Turmoil Hits China Factories

Turmoil Hits China Factories
Insiders are mixed on whether production woes will have a long term impact.

LOS ANGELES — The global credit crisis and a drop in production orders has forced hundreds of footwear factories in China out of business during the last few months — and the situation could worsen next year.

“The factories are [being] hit with a lot of issues,” said Chinese Laundry CEO Bob Goldman. “The new issue is the credit crunch. Material suppliers aren’t giving them the credit, so they’re being forced to come up with half a million to a million dollars per production run. Some don’t have it; others won’t spend it. So they’re closing.”

Ted Gedra, president of Wolverine Footwear Group, a division of Wolverine World Wide, said factories had been hit recently with a wide range of new costs, including tariffs imposed by the European Union anti-dumping legislation, which has been in effect since 2006. Other producers have simply fallen victim to poor business practices, which led to their closure. “[Factories] have been hurt by the fact that they were taking business based on pairage and not on the margins necessary to be profitable,” he said. “Some were having trouble with their cash flows in general.”

Smaller vendors are also having difficulty securing credit, which is affecting larger factories — and larger manufacturers. “In a factory where I account for 70 percent of the capacity, the guys who make up the other 30 [percent] aren’t coming up with their [lines of credit],” said an anonymous athletic manufacturer.

Goldman said as many as 400 factories have closed in recent months, including some facilities where his shoes were made.

Nate Herman, senior director of international trade for the American Apparel & Footwear Association, pegs the factory closure number even higher. According to AAFA figures, more than 2,000 footwear factories have been shuttered this year in southern China alone, and more closures are likely.

“A lot of people feel [closures] could accelerate after the New Year, after brands and retailers have a bad holiday season and orders dry up,” said Herman.

But credit woes are just the latest in a series of challenges that have hit factories over the past year, including rising costs for labor, transportation and petroleum-based shoe components.

Now comes a new wrinkle — a decline in demand. The full impact of this new factor on already-stressed production facilities is unknown and has yet to play out. Indeed, the lack of new orders may be the final undoing for struggling manufacturers.

“The last orders [many factories] got were for spring ’09,” said Herman. “This is relatively late for people not committing to summer ’09 orders.”

That puts many shoe factories in a particularly perilous situation. As credit dries up, they are unable to raise production prices due to a drop in demand.

“When business gets scarce, prices don’t go up,” said Peter Mangione, president of Footwear Distributors & Retailers of America. “It’s very hard to raise prices in a down market. The pressure on the factories is greater now.”

There are signs that the Chinese government is trying to intervene to lower costs for foreign brands, with the hope of generating more work for order-starved manufacturing facilities. On Nov. 17, the government announced it would increase its value-added tax rebate from 11 percent to 13 percent as part of its $586 billion economic stimulus package. The program refunds tax on some component costs when Chinese-made products are exported.

“We’ve been hearing rumors that they’re going to increase the rebate even further, maybe to 17 percent by the end of the year,” said Herman.

Still, it’s unknown if this could cure ailing factories. “If nobody is buying shoes in the U.S., it doesn’t matter how low they reduce their prices,” said Mangione.
So what is the long-term impact of factory closures?

Mangione doesn’t think production will be hindered, at least for now. “Look, Wolverine’s factories aren’t closing,” he said. “Brown Shoe’s factories aren’t closing. Payless’ factories aren’t going to close. The shoe business is holding up pretty well, especially compared with apparel.

“I don’t think we’re in a situation where there is so little capacity that prices are going to go up,” he said. “Some people might say they can’t find quality capacity, [but] that’s a separate issue.”

However, at least one major manufacturer in the athletic sector said the current spate of closings would lead to a dramatic change in footwear production, as cheap labor moves outside China. “[Factory closings] would have happened even without the current economic crisis,” said an executive who requested anonymity. “Southeast Asia is coming to the end of the shoe cycle. The time has come to move along.”

Gedra agreed, adding that many footwear firms are already looking to become less dependent on China as their sole production base. “A lot of people have diversified already,” he said. “Most large branded companies are trying to establish solutions to China so they aren’t dependent on only China-made footwear.”

However, a viable alternative for mass production has yet to emerge, he said. “For the foreseeable future, China is still going to be the primary source for footwear.”

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