December 2007 Archives

As Beijing celebrated the start of its 'Olympic Year' with a large outdoor music performance on Monday night, we might well look at some of the trends that could impact China sourcing in 2008.

Homeworldbusiness speaks of "shifts in the China sourcing paradigm" as a 'macro' issue of 2007, and one which is expected to escalate in 2008. As a gloomy forecast of the outlook for the U.S. housewares industry in 2008, changes in the Chinese economy in the coming year like 

Inflated prices on Chinese-made housewares induced by rising raw material and fuel costs are a reality that the biggest retailers can no longer deny. Get ready for mounting increases in 2008 stoked by a weaker dollar to the Yuan RMB, reduced export tax rebates to Chinese factories, stiff pollution penalties and tightened product safety standards as the Chinese government adopts and enforces regulatory controls.

The benefits of stricter product safety standards, however, should be more evident in 2008, even though housewares retailers and suppliers will have to "rigorously self-police" to ensure the quality and safety of all their products. And as an additional challenge to Chinese sourcing in 2008, the Olympics may lead to labour shortages as workers are temporarily relocated to Beijing, resulting in restricted production during the usually critical June/July manufacturing period.

For Supply&Demand-Chain Executive the advent of the Olympics could in 2008 coincide with media attention focusing on China as the world's next potential 'bubble,' leading many manufacturers to shift sourcing strategies away from Asia. The falling dollar, limited free trade agreements, high energy costs and rising production costs will all contribute to companies reevaluating extended supply chains in Asia, and in addition

shareholders and board members could question their company's reliance on China and the Asia region should any further negative headlines arise regarding quality issues or if China receives bad press on the handling of protestors and dissidents prior the the Olympics. 

Prospects for 2008 have a few few commentators fearing signs of 'bubble(s).' The Washington Post on Sunday outlined China's current dot-com boom where start-ups have proliferated in the past decade in 'new Silicon Valley' districts thanks to an aggressive government campaign to attract private investment. Since the beginning of a frenzy of investment in 2005, many domestic Chinese companies that have gone public have traded at exceedingly high valuations, and some fund managers are worried that China is creating a tech bubble similar to the one that burst in the United States at the start of the decade.

Yet the party seems far from over in China, and Moneymorning.com views China as being on the edge of an economic transformation known as 'global decoupling' in which the growing prosperity and influence of China is contributing to the U.S. slowly being excised from its role as global economic trendsetter, all indications that 2008 will see a continuation of trends prevalent in 2007.  

As Barack Obama retreated from his far-fetched call for a ban of all Chinese toys (see posting from China Law Blog welcoming Obama 'back to reality'), Xinhua reported on Sunday all Chinese food enterprises will be required to have a quality safety label on their products to gain market access starting from January 1 2008. The regulation is said to fulfill China's market access labeling system which was first put into practice in 2002 but had not yet been applied to all food products. According to findings from a report about China's food quality and safety released in August, the article continued, by June some 107,000 food production licenses had been issued to enterprises, accounting for 90% of the market. During the nationwide campaign from late August until December this year to crack down on unqualified food products, 192,400 unlicensed food shops were closed down. 

In light of the "stigma in many peoples' minds about the quality of goods produced in China," sourcing website SourceJuice Friday posted an analysis of the rating system many manufacturers use for their products. Simply put, the product rating system is comprised of 'A' rating indicators, the more of them, the higher the quality and cost. Every country typically has a particular acceptable 'A' rating in place for a product. The time (the posting concluded)

of China producing cheap knock-off goods, toys or furniture has long since passed. This is an era where high quality goods are available if you look in the right places.

Yet problems with product quality in China can also be more systemic in nature. In the Investor Environmental Health Network's (IEHN) December video webcast "Product Toxicity and China: Insights for Investors and Companies," Melissa Brown of the Association for Sustainable and Responsible Investment in Asia (ASRiA) outlined some of the real issues affecting the quality of products in the China supply chain. China's development has progressed rapidly, Brown states, yet

all the infrastructural support and key raw material support that Chinese companies may need are not there every day of the week. There's tremendous pressure on suppliers at all tiers of the supply chain. 

And moreover,

The knowledge level of companies themselves about their risk profile on toxic chemical issues in Asia is low. The information in simply not there...

To develop regulatory and enforcement tools for product quality and safety issues takes years or even decades, and in a sober assessment of the situation in China, Brown contends that China is 'only just starting' down this road. While the Chinese government is beginning to act strongly on this issue, the necessary tools are only just beginning to emerge in Asia, however, and typically only come into public view when there's been a disaster or scandal.

So Brown's advice: keep following the scandals.    

If there is one product that has received way too much attention in 2007, it must be those millions of toys 'made in China,' a tainted few of which caused such an uproar this year. Those 'few,' whether blamed on the faults of foreign importers or on Chinese manufacturers, had a significant impact on global perceptions of the quality of Chinese products. Yet in the aftermath of the Mattel saga Chinese toys, food products and others have all been subjected to stricter quality controls, and have moreover been caught up in 2007 in the general drive for improved quality occurring in China (see CSB's 2007 China Sourcing Review).

As reported in a previous posting, China's toy-making heartland in Guangdong province stated already by late November that global demand for its toys had rebounded from the recall dramas of earlier. In the end nothing much has changed, because with Chinese toys still cheap and their quality improving, demand for them will not abate. 

But not so for Barack Obama.

A Reuters report yesterday quoted the presidential hopeful as saying he would ban all China-made toy imports following the safety scandals of this year, though admitting that such a move would cut off about 80 percent of toys in the United States. Calling for tougher inspections, Obama cited the example of Japanese food safety inspectors who go to China and meticulously test all food products sent from there.

Obama would probably be heartened by reports from China yesterday claiming the four-month national food safety campaign managed to hit its targets early, with a state newspaper reporting that officials seized 'thousands of tainted products and (put) many unregulated shops and eateries out of business... Inspectors shut 192,400 unlicensed food producers and pulled 29,800 products from the shelves.' 100% of stores in larger towns and cities, it was proclaimed, now had a quality label system in place and could trace back where their supplies came from.

And on the day after Thanksgiving, Xinhua reported yesterday, U.S. customers 'rushed in their hordes' to stores such as Toys 'R' Us to purchase Christmas gifts for their children. The article mentions Samantha Gusteins, a mother of one, who was carrying two big bags of toys and about to leave a store, saying "The toys are many and affordable."

No doubt she and many other shoppers would have Obama think twice about going to such extremes...      

As public images go, 2007 has not been a good year for products sourced from China. Media attention was seemingly constantly awash with a recurring chain of events starting with news of (Chinese-made) product recalls and reservations about product safety and quality to outcries regarding dangerous Chinese products (so poignantly expressed in the idea of Chinese-made toys poisoning Western children), to bickering in the media and protestations of innocence from the Chinese side, and culminating in a quality and safety backlash of measures to address the problems discovered.

Safety and quality issues are bound to appear in China, and in this regard 2007 has been unprecedented. It seems a logical deduction, yet is a myopic view of the larger changes and forces at work affecting China sourcing.

The U.S.-based retail environments association NASFM (name recently changed to Association for Retail Environments, A.R.E., according to website) published in its official publication the findings from its 2007 study tour to China, organised by the International Shopfitting Organisation (ISO). In May this year 14 of NASFM's representatives inspected 'a variety of Shanghai-area manufacturing facilities,' visited the CRC Expo trade fair and attended presentations by 'Maersk, the world's largest shipping company.' On the lookout for sourcing and business opportunities, the participants found changes within China since 2004 'even more dramatic than the changes in North America.'

Practically every plant we visited was either undergoing expansion or preparing to move to larger facilities, or had recently moved or expanded. Also evident was heavy investment in equipment, together with improvements in productivity, quality, and design. 

Yet the participants also heard from 'many sources' that Chinese facility owners and managers now face 'new' challenges of labour shortages, rising labour costs, and high employee turnover. With high turnover issues appearing more severe in urban and coastal areas, several companies were found to be looking at moving their manufacturing facilities westwards to reduce costs and to find a more stable workforce.

At the same time, while the 'blame game' was in full swing this year amid accusations of low quality standards in China and protectionism in the U.S., multinational corporations and their incessant drive to lower prices have in 2007 contributed to a particular dynamic among Chinese manufacturers. In the words of China-based Fiducia Management Consultants in a recent newsletter,

One fact is that many Chinese manufacturers cut corners: by using lower-quality materials, by running cheaper production processes and by violating pollution laws... (The) driving force behind this are, in fact, multinational corporations who have been aggressively pushing down prices... With shrinking margins, suppliers struggle to make ends meet; a fact likely to result in this so-called "quality fade."'

Yet notwithstanding the events of 2007, a competitive analysis of U.S./China manufacturing industries conducted by Grant Thornton in 2005 found that 'a surprisingly large' 73% of Chinese plants indicated that 'high quality' is also a focus of their market focus, while only 28% of them indicated 'low cost' as a market focus. Moreover, more than half the Chinese plants reported having an 'innovation' focus, compared to just 26% of U.S. plants. China's emphasis on innovation as well as 'service and support,' the study concluded,

shows that a real shift has occurred among the country's manufacturers - in short, China's manufacturers are recognising the need for a full complement of manufacturing skills to compete when low cost isn't the only advantage.

And as an Ernest & Young Spotlight on China study pointed out last year (available here), while in the past China strategy for foreign companies was only about sourcing, with the Chinese determination to move up the value chain and evolve from the world's manufacturing centre to a world class innovation centre, today the options have multiplied to participating in China's market growth from the inside or even importing to it. The 'differences and difficulties' in concluding satisfactory deals in China are slowly diminishing, and while foreign firms are getting more adept at navigating the challenges, WTO commitments and the need to develop lasting relationships with outsiders are gradually bringing more sectors in China in line with business practices recognised in other parts of the world.

While 2007 thus witnessed unprecedented fears about the quality and safety of products sourced from China, the clear underlying trend evident this year for manufacturers in China is one of an increased focus on quality and innovation. So with the uproar about Chinese-made product safety issues and recalls in 2007 still lingering (a C100 survey on American and Chinese attitudes toward each other released last week found that favorability in the U.S. about China has fallen since 2005, partly reflecting 'media attention on the Chinese product safety issue'), the underlying patterns at work in China in 2007 actually paint a vastly different picture as China slowly comes to grips with the demands of manufacturing quality products.

Note: This posting is an abridged version of an article by Julian Hewitt which originally appeared on The Beijing Axis website. The full verison of the article can be accessed here.

Two and a half decades of economic reform have placed China firmly on the path of rapid industrialization. China’s recent ascension to the World Trade Organisation has further hastened its opening up to the rest of the world.

At the same time, South Africa has also enjoyed a fruitful period of economic and political progress after many years of international isolation. However, it was only since the establishment of formal diplomatic ties in 1998 that these two regional leaders have begun to realize a significant growth in trade.

In 2006 China exported USD6.6 billion worth of goods (dominated by electronic equipment and textiles) to South Africa while it imported USD2.0 billion worth of goods (dominated by raw materials) from South Africa, according to South African Revenue Service figures. Official statistics from the Chinese Statistical Bureau paint a rosier picture, however, with Chinese exports to South Africa standing at USD5.8 billion and imports from Africa’s largest economy at USD4.1 billion.

China’s rapidly growing middle class is opening up new exporting markets for South African suppliers, and from a South African perspective, rising Chinese living standards are translating directly into more wines, fruit juices and fruit on local supermarket shelves. In addition, China is also becoming a focal point of international gold, diamonds and platinum sales, and on an industrial level South Africa is a large supplier of raw materials that help fuel China’s factory-floor economic model.

China presents big importing prospects for South African suppliers and retailers, yet sourcing of products from Chinese suppliers and maximizing China’s strength as a producer of the lowest cost goods is an avenue South African firms have not yet fully tapped into. Of course, trading with China is not without its pitfalls, even for companies with previous Chinese experience. Language and cultural barriers and often opaque importing and exporting processes serve to complicate business interactions and frustrate expectations between buyers and sellers. China is also a very regionally fragmented market, and this often requires specialized local knowledge of how to tap into potential Chinese business opportunities.

However, it is not without just cause the China commands daily media attention. The benefits of incorporating a China objective into your business’ importing or exporting plan far outweigh challenges on the way. China represents a competitive advantage and it not taken up, could easily be to your competitors advantage.

Ahead of impending cabinet-level talks between China and the United States likely to be dominated by fears of substandard Chinese-made products, the U.S. Secretary of Health and Human Services Mike Leavitt today in a conciliatory tone said the issue at hand was one of improving the monitoring of imports,

Our message to China, as well as to every other import/export partner we have, is if you desire to produce goods for the American consumer, you need to meet American standards of quality. We want you to know what they are, and we'll work with you to meet them.

The current emphasis on effective and sustained monitoring, resulting from the product quality and safety issues involving Chinese products in 2007, echo findings from KPMG's March 2007 Sourcing Survey (available here). Acclaiming sourcing, when managed well, as having evolved today to a key strategic business tool, the survey found 'significant opportunities' still exist for organizations to capitalize on the strategic value of sourcing;

this potential is often unlocked by more consistent measurements of contract provisions and other metrics about the relationship with service providers... This measurement process, while challenging, can be instrumental in protecting the bottom line (and) also helps consolidate the alignment of expectations among both customers and service providers, enhancing overall corporate governance and ensuring money is well spent.

In Asia Sentinel today John Berthelson looked at how the events of 2007 have impacted on sourcing companies in China. Numerous quality concerns have contributed to the development of a flourishing quality-testing industry, and with such vast amounts of products flowing out of China, Chinese producers have come under ever-increasing scrutiny. Yet the companies in the first line of fire here are the sourcing companies who constantly and vigilantly need to ensure factory owners are delivering on what they promised. Hence sourcing companies are constantly engaged in monitoring and testing, not only when products are made but also when they are transported. Speaking of logistics, in today's macro-growth China forecast the organiser of the Asian International Transport and Logistics Exhibition stated in Beijing that the value of China's logistics industry rose 12.1% over last year and is expected to grow 20% annually, reaching 1.2 trillion RMB in 2010.

China Briefing.jpgWith the new China Labour Contract Law coming into effect on January 1 2008, the December edition of China Briefing (req. registration) analyses the changes foreign invested companies in China must make to their employment contracts for all staff. Foreign investors are the prime target for legal and financial control mechanisms in China, and aiming to discourage employers from signing short-term labour contracts, the new labour law will have a direct impact on employment costs. Officially designed to improve employment relationships, clarify rights and obligations and provide more stability and security for employees, the law will in effect result in the abolition of fixed-term contracts as every such contract will require a severance obligation when expiring.  

And from the China Briefing blog yesterday, foreign enterprises in China seem set to lose their tax holidays as China moves to implement new corporate income tax regulations. As tax authorities have recently increasingly focused on foreign invested enterprises (FIE's), many of these enterprises have seen their tax holidays eliminated for breaching Regulation #43 of the new law, which dictates that once the tax breaks end, income tax should be submitted without delay and any changes affecting the tax payer within 15 days of the change should be declared. And taxpayers who no longer qualify for the tax breaks must pay up.

According to Steven Dickinson in Business Week, China has made 'remarkable progress in introducing a fully functioning civil law system... The Chinese authorities fully understand that economic development and development of a strong legal system go together.' Citing data from the Report on China Law Development published earlier this year, Dickinson pointed to a full 94,288 laws and regulations promulgated in China between 2001 and 2004 as an indication of a legal system being established in China which, once in place, 'will do its job of providing the guidance and legal certainty required of a modern market economy.'    

The Central Economic Work Conference closed in Beijing on Wednesday with headlines proclaiming that the 'ten-year prudent' monetary policy will be replaced by the 'tight one' in 2008. The current 'prudent' policy itself replaced the 'proactive' policy in 2005. Amid familiar fears of 'overheating,' China's economy has been running at 11.5% year-on-year growth in the first nine months of 2007, and the annual consumer price index was estimated to stand at about 4.5%, overrunning the warning threshold by more than 1%. The conference identified five major problems in the national economy, starting with 'overheating' and inflation concerns, to a weak agricultural sector and difficulties with energy conservation and emission reduction, and ending with welfare issues.

So with the economy frequently showing signs of overheating, how long can China's phenomenal growth rates continue? Moreover, while low labour costs have undoubtedly been China's trump card in capturing world markets, how long can this advantage persist with labour costs likewise creeping upwards?

One study (see reference 1 below) conducted this year examining the impact of market access and internal migration on average provincial manufacturing wages in 29 Chinese provinces between 1997 and 2004 found that provincial wages increased by about 15% per year (or 130% over the 7 year period), corresponding to 'common shocks possibly like total factor productivity growth and national rise in prices.' Internal migration, the study found, has slowed down wage growth by only 2% per year.

The question is really how China can keep increasing the competitiveness of its products and maintain its export growth, and factors such as low wages, a favourable exchange rate and the flow of foreign direct investment have all played their part in fuelling China's growth. Yet according to a study (2) assessing the causes for China's competitiveness, China's pool of cheap and increasingly mobile labour means competitiveness based on low wages will persist for 'quite some time,'  and Chinese producers are becoming much more proficient in enforcing world requirements for quality and product design, partly facilitated by the inflow of foreign direct investment and entrepreneurship. In effect, the study suggested, with China's enormous rural population and increasing number of 'floating' urban workers, 'it will be many years before the supply of low-cost unskilled labour runs out.'   

(1) De Sousa, J; Poncet, S, How are wages set in Beijing?, CEPII, No. 2007 - 13.   

(2) Adams, FG; Gangnes, B; Shachmurove, Y; Why is China so competitive? Measuring and Explaining China's Competitiveness, 2006.

 

Trade Fair.jpgThe International Expo Centre in Shanghai will play host to the China Hosting Fair on 12-14 December, showcasing fashion accessories and baby & children's products. For details of this and forthcoming sourcing fairs, see Global Sources.

At the China Business Network you can also listen to a podcast by Peter Zapf, Vice-President of Community Develoment for Global Sources, about what to expect at the coming fair.

(Thanks to Global Sources for the montage.)

 

All Roads Lead to China recently emphasized the importance of logistical frameworks in facilitating trade and investment in China, citing as citing as further proof a World Bank report of early November (based on a world survey of international freight forwarders and express carriers) stating that trade logistics (the capacity to connect to international markets to ship goods) is critical for developing countries to improve their competitiveness in 'an increasingly integrated world'. In China, the posting concluded,

the logistics industry that has been set up for the export market is in many ways the most efficient system in place... Domestically though, China is still in a mess in many ways... but is improving.  

DHL Worldwide Express Inc. announced plans last week to invest $175 million on a new North Asia cargo hub at Shanghai's Pudong International Airport, and the CEO of DHL for Asia-Pacific was quoted as saying 'China remains the most important player in the global logistics chain in North Asia.' News reports last week (see China Daily's) also had China joining the 'world elite' in shipping, with the number of container units handled by mainland ports this year hitting the 100 million mark. Yet the China Daily article also quoted comments by Song Dexing, Director of the Chinese government's Water Transport Department, who claimed that China

is still a long way from meeting the growing demand of its rapidly expanding economy. The container industry must move away from traditional transportation and toward comprehensive logistics and service industries.

In fact, Logistics Management magazine identified China's underdeveloped transport infrastructure and immature logistics industry as a crucial challenge to the government's pursuit of a 'harmonious society.' Fragmented distribution systems, limited use of technology in the distribution and logistics sector, dearth of logistics talent, regulatory restrictions and local protectionism are all factors inhibiting the efficient distribution of domestic and imported products. Despite China's reputation as a low-cost country for business, selling in China remains expensive. Logistical costs are 40-50% higher in China than in the U.S., and by 2010 China will need an estimated 400,000 logistics professionals, while local universities struggle to produce even 10,000 logistics graduates a year. The logistics industry has at least begun to consolidate, which is gradually stiffening competition and lifting service standards. There are still over 18,000 registered logistics providers in China, however, and no single company commands more than 2% of the market. 

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Michael Pettis at China Financial Markets (site blocked on the mainland) on Wednesday made some significance of the first decline ('after many days of strength') of the RMB to the dollar.

Is this simply a random event or are the Chinese financial authorities warning European officials to stop pushing on the RMB front? If it is the latter, its likely to be a wasted warning.

According to Pettis, Europe's trade deficit is likely to rise even further over the next few months, and with anti-Chinese feelings already high in Southern Europe and a 'chill' in the air between China and Germany after Merkel's meeting with the Dalai Lama, at this rate its hard to see how China will avoid a nasty trade dispute with Europe. Yet though it makes sense for domestic reasons for the Chinese government to adjust the RMB more quickly, this is unlikely to happen without serious foreign pressure.

I think they are making a huge mistake, however. China's out-of-control monetary policy is already very likely to lead to domestic grief, and if we keep this pace of reserve accumulation up for another year, I think the chances of an ugly adjustment become extremely high.

Richard Brubaker at All roads lead to China on Saturday commented on the New York Times reporting on China agreeing to remove a dozen subsidies on WTO-disputed products. Quoting the analysis of Susan Schwab claiming the step as a victory for U.S. 'manufacturers, producers and their workers,' according to Brubaker the impact is likely to be insignificant as   

they are not clear on what is an American product, a Chinese product, and what is an American product made in China...and without this distinction, I do not think they would be able to correctly solve the imbalances that are present in the system.

American made cars and telecommunications equipment made for instance by Buick, GM, Cisco and others are doing well in China, yet none of these items are made in America and sold to China; manufacturers have found its more cost-effective to produce and sell in the same market.

Through this process, American manufacturers have in essence become their own competitors, and while I am not saying this is right or wrong, I am saying that the way the argument is being framed, the discussions conducted, and the solutions created to address these problems is wrong.

Discussing the same news report, Stan Abrams at China Hearsay today put the U.S. manufacturers' 'victory' in the following light:

 Illegal subsidies provoke quiet complaints in different bilateral venues. After that, you issue formal complaints and let the media get in on the action. Still no progress, you ratchet up some rhetoric. No movement? You then threaten to take the case to the WTO. Eventually you file a case and hope to settle at some point. This is ultimately what happened here. That's sort of what every U.S. administration would have done; its called cycling through your options. Even calling it a policy or strategy is rather embarrassing. I'm not sure how else you would do it.

The last few months have seen clear indications of the changed state of China's payment and settlement systems. Research reported in August of this year by Towergroup found that, following a series of modernizations, China now possesses national payment capabilities worthy of an 'economic powerhouse.' In just ten years China's Central Bank has managed to implement three new payment systems using state-of-the-art technology, providing a national network for high-value payments, bulk low-value payments, and national check-image exchange. As China has historically been prone to inefficient and fragmented payment systems, implementing advanced payment products and infrastructure to cope with China's commercial expansion is a significant step. China has also been able to leverage Hong Kong's advanced infrastructure and banking reputation under the "one country two systems" policy while the separate payment systems of China and Hong Kong have become more integrated.

In the wake of payment system modernization, China's Internet payment systems environment is likewise developing rapidly. However according to Chen Lei of China Payments News (in an article last month on gtnews, needs registration) Internet payment systems in China are fundamentally developed and pursued by banks individually, as a nationwide integrated bank card system (China Unionpay) was only set up in 2002. And though growing in popularity, credit cards as yet make up only a fraction of all bank cards in use in China (0.3% of 500 million bank cards at the end of 2002).

Yet it seems that business for online retailers in China is definitely starting to pick up. According to the Internet Society of China (as presented in an article appearing in Business Week last month), consumer e-commerce in China is set to top $1 billion in 2007 and grow at an average of 34% annually over the next three years. The article also presented figures from market watcher iResearch, which projected that online payments by both companies and consumers in China are expected to triple over the next two years to $24 billion. No doubt the spectacular rise of Alibaba.com will provide further impetus to this process.