China Report: The New World Order

There’s no question that China remains the king of production. But today’s higher commodity prices, swelling wages and environmental challenges are prompting companies to rethink their footwear manufacturing strategy in the country.

Following 15 years of stable prices in China, the past five years have seen a marked increase in total production costs, with much of the change coming in the last 24 months.

“Rising labor costs and the appreciation of the Chinese yuan squeezed the margins of many Chinese suppliers, which in many cases led to higher selling prices,” said Perrine Ardouin, director of APLF Ltd., a China-based fashion and leather trade fairs organizer.

“The biggest issue facing China is the labor shortage and its impact on the traditional production process. The Chinese government is doubling the minimum wage in many of these coastal provinces,” added Matt Priest, president of the Footwear Distributors & Retailers of America. “Even with that factored in at traditional manufacturers, you are having trouble locating and retaining talent.”

Such obstacles could explain why the country saw footwear exports to the U.S. drop to 69 percent on a value basis in 2013, from 72 percent a year earlier.

“If labor costs continue to rise — which is very much apparent — you will find more and more companies exiting China, or maybe they have a China office that manages the flow of the production process from China,” said Scott Mendelson, president and partner of JVR Group Ltd., a footwear licensing and consulting firm based in Guangzhou, China.

Mendelson added that he expects the trend of firms forming partnerships with factories in different regions of China to diversify risk to continue over the next five years.

As of now, though, companies aren’t fleeing the country. Instead, they are buckling down to address these challenges.

Stephen Chi, CEO of the women’s footwear division and retail business for manufacturing firm Stella International, said he expects China to remain the main manufacturing hub throughout the next decade.

“For us, [China is the major sourcing region]. It still offers the skills and supply chain that are essential for the creation of quality products. It takes years of training for workers to develop the level of craftsmanship that we are enjoying there,” he said.

Wolverine World Wide Inc. has a similar outlook for the region: “China will still be the majority of our sourcing over the next five years, and we are targeting China to be 50 percent of our manufacturing by 2019,” said Mike Jeppesen, president of global operations at Wolverine.

Many companies are finding ways to more cheaply manufacture within the country by investing in less-labor-intensive methods.

“Factories are fast adopters of advanced technologies. Any tool supporting the business acceleration process will be incorporated sooner or later, and Chinese factories have the financial capacity to afford it,” said Enrique Montiel, assistant director at Inescop, a technological institute for the footwear industry. “Technology renewal is a way of investing in labor [skills].”

Another tactic being used by the industry is a phenomenon known as “regional drift,” wherein many companies are relocating their production processes further inland, away from the more-expensive coastal cities and closer to the home cities of workers. As Jeppesen noted, that helps to offset labor cost increases as well as shortages.

Chi observed, “This trend will continue as the labor supply in central and western China is much more stable than in coastal areas.”

Sharon Jones, H.H. Brown’s SVP of sourcing and logistics, added, “This drift exemplifies that labor-intensive production continues to gravitate toward low-cost, abundant workforces. Companies with an extensive infrastructure and experience operating in China may find the changes less challenging.”

In the first half of 2013, the growth rate of manufacturing output value in Zhejiang and Guangdong — both former “hot spot” coastal areas — were much lower than the national average. (For more, see page 26.)

Meanwhile, in the provinces and cities in central and western areas, such as Henan, Hunan and Chongqing, the growth rate was much higher, at between 30 percent and 40 percent over the same period, according to a presentation at the 18th UITIC International Technical Footwear Congress in Guangzhou in November.

A downside to moving inland is the increased logistical costs of delivering raw materials and shipping the finished product offshore.

However, efforts are being made to combat this, according to Yingying Xu, an economist at the Manufacturers Alliance for Productivity & Innovation. “The government has invested heavily in infrastructure in central and western China, which will hopefully reduce logistics costs,” she said.

Market observers have noted that some migration of footwear manufacturing from China to other nations is being encouraged, as the country’s economy matures and expands its service sector, creating higher-skilled manufacturing jobs at a rapid pace.

“China was coming from a position where it was 90 percent of the U.S. footwear market and 60 percent of the world market. China will lose over the next 10 years and could become 60 percent of the U.S. market,” said Nate Herman, VP of international trade at the American Apparel & Footwear Association.

“That said,” he added, “the two strong things about China are that it’s stable and you can always depend on your shoe being made and having all the materials available, although the sharpened focus on the environment is starting to chip away at it.”

A number of countries are picking up a small portion of production, including Vietnam, Indonesia and Cambodia in Southeast Asia, as well as Ethiopia, Mexico and Bangladesh.

The primary driver of this move is lower labor costs, but labor is only one part of the manufacturing process.

“When multinationals think about their production locations, lots of factors play into that picture. They also have to consider raw materials, currency, interest rates, labor costs, intellectual property issues and government attitudes toward foreign investment,” said Xu.

Peter Mangione, former FDRA president and managing director and founder of Global Footwear Partnerships LLC, noted that “China continues to be the most important supplier of footwear for the U.S. market, particularly in regard to low-price and women’s fashion footwear. … No other country or group of countries can offer the variety and depth of women’s fashion footwear.”

Still, there are a number of major challenges ahead, including environmental concerns.

In recent years, Chinese manufacturers have heightened their focus on decreasing the impact of manufacturing. Driven by both government mandates and greater scrutiny from consumers and green-related global institutes, the new emphasis on the environment has resulted in the consolidation of many leather businesses. The government has required the closing of smaller tanneries and a reorganization of the entire sector, so that firms are clustered. Now these groups of factories can share the costs of environmental control and the processing of waste water.

“We can save more from our total factory costs by reducing waste to cover the increase in labor costs without any [significant] investment,” said Rodney Hammond, COO of China-based Impactiva, which oversees quality assurance in the footwear and apparel industries in the country.

On recent green initiatives, Herman explained, “You’re not just selling a shoe at the right price anymore. You have to worry about the chemicals and making sure the product is safe for children, and that the workers are treated well.”

 

 

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