan that are cheaper.But there are plenty o signs that labor costs are rising even

in Chengdu, Sichuan, and Wuhan.And no matter where they relocate on

the mainland, manuacturers ace thesame newly stringent labor law, high

commodity prices, and pressure romthe ever-climbing currency. That has

major implications or the global econ-omy. Unlike in the last 20 years, when

China exported defation, rom now on,China will export infation, says Peter

Lau, CEO o Hong Kong retailer Gior-dano International, which has extensive

operations in China. Consumers willhave no choice but to accept the new

reality. They should get psychologicallyprepared or that. ^

With Chi-Chu Tschang in Beijing

as industries move. We have more than

100 suppliers in the Dongguan area,explains Hsu. Moving is not easy.

Even in countries like Vietnam, laborcosts are already rising, and shortages

are emerging. Other costs may ar out-pace those in China. The bill or con-

structing Apaches India actory wasalmost three times what it would be

in China, the company estimates, be-cause the Indian government required

that it be built to British specications.Frequent power and water shortages

mean Apache has had to provide itsown expensive backup systems or its

Indian plant as well. Adidas says weshould move as ast as we can to India.

But productivity in India is 65% to 70%the level o China, says Charles Yang,

Apaches executive general manager.

I we ramp up too ast in India, we mayshoot ourselves in the oot.

kindergarten and camp

Fear o stumbling abroad has led many

manuacturers to seek even more pro-ductivity gains in China. The most

important thing we can do to cope isto raise our eiciency, says Li Dong-

sheng, chairman o top Chinese elec-tronics maker TCL. Reducing employee

turnoverwhich nears 75% annually atmany Guangdong companiesis one way to do that. Thats

why Apache oers perks like a kindergarten and even a summercamp or employees children to learn English. It has just n-

ished building 280 apartment units it will sell at below-marketprices to its married employees. We are trying to make it eel

like home here, says Yang. It stabilizes your workorce.Will these eorts keep a lid on the prices o products coming

out o China? Probably not. For years manuacturers have metthe demands o U.S. retailers to lower their prices. But their

backs are nally to the wall, says CharlesSwindle, a senior vice-president at Hong

Kongs Flora Forte, which sources rom20-plus China actories or Bed Bath &

Beyond, Wal-Mart, and major U.S. de-partment stores. I know actories are

turning down millions o dollars in or-ders because they will lose money i they

take them.The next step is inevitable, says the

American Chamber o CommercesSeyedin: There will be a rise in the prices

o shoes, textiles, and all kinds o house-hold products. Georey Greenberg,

president o Creative Designs Interna-tional, saw the cost o toys and costumes

he sources rom Guangdong rise as much (fromtop)Bwp

Hoto;cHArtByrAyvellA/Bw

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IN DEPTh


Tis suttered

Dongguanactory is one

o many, wit

more to come

there will be a rise in the priCes of shoes,

textiles, and all kinds of household produCts,

says an ameriCan Chamber of CommerCe exeC

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By Dexter RobertsPotograpyby Name here

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Deck goes ere (3 lines)

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creDIt Here

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DESK QUERIES: Please DO NOT return story to desk without conrming or correcting.

(Do not delete the sentence above)we show Asia Footwear Assn.

we show American Chamber o Commerce in ShanghaiAliya Internaitonal

Ben SchwallHong Kong Textile Co. -- we show Textile Council o Hong Kong

Hebei Yong Jim CableShorrocks title

Shan HsingCharles Yang

Charles SwindleFlora Forte

we show Fung as group managing director

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COMPANY INDEX

(Do not delete the sentence above)Strategic Sports

UBSBooz Allen Hamilton

Aliya InternationalHong Kong Textile

Hebei Yong Jin CableApache Footwear

AdidasTCL

Flora ForteBed Bath & Beyond (BBBY)

Wal-Mart Stores (WMT)Kmart (SHLD)

Li & FungGiordano International

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CopyDesk Header Ino

(Do not delete the sentence above)

Slug: china14Reporter/Writer: roberts

NY Editor: powerCopy Editor: purcell

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china's factory blues

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