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Behind The Great Wall
By Dave Vagnoni
August 2011

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The Great Wall of ChinaUnprecedented changes in China are having a significant impact on the ad specialty industry in North America. With so much at stake, Counselor traveled to the other side of the world for an in-depth look at a nation and a people in unavoidable transition.

The road to Dongguan is as hopeful as it is heartbreaking. Along the way, elderly farmers, who may earn $6 daily, tend to uncountable acres of crops. Masked border agents use temperature guns to screen for diseases. Instead of being supported by metal bars, construction workers trust bamboo scaffolding to keep them from falling to the ground.

Yet, this awakening land, while in transition, is certainly not primitive. The three-lane highway to travel on is better maintained than those in many large U.S. cities. The poverty of the countryside is no more noticeable than the wealth of bustling town centers. And while life is not easy close to the southeast coast of China, people acknowledge that the economic and social oppression here is much less than it was at the turn of the century.

“Where we’re going, it’s standard to work eight hours a day and five days a week,” says a young woman named Polly, dispelling the notion that sweat shops are prevalent. “In the summer, it’s common for factories to shut down for a day or two. There’s only so much electricity. People have to live before manufacturing products.”

Indeed, there’s only so much of a growing number of resources in this maturing superpower. For many decades a place of government-imposed stagnancy, China is now undergoing a monumental transformation. Manpower, infrastructure and societal changes are reshaping both this country and its impact on the rest of the world. Simply put, the cost of doing business in China is rapidly increasing and there’s no easily-available tourniquet to stop the bleeding.

“We should not expect the same price as last year,” says Jeffrey Lam, a prominent businessman and a member of the Legislative Council of Hong Kong. “Labor costs are up 10%-15% in 2011 and I don’t see that changing for several years.”

Of course, labor costs are just one piece of the complicated manufacturing puzzle of China. Following two decades of deflation, raw material prices (think cotton) have spiked in the last eight months and remain high. Product quality continues to fluctuate from factory to factory. Regional rolling brownouts frequently stifle efficiency. After a global recession reduced inventories, ramped-up demand has led to fierce competition for orders. There’s also a new mindset among the rising generation of Chinese workers, who are flocking to cities to take service jobs, while leaving the life of manufacturing behind. Then, not to be forgotten are China’s domestic needs, further complicating the trading game. “China is a growing market and they need products for themselves,” says Hans Poulis, CEO of IGC Global Promotions, a multi-national partnership of promotional products distributors. “As needs increase, China will be exporting less. Some manufacturing will return to the West.”

With so many issues so markedly affecting suppliers worldwide, including those in the ad specialty industry, Counselor traveled to China to gauge first-hand the challenges that exist. On the road to Dongguan, after taking a two-hour drive north from Hong Kong, you arrive at the short iron gates of a 300-worker factory in the heart of Guangdong Province.

A Factory Tour

About 45 minutes before arriving at the factory – which is used by Counselor Top 40 supplier Dard Products (asi/48500) – you get an idea of what it’s like there. “We’ll see the actual molding process for tooling,” says Randee Horwitch, national sales director for Dard. “Then we’ll see an assembly line of products being put together at various stages.”

Just beyond the factory’s main office, there’s a courtyard that could’ve been mistaken for a quad on an American college campus. At the center of it was an empty soccer field, with a basketball court not far away. Another 50 yards to the left were two rows of 30 bicycles that faced an elaborate fountain where water bounced over stacks of flat rocks. Unlike the scenes outside of U.S. factories, it was clear this was a place where employees both worked and lived.

“People can leave the grounds at night after work to go spend time with their families and go into town,” says a thin, pleasant man named Michael who manages the factory.

Heading away from the gates, only a handful of workers wander by under a scorching sun. Most, at that point, are in one of two places – the large dormitory where some workers bunk six to a room, or in the factory itself. The ground floor of the factory building bears a strong resemblance to the inside of a small airplane hangar, and near the doorway, there are over a dozen bags of red plastic pellets about to be run through large, noisy machines and eventually turned into components for a promotional product.

“This particular project, which is for pedometers, uses a four-cavity tool, so we’re able to make four pedometer cases at a time,” Horwitch says. “In an average eight-hour day, you’re looking at 9,000 pedometers. It’s a process and it’s not just one, two, three.”

While workers aren’t rushing around here, they’re moving steadily. As a man rips plastic pieces from a machine, a woman clips off molded sections and drops them into blue bins. Workers either sit or stand in makeshift wooden cubicles and seem focused on their individual task, with good reason. “I need this job,” says Ming Can Yang, a 28-year-old who works at the factory to support his family. “This is one of the best jobs I’ve had. Because it’s not in the city, the air is good.”

Up a few flights of stairs in a different building, other workers are using smaller, but still intricate tools. As a group, they are nondescript, wearing very plain short-sleeve shirts and pants. They sit on an assembly line for electronics, drilling parts into light-up musical keyboards.

In an adjacent room, other employees are pad printing logos and messages on products. Ink is swept onto a plate and then onto promotional items, producing two-dimensional images on three-dimensional pieces. “With each change, you have to then clean the ink out of the tray and put a new plate in,” says Horwitch.

Seen & Unseen Conditions

At this Dard factory outside of Shenzhen, typical workers earn 3,000 yuan or roughly $500 per month, which is considered to be an excellent wage. Similar to U.S. companies, what employees are paid here depends on their role, level of skill and seniority. “Workers can increase their salary through performance,” Michael says.

Normal hours for floor workers like Ming are 8:30 a.m.-5:30 p.m. with a space in the middle for an extended lunch and rest break. Employees are given three meals a day, served in what looks like a school cafeteria that has short metal benches, spaced close to each other. While families are able to live together, single workers are clustered in dorm rooms that are far from luxurious, but good enough to keep employees content. “Each room has a TV and a bathroom attached,” Michael says.

Truly, though, it would be naïve to think all factories in China are as relatively comfortable and modern as this one. Within this province alone, factory conditions run the gamut and, in cases of neglect, continue to lead to labor unrest. In a span of two weeks in June, separate riots in parts of Guangdong resulted in burned cars, more than 100 injuries and the death of a man who was defending his pregnant wife.

One of the riots was triggered when a couple approached the head of a ceramics factory in Guxiang demanding to be given unpaid wages. A fight ensued. Once word spread that the complaining worker was injured, five days of riots began. “Chinese workers are getting smarter and smarter and they will not take any more crap,” says Garry Hurvitz, president of Top 40 firm Ash City (asi/37143), who spends about three months a year in Asia.

Certainly, not all labor hostility spills out onto the streets of China, but there is evidence tensions continue to mount. Just last year, a report issued by the National Labour Committee (NLC), a human rights watchdog group, listed deplorable conditions in a Dongguan plant. At a KYE Systems factory – which is used for outsourcing work by companies like Microsoft – the report alleged female employees have been forced to work 15-hour days in overheated rooms, wash themselves with only a bucket and sponge, and endure bouts of sexual harassment from security guards. “We are like prisoners,” one worker told NLC. “It seems like we live only to work. We do not work to live. We do not live a life, only work.”

A Restless People

While the KYE case may be an especially dramatic example, it underscores the enormity of China’s labor problems. Though serious, the issue of uneven factory conditions is just one red flag among many. Consider, for example, the incredible leverage workers have created by haphazardly organizing and carrying out strikes.

In an unprecedented result last year, workers at Honda’s Nanhai plant negotiated wage increases of more than 30%, with an agreement in principle to further raise wages in 2013. “With strikes, the government is intervening and putting pressure on factory management to soothe workers,” said Li Qiang, executive director of China Labor Watch, in an interview with Counselor. “Striking can influence government behavior.”

Even government leaders like Chinese Premier Wen Jiabao are spurring what amounts to a grassroots revolt. “Your work is glorious and should be respected by society at large,” Wen said in a speech last year. “Migrant workers should be cared for, protected and respected, especially the younger generation of them.”

Data from a just-released Nankai University study shows there were 90,000 “mass incidents” of protest in China in 2009. Even those who don’t work in factories are striking, affecting the supply chain in various ways. “There was just a major strike because the cost of the service and fuel make it impossible for drivers to bring goods to Shanghai,” says Trevor Gnesin owner of Top 40 supplier Logomark (asi/67866). “That’s just a very small part of what’s happening in China.”

With unrest gaining more headlines and laborers having more options, movements have begun to attract workers to specific regions and towns. In April, Zhejiang Province raised its minimal salary to 1,310 yuan, largely in response to a similar action in Guangdong Province – which set the wage floor at 1,300 yuan – a month earlier.

While some of China’s labor pains can be eased with money, other issues, like those related to changes in demographics, are unpreventable. For example, being better educated than their parents and exposed to Western ideals through technology, younger workers are looking to claim even a mildly improved status. “They prefer to work at fast-food restaurants like McDonald’s rather than in a factory,” says Bonni Shevin-Sandy, executive vice president of Dard. “It’s more prestigious.”

Without question, the most prestige is found in cities, not in poorer rural areas. Already in fact, according to the latest census data, 665 million Chinese live in cities, a 50% increase from 20 years ago. It’s further estimated that nearly 200 million Chinese work in major cities for part of the year and return later to their rural homes with their earnings. “The available pool of labor is changing,” says Jonathan Isaacson, president of Top 40 supplier Gemline (asi/56070). “People are doing different types of work and fewer people are entering the workforce. In a matter of time, the population will also start to age.”

The Shows Must Go On

Even with China’s people and economy being in such flux, manufacturing leaders in Asia are still putting great emphasis on the marketing and showcasing of their products. There are arguably no brighter stages in the world to do so than the annual spring shows in China, which include the Canton Fair and the Hong Kong Gifts & Premium Fair.

“This is a huge brainstorming opportunity where we get new ideas, come up with innovative solutions and meet with product designers,” says Jeff Lederer, president of Top 40 supplier Prime Line (asi/79530), to Counselor while at the Hong Kong Gifts & Premium Fair. “It culminates into experience we can bring to the table for distributors. There are new trends we can bring to the U.S.”

A 30-cent ferry across Victoria Harbor from the Kowloon Peninsula is one way to get to the massive trade show at the Hong Kong Convention and Exhibition Centre. Filling five large halls on multiple floors, the show presents 4,000 suppliers from 36 countries. “Many U.S. buyers see this as an important show,” says Lam, who serves as chairman for the fair. “U.S. buyers come and place their orders.”

Unlike industry trade shows in the U.S., though, buyers here aren’t distributors. In fact, they’re much more often suppliers, who not only display promotional products in booths, but also search for them as well. “We’re looking for different and interesting items, based on price point for our catalog,” says Horwitch, as she walks the show floor.

This year’s product highlights include eco-friendly items, smartphone accessories and multi-functional gadgets. While one supplier demonstrates how her specialty item keeps iPods playing underwater, another shows off a pink crystal-covered wireless mouse that contains a pop-out USB stick. “At this show we’re looking for major accounts and we want to support our customers long-term,” says Sagi Schneider, sales director for Hong Kong-based Dazzle Manufacturing. “We’ve worked very hard and we’ve prepared a beautiful product.”

Just as the ad specialty industry has rebounded in the last 18 months, Asia’s gift and premium market has bounced back as well. In 2010, Hong Kong’s gift exports increased 17% to HK$155.7 billion ($20 billion U.S.), according to fair officials. This year, gift exports have continued to increase by double-digits, with the U.S. remaining a leading importer.

“Our Magicool neck scarf is our best-selling product in Japan,” says Hidenobu Watanabe, a manager at Tokyo-based Daisaku Shoji Ltd., “but we’re now trying to break into the U.S. market.”

As industry suppliers make new contacts and compete to find attractive products, it’s fascinating to see the role of factory reps in the process. One of the busiest reps at the show is a woman named Jerrie, who literally rolled around a suitcase filled with product samples, giving presentations and fielding questions. “If you made this white, for example, can you print all-over, four-color process on it?” asks Danielle Ruiz, Dard Design’s managing director. “Yes, yes,” Jerrie answers. “Can we have exclusivity with this?” asks Horwitch, pointing to an item on the table. “Yes, yes,” Jerrie says.

This conversation continued for 20 minutes, hitting on topics like compliance, price points and turnaround times. Of the 50 or so products discussed, maybe a handful will end up in Dard’s catalog. “Even if we like a product, it still needs to be approved by a committee at our company,” Horwitch says.

Later in the day, Lederer and one of his factory reps, a man named Benjamin, highlight the process at the show. “Anybody can meet with a vendor,” Lederer says, “but you have to put it all together and have the right feel. It’s gratifying to see designs we came up with. We know we’re trendsetters.”

As Lederer sorts through a stack of products, he finally picks up a $.50 pen. “Can we put a microfiber cloth on the end of this clip?” he asks the rep. “It can be a screen cleaner for a phone. That’s something I’d like to see.”

A few minutes later, as he looks over another product, Jerrie’s name curiously comes up. It turns out in this case, an offer of exclusivity didn’t last very long at all.

The Cost Of Doing Business

It was early in 2010 when everything in China’s factories began to change. Extraordinary numbers of workers didn’t return to their jobs following the Chinese New Year, leaving more than 400,000 openings in Zhejiang and a mindboggling 900,000 openings in Guangdong. Ever since, suppliers have been trying to recover. “With the downturn that happened in the past two years and the recession that everybody went through, a lot of manufacturing was lost in China,” says Gnesin. “Factories were shut down and when you lose manufacturers it’s very hard to regain them. Re-setting up that infrastructure takes time.”

Even though a significant number of Top 40 suppliers tell Counselor their inventories have been restocked, they admit lead times for many items remain long. As a double whammy to distributors, prices of items produced in China are only going up. “Distributors need to know there’s no escaping this,” says Isaacson of Gemline. “There are big trends that go beyond any supplier.”

One much-discussed trend is the higher cost of raw materials like petroleum and cotton. Much less-discussed is the strengthening of the yuan against the U.S. dollar. “These factors combined have resulted in the highest pricing I have seen in my 35 years in this business,” says Hurvitz of Ash City.

Adding to price increases is the need to assure product quality and safety. “Compliance is such a huge issue and we’re having a really hard time with even our best factories right now,” says Shevin-Sandy of Dard. “We’ll spend $2,200 to send in teams to do audits, but factories will turn them away at the door. It happens all the time.”

While many suppliers in the industry have committed to rigorous testing and compliance standards, implementing those also adds extra cost into the whole ad specialty supply chain. “The cost to be compliant is enormous,” says Ruiz. “When you’re offering a compliant product, it’s going to cost more. You have to relay that information to your distributors.”

Some distributors have already gotten the message and say those who overlook product safety will soon regret it. “Distributors who are going solely on price will be in for embarrassment and a rude awakening,” says Marc Simon, CEO of Counselor Top 40 distributor Halo Branded Solutions (asi/356000). “It’s not just about the enforcement side, it’s also about protecting brands. You have to know your supplier. You get what you pay for.”

A Host Of Challenges

Beyond the rising costs of labor, materials and compliance, there are still several more hurdles to clear within China’s manufacturing process. For example, in the summer, factories must contend with occasional brownouts, according to executives like Ross Beaton, managing director of Logo-Line, the largest supplier in Australia. “Factories are saying to us, ‘We couldn’t produce your order this week because we only had so many hours of power,’” he tells us.

Shipping logjams are another obstacle. Six of the 10 busiest container ports in the world are in China, led by Shanghai, Shenzhen and Hong Kong. A visit to China clearly reveals hundreds of standard shipping containers in one spot along Hong Kong’s shoreline. Stacked high in long rows, no containers move for days.

There may eventually come a time, some suppliers say, when the stream of products being shipped to the West will slow even more dramatically. A great percentage of what China produces, in effect, will stay in China, and what is exported will cost more. “The problem’s going to come in when the domestic market really starts to kick in,” says Gnesin. “They’re just starting to touch the surface right now. You see orders for promotional products for companies like China Telecom for one million pieces. They’ve got 600 million members who use their cell phones.”

China companies are not only likely to buy more promotional products in the future, they’re also likely to sell more as well. China-based Alibaba Group – which operates websites used by more than 50 million people in 250 countries – has grown exponentially in recent years, reporting 2010 revenues of 5.5 billion yuan, or $850 million. “Any nation that has small- and medium-size businesses, we’ll be there,” says Jack Ma, Alibaba’s founder.

In Alibaba’s online marketplace, the lines that have traditionally linked suppliers to distributors to end-users have been blurred, if not erased. On Alibaba.com, distributors can easily source product directly from China and cut out suppliers altogether. End-users, meanwhile, can bypass distributors and buy virtually any promotional products right from Alibaba’s site.

In addition, Ma continues to expand Alibaba’s influence in the West, recently rolling out a $30 million ad campaign in the U.S. and tripling his firm’s American-based staff. “If Alibaba cannot become a Microsoft or Walmart, I will regret it for the rest of my life,” Ma has said.

What Lies Ahead

In a crowded room of international media, businessmen and politicians, Jeffrey Lam is the headliner. Not only is Lam the managing director of a prominent toymaker, he’s also an accomplished legislator and the chairman of the Hong Kong Gift Show. “China needs the United States and the United States needs China,” he tells Counselor, in an exclusive sit-down interview. “On the face, they have a lot of disagreements and they argue, but in the end they will compromise. I see great opportunities for American buyers and American sellers.”

Yet, not everyone would agree the future for Western companies is so rosy here. Consider that during their final days in Hong Kong for the spring trade shows, three members of Dard’s local team were arrested, while two executives were questioned for 10 hours. Chinese officials took issue with a trademark etching on a promotional product displayed in Dard’s booth. “I was on the phone with the U.S. embassy and the Chinese consulate all through the night,” says Shevin-Sandy, who wasn’t in Hong Kong during the incident. “It was the most random thing. I believe this comes down to the fact that the Chinese don’t want U.S. suppliers exhibiting at their shows.”

As incredible as stories like this are, Shevin-Sandy says they represent the new reality of doing business in China. The climate is intense and complicated, but still necessary to deal with to survive as an ad specialty supplier. As it stands today, more than 90% of the ad specialty industry’s products are manufactured in China and suppliers don’t think that will change anytime soon. “The world is only so big,” says Philippe Varnier, chairman of the largest ad specialty supplier in the world, Paris-based Polyconcept. “There may be some commodities that can be produced in India, but there are commodities China will be very competitive in for a long time.”

While it’s true that apparel manufacturers are increasingly looking to source product in places like Vietnam, Cambodia and Mexico, suppliers believe these countries still lack the infrastructure to take on substantial amounts of hard goods. “These countries are like China was 20 or 30 years ago,” says Gnesin. “At this point in time, I think we’re stuck with China.”T

Dave Vagnoni is a senior writer for Counselor.

Q&A: Jeffrey Lam

To learn more about the changing dynamics of China, Counselor interviewed Jeffrey Lam, chairman of the Hong Kong Gifts & Premium Fair.

Counselor: How can companies really know that products manufactured in China are safe and compliant?

Jeffrey Lam: Hong Kong has a very mature testing industry. The international companies are here and the labs are here. They are here to help the industry test their products. All the manufacturers do test their raw materials and also the finished product before shipping. I’m sure they can provide the buyers with the certificate about the safety aspect of the product. You know, this is something that the buyer should ask for and the supplier should supply to buyers.

Counselor: What challenges do suppliers face in China?

Jeffrey Lam: This year, we are facing different difficulties. We have high inflation. We should expect labor rates to go up. Material prices are also on an increase. Plastics, because of the oil price, have increased quite a bit since January 1st of this year. Paper prices have also gone up. We should not expect the same price as last year.

Counselor: What are the benefits of doing business in China?

Jeffrey Lam: China has opened the door for all our friends, including our best partner, the United States. With the opening of the Chinese market, I see great opportunities for American buyers and American sellers. We are obviously looking forward to many good American products in China.

Counselor: How will trade relations be between the U.S. and China in the future?

Jeffrey Lam: I think China needs the United States and the United States needs China. On the face, they have a lot of disagreements and they argue, but in the end, they will compromise. This is politics and also economics.

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