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China manufacturing: Adapt or die

23 2016.09

Hyde Xu, sales manager at GKO, a Chinese maker of aluminium products, has come to the Canton Fair — the country’s biggest trade show — not so much to do deals but to show customers “we are still alive”. “Exports are not good and the domestic market is also bad,” says Mr Xu, throwing his hands up in resignation. “The price of shipping containers for export has fallen by half . . . and now freight companies as well as factories are worried about going bust.” While they are accused of dumping on international markets, many Chinese metals producers have already gone out of business themselves because of massive oversupply, a slowdown at home and an uncertain global outlook. GKO, based in Zhejiang province, has responded by pushing its suppliers to cut costs and developing new, higher value products. After riding China’s construction and car market booms, the company is now trying to tap into another part of the world’s second-biggest economy, one that is still growing: tourism. GKO has recently started producing lightweight aluminium suitcases, similar in appearance to the luxury models made by Samsonite and Rimowa and adored by Chinese travellers, but at half the price. Having specialised in producing huge rolls of aluminium sheet, which were later made into car parts and building decorations, GKO invested in new machines to press its raw material into suitcases. Reinvention Struggling factory owners are changing what they produce as domestic and global factors combine to shrink markets Anxiety complex Worries about China are undermining confidence in advanced economies which are themselves only seeing tepid growth Feeling deflated Factories that cut costs and offer discounts to survive are contributing to deflationary pressures “If we just sell simple aluminium products it’s hard to make a profit, so we have to find new business lines or we will die,” says Mr Xu. Across Zhejiang and south to Fujian and Guangdong, the provinces that form the heart of China’s factory belt, companies such as GKO are under pressure like never before. Global demand remains weak with Europe still struggling to emerge from years of crisis, the US recovery tepid and emerging markets such as Brazil and Indonesia struggling as China’s appetite for their commodities has waned. The Chinese economy continues to slow, with annual gross domestic product growth officially down to 6.9 per cent in the third quarter from double digits in the 2000s. Many analysts question the official data and believe the real economic performance is much worse. In a negative feedback loop, worries about China are now further undermining confidence in advanced economies. Janet Yellen, chair of the US Federal Reserve, recently flagged “heightened concerns about growth in China and other emerging market economies” as a threat to the US recovery. If the macro picture is bad, the micro view for China’s manufacturers, a key engine of economic growth, innovation and employment, is no better. The government does not release comprehensive data on the nationwide scale of jobs losses and business closures. But factories have been shedding jobs for two years, according to the purchasing managers’ index produced by Caixin, a respected financial news organisation. Caixin’s latest PMI, which incorporates more private sector companies, and the government version, tilted more towards larger state-owned industries, both indicated further contraction in the manufacturing sector in October. Factories that are cutting costs and offering discounts to survive are also contributing to deflationary pressures , with the annual producer price index having fallen for 44 consecutive months. While prices are slipping, other costs are still high and rising, especially the key component, labour which typically accounts for around a quarter of expenditure for exporters. Average factory worker wages in China have more than quadrupled over the past decade, according to the Conference Board, a US business lobby group. Beijing’s preferred solution is for companies to “move up the value chain” and make more advanced products with stronger brands. Mobile phone producer Xiaomi is a prime example. But that requires financing, which is hard for many smaller private-sector manufacturers to secure when state-owned banks are pushed by the government to maintain support for struggling state-owned industries. Manufacturers are increasingly squeezed, having to negotiate a structural shift away from low-cost production at a time when they also face strong headwinds. Xu Bing, a Canton Fair official, warns that “the traditional advantages of our country are weakening and the new competitive edge is not yet consolidated”. Since the opening up of the country accelerated in the 1980s, nimble factory owners — the street fighters of the Chinese economy — have always responded to changing consumer tastes and global demand. Now, more than ever, they must adapt or die. Prices fall as orders shrink Held twice a year in Guangdong’s provincial capital of Guangzhou, the Canton Fair was originally established in 1957 as the only place where foreigners could buy products made in a nation then closed to outsiders. Despite the rise of ecommerce portals such as Alibaba, the fair remains the major showcase for Chinese products and a must-visit event for tens of thousands of traders, distributors and retailers from Brazil to Benin and Albania to Australia. Inside three huge exhibition halls, manufacturers sell everything from the mundane — taps, electrical cabling and floor tiles — to the cutting edge of 3D printers and crop-spraying drones. Attendance at the trade show, which closes on Wednesday, was 140,000 — down 7 per cent from last year. And while the mood among factory executives was gloomy, buyers saw an opportunity to cut prices, negotiate better trade terms and secure smaller order sizes. Jayesh Vyas, an Indian trader, has been attending the fair to source electronics and furniture since 2001. “I was just talking to a factory selling stainless steel shelving,” he says. “They were willing to reduce their minimum order size from 500 to just 50 pieces. That’s how bad thing are.” As factory owners battle with falling orders, many are following the example of GKO, the troubled aluminium maker, by pushing more advanced products and targeting the domestic market. Megmeet, based in Shenzhen, the first of the special economic zones that drove the transformation of China’s economy in the 1980s, built its business manufacturing basic components such as power supplies and heaters. But it has reinvented itself as a maker of own-brand, high value consumer products like its new range of $2,000 “smart toilets”. “Every Chinese person has an iPhone now, even cooks and cleaners, so if rich people want to show their status the best way is with an expensive toilet,” argues Andy Yang of Ikahe, Megmeet’s toilet-making subsidiary. In business terminology, the “pivot” is usually reserved for Silicon Valley start-ups who fail at one idea and then switch direction, refocusing their brainpower and venture capital funding on an altogether different market. More and more Chinese factories are being forced to take this approach but not all succeed. Facing cut-throat competition and waning demand for its hedge trimmers and chain saws, toolmaker Gezhi decided to move in to self-balancing, one-wheel electric scooters. But what the Zhejiang-based company hoped would be a Christmas best-seller turned out to be an embarrassing flop. “To be honest, they are too hard for many people to ride,” admits Jason Liao, sales manager for Gezhi. “After one month of trying, even I was still falling off sometimes.” Survival of the fittest The private-sector factory owners trying to adapt their business models are driven by survival instincts rather than Chinese Communist party rhetoric. President Xi Jinping and other top officials have repeatedly emphasised the need for China to rebalance its economy toward consumption and services, and away from construction and investment. At the same time they want to upgrade industry under the “Made in China 2025” initiative, which is designed to create more skilled jobs and promote innovation in areas like pharmaceuticals, aerospace and new energy. Funds have been freed up for local governments to support the development of industrial robots to reduce the reliance on human labour as factories struggle to find enough workers at low enough wages to remain profitable. But economists argue that, after an initial push, the government’s reform drive has lost pace and focus because of the economic slowdown. “The government has been caught off guard and has switched its attention to stabilising growth, thereby compromising the structural reform push,” says Louis Kuijs, the Hong Kong-based head of Asia for Oxford Economics. “The overall numbers show that China is starting to move up the value chain but, at the level of individual companies or sectors, this comes alongside a lot of short-term challenges and pain.” With their products still deemed inferior in many advanced markets and demand at home slowing, successful domestic manufacturers like Haier, China’s largest home appliance producer, and SAIC, one of the top four carmakers, have been hoping to boost sales in emerging markets but they too are stalling. Meanwhile, the manufacturers that have traditionally focused on exports are finding it difficult to switch their focus to the domestic market. Willy Lin, who runs a factory making high-end knitwear in Dongguan, one of Guangdong’s main industrial cities, says that China seems like a great potential market for companies such as his, which exports 90 per cent of its products to Europe and 10 per cent to the US. But he says the credit risk is too high, especially in the current climate, and that domestic buyers lack the sophistication of their international counterparts, with unrealistic expectations of pricing and little understanding of production. Peter Helis, who runs an investment consultancy in Foshan, another sprawling industrial city in Guangdong, argues that despite these limitations, more manufacturers will look to the domestic market as consumer buying power rises and Chinese retail develops. He says that while the headlines look bleak, the prospects for different parts of the country are diverging. “The most northerly provinces are dominated by state-owned companies and heavy industry, and they are talking about a deep recession,” he explains. But southern Guangdong, dominated by private exporters, is faring better. With the government’s reform drive stalled and no sign that the slowdown is going to reverse any time soon, much of the heavy lifting in terms of growth and rebalancing in China will have to come from the nation’s factories, which still account for just under 30 per cent of economic output, according to Mr Kuijs. Whether they are creating luxury toilets and trendy scooters or streamlining the production of metal pipes and clothing, their fate will help determine the success or failure of the government’s restructuring strategy. Andrew Wang of ERA, a maker of solar-powered equipment, typifies the factory owners’ pragmatism. “We always have to adapt,” he says as he shows off his company’s latest products: cut-price solar chargers for mobile phones. “The collapse of the price of solar panels has been bad for those making them but it’s allowed us to start producing these cheap chargers, which are selling really well.”

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