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The Asia Effect
By Michele Bell
August 2010

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With workers striking, wages rising, factory output decreasing and labor pools shrinking, the “world’s workshop” is undergoing unprecedented change and growing pains. How does this affect you? The result is depleted supplier inventories, longer lead times and higher prices.

Kathryn Kaufmann, owner of Authentic Creations (asi/127618), is quite blunt about her current quandary. “I’ve never had so much trouble with orders going awry,” she says. “I’ve had more problems in the past five weeks than in my past 12 years in the industry. I’m starting to wonder whether ad specialty suppliers are understaffed and overworked, or am I just having a streak of weird luck? Seriously, what’s happening with suppliers not being able to fill orders?”

The source of most of the issues is exports from Asia, where there’s a confluence of unusual and unprecedented problems: newly empowered workers are demanding wage increases; many factories closed during the recession, and those that stayed open don’t have enough staff or production capabilities; there are too few cargo ships in operation, causing limited container space; and there are surging cotton prices and rampant yarn shortages. Indeed, economists having been throwing around a word lately to describe the extraordinary events in Asia: seismic.

“The U.S. ad specialty industry is especially affected by these events because we are an industry known to fulfill any request,” says Bonni Shevin-Sandy, executive vice president of Counselor Top 40 supplier Dard (asi/48500). “Now we’re faced with the issue that our orders may not be fulfilled in a certain time period, or even filled at all. China needs to take the appropriate measures in order to continue to be a market that’s highly sought after.”

The tectonic shift in Asia, specifically, is happening because companies have come to rely on the country’s low-cost labor to keep a steady flow of inexpensive products. That’s not necessarily the case any longer. Here, we dissect how changes in Asia are impacting the ad specialty market.

Advantage: Employees

“This story starts with a recession,” says Marty Lott, owner of Counselor Top 40 supplier SanMar (asi/84863). “And when a recession hits the way this one did, the common thing that’s done by people who inventory product is to cut back on their ordering.”

Over the last 18 months, with fewer orders coming in, many Chinese exporters cut capacity by reducing headcount, says Jonathan Isaacson, owner of Counselor Top 40 supplier Gemline (asi/56070). “Given the growth in the Chinese economy, many workers have been able to find jobs in other industries closer to their hometown, as opposed to being in the South or near some other areas in China where the factories are clustered.” 

Shevin-Sandy notes that the most pressing issue right now for the ad specialty industry is that China anticipates more than $1.5 trillion (U.S.) in merchandise exports in 2010. “This is an issue because China is sought out for our raw materials, imprinting, packaging, testing and shipments of orders,” she says.

Employers are also complaining about increasing costs and labor shortages, and laborers are being pickier about their wages, benefits, social status and working conditions. Younger workers are much more aware of how to use their rights to pursue higher wages and a better, healthier working environment.

Much of the change has come from shifts in the nation’s population. Demographers expect the size of the working-age population to peak in the next five years or so, and then gradually decline. Experts say that labor-intensive sectors such as garment and toy manufacturing will be hit the worst by labor shortages.

Having a dwindling labor supply may seem odd for a country with 1.3 billion people. But, the trend’s been discernable for a while, as the effects of an aging population and China’s one-child policy kick in. In the past 10 years, the population of 20- to 39-year-olds has fallen 22%. “A typical 18- or 20-year-old worker was born in 1990, well after the Chinese reforms,” Isaacson says. “They matured over the last 10 years and have no memory of anything but a rapidly growing country. These workers now have many options that did not exist before. When I first went to China over 20 years ago, there were no McDonald’s at which to work. Today, there are many, and that is seen as a relatively higher-status job than a factory job.”

Additionally, young workers in China won’t tolerate the harsh working conditions their parents accepted. Many will work for only a few months before moving on to another factory or a new town, as they have many more employment options than previous generations. Decades of prosperity – along with Beijing’s $586 billion infrastructure-focused stimulus package unveiled in 2008 – have created more jobs in China’s interior, leaving workers with more choices. Officials in the key export areas are taking no chances that things will turn around on their own. To attract workers, Guangdong labor authorities have urged companies to raise wages and provide better living and working conditions, as workers live at the factories.

“Most young people in China don’t want to work in factories and want higher-paying jobs,” says Trevor Gnesin, owner of Logomark (asi/67866). “The largest factory in China just gave its 500,000 workforce a minimum 30% increase to avoid a strike. This will impact all factories over China.”

Indeed, Chinese workers have begun doing something unheard of – striking for higher wages,  better work conditions and perks such as activities rooms in their dormitory housing. In an unprecedented move, workers at a Honda plant in southern China recently went on strike, forcing the automaker to give employees raises of 24%-32%.

The Inventory Logjam

“In Asia right now, it’s a seller’s market,” says David Nicholson, president of Counselor Top 40 supplier Polyconcept North America. “We’re being put in the position to accept price increases or factories won’t take our orders.”

Nicholson says pricing, while an issue, is secondary to inventory problems. “The vast majority of suppliers are going through their worst inventory issues ever,” he says. “This comes at a time when many are starting to return to profitability. And, it doesn’t look like it’s going to get better soon, especially with prices going up.”

To be sure, during the economic crisis that started in 2008, many suppliers brought down inventories to be in line with demand. Now, demand has returned, and many suppliers are trying to get back into a stock level commensurate with the demand they’re seeing today, Isaacson says. “For suppliers with a lot of lines, but without the ability to concentrate orders to vendors, it’s now harder to get the attention of the factory,” he says. 

Then there’s the question of quality control. “The most pressing issue we’re dealing with is the manufacturers’ increased production times, meaning standard production times are being pushed out,” says Jim Hagan, president/CEO of Counselor Top 40 supplier Sweda Company LLC (asi/90305). “It’s not easy to move production to other countries, due to the fact that we have a stringent qualification process to ensure we are partnered with manufacturers that support our quality, material and social compliance expectations.”

Gnesin agrees. “Getting compliant product is getting harder, as the factories in China would rather deal with easier orders,” he says. “This is becoming much more costly, and we are paying a huge premium to make sure our goods stay compliant.”

And, while the Asian factories are creating inventory and quality-control issues for industry suppliers, another element is adding to delivery problems: a dearth of transport vessels for products coming into the U.S. from Asia. Very simply, there aren’t enough container ships – or containers, for that matter – to accommodate the revved-up orders waiting to be shipped out of China’s ports right now.

“Business was so bad in ’08 and ’09 that people cut down on their ordering, and the freightliners cut their capacity,” says Randy Chen, owner of Impex, a company that imports, sources and warehouses ad specialties for industry suppliers. “So everybody’s cutting containers and freightliners, when all of a sudden business picked up unexpectedly. Everyone got caught with their pants down.”

Chen says that instead of the normal 70 to 80 days for a shipment from China to reach a port in North America, now it can take upwards of 120 days. “Back in March and April we told our customers to forecast six months out in advance,” he recounts. “This has caused supply chain problems in the industry. Everybody’s running out of inventory and nobody has large quantities.”

Apparel Included

Lest you think that Asia’s issues are only affecting the hard-goods segment of the industry, the apparel market has its own set of problems right now. “The reduced cotton fiber supply and increased cost of raw materials are due to a damaged cotton crop from poor weather conditions in China (the world’s largest producer), a temporary ban on cotton exports from India (the second-largest producer), and export tariffs imposed on Pakistani cotton exports,” says Ira Neaman, owner of Counselor Top 40 supplier Vantage Apparel.

Garry Hurvitz, president and CEO of Counselor Top 40 supplier Ash City Worldwide (asi/37127), took the unusual step in June of sending out a letter to customers, detailing how the problems in Asia will affect his company and the industry overall.  

Hurvitz points to the labor issues in Asia, ranging from a 50% increase in wage rates mandated by Bangladesh, to workplace labor shortages in China that originated from recessionary pressures of last year. “Severe production cutbacks in the last two years have shifted workers in Asia from the apparel production plants to government-funded infrastructure projects and domestic production,” he says. “The result of this labor displacement is a significant reduction in Asia’s production capacity as suppliers look elsewhere for replacement factories. As the economy improves, this overall lower supply of production capacity combined with a greater demand for products has lead to higher prices and longer lead times.”

Hurvitz adds that with vendors having greater negotiating power, there are new demands for larger garment production runs spread over the entire year before orders are accepted. Delays in getting garments to the marketplace will result from this change.

“We’re only seeing the beginning of these issues, but I think it will be bad for at least 18 months,” Hurvitz says. “In the case of Bangladesh, we’ve moved over 60% of our orders out in the last six weeks, as the unrest and the violence will continue until the higher wages go into effect. Everyone is pulling out of the country, as new prices are too high and orders are running anywhere from two to five months late at present.”

Lott notes that through March, April and May of last year, receivables for 2010 were on time. “Not early like they had been, but on time,” he says. “By the time we got to placing orders from January to March this year for a June order, we were told we’d get it in July, and July’s order in August, and, well, August’s order we’re not so sure about.”
Of course the logical question becomes, if China is such a hotbed of a hot mess, why can’t suppliers send their orders to factories in other countries? The short answer is that no country right now has the well-oiled machine of production that China does – all evidence to the contrary.
  
“China is a market that made its mark in manufacturing, while India has made its mark in technology and services,” Shevin-Sandy says. “Since China has been well-known for generations in manufacturing, distributors trust China and know its capabilities and what the finished products look like. Distributors need to be comfortable that their orders are in good hands, and they have that despite the issues there right now. Other countries such as Mexico and Vietnam are not as well-known for their production capabilities and don’t carry the same reputation.”

Even before these problems, manufacturers and buyers of low-cost products were actively seeking alternative locations such as Vietnam, Cambodia and Indonesia, where production of sports shoes has grown 25% since 2007.

For apparel, Nicholson says, there are options outside of China. “This is largely due to the fact that apparel doesn’t require advanced manufacturing or a wide range of materials,” he says. “But for most hard-goods categories, very few countries have developed the supply and manufacturing infrastructure that China has. It now produces almost all of the raw materials used in its products, it has better manufacturing equipment, and it has a well-developed infrastructure for business. So, while certain countries can offer low-cost labor to match China, none have the other capabilities that China offers.” 

Jeff Lederer, executive vice president of Counselor Top 40 supplier Prime Line (asi/79530), concurs. “Most products in the world are made in China,” he says. “I believe that Walmart alone represents 4% of all Chinese exports. If they could buy elsewhere, they would.”

Industry Fallout

With the inventory depletion and higher prices, what can suppliers and distributors expect in the near future? Experts agree that more ships and containers will become available in the upcoming months, and Nicholson believes that the capacity and lead-time issues will eventually resolve themselves and supply-demand will reach an equilibrium.
 
“I expect that we’ll be back to a more predictable buying cycle by the end of this year,” Nicholson says. “But, I fear that the inflation pressures – particularly due to the structural changes within China affecting the currency and labor – will be long-term.”

Nicholson says the effects of inflation are both direct and indirect on the ad specialty market. “The obvious impact will be higher prices – and this will be largely unavoidable for any importer,” he says. “The indirect implications pose other challenges. For example, during periods of inflation, factories and buyers look for ways to mitigate the cost of inflation by changing materials, moving production to new regions and altering manufacturing processes. These tactics can lead to increased instances of quality and safety-compliance issues.”

Nicholson acknowledges that another significant effect will be far greater margin pressure on suppliers and distributors. “With an uncertain U.S. economy, it will be difficult for many suppliers and distributors to pass along these increases,” he says. “On the inflation issue, I expect that suppliers will see increases in the 5%-10% range this year, with a minimum 5% increase again in 2011.”

For apparel, Neaman says that it’s anticipated that cotton fiber will replenish with upcoming growing seasons, provided that government export regulations in Asia don’t discourage farmers from planting cotton and switching to soybeans or other commodities. “With raw materials accounting for one-fourth to one-half the cost of producing a garment,” he says, “product cost increases and/or reduced margins are inevitable through the remainder of 2010.”

And, the wildcard in the game? The floating yuan, the Chinese currency. “Because it’s so difficult for anyone to predict what will happen with the Chinese currency, it means that factories and importers will have to assume continued appreciation,” Nicholson says. “That means factory owners will be less likely to increase their factory capacities, but will have to increase prices as a hedge.”

Ultimately, the changes will lead to some ingrained process changes in the North American ad specialty market. “We’ve all been spoiled,” Lott says. “I’m as guilty as anyone of engaging in the trend of taking the order today and shipping it today. Distributors are used to not checking with us, because they assume we’ll always have the items they need. Well, now, we may not always have it.” 

Lott’s advice to his clients is similar to that of other suppliers: “Distributors should check before they sell,” he says. “They need to plan ahead with what they’re going to order, always have a backup product ready to go, and be in close contact with their suppliers regarding the status of their inventories.”

Michele Bell is senior editor of Counselor and the editor of its sister publication, Supplier Global Resource. 

What’s A Distributor To Do?

Similar among all the industry suppliers we talked to, here’s the advice they shared for getting your orders filled in the quickest and most efficient way possible:

  1. Stay in regular contact with suppliers so you’re aware of inventory fluctuations. Assuming that items are in stock and can be shipped in 24 hours isn’t going to cut it anymore. 
  2. Order early, and – if you know your client places repeat orders – suggest they order more than they immediately need. Here’s where you can step up as the relationship builder and offer to hold the extra stock until they need it.
  3. Give your clients product options. If they love a certain style of bag, suggest two similar bags as a backup plan in case the first is in a holding pattern on a production line in a Chinese factory. 
  4. If your client is a good one and the item they ordered just isn’t going to make their in-hand date, consider offering a similar, though slightly more pricey, item to save the order – and more importantly, the relationship. Don’t do this often, but do it when necessary.

In A Nutshell …

Do you have clients who simply don’t understand why inventory seems to be perpetually on back order and prices are rising? Here’s a tutorial for you to give them as to where the issues lie:

  • A lack of workers. A survey by the Chinese government showed a 35% increase in vacancies posted by employers in the first quarter of 2010, but only an 8% increase in the number of applicants for those vacancies. The result is the tightest labor market in recent years.  
  • An increase in wages. Economists say increased salaries for factory workers will ripple through the global marketplace, driving up prices of everything from T-shirts and sneakers to computer servers and smartphones.
  • Fewer factories. When the worldwide recession hit, many factories in Asia closed. But, now that ad specialty sales are picking up, there simply aren’t enough factories in China, specifically, to fill the orders. 
  • A ship shortage. Freightliners and the containers they carry have been dry-docked over the past couple of years as orders have reduced. Now, when demand is picking up, there just aren’t enough of them ready to set sail. Rather than taking a week, which is the norm, for products to be put on ships from Asia to North America, it’s now taking upwards of three weeks. 
  • A dearth of cotton. Specifically impacting cotton-based apparel is the worldwide shortage of this product, and with yarns being more difficult to obtain, there are production delays and material cost increases everywhere. Add to that the labor issues in Asia, ranging from a 50% increase in wage rates mandated by Bangladesh to workplace labor shortages currently in China.
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