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Crouching tigers, falling dragons

 

by Stephen White

 

The Asian tiger economies have not been immune to the effects of the downturn of the global economy. Markets are stalling and for the first time Chinese manufacturers are finding themselves under pressure
Asia’s tiger economies have taken a bigger hit from the global slowdown sooner than expected. South Korea’s industrial output fell sharply in October and Thailand posted its slowest export growth in six years. The large manufacturing corporations carrying huge debts of Japan, Indonesia, and India have been hit sideways by the credit crunch.

 

Even the region’s two powerhouse markets of India and China are suffering. Despite India’s annual economic growth between July and September coming in stronger than expected according to a Reuters poll at 7.6 percent, it is the slowest pace of expansion in almost four years. Economic data out of China suggest that the world’s fastest growing economy is also slowing down, just as the rest of the world is counting on it to maintain growth. Inflation in China fell to 4 percent in November, marking a 16-month low. The government responded in late 2008 with a $600 billion spending plan to rev up the economy.

 

"We knew Asian economies would be caught in the direct headlights of two oncoming trains: the global credit freeze and the weak global demand," investment bank UBS explained in a recent report. "While these aren’t unexpected factors, what has surprised us was the extent and speed at which these shocks have hurt what we still maintain were/are strong Asian fundamentals as the credit storm approached."
Despite the region’s strong fundamentals any hope that the region would escape the crisis largely unscathed has evaporated. Weak global growth will depress demand for Asia’s exports, and there are signs that a significant export slowdown is already underway.

 

China’s economy has slowed in each quarter for over a year, but was still growing at a relatively brisk pace of 9 percent in the three months to September. However, there are increasing reports of thousands of factory closures across the southern manufacturing belt, with some desperate owners simply walking away from their plants. Almost 40 percent of China’s economy is made up of its exports, and many predict tough times ahead.

 

The Chinese government is hoping the $600 billion that it has pumped back into the economy will encourage Chinese households to spend more money and boost the domestic economy. It has also pledged a change on VAT to cut corporation tax and has added tax rebates on a wide range of goods to encourage exports. As early as August, the government increased tax refunds on textile and garment exports to 13 percent from 11 percent.

 

Overcapacity and over-expansion

 

Like many of its manufacturing sectors, China’s OP industry suffers from overcapacity. Fine when in a time of strong growth but what happens when your economy and that of the countries you export to start to wobble? Factories and jobs will go.

 

"Over-expansion happens all over the world but never to the degree that it does in China – in other parts of the world, there are checks and balances," explains Bennett Little, President & CEO, Business Stationers. A fluent Chinese Mandarin speaker, Little was one of the first westerners to enter China after it re-opened its doors 30 years ago. Decades down the line, he feels he has a rare insight into China’s complex business culture.

 

"If one goes to put up an office building and wants to borrow money from a bank or insurance company, one has to show projections, population density studies, etc. In China, for the most part, all one has needed is connections. Look at the overhang of supply of office buildings in Pudong – saying that it was a bubble economy is just a simplistic (and understated) label."

 

China does not have the built-in enforced safeguards in terms of quality and reliability, banking, forecasting, etc, that are taken for granted elsewhere. Indeed, with just a few regional exceptions there have been no economic downturns, even during the Asian financial crisis of the late 1990s.

 

"You take that lack of experience and couple that with the fact that preparing for a ‘worst case scenario’ and, worse still, talking about it, is considered to be unpatriotic negativism with the cultural more that it is bad form (or worse) to give your boss bad news, and you have a country that has both poor safeguards (at best) and no preparedness for the mess that is here, much less the one that is to follow," Little warns.

 

It is estimated that 40 percent of China’s GDP is based on exports. And Little explains that office products manufacturers are more reliant than most on exports to Western customers. "Just go into any average office in any average Chinese company and compare (how much less) is used versus that of an average Western entity. As the West cuts back on usage, only companies with sound manufacturing techniques and a handle on all their costs have a chance at survival," he says.

 

Little’s view is that there is a gloomy future for Chinese manufacturing. The current financial crisis will only serve to expose fundamental problems in the system.

 

"Only those with access to capital will be able to retain their trained employees and ‘ride out’ the tough times," he says. "Relatively speaking, these are few and far between, and you are going to see some big names as well as a myriad of small ones closing up and that process has already begun. It will accelerate after the Chinese New Year (26 January 2009)."

 

Simply put: Chinese manufacturers are just not as cheap as they once were. The Yuan/US dollar rate was 8:1, now it is about RMB6.8 to 1 dollar. Effectively wiping out 15 percent off their value. They have also been struck by a cut in tax rebates that were once as valuable as 17 percent to exporters. The Chinese government dropped it in 2007 to, ironically, slow exports and counteract its trading deficit with the US. Labour and environmental costs have skyrocketed, as have taxes and the cost of raw materials, while declining from recent highs, are still way above what they were in 2007.

 

"While margins will be constrained by increased competition to get any order ‘out there’ and to keep every client, orders themselves will be smaller and farther apart and there will be less clients as well," explains Little. "If there is a benefit, there will be far less demand for things that have been traditionally in short supply."

 

Little warns that production from China is vulnerable as there are just too many factories that are content to produce poor product.

 

Little claims: "Many is the company who received a shipment nowhere near the quality evidenced in the ‘sample’. Often the sample was one that was bought in the market or brought in by an ex-employee from another company."

 

Eroding principles

 

Little also feels that, in many cases, the principles of business that existed when China first re-opened its doors in the late 1970s are slowly being eroded away.

 

"Many conversations (used to) revolve around peng you (friend) and lao peng you (old friends), with the thought that business should be between friends and that ultimately they become old friends. In case it was not clear, a translator would stress that no one wanted just one order, but a long term relationship."

 

Little says that today when meeting a new factory the buyer will be called peng you de jiaqian, quite literally ‘friend because of the price’. In other words, you are a friend because you accepted the order at that price – they are not going to be too concerned about giving you what you ordered as you specified.

 

As one buyer told OPI recently: "A solid company would either re-make the order if there was an error or they would offer a discount on the next order (it is often necessary to do it this way because of Chinese export controls). But many companies are not concerned about another order being received from you because they know what they are making is sub-standard."

 

Investment is needed to improve standards but companies struggle to raise capital in China. "They don’t have any money – the state-operated enterprises have first dibs on almost all of it," clarifies Little.
There are real signs that this inflexibility is starting to harm manufacturers so severely they are willing to risk losing new business just to keep afloat.

 

According to one Chinese manufacturer money is so short at the moment that it cannot afford to exhibit at Paperworld in Frankfurt – a major destination to gather orders in recent years. And it is not the only one.

 

"A system like this cannot continue – when it is expanding with great rapidity, it can outrun certain fissures, certain deficiencies but, as it slows, these problems will ultimately manifest themselves, and hit hard. It’s like getting a flat tyre at 160 kph – often you won’t know it is flat because the air keeps going around and around inside the tyre but slow down to 80 kph and you can wind up losing control and crashing."

 

Chinese manufacturers like their international counterparts are going to be learning some harsh lessons in the tough times ahead.

 

Benefitting from turmoil in Thailand

 

Nath Vongpanich, Managing Director of Office Club (Thai), the licensed operator of Office Depot stores in Thailand, feels that his company has benefited from the company’s struggles in its traditional markets. "We have received greater support from our licensor as they want to generate higher income from Asia in order to compensate for a big fall in the US market," said Nath. Despite the growth in the overall office supplies market in Thailand projected to slow to between 7 percent and 8 percent this year, down from more than 10 percent witnessed annually in recent years, he still feels that: "There are still great business opportunities for office products in Thailand, particularly in some potential channels such as direct selling, which is a new distribution channel to be focused on by the company."

 

Riding out the storm in Japan

 

In terms of the business sector Japan is the second largest market in the world. However, exactly how the Japanese economy will be affected by the current financial crisis is still a bit of a question mark.
"Obviously there will be some negative effects and we are already seeing a lot of low cost retailers such as Uniqlo, for example, reporting a jump in sales," says Andrew Hankinson, Managing Director, Esselte Japan. "Overall though, Japan is lucky in that the Yen has appreciated up to 25 percent against some currencies and thus making imports much cheaper and allowing importers to control costs and margin to some extent."

 

Hankinson, who has spent 12 years in Japan, feels that now is the time for his company to work the channels as life gets increasingly difficult. "Specifically for Esselte Japan, we have extensive traditional and non-traditional sales channels which allow us diversification to alleviate some risk. For example, our product line-up in the non-traditional channels is less price sensitive and higher margin. In the traditional channels we have a large product presence with Askul which is the market leader for mail order/catalogue and where many customers will consolidate their purchases. Another strategy which has been on-going and we feel will benefit us is the streamlining of our operations in such areas as product rationalisation, logistics, and expense cutting."