Issue 56
December 2008
IN THIS ISSUE :
I. The changing manufacturing landscape II. Policy direction: industry relocation and upgrade III. Implications for sourcing business 14 7 2
Chinas industry relocation and upgrading trends: implications for sourcing business
China is no doubt one of the most important sourcing centers in the world. However, the business environment facing manufacturers in China has become tougher since 2007. Their profit margins are being squeezed to such a degree that some of them have been forced to shut down. There is thus growing concern over the industry consolidation and relocation trends of manufacturers in China, and the impacts on sourcing business in China.
Policy direction: policies have been launched by both central and local governments to promote industry relocation and upgrade
The Ministry of Commerce plans to set up 50 designated areas by 2010 in central and western China for enterprises moving out from coastal regions. The local governments of the central and western region regard the relocation policy as an opportunity to develop industries and boost economic development and are actively improving their business environment and offering various incentives to attract relocation. Li & Fung Research Centre 13/F, LiFung Centre 2 On Ping Street Shatin, Hong Kong Tel: (852) 2635 5563 Fax: (852) 2635 1598 E-mail: lfdc@lf1937.com http://www.lifunggroup.com/
The traditional manufacturing hubs in the coastal provinces, such as Guangdong province, also see the importance of industry relocation and upgrade and are actively promoting relocation in their vicinities.
China is one of the most important sourcing centers in the world. The presence of abundant skilled labor, thousands of vibrant industrial clusters, political stability, rapidly developing transport infrastructure, etc. make its manufacturing sector highly competitive. As Chinas manufacturing sector grows in strength and sophistication, many foreign companies regard China not only as a place to buy cheap and quality products, but also a major manufacturing hub and research and development (R&D) centre. However, since 2007, Chinas manufacturing sector has been hit hard by factors like slackening global demand especially after the outbreak of the subprime crisis and financial tsunami, production cost hikes, renminbi (RMB) appreciation, processing trade policy change and tightening monetary policy. Manufacturers profit margins are largely slashed to a degree that some production was forced to cease. Factory consolidation and relocation is taking place, which has aroused great concern among buyers and retailers. In this paper, we will first look at the new developments in Chinas manufacturing sector, including factory consolidation, relocation and industrial upgrade. Then, we will discuss the policy initiatives launched by both central and local governments towards industry relocation and upgrade. Lastly, we will analyze the impacts of these new developments on sourcing strategies.
Type III Relatively weak - substitutes of intermediate inputs are readily available elsewhere in China Relatively low Strong - mainly to central and western China; some to low-cost countries nearby
It is difficult for Type I enterprises to relocate since they are deeply rooted in their original locations, where their cost advantages and efficiency are derived from strong cluster effect. As relocation is not an option, these enterprises are under strong pressure to enhance competitiveness and upgrade.
Type II enterprises are mainly foreign-invested processing trade enterprises with strong mobility. Given its export-oriented nature, they are unlikely to move to inner provinces of China due to the high transportation cost from the inland to the coast. They are more likely to relocate to less developed cities along the coast or other low-cost countries in South or Southeast Asia. Type III enterprises are cost-cautious. As they focus on the domestic market, they will tend to stay in China and relocate from the high-cost coastal region to the inland regions; while some may move to other low-cost countries nearby. To better illustrate, lets look at the case of shoes industry, a traditional labor-intensive industry. Shoes-making is relatively low value-added and the production chain is short and not very sophisticated. In general, shoes manufacturers do not rely heavily on the local industrial clusters. Their geographical mobility is strong. It is observed that an increasing number of Taiwanese export-oriented shoes manufacturers have moved their production facilities to other Southeast Asian countries. For those who focus on domestic sales, they tend to set up production facilities in central and western China including Sichuan, Hunan, Jiangxi, Guangxi and Henan provinces. For instance, Aokang Group ( ) of Wenzhou had already ) of Sichuan. initiated a group of eight enterprises engaging in shoes making to relocate to Bishan County of Chongqing in September 2003. As of end-2007, a total of 218 shoes enterprises have set up their presence in Chongzhou (
All in all, most enterprises will adopt a gradual approach instead of relocating the whole production at one go. Many companies tend to relocate the labor- or resource-intensive processes to inland cities as the first step. Once the supporting facilities in the inland cities have improved, they will consider relocating the more complicated processes. This approach allows a transitional period for adaptation of new production sites, lowers operation risks and eases their financial burden.
3. Industrial upgrade
On the other hand, we witness an upgrading trend of manufacturers in China, not only because of the growingly challenging business environment but also because of the increasingly stringent government policies on product quality and environmental standards, as well as the rising global calls for safer and quality products. Many manufacturers are actively seeking to transform and upgrade themselves, through strengthening their core competencies, increasing investment in R&D, and upgrading their equipment and facilities, etc. HKTDC has conducted a survey with about 2,000 Hong Kong traders and manufacturers and the results were announced in September 2008. The findings reveal that the major reasons driving the respondents to upgrade included meeting the market demand for the development of new products, exploring new business opportunities, and fighting against competition from the Chinese Mainland (see Exhibit 3). Exhibit 3 Reasons for industrial upgrade Reasons for industrial upgrade Keep abreast of market/ customer requirements on product development to avoid falling behind Develop new products to explore new business opportunities Withstand competition from Chinese Mainland enterprises Develop higher value-added products to ensure profitability Comply with ever more stringent overseas requirements on product safety/specification Demand for high quality products from Chinese Mainland consumers as their income level rises Withstand competition from other regions Higher Mainland production capability can support production of higher value-added/ high-tech products by Hong Kong enterprises Mainland industrial upgrade will boost demand for high quality precision industrial products Others
Source: Hong Kong Trade Development Council (HKTDC), September 2008
% of respondents 55.2 53.8 47.0 46.7 38.8 17.6 9.8 9.5 8.2 4.3
Exhibit 4 demonstrates possible ways of industrial upgrade, including improving product quality and efficiency, expanding along the supply chain to embrace more high value-added functions like R&D and marketing, and produce higher valueadded products. Exhibit 4 Industrial upgrade
According to the HKTDCs survey in September 2008, 84.7% of the respondents had invested in different areas in the past three years to upgrade their production. Most of them have strengthened quality control, improved design and engineering capabilities, and further developed competence in R&D (see Exhibit 5). Exhibit 5 Strategies to transform and upgrade Areas received investment in the past three years Strengthening quality control Improving design and engineering capabilities Enhancing product R&D capabilities Complying with green production requirements Raising production technology and automation levels
Source: Hong Kong Trade Development Council (HKTDC), September 2008
Apart from self-initiated enterprises, the government also makes efforts to promote industrial upgrade. For example, the Dongguan government has committed to channel five billion yuan in the coming 5 years to assist Dongguan enterprises in R&D and innovations.
4. The emergence of domestic enterprises and manufacturers outside the coastal area
Today, domestic enterprises are growing both in scale and strength. They are now spending more efforts in product development. They are also benefited from the Corporate Income Tax reform, which reduces their tax rate and puts them on a level playing field with foreign enterprises. In the less developed regions, many manufacturers are growing fast amid the rapid economic growth. We saw an increasing number of labors who used to work in coastal regions went back to their hometowns (mostly in inland provinces) and started their own business there after accumulating sufficient experience, network and capital. Also, after some years of efforts, some retailers managed to get a foothold in the inland provinces, and they set up production facilities in the vicinity of their retail sites to take advantage of proximity to market.
Map 1 Designated areas for industry relocation by the Ministry of Commerce as of end-2008
Exhibit 6 The first batch of designated relocation areas, MOFCOM, 2007 The first batch of nine key relocation destinations was selected by the MOFCOM in April 2007. All of them are located in central China. Province Hubei ( Hunan ( Henan ( Jiangxi ( Shanxi ( Anhui ( City Wuhan ( ) Chenzhou ( ) Xinxiang ( ) Jiaozuo( ) Nanchang ( ) Ganzhou( ) Taiyuan ( ) Hefei ( ) Wuhu ( )
) ) ) ) ) )
Source: MOFCOM
Exhibit 7 The second batch of designated relocation areas, MOFCOM, 2008 The second batch of designated relocation areas was announced in April 2008. Most of the 22 selected cities are located in central and western parts of China. Region Central ( Province/Municipality Hubei ( ) Hunan ( ) City Yichang ( ) Xiangfan ( ) Yueyang ( ) Yiyang ( ) ) Yongzhou ( Luoyang ( ) Zhengzhou ( ) Yian ( ) Shangrao ( ) Houma processing zone ( Anqing ( ) Nanning ( ) Qinzhou ( ) Chengdu ( ) Mianyang ( ) Xian ( ) Yinchuan ( ) Kunming ( ) Haikou ( ) Baotou ( ) Harbin ( )
Henan ( Jiangxi (
) )
Western (
Others
) )
Source: MOFCOM
The traditional manufacturing hubs in the coastal provinces also see the importance of industry relocation and upgrade. However, aggressive relocation to other provinces will bring harm to the local economy. Thus, they are actively promoting relocation in their vicinities. Guangdong province is a case in point. In late May 2008, Guangdong announced the Decision on Encouraging Industry and Labor Relocation ( Relocation province. To summarize, Double Relocation refers to: (1) Industry relocation: relocation of traditional labor-intensive industries, resources-consuming industries, processing industries from the central PRD to less developed regions in the province, i.e. the eastern and western PRD and northern Guangdong; (2) Labor relocation: relocation of labor engaging in primary industry to secondary and tertiary industry; and relocation of skilled labor from less developed regions to developed regions in PRD. Map 2 illustrates the Double Relocation strategy of the Guangdong province. More than 40 billion yuan has been earmarked for measures encouraging Double Relocation in the coming five years (2008-2012). Resources will be allocated to improve transport infrastructure, develop industrial relocation parks, develop pillar industries, set up an award fund to encourage relocation, provide training to nurture skilled labor, improve productivity of farmland and increase land supply in less developed regions in the province. ) (also known as Double ) in which measures and funds are designated to facilitate industry and labor relocation within the
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Map 2
Subsequently, the Guangdong government released the Guidelines on the Layout of Industry Relocation Regions in Guangdong Province ( ) (the Guidelines) in June 2008 to guide relocation of industries in central PRD to the less developed areas within the province in a coordinated manner. In the Guidelines, the government stipulated that the relocation process is going to be a coordinated one a number of selected industries will be encouraged to relocate to designated areas to achieve a clear division of work and to avoid direct competition among regions; while an array of industries, especially those causing serious pollution, will not be allowed to relocate. Also, the government has identified more than 20 industrial relocation parks within Guangdong as shown in Exhibit 9 and Map 3 below.
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Exhibit 9 Provincial industrial relocation parks identified by the Guangdong government Region (M-Mountainous area; E-Eastern PRD; 1 2 3 4 5 6 7 8 9 Industrial relocation parks* Shenzhen Yantian (Meizhou) ( ) Shenzhen Futian (Heping) Shenzhen Nanshan (Chaozhou) Shenzhen Longgang (Wuchuan) Dongguan Shijie (Xingning) ( ) Dongguan Shilong (Shixing) Dongguan Dongkeng (Lechang) Dongguan Fenggang (Huidong) W-Western PRD) M M E W M M M M M E W W M M M W W M Approved industries to be relocated Electronic information, electrification and automation Watches and clocks, electronic and telecommunications equipment Machinery and new materials Electronics and toys Automobiles and metal machinery Electronics, precision machinery and equipment Machinery and furniture Shoes and household electronic appliances Apparel and furniture Electronic information and bio-technology Textile and processing of agricultural products Electrical appliances and apparel Electronic information and machinery e.g. auto parts Furniture and metal products Telecommunications equipment and machine tools Textile, apparel, food and pharmacy Electronic information and household electronic appliances Machinery and furniture
Dongguan Qiaotou (Longmen Jinshan) ( ) 10 Dongguan Dalang (Haifeng) 11 Dongguan Dalang (Xinyi) 12 Dongguan Changan (Yangchun) 13 Zhongshan Sanjiao (Zhenjiang) 14 Zhongshan Dachong (Huaiji) 15 Zhongshan (Heyuan) 16 Zhongshan Torch (Yangxi) ( ) 17 Zhongshan Shiqi (Yangjiang) ( ) 18 Foshan Chancheng (Yuncheng Duyang) ( )
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Region (M-Mountainous Industrial relocation parks* 19 Foshan (Qingyuan) area; E-Eastern PRD; W-Western PRD) M M M W W W Approved industries to be relocated Machinery and pharmacy Machinery for light industry and telecommunications Lighter (tobacco tools) and furniture Metal machinery and furniture Manufacturing and processing of small household appliances Electrical appliances, textile and apparel
20 Foshan Shunde (Yunfu Xinxing Xincheng) ( ) 21 Shunde Longjiang (Deqing) ( ) 22 Foshan Chancheng (Yangdong Wanxiang) ( ) 23 Foshan Shunde (Lianjiang) 24 Guangzhou Baiyun Jianggao (Dianbai) ( )
Source: Guangdong Government * The name of the industrial relocation parks provides information on the original location of industries as well as the location of the industrial relocation park. The place in the bracket refers to the location of the relocation park. For example, Shenzhen Yantian (Meizhou) means that enterprises in Shenzhen Yantian are encouraged to relocate to the relocation park in Meizhou.
Map 3
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Apart from boosting relocation to its vicinities, the Guangdong government also regards Southeast Asian countries as partners for industry relocation and upgrade. To foster closer economic ties, in September 2008, a Guangdong delegation, led by the Party Secretary-General Wang Yang, paid a visit to the ASEAN Secretariat and some of its member countries, and signed an agreement aimed at deepening and widening cooperation and business platform between Guangdong and ASEAN. Trade contracts worth billions were signed and dialogue mechanism with the ASEAN Secretariat and some of the member countries was established. Moreover, Guangdong has successfully presented the business opportunities brought by its relocation plan: some of Guangdongs labor intensive industries could relocate to countries such as Vietnam and Indonesia while enterprises with competitive edges in services and management from countries such as Singapore are encouraged to invest in Guangdong.
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3. Buyers should pay attention to the sourcing potential of other emerging cities in China
Buyers should no longer concentrate solely on the traditional manufacturing areas. As the manufacturing sector in the less-developed regions develops and the industry relocation process continues, more competitive factories and a wider range of product will be available for the buyers to select. Though currently many factories in those regions are still in infant stage, their long-term potential cannot be ignored. Buyers should start exploring and nurturing relationship with these emerging suppliers.
5. China is not only the worlds factory, but also a consumer market not to be missed
Chinas retail sector is expanding fast and has maintained double-digit growth for the past few years. Exhibit 10 shows Chinas total retail sales of consumer goods from 1990 to 2007. The total retail sales of consumer goods hit 7,788.6 billion yuan in 1-3Q 2008, representing an increase of 22.0% yoy.
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Seeing the huge potential of Chinas consumer market, many buyers and manufacturers which are originally exportoriented are now flipping their supply chains over and targeting at the domestic sales opportunities instead. According to the HKTDCs survey in September 2008, 46.5% out of some 2,000 Hong Kong traders and manufacturers indicated that they would consider expanding their retail business in China. On the other hand, some export-oriented buyers want to tap into Chinas lucrative consumer market but often found it difficult as many of their suppliers in China are processing trade factories with no domestic selling right. However, as we observed, this situation should be improved gradually as many processing trade enterprises in China are now transforming to foreign-invested enterprises (FIEs) with domestic selling right amid the weakening global demand.
Copyright 2008 Li & Fung Research Centre. All rights reserved. Though Li & Fung Research Centre endeavours to have information presented in this document as accurate and updated as possible, it accepts no responsibility for any error, omission or misrepresentation. Li & Fung Research Centre and/or its associates accept no responsibility for any direct, indirect or consequential loss that may arise from the use of information contained in this document.
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