Factory Closing: Why Is Anyone Shocked? This Was Coming…

Wednesday, February 27, 2008 9:33
Posted in category The Big Picture

The last couple of weeks has been an absolute flurry of reports and posts on the factory closings in the south, and I am a bit surprised by the coverage.

It has been linked to snow, labor shortages, to the RMB effect on trade, and a move to new low costs bases, and so on… and what makes me laugh a bit is that this is something that could not only be seen coming from a long way off, but where I think many reports are actually off is that they have failed to take into account a MAJOR cause of these closures.

These businesses were losers to begin with, they were being propped up by an inefficiency, and they would have closed in short order anyway.


1) First, let’s look at the announcements.  The Asia Footwear Association and Federation of Hong Kong Industries who are claiming that they are seeing large amounts of closures in the Guangdong province due to labor costs pressure.  No doubt, this accounts for a portion of this.  These are industries that are in constant need of labor, and apparently the members of both associations are in need to cheap labor. 

Next, let’s look at who is not making the announcements. I have not seen any announcement by Nike that they are moving, I have not seen any announcement that Addidas is moving, I have not seen an announcement that any other foreign brand is moving….and as my friends working in this company have not told me telling me about massive labor woes

so, my first conclusion/ assumption is that the organizations being referenced in these article are the those who have been consistently the lowest on the wage scale… and have only survived because they have exploited workers, and dodging a host of other things.

2) Let’s look at the articles for a moment.  14,000 factories are closing and larger factories are moving inland. So where are the little ones going?

Well.  I will provide two guesses: (1) they closed or (2) they were consolidated

With respect to the potential idea that they closed, it is important to remember just how fragmented many industries in China are: particularly in textile & footwear, but also in many others (cement, fiberglass, logistics, real estate development, food, automotive, etc).  Name an industry, and one can easy see where there are significanlty more companies today than there will be in 5 years.  It is something that crosses every provincail border in China, but it is something that is changing.. and fast.

BEsides domestic M&A activities dricing consolidation, we are now seeing local brands become regional brand and reginoal brands become national brands… and this dynamic is forcing a lot of waste (i.e. poorly funded and managed companies) to be removed from the system (i.e. closed).

3)  Let’s review the last 18 -24  months of policy.

Over the last 18-24 months (really 36) there has been an enormous amount of activity on the regulatory and monetary side that have impacted local manufacturers.  Of course, it has impacted foreign investors as well, but contrary to popular belief in many circles the steps taken to rework the M&A, labor, investment, energy, logistics, and other laws were done so with domestic considerations as a priorirty. … and in nearly all cases, whether fully enforced or not, it was the domestic manufacturer who was hit the hardest.

with respect to this thread though, it was the labor and tax laws that I think one can draw a direct connection to.  Many smaller shops closed as a result of these new laws, and while it hit the larger shops, they have been able to weather the storm a bit better

from the monetary perspective, you have the RMB and VAT.

The RMB has made prices for everything exported nominally more expensive, and it has surely had an impact, but it was the reduction of the VAT rebate that really hurt.

Reduction of VAT rebates over 3000 categories.. impacts those who are not adding value, but is a death blow to anyone who works in low margin industries that require low labor content (think steel stamped parts).  Those who were integrated, had a product portfolio, and had some market power were able to weather the storm – and even potentially pass on some of the increased cost.

Vice Chairman

Michael Duke confirms much of this in a recent CNN quote

productivity improvements by its Chinese suppliers are helping to offset rising costs due to inflation and an appreciating yuan.

Take all the above, put that together, and where I am leading this horse cart is that while there are surely some factories who are moving to other areas of China, and there are surely some who will make it to other markets like Vietnam, the fact is that a large percentage of these organizations were losers and closed because their industry simply did not require them anymore.

They were unable to scale, they were unable to add value, and after VAT/ RMB/ rising costs were calculated they were no longer profitable.  It is a trend that many in China have been watching, and hoping for, for a long time, and it is simply a process that every mature economy goes through…

and where I think everyone should pay attention is that if your supplier recently moved because of costs, I would strongly suggest you look deeper into their operations before placing anymore orders…

Stay tuned.  I have written a sister post to this that looks at the recent news of china’s exporting of inflation where I question the logic behind that as well… and the third post on  all those reports of factories leaving for Vietnam is in the planning as well…

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