Articles

Tough Times for China

By Bill Quarless
May 2009

{Note: This featured article appears in the May 2009 issue of Electronic Retailer. Click here to read it on the Electronic Retailer site.}

Despite a worsening economy, or perhaps because of it, the DRTV business is booming in the United States. This might cause DRTV companies to overlook an important area where they are not immune to the effects of the global recession: their manufacturing operations abroad.

Here in Hong Kong, these effects are clear. Indeed, it could be argued that the industry most affected by America's economic woes isn't the banking industry, the auto industry or any other American industry-it's the Chinese manufacturing industry. As U.S. consumer spending has contracted stateside, the flow of purchase orders that keeps this industry afloat has slowed dramatically. The result: An astounding 70,000 factories have closed in the last few months, putting some 20 million migrant workers from rural China out of work.

HITTING CLOSE TO HOME

Some experts are estimating that nearly 10 percent of China's total factories may ultimately fail, leading to another 20 million without jobs. The situation is so dire that, mirroring the actions of the U.S. government, China's communist government recently approved a $586 billion stimulus plan.

According to government statistics, the hardest hit have been the factories that supply toys and shoes. But close behind them are the factories that supply inexpensive, low-margin housewares and fitness items. In other words, exactly the type of factories that supply the DRTV industry.

Before the global economic crisis hit, these manufacturers of low-cost products were already contending with a host of new pressures. Among them:

   • A steady increase in raw material prices over the past two years;

   • A new China labor law mandating labor contracts, contributions to pension funds and insurance programs for all workers;

   • Stricter environmental regulations in preparation for the Olympic Games; and

   • The rise of the RMB against the U.S. dollar.

BEING PROACTIVE

With already thin margins and significant fixed costs, it's easy to see how these factors combined with a drastic reduction in purchase orders could cause so many factories to fold.

So what does all this mean for DRTV companies? There are five ways the industry will be affected by this crisis:

1. Production delays. To reduce unemployment in February, China's State Council issued an order requiring factories to secure approval from local authorities before any layoffs involving at least 20 people or 10 percent of the staff. Since migrant workers are essentially "let go" every year and then re-hired after Chinese New Year, many factories reacted by being more conservative about how many they re-hired.

The same phenomenon is also affecting skilled labor, such as engineers and factory managers. Some 25 percent of last year's 6 million college graduates remain unemployed, according to university data. Factories are understandably cautious about hiring these workers without steady orders coming in. Adding to their concern are new labor laws requiring factories to sign contracts with their workers. Such contracts make it difficult for employers to reduce their staff when orders dry up.

Even existing staff is being managed to reduce costs. We experienced this during the recent Chinese New Year holiday. Many factories asked their workers to leave early for the annual two- to three-week holiday, and return later, in an attempt to lower costs. These "extended vacations" affected the entire supply chain, since most DRTV products require several factories to complete the final product. Whether it's the plastic injection parts supplier, the stamped metal supplier, the paint supplier or the box printer, if one component is not in the chain, the production is delayed.

The bottom line is that even suppliers who are enjoying booming business because of the increase in DRTV sales are scrambling to find new raw material and component suppliers. An immediate effect on the DRTV business will be longer ramp-up times.

2. Higher defective rates. Last year's news out of China was dominated by stories of defective products. From lead paint in toys to melamine in candy and deadly baby formula, all of these tragedies were the direct result of cutting corners in an attempt to increase profits. These actions were motivated by greed. This year, similar actions are predicted-this time motivated by survival.

Life in China without an income is no life at all. Many factories will do almost anything to stay in business. DRTV companies would be well served to tighten their quality control measures in the coming year.

3. More knockoffs. Desperate factories on the brink of failure will also gravitate to where the demand is. As mentioned earlier, the DRTV industry is booming while many other industries are struggling. That can only mean one thing: An increase in DRTV knockoffs.

The evidence will be everywhere at the next China tradeshow. Even factories that don't normally counterfeit items will be showing off their copies of the latest DRTV hits.

Worse yet, there will be no one to stop them. The Chinese officials at the central, provincial and local levels all have more to worry about than copycats. In fact, they may just be glad that exports are going out at all.

4. Increased social unrest. If the financial crisis in China worsens, as many experts predict, it could have disastrous social consequences that also have implications for the DRTV business. Some experts are suggesting that a "rural revolution" is imminent amid the financial crisis. The reason: In a rural village, as many as three or four people depend on the income of a single migrant worker. So, while current estimates put the unemployment rate at 20 million workers, as many as 80 million people are directly affected. Double that if the most dire predictions for this year come to pass.

In an attempt to prevent this, the Chinese government is creating training programs throughout the country to re-train factory workers in farming and agricultural skills. For example, in the southern central city of Chongqing, some 30,000 factory workers have already taken these classes. However, China's own leaders admit the national economy must grow by a minimum of 8 percent this year to keep everyone employed and to maintain order.

In recent months, there has been a troubling increase in strikes, worker protests and labor disputes with factories. This news doesn't make it onto CNN, but it happens often and is a real concern for the central government. With 90 percent of DRTV hard goods made in China, supply lines could be seriously affected if this crisis deepens and is prolonged.

5. New risks. In the current economic climate, there are new risks DRTV companies never had to think about before. An obvious one: What if your factory fails in mid-project?

When demand was high, a factory could make up for lost business with new business. But these days, a few lost orders can be the final straw. And so, after selecting a factory to make your hit DRTV item and wiring them $25,000 for molds, it's possible you could learn they just became the 70,001st factory to close its doors this year.

All of these concerns are ominous and real, but there are ways for DRTV companies to minimize their exposure. The biggest one is to maintain a constant presence in China.

Doing so will allow you to react more quickly to production delays, to give increased attention to quality control measures that prevent defectives, to police tradeshows and nip counterfeits in the bud, to stay abreast of what regions are experiencing social unrest (and avoid them) and to vet suppliers personally before you risk money with someone on the verge of bankruptcy. If you don't have the personnel or resources abroad to accomplish this, the need for a competent and trustworthy China partner has never been more critical.