Special China: the world’s for fashion goods
For a long time, China was the Eldorado for consumer goods manufacturing. Flexibility, strong skilled workforce and low production costs were unquestionable assets for foreign markets. Currently, decision makers are less optimistic. Recently, several factors have clouded the picture. To begin with, the rising cost of raw materials along with increased salaries has decreased the competitive aspect of Chinese made products. “In the end, there could be a less significant difference in price when compared to French made products,” conclude some. However, the other main element concerns a structural change in the Chinese economy, which now not only relies on export-based growth, but on internal demand. Not a month goes by without the press covering the rising middle class and the nouveau riche. Luxury labels understand very well and have stronger ambitions to conquer this new market that has been deprived of consumerism for too long (see the article in this file). The result is that production capacity is running out of the steam. Decision makers have to put up with much longer delivery times and Europeans have a harder time than Americans who still have an advantage because they place larger orders. Moreover, according to a study conducted by the IFM, negotiations with Chinese directors are more laborious than they used to be. They have increased their skills and demands, are increasingly better trained, no longer accept the same sales conditions and know that if there is a breach of contract, the internal market will make up for the loss. The balance of power tipped in favor of the Middle Empire who, in turn, qualifies Europe as a priority investment region. This new political order forces fashion players to rethink their sourcing. Although seelight they cannot change anything, they are already wondering what the repercussions of the unavailable increase in prices will be for the end consumer. Will consumers be ready to open their wallets to purchase the same product for 30% more? Not so sure… With new stakes at hand, we sent a correspondent to China to investigate for us on the reality in the field and the strategic position held by Chinese directors.
Evolution in Chinese manufacturing
Times are changing. Once considered an Eldorado where customers could obtain desired products at low prices, China is becoming an increasingly complicated business field. To the point where some players wonder if the time has come to transfer production to countries other than the Chinese giant where difficulties seem to accumulate.
However the leather goods sector is healthy in China. Import increased 25% during the first six months in 2010, compared to a 7% drop for the same period for the previous year, and production is up 18% compared to 2009.
Increased cost of labor
However, Chinese suppliers who based their success on low-cost labor are currently forced to increase prices. Their employees demand higher salaries, after a long period of sacrifice to the benefit of economic growth. The year 2010 was marked by an increased number of social movements in Chinese factories, particularly in high-production provinces, which attract millions of young migrant workers from all over the country who are looking for jobs. The increased number of strikes in workshops in the southern province of Guangdong, whether on assembly lines at Honda automobile of Sanyo calculators, as well as a series of suicides among workers at the immense production complex for the world’s leading IT and mobile phone sub-contractor, Foxconn; located northwest of the city-factory of Shenzhen, sounded the alarm for rising social tension. In response, local governments increased the minimum wage at the end of 2010, for all exporting provinces, which affected rates that were billed to customers.
Zhang Jiayong, General Manager of Jinduo Trading, a supplier that works with French buyers in leather goods, acknowledges the situation. In his workshops, labor cost has increased and it is difficult for him not to pass the increase on to customers. “Our employee salaries have increased an average of 30% explains Mr. Zhang, “and we are also confronted with labor shortages”.
Like many Chinese companies, Jinduo has a hard time filling all of its positions necessary for continues production. After the Chinese New Year in February 2010, many migrant workers did not return to the provinces where they were employed. The high cost of living and low wages in the coastal provinces made them decide to seek work closer to their homes. Therefore, the province of Guangdong had to offer higher salaries to attract job applicants. This increase was necessary after the wage freeze caused by the crisis. The federal government sets the standard minimum wage, points out Geoffrey Crothall, spokesperson for the China Labour Bulletin, an association for the protection of laborers right based in Hong Kong. “Each province is supposed to adjust its own minimum wage level every two years according to price increases. Therefore, it is just back pay that has accumulated since the crisis”, explains Mr. Crothall. However, for Huadu Aobo, a leather handbag manufacturer in Guangdong, these increase have strong repercussions, with labor rising one year. “Even when we increased salaries. It was not enough to retain all of our employees”, explains Liu Jinpei, Assistant General Manager.
At Huahui Leatherware, higher prices causes customers to complain, notes May Xie, Manager for International Sales. “They always think that prices are too high, that it is intolerable but after all, aren’t discussions what business is all about? He wonders.
Increased cost of raw materials
Along with the increase in salaries, the cost of raw materials has risen, and it is felt in all sectors, particularly in leather goods, explains Zhang Jiayong from the Jinduo Company: “Suede, leather, materials used to line bags, accessories: all of the prices for the these essential products have increased.” He says that prices rose 15% in 2010 while managers at Huadu Aobo speak of a 20% increase. Leather prices have risen due to world demand in the aftermath of the economic crisis and booming new emerging markets. China’s new concern for the environment is an added factor. In Beijing on December 11, 2009, the Ministry of Industry and Information announced the launching of a compaign for environmental protection concerning the leather tanning and textile industries. It set a deadline for the beginning of 2011 for small tanneries to improve their environmental performance, reduce water consumption, and decrease sulfide emissions. This measure would cut production by 30 million pieces, thus lowering the offer. Other local level measures for the protection of the environment have since been added providing for consolidation within the leather-tanning sector so that companies would be large enough to be able to invest in required environmental standards. For example, in the Fujian province, building of new tanneries has been suspended and all existing tanneries that produce less than 100000 pieces per year will have to close by January 1, 2012.
Leaving the low-cost model
Along with the increased costs resulting from the Chinese context, some companies wish to improve their product quality. That is the case for the Huadu Aobo group’s workshop in Canton that decided to distinguish itself with improved quality. “We doubled our investment in the research and development department this year”, explains Liu Jinpei, Granted, we had to pass the cost on to customers, but it seems to be paying. “The result is that we have more products, diversified styles, and highly improved quality. Therefore, sales volumes significantly increased. It has been an excellent year for us”.
In this context, French customer for Chinese leather goods has to open their wallets. But are they willing? “Generally, yes”, answers Zhang Jiayong, General Manager at Jinduo, who exports handbags to France. “They know that there is a real increase in upstream costs”.
Do they complain about it? “No, very little”, continues Liu Jinpei from Huado Aobo”, the foreign companies that we work with have representing offices in China or they travel frequently to China, so they understand the current situation. Of course, they make tight negotiations, but we have a price floor under which we can no longer work, even if we do make some compromises” he explains. “In this case, it is not possible to make an agreement period”.
New emerging markets
French customers are no longer kings in China. Their purchase volume is smaller than that of American or Asian buyers and it is decreasing, note local producers. “All of our products leave for foreign markets, mainly in Europe, but French purchases are a small portion” Huahui carefully advances.
New emerging markets are more interesting for suppliers. The Huadu Company had an increase of 40% in sales in 2010 and says that it is due to markets that were insignificant a few years ago, such as Brazil and Africa. However, the new temptation is to give Chinese customers the first choice in production. “Handbag sales are down 30% abroad this year, while our costs have increased 15%, so of course we are focusing more on the domestic markets have become narrower while the Chinese market is booming. In fact, recently, we work more with Chinese customers” points out Whang Jiayong. With 10% growth in the economy in 2010, according to the central government, nearly as much is predicted for this new year and the trend is not expected to change. The rebalancing of the Chinese economy from low-cost export to domestic consumption will very likely be one of the pillars of China’s next Five-Year Plan that will guide policies until 2016, to be adapted this spring in Beijing.
Chinese suppliers are still quite confident in their customer relations. Although they realize that the market is difficult for European buyers, they also know that China remains an essential production region. Land and maritime infrastructures as well as the increasing number of choices remain unequalled in Guangdong where the majority of suppliers are located, even though some customers are tempted to work with southeast Asian countries where the majority of suppliers are located, even though some customers are tempted to work with southeast Asian countries where labor costs are cheaper. In a way, the customer is forced to came back to China.
However, they promise that there is no reason to neglect a customer is a customer. “Never” states Zhang Jiayong. “We will not withdraw from foreign markets. We still honor foreign orders, even though margins are narrower. However, we need to be able to rely on domestic demand when foreign markets slump”, he notes. “The important thing for us is to strike a balance”.
Harold Thibault in Shanghai.
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